Draft Short Selling (Amendment) (EU Exit) Regulations 2018

Seema Malhotra Excerpts

Wednesday 21st November 2018 General Committees

[The Economic Secretary to the Treasury (John Glen)]

I beg to move,

That the Committee has considered the draft Short Selling (Amendment) (EU Exit) Regulations 2018.

May I say what a pleasure it is to serve under your chairmanship, Mr Robertson? It is a pleasure to be here again to introduce a statutory instrument. I thoroughly enjoyed the preparation for this debate.

In the context of the UK’s withdrawal from the EU, the Treasury has been preparing extensively for a range of potential outcomes, including a no-deal scenario. This statutory instrument forms part of the work that is necessary to ensure that there continues to be a functional regulatory and legislative regime for financial services if the UK leaves the EU with no deal and no implementation period. As colleagues are aware, we have had a number of debates in the House as part of that process. The statutory instrument is another part of that programme of legislation.

Short selling is the practice of someone selling a security that they borrowed, with the aim of buying it back at a lower price than they sold it for. Following the financial crisis, a number of countries, including the UK, acted to suspend or ban short selling due to the risks it posed to the stability of the global financial system. In response, the EU introduced the short selling regulation—the SSR—which introduced a harmonised regulatory framework for short selling and certain aspects of credit default swaps. That regulation relates to financial instruments that are admitted to trading or traded on a European economic area trading venue.

Given that the UK would be outside the EEA and the EU’s legal, supervisory and regulatory framework in a no-deal scenario, the existing legislation needs to be updated to reflect that and amended to ensure that its provisions work properly in such a scenario. The statutory instrument will therefore make a number of amendments to the SSR and related legislation, including certain parts of the Financial Services and Markets Act 2000, to ensure that they continue to operate effectively in the UK once the UK has left the EU.

First, the statutory instrument amends the scope of the regulation so that it relates only to instruments admitted to trading on UK venues and UK sovereign debt. Financial instruments admitted to trading only on EU venues will no longer be in the scope of UK regulation. Additionally, the statutory instrument amends the UK’s powers to address threats to financial stability or market confidence in the context of the SSR. Under the current regulation, the UK can take action on instruments for which it is the most liquid market in Europe or that were first admitted to trading in the UK. If the UK wishes to take action on an instrument that has its most liquid market elsewhere in the European Union or was first admitted to trading on an EU venue, it is required to seek consent from the relevant EU regulator. The statutory instrument deletes that provision so that those instruments will be treated in line with other third-country instruments. That means the UK will be able to take action against any instrument traded on a UK venue and, before using those powers, will consider threats solely to UK market confidence and financial stability.

Secondly, the statutory instrument transfers to the appropriate UK bodies functions that are currently carried out by EU authorities. For example, there will be a transfer of powers, such as the power to specify when a sovereign credit default swap transaction is regarded as hedging against a default risk, from the European Commission to the Treasury. Powers will also be transferred to the Financial Conduct Authority from EU supervisory bodies. Those include powers that will enable the FCA to make technical standards and take action on all instruments admitted to trading on a UK venue. The FCA is the appropriate regulator to which to transfer those functions because it has the necessary technical expertise to make technical standards, due to its existing supervisory responsibilities in relation to short selling.

Thirdly, the statutory instrument deletes provisions that facilitate co-operation and co-ordination across the European Union. Currently, regulators in member states must notify their counterparts in other member states before taking action to restrict short selling, with other regulators subsequently determining whether to apply similar restrictions. This instrument removes those provisions, along with the powers of the European Securities and Markets Authority to intervene in exceptional circumstances.

The statutory instrument makes technical amendments to existing UK legislation, particularly part 8A of the Financial Services and Markets Act 2000, to ensure that the UK can continue to respond to overseas regulators’ requests for information. It is the intention of the UK to preserve as far as possible a mutually beneficial working relationship with the EU, in the same way as we currently co-operate with non-EU regulators under existing provisions in the 2000 Act.

[Seema Malhotra (Feltham and Heston) (Lab/Co-op)]

What assessment has the Treasury made of the likely increase in the volume of activity at the Financial Conduct Authority and whether the resources are sufficient to deal with that?

[John Glen]

I can confirm that the Treasury worked very closely with the FCA before publication of this SI on 9 August. Over the two months before the regulations were laid on 9 October, we took feedback from industry and the regulator, and we are confident that they are in a very strong position to deal with the requirements that they would be given in the context of a no-deal outcome subsequent to the SI.

Let me make some progress—I am nearly there. The instrument maintains a number of existing exemptions. The current regulation provides exemptions from certain reporting requirements, restrictions on uncovered short selling for shares that are traded primarily in a third country, and the buy-in regime. Those will be maintained, and the FCA will now take on responsibility for publishing a list of relevant third country shares that are subject to the exemption—a responsibility that currently rests with the European Securities and Markets Authority. To ensure continuity at the point of exit, the FCA will recognise the ESMA list for two years following exit day, so that there will be no change to the exemptions.

Additionally, the SI maintains the exemption for market makers and authorised primary dealers under SSR. This exemption enables firms to carry out certain primary market operations and market-making activities without the requirement to disclose their net short position. Moreover, provided that they meet certain thresholds, those operators are not required to comply with relevant restrictions on uncovered short selling. Market makers will be required to join a UK trading venue and notify the FCA at least 30 days before exit should they wish to benefit from the exemption. However, the operators that have already done that will not experience a change.

The instrument deletes the conditions in the current regulation that must be met to be able to correlate sovereign issuer positions to sovereign debt. To determine sovereign debt correlation under SSR that can be used to offset the positions of sovereign issuers, those conditions are currently used. The deletion reflects the fact that the UK will be the sole sovereign issuer in question post-exit. The instrument will also provide the Treasury with the power after exit to set the relevant thresholds.

The instrument makes amendments that will enable UK credit default swaps to be used by market participants to hedge correlated assets and liabilities anywhere in the world, rather than solely in the EU. That will ensure that UK firms can continue to use UK sovereign credit default swaps to hedge correlated liabilities or assets issued by issuers in the EEA and, in future, across the rest of the world, too.

In summary, the Government believe that this SI is necessary to ensure that the regulatory regime relating to short selling and certain aspects of credit default swaps works effectively if the UK leaves the EU without a deal or an implementation period. I sincerely hope that colleagues will join me in supporting the regulations; I commend them to the Committee.

--- Later in debate ---

[Alison Thewliss (Glasgow Central) (SNP)]

It is not just the enthusiasm from the Finance Bill but from the Scotland win last night, that has brought me here this morning. I am delighted to be here, and to report that news to the Committee, if Members have not already heard.

I have many of the same concerns about this instrument as the hon. Member for Stalybridge and Hyde. I continue to be concerned that we are putting an additional burden on the FCA and the Treasury, and I am yet to be convinced that we have not just the expertise, but the numbers of staff and the capacity, to take this on in addition to all the other SIs that have already been laid before the House, or will be in the weeks and months ahead. I would like some more information from the Minister about the detail of that.

Secondly, with all these powers going to the FCA and the Treasury, what will be the role of this House in scrutinising the measures as we go forward? Obviously, these are very important regulations, given the issues that arose in the 2008 crash, which might not have happened if we had had greater scrutiny at the time. After 10 years of progress on developing regulations, we do not want to slip back again once we fall out of the European Union mechanism for co-operation. I want safeguards to be put in place to make sure, should we move away from the current co-operation mechanism, that we do not end up in the same circumstances as we were in during the financial crash.

I was concerned to hear the Minister discuss the deleting of co-operation provisions. Clearly, that is a result of coming out of the EU, but I want to know a bit more about what might replace those provisions in future, or what mechanisms will be set up for European co-operation in this area. It is in all of our interests to have those mechanisms—to have some means of working together—and just saying, “We will find a way of doing that in future” does not really cut it when we are talking about something that, if it is not done absolutely correctly, could bring down the entire economy.

[Seema Malhotra]

Further to my intervention on the Minister, and regarding the point that the hon. Lady has eloquently made, there appears to be an assumption that the volume of activity that this instrument may lead to will just be absorbed by the existing resources. Combined with the fact that it is not going to be business as usual post-Brexit, or indeed in the run-up to Brexit, does the hon. Lady agree that the issue of resources needs to be looked at more seriously as a result of this and other measures?

[Alison Thewliss]

I absolutely share the hon. Lady’s concerns. As I said, we already have many SIs, and lots more are coming down the line. I am sure that many more exciting Committee sittings will take place to examine the details of those SIs. I would like a bit more clarity about the numbers of people who will be required to implement this regime, monitor it, and make sure that it works in future.

I would also like to know a bit more about the implications of this SI. The explanatory memorandum states:

“Wherever practicable, the proposed approach is that the same laws and rules that are currently in place in the UK would continue to apply at the point of exit”,

and it goes on to talk about continuity, certainty and all of those things. It would be useful to know how tightly we need to remain aligned to existing measures, now that we no longer follow those rules or have any influence in making them. I would question the whole point of leaving the EU in the first place if we have to stay that closely aligned—what is the point in leaving and having an inferior deal? Of course that is not what Scotland voted for, and that remains the case. Those are my questions. Other points were raised by other hon. Members, so I am happy to sit down and let the Minister reply.