1. On 22 January 2014 the Court of Justice of the EU  (“CJEU”), in a controversial but not unanticipated  decision 1, dismissed the UK’s challenge to the  powers conferred on the European Securities and  Markets Authority (“ESMA”) in the short selling  regulation 2  and handed down a judgment that could  encourage the EU to transfer further powers to EU  bodies and limit the oversight of these bodies.   

Background

  1. The provisions of the short selling regulation were  analysed in our client alert of 30 October 2012  entitled “Short Selling and Credit Default Swaps  - New EU Rules Enter into Force on 1 November  2012” 3 .  In summary, the regulation focuses on  shares admitted to trading on a trading venue in  the EU and the sovereign debt of the EU Member  States.  It bans naked short sales of shares and  sovereign debt in the EU, imposes a general ban  on uncovered sovereign credit default swaps  and requires that certain net short positions are  privately notified to the relevant national regulator  and, at higher levels, are publically disclosed.  It  contains various exemptions, including for shares of  a company admitted to trading on a trading venue  in the EU where the principal venue for the trading  of the shares is in a third country and in relation  to transactions carried out in the performance  of market-making activities and when acting as  an authorised primary dealer.  The short selling  regulation also gives various emergency powers  to curb short selling to national regulators and  to ESMA.  It was the powers that were conferred on ESMA that were the subject of the UK’s legal  challenge
  2. Article 28 of the short selling regulation gives  ESMA the power to prohibit or impose conditions  on the entry into short sales or similar transactions  and to require such persons to notify or publicise  net short positions.  The trigger for the use of the  power is set out in Article 28(2) and is where ESMA  assesses that:
    1. the measure it is considering imposing  addresses a threat to the orderly functioning  and integrity of financial markets or to the  stability of the whole or part of the financial  system in the EU;
    2. there are cross border implications; and,  significantly,
    3. competent authorities have not taken measures  to address the threat or the measures that  have been taken do not sufficiently address the  threat.

There are no criteria to guide ESMA’s assessment,  although the Commission has adopted a delegated  regulation to specify the criteria and factors to be  taken into account when determining when the  threats referred to in (a) above arise 4  which involve  further questions of discretionary judgment 5.

  1. Article 28(3) sets out certain further issues ESMA  should take into account in deciding whether it  needs to take measures.  These are the extent to  which the measure it is considering imposing: 
    1. significantly addresses the threat to the orderly  functioning and integrity of financial markets  or to the stability of the whole or part of the  financial system in the EU or will significantly  improve the ability of competent authorities to  monitor the threat; 
    2. does not create a risk of regulatory arbitrage; 
    3. does not have a detrimental effect on the  efficiency of financial markets, including by  reducing liquidity in those markets or creating  uncertainty for market participants, that is  disproportionate to the benefits of the measure.

There are no criteria on how ESMA should  determine whether a measure will have the effect  set out above nor what regard ESMA should have to  the matters set out above when imposing a measure.

  1. The power is based upon the first limb of Article  9(5) of the regulation establishing ESMA6  which  provides that ESMA “may temporarily prohibit  or restrict certain financial activities that threaten  the orderly functioning and integrity of financial  markets or the stability of the whole or part of the  financial system in the Union in the cases specified  and under the conditions laid down in” other  legislative acts.  The regulations establishing the  other European Supervisory Authorities (“ESA”) 7 mirror that in respect of ESMA mutatis mutandis and thus contain provisions identical to Article 9(5). 
  2. Article 28 of the short selling regulation is the first  example of such a power being conferred on an  ESA but the recently agreed Markets in Financial  Instrument Regulation (“MiFIR”) contains  provisions which are also based on Article 9(5) of  the ESMA regulation8.  In addition, Articles 17 – 19  of the ESA regulations confer powers on the ESAs  (in the case of a breach of EU law, in the case of an  emergency situation as declared by the Council and in cases of binding mediation respectively) which  permit the ESAs to impose direct decisions on  national regulators and ultimately on firms.  These  powers have yet to be exercised but raise similar  issues to those discussed in this article.

Legal challenge

  1. The EU Treaties, which contain the EU’s legislative  framework, do not provide for the creation of EU  agencies but nor do they exclude them. There  has been no serious disagreement about the need  to delegate some regulatory powers and so the  objective usefulness of EU agencies has not been  challenged but, as agencies do not have a legal base  in the Treaties, there are limits on the extent of the  powers can be delegated to them.  The UK argued  that these limits meant that the power conferred on  ESMA in the short selling regulation was unlawful.  
  2. The UK grounds of challenge to Article 28 were as  follows:
    1. It is contrary to the Meroni 9 principle which  provides that EU institutions may delegate  powers to independent or executive or  regulatory bodies as long as the delegation  relates only to clearly defined executive  competencies, meaning that no power which  may make possible decisions on policy choices  may be granted to the delegated body.  In  Meroni a distinction was made between “clearly  defined executive powers the exercise of which  can, therefore, be subject to strict review in the  light of objective criteria determined by the  delegating authority” and “a discretionary  power, implying a wide margin of discretion  which may, according to the use which is made  of it, make possible the execution of actual  economic policy”.  The former can be delegated  to a European body but the latter cannot.  The  UK reasons for reliance on the Meroni principle  included the following: 
      1. The criteria as to when ESMA is required to  take action under Article 28 entail a large  measure of discretion. 
      2. ESMA is given a wide range of choices as  to what measure or measures to impose,  and what exceptions to specify, and these  choices have very significant economic  policy implications. 
      3. The factors which ESMA must take into  account contain tests which are highly  subjective.
      4. ESMA has a broad discretion as regards the  application of policy to any particular case.
    2. Article 28 purports to empower ESMA to  impose measures of general application which  have the force of law contrary to the case of  Romano 10.
    3. Article 28 purports to confer on ESMA a  power to adopt non-legislative acts of general  application that is not consistent with Articles  290 and 291 of the Treaty on the Functioning of  the EU (“TFEU”) which provide the only basis  for delegations of power at EU level. 
    4. Article 28 cannot properly be adopted under the  chosen legal base, Article 114 TFEU, which can  only be used for the purposes of internal market  harmonisation. 
  3. The Advocate General to the CJEU, Advocate  General Jääskinen, delivered his opinion on 12  September 201311.  His role was to analyse the law  and advise the CJEU on its decision.  Opinions of  Advocate Generals have persuasive, rather than  binding, effect but are, in practice, followed by the  CJEU in most cases.  Advocate General Jääskinen  upheld ground 4 only.  He was of the view that the  conferral of decision-making powers on ESMA “in  substitution for the assessments of the competent  national authorities” does not amount to internal  market harmonisation so as to permit the use of  Article 114 TFEU and, although the power set out  in Article 28 can be conferred on ESMA, allowing  an EU agency to substitute its decision for a  national decision is so significant that legislation  permitting this transfer of competence must be  adopted under Article 352 TFEU.  Article 352  requires the unanimous agreement of all Member  States and only the consent of the European  Parliament whereas Article 114 requires a qualified  majority vote in Council and joint adoption by the  Parliament.  The Advocate General’s opinion was,  therefore, significant, particularly given the recent  direction of travel in the regulation of financial  services which has seen an increasing number of  regulatory powers being transferred to EU level.

The decision of the CJEU

  1. The judges of the CJEU deliberate on the basis of a  draft judgment drawn up by the judge rapporteur.   Each judge involved in the matter may propose  changes but decisions of the CJEU are taken by  majority and dissenting judgments are not produced:  there is just one judgment made public. The  judgments, which are usually fairly short, are signed  by all the judges who took part in the deliberation  and the outcome is handed down in open court.
  2. The CJEU handed down its judgment on the UK’s  challenge on 22 January 2014.  It disagreed with  the UK and, more unusually, with its own Advocate  General.  It dismissed all four heads of challenge for  the reasons summarised below:
    1. The CJEU concluded that the Meroni principle  was satisfied because ESMA’s discretion is  limited by various conditions and criteria,  ESMA is required to “examine a significant  number of factors”, ESMA can take only certain  types of measures and ESMA has duties to  consult and notify various bodies.
    2. ESMA does adopt measures of general  application but this is envisaged by Articles 263  and 277 TFEU and is not at odds with Romano.
    3. The delegation of powers to ESMA was valid  even though it did not “correspond to any of the  situations defined in Articles 290 TFEU and  291 TFEU” and the Treaties do not contain any  specific provisions for the delegation of powers  to EU agencies.  
    4. The CJEU did not specifically address the  Advocate General’s argument.  It stated simply  that Article 28 was directed at harmonisation  and its purpose was to improve the internal  market in financial services so Article 114 was  an appropriate legal basis.

Conclusion

  1. The CJEU’s reasoning is skeletal and, in parts at least,  opaque but there is no avenue of appeal.  The decision  appears to deprive the Meroni principle, which placed  limits on the powers that could be conferred on EU  agencies, of all real effect as Article 28 of the short  selling regulation appears to give ESMA significant  discretion without oversight by an EU institution.  
  2. The Court in Meroni referred to the “fundamental  guarantee” as to “the balance of powers which is  characteristic of the institutional structure of the  Community” and said “[t]o delegate a discretionary  power, by entrusting it to bodies other than those  which the Treaty has established to effect and  supervise the exercise of such power each within  the limits of its own authority, would render that  guarantee ineffective”.  The effect of the Meroni  doctrine is evident in the EU legislation that has  been adopted since the establishment of the ESAs.   There has been a tendency to attempt to limit  the discretion of the ESAs by setting out criteria  and conditions to guide their decision making  or by constructing procedures whereby the ESA  decisions require endorsement, typically by the  Commission.  The decision of the CJEU in the short  selling case could be used to support the case for  the conferral of further discretionary decisions on  the ESAs, perhaps even without the requirement of  endorsement by the Commission.
  3. The decision, although not unexpected, is also likely  to cause concern in the UK and some other Member  States which are already uneasy with the way in  which the EU’s legal framework is being stretched  as the EU seeks to transfer existing national powers  and confer wide new powers on EU bodies whilst  avoiding the contentious question of whether this  actually necessitates Treaty change.
  4. As set out above at paragraph 6, the decision  will have immediate read-across to MiFIR but it  is of wider significance.  The Single Resolution  Mechanism, which is currently in trialogues,  includes the proposal for a new EU agency which  would determine the application of resolution tools  and the use of a mooted single resolution fund.   The Meroni principle and the opinion of Advocate  General Jääskinen had been used in Council  negotiations to limit the role of the proposed  agency and to justify oversight by the Council but  the ongoing discussions about its powers are now  likely to focus on political and practical rather than  legal concerns.  The decision is also relevant to the  ESAs’ existing powers, also as described above,  and to the current review of the ESA powers.  The  decision is not, however, relevant to the European  Central Bank’s (“ECB”) supervision of banks in  the Eurozone as the ECB is an EU institution  established under the Treaties (as opposed to an EU  agency established under secondary legislation) and  thus the parameters of its powers are found in the  EU Treaties themselves.