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Brussels, 16 November 2000

Securities markets: Commission analyses application of investor protection rules

The European Commission has published a Communication on the application of "conduct of business rules" to investment firms as regards both "professional investors" (aware of the risks) and other investors, more in need of protection. These rules are important to ensure adequate levels of protection to those investors that need it. The way in which these rules are applied can also have a profound bearing on the ability of investment firms to use the 'single passport' conferred on them by the Investment Services Directive (ISD - 93/22/EEC), whereby a firm can operate EU-wide on the basis of mutual recognition of supervision by its home Member State. The Communication therefore analyses experience concerning business conduct rules since the entry into force of the ISD in 1995 and suggests ways of striking a better balance between allowing firms to use the 'single passport' while adequately protecting investors. The Communication is one of the Commission's ten priorities in the next six months under the Financial Services Action Plan (FSAP - see IP/00/1269). The FSAP, endorsed by the Lisbon European Council, aims to create a fully integrated single market in financial services by 2005. The Communication draws on and complements the Communication on the upgrading of the Investment Services Directive (see IP/00/1315).

Internal Market Commissioner Frits Bolkestein said: "This Communication goes hand-in-hand with our review on the upgrading of the Investment Services Directive. We need to ensure that the ISD is updated to reflect market changes and that the single passport system works as efficiently as possible. But in doing that, we also need to guarantee that investment firms using the passport are adequately supervised and that investors are properly protected."

Conduct of Business rules

The Investment Services Directive (Article 11) lays down common principles for Member States to apply so-called 'conduct of business rules' to investment firms from another Member State. In doing so, it provides for a degree of approximation of these important rules which govern the dealings of authorised investment firms with investors and their conduct on securities markets. This degree of harmonisation aims to enable authorised investment firms to provide services in other Member States without, in principle, encountering additional legal or administrative requirements ("single passport").

The Directive "Article 11(1)requires national authorities to distinguish between professional and other investors when implementing conduct of business rules. To date, compliance with this requirement has not been systematic partly because there has been no common understanding of what constitutes a "professional investor".

Recently, national securities commissions have concluded an understanding as regards the classification of investors for the purposes of applying conduct of business rules. In its new Communication, the Commission invites national authorities to ensure that this distinction is effectively implemented.

Large numbers of investment firms are making use of the ISD 'single passport', but often find that in practice they are unnecessarily burdened by having to comply with two sets of conduct of business rules the rules of the home country of the service provider to which they are automatically subject, and those of the country of the investor which generally opt to impose their local rules on incoming investment services. Pending harmonisation of the rules of conduct, Article 11(2) of the ISD gives host country authorities some room to apply their own conduct of business rules if they consider this is necessary to protect the public interest ("general good").

Looking forward

The present Communication outlines the Commission's view that in exercising these responsibilities, host country authorities should ensure that implementation of local rules is strictly necessary and proportionate to the objective of investor protection. The Communication suggests that host country authorities should carefully consider whether the investor in question objectively requires the protection offered by imposition of host country conduct of business rules. It goes on to suggest that an assessment of whether the investor is a professional or not could be one relevant factor in assessing the 'need for protection'. Member States could therefore give consideration to not applying local conduct of business rules in the event of services provided to their resident professional investors.

The Commission's analysis in this Communication of the current situation suggests that the existing Article 11(2) of the Investment Services Directive is ambiguous as regards home and host country responsibilities. This is exacerbated by the fact that Member States often do not properly distinguish between professional and other investors when implementing conduct of business rules.

The discussion document therefore suggests that, in the context of discussions on upgrading the Investment Services Directive, attention should be given to a formal modification of Article 11 so as to clarify the relative responsibilities of home and host country supervisors. The Commission considers that, at the very least, a modernised ISD should ensure that business between professionals can be undertaken subject only to the requirements in force in the country of the service provider. This would represent an important step towards ensuring investment firms can exercise the 'single passport' more effectively.

As far as retail investors are concerned, progress cannot be at the expense of investor protection. Non-professional/'retail' investors need to be able to have confidence in the integrity of investment firms and understand the risks associated with various investments. Discussions on upgrading the ISD aim to create the conditions under which retail investors will enjoy full protection under the rules enforced in the country of the service provider.

The full text of the Communication is available on the Europa Website:

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