Statement No. 8
London, 12 June 2000
Over the past decade,
the development of the European securities exchanges has been a remarkable success story. Owing directly
to the force of cross-border competition, European exchanges have implemented major reforms in trading
systems and internal governance which have significantly improved their efficiency and reduced investor
trading costs. Yet the exchanges are now facing enormous pressure from the major international trading
houses to cut costs much further by consolidating trading and settlement operations on far fewer platforms. This has led
to a wave of dramatic merger and alliance proposals which augur a fundamental restructuring of the competitive landscape
in trading operations and the reallocation of market regulation authority across EU national securities commissions.
The European Commission is currently conducting
a major review of the 1993 Investment Services Directive (ISD) as part of its "Financial Services Action Plan",
with the aim of proposing wide-ranging reforms. In this statement the ESFRC urges the European Commission to address
a key weakness of the ISD – the so-called "regulated markets" concept – which,
as things stand, may be used by national authorities as a protectionist weapon.
"Regulated Markets" in the ISD
Article 15.4 of the ISD provides for a "single passport" for EU trading systems, allowing
a system authorized by the competent authority in one national jurisdiction to provide remote services
in all the others. This single passport is a manifestation of the concepts of "mutual recognition"
and "home country control", utilized in a number of Single Market Programme directives to facilitate
market integration without the need for prior harmonization of laws and regulations across the Union.
Home country control provides a major stimulus to market integration by negating the natural protectionist tendencies
of host state authorities, which may attempt to hinder the operations of foreign competitors when they threaten the
franchises of domestic incumbents.
ISD single passport, however, only applies to so-called "regulated markets". The definition
of such markets was the source of enormous controversy within the Council of Ministers during the original
ISD negotiations, which began in 1988. If an exchange or trading system was not legally a "regulated
market", then it was obliged to seek explicit authorization to operate in each and every national
jurisdiction in which it wished to provide services, even if only by remote cross-border electronic link.
Local protectionism was therefore a real threat to any trading system operator which could not satisfy the "regulated
The London Stock Exchange’s SEAQ International trading platform was the
primary target for protectionist manipulation of the "regulated market" definition in the ISD negotiations. A
significant competitor to the continental exchanges in the late 1980s, it had nonetheless been overtaken by the time
of the ISD implementation deadline in 1996. Cross-border expansion of electronic trading systems proceeded
rapidly in the late 1990s, but as the exchanges generally refrained from competing in each other’s
products there were few opportunities for testing the
significant recent example has emerged in electronic bond trading. The Italian Treasury has given an
effective monopoly in electronic trading of Italian government securities to the MTS "telematico"
system by restricting central clearing counterparty services to official "regulated markets",
as designated by the Treasury in accordance with the ISD. MTS is the sole operator so recognized for
Italian government securities. Aspiring foreign competitors such as Instinet, eSpeed and Brokertec Global
must therefore operate at a significant competitive disadvantage.
There are also worrying signs emanating from both Frankfurt and London that the
long-overdue cross-border consolidation of exchanges may be blocked or distorted by local protectionism.
And given the clear indications that existing exchanges will in short order be expanding their cross-border
services, and that new electronic competitors will be entering the fray, it is now more important than
ever to ensure that the ISD does not act as a barrier to the long sought integration of the European
capital markets. If flaws in the ISD are not addressed, we are bound to witness the wholly undesirable
transformation of EU national securities commissions from market regulators into trade negotiators, operating on behalf
of local incumbent exchanges threatened by more efficient foreign competition. This trend is already clear in the US,
where the Securities and Exchange Commission has steadfastly refused direct electronic access for non-US
exchanges, while at the same time turning a blind eye to US brokers providing their own electronic links
direct from US investor desks to foreign trading systems.
In this statement, we focus on four clauses in the ISD which relate
to the legal concept of the "regulated market":
the listing requirement in article
the "new markets" provision
in article 15.5;
the "concentration principle"
in article 14.3; and
the "transparency" rules
in article 21.
We explain the source of their protectionist potential, and recommend
surgical revisions of the text to mitigate it while minimizing the likelihood of provoking political gridlock.
De-linking Listing and Trading
The ISD unnecessarily conflates the regulation of corporate disclosure with the regulation of trading systems.
"Listing" of securities in conformance with basic standards is held to be a hallmark of a "regulated market",
and acquisition of a single passport is therefore made contingent on it. As SEAQ International did not list the continental
stocks which it traded in the late 1980s and early 1990s, a formal listing requirement was clearly a threat to its cross-border
operations at the time. A North-South split emerged in the Council of Ministers during the ISD negotiations over the appropriateness
of a listing requirement, leading to a compromise around deliberately ambiguous text. Article 1.13 therefore specifies
that a "regulated market" must satisfy the requirements of the Listing Particulars Directive (79/279/EEC) "where
[the Directive] is applicable". Failure to identify who ultimately determines applicability leaves considerable room
for protectionism by host state authorities on behalf of their own domestic exchange operators.
is a major revenue-generating function at most exchanges, akin to rating debt in the bond markets, and does not need to
be carried out by the same body which operates the trading system. Indeed, newer European trading platforms (eg,
Tradepoint and Jiway) intend
We would like to see a competitive
market emerge for listing services in Europe, with non-exchanges competing directly with exchanges for establishing standards
appropriate to the age and size of the companies which wish to be publicly traded. The lack of trading interest in London’s
small cap AIM market clearly demonstrates the commercial cost of establishing insufficiently high disclosure standards.
Market forces can only improve on the current situation by allowing specialization between listing service provision and
trading service provision.
To move us in this direction,
the ISD should be revised to make clear (a) that whereas "regulated markets" may be obliged by home
state authorities to deal only in formally "listed" stocks, the actual listing function may be performed by any
exchange or other body (such as an accounting firm, rating agency or government institution) duly authorized to provide
listing services in any EU national market; and (b) that it is the home state authority which is authorized to decide
whether the Listing Particulars Directive is applicable in any given case. This would ensure that a trading system operator
designated as a "regulated market" in one jurisdiction is not denied single passport rights in another jurisdiction
on the basis that that particular operator does not itself "list" the securities which it trades.
15.5 states that article 15 "shall not affect the Member States’ right to authorize or prohibit the creation
of new markets within their territories". This clause is clearly unnecessary if its true intent was merely to reinforce
home state discretion in designating "regulated markets". But the intent was actually to furnish host states
with an escape clause from the single passport provision for screen-based trading systems. By declaring a foreign trading
system to be a "new market", a host state could deny it single passport rights.
Indeed, an early sign of the potential for abuse of the new markets clause came
in 1995, when the Dutch Ministry of Finance opined that a foreign screen-based system wishing to provide
for remote access in the Netherlands might be considered as intending to create a "new market"
in the Netherlands. The Dutch position provoked considerable criticism from abroad, and was never applied.
If its validity were to be upheld, however, the single passport would be entirely negated. With the recent
establishment of new trading platforms for equities and bonds the potential for abuse is now considerable.
In order to eliminate this possibility, article 15.5 should simply be extirpated from the Directive.
Through the removal of the new markets clause, the protectionist potential of another provision, the so-called
"concentration principle", article 14.3, will be considerably lessened. Another source of North-South tension
in the drafting of the Directive, the concentration principle gives Member States the right to mandate that transactions
in domestically traded securities be carried out only on a "regulated market". The new markets clause gives Member
States the possibility of claiming that a trading system designated a "regulated market" by its home authority
is not actually a "regulated market" outside its home state if tries to expand its product base – as
it would then be creating a "new market". This would further restrict the scope of the single
passport and severely limit the prospects for cross-border trading system competition.
Having been incorporated into law in a number of Member
States, the concentration principle will be exceedingly difficult to remove, or even significantly amend.
Therefore reducing the
Transparency in the ISD refers to rapid publication of post-trade
transaction data. In a competitive market, government-mandated transparency rules are either unnecessary or damaging.
They are unnecessary for the electronic auction systems being operated by the EU exchanges, since all
of them have the incentive to sell real-time transaction data to private vendors, such as Reuters and
Bloomberg. They are damaging for block transactions facilitated by dealers, because dealers will not
quote prices on blocks if they are forced to reveal the transactions to their competitors before they
have rebalanced their portfolios. And if block transactions are eliminated by transparency rules, the
market is not actually made more transparent. Whether the investor breaks up a large sell order for execution
in an auction market, or sells the entire block to a dealer who then does the same, the transactions will always get published
through the auction market.
The ISD transparency
rules (article 21) are in their present form inconsequential, so there is no pressing need either to amend or remove
them. A further compromise in the ISD negotiations led to a bizarre requirement for "regulated markets"
to publish "at least" weighted average prices at regular intervals, with unspecified delays
permitted for "very large" transactions. Deutsche Börse demonstrated that the requirements
could be avoided entirely by declaring all trades which they did not wish to publish, those done by telephone,
to be "off market". Since, logically, only their electronic trading system (IBIS, now Xetra)
required a single passport to accommodate remote access, this system itself became the "regulated
market", and trades off the system remained outside the scope of the ISD transparency rules.
The FESCO document, "Standards for Regulated
Markets Under the ISD" (December 1999), endorses real time disclosure of "all completed transactions", but
acknowledges the application of delays or suspensions in accordance with article 21. However, the document also calls
for real-time disclosure of bid-ask prices and volumes, known as "pre-trade transparency", without derogation.
Such limit order revelation, however, is not clearly desirable in all market architectures. New electronic call market
structures, where trading occurs at specific predesignated points in time, process complex contingent orders which
are frequently not amenable to pre-trade revelation. Furthermore, disclosure of pre-trade "indication" prices
may actually encourage undesirable gaming of such systems, through manipulative order placement and retraction strategies.
Therefore, FESCO’s statement that the organization "does not regard it as the role of the regulator to prescribe
market design" is incompatible with regulations requiring order revelation. The latter is intimately related with
market design, and should therefore not be mandated.
for Revising the ISD
In conclusion, we recommend the following two amendments to the
Article 1.13 should be rewritten
so as to make clear that a "regulated market" need not itself meet the requirements of the Listing
Particulars Directive. A trading system operator should not be required to enter the listing business as a condition for
acquiring a single passport. Home state regulators should be permitted, but not obliged, to require trading systems which
they designate to be ISD "regulated markets" to trade only formally "listed" securities, but any
institution authorized to provide listing services in any EU jurisdiction should be considered competent
to carry out such a listing requirement.
• Article 15.5 should be eliminated,
so as to preclude an EU authority from denying single passport rights to a foreign "regulated market"
on the grounds that it is seeking to create a "new market" in its territory.
changes will further serve to mitigate the protectionist potential of the "concentration principle" enshrined
in article 14.3. With regard to the transparency provisions in article 21, we prefer to let sleeping
text lie. We consider these provisions unnecessary, but fundamentally harmless in their current form.
We simply urge FESCO not to seek to expand their application to "off market" transactions
facilitated through dealer capital, or to pre-trade price and volume information in the case of periodic