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Brussels, 19th November 2002

Investment services: proposed new Directive would protect investors and help investment firms operate EU-wide

The European Commission has presented a proposal for a new Directive on investment services and regulated markets. The proposal aims to overhaul existing legislation in response to the far-reaching structural changes in EU financial markets over the last decade. It would increase harmonisation of national rules and meet two key prerequisites for the completion of the Internal Market in financial services. First it would give investment firms an effective "single passport", which would allow them to operate across the EU. Second, it would make sure investors enjoyed a high level of protection when employing investment firms, wherever in Europe they were located. It seeks to establish, for the first time, a comprehensive regulatory framework governing the organised execution of investor transactions by exchanges, other trading systems and investment firms. Once adopted, the proposed Directive will uphold the integrity and transparency of EU markets and foster competition between traditional exchanges and other trading systems, with the effect of encouraging innovation, reducing trading costs and releasing more funds for investment, ultimately boosting economic growth. The new proposal follows extensive consultations.

Internal Market Commissioner Frits Bolkestein said: "This proposal is a cornerstone of the Financial Services Action Plan. If we want a true Internal Market in financial services, with all the enormous benefits that will bring, we need investors large and small to be able to invest across borders easily and with confidence. That in turn means we need investment firms to be able to work anywhere in the EU, under supervision rigorous enough to weed out the cheats and charlatans and flexible enough to liberate reputable operators from the headache of fifteen different sets of regulations. What is more, we need to increase liquidity, make European markets more competitive and raise overall investment by helping people to trade securities at maximum efficiency and at minimum cost. That means making the most of new ways of trading."

The proposed Directive would replace the existing Investment Services Directive, dating from 1993. The current Directive relies heavily on mutual recognition and has not proved sufficient in practice to ensure investment firms can operate EU-wide on the basis of approval in their home country. The proposal will be forwarded to the European Parliament and the EU's Council of Ministers for adoption under the so-called co-decision procedure.

Structural changes in EU financial markets have made new legislation on investment services necessary. These changes include the greater participation of retail investors in financial markets, increased competition between exchanges and trading systems and the growth of cross-border equity transactions (by 20-25 % annually between 1996 and 2001). The intensification of linkage between national financial markets has meant that the 1993 Directive no longer provides adequate investor protection or sufficiently guarantees market efficiency.

Equally importantly, the existing Directive does not provide an effective legal foundation for fully realising the extensive benefits of an integrated financial market. Research recently published by the European Commission indicates that financial integration could lead to additional economic growth of about 1 % over a decade or so and to a 0.5 % rise in total employment (see IP/02/1649).

The new proposal follows two periods of extensive consultation, including an open hearing held in Brussels in April 2002 (see IP/02/464 and MEMO/02/80).

The proposal is for a framework Directive in line with the February 2002 agreement with the European Parliament on improving the regulation of EU securities markets, following the recommendations of the Committee of Wise Men chaired by Alexandre Lamfalussy (see IP/02/195). It therefore confines itself to setting out the general high-level obligations which Member State authorities should enforce. More detailed implementing measures will be set down by the Commission, following consultations with market participants and Member States, and taking into account advice from the Committee of European Securities Regulators (CESR).


The Commission's proposal seeks to clarify and expand the list of financial instruments that may be traded on regulated markets and between investment firms. Certain cash-settled commodity derivative instruments are included. Consequently, markets where these instruments are traded would be subject to the Directive. There are exemptions from the proposed Directive to ensure that entities who do not deal with such instruments on a regular basis would not require authorisation as investment firms.

The proposal would broaden the range of investment services for which authorisation is required under the Directive, notably to include investment advice, and clarify the ancillary services which investment firms could provide. Financial analysis and research would be explicitly recognised as such ancillary services. As a result, they would, where undertaken in conjunction with core investment services, be subject to the Directive's provisions regarding conflicts of interest and conduct of business.

Possible conflicts of interest can arise in particular when securities houses combine making recommendations to clients on investments with providing services to companies who are potential recipients of such investment.

Obligations of investment firms

The proposed Directive would update and harmonise the regulatory conditions with which investment firms must comply, at the time of initial authorisation and thereafter. It would reinforce the disciplines that investment firms must respect when acting on behalf of clients.

The proposal would thus impose:

  • clearer and more precise rules on the conduct of business

  • reinforcement of "best execution" obligations, in other words stronger requirements to make sure investment firms execute orders in a way that provides best value for the client. As well as safeguarding investors' interests this will improve market efficiency by making sure the most efficient trading arenas, with the lowest costs to the client, are rewarded with more business

  • new rules for handling clients' orders

  • an obligation for large dealers and broker-dealers to make public firm bid and offer price for a specified transaction size in liquid shares ("quote disclosure" rule)

  • requirements for managing conflicts of interest which may arise when investment firms execute client orders against their own trading book in other words when they sell securities to, or buy them from, their own clients

  • reinforced obligations on transparency and the information to be made available to clients.

Opportunities for investment firms

The new proposal would greatly enhance the practical application of the "single passport" for investment firms, by reinforcing and extending the principle that firms should have the right to operate anywhere in the EU on the basis of authorisation and supervision by the competent authority in their home Member State.

The proposed Directive would allow investment firms to "internalise" their client orders. Internalisation is where banks and other investment institutions process client orders in-house without going through a regulated market, for example if a client has placed an order to sell a particular security and another client or the bank itself is willing to buy. However, "internalisation" would be limited to situations where it is demonstrably in the client's best interests.

Marketplace regulation

The proposed Directive would establish a comprehensive regulatory regime to ensure a high quality of execution of investor transactions wherever they take place - on "regulated markets", through a new generation of organised trading facilities (known as either Multilateral Trading Facilities (MTFs) or Alternative Trading Systems), or off-exchange.

The Directive would establish a package of safeguards which regulated markets and investment firms would need to respect. It would create a comprehensive transparency regime to enable market participants to observe conditions for the most recent sale/purchase of an equity instrument at all execution points. This would allow market participants to identify the best trading opportunities and to take advantage of the best prices. Such transparency is therefore a powerful tool for ensuring that competition between markets and trading venues contributes to, rather than impairs, overall market efficiency.

The proposal envisages the definition, for the first time in EU law, of the requirements for authorisation to operate a regulated market, and of conditions applying to such markets. These provisions lay down minimal requirements for the admission of instruments to trading.

In practice many MTFs are broadly comparable to "regulated markets" in the way they operate and the services they provide. The proposal would therefore extend to such facilities the core elements of the regime covering regulated markets.

Powers and obligations of enforcement authorities

Without confidence in the effectiveness and quality of supervision and enforcement throughout the Internal Market, a truly integrated financial services market based on a network of Member State authorities cannot exist.

In order to promote consistent enforcement throughout the EU, the new proposal would therefore set minimum standards for the mandate and the powers national competent authorities must have at their disposal. It would also establish effective mechanisms for real-time cooperation in investigating and pursuing breaches of the Directive's obligations, by upgrading the obligations of competent authorities to assist each other, exchange information and facilitate joint investigations.

See also MEMO/02/257.

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