Cablegate: Investment Services Directive Moving Toward
This record is a partial extract of the original cable. The full text of the original cable is not available.
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TREASURY ALSO FOR IMI HARLOW, AUSTIN
PARIS ALSO FOR OECD
TREASURY FOR OCC RUTLEDGE, MCMAHON
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TAGS: ECON EFIN EUN
SUBJECT: Investment Services Directive Moving Toward
This cable is sensitive but unclassified. Not/not for
Ref: (A) 02 Frankfurt 11356 ; (B) Frankfurt 2629; (C) USEU
1. (SBU) Summary: Negotiations on the controversial pre-
trade transparency provisions of the proposed revision to
the Investment Services Directive appear to be moving toward
a compromise. Compromise amendments circulated in the
European Parliament and texts being discussed in the Council
Working Group point in a similar direction: to maintain pre-
trade transparency, but make the provisions more workable
for investment firms. Investment bankers, recognizing they
have lost the battle for deleting any pre-trade transparency
requirements, hope and pray the compromise texts will be
accepted. Nothing is certain.
2. (SBU) The fact that the Italians and the Dutch, both
reportedly having favored a strong pre-trade transparency
text, now have drafted compromise language gives reason for
optimism that the directive can be finalized in the next few
months. Their new position doesn't necessarily represent a
change of heart, but rather a change of point of view. The
Italians now have the EU Presidency, meaning they now have
the lead on ISD drafting and have pledged to get it done.
The Dutch position is driven by the Finance Ministry,
according to an investment banker, which takes a different
view of the issue than the securities regulators who had
shaped their earlier position. Thus, the text could be
finalized this fall. Given its history and the number of
technical issues, risks remain for slippage. Notably, the
ECB has weighed in favoring pre-trade transparency not only
for shares, but also debt instruments. While one bond
expert regards the ECB position as out of touch, a Brussels
lobbyist reports that the Italians are willing to consider
such an extension. End Summary
Pre-Trade Transparency in the ISD: Questions with No Clear
3. (SBU) The London Investment Bankers Association (LIBA)
and the US Securities Industry Association (SIA),
representing European and US investment firms, were sorely
displeased when the European Commission modified its
proposal for revising the ISD at the last minute by
including a requirement for these firms to provide pre-trade
transparency (ref A). They had argued that publishing
prices before executing a trade provides little information
to the market place not captured by post-trade reporting.
Investors would be protected from being fleeced by
subjecting investment firms to "best execution" obligations.
Moreover, pre-trade transparency could drive market prices
down, resulting in lower prices for investors. Such
requirement would also require changes to the way investment
firms do business, requiring investment in new mechanisms.
All arguments that Commission staff had accepted, but the
Commissioners did not.
4. (SBU) Investment firms took a hard line position that
the pre-trade transparency provisions were unworkable and
should be deleted. The lead manager for the legislation in
the European Parliament, Theresa Villiers took a similar
view in her initial report on the ISD (ref B). In her view,
the best solution would be to drop the offending article.
Privately, however, she knew that a compromise would be
5. (SBU) Investment firms complained about the details of
the proposed pre-trade transparency requirements. Under the
Commission's proposal, investment firms are to "make public"
a "firm bid and offer price" for transactions of a "size
customarily undertaken by a retail investor" and to trade
with "other investment firms and eligible counter parties at
the advertised prices." How were they to make such
information public? Would a firm price mean that they would
not be able to offer price improvements, even as market
conditions changed? What is a transaction size that is
customary for retail investors? Forcing investment firms to
deal with all potential investors, regardless of their
credit rating or relationship with the firm, could subject
them to higher credit risks. Too many questions with no
clear answers. Some investment bankers had the distinct
feeling that these provisions were designed to increase
costs to investment firms and deprive them of their
competitive advantage over stock exchanges.
Compromise Possibilities: Italians and Dutch Try Their
6. (SBU) At the end of June and early July, the Dutch and
Italians took their hands at fashioning possible compromise
texts in the Council Working Group. The role of both is
notable. The Dutch financial market regulator had
criticized "internalization," e.g. where an investment firm
can match trades in-house. Italian interests reportedly
were among those that had moved the College of Commissioners
to adopt a pre-trade transparency requirement last November.
According to one investment banker, the Dutch position has
shifted as the Finance Ministry has taken the lead on the
issue and has a different view. The Italians, now in the
Presidency, feel the pressure to deliver results on the ISD.
The Italian Finance Minister has pledged that the ISD will
be completed under the Italian Presidency.
7. (SBU) The Dutch took the view that some transparency is
needed to benefit price formation but that competition
between different trade execution venues was also
beneficial. To cover both points they proposed that the pre-
trade transparency obligation apply only to retail trade.
Pre-trade disclosure of large trades could result in the
market moving against the firm publishing the quote, a view
shared by investment firms, which could dry up market
8. (SBU) Further, the Dutch reasoned that only firms
active in the retail market that internalize would be
subject to pre-trade transparency requirements. Such
"internalizers" would be defined as those who regularly
execute retail client orders in shares by dealing on its own
account. Just trading in-house against a firm's propriety
book would not count as internalization. A firm should also
be able to improve or change the price depending on market
conditions, in the Dutch view. Finally, investment firms
should be able to control with whom they do business, e.g.
they would offer their services to their own retail clients
but not have to trade with all comers.
9. (SBU) These same points have been picked up in a
Council Working Group text drafted by the Italians based on
a Group meeting on July 7. In this Italian version
investment firms are to publish firm prices for shares for
which they are "systematic internalizers," i.e.
systematically dealing on its own account in transactions of
a "standard size" of shares admitted to trading on a stock
exchange. Such internalizers would be able to withdraw
prices in accordance with market conditions. Prices and the
sizes of trades are to be made public in a manner that is
easily accessible to the firms' clients and to market
participants on a "reasonable commercial basis." Finally,
systematic internalizers would be allowed to decide, in a
non-discriminatory way, the persons they accept as clients.
Parliament in Sync
10. (SBU) Whether by coincidence or design, the compromise
amendments offered by Villiers on July 10 look very similar
to the new Italian text. Investment firms which practice
systematic internalization are to publish firm "quotes" (not
prices) for transactions of a "standard market size" for
shares admitted to trading on a stock exchange. Systematic
internalizers would have to deal with their "clients" at a
price equal to or better than the quote. Thus, they would
not have to trade with all comers and they could improve the
price based on market conditions. Finally, the compromise
text would require the prices to be accessible to other
market participants on "reasonable commercial terms."
Principle Established, A Question of Price
11. (SBU) Investment firms experts are generally pleased
with the direction of these ideas. Their preference still
is not to have any pre-trade transparency provision. Not
winning the principle, their next objective is to make the
provisions as tolerable and as inexpensive as possible.
12. (SBU) Even if the compromises being discussed were to
be accepted, important details would remain to be
elaborated. Both the Italian and Villiers text would have
the European Commission together with the Committee of
European Securities Regulators (CESR) specify the size of a
transaction that would constitute a "standard market size,"
in implementing measures. A standard market size could vary
from market to market. Thus, the scope of the provision
will remain unknown until such measures are adopted.
Chance for Success?
13. (SBU) According to a representative of an investment
firm, the Villiers and Italian text have a chance of being
adopted. The Villiers text is scheduled to be voted on in
the Economic and Monetary Affairs Committee on September 10.
The compromise text is to be the basis for that vote.
However, according to this representative, EMAC members
agreed to vote as long as all respected a "cease fire"
during the summer recess not to seek changes to the text.
14. (SBU) Whether the Italians can pull their text through
the Council Working Group is also unknown at this point.
The Italians, however, have been working on the text in
August - but the August vacation period has slowed their own
internal efforts. European Parliament staffers have pointed
out that if the Council does not send a text to EMAC by
November, legislative mechanics alone could preclude final
adoption of the directive before the Parliament's scheduled
European Central Bank Takes A Hand: Nave or Just Out of
15. (SBU) On June 12 the European Central Bank (ECB) issued
an opinion on the proposed revision of the ISD. The ECB
"welcomed" the Commission's proposed rules on pre-trade
transparency as "advancing the fundamental goal of allowing
investors to choose the more efficient trading venues." The
ECB also opined that there is a "strong case for
consolidating price information at the EU or euro area
level" and thought that public authorities could "act as
catalysts" to the private sector to undertake such an
16. (SBU) The ECB goes on to criticize the Commission's
proposal for limiting transparency to shares. Rather, the
ECB "recommends that the Commission reconsiders the scope of
the transparency rules and extends them to debt securities."
If it is not possible to do so, then the Commission should
report in two years on the possibility to extend the
provisions to debt securities, rather than in four years as
provided in the Commission's initial proposal.
17. (SBU) The "Financial Services Newsletter" of Brussels-
based Houston Consulting reports that the Italian Presidency
is will to consider the extension of the Article 25
reporting requirement to bond. The Italian July draft,
however, does not extend pre-trade transparency provisions
to debt instruments, but does incorporate the idea of a
Commission report in two rather than four years.
18. (SBU) According to several bond experts, the notion of
transparency in debt security prices is rather unique. They
point out that the bond market is composed of many bonds
that have many different features and are much more
heterogeneous than equities. Thus, comparisons between bond
prices are very difficult. Moreover, once bonds are placed,
generally they are not traded but held by investors.
Accordingly, these experts note that the market for a
specific bond may not be very liquid after the initial
placement. One bond expert believed that the ECB was rather
nave in its approach. Pre-trade transparency for bonds
sounds fine in theory, but in practice irrelevant, in his
19. This cable coordinated with Embassies Berlin, Rome, The
Hague and USEU Brussels.
(U) POC: James Wallar, Treasury Representative, e-
mail email@example.com; tel. 49-(69)-7535-2431, fax