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Thank you. It’s a pleasure to be here this morning and to talk to you about the regulatory reform of markets.
As the Minister responsible for financial services, I spend a huge amount of time on the vast array of European markets’ initiatives.
London is Europe’s only global financial centre with - for example - 40% of the global OTC derivatives market.
And so regulatory reform offers the UK both great opportunities and great challenges.
In my discussions with industry, I know that you understand the need for reform.
Want to see stronger and more resilient markets.
And understand that we simply can’t afford another financial crisis.
But I recognise also that fundamental reform is incredibly challenging.
It requires thought.
Where most people can generally agree on the direction of travel, the final destination remains a point of contention.
So today, I’d like to set out the UK’s priorities when it comes to the regulatory reform of markets;
- First of all, the need to create more resilient and more stable financial markets. To learn and put into practice lessons from the financial crisis;
- And secondly, to improve competition: to complete - and not fragment - the Single Market- and so promote, rather than stifle, growth.
In order to achieve these aims, we need to focus on what really matters.
Which is why, underpinning these aims, we continue to argue in Europe that every proposal - and every reform - needs to be backed up by clear and compelling evidence.
With detailed consideration of the relative costs and benefits.
Because it’s far more important to be doing things right, than to be seen to being doing a lot.
So let me take these priorities in turn.
Europe’s Financial Sector
Starting first with the issue of stability.
Now it goes without saying that the events of recent years have tested the underlying strength of the global financial sector.
They’ve called into question the very nature of how financial markets operate.
And across the world, people have been asking questions about the sustainability of different investments, institutions and financial products.
With general consensus that reducing systemic risk and improving transparency is essential in improving stability.
Derivative trading is one of the many areas that have come under the spotlight.
Indeed, derivatives continue to divide opinion.
Some people would argue that derivatives were as much a part of the crisis as the sub-prime mortgage debacle, light-touch regulation, or low levels of liquidity and capital reserves.
Others, including myself, would take the view that the problems concerning credit derivatives were more of a symptom of the crisis as opposed to an actual cause.
Nevertheless, there is agreement that action can be taken to improve the infrastructure surrounding derivatives.
If we look at EMIR, for example, the idea that central counterparties should be used to clear certain classes of derivatives is a welcome one.
This, if implemented proportionately, will reduce the systemic risk presented by the derivatives market.
But it’s important that this proposal is properly formulated and avoids creating unnecessary burdens.
Not all derivatives deemed eligible for central clearing will necessarily be suitable for platform trading.
We must look at the facts, rather than make broad assumptions.
But equally, it is important that the scope of the regulation is sufficiently broad.
When it comes to deciding which derivatives should be covered by EMIR, there are two different roads we could go down.
The first would see all trades covered by this regulation, regardless of their venue of execution.
The second would see only those derivatives executed outside of an exchange being subject to this legislation.
All the arguments clearly favour the first approach
The first one being that the purpose of clearing derivatives is to reduce systemic risk - it’s not obvious to me why a derivative would need to be cleared if traded off-exchange, but not if traded on an exchange.
And the second is market distortion- restricting the scope would create a rather sizeable regulatory loophole- which, if exploited, would lead to damaging asymmetry in the market.
The arguments against a broad scope are hard to fathom, and seem to be about preventing competition in clearing - a subject I will come on to later.
High frequency trading (HFT)
Another stability issue where opinion is divided is high frequency trading.
Concerns that HFT contributes to instability in markets- with the US Flash Crash often held up as an example- have prompted calls for action.
But I feel that evidence is lacking- and that, for example, proposals around minimum order resting times and restrictive order to execution ratios in MiFID should be based on robust research.
That’s why the Government has established a Foresight project looking at the Future of Computer Trading Financial Markets.
This will examine the impact of technological developments in HFT to ensure that any regulatory intervention is both sustainable and effective.
Because, at a time when Europe has record financing needs, liquid markets are absolutely crucial.
But they are also vulnerable.
As I outlined at the beginning of my speech, any measures to improve stability must look at the wider impact- particularly the impact on competition and on the effective functioning of these markets.
Market regulation in Europe needs to recognise that member states don’t work in isolation to each other- and Europe doesn’t work in isolation to the rest of the world.
We should bear in mind that protectionist attempts to close down our borders or Balkanize markets by currency or geography will do huge damage to European growth.
As will seeking to impose so-called ‘strict equivalence’ to detailed European standards before anyone can do business in the EU.
Based on recent IMF data, last year, non-EU investors provided 27% of the total investment in EU cross-border securities.
This means $5.2 trillion of all cross-border investment in the EU came from outside of the Union.
It’s clear, therefore, that Fortress Europe is not the answer to strengthening our competitiveness.
We face fierce competition from overseas… not just from traditional financial centres in the US… but increasingly from Asia.
And at the same time, these emerging economies present us with huge opportunities to serve new and expanding markets.
But if - in our goal of making markets stronger and more resilient - we get our regulation wrong, these are opportunities that will fall by the wayside.
We can look to MiFID for an example of the competition benefits that regulation can achieve.
Ten years ago, Europe was an underdog, relative to the strength of the US capital markets.
Member States worked in relative financial isolation.
Were hampered by high costs and low liquidity.
And the Single Market had hardly got off the ground.
But MIFID became instrumental in breaking down some of the barriers that were holding us back.
Today, as a result of the competitive pressure of MIFID, Europe has exchanges that are capable of competing globally;
- Deutsche Boerse;
- the London Stock Exchange;
- Euronext-Liffe - just to name a few.
Europe has become the destination of choice for many global companies seeking to access deep pools of capital.
Competition has brought down trading costs, improved liquidity, and resulted in better protection for investors. In fact, I’ve read some estimates that suggest the single markets benefits of MIFID could have contributed as much as 0.8% to EU GDP.
And if we get the MiFID Review right, we have the potential to build on this progress.
But if we get it wrong we could set ourselves back a decade.
So what is our impression of the MiFID review so far?
Well, there are some clear positives to some of the measures on which the Commission has consulted : for example;
- the SME market proposals;
- the underlying theme of investor protection;
- and the potential to support G20 commitments on the regulation, functioning and transparency of markets.
I also recognise that impressive progress has been made by the Commission in developing proposals for derivative markets.
At the outset, I think it’s fair to say that they didn’t quite grasp all of the issues, but have worked hard to understand them through a genuinely consultative process.
This should be commended.
But the Commission have much more to do to convince me - and the industry- that they’ve genuinely grasped all the issues at stake.
And any changes will have profound implications for tens of thousands of firms.
We must learn from the AIFM Directive and other proposals which - in their original form - were fundamentally flawed and lacked an understanding of how our markets operate.
So with MiFID, areas such as;
- the governance of trading platforms and venues;
- pre- and post-trade transparency requirements and;
- transaction or position reporting.
we must implement proportionate regulation.
A crucial part of this is understanding our markets. What works for regulation of equities - a homogenised trading instrument - should not be arbitrarily copied to bonds, sovereign debt, derivatives, or commodities markets.
Also, within each asset class, the markets have their own dynamics and features, which only properly informed regulation will understand.
Indeed, each commodity market is unique - where electricity trades in a different way to gold, metals, or agricultural commodities.
If regulation fails to recognise this, firms will start to look elsewhere when it comes to matters of finance.
And this will feed through to our companies, our businesses and our citizens.
In EMIR, there are opportunities to promote competition market structure- competition which is healthy and should be encouraged.
We all agree that CCPs must be made safe - that is why so much of EMIR is focussed on new robust prudential standards for CCPs
But we must not allow new standards for CCPs, combined with a legal obligation to clear derivative products, to embed monopolies in clearing that will result in costs passing back to the wider economy.
To prevent this, our view is that, while linked structures - so called vertical silos - can be effective, they must be subject to fair and open access requirements.
Market participants should be offered a meaningful choice of using all or part of a vertical structure.
In securing the aims that I have discussed today, engagement is absolutely crucial.
The Commission should continue to work with all interested parties on markets legislation;
- engaging with businesses across Europe with expert groups on specific areas;
- allowing particular care over legal drafting, to prevent unintended consequences;
- and, again, ensuring that all impact assessments are of the highest quality.
And I can assure you, the Government will be a positive and constructive partner in this process.
But when it comes to finding the best solutions for Europe, we’re at our most effective when we work with you and engage openly on our priorities.
Where we both share analysis to back-up our proposals.
Which is why the industry has just as, important role to play as Government. EU regulation will have a direct impact on the business you transact.
As we need more hard-headed analysis.
To strengthen our argument.
Make clear our concerns.
And deliver outcomes to suit everybody’s needs.
We’ll need your engagement.
And your positive ideas for reform.
So that any amendments to the current rules are;
- proportionate - not overbearing;
- grounded in fact - not political whim;
- and look to support stability, growth, and competitiveness.
That is what we need to achieve.