Towards a more integrated primary issuance market for securities in the EU: Legal and policy issues

1.1. Possible Legal Bases

Article 114 of the Treaty on the Functioning of the European Union (TFEU or ‘the Treaty’) – the so-called internal market legal basis – forms part of Title VII, Chapter 3 (‘Approximation of Laws’) of the TFEU. ⁴¹ Article 114 TFEU has been the main legal basis for internal market harmonisation and the approximation of laws, and it has been invoked, in recent years, as legal basis for the establishment of the European System of Financial Supervision and the Single Resolution Mechanism. Although Article 114 TFEU does not vest in the Union legislature ‘a general power to regulate the internal market’, ⁴² the jurisprudence of the Court of Justice of the European Union (‘the Court’) is rich in instances where the creation of institutions or the enactment of harmonisation-motivated legal frameworks based on Article 114 TFEU were judicially upheld. ⁴³ By the same token, we are only aware of one instance where a measure enacted on the basis of Article 114 TFEU was struck down by the Court. ⁴⁴

It follows from the jurisprudence of the Court that the litmus test on the basis of which to determine whether the EU legislator has validly invoked Article 114 TFEU is whether the genuine object of the approximation or harmonisation measures adopted on its basis is ‘the improvement of the conditions for the establishment and functioning of the internal market’. ⁴⁵ Mere disparities amongst national laws are not adequate to meet the threshold for validly invoking Article 114 TFEU. ⁴⁶ Would the creation of an ECSD meet the Article 114 TFEU threshold? In answering this question, regard should be had to the rationale for establishing of an ECSD: this is to contribute to financial integration through an infrastructure that would not only bridge differences in national primary issuance rules and practices but, also, improve the functioning of the internal market by removing some of the obstacles to primary issuance market integration, helping attain the goal of a Capital Markets Union (CMU). In light of the above, we consider the establishment of an ECSD to fall within the remit of Article 114 TFEU, which, accordingly, could be legitimately invoked by the Union legislator as its legal basis (as well as the legal basis for the adoption of the accompanying ‘European private securities law’, discussed below).

Alternatively, it is submitted that a fall-back legal basis for the creation of an ECSD could be sought in the so-called ‘flexibility clause’ of Article 352 TFEU. ⁴⁷ Three cumulative conditions are to be fulfilled before this provision can be activated, namely (i) certain action should be necessary to attain one of the Union’s objectives, (ii) no provision in the Treaty should provide for action to attain that objective, and (iii) the envisaged action should not lead to the EU’s competences being extended beyond those provided for by the Treaties. ⁴⁸ Article 352 TFEU – the use of which is not limited to the adoption of EU internal market-specific measures – has repeatedly been relied on as legal basis for the adoption of EU legal acts as well as for the creation of EU legal structures. The circumstances of the deployment of Article 352 TFEU were the object of judicial scrutiny in Pringle. ⁴⁹ There, the Court ruled that Article 352 TFEU conferred sufficient powers to the EU to adopt the Treaty Establishing the European Stability Mechanism, as there was no specific legal basis in the Treaties for its establishment, despite the fact that its creation belonged to the sphere of economic policy, an objective of the EU under Article 3(4) TEU. ⁵⁰ Applying, mutatis mutandis, the reasoning of the Court in Pringle to the eventual creation of an ECSD, it is submitted that Article 352 TFEU could legitimately be invoked as legal basis for its establishment, without resulting in an extension of the EU’s competences beyond those provided for in the Treaties. This is notwithstanding the fact that the business of a future ECSD (that is, the centralised provision of EU-wide primary issuance services to the issuers of transferable securities) would be unprecedented for the EU: it is not the novelty of Union action that determines its legitimacy but, rather, the extent to which such action is consistent with attaining one of the Union’s objectives. The objective to which the creation of an ECSD would contribute (that is, the establishment of an internal market in cross-border securities issuance services) is a Union objective, which can legitimately be pursued through EU action.

1.2. Proportionality Considerations

It follows from Article 5(4) TEU that the ‘content and form of Union action shall not exceed what is necessary to achieve the objectives of the Treaties’. ⁵¹ What lies at the heart of the principle of proportionality is the idea that EU action should match, in terms of means, the objective it pursues, without going beyond what is necessary to achieve those objectives. ⁵² One of the more recent, high-profile instances of the application of the principle of proportionality was in the context of the Court’s scrutiny, in Gauweiler, ⁵³ of the Eurosystem’s Outright Monetary Transactions (OMT) programme. Following its established practice, the Court split its proportionality analysis in two parts: first, it assessed the appropriateness of OMTs to attain their declared monetary policy objectives and, second, it examined the compliance of OMTs with the necessity requirement.

The proportionality analysis to which the Union’s decision to create an ECSD would be subject is bound to consist of the same two legs as in Gauweiler: one appropriateness and one necessity leg. In terms of appropriateness, the Union would need to demonstrate that the policy decision to create an ECSD is backed by an adequate statement of reasons, that it is based on a substantiated analysis of the state of the EU and euro area primary issuance markets, and that the analysis in question is not vitiated by manifest errors of assessment. In terms of necessity, the Union would need to demonstrate that the decision to create an ECSD does not go beyond what is necessary to achieve the objective of establishing an internal market in cross-border securities issuance services: this could be achieved in a number of ways such as, for instance, by the Union demonstrating that, notwithstanding the importance of the public interest in the creation of a pan-European securities issuance infrastructure, adequate and effective Member State or market-led initiatives have yet to be taken to overcome fragmentation in primary issuance processes across the EU or, even if taken, would be less effective than EU level action. ⁵⁴ Considering that primary issuance activity is fragmented along national borders, that no national or market-lead initiatives are in place to overcome fragmentation, and that the issuance of certain types of transferable securities can only be undertaken, de lege lata, by licensed CSDs, ⁵⁵ we consider it likelier than not that any eventual EU decision to establish an ECSD would pass the proportionality test.

1.3. Subsidiarity Considerations

It follows from Article 5(3) TEU that, ‘[U]nder the principle of subsidiarity, in areas which do not fall within its exclusive competence, the Union shall act only if and in so far as the objectives of the proposed action cannot be sufficiently achieved by the Member States, either at central level or at regional and local level, but can rather, by reason of the scale or effects of the proposed action, be better achieved at Union level’. Applied in an EU context, the principle of subsidiarity seeks to govern the use of competences allocated to the Union (rather than, strictly speaking, their delineation) by ruling-out Union action in areas of shared competence unless the criteria of Article 5(3) are met (first, the objectives of the proposed action cannot be sufficiently achieved by the Member States – ‘necessity’ criterion - and second, the action can more successfully be undertaken at the Union level – ‘added value’ criterion). Unlike in the case of the proportionality principle, which applies to all Union actions, subsidiarity only applies in areas not falling within the Union’s exclusive competence. The internal market – that the establishment of a future ECSD would contribute to – is amongst the areas of shared competence (see Article 4(2) TFEU), to which the principle of subsidiarity applies.

EU institutions enjoy wide discretion in applying the principle of subsidiarity. However, pursuant to Article 8 of Protocol (No 2) to the TFEU on the application of the principles of subsidiarity and proportionality, the consistency of legislative measures with the principle of subsidiarity can be the object of ex post judicial review by means of an action for annulment. ⁵⁶ Notwithstanding its ‘constitutional’ importance, the principle of subsidiarity has yet to feature conclusively in the jurisprudence of the Court. ⁵⁷ In its judgment in the Deposit Guarantee case (an action brought by Germany against Directive 94/19/EC ⁵⁸ ), the Court found that a legislative measure’s consistency with the principle of subsidiarity can be ascertained on the basis of its recitals, and the reasons stated in them for its adoption, in line with the requirement of Article 296 TFEU for the EU to state the reasons for its legislative acts. ⁵⁹ Although some of the more recent jurisprudence of the Court reveals a judicial tendency to engage with the principle of subsidiarity not only procedurally but, also, substantively, ⁶⁰ the Court’s overall approach remains deferential and non-activist. What probably explains the Court’s deference is the fact that deciding which objectives can be better achieved at Union level can be politically sensitive. This is particularly so in the context of measures intended to contribute to the establishment and functioning of the internal market, where the Court has been reluctant to substitute its own assessment to that of the Union legislator in complex matters of economic policy, where the EU legislator’s leeway is, understandably, greater. How would the Court view, from a subsidiarity standpoint, the establishment of an ECSD? Without prejudice to the difficulty of risking predictions over the outcome of future litigation, it stands to reason that the Court should approach favourably any EU action which, as in the case of the establishment of an ECSD, would aim to remove barriers to the effective functioning of the internal market. The likelihood of a Union-friendly judicial interpretation of an eventual Union decision to create an ECSD is, therefore, greater than that of its rejection on subsidiarity grounds.

1.4. Other Legal and Design Considerations

In designing an ECSD, reflection would be necessary on at least four more questions namely, a) the ECSD’s legal form, b) the type of securities to be issued through it, and, by necessary implication, their (eligible) issuers, c) the money, central or commercial bank, in which a future ECSD would settle its securities trades, and d) the technology, centralised or decentralised, that an ECSD would use for the purposes of the initial recording of securities issued through it, and for the monitoring of subsequent transactions over them.

Starting with the first question, a future ECSD should clearly be possessed of legal personality; this is because the CSDR’s definition of ‘CSD’ refers to ‘a legal person (emphasis is ours) that operates a securities settlement system (…) and provides at least one other core service (…)’. ⁶¹ Turning to the types of instruments to be issued through an ECSD, and their eligible issuers, it is submitted that, for several reasons, the primary focus of a future ECSD should be on public debt instruments issued by European issuers. ⁶² That said, in order for the creation of an ECSD to be consistent with its market integration rationale, reflection should be given to the gradual opening up of its scope to all instruments issued by European issuers, including equities. Regarding the money, central or commercial bank, in which a future ECSD would settle its trades, note should be taken of the policy preference for settlement in central bank money (that is, money that represents a claim on a central, rather than a commercial, bank). ⁶³ Provided a future ECSD would participate in T2S, transactions in ECSD-issued securities would be settled in central bank money, in line with the above mentioned policy preference. Finally, as regards the technology, centralised or decentralised, that an ECSD could deploy for the purposes of the initial recording of securities issued through it, and for the monitoring of subsequent transactions over them, it is submitted that, for operational risk-management reasons, a centralised issuance model would be preferable to the use of decentralised (distributed) technologies (the latter could be meaningfully used in the context of a shared issuance and distribution set-up, in which no benefit is obvious in the case of the proposed ECSD).

1. A substantive ‘European Private Securities Law’?

It has aptly been observed that, ‘[T]he remaining fragmentation [in securities issuance] is often the result of legacy and national rules’. ⁶⁴ It stands to reason that, if fragmentation in this area is to be overcome, and if investors are to have clarity as to the nature of their legal entitlement in ECSD-issued securities, ⁶⁵ certain legal reforms would be required, as a necessary complement to the establishment of the proposed ECSD. These reforms would need to pursue a two-pronged objective. On the one hand, they should clarify the legal regime subject to which the proposed ECSD would eventually operate, as well as the regulatory compliance obligations of issuers when issuing through it. On the other, they should determine the law of issuance of ECSD-issued securities, ⁶⁶ elaborating, as a minimum, on the content of the legal entitlement in them, that is, on the concrete legal attributes attaching to the holding of ECSD-issued securities (a de minimis European private securities law). ⁶⁷

Starting with the legal regime governing the proposed ECSD, it is submitted that this can legitimately deviate from the one laid down in the CSDR, given the ECSD’s public (Union) ownership, and the public interest rationale of its establishment. It is worth recalling in this context that, in accordance with Article 1(4) of the CSDR, many of its provisions, ‘(…) do not apply to the members of the [European System of Central Banks] ESCB, other Member States’ national bodies performing similar functions, or to other public bodies charged with or intervening in the management of public debt in the Union in relation to any CSD which the aforementioned bodies directly manage (…) and which is not a separate entity’. In the interest of legal certainty, Article 1(4) of the CSDR could be revisited, to expressly bring within its scope of application CSDs operated by EU institutions or dedicated EU agencies.

CSDR provisions that, on the above understanding, would not bind the eventual operator of the proposed ECSD would include, notably, the CSDR’s rules on CSD authorisation, supervision, capital requirements, and outsourcing. ⁶⁸ As regards the regulatory compliance obligations of issuers using the proposed ECSD for the issuance of their instruments, these should not, for equal treatment and public policy reasons alike, differ from those laid down in Directive 2003/71/EC (‘the Prospectus Directive’) ⁶⁹ and Directive 2004/109/EC (‘the Transparency Directive’) ⁷⁰ (except for the possibility for issuers to publish their offering document, the summary thereof, and their periodic disclosures in a single language – rather than in the languages of all national competent authorities – irrespective of the type and value of the total issuance, and whatever its target audience).

Turning to the law of issuance of ECSD-issued securities, and the content of the legal entitlement evidenced by their crediting to their holders’ investor accounts, it is legitimate to posit that, de lege lata, the former will typically be the law of the Member State of the eventual establishment of the ECSD, which would, then, also determine the latter. It is only in the presence of a body of substantive ‘European private securities law’, currently not in existence, that the law of issuance and the content of the legal entitlement in ECSD-issued securities could be determined by reference thereto, instead of being a function of purely national law concepts of property law in transferable securities, in the jurisdiction of the eventual establishment of the ECSD. Does the EU possess the legal competence to establish such a body of law, and, if so, what should its minimum content be?

It is trite law that although the EU legislator has progressively regulated many different facets of financial transactions (increasingly so since the start of the sovereign debt stage of the Global Financial Crisis of 2007-2009), ⁷¹ it has yet to harmonise the national private law rules applicable to them. As it happens, the EU lacks a general competence to harmonise private law. ⁷² Although there is no across-the-board EU competence to regulate private law matters, several Treaty provisions already grant specific competences to the Union over selected private law aspects. These include, notably, Article 50 TFEU (which empowers the EU to harmonise certain aspects of company law in order to attain freedom of establishment), Articles 114 and 115 TFEU (which empower the Union to approximate both public and private law in pursuit of the establishment of the internal market and the removal of obstacles to its functioning) and Article 118 TFEU (which, ‘in the context of the establishment and functioning of the internal market’ empowers the EU to create ‘European intellectual property rights’). It is also recalled that the so-called ‘flexibility clause’ of Article 352 TFEU allows the EU to adopt, under certain circumstances, secondary legislation through which to regulate areas of public or private law not falling within the remit of a specific conferral, to the EU, of legislative powers. ⁷³ Finally, it bears noting that the object of the Treaty’s anti-trust framework are private law relationships among private law subjects, ⁷⁴ and the same is, at least to an extent, true of the recently introduced EU recovery and resolution regime, ⁷⁵ in the form of Directive 2014/59/EU, ⁷⁶ despite the fact that the European Banking Union, of which the abovementioned regime is a core component, ‘does not focus on private law, at least not primarily’. ⁷⁷

In light of the above, the better view is that, however substantial the challenge of establishing a body of European private securities law (inter alia from the perspective of its harmonious interplay with relevant national law), ⁷⁸ the EU is already possessed of the primary law competence to adopt secondary legislation in this field. What is less clear is what the minimum content of such secondary legislation should be, a question explored below.

2. Minimum Contents of a European Private Securities Law

In deciding on the minimum content of a European private securities law necessary to complement the eventual establishment and operation of the proposed ECSD (effectively, a ‘29th regime’, specifically intended for ECSD-issued securities), inspiration can usefully be drawn from the work of the Legal Certainty Group (LCG) on securities holdings with a cross-border dimension. It is recalled that the mission of the LCG was to explore the legal position (effectively, the property rights) of account holders in respect of securities credited to their account, and their legal effects (effectively, how these, or an interest in them, can be validly acquired and disposed of), rather than to harmonise basic legal concepts of relevance to the fundamental nature and core attributes of ‘securities’. ⁷⁹ Thus, the (modest) ambition of the LCG was to achieve clarity in terms of the legal effects of entries made in securities accounts rather than to devise a fully-harmonised body of ‘EU securities law’ since, to tamper with the fundamental nature of ‘securities’ (an integral part of the legal system of each Member State) would be to open a Pandora’s box in an area of great complexity and interconnectedness with other areas of the law. It is submitted that the same approach should also be followed in charting the minimum content of a European private securities law: the aim of EU legislation to be introduced in support of a future ECSD should be to harmonise those aspects of securities law only that are essential for the holders of ECSD-issued securities to be in a position to put their securities into the economic uses that these were intended to serve. ⁸⁰ It follows that legislation to be introduced in support of a future ECSD should, as a minimum, aim at the following:

– Declare ECSD-issued securities to be, functionally, on a par with ‘dematerialised securities’ issued on any of the EU Member State CSDs, in terms of their legal effects and attributes (that is, prescribe that they enjoy the same legal status as dematerialised securities in any and all EU Member State jurisdictions, regardless of the status and location of the ECSD as the relevant securities account-providing intermediary),

By ensuring that all existing EU Member State CSDs have access, under the same objective and non-discriminatory terms, to the proposed ECSD, as investor CSDs, it should be possible to facilitate cross border secondary market trading in ECSD-issued securities even without a full network of links amongst all existing EU Member State CSDs.

We are conscious that even if the above limited harmonisation approach were to be followed, the establishment of a distinct body of European private securities law would represent a significant challenge. What the recognition, throughout the EU, of the legal effects of dematerialised securities issued on a future ECSD would entail is the parallel disapplication of national legislation incompatible with the letter and the spirit of the proposed European private securities law. How much appetite there is for the above is difficult to assess, and one can only speculate on the existence or otherwise of the political will to see a body of European private securities law emerge, notwithstanding the vested interests (some of them perhaps legitimate) in the maintenance of the status quo. What is, nonetheless, clear to us is that without such a de minimis body of law an ECSD would make little sense, and would only have a negligible contribution to make towards overcoming fragmentation in national primary issuance practices and patterns.

1. Introductory Remarks

Pursuant to Article 119(1) TFEU, the Union shall conduct an economic policy in accordance with the principle of an open market economy with free competition. ⁸³ In deciding whether to establish an ECSD, in pursuit of the (economic) objective of furthering EU securities market integration, the Union should also have regard to the implications of its establishment for free competition. We examine, below, the parameters of the application, in this context, of the Treaty’s competition framework, with an emphasis on the provisions prohibiting anti-competitive agreements (Article 101 TFEU) and the abuse of dominant positions (Article 102 TFEU). Given that Articles 101 and 102 TFEU only apply to ‘undertakings’, our analysis is preceded by an assessment of the extent to which, in offering primary issuance services, the ECSD would be acting as an ‘undertaking’ within the meaning of EU law.

It follows from the Court’s jurisprudence that, in the sphere of EU competition law, the concept of ‘undertaking’ covers any entity engaged in an economic activity, regardless of that entity’s legal status (public or private) or the manner of its financing. ⁸⁴ To determine whether the activities in question are those of an ‘undertaking’, it is necessary to examine their nature. ⁸⁵ Any activity that consists in offering goods or services on a given market is, a priori, an economic activity. ⁸⁶ The fact that the offer of goods or services may be made on a not-for-profit basis does not prevent the entity carrying out those operations on the market from being considered to be an undertaking, since that offer will exist in competition with the offer of other operators, including those who offer goods or services in the expectation of profit. ⁸⁷ Services normally provided for remuneration are to be classified as ‘economic activities’: the essential characteristic of remuneration lies in the fact that it constitutes consideration for the service in question. ⁸⁸ Would the ECSD be pursuing an ‘economic activity’ for the purposes of EU competition law? It is difficult to accept that the proposed ECSD would not be acting as an ‘undertaking’ when offering remunerated primary issuance services, even if it were to operate on a cost-recovery (not-for-profit) basis, and irrespective of the public dimension of its activities (the creation of an internal market for pan-European issuance services). ⁸⁹ The likelihood that the proposed ECSD would be deemed to qualify as an ‘undertaking’ for the purposes of the application of Articles 101 and 102 TFEU is, therefore, substantial. The above has nothing to say about the outcome of the application of those two provisions to a future ECSD, a point examined below.

2. Substantive Assessment

Article 101(1) TFEU prohibits all agreements between undertakings, decisions by associations of undertakings and concerted practices, which may affect trade between Member States, and which have as their object or effect the prevention, restriction or distortion of competition within the internal market. Thus, an infringement of Article 101(1) TFEU pre-supposes collusion between at least two undertakings. ⁹⁰ Provided the contractual agreements to be entered into between a future ECSD, on the one hand, and securities issuers and participating (investor) CSDs, on the other hand, are not unduly restrictive, ⁹¹ it is difficult to see how the establishment of an ECSD could lead to the ‘foreclosure’ normally associated with a breach of Article 101(1) TFEU. If anything, the establishment of an ECSD should be expected to promote rather than to restrict competition, since its objective would be to facilitate the development of a genuine single market for the pan-European issuance of securities, free of the national strictures to which the securities issuance and distribution processes are currently subject.

For its part, Article 102 TFEU prohibits abuses, by one or more undertakings, of a ‘dominant position’ in the internal market or in a substantial part thereof, unless these can be objectively justified.

In line with the standard practice of the European Commission (which is responsible for policing compliance with EU competition rules), in order to assess the extent to which the eventual establishment and operation of an ECSD would infringe Article 102 TFEU, it is essential to define the relevant market. ⁹² In one of its more prominent decisions in the field of securities, the European Commission made a distinction between issuer-facing and investor facing services: ⁹³ the exact product scope of the former was left undefined (as it did not affect the European Commission’s competition assessment in relation to settlement and custody services), and the same was true of its geographical scope (which was, however, thought to likely be national). Investor-facing services were defined to include settlement, and the provision and maintenance of securities accounts (including custody services), whether provided by an issuer CSD, an international CSD (ICSD), or another intermediary (whether investor CSDs, ICSDs or custodians); geographically, the relevant market was defined to be at least European Economic Area (EEA)-wide. ⁹⁴ Based on the foregoing, we are of the view that, for the purposes of Article 102 TFEU, the relevant product market would likely be the market for both issuer and investor-facing services; in geographical terms, this market would likely be national or EU-wide.

Turning to the concept of a ‘dominant position’, this has been defined by the Court as ‘a position of economic strength enjoyed by an undertaking, which enables it to prevent effective competition being maintained on a relevant market, by affording it the power to behave to an appreciable extent independently of its competitors, its customers and ultimately of consumers’. ⁹⁵ A dominant position is not likely if an undertaking’s market share is below forty per cent, ⁹⁶ and there is a rebuttable presumption that a market share in excess of fifty per cent is constitutive of a dominant position. ⁹⁷ Even if an ECSD were to attain, at some future point in time, a market share consistent with the finding of a dominant position, it is the abuse of that position that is prohibited (not the dominant position itself), through the imposition of unfair prices, trading conditions, or limits in markets and technical development, the application of dissimilar conditions to equivalent transactions, or the conclusion of contracts subject to the acceptance by other parties of supplementary obligations that have no connection with the subject matter of the contracts in question. ⁹⁸ On balance, we consider it unlikely that an ECSD that a) operates on a cost-recovery basis, b) offers its services to securities issuers on the basis of the same terms and conditions, free of ‘tying practices’ (that is, without compelling them to exclusively issue their securities through it), and c) provides for equal access conditions for its participating (investor) CSDs, could be deemed to abuse an (eventual) dominant position in the market for issuing-facing services.