LIBA
L O N D O N I N V E S TM E N T B AN K I N G A S S O C I A T I O N
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e-mail: liba@liba.org.uk website: www.liba.org.uk
COMMISSION CONSULTATION ON THE REVISION OF THE
INVESMENT SERVICES DIRECTIVE
A RESPONSE BY THE LONDON INVESTMENT BANKING ASSOCIATION
(LIBA)
Summary of key issues
Introduction
Relationship between the ISD review and the Lamfalussy process
Proposed regulatory classification
Proposed adjustments to scope
Definitions
Proposed investment firm regime
High-level principles for regulated markets
Clearing and settlement
Paragraphs 1-4
Paragraphs 5-14
Paragraphs 15-27
Paragraphs 28-36
Paragraphs 37-39
Paragraphs 40-56
Paragraphs 57-59
Paragraph 60
Annexes:
List of Members of LIBA
Extract from LIBA’s response to the Commission’s November 2000
Communication: obstacles to cross-border business
_____________________________________________________________________
SUMMARY OF KEY ISSUES
The review of the ISD is central to the Financial Services Action Plan. It is a vital
opportunity to use the Lamfalussy approach to maximise the quality of the
legislative and regulatory framework for European investment services, in order to
encourage the development of efficient European markets, minimise cost of capital
for businesses, and provide investors with rates of return which reflect the risks taken
(paragraphs 5 – 14 below).
In most respects the existing ISD has worked well. It has provided a framework
within which European capital markets have been able to expand and innovate. It will
be vital for the revised ISD to enable continuation of this expansion and development,
which has hugely benefited investors, businesses, and European prosperity. A global
perspective is essential, to ensure that these benefits remain in the EU, and markets
are not driven elsewhere (paragraph 7).
Where the existing ISD has not worked well, the review should focus on targeted
amendments and effective enforcement. We welcome the proposals to address
shortcomings in the internal market, especially:

mutual recognition of country of origin requirements for all types of
business, limiting the ability of Member States to impose their own conduct of
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business and marketing rules on incoming cross-border business (paragraph
47): but this should not be contingent on prior harmonisation, especially in
relation to wholesale business;

appropriate definition of and limited rules regime for professional investors
(paragraphs 38, 39, and 45): but the definition needs to be broader and more
flexible,

removal of barriers to cross-border business, especially the abolition of the
connection requirement for foreign exchange business, and of the ability
of Member States to impose ‘concentration requirements’ (paragraphs 19,
34, 51): but the proposals on reporting of OTC trades could be even more
harmful than existing concentration rules.
But a number of the proposals would impose too interventionist and inflexible a
framework on European markets, especially on inter-professional transactions.
Such contentious and fundamental changes would risk delay in achieving more
urgent, realistic and beneficial improvements. The concerns which give rise to them
should be dealt with in a much more targeted and proportionate way (paragraphs 15 –
27). Particular concerns are:

the proposed restructuring of regulatory classifications of EU markets and
exchanges is too interventionist and would damage European markets;

the proposed mandatory reporting and immediate publication of OTC
trades in securities traded on ‘regulated markets’ would cut across the
existing balance between transparency and liquidity, and would seriously harm
European OTC markets.
The Lamfalussy approach should be applied as follows:

Level 1 framework directive: to define the scope and key concepts, and to
establish principles to govern the flexible use, but also to limit the misuse, of
implementing measures

Level 2 implementing measures to enable the adaptation of Level 1 definitions
in the light of changing circumstances, and to enable the flexible application
of Level 1 principles to the different characteristics and dynamics of different
markets

Level 3 cooperation to develop more detailed regulatory standards, where
necessary and appropriate, with improved coordination between the
Commission’s and CESR’s policy development

Level 4: effective and consistent enforcement of the directive

full and responsive consultation with interested parties at all levels as the
review develops, so that the revised ISD framework is fully adapted to EU
markets and their users, and so commands the support of all (paragraph 14).
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Introduction
1. LIBA represents the major European and international investment banks and
securities houses which base their European operations in London. Our Members
are major participants in European capital markets, and major providers of
investment services to European investors and businesses. A list of our Members
is attached as an Annex.
2. LIBA welcomes the opportunity to contribute expert opinions and advice whilst
the Commission’s proposals are still at a formative stage. This response is
consistent with our comments on the following consultations which have preceded
or are running alongside it:




the Commission’s November 2000 Communications on Upgrading the ISD
and the Application of Article 11 of the ISD.
FESCO/CESR 2000/2001 consultations on customer categorisation,
harmonised standards and rules for conduct of business, and the regulation of
ATSs.
The 2001 Report of the Lamfalussy Committee of Wise Men, the conclusions
of which we strongly supported
Other Directives and proposals, including the 2000 Electronic Commerce
Directive and the 2001 Proposals on Market Abuse, Prospectuses, and
Transparency for issuers.
3. This response starts with a summary of the most important general principles
which we think should guide the Commission’s further development of the
proposed new ISD (see above). It then considers how the review should be
brought into line with the Lamfalussy approach (paragraphs 5 to 14), proposes an
alternative approach to the issues which surround the Commission’s proposals on
regulatory classification and transparency (paragraphs 15 to 27) and concludes
with a detailed analysis of the Commission’s proposals and draft amendments
following the order of the consultation paper (paragraphs 28 to 60).
4. We have had the opportunity to see the responses of a number of other
associations, and we particularly support the general approach of the International
Swaps and Derivatives Association, the International Securities Market
Association, and The Bond Market Association.
The ISD review in the context of the Lamfalussy process
5. The efficient application of the ‘Lamfalussy approach’ to the review of the ISD
involves basing legislation on fundamental public policy objectives and expert,
market-aware analysis of the issues involved and the effect of legislative and
regulatory intervention. This approach should in turn enable efficient and
effective adoption and implementation of the revised ISD as one of the most
important elements of the Financial Services Action Plan.
6. The Lamfalussy Report recommended that European policy development should
be guided by fundamental public policy objectives. We suggest that in the case of
the ISD review, these objectives should be:
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
to encourage the development of efficient European markets,

to minimise the cost of capital for businesses in European markets,

to provide returns for investors in European markets which reflect the risk
taken.
7. It is particularly important to legislate for European capital markets with a global
perspective. The existing ISD has been successful in enabling the expansion of
existing European markets, the establishment of new markets and new trading
mechanisms, the exploitation of new technologies, and the development of new
instruments and new delivery mechanisms. These developments have enormously
benefited investors and businesses in Europe, and rendered European markets
highly competitive globally, by:

giving access to a wide choice of innovative means of investing and raising
capital and managing risk, and

promoting competition, thereby minimising the cost of capital and maximising
rates of return
The revised ISD must maintain innovative and dynamic European markets. It
should be noted that Europe’s most important competitor, the United States, is
currently liberalising its markets (partly because of competition from Europe and
other financial centres). It is therefore particularly important for Europe to avoid
any legislative or regulatory restrictions which would render European markets
uncompetitive internationally. If regulation is excessive or inefficient, markets
will be driven outside the EU. It is much more difficult to regain a market that has
been lost than it is to retain it in the first place.
8. The Commission’s July 2001 consultation on the amendment of the ISD can be
divided into two main elements:

Targeted liberalising amendments to resolve ambiguities, remove restrictions,
and entrench the internal market and mutual recognition basis of the directive
– broadly, and subject to a number of specific concerns detailed in paragraphs
28 to 60, these amendments command industry support, and are also
consistent with Lamfalussy’s identified priorities;

Wide-ranging restructuring of the conceptual framework of the ISD, replacing
a flexible framework based on choice between regulated market and
investment firm status with a rigid framework of regulated markets, ‘nonregulated’ markets, and investment firms, based on particular criteria. We
believe this restructuring is intended to tackle public policy concerns about the
existing regulatory framework in certain markets (notably equities) because of
the perceived effect of competition between trading platforms and
internalisation of order flows by investment firms. However, the proposed
restructuring has given rise to widespread concern about harmful side-effects
(see our detailed comments in paragraphs 15 to 27 below). It will be
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important to ensure that urgently needed targeted amendments to the
current legislation are not delayed by more controversial restructuring
proposals.
9. The priority for the review of the ISD should be the liberalisation of markets
and the elimination of barriers. The review should avoid either creating new
barriers or providing an opening for Member States to retain existing barriers or
introduce new ones. It should focus on agreeing and putting in place correctly
targeted amendments, and effective enforcement of the directive. This approach
will be consistent with both the Financial Services Action Plan and the
Lamfalussy Report, and will deal quickly and effectively with the priority issues,
in particular:

the need for a properly functioning internal market based on mutual
recognition of country of origin requirements for all types of business (on-line
and off-line, wholesale and retail),

the need for appropriate definition of and a limited rules regime for
professional investors, reflecting their greater expertise and lesser need for
protection against malpractice,

the removal of restrictions, ambiguities or loopholes that can be exploited by
Member States to restrict the internal market.
10. The proposed changes to the regulatory classification are too far-reaching,
and would have many harmful side-effects. They are not justified as a response
to the particular issues in particular markets which we understand they are
intended to address (see details in paragraphs 15 to 27). They are also too
inflexible: the ‘Level 1’ directive should not impose a single unadaptable
framework on all markets. It should allow market forces to determine the structure
of markets and encourage innovation and choice. We suggest an approach as
follows:

Level 1: Retention of the existing ISD’s flexible framework, combined with
high-level framework principles (reflecting public policy objectives) dealing
with issues of competition, market integrity, transparency etc.

Level 2 legislation and Level 3 regulatory cooperation: Thorough analysis of
the technical, commercial, and regulatory issues, in full consultation and
cooperation with market experts and market participants, resulting in
development of targeted measures which focus on the public policy concerns
which arise in each market.
11. More generally, we suggest that Level 1 legislation should cover the following:

Reinforcement of treaty principles: freedom to offer services cross-border;
mutual recognition; access to markets; removal of restrictions

Definition of scope and key concepts (e.g. professional investor)
5

Risk-based principles to govern the application of Level 2 legislation or Level
3 regulatory cooperation relating to detailed prudential, conduct of business,
and market conduct standards. Such principles should ensure that Level 2 and
Level 3 adapt flexibly to cater for the specific characteristics and dynamics of
different markets. They should also set appropriate limits on implementing
legislation: for instance, they should establish the principle of light regulation
of business with professionals.
12. We suggest that Level 2 measures should cover the following:

Adaptation of Level 1 definitions to enable flexibility in the light of changing
circumstances

Flexible and market-oriented application of Level 1 principles to the different
characteristics and dynamics of different markets, in consultation with market
experts and participants.
13. Level 3 cooperation should develop more detailed standards for regulated markets
and investment firms where necessary and appropriate. These should be
appropriately differentiated for different markets, developed in consultation with
market experts and participants, and with improved coordination between CESR’s
policy development and the work of the Commission and the European Securities
Committee at Levels 1 and 2.
14. Consultation is a central plank of the Lamfalussy approach. We welcome the
consultative approach which the Commission has adopted to the ISD review,
complemented and supported by CESR’s consultations on conduct of business
standards and the regulation of ATSs. The public hearing in Brussels on 18th and
19th September 2001 was a welcome opportunity for constructive discussion of the
issues, although it also showed the difficulty of attaining agreed solutions, and
demonstrated how important thorough analysis of the issues and fully
responsive consultation are, both now and going forward, to ensure that the
resulting legislation in this highly complex and technical area has the highest
possible degree of effectiveness, proportionality, relevance, and adaptability.
The Commission’s proposals on regulatory classification and trade reporting as
presented raise considerable concerns that they would harm European markets and
give rise to avoidable costs. The Commission should not proceed with these
aspects in their current form. Depending on how the Commission proposes
to proceed, it may well be the case that further consultation will be
appropriate in these areas. In any event, the Commission should justify any
new obligations or far-reaching changes to the structure of the ISD by means
of a thorough analysis of the existing problems and how its proposals are
designed to solve them. We are keen to continue to help the Commission to
develop a measure which addresses threats to public policy objectives in a
proportionate way, but also does not damage European markets.
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Proposed regulatory classification; definition of organised and regulated markets
(Definitions 13 and 14); reporting of off-market trades to enable integration in realtime price feeds (Article 18)
15. Our understanding is that, through the proposed new regulatory classification, the
Commission intends to tackle certain specific risks which arise in certain markets,
in particular the equities market. In the Commission’s view, these arise because
of:

the emergence of entities which, while they are regulated as investment firms,
have certain exchange-like characteristics, and

the internalisation of order flow by investment firms.
16. We understand that a particular concern is a possible ‘deterioration of the
efficiency of price-formation’ because substantial volumes of transactions are not
made available ‘to the market as a whole’. Clarity of definition of terms is
particularly important in this context, given the current wide variation across
Europe in trade reporting requirements. For example, members of the London
Stock Exchange are generally required to trade report to the Exchange all trades in
listed securities, even if they are transacted ‘off exchange’; this level of
transparency is not replicated by other European regulated markets. Not all
European exchanges currently mandate immediate trade reporting. The result is a
wide variation between different markets in the way information on OTC
transactions is made available to other market participants.
17. The approach to transparency needs to be informed by due regard for the other
elements of efficient markets, in particular liquidity and the avoidance of
excessive volatility. While information about an OTC transaction might help a
third party in determining the price of a security, the possibility not to disclose a
transaction to the market might be an essential condition for a market participant
to take on risk and enter into the transaction in the first place. This dichotomy
defines the widely recognised fact that the benefits of increased transparency must
be weighed against possible negative effects on liquidity. There is also a need to
recognise the different characteristics of different markets, and the fact that the
‘market price’ is not necessarily the same for wholesale and retail business. In
non-equity markets (e.g. bonds and derivatives) immediate trade reports could be
much less meaningful than they are in equity markets: in some instrument they
would serve little price-information purpose, and could reduce liquidity. In OTC
derivatives markets, where transactions are not standardised and there is no
centralised marketplace, and also in the case of structured transactions, price
publication could be positively misleading. In complex markets with many
participants, the location of the reference price can change when the liquidity
changes. For example, even in liquid and transparent equity markets, price
formation is affected by markets outside the EU, and can take place outside
Europe altogether, in US ADR markets, after European markets have closed. In
bond markets, the recent arrival of ATSs has improved the liquidity, transparency,
competition, and efficiency of the market as a whole, and the complexity of
ATSs’ interaction with the continuing OTC markets means that the equity-marketbased model cannot be efficiently applied. Many corporate bonds and most
7
government bonds are admitted to trading on regulated exchanges, often because
admission to trading is a necessary requirement if funds are to invest in them.
However, for many bonds trading takes place rarely on regulated exchanges, and
almost exclusively in OTC markets, and the reference price is not determined by
on-exchange trading.
18. It has not been demonstrated that the existing ISD structure has prevented the
development of diverse and innovative capital markets in the EU. In fact the
reverse is true. Under the existing structure, innovation, driven by competition
and technological development, has enabled markets to respond to demand for
new products, new trading mechanisms, and new risk-management methodologies
in a way which has increased the efficiency of markets and benefited both
investors and raisers of capital.
19. We believe that the radical change to the regulatory classification which the
Commission proposes, combined with the proposed obligations for trade
reporting and the strict demarcation of instruments between regulated and
non-regulated markets, is not an appropriate or proportionate response to
any risks which may currently exist. It is difficult to predict all of its
consequences, but it is reasonably clear that the Commission’s proposal would
have harmful side-effects which are very likely to outweigh substantially any
potential benefits. It could:

harm the liquidity of the OTC markets in exchange-traded instruments

deter investment firms from using their own balance sheets to execute large
trades

impose substantial cost burdens on investment firms which would need to
adapt systems to be able to identify when they might have to report
transactions to exchanges, and to create the necessary links to be able to make
those reports (apart from the charges that exchanges would impose for
receiving the reports)

constrain the market’s freedom of operation (for instance, an investment firm
would need to monitor or constrain improvements to its order-matching
service if it risked becoming an organised market and thereby either losing its
passport or becoming liable to become a regulated market),

restrain innovation (for instance, innovation in derivatives markets depends on
the continual development of new products, only a small proportion of which
attract liquidity and become successful; this source of new products could dry
up if they were vulnerable to ‘takeover’ by regulated markets.);

confer unfair competitive advantage on incumbent traditional exchanges (for
instance because of their preferential access to valuable trade information,
their better positioning to adapt to the proposed new standards, and their
ability to undermine non-regulated markets by admitting new instruments or
products to trading);
8

fail to take due account of the varying characteristics of different markets (for
instance, by applying a model which we believe has principally been designed
to cater for certain perceived issues in equity markets - partly because of their
significant retail participation – to other markets which are mainly
professional in character and to which very different market dynamics and
regulatory considerations apply);

risk making European markets uncompetitive globally, and driving business
outside the EU (for instance, by reducing the ability of the market as a whole
to adapt continuously to users’ needs);

give scope for manipulation of market structures by enabling regulated
markets to force other entities to change their regulatory classification, or even
to ‘take over’ the market in products which have been developed by nonregulated competitors, by admitting instruments to trading on the regulated
markets, and thereby prevent their being traded on non-regulated markets (this
problem could be particularly acute in derivative markets, given the ambiguity
of the concept of a ‘proper market’);

effectively represent a reimposition, by other means, of concentration
requirements, which the Commission has elsewhere recognised are an
impediment to the internal market. However, whereas concentration
requirements are optional under the existing ISD, the channelling of trading
under the Commission’s proposals would be mandatory.
20. The interdependence of the proposed definition of regulated markets and of the
instruments traded on them (quite apart from the serious concerns which the
industry has expressed elsewhere about the Proposal for a Prospectuses Directive),
combined with the proposed prohibition on trading of regulated market
instruments on a non-regulated market, is likely to give rise to further rigidities,
and to slow down the responsiveness of markets to the commercial needs of their
users.
21. In practice we think that the uncertainty associated with non-regulated organised
market status would be likely to be such that the status would be commercially
unsustainable. The effect of the Commission’s proposals would thus be that
trading platforms would be either regulated markets or investment firms (as at
present), but without the flexibility in the system which at present allows and
encourages development of new systems, innovation, and competition. This
would be particularly problematic for investment firms which have closely
integrated systems which would be defined as ‘organised markets’ into their
operations, or which might want to do so in future.
22. In summary, we do not think that the ISD should introduce a rigid definition
of regulated markets, nor define an ‘organised, non-regulated market’ to
which the ISD passport would not apply, since this could introduce rigidity in
market structures, prevent innovation, and distort competition. We think
that a ‘bottom up’, graduated, targeted approach offers a better opportunity
than a heavy-handed ‘top down’ approach to develop appropriate policy for
9
multiple and diverse trading platforms without distorting the overall
European market framework.
23. CESR has already initiated a debate on how to approach transparency issues in
evolving market conditions in its 2001 consultation on the regulation of
alternative trading systems. This initiative is consistent with the commitment in
CESR’s Charter to ‘observe and assess the evolution of financial markets and the
global tendencies in securities regulation and their impact on the regulation of the
Single Market for financial services’. The industry has commented widely on the
need to narrow down and target CESR’s proposed standards, in particular to
ensure that they:

are justified by an identified public policy need which cannot be met otherwise

do not duplicate other existing requirements

take account of the discipline imposed by market forces

distinguish effectively between markets where there is retail participation and
markets which are exclusively professional

are tailored to the specific characteristics of each market
24. We think that the appropriate way forward on the transparency and priceformation issue is to retain the ISD’s existing flexible regulatory classification,
and to develop tailored and targeted measures only where it is shown that the
market has failed to deliver an appropriate level of transparency. Before
supplementing the market-driven level of transparency in any given market, the
Commission and CESR, in consultation with market participants, market
operators, and market users, should:

conduct a detailed analysis of the public policy need and market dynamic in
the different markets (taking account of the need to strike an appropriate
balance in each market between transparency, liquidity, and avoidance of
excessive volatility, and also of the extent to which voluntary arrangements –
such as sale of trading data, membership of exchanges and other execution
venues, and other private law agreements – already maintain an appropriate
level of transparency),

develop, at Lamfalussy Level 2 or 3, tailored additional standards for each
market, but only where the analysis has clearly shown a need for regulatory
intervention, and

introduce at Level 1 high-level principles which would require the detailed
standards to take account of all the elements of an efficient market.
10
25. The advantages of this approach over the Commission’s proposals on regulatory
classification include:

it would enable the retention of the existing flexible structure, and thus avoid
the undesirable consequences of forcing entities to structure their services on
the basis of regulatory rather than commercial criteria.

it would enable effective and targeted regulation of ‘off-exchange’ trading by
entities which would, because of their characteristics, fall into the proposed
‘non-regulated organised market’ category, without constraining their ability
to structure their services on the basis of commercial criteria.

it would enable effective and targeted regulation of transparency and priceformation, taking account of the specific characteristics of different markets.

it would lend itself to effective development and update, in an ongoing
consultative process with market participants, at Level 3 or Level 2 of the
Lamfalussy structure.
26. We strongly oppose the Commission’s proposal under Article 18 not to allow
deferred reporting of ‘off-regulated exchange’ very large trades which give
rise to market exposure. Deferred reporting is vital if firms are to be prepared to
take on the risk of a substantial exposed position when the market may move
against them. It should be noted that for on-exchange trade reporting Article 21 of
the ISD currently allows for block trade exemptions. Large trades are often
undertaken by pension funds or UCITS which manage funds on behalf of private
individuals, on whom the harm of adverse price movements would therefore fall.
In practice, without deferred reporting such transactions would either not be
undertaken at all because of their high market-impact costs, or might migrate
outside the EU to a jurisdiction where anonymity could be preserved. Liquidity is
likely to follow, so that EU markets would end up less liquid and less transparent.
27. We agree with the Commission’s reservations about its proposal under Article 18
to require trade reporting to the ‘leading regulated market’, and we strongly
oppose this proposal. It would give rise to a severe danger of market distortion
and the establishment of a legislative monopoly on price formation. We are not
aware of shortcomings in the existing market-driven arrangements for aggregating
trading data from different markets which would justify such a rule. The approach
to this issue needs to be graduated and take full account of both variations
between markets, and solutions provided by the market itself. In bond markets,
for instance, the ‘regulated market’ is a late-comer, and the market with the
longest tradition of trading is the OTC market. Regulated exchanges have
developed in order to fulfil a market need to provide greater liquidity and
transparency; the development of alternative trading systems has been prompted
to fulfil the same need. There is no need for the position of regulated exchanges
to be artificially reinforced, indeed requiring all OTC trades to be reported to them
could be highly damaging to the market as a whole. In derivatives markets,
regulated exchanges have also developed only recently, and substantial liquidity
(which could often not be provided otherwise) remains with OTC markets. In
both bond and derivative markets it is only very rarely that the OTC market
11
influences the price formation process on regulated exchanges. The competitive
effect of requiring investment firms to report valuable, time-sensitive trade data
immediately and free of charge to competitor exchanges could also be highly
damaging. The Commission should also consider the cost implications for firms of
the multiple price feeds which they would need to establish to a range of regulated
markets if the proposals were to go ahead.
Proposed adjustments to scope
28. Some of the proposed adjustments are helpful clarifications of provisions in the
existing ISD where ambiguities may have been exploited by Member States to
restrict the internal market. However, amendments to the text should not be a
substitute for ensuring that investment firms are able to take advantage of the
passport. Going forward, in the context of both the existing and the new ISD, the
Commission should actively enforce passporting rights. We also assume that the
Commission plans to review the scope of the Banking Consolidation Directive to
ensure the necessary degree of consistency with the ISD.
29. Arranging/facilitating (Definition 1): We think that the proposed clarification that
the passport applies to order-routing, bulletin boards, and introducing brokers is
likely to be helpful to regulated firms. We welcome the proposal to provide for
variation of conduct of business requirements to reflect the reduced risk: the detail
of this should be dealt with at Level 3. It would be important to ensure however
that the extension of scope was structured so that it did not bring into the ISD
internet portals.
30. Order-matching (Definition 2): We welcome the proposed clarification that the
passport for brokerage includes automated order-matching and execution-only
business. The definition should not be restricted to firms acting as agent, but
should include riskless principal business. It should also not be restricted to
transmission of orders to ‘appropriate execution venues’.
31. Underwriting and placement (Definition 4): We welcome the extension to include
support and placement services which do not involve a guarantee to take up
unsubscribed capital.
32. Investment advice (Definition 6): Under the Commission’s proposal firms would
obtain a passport only for personalised, separately remunerated advice. However
it will be essential to ensure that investment advice is retained as a non-core
service within section C of the Annex as well so that investment firms can
continue to provide cross-border advisory services in association with their core
services.
33. Securities lending and borrowing, repos, reverse repos (Definition 8): We support
the proposal to make clear that the passport applies to these, although we would
argue that they are already covered by paragraph 2 of section A of the Annex of
the ISD. However we are concerned that its usefulness should not be limited by a
requirement for the ‘express consent’ of clients. It will be important to ensure that
the wording does not imply that consent is required for each and every transaction.
12
34. Foreign exchange services (Definition 9): We support the Commission’s proposal
to remove the requirement that foreign exchange services be linked to provision of
core investment services.
35. Granting credits or loans (Definition 10): We oppose the restriction of the
passport to circumstances where the firm acts in a fiduciary capacity. We favour
the retention of the existing paragraph 3 of section C of the Annex.
36. Commodity derivatives (Definition 12): Any directive-level provisions on
commodity derivatives should clearly target the removal of barriers to such
business. No case has been made for imposing licensing requirements on
wholesale commodities-related business. Preferably the directive should require
both home and host Member States to remove licensing requirements on
wholesale commodity business, although we recognise that this may be difficult to
achieve, at least in the short term. But if Member States are able to continue to
impose licensing requirements, it would be important for the directive to
recognise that host State licensing requirements are legitimate only for firms
which are not properly regulated in their home State (in accordance with the 1986
insurance judgements) – a recital to this effect would be necessary to make the
position clear.
If the removal of licensing requirements for wholesale business is not feasible,
there are two possibilities for including commodity derivatives in the directive: as
a non-core service in section C of the Annex (which we would prefer), or as a core
service in Section A of the Annex. In either event, inclusion of commodities
business within the scope of the ISD would reinforce the importance of other
issues with respect to the structure of the ISD which are discussed elsewhere in
this response:

The directive would need to make clear that Member States could not apply
their licensing requirements to derivatives transactions entered into by an
entity for its own account with, or through the agency of, an authorised firm.
An entity which conducts business in this way should not be regarded as
dealing for third parties.

Conduct of business rules would need to be appropriate to the nature of
commodity derivatives business, and above all the directive must require a
light and flexible conduct of business regime for business conducted with
professional investors.

The directive would need to include a broad and flexible definition of
professional investors which allowed corporate investors to be treated as
professionals.
Of the two options indicated above, we would prefer commodity derivatives (and
other commodity-related services including physical business – to cover the case
where Member States extend their licensing requirements that far) to be included
as a non-core service in section C of the Annex. This would avoid requiring
Member States to impose licensing requirements (which would involve a need to
check through the directive to ensure that provisions relating to investment firms
13
were appropriate to commodities business), while extending the benefit of the
passport, but only to investment firms. Member States would retain the flexibility
to ensure that some regulatory oversight is applied to such business.
If, nevertheless, commodity derivatives are included in section A of the Annex as
a core service, Member States would be required to impose licensing
requirements, and it would be essential to ensure that the directive made provision
for the following in addition to the three general bullet points set out above:

an exemption under the current ISD’s Article 2 for firms which solely trade
with other professional investors;

at the very least, Member States having the ability to modify the regulatory
capital regime for commodity firms, especially in the case where they trade
only with other professional investors (thus recognising the special nature of
commodities business and, in particular, the importance of the liquidity which
specialised firms provide to the market). This could be done by including a
provision to this effect at the end of proposed Article 3.

the inclusion of services related to physical commodity transactions in section
C of the Annex as non-core services, to address barriers to business in
countries which persist in applying licensing requirements to physically settled
transactions;
If commodities business were brought within the ISD on an inappropriate basis,
without regard for such points, we believe that the damage to the European
commodities markets, their users, and those sectors of the economy that depend
on them, could be significant. (See also our comments in paragraphs 19 and 27
above on the harm which could be done to the commodity markets as a result of
the Commission’s proposed regulatory classification and trade reporting
requirements.)
Definitions
37. Organised markets, Regulated markets (Definitions 13, 14): See our comments on
the proposed regulatory classification in paragraphs 15 to 27 above.
38. Professional investor (Definition 18): We welcome the Commission’s acceptance
of the general principle that the definition of professional investors needs to be
tailored to recognise the extent to which all participants in wholesale markets are
sophisticated, and there is not in wholesale markets any inequality of market
power which means that one party needs to be ‘protected’. We also welcome the
proposal to include large and sophisticated corporates among ‘professionals’.
However, a number of specific adjustments are still needed, and similar
modifications are required to bring CESR’s October 2001 proposed definition into
line. ‘Professional investors’ should be defined so that the following are also
included:

non-EU listed corporates;
14

members of groups which include large or listed companies;

non-publicly-offered listed companies

local and public authorities, and national and central banks

sophisticated small corporate and individual investors whom the firm has
assessed as expert, and who have agreed to be treated as professionals.
39. We also welcome the proposed provision enabling non-professionals to agree to
be treated as professionals. It will be important to ensure that both parties can rely
on such agreement, and that any provision for it to be ‘overridden by the initial
public law categorisation’ does not provide scope for the parties to renege with the
benefit of hindsight. It will also be important to word the Level 1 definition, and
develop Level 2 legislation or Level 3 standards, so that the parties can agree the
disapplication of protections in a targeted way if they so wish.
Proposed investment firm regime
40. Vetting and approval of business operations (Article 2): It will be important to
ensure that firms are given the opportunity to manage conflicts of interest, and are
not required simply to limit them. In many circumstances (particularly with large
integrated houses), conflicts of interest are unavoidable but are managed through
Chinese walls or other internal independence policies, and/or are disclosed to
customers.
41. The Commission’s proposals do not appear to replicate the current ISD
requirement (Article 3.5) that supervisors inform applicants within six months
whether or not authorisation has been granted. We believe that this deadline is a
valuable discipline for regulators, and should be retained.
An additional point which is being raised by our Members concerns the way in
which the regulators calculate the fees that they charge firms which undertake
business outside their home State. There is growing concern that the fee tariffs
which are used in such cases do not reflect the extent to which the supervisory
work of the home State regulator significantly reduces the amount of work which
the host State regulator has to undertake (as compared with the latter State’s
activity in respect of firms of a similar size and business profile for which it acts
as the home State regulator. As a result, firms undertaking business outside their
home State are charged more than they should be. Where a host State has no
regulatory responsibility for the business of a firm authorised in another Member
State, it should not charge the firm a supervisory fee; to the extent that host States
retain regulatory responsibilities under the ISD, the directive should be amended
to include provisions requiring competent authorities to take into account their
reduced responsibilities when fees are set for firms authorised in other Member
States. Paragraph (d) of Annex II to the Investor Compensation Schemes
Directive provides an example of this sort of approach.
42. Organisational requirements (Article 12): The Commission proposes new
organisational requirements relating to: systems resilience and contingency
15
arrangements to cope with fluctuations in demand or usage or to provide back-up
facilities; prior approval of a number of aspects of order-matching facilities; and
prior approval of ‘important’ outsourcing arrangements. Whilst these may be
areas of legitimate regulatory interest, it will be important to structure the
provisions to prevent regulators from ‘micro-managing’ firms’ IT systems and
outsourcing arrangements, and to limit regulators’ ability to use ‘prior approval’ to
override firms’ commercial judgement. Similarly, it will be important to limit the
definition of ‘important’ outsourced services.
43. In many circumstances it is not appropriate to require a market to have systems
which are robust enough to contend with large fluctuations in demand. Usually it
will be possible for professional customers to have access to alternative means of
trading. Only if the system is the only or only significant trading mechanism for
the relevant instrument, or in relation to retail customers, should such a
requirement apply.
44. The Commission suggests that record-keeping, client money and assets
identification, and conflict of interest control (but not the ‘system-related’ matters
discussed in paragraph 42 above) might need to be subject to country of origin
control because they are ‘investor-facing’ in nature. We support a country of
origin approach in these circumstances. The ‘country of origin’ should be as
defined in the Electronic Commerce Directive. This would mean that when the
relevant function was provided in connection with a service provided by the
branch but not by the head office, the country of origin would be the country of
the branch. If however the relevant function was part of a centralised service
provided by the group as a whole, the country of origin would be where the centre
of the activities was, and would equate to the home State.
45. Conduct of business and dealing requirements (Article 13): We welcome the
specific provision in Article 13 requiring implementing measures to take account
of the nature of the service offered, and of the capacity of professional investors to
make informed or expert judgements. However, we think that the Directive
should go further, and explicitly state that certain types of service (e.g. executiononly) and the professionalism of the investor imply a lesser need for conduct of
business protection and therefore a lighter conduct of business regime (this would
accord with the statement on page 18 of the consultation paper: ‘the Directive
should reaffirm the principle that the full weight of conduct of business
protections does not need to be brought to bear in the case of services provided to
professional clients’). The lighter regime for professionals should encompass the
exclusion from the proposed conduct of business obligations of certain of the
detailed provisions as detailed at the end of this paragraph. Some of these
concerns continue to apply also to CESR’s proposed standards and rules for
conduct of business, in spite of the revisions to CESR’s proposals in its October
2001 consultation paper. It will be important for the provisions of implementing
legislation under the ISD and CESR’s final standards to be consistent and to take
account of these issues.

The statement that a firm should act ‘in accordance with the best interest of its
clients’ is not appropriate to inter-professional markets, the nature of which is
such that firms cannot be expected always to know or act on their clients’ best
16
interests; the equality of market power between professionals makes a
fiduciary relationship inappropriate;

Some of the proposed requirements are relevant only to non-professional
customers, in particular: details of compensation scheme (2); suitability
obligation (3); operation in the best interests of the investor (6); risk warnings
and guidance (7); information about instruments, investments and execution
venues (8); best execution (9)
46. We welcome the exclusion from conduct of business protection of principal to
principal business (but see also our comments on look-through provisions in
paragraph 50 below).
47. We strongly support the Commission’s proposal to apply the country of origin
approach (home State control for services provided from head office,
supplemented by branch State control for services provided from branches, with a
prohibition of host State requirements on incoming cross-border services) to all
investment services, whether the service is provided on- or off-line, and whether
the client or counterparty is wholesale or retail. However the Commission
proposes that the country of origin approach shall apply only after the
implementing measures are in place. We do not think that such a delay is
justified, in principle or in practice. We attach as an Annex an extract from our
response to the Commission’s November 2000 Communication on the Upgrade of
the ISD which describes why the broad application of the country of origin
approach is so urgent. The progress of CESR towards agreeing conduct of
business standards at Level 3, together with the progress towards agreement of the
proposal for a Directive on the Distance Marketing of Financial Services and the
imminent implementation of the Electronic Commerce Directive removes any
justification for retaining detailed harmonisation as a pre-condition for the full
adoption of a country of origin approach. Acceptance of the country of origin
principle will in itself provide an incentive for rapid convergence of Member
States’ conduct of business standards at an appropriate level, and it is therefore
appropriate for the Commission to give its backing to it, not only without preconditions in the revised ISD, but also immediately in the context of the
enforcement of the existing ISD. The implementation of the Electronic
Commerce Directive in January 2002 will apply the country of origin approach to
conduct of business requirements for services provided electronically; the regime
for off-line business should be brought into line in order to avoid competitive
distortions between services according to how they are delivered, and to enable
the effective and well-regulated provision of services which are delivered using
both on-line and off-line media. Any deficiencies in Member States’ detailed
conduct of business rules should be dealt with directly, rather than being allowed
to impede the single market. Furthermore, there is a risk that if the country of
origin approach is made conditional on the implementation of harmonised
standards, the internal market could be delayed by Member States which are slow
to put in place the implementing measures.
48. We support the inclusion of advertising and marketing rules with conduct of
business rules and the application of the country of origin regime to them.
17
49. These principles of country of origin control and a lighter regime where
appropriate to the type of business or customers’ reduced need for protection
should be established unequivocally at Level 1. Provisions on the detailed content
of conduct of business provisions are not necessary at Level 1, and detailed
conduct of business standards should be dealt with (subject to full transparency
and consultation) via the continuing CESR consultation process at Level 3.
50. Look-through provisions (Article 13): The proposed provision appears to have
widened the circumstances in which an investment firm has fiduciary
responsibility for another firm’s client. The current Article 11.3 applies only
when the immediate customer receives or transmits orders, whereas the proposed
provision applies when the other investment firm has ‘mediated or interposed
itself’. In spite of the exception for a customer which does not disclose that it is
acting on behalf of a third party, the Article is likely to impose too great a level of
fiduciary responsibility on firms. It is similarly particularly important that
CESR’s proposed regime for market counterparties should apply to agency
dealing as well as principal dealing between authorised firms.
51. Obligation to disclose order-routing practices (Article 15): We welcome the
proposed abolition of concentration rules. However we are concerned that the
Commission’s proposed regulatory classification would have the effect of
reintroducing concentration requirements in a mandatory context (see paragraph
19 above). We think that the proposed quarterly reporting to competent
authorities on execution venues will be a less effective means of policing best
execution than a requirement to report to clients on which markets the firm has
access to, supplemented by appropriate conduct of business rules on best
execution. This disclosure to clients would be an important element of the
solution to the transparency and price formation issue which we propose in
paragraphs 22 to 27 above, since it would enable clients to make a proper
assessment of the relative costs and benefits of investment firms’ services. Client
reporting should be dealt with as a conduct of business rules matter at Level 3.
52. Obligations of investment firms to the market (Article 16): The Commission has
published a separate Proposal for a Market Abuse Directive, on which LIBA and
other associations are commenting separately. It will be important not only that
the industry’s concerns about the Proposal are resolved satisfactorily, but also that
the ISD does not duplicate that Directive or impose additional obligations. Whilst
it is clearly important for investment firms to be prepared to assist the authorities
to detect or prevent abusive behaviour, it is not clear that there is a need for this
issue to be dealt with in the ISD at all. Any provision in this area in the ISD
should make clear that control is by the Home State; cross-border issues should be
dealt with by cooperation between regulators via existing mechanisms. Any
provision in the ISD should also not single out order-matching systems for more
onerous requirements than other dealing methods.
53. Reporting of transactions to competent authority (Article 17): The implementation
of the proposal to extend reporting obligations to all transactions which take place
on a regulated market is likely to be complex and would impose on firms the
additional cost of establishing the necessary data feeds. Particular problems are
18
likely to be caused by the proposed requirement to provide data on the identity
and professional or retail status of the customer.
54. Reporting of transactions in instruments admitted to trading on regulated markets
which are performed outside the rules of a regulated market (Article 18): See our
comments on this issue in the discussion of the proposed regulatory classification
in paragraphs 16 to 27 above.
55. Counterparties to public authorities (Article 21): We think that the ability of
Member States to restrict access to primary dealing should be removed. Whilst
we welcome the proposed tightening of the exception for counterparties to public
authorities in Article 21, so that any restrictions on branch or cross-border
provision of these services would need to be based on ‘objective, proportionate
and transparent’ requirements, we think that this leaves too much scope for
ambiguity and protectionist exploitation. At the very least, the Commission must
rigorously police the proportionality of restrictions at Level 4.
56. Access to regulated markets and clearing and settlement (Articles 22-23): We
welcome the Commission’s proposals for non-discriminatory access to regulated
markets and clearing and settlement facilities.
High-level principles for regulated markets
57. (See also our comments on the proposed regulatory classification in paragraphs 15
to 27 above.) Our attitude to the proposed high-level principles for regulated
markets depends very much on whether the Commission persists with its proposal
to make regulated market status compulsory if the relevant criteria are satisfied, or
whether it is decided to continue (as we think essential) with the present structure
under which regulated market status is a matter of choice. Certain of the proposed
standards (for instance operation of strict controls on instruments admitted to
trading, immediate post-trade transparency) would be likely to give rise to
considerable additional cost to platforms currently regulated as an investment firm
which decided or was obliged to become a regulated market. Such costs would be
likely to be a material factor in such entities’ decision-making, and are therefore
likely to distort the ‘regulated market’ sector in a way which would discourage
new entrants, discourage innovation, and favour incumbents.
58. Provided that platforms retain the flexibility to choose between regulated market
and investment firm status, and subject to our detailed comments below, in
general the proposed principles appear to be a reasonable statement of what
should be expected of exchanges. There should be high-level principles only at
Level 1, with details worked out adaptively and consultatively at Levels 2/3,
building on the existing FESCO standards for regulated markets.
59. We have the following comments on particular aspects of the proposed principles:

Financial resources (Article 28): The Commission asks for comments on
possible methodologies for establishing a financial resources requirement.
The Commission’s proposed principle is stated generally: ‘sufficient financial
resources to contend with the risks to which the system may be exposed…and
19
to allow for orderly closure. In order to avoid competitive distortion, financial
resource requirements for regulated exchanges should broadly correspond to
the requirements which investment firms are subject to under CAD.

Controls on instruments admitted to trading (Article 29): See our comments in
paragraph 19 above on the constraints to which the market would be subject as
a result of allowing only instruments which meet the specified criteria to be
admitted to trading. Market integrity and investor protection are sufficiently
served by the FESCO standards’ approach of requiring disclosure of the basis
on which instruments are admitted to trading.
It will be important to make unambiguously clear that the principle that
regulated markets must operate strict controls on the instruments admitted to
trading does not imply that a regulated market is required to have a contractual
relationship with the issuer of the instrument, and does not enable issuers to
restrict the markets on which the instrument is traded.
The requirement for there to be a ‘proper market’ in derivatives based on
commodities, rates, or indices could prevent market operators from
introducing new contracts in situations where it is not certain that liquidity will
be forthcoming, and thereby inhibit innovation.

Arrangements to promote transparency (Article 33): See our serious concerns
in paragraphs 16 to 27 above on the proposed obligation for investment firms
to report off-market transactions in relevant instruments to the ‘leading
regulated market’: the Commission should not continue with this proposal.
See also our concerns in paragraph 26 above about the proposed absence of a
block trade exemption in Article 18. The proposal in Article 33 for ‘as
instantaneous as possible’ publication of trades, without any provision for
delay for block trades, fails to recognise the market distortion and the
damaging effect on market liquidity and competitiveness which such a
requirement would cause. The function of delayed reporting is to enable
market participants which take on large exposures to take steps to manage
their risk before the trade becomes public. Immediate publication of such
trades would enable other participants to move the price against the holder of
the exposed position (typically pension funds or UCITS which manage funds
on behalf of private individuals, on whom the harm of adverse price
movements would therefore fall), so that the price would be artificially
distorted. Article 21 of the current ISD recognises the function which block
trade exemptions serve, and the revised ISD should do so as well. In practice,
the absence of block trade exemptions would result in the withdrawal of the
liquidity which they provide from European markets altogether.
Clearing and settlement
60. We welcome the Commission’s proposals on liberalisation of access by
investment firms and regulated markets to clearing and settlement systems. It is
however important that the limits and qualifications to these rights cannot be
20
exploited to restrict competition or market access. The wording of the revised
ISD needs to strike the appropriate balance between:

not mandating links, and

encouraging interoperability.
London Investment Banking Association
2nd November 2001
TMMB/Oct24/COM77A
21
MEMBERS OF THE LONDON INVESTMENT BANKING ASSOCIATION
Ansbacher & Co Limited
ABN AMRO Bank N.V.
Arbuthnot Latham & Co., Limited
BNP Paribas
Barclays Capital
Bear, Stearns International Limited
Beeson Gregory Limited
CIBC World Markets Plc
Cazenove & Co.
The Chase Manhattan Bank
Close Brothers Corporate Finance Ltd
Collins Stewart Limited
Commerzbank AG
Credit Suisse First Boston International
Daiwa Securities SMBC Europe Limited
Dawnay, Day & Co., Limited
Deutsche Bank AG London
Dresdner Kleinwort Wasserstein
Goldman Sachs International
Granville Baird Ltd.
Hawkpoint Partners Limited
HSBC Investment Bank plc
ING Barings
Insinger English Trust
Instinet UK Ltd
Investec Bank (UK) Limited
Knight Securities International Ltd
Lazard
Lehman Brothers
Merrill Lynch Europe PLC
Mizuho International plc
Morgan Stanley International Ltd
Nomura International plc
Old Mutual Securities Ltd
Peel Hunt plc
N M Rothschild & Sons Limited
Schroder Salomon Smith Barney
Singer & Friedlander Holdings Limited
Société Générale
3i Group plc
The Toronto Dominion Bank
UBS Warburg
Westdeutsche Landesbank Girozentrale
sd E/memnam
July 16, 2016
22
ANNEX: Extract from LIBA’s response to the European Commission’s
November 2000 consultative Communication on the Upgrade of the Investment
Services Directive
1. The imposition of country of destination rules in addition to country of origin
rules imposes a major barrier to cross-border business, not just for SMEs, but for
major financial institutions as well. We outline below some of the main
difficulties. It is important to emphasise that overlapping and conflicting rules,
coupled with insufficient recognition of investor sophistication, uncertainty of
application, and the possibility of unenforceability of contracts, gives rise to
unnecessary risk which affects the willingness of all affected financial institutions
to enter into transactions.
2. Both the direct cost and the indirect cost associated with managing the risks are
likely to be reflected in the costs charged to customers. Overlapping requirements
thus make financial products in Europe (including retail products, since product
providers lay off their risk in the wholesale markets) more costly than they should
be. The risk involved may also be such that the firm decides not to enter into the
transaction: overlapping requirements can thus restrict the choice of products
available across borders in Europe.
3. The risks involved for a firm which wishes to deal across a range of countries are
many-layered. Aspects of this include the duplicative application of both the
country of destination and country of origin rules, the differences and potential
contradictions between them (and the cost of establishing what the local
requirements are), the fact that country of destination rules may be
disproportionate to the needs of the investor, and the risk that the contract may be
unenforceable if country of destination rules are not complied with. This
complexity in itself increases the level of risk.
4. The development of electronic commerce and consequent expansion of demand
for cross-border trading has given new prominence to the obstacles, and made it
all the more urgent that they be removed.
5. Specific obstacles include the following:

Member States use different criteria to determine the Member State 'in which' a
service is provided, including the 'characteristic performance' test (which is
consistent with the country of origin principle, and is supported by the
Commission's interpretation of the Second Banking Directive), solicitation tests,
and tests based on the country of residence of the investor.

Article 11 requires Member States to impose conduct of business rules on
investment firms (including banks conducting investment business). However, the
way in which Member States do this differs substantially. Some Member States
have very detailed conduct of business rules. Some have only high-level general
principles. Some distinguish sharply between the rules that apply to business with
a defined class of professional investor. Others do not distinguish so sharply e.g.
by imposing duties that vary according to a subjective assessment of the level of
expertise of the investor. Some classify corporates as non-professionals unless
23
they opt to be treated as professionals, whereas others classify them as
professionals; some do not allow corporates to opt to be treated as professionals,
while others do not distinguish at all between professional and retail customers.
Furthermore, many Member States do not recognise the concept of 'expert' private
individuals who may opt to waive some of the protections available to less
experienced private customers.

Restrictions remain on the ability of firms to use the passport for trading in
various Member States. Even when companies or banks are granted a passport,
implying that they have met the local licensing requirements, they may still be
denied access to local markets. In some Member States a broker or dealer is
entitled to operate an electronic trading platform to provide services to its
customers. In others the provision of services in that way is regarded as the
operation of an ‘exchange’, and the passport is deemed insufficient. Despite the
passport provisions of the ISD, not all Member States permit EU securities firms
to access exchanges and clearing services without requiring that the EU firm
offers services from a branch or subsidiary located in the Member State. Some
Member States do not allow remote access to stock exchanges.

Some Member States apply concentration rules under Article 14(3), but most do
not (see our separate comments on this issue)
To the extent that the Upgrade of the ISD continues to restrict the application of the
country of origin principle to particular categories of investors, such restrictions on
the effectiveness of the single market are likely to remain. Clear and agreed
definition of the boundaries of categories and approximation of detailed conduct of
business requirements could help to reduce obstacles, but only the extension of the
country of origin principle to all business will eliminate them.
24