U.K. Wins Backing in Fight Over EU Short-Selling Rules

The U.K. won the backing of a top European Union court official for its bid to overturn rules allowing EU regulators to ban short selling.

Emergency powers granted to the European Securities and Markets Authority were based on a flawed interpretation of EU treaties, Niilo Jaeaeskinen, an advocate general at the EU Court of Justice said in a non-binding opinion today. The decision to give the powers to ESMA should have required a unanimous vote among nations to ensure “enhanced democratic input.”

The short-selling skirmish is one of several legal U.K. challenges against EU financial regulations at the bloc’s courts. It opposed a proposed common financial transactions tax and sued the European Central Bank over policies it says push clearing of some derivatives away from the City of London. U.K. opposition has prompted warnings from EU officials that it can’t pick and choose the terms of its relationship with the bloc.

If the court follows today’s advice, it “would be a very significant development in the field of EU law and would have immediate read-across to a number of dossiers currently being negotiated,” said Alexandria Carr, a lawyer with Mayer Brown in London. These include plans for a single bank resolution mechanism and also proposals to overhaul the EU’s Markets in Financial Instruments Directive, or Mifid.

The Luxembourg-based court follows these opinions in a majority of cases and normally rules about six months later.

Emergency Powers

A provision in the short-selling rules that grants Paris -based ESMA the powers to intervene in the financial markets to regulate or prohibit short selling was adopted in a manner that goes beyond what is “necessary for the establishment or functioning of the internal market,” the court said in the opinion.

While Jaeaeskinen backed the U.K.’s argument that the emergency powers were wrongly adopted, he dismissed the government’s remaining claims. He didn’t agree that the EU authority’s powers are too “wide” and give it a “large measure of discretion.”

ESMA’s powers “are in line with the relevant EU constitutional rules in relation to the delegation of powers to an agency and do not leave too wide a margin of discretion to ESMA,” the EU court adviser said.

Volatile Markets

ESMA, which brings together markets regulators from the EU, was handed an upgraded mandate to police short selling last year as part of a bid by EU lawmakers to make markets less volatile and tame speculation by traders blamed for driving up governments’ borrowing costs.

Short sellers seek to profit on declining markets by selling borrowed shares or bonds, on the belief their price will fall, then replacing them with securities bought at a lower price.

The opinion “vindicates the U.K. challenge to ESMA’s power to impose short selling restrictions against the will of U.K. regulators,” Michael Wainwright, a partner at Eversheds LLP in London, said in an e-mail. “The outcome hangs in the balance.”

While the advocate general rejected the U.K.’s argument that the power was too broad, he ruled that the power was based on a provision in the EU’s treaties that could not justify it. The acceptable treaty provision would have required unanimity by the EU’s 28 member nations, including the U.K.

Full Court

If the full court disagrees on the interpretation, “then the U.K.’s challenge could still be lost,” said Wainwright. “If the U.K. was hoping that the decision might provide support for arguments to restrict the powers of the other new EU financial regulators, including on bank regulation, then this opinion provides little assistance.”

The U.K. Treasury said in a statement that it “supports the short-selling regulation, and has engaged constructively” with the European Commission, ESMA and other member states.

“Our legal challenge does not change this,” the Treasury said. “We are seeking legal clarity on how powers given to ESMA to restrict or ban short selling sit with the principles established under the existing case law.”

While Prime Minister David Cameron has promised a referendum on EU membership by the end of 2017, this has failed to quell calls from members of his Conservative Party for Britain’s European destiny to be put to the people sooner.

Bonus Rules

The U.K. has often found itself on the defensive in EU discussions on financial regulation. The nation was the sole dissenting voice in March opposing a deal to ban bonuses more than twice fixed pay.

The U.K. said in June that that part of the Mifid proposal to give ESMA agency emergency powers to ban some securities trades may also be illegal.

Michel Barnier, the EU’s financial services chief and architect of draft laws for the industry, has warned Britain that it must accept EU financial regulations in exchange for access to the bloc’s single market.

“We take note of the advocate general opinion,” Chantal Hughes, a spokeswoman for Barnier, said in an e-mail. “We will look at it carefully, and need to wait for the court’s final ruling.”

The German Finance Ministry said that the treaty limits invoked in the advocate general’s opinion echo its concerns about the centralized powers of the proposed single resolution mechanism for banks. The resolution proposal is part of a bid by the euro area to restore confidence in its banks by pooling oversight and crisis management.

Before it's here, it's on the Bloomberg Terminal.