European financial markets. The City grumbles

Date: 11/10/03

London bankers complain about proposed European share-trading rules

PAUL BOATENG, a British Treasury minister, this week condemned as “misguided and profoundly anti-competitive” the latest proposal from the European Union for regulating financial markets. He said it would damage the City of London's way of doing business, increase the cost of capital and put Europe at a disadvantage to American rivals. Mr Boateng cited a study which estimates that the proposal would raise the cost of share trading outside stock exchanges by €450m ($530m) a year.

It would seem that London and Brussels have profoundly different views of how financial markets can and should be regulated. The European Commission wants to replace the current, ten-year-old, ineffective law on investment services, itself an unhappy compromise, with a new version which would harmonise regulatory regimes across the 15 (soon to be 25) states of the EU. The aim is to break down barriers to cross-border trading, in pursuit of a single financial market across the EU.

On October 7th the commission's proposal cleared another legislative hurdle when a majority of finance ministers approved the latest draft. The commission is anxious to get the European Parliament to pass the law before the end of its five-year term next summer. France and Italy are its staunchest supporters; Britain, in alliance with four other countries, its fiercest critic.

The City broadly supports the aim of harmonising regulatory regimes. The existing law is a failure because it allows national governments to impose domestic regulatory burdens on financial-services firms from other EU states. But the City is balking at greater regulation of “off-market” transactions, which is the price that must apparently be paid for creating a common European regulatory regime.

Off-market trades are common in London, where investment banks do deals for professional clients, matching buy and sell orders without going through the stock exchange. The big banks in Frankfurt conduct similar transactions. But in France, Italy, Spain and Greece such deals have up to now been all but forbidden. National regulatory regimes have demanded that shares be traded through an exchange.

Any such requirement will disappear under the new EU law. However, to allay concerns in southern states with less developed financial markets that investors who trade off-exchange might be vulnerable to being ripped off, the commission is proposing that there should be pre-trade transparency: investment banks would have to make firm quotes public ahead of a trade. This requirement will only be lifted for transactions above a certain size, all parties to which are assumed to be sufficiently savvy. The investment banks protest that this is too great a regulatory burden: the obligation to honour pre-trade prices runs counter to the need to adapt to market circumstances. They conclude that European banks will be deterred from entering each other's markets, and thus that the law will not achieve its purpose.

The London investment bankers claim they will lose out to competitors outside the EU, as well as to the stock exchanges. They say revealing certain types of large order to the market before execution will move prices against investors. The exchanges and their allies are successfully fighting back against the idea of a light regulatory touch. Expect another round of loud lobbying before the European Parliament votes in a few months' time.

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