Imaginary borders
If the pandemic has taught us anything, it is that borders are imaginary. A virus that appears in China today can be in the US tomorrow, and a “South-African” variant can infect people all over Europe.
This is why effective handling of the coronavirus requires international cooperation. The novel coronavirus is a global, cross-border phenomenon, and as such necessitates action taken by a large number of authorities in multiple locations at once.
Another prominent cross-border phenomenon of the last two years – other than the coronavirus itself – is online trading of financial instruments. This has grown to a magnitude, that prompts regulators to deal with a previously somewhat overlooked problem in financial trading – cross-border regulation and enforcement.
Regulators on the offensive
The latest development in this area can prove, in my opinion, to be no short of an earthquake in the EU. In January 2022, the French and Dutch financial regulators, (the AMF and the AFM) came out with a position paper, which can potentially start a regulatory war – their proposal is to give enforcement powers, not to the regulator where the investment firm is licensed; but to the one in whose jurisdiction live the majority of the firm’s clients.
The backdrop to this proposal is depicted in the position paper. “The AFM and AMF increasingly observe practices of financial firms obtaining a license and European passport in other EU member states than that of their target audience. The AFM and AMF note that such firms are overrepresented in offering high-risk products (such as CFDs) as well as in terms of the complaints received from consumers on their practices”.
Behind these well-mannered words lies a clear accusation – there are firms who mis-use the EU passporting regime. They get their license in one jurisdiction; but conduct most of their business in another. This, according to the two regulators, makes it hard on both the “home” regulator (where the firm is licensed) and the “host” one (where the clients are) to supervise and enforce effectively. Between the lines another accusation lurks – some regulators are more lenient on firms (perhaps as they know those firms will do very little business in their own jurisdiction), therefore these firms choose to “set up shop” there.
“We therefore propose to reconsider whether the physical presence of a firm in a host Member State should still determine the home/host division of responsibilities. A future-proof cross-border supervisory set-up is best suited by placing responsibilities for conduct supervision where they are most efficient: with the NCA of the host Member State”.
Other proposals the AMF and AFM present are “the introduction of a requirement for NCAs to withhold, or withdraw, authorisation where a firm has clearly chosen to place its seat in a particular Member State in order to avoid stricter standards of the Member States where it will carry out most of its activity”, and a “centralised and up-to-date database on cross-border activities at the ESA level”.
Cracks in the Union
The meaning of this proposal is double. First, it is a clear admittance that the passporting system does not work; and should be nearly-abolished, and replaced by a “proxy-regime”.
In essence, say the two regulators, we cannot protect our citizens; and we cannot trust other regulators to do so as well; therefore we want the power back in our hands. It’s a crack in the European Union – another crack, it should be said, exposed by the pandemic, which saw European borders closing and respirators withheld despite the clear cry of help from some countries. (And of course, we shouldn’t forget the giant tear caused by Brexit. We certainly do not want the public in another EU country to lose confidence in the EU’s ability to safeguard them).
The second and practical meaning of this proposal is the eradication of small countries as licensing centres. No more regulatory arbitrage.
Who taught you how to drive?!
Perhaps this is the place to clarify what “regulatory arbitrage” is. We’ll do that using by a driver’s license as an example. Imagine there’s a country in the EU, where one can get a truck driver’s license with hardly any training, and the authorities are very lenient in respect to fines, supervision etc. Since that country is in the EU, the trucking license is valid throughout the EU; and can be obtained by all EU citizens.
Such a situation will undoubtedly be attractive to many European aspiring truckers, and thus, even though they are not from that country and do not intend to drive in that country, they will take out a trucking license there; and then go to another Member State and raise traffic havoc there, knowing very well that it’s also very hard on the authorities in that country to revoke their license or effectively fine them.
In essence, what the AMF and AFM are saying is, that if you’re driving in our countries, you should have a local driver’s license. We need it to protect our own population from bad truckers.
Long coming
I don’t know if this is the situation in the trucking industry, but it IS the situation in Capital Markets and has been for many years now.
In 2018, in a chapter entitled ‘Passporting in the EU – is an Opportunity also a Problem?’ that I wrote for The RegTech Book (Wiley, 2020), I highlighted some aspects of the passporting regime that can lead to regulatory arbitrage, and wrote: “What is needed is not more regulation but more active supervisory cooperation between financial services authorities of home and host member states supported by standardization and automation through software in order to ensure the safeness and soundness of the single market, and to protect the interests of clients across the European Union.
“EU financial services authorities must work together to try to harmonize areas that should be simple to harmonize. ESMA could lead this effort to secure consistency and investor protection across the EU. Otherwise, we are undermining the value of passporting in the financial sector across the European Union. Leaving as is will simply become an opportunity for regulatory arbitrage.”
Coming from a different perspective, the Commission and the EBA have been working on creating a Single European Market for years now, and are trying, in many different ways, to level the playing field for retail clients across the continent (for example, create uniformity in terms of client onboarding requirements).
Where Is This Heading?
The culmination of this process of uniformity may be a single, pan-European rulebook, which will help level the playing field across the continent. The AMF and AFM, however, clearly do not believe they have the time to wait for this process to take course (or perhaps that it won’t help), and therefore wish to set on a parallel course, one that takes us farther away from a Single Market in favour of client protection.
The fact that we see two regulators, not one, acting together on this, may suggest they wish other regulators to join them. In my opinion, this will indeed happen, eventually resulting in a somewhat restricted passporting regime.
The change does not have to be drastic – for example, passporting may be allowed for light activity; but if an investment firm exceeds a minimum threshold, it will be required by both its “home” and “host” regulators to “move shop” to the “host” country, within a certain period of time.
Ultimately, this is about protecting investors and making sure they have all the protection they need by their regulators, and should things go wrong, they should be able to have access to a compensation scheme where they understand their rights, and in a language that they understand. I have seen many announcements of liquidated brokers across Europe and beyond made in the local language, meaning if you are a client from another country of the broker, you may not understand what these announcements mean even if you receive them and are likely to miss essential deadlines, leaving you with no recourse.
Therefore I fully support what the Dutch and French regulators are trying to achieve. It’s time for a change! But as mentioned above, the change doesn’t have to be drastic, it just needs careful thinking centered around more harmonization and digitization, to secure the safeness and soundness of the single market, and to protect the interests of clients across the European Union.
Remonda Kirketerp-Møller is CEO and founder of Muinmos
