Committee Reports > List of Committees > Joint > 1990 > Committee on the Secondary Legislation of the European Communities (6th Committee) > Report No. 03 - Investment Services in the Securities Field

INVESTMENT SERVICES DIRECTIVE COM (89) 629 FINAL

A. INTRODUCTION

1.The proposed Council Directive on the coordination of laws, regulations and administrative provisions relating to the taking-up and pursuit of the business of investment services was examined for the Joint Committee by its Sub-Committee on Economic, Commercial and Financial Affairs.

This Report was prepared by Deputy Sean Barrett, Chairman of the Sub-Committee. The Joint Committee is indebted to Deputy Barrett and his colleagues for their dedicated work.

2.Written submissions were received from the Department of Finance, the Irish Bankers Federation, and the Financial Services Industry Association of CII and the Irish Stock Exchange.

The Joint Committee gratefully acknowledges the assistance and co-operation of these bodies. It gratefully acknowledges also the assistance given to it and to the Sub-Committee by Mr. John Hogan in preparing this Report.

3.The Sub-Committee had consultations with the Departments of Finance and Industry and Commerce, the Central Bank, the Financial Services Industry Association of CII, the Irish Bankers Federation and the Irish Stock Exchange. These consultations provided a valuable opportunity for consideration and discussion of many points raised in the written submissions.

B. BACKGROUND

4.The Commission’s White Paper of June, 1985 on Completing the Internal Market (endorsed by the Heads of State or Government and incorporated in the Single European Act) which was the subject of Report No. 26 of the Fourth Joint Committee represented a watershed in the development of the European Community. The pivotal change in the Commission’s approach, as enunciated in the White Paper, was the substitution of mutual recognition of standards for harmonisation of standards. The harmonisation procedure was recognised as cumbersome and, in many cases, impractical. There is general agreement that the change of approach has produced a very significant improvement in coping with the vast work-load to be discharged in securing the objective of completing the internal market by 1992.

5.It is, perhaps, in the financial and banking sectors that the limitations of total harmonisation are at their most evident, due to disparate systems within the Community of an economic, legal and political nature.

6.The White Paper on the Internal Market established an unequivocal link between removal of physical barriers and progress on liberalisation of capital movements and of financial services.

7.On the capital side, the White Paper suggested that liberalisation should achieve three aims:

“First, the completion of a large internal market inevitably involves a financial dimension. The free movement of goods, services and persons must also mean that firms and private individuals throughout the Community have access to efficient financial services. The effectiveness of the harmonisation of national provisions governing the activities of financial intermediaries and markets would be greatly reduced if the corresponding capital movements were to remain subject to restrictions.

Secondly, it must be stressed that monetary stability in the sense of the general level of prices and exchange rate relations, is an essential precondition for the proper operation and development of the internal market. In this regard, action to achieve greater freedom of capital movements would need to move in parallel with the steps taken to reinforce and develop the European Monetary System. Exchange-rate stability and convergence of economic policies help the gradual removal of barriers to the free movement of capital; conversely, greater financial freedom leads to greater discipline in the conduct of economic policies”.

Thirdly, the decompartmentalisation of financial markets should boost the economic development of the Community by promoting the optimum allocation of European savings. The task is to set up an attractive and competitive integrated financial system for both Community and non-Community business circles.

8.On financial services, the White Paper suggested that liberalisation of such services, linked to that of capital movements, would represent a major step towards Community financial integration and the widening of the internal market.

“The accent is now put increasingly on the free circulation of ‘financial products’, made ever easier by developments of technology. Some comparison can be made between the approach followed by the Commission after the ‘Cassis de Dijon’ judgements with regard to industrial and agricultural products and what now has to be done for insurance policies, home-ownership savings contracts, consumer credit, participation in collective investment schemes, etc. The Commission considers that it should be possible to facilitate the exchange of such ‘financial products’ at a Community level, using a minimal coordination of rules (especially on such matters as authorisation, financial supervision and reorganisation, winding up, etc.) as the basis for mutual recognition by Member States of what each does to safeguard the interests of the public.

Such harmonisation, particularly as regards the supervision of ongoing activities, should be guided by the principle of ‘home country control’. This means attributing the primary task of supervising the financial institution to the competent authorities of its Member State of origin, to which would have to be communicated all information necessary for supervision. The authorities of the Member State which is the destination of the service, whilst not deprived of all power, would have a complementary role. There would have to be a minimum harmonisation of surveillance standards, though the need to reach agreement on this must not be allowed further to delay the necessary and overdue decisions.

The implementation of these principles in the field of credit institutions (especially banks) is being pursued actively, in particular on the following lines:

-the standards of financial stability which credit institutions must live up to and the management principles which they must apply (concerning, for instance, their own funds, the solvency and liquidity ratios, the monitoring of large exposures) are being thoroughly coordinated;

-the rules contained in the fourth and seventh company law directives on annual accounts and consolidated accounting are being adapted to the sector of credit institutions;

-furthermore, the conditions which must be fulfilled by institutions seeking access to the markets as well as the measures to be taken at Community level when it comes to reorganising or winding up an institution in case of crisis are being coordinated;

-to name a more specific area, the Commission is working towards the mutual recognition of the financial techniques used by mortgage credit institutions and of the rules applying to the supervision of such institutions”.

9.The draft Directive under consideration conforms to the principles enunciated in the White Paper on the Internal Market as regards harmonisation of essentials, mutual recognition and home country control. It has these factors in common with, for example the Second Banking Directive, the subject of the Joint Committee’s Report No. 9 of 26 January, 1989. The move by the Commission in these and other directives to the notion of home country control is welcomed by the Committee. The Investment Services draft Directive, the Second Banking Directive, the 1988 Directive liberalising Community capital movements, the second Non-Life Insurance Directive, the Directive on mutual funds and unit trusts and the Directive on capital adequacy will constitute significant response to the need for integration of the EC banking and financial market.

10.The Commission has submitted to Council a proposal for a Directive on rules governing investment firms’ capital adequacy. This proposal establishes rules as regards the definition of own funds of investment firms and the supervision of market risk.

11.The present proposal for a Council Directive is based on Article 57 of the Treaty (copy attached as Annex I) and consultation with the European Parliament and the Economic and Social Committee is mandatory. Consultations with the European Parliament and the Economic and Social Committee have been effected and the proposal incorporates a number of amendments recommended by these institutions.

C. MAIN PROVISIONS OF DRAFT DIRECTIVE

12.The draft Directive has as its main objective the establishment of an authorisation procedure for any person (natural or legal) wishing to provide one or more of the services coming within the Directive’s scope (e.g. investment advice, broking, dealing or portfolio management). The services in question are specified in Annex II to this Report. On the basis of such authorisation the person in question will be allowed to provide the service in question on a cross-border basis within the Community or to set up branches in the other Member States without needing to be authorised again. In this respect the present proposal should be regarded as an essential follow-up to the Commission’s proposal for the Second Banking Directive which provides for similar freedom of services and to create branches for credit institutions, not only in the banking field but also in connection with the carrying out of securities transactions. Accordingly, many of the Articles in the Directive reflect, mutatis mutandis, the provisions of the Second Banking Directive.

13.If a credit institution is already authorised to engage in the activities covered by the present Directive as a result of its banking authorisation, it will not be required to be authorised again under the present Directive.

14.In putting forward its proposals the Commission accepted that in addition to mutual recognition by other Member States of the initial authorisation granted by the home Member State authorities it is desirable for the creation of a true internal market in financial services and required that:

(i)the monitoring of the financial soundness of the investment firm, and

(ii)its compliance with other major prudential and conduct of business rules

should also, as far as possible, be within the exclusive regulatory competence of the home Member State supervisors.

15.As regards the monitoring of the investment firm, the present Directive requires that the initial financial resources on the basis of which authorisation was given should not be allowed to fall below level following authorisation. The monitoring of compliance with this rule will be within the competence of the home Member State authorities.

16.As regards compliance of the investment firm with major prudential and conduct of business rules, the Directive identifies certain rules of a prudential nature and for the protection of investors which are placed under the exclusive regulatory competence of the home supervisors straightaway.

In particular, the Directive requires all Member States to establish a compensation fund to protect investors against default or bankruptcy by an investment business. Pending further harmonisation, however, the host country compensation rules would apply to branches of investment businesses authorised in other Member States. The home country compensation scheme would apply to business done on a service basis.

17.The rules which regulate the relationship between investment firms and their clients (conduct of business rules) are not brought within the competence of the home country authorities at this stage. At present there are considerable divergences between Member States in the content of such rules and in the way they are applied. A considerable further effort of harmonisation will be needed to permit the application of these rules to pass under home country control.

18.The Commission’s view is that, pending such further harmonisation, the confidence of the investor is best ensured by leaving the conduct of business rules within the competence of host country authorities for the time being. Accordingly, the Directive provides that host country conduct of business rules, notably for the protection of the investor, can for the moment continue to apply to investment firms from other Member States provided such rules are justified on the grounds of public good, this provision is identical to a provision of the Second Banking Directive.

19.A second main objective of the proposal is to liberalise access to stock exchange membership in host Member States for investment firms authorised to carry out the relevant type of service in their home Member State. Similar liberalisation will apply to membership of financial futures and options exchanges. It is clear that a “passport” giving investment firms established under the draft Directive the right to set up a branch in, or provide investment service direct to, other Member States of the Community would be of little use unless accompanied by access to the main securities market there - the Stock Exchange. Accordingly, the draft Directive envisages that, once a firm is authorised in its own Member State, it can become a member of any Stock Exchange in another Member State (subject, of course, to compliance with Stock Exchange rules). Finally there is nothing in the draft Directive which interferes with the right of host Member States to require adherence by all comers to legally enforceble local conduct of business rules that are adopted in the interests of the common good.

20.It is also the Commission’s intention to coordinate rules relating to the capital to be set aside by investment firms in respect of market risk arising from the activities covered by the Directive. Once again, monitoring of compliance with such rules will be the responsibility of the home supervisors.

A separate capital adequacy Directive submitted to the Council by the Commission in May, 1990 establishes rules as regards the definition of own funds of investment firms and supervision of market risk.

D. VIEWS OF THE COMMITTEE

21.In general, the Joint Committee welcomes the Draft Directive and accepts that its proposals, taken in conjunction with the Second Banking Directive, the 1988 Directive liberalising community capital movements, the second non-Life Insurance Directive, the Directive on mutual funds and unit trusts and the Directive on capital adequacy will constitute a significant response to the need for integration of the EC banking and financial market. The Committee accepts that the Draft Directive conforms to the principles enunciated in the Commission’s White Paper on the Internal Market as regards harmonisation of essentials, mutual recognition and home country control and that the Draft is well designed to achieve objectives which would be desirable in themselves, even without reference to the completion of the Internal Market. The drive to achieve the Internal Market enhances the desirability of these objectives.

22.The Joint Committee, having considered the written and oral submissions of the interest groups, further accepts that, in its general trust, the Draft Directive does not present undue difficulties for Ireland. Indeed, to the extent that the Draft allows for better facilities for Irish firms seeking to export financial services to other Member States, its provisions should represent an opportunity for firms established or establishing in the International Financial Services Centre. The “European passport” which the Directive will confer is bound to be of considerable value to such firms. Furthermore, the provisions of the Draft Directive, - especially the single licence - should offer a major inducement to non-EC institutions to establish in Ireland. For US firms in particular, establishment in Ireland should be attractive not only on language grounds but on the grounds of a shared common law tradition which is substantially different from the continental civil law tradition.

23.The Committee has paid particular attention to the consumer protection aspect of the Draft Directive. It accepts that implementation of the Directive, involving considerably increased supervision of investment services, will promote the interests of the investing public. The supervisory framework will, furthermore, serve to achieve the desirable objective of promoting the sound development of the financial system itself.

24.In view of the positive implications for Ireland, the Committee notes with satisfaction the degree of progress on the Draft Directive achieved during the Irish Presidency just ended.

25.The Joint Committee is satisfied that it is essential that the Draft capital adequacy Directive should be advanced to a stage where it, contemporaneously with the Draft Investment Services Directive, will be ready for implementation on 1 January, 1993. It is advised that the necessity for the two measures to run in tandem is accepted within the instances of the Council and that discussions on the Draft Directive on capital adequacy are proceeding at a pace which should ensure implementation simultaneously with the Investment Services Directive.

26.The Committee while appreciating the considerations leading to the decision to exclude conduct of business rules from the competence of the home country authorities at this stage (paragraphs 17 and 18 above), regrets that as yet, Commission proposals in this matter have not been submitted to Council. The Committee is advised, however, that the Commission has undertaken to insert in the preamble to the Draft Investment Services Directive a commitment to harmonise the conduct of business rules. Apart from the breach of the principle of home country control that this provision involves, the Committee is concerned here that host country rules could operate in such a way as to create a distortion of competition.

27.The Draft Directive requires that Member States establish a compensation fund to protect investors against default or bankruptcy by an investment business. While the home country compensation scheme will apply to business done on a service basis, host country compensation schemes will apply to branches of investment businesses authorised in other Member States. The Committee appreciates that harmonisation of compensation schemes is required. It is concerned, however, that the position as it now stands could distort competition and it feels that, here again, the principle of home country control should be made to apply at the earliest possible date. The fact that the home state will be the regulatory authority adds force to the necessity of adhering to the principle of home country control.

28.Having regard to the necessity for Ireland, under the Draft Directive, to introduce a system of authorisation and prudential supervision for the investment services sector to update the legislation affecting the Stock Exchange and stockbrokers and to introduce a supervisory framework for activities not now supervised, the Joint Committee assumes that the transposition of the provisions of the Directive into Irish law will be by way of primary legislation.

29.As to whether there ought to be a single Irish regulatory authority for investment services and, indeed, for banks and investment services, the Joint Committee has an open mind. It is aware that the question is the subject of on-going consideration at a high administrative and professional level and it does not wish to pre-empt or prejudice the outcome of these deliberations. The Committee feels, however, that the regulatory arrangements decided should involve (1) regular consultation between the regulatory authority and the representative bodies of firms engaged in the provision of the financial services covered by the Directive, (2) the maximum degree of self-regulation and (3) continuing regulatory responsibility (post-authorisation) by the regulatory authority either on its own behalf or by means of powers delegated to bodies at present exercising supervisory rules.

30.The Joint Committee feels that, ideally, the introduction of the provisions of the Draft Directive and of other measures affecting the EC banking/insurance/investment sector, should be taking place pari passu with measures to promote tax harmonisation. It takes cognisance, however, of the fact that the impact of these measures, taken together, in terms of competition and market penetration is likely to create its own momentum towards the harmonisation of taxes within the community.

31.The Joint Committee is advised that the question of the inclusion of professional investment advice within the scope of the Draft Directive is still at issue in the instances of the Council. On the basis of its discussions with the interest groups, the Committee is satisfied, not least in the interest of investor protection, that this activity should be regulated by inclusion within the scope of the Directive.

E. RECOMMENDATIONS OF THE COMMITTEE

IThe Draft Directive on Investment Services should be finalised as quickly as possible.

IIThe Draft capital adequacy Directive should be progressed for implementation contemporaneously with the Investment Services Directive.

IIIWork on the harmonisation of conduct of business rules and compensation schemes should be expedited so that, in both cases, supervision should pass to the home country as quickly as possible, provided that, in both cases harmonisation is achieved at the level of the best existing community practice.

IVThe business of the purveying of professional investment advice should be brought within the scope of the Draft Directive.

VThe transposition of the terms of the Directive into Irish law should be by way of primary legislation which should address, in particular, the objective of investor protection and especially the protection of the private, or small investor. The need to protect the investor against misleading advertising should be addressed as a priority.

VIThe regulatory authority to be established under the Directive should involve (1) regular consultation between the regulatory authority and the representative bodies of firms engaged in the provision of the financial services covered by the Directive, (2) the maximum degree of self-regulation and (3) continuing regulatory responsibility (post-authorisation) by the regulatory authority either on its own behalf or by means of powers delegated to bodies at present exercising supervisory rules.

(17 July, 1990)