EU short selling regulation survives UK legal challenge; more EU regulation is likely result

Financial Services
Document Number: 1264792 Version: 2Document Number:
1253061 Version:
Client Alert
February 2014
EU Short Selling Regulation Survives UK Legal
Challenge; More EU Regulation Is Likely Result
Recent Developments
Rejecting a spirited challenge by the United Kingdom, the European Court of
Justice (“ECJ”) recently upheld the power of the European Securities and
Markets Authority (“ESMA”) to regulate short-selling across the European
Union under the EU's Short-Selling Regulation (“Regulation”). The ECJ's
decision provides a strong legal foundation for additional EU-wide rules in the
financial services sector.
On Jan. 22, 2014, the Grand Chamber of the ECJ issued a decision in the
U.K.’s request to annul Article 28 of the Regulation, dismissing the case in its
entirety. The ECJ held, among other points, that Article 114 of the Treaty on
the Functioning of the European Union (“TFEU”, commonly referred to as the
Lisbon Treaty), which allows the EU and its authorized institutions such as
ESMA to take measures in order to harmonize the internal market, provided
the appropriate legal basis for Article 28 of the Regulation. Article 28 gives
ESMA power to ban short-selling if the stability of the EU market is
threatened, even in cases where the Member State competent authorities
have not taken action.
The outcome surprised many, as the ECJ's Advocate General, Niilo
Jääskinen, had issued an opinion on Sept. 12, 2013, agreeing with the U.K.’s
contentions that TFEU Article 114 did not provide the appropriate legal
grounds for the enactment of Article 28 and that it should be annulled. In
reaching his decision, Jääskinen explained that Article 28 “uniquely
empowered” ESMA to make legally binding decisions overruling national
regulators in emergency situations where Member States could not agree on
how to act. Such power, Jääskinen warned, did not result in “harmonization
but the replacement of national decision-making with EU level decisionmaking
. . . go[ing] beyond the limits of Article 114.” Jääskinen recommended
that Article 28 be adopted by a TFEU 352 process requiring EU Member State
unanimity, as opposed to Article 114's qualified majority requirement.
Jääskinen's opinion was only advisory. In the past, the ECJ has followed the
recommendations provided by the Advocate General in a vast majority of
cases. In this particular case, though, the ECJ did not agree with Jääskinen's
recommended annulment of Article 28. Unlike Jääskinen's opinion, the ECJ's
decision is both binding and final.
Background of the U.K. Challenge
The EU sought to coordinate short-selling bans through the enactment of
Article 28 in order to avoid a repetition of the ineffective, piecemeal measures
taken by EU Member States beginning in September 2008, when the global
markets were in turmoil following the collapse of Lehman Brothers. Critics of
the Regulation, including the U.K., argued that temporary bans on shortselling
would hamper the ability of markets to generate prices, creating the
possibility of significant price swings.
ECJ Case Analysis
In dismissing the U.K.’s case in its entirety, the ECJ rebuked all of the U.K.’s
following claims:
I. ESMA's determination as to whether a “threat” to the stability to the
EU market exists — in whole or in part — based on the criteria set out
in Article 28(2) of the Regulation grants ESMA “a very large measure
of discretion” to make a “highly subjective judgment” of when to
intervene and overrule national authorities, violating the precedents
set out in the Meroni case requiring agencies with delegated powers
to have specific and clearly defined operating parameters;
II. Article 28 authorizes ESMA to adopt quasi-legislative, normative
measures of general application, violating the principle established in
the Romano case that administrative commissions may not be
empowered by the European Council to adopt acts of general
application “having the force of law”;
III. TFEU Articles 290 and 291 allowed the legislature to delegate power
to adopt non-legislative acts of general application only to the
European Commission, not to an EU agency, and thus the legislature
could not delegate powers outlined in Article 28 to ESMA; and
IV. Article 114 “harmonization” did not provide legal grounds for the
creation of Article 28, since actions taken under Article 28 are directed
at individuals (legal and natural) within Member States and override
actions made by competent national authorities, resulting in the
creation of ultra vires direct regulatory measures by an EU agency.
Addressing the U.K.’s first and second claims, the ECJ used a two-step
analysis to clarify where ESMA stood in regard to the Meroni and Romano
precedents. The first step was to outline the clearly defined parameters under
which ESMA was given delegated executive powers to operate. The second
step built on this argument by explaining how the Council could legally create
an agency such as ESMA once ESMA was given clear, precise and — most
importantly — reviewable operating parameters.
The ECJ dismissed the U.K.’s first claim by concluding that the Regulation
gave ESMA clearly defined executive powers that could be exercised only
under strict circumstances. The ECJ explained, “ESMA can adopt measures
under Article 28(1) . . . only if, as provided for in Article 28(2), such measures
address a threat to the orderly functioning” of financial markets. Additionally,
the ECJ also noted that ESMA could act only after it has been shown that
national authorities had failed to appropriately respond to the threat.
It was the clearly defined nature of the executive powers delegated to ESMA
that gave the ECJ the grounds to also dismiss the U.K.’s second claim. The
Court pointed to TFEU Articles 263 and 277 in stating that agencies such as
ESMA could adopt rules of general application if such agencies were
operating under strict, reviewable operating parameters, tying Meroni and
Romano together.
The ECJ unabashedly characterized the U.K.’s position on the third claim as
based on an overly narrow reading of Article 28. It noted, “while the treaties do
not contain any provision to the effect that power may be conferred on a
Union body, office, or agency, a number of provisions in the [TFEU]
nonetheless presuppose that such a possibility exists.” The ECJ further
stated, “Article 28 cannot be read in isolation,” but rather must be read as
“forming part of a series of rules designed to endow the competent national
authorities and ESMA with powers of intervention to cope with adverse
developments” threatening EU market stability. Such a reading, the ECJ
concluded, could not be regarded as undermining the rules governing the
delegation of powers laid down in TFEU Articles 290 and 291.
The ECJ then focused on the last and most controversial leg of the U.K.’s
case — the use of TFEU Article 114 as the legal basis for adopting Article 28.
The Court began its analysis by defining the two legal requirements for a
“harmonization” measure under Article 114: 1) the measure must approximate
provisions laid down by law, regulation, or administrative action in Member
States; and 2) the measure must have as its goal the establishment and
functioning of the EU market.
On the first prong of the harmonization test, the ECJ explained that “the
approximation of general laws alone may not be sufficient to ensure the unity
of the market,” and thus “the concept of ‘measures of approximation’ of
legislation must be interpreted as encompassing the EU legislature's power to
lay down measures relating to a specific product or class of products as well
as, if necessary, individual measures concerning those products.”
Acknowledging the existence of certain circumstances where ESMA's power
to adopt measures of general application would inevitably lead to measures
affecting individuals (natural or legal), the ECJ concluded that Article 28 does
approximate “Member States' laws, regulations and administrative provisions
relating to the supervision of a number of stocks and the monitoring, in
specific situations, of certain commercial transactions concerning those
stocks, namely net short positions in relation to a financial instrument or a
specific class of financial instruments.” The Court punctuated the need for
such harmonization by citing the divergent and often fragmented responses to
short-selling that Member States had adopted prior to the Regulation.
The ECJ then dispensed with the second prong of the harmonization test with
a brief and straightforward analysis. Citing the Regulation's preamble, the ECJ
determined that “the purpose of the Regulation [creating ESMA] is to ensure
the proper functioning of the internal market and to improve the conditions of
its functioning . . . in particular regard to the financial markets.” Similarly, the
ECJ recognized Article 28's purpose as the improvement of “conditions for the
establishment and functioning of the internal market in the financial field.” The
ECJ thus held that Article 28 of the Regulation and the Regulation itself were
properly enacted as harmonization measures under TFEU Article 114.
Conclusion
After methodically analyzing and rejecting all four claims, the ECJ readily
dismissed the U.K.’s action in its entirety. The lessons of the financial crisis
proved too strong for the U.K., as it failed in its quest to annul Article 28 of the
Regulation in the name of separation of powers and subsidiarity.
With the ECJ's support, ESMA and the European Banking Authority (“EBA”)
are now able to impose additional EU-wide regulatory measures in the
financial services sector. Combined with the new powers granted to the EBA
under the Banking Union, the ECJ's decision solidifies the jurisdiction of
ESMA and the EBA and grants them a status akin to the regulators in the U.S.
Although the U.K. may bring further challenges if it thinks ESMA and the EBA
have gone too far, the ECJ's recent decision points the way to a regulatory
landscape where EU Member States have much less to say.
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