Margarida Vasconcelos: The City is in great danger

 According to The Financial Times, Olli Rehn, the EU economic and monetary affairs commissioner, has recently said that there is no reason to fear that eurozone member states will impose protectionist regulations on the UK and that there was no reason to believe that a banking union in the eurozone would have “any major conflict of interest with the City of London”. However, this is not true, in fact, several financial regulations have already been adopted, such as a cap on bankers’ bonuses, against the UK interests, and likely to drive businesses out of the City of London. The UK is losing control over financial services and banking in the City of London. The situation will exacerbate when the banking union is up and running. It is important to note that the CityUK fears that the EU banking union, chiefly the creation of a single supervisor, as well as other EU financial regulations proposals will damage the single market and hurt the UK financial sector, which will become less competitive. The City is therefore in great danger.

The financial services industry accounts for 12% of UK GDP. Yet, the financial services regulation belongs to the internal market and it is therefore subject to Qualified Majority Voting (QMV) and to the ordinary legislative procedure. The City of London is subordinate to the EU jurisdiction. The Westminster Parliament under the European Communities Act 1972 is obliged to accept the EU legislation and the final jurisdiction of the European Court of Justice.

The Government’s power to influence EU legislation is very limited due to QMV. In fact, due to QMV, the UK has been outvoted on matters of extreme importance. The Government could not veto a damaging Directive on Alternative Investment Fund Managers, which has already been transposed into national law.  The UK hedge fund and private equity competitiveness is seriously affected by this legislation, which entails further costs and red tape to the industry for no significant benefit. The EU legislation imposing caps on bankers' bonuses has also been introduced despite UK’s opposition. From the outset, the UK Government has been against the introduction of EU legislation imposing caps on bankers' bonuses but, at the European Parliament insistence, this had been inserted into the proposals. Whereas the European Parliament was able to influence the Council and to change the outcome of negotiations the Government was only able to win minor concessions. This demonstrates that the Government is not always able to form political alliances to stop damaging legislation from being adopted.

There is a EU’s ‘power grab’ over regulation of the British financial services industry. We have been seeing a shift of financial regulation from the UK to the EU, and bit-by-bit EU regulation would be taken over from national regulation, and this is irreversible. The Government has failed so far to win stronger safeguards to protect the City of London’s interests. David Cameron took the historic decision to veto changes to the EU Treaties, on the grounds that the deal was not in Britain’s interests, as it did not contain safeguards to protect the single market and the UK financial services. However, the other member states, particularly Germany and France, have made clear that they would never accept an opt-out for the City of London from EU financial regulations and David Cameron's proposed safeguards were not accepted. They were able to overcome the UK's veto by adopting, in an unlawful manner, an inter-governmental treaty - the Treaty on Stability, Co-ordination and Governance in the Economic and Monetary Union.

The financial crisis has led to an overhaul of the EU regulatory and supervisory framework. The Commission has tabled over 40 proposals in less than 5 years. There is no doubt that the European Commission will continue to proposed more legislation affecting financial services, which is then subject to the ECJ’s jurisdiction. The UK would have no say in setting up the EU agenda for this policy area. The EU financial regulations will be mainly intended to address the eurozone interests and protect the single currency. The eurozone financial integration is therefore a threat to the City. The eurozone leaders by having their own meetings will be able to agree positions on financial and economic issues, which they would then impose on the UK through QMV. It is important to recall that from this November QM will be calculated according to double majority: 55% of EU Member States (15 Member States) and 65% of the EU’s population. Consequently, within few months the eurozone will have a qualified majority. The eurozone member states can use their voting power at EU level to force through measures in detriment of the UK’s national interest. The chances of the UK being able to influence EU’s policies and legislation would be even more limited not only because of the QMV but also because of “solidarity” among eurozone member states. The situation will exacerbate when the banking union is up and running. As Bernard Jenkin MP rightly noted  “… the member states of the eurozone that are in the banking union will caucus in the Council and use a single-market measure to create a single market in banking services to reflect the policy already adopted by the banking union.” While addressing the interests of the member states participating in the banking union, the Commission, using the single market umbrella, will propose banking and financial regulations for all EU member states. The eurozone member states, as well as the other member states participating in the banking union vote as a block outvoting the UK in matters of national interest, imposing, in this way, further regulations on the City of London. The UK would see itself in the position of having no choice but to accept legislation without having the chance of negotiate it.

The Government has been launching legal challenges at the ECJ to limit the impact of the EU financial regulation in the UK. In a speech to an Open Europe Conference, George Osborne said “…we are using the European court to enforce European principles of non-discrimination and adherence to European law…” and “We have a good argument in all these cases.” However, the ECJ has already decided against the UK in two of the cases, short selling and the financial transaction tax. The ECJ is most likely to decide against the UK in the bonus cap case too. In fact, the ECJ has been the motor of EU integration. It interprets the Treaties broadly, extending, consequently, the EU competencies.

It is important to recall that the European financial regulatory structure, which established the three European supervisory authorities – a European Banking Authority (EBA), a European Insurance and Occupational Pensions Authority (EIOPA) and a European Securities and Markets Authority (ESMA) has created an overall judicial architecture, conferring European Court of Justice jurisdiction over the City. There has been a transfer of powers from national financial supervisors to the EU authorities, which have binding powers to supervise cross-border firms in banking, securities and insurance sectors. The ESAs were established under Article 114 TFEU, the general legal basis for internal market legislation, but the EU regulations went further beyond what is necessary to achieve the objective pursued – “improving the functioning of the internal market.” The Commission has been extensively using article 114 to expand EU competences to the detriment of the competences of the Member States. In fact, there has been an increase in the use of this provision in the field of financial services, since the beginning of the financial crisis.

Despite UK’s opposition the regulation on short selling and certain aspects of Credit Default Swaps (CDS) was adopted and entered into force in 2012. Such regulation, which was proposed at Germany and France request, has transferred even more powers from national regulators to the European Securities and Markets Authority (ESMA). From the outset the Government wanted to limit ESMA’s powers. However, due to QMV, it was outvoted in the Council being therefore unable to prevent Esma of getting the powers to ban short selling. Thus, the Government has decided to launch a judicial challenge to the Short Selling Regulation on the grounds that it confers discretionary powers on the European Securities and Markets Authority. However, the Government has not achieved what it was expecting as, last January, the European Court of Justice rejected all the Government’s pleas against the EU Short Selling Regulation. The Government was seeking annulment of Article 28 of the regulation whereby ESMA has been granted intervention powers, by way of legally binding acts, in exceptional circumstances. The Court found the power of the European Securities and Markets Authority to adopt emergency measures on the financial markets of the Member States in order to regulate or prohibit short selling compatible with EU law and dismissed the action for annulment in its entirety. The other Member States and the European Parliament have already outvoted the UK, during the negotiation process, and now the ECJ has not only confirmed but also strengthened the ESMA’s powers to override national financial supervisors to regulate or prohibit short selling.

Under the Financial Services Act 2010, the Financial Services Authority has powers to take action against short selling and to impose a disclosure regime on equities. However, Article 28 has provided ESMA with the power to forbid or impose conditions on the entry by persons into short sales or to require them to disclose such positions if the transactions have been considered a threat to the functioning and integrity of the financial markets, or to financial stability, if the situation has cross border implications and if the competent authorities have not taken measures, or the measures taken were not adequate, to address the threat. According to the Government ESMA enjoys wide margin of discretion when deciding how to take into account such factors and which measures to impose. The Government noted that ESMA could be required to take “potentially controversial decisions” while deciding whether or not competent authorities have taken measures to address a threat, which will entail ESMA’s involvement in the implementation of actual economic policy. The government argued therefore that this provision is illegal as it breaches the limits set by the Court in the Meroni judgment for delegation of powers. In 1958 the Court set up a general principle “A delegating authority cannot confer upon the authority receiving the delegation powers different from those which it has itself received under the Treaty.” It held that the discretionary delegation of powers to bodies, which are not foreseen in the treaty, would imply a wide margin of appreciation, replacing “the choices of the delegator by the choices of the delegate”, entailing, in this way, “an actual transfer of responsibility.” Britain has been relying on this principle to prevent EU institutions overstepping their mandate and extending its powers. However, this argument has now been overturned by the ECJ and a new precedent has been opened. 

The Court rejected the UK's claim as it concluded “the powers available to ESMA under Article 28 of Regulation No 236/2012 are precisely delineated and amenable to judicial review in the light of the objectives established by the delegating authority. Accordingly, those powers comply with the requirements laid down in Meroni v High Authority.” The Court found that “those powers do not, therefore, imply that ESMA is vested with a ‘very large measure of discretion’ that is incompatible with the FEU Treaty for the purpose of that judgment.”

The Government has also argued that Article 28 allows ESMA to adopt quasi-legislative measures of general application that have the force of law, which breaches the principle established in Case 98/90 Romano. Yet, the Court said “It is clear from Article 28 of Regulation No 236/2012 that ESMA is required, in strictly circumscribed circumstances, to adopt measures of general application under that provision” which may “include rules affecting any natural or legal person who has a specific financial instrument or specific class of financial instruments or who enter into certain financial transactions.” The Court pointed out “the first paragraph of Article 263 TFEU and Article 277 TFEU, expressly permits Union bodies, offices and agencies to adopt acts of general application.” In fact, the Court noted that EMSA “may also be required, under the powers conferred on it by that provision (Article 28), to take decisions directed at specific natural or legal persons.”

The Court also found that Article 28 does not undermine the rules governing the delegation of powers laid down by the TFEU, namely Articles 290 TFEU and 291 TFEU. It noted that the Treaties “do not contain any provision to the effect that powers may be conferred on a Union body, office or agency” but stressed that there are several provisions “presuppose that such a possibility exists.” The Court particularly stressed that Article 28 confers upon ESMA “decision-making powers in an area which requires the deployment of specific technical and professional expertise” but stressed that “that conferral of powers does not correspond to any of the situations defined in Articles 290 TFEU and 291 TFEU.”  The Court noted that “Article 28 of Regulation No 236/2012 cannot be considered in isolation” but “must be perceived as forming part of a series of rules designed to endow the competent national authorities and ESMA with powers of intervention to cope with adverse developments which threaten financial stability within the Union and market confidence.” According to the Court “To that end, those authorities must be in a position to impose temporary restrictions on the short selling of certain stocks, credit default swaps or other transactions in order to prevent an uncontrolled fall in the price of those instruments” and to “pursuit of the objective of financial stability within the Union.”  Hence, it held that Article 28 read in conjunction with other EUregulatory instruments, aiming at creating international financial stability, cannot be considered as breaching the rules governing the delegation of powers laid down in Articles 290 TFEU and 291 TFEU.

The Government also challenged Article 114 TFEU as a legal base for the adoption of the rules laid down in Article 28. The Government took the view that Article 28 main purpose is not to authorise ESMA to take individual measures directed at natural or legal persons but to adopt measures of general application. But even if that was the case that provision is ultra vires as Article 114 TFEU does not allowed the EU to adopt individual decisions which are not of general application or to delegate to the Commission or an agency the power to adopt them. Hence, rather than being “harmonisation measures”, as provided by article 114 TFEU, the decisions directed at financial institutions, overriding decisions made by national authorities, are regulatory measures by an EU agency directed at individuals in Member States.

It is important to recall that according to advocate general Niilo Jääskinen “…the outcome of the activation of ESMA’s powers under Article 28 of Regulation No 236/2012 is not harmonisation, or the adoption of uniform practice at the level of the Member States, but the replacement of national decision making under Articles 18, 20 and 22 of Regulation No 236/2012 with EU level decision making.” He agreed with the UK that article 114 is not an adequate legal basis and recommended the use of Article 352, which would require unanimity. However, the ECJ has not agreed with the advocate general and made clear that the aim of the integrity of the financial markets as well as the stability of the EU financial system includes the establishment of mechanisms, which would facilitate the adoption of EU measures that may take the form of decisions directed at certain participants in those markets. The Court held “the EU legislature, in its choice of method of harmonisation and, taking account of the discretion it enjoys with regard to the measures provided for under Article 114 TFEU, may delegate to a Union body, office or agency powers for the implementation of the harmonisation sought.” It then emphasized That is the case in particular where the measures to be adopted are dependent on specific professional and technical expertise and the ability of such a body to respond swiftly and appropriately”. The Court pointed out that the EU “faced with serious threats to the orderly functioning and integrity of the financial markets or the stability of the financial system in the EU” has sought by adopting Article 28 “to provide an appropriate mechanism which would enable, as a last resort and in very specific circumstances, measures to be adopted throughout the EU which may take the form, where necessary, of decisions directed at certain participants in those markets.” The Court found “that Article 28 of Regulation No 236/2012 satisfies all the requirements laid down in Article 114 TFEU", hence this provision “constitutes an appropriate legal basis for the adoption of Article 28.”

The ECJ ruling will have far-reaching implications not only to the City of London but also to the UK’s national interest. It not only raises concerns of further powers being transferred to EU agencies using Article 114 but also the possibility of Brussels widening the use of this legal basis. The EU is therefore allowed, particularly in areas that require the deployment of specific technical and professional expertise, to confer discretionary powers upon an agency if such powers are clearly defined by the European Parliament and the Council. Hence, Article 114 TFEU can be used as a legal base for safeguarding financial stability as well as to set up EU agencies and conferring upon them discretionary implementing powers. It is possible to argue that the ECJ by making a broader interpretation and authorising a widener use of Article 114 might create the necessary conditions to eurozone member states to use this as well as other single market provisions to pursue their own interests to the detriment of the UK as well as other non-eurozone countries. The ECJ’s judgement will particularly facilitate the creation of a banking union. It would allow further integration for the eurozone without the need of amending the Treaties.

In April 2013 the Government also lodged an application at the European Court of Justice for the annulment of the Council’s decision authorising enhanced cooperation for a Financial Transaction Tax. It is important to mention that enhanced cooperation involves the adoption of two different acts, the authorizing decision and the substantive legislative act. Greg Clark explained to the European Scrutiny Committee that the Government has decided to take this step because “there is a risk that, in the event that it needs to challenge the Directive that would implement the FTT, currently under negotiation, the case could be rejected by the Court as being too late.” In fact, the Government formal submission to the Court accepted that the action could be considered to be premature but it was brought as a precautionary measure.

Following the UK veto of the Commission’s draft directive introducing a financial transaction tax (FTT) in the EU, a group of 11 EU Member States have decided to go ahead with enhanced cooperation. The Council, acting by a qualified majority on the Commission’s proposal and after the European Parliament’s consent, gave the green light for enhanced cooperation in January 2013. Then the European Commission put forward a draft proposal for a Council directive implementing enhanced cooperation in the area of financial transaction tax. The proposal is based on Article 113 TFEU whereby the Council, acting unanimously, shall adopt “provisions for the harmonisation of legislation concerning turnover taxes, excise duties and other forms of indirect taxation” but only if such “harmonisation is necessary to ensure the establishment and the functioning of the internal market and to avoid distortion of competition.” However, the FTT can no longer be justified to avoid fragmentation in the internal market for financial services if enhanced cooperation is used to adopt it. The conditions for enhanced cooperation are defined under Articles 326 to 334 TFEU. Particularly, article 326 TFEU provides that enhanced cooperation “shall not undermine the internal market or economic, social and territorial cohesion [and] shall not constitute a barrier to or discrimination in trade between Member States, nor shall it distort competition between them.” Moreover, Article 327 TFEU provides that “any enhanced cooperation shall respect the competences, rights and obligations of those member States which do not participate in it”. Despite the Commission has asserted the opposite, enhanced cooperation on the FTT will lead to a significant distortion of competition in the internal market, and it would affect the rights and competences of non-participating Member States.

The Commission has initially defined the FTT´s territorial application on the basis of the “residence principle”, hence a financial transaction would be taxable in the EU, if one of the parties to the transaction was established in the territory of a Member State. However, the Commission wanted to prevent investors from moving from the 11 participating member states, to other financial centres, to avoid the FTT, so it has decided to complement the residence principle with the issuance principle.

Under the Commission’s proposal a financial transaction would be subject to the FTT, even if “none of the parties to the transaction would have been “established” in a participating Member State”, but they are trading in financial instruments issued in that Member State. Hence, due to the issuance principle, financial institutions will have to pay FTT in the participating Member State in which the issuer is located. Under the enhanced cooperation proposal the FTT would apply to financial products, even if they are traded outside the FTT area or outside the EU, but they are issued from the participating countries, in order to prevent relocation from the participating member states to other financial centres. Consequently, it will have an impact in the City of London, as the tax would apply to any transaction involving investors based in the participating member states, even if it was executed in London.

The extra-territorial elements of the Commission’s proposal would impinge on the sovereignty of the non-participating Member States. They will have as effect extending the taxing jurisdiction of the participating Member States over entities established outside their territories. The UK would be forced to collect the tax on behalf of other states, although it will not benefit from it. The FTT will impose costs on non-participating Member States. Although the tax authorities of participating Member States are not allowed to impose a tax directly on non participating Member States’ firms they are allowed, under the EU Mutual Assistance Directive, to required HMRC to collect the FTT for them. Hence, the proposal entails costs to HMRC and British companies.  Hence, the FTT proposal does not respect the UK’s jurisdiction over its own tax system.

The UK is home to Europe’s biggest financial centre thus this tax is an attack on the City of London. There is widespread opinion that the FTT will lead to job losses and financial businesses moving from the EU, particularly from London, which is unacceptable. The UK does not participate in the enhanced cooperation yet it has also been found that the cost of UK government borrowing could rise by £4bn. According to a research carried out by London Economics on behalf of the City of London Corporation the FTT would also reduce the value of UK equity and debt holdings by £3.6bn.

As above-mentioned, the Government challenged the authorising decision before the ECJ.  According to the Government the FTT represents a breach of the EU treaty, as the requirements for the enhanced cooperation procedure have not been properly fulfilled. It believes that the current proposal “would infringe the rights and competences of non-participating Member States and would depart from accepted international tax norms;” The challenge was mainly focus on the extraterritorial elements of the tax. The Government is particularly concerned over the proposed rule whereby financial institutions in non-participating Member States would be considered established in the FTT area when trading with counterparties based in this area, which is likely to breach Article 327 TFEU. The Government argued therefore that the decision authorising enhanced cooperation, allowing the introduction of an FTT, which would be applicable, due to the abovementioned principles of taxation, to institutions, persons or transactions situated or taking place in the territory of non-participating Member States, harmfully affects the competences and rights of those Member States.

The Government also believes the decision authorising the adoption of an FTT will impose costs on the non-participating Member States’, due to the application of Council Directives concerning mutual assistance for the recovery of claims relating to taxes, duties and other measures and on administrative cooperation in the field of taxation, breaching of Article 332 TFEU which specifically states “Expenditure resulting from implementation of enhanced cooperation, other than administrative costs entailed for the institutions, shall be borne by the participating Member States, unless all members of the Council, acting unanimously after consulting the European Parliament, decide otherwise.”

Unsurprisingly, the ECJ has recently ruled against the UK, as it has not annulled the Council’s decision authorising enhanced cooperation. The Court considered the UK’s challenge premature and consequently inadmissible, as the negotiations had not been concluded yet. The Court found that “The principles of taxation challenged by the United Kingdom” as well as “the issue of expenditure linked to the implementation of the enhanced cooperation” are not constituent elements of the contested decision. The Court stressed that “the possible effects of the future FTT” depend “on the adoption of ‘the counterparty principle’ and the ‘issuance principle’,” which “are not constituent elements of the contested decision”, consequently the Court rejected the UK’s arguments and dismissed the action. This was a significant setback to the City of London, as such tax is likely to significantly damage to the UK’s financial industry, based in the City.

It is important to recall that the EU Council Legal Service has deemed the FTT incompatible with EU law. According to the EU Legal Service’s legal opinion the Commission’s proposal for a FTT “infringes upon the taxing competences of non-participating member states” and “exceeds member states' jurisdiction for taxation under the norms of international customary law as they are understood by the Union”. Moreover, it suggested that the proposal was "discriminatory and likely to lead to distortion of competition to the detriment of non-participating member states.” This opinion is not legally biding but it should, at least, have created doubts over the legality of the proposal. Yet the 11 participating member continue supporting the introduction of a FTT and the Commission continues to push for it. Unsurprisingly, the European Commission strongly disagrees with the Council lawyers' opinion. In fact, following the ECJ’s ruling, a European Commission spokesman, said, “The commission has always been confident that the decision for enhanced cooperation on the FTT was legally sound.”

The Government wants to participate in the Council debates on the FTT in order to make sure the final text of any tax agreed by the participating Member States addresses the Government main concerns and reflects the UK’s views. However, it is important to note the non participating member states have no say, as solely the member states participating in enhanced cooperation are allowed to vote, they must unanimously agree on the proposal. Nonetheless, there has been a total lack of transparency in the FTT negotiating process. The non-participating countries have been kept out of the negotiations, which have been conducted behind closed doors. On the 6 May the participating countries, meeting in the sidelines of the Ecofin, reached a broad political agreement on the FTT. In a joint statement 10 participating member states, Slovenia has not signed the statement, confirmed they will progressively implement the FTT and announced that it will initially covered the taxation of shares and some derivatives, which would be implemented by January 2016. The non-participating countries were presented with an extremely vague, one page, political deal, which provides no details and there is no reference on the FTT impact on non-participating countries. In fact, there are doubts whether the participating member states are even considering the impact of the proposal on non-participating countries. Obviously, George Osborne was not pleased with such negotiations and reiterated the Government “will not hesitate to challenge a Financial Transaction Tax that damages the UK, other member states or the single market."

The UK had a veto over this damaging proposal and the Government has used it. However, despite the veto and despite the non-participation in the enhanced cooperation, the UK will still be affected by such tax, as it will have extra territorial effects. The Government attempt to stop the proposal before being adopted has failed. The Government has already said that will launch a legal challenge against the Council Directive implementing enhanced cooperation in the area of financial transaction tax when adopted, if it is not in the UK’s national interest and undermines the integrity of the single market. However such a challenge does not have a better chance of being successful. The ECJ’s ruling confirms that further integration among a group of member states, in the EU and eurozone, can move forward even if it has an impact on the other member states. It draws attention to the Government powerless in stopping other member states moving forward with further integration and joint policies, under enhanced co-operation, that jeopardise UK interests. It is important to recall that there is an explicit reference in the Treaty on Stability, Co-ordination and Governance in the Economic and Monetary Union to the possibility of using the general rules on enhanced cooperation within the current EU Treaties, to adopt EU measures that will apply solely to the member states that participate in this treaty.

The UK will continue to be subject to damaging proposals, even if it does not join in, whilst the Government ability to protect national interest is increasingly restricted. Hence, the Government should not seek to protect UK national interests by challenging damaging EU financial regulations before the ECJ. This strategy was doomed to fail. The ECJ is chiefly a political court and it is unlikely to protect the City’s interests against EU regulations. The ECJ’s ruling on short selling has shown us that the Court is unlikely to annul EU regulations indented to ensure financial stability, particularly in the eurozone. David Cameron must ensure that Westminster retains supremacy on matters of financial and banking markets regulation. Britain must regain control of the City of London. But this cannot be achieved without a fundamental renegotiation of the treaties, unless the Government applies the notwithstanding the 1972 Act formula. All EU regulations and all provisions of EU law that have direct effect are automatically incorporated and binding in national law, under Section 2(1) European Communities Act 1972, without the need for a further Act of Parliament, regardless Government policy. The other EU law measures are implemented by secondary legislation, under Section 2(2). Under Section 2(4) and 3(1) UK courts are required to override any national legislation, which is deemed to be incompatible with EU law. Likewise, Parliament has always accepted the obligation to amend national law to comply with the European Court of Justice decisions. The European Communities Act 1972 is, therefore, the root of the problem. The Westminster Parliament voluntarily accepted to limit its sovereignty when it enacted this Act. Hence, as Bill Cash has been saying, Parliament can repeal the European Communities Act 1972. The UK Parliament can repudiate and disapply EU legislation, which is inconsistent with the UK’s national interests.

The ECJ’s judgments against the UK stress the urgency in adopting the European Scrutiny Committee proposals: the introduction of a unilateral veto and disapplication of EU legislation notwithstanding the European Communities Act 1972. It is important to recall that Bill Cash’s Sovereignty Bill introduces a unilateral veto over EU legislative proposals and includes clauses on disapplication that will enable Parliament to disapply legally binding EU measures. In fact, it would ensure that all EU proposals that are adopted despite UK opposition “shall not form part of the law applicable in any part of the United Kingdom.” This would enable the UK to regain regulatory sovereignty over financial and baking matters whilst the City would be able to regain its competitiveness.

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