The Court of Justice of the EU's rejection of British attempts to appeal against a European short-selling ban could signal a new degree of harmonisation on financial regulation.

On January 22, 2014, the UK’s attempt to exercise autonomy over its right to regulate short selling was extinguished, as the Court of Justice of the EU (CJEU) dismissed the UK’s case for the annulment of the European Short Selling Regulations. Article 28 of the Short Selling Regulations currently grants the European Securities and Markets Authority (ESMA) the power to intervene within the financial markets of EU member states and impose conditions on short selling, if and when it considers there to be a threat to the stability of the EU financial system.

The UK’s objection is supported by case law around Article 114 of the Treaty on the Functioning of the EU (TFEU) – one of the legal bases under which the EU has the power to adopt legislative acts such as the Short Selling Regulations. This previous case law had shown that Article 114 may only be used as a legal basis for adopting measures where it is actually apparent that the purpose of the measure is to improve conditions for the establishment and functioning of the European internal market. However, the CJEU judgment counteracted this argument and stated that Article 28 of the Short Selling Regulations was “[in] keeping with the spirit of Article 114 TFEU, at the harmonisation of the member states’ laws, regulations and administrative provisions”.

The decision to dismiss the challenge is a blow not only to financial institutions’ short-selling activity, but also has wide-reaching consequences for the future of banking regulation in the UK as Europe flexes its muscles.

A significant decision

This ruling by the CJEU is significant. Decisions are typically made based on the advice of advocate general Niilo Jääskinen (although the opinion is non-binding). In this case the CJEU has veered away from traditional practice and contradicted Mr Jääskinen’s recommendation.

The advocate general agreed with the UK's argument that Article 114 TFEU is not an appropriate legal basis for Article 28 of the Short Selling Regulations. Although in principle empowering ESMA to take legally binding decisions was not beyond the scope of Article 114, in order to allow such powers, the key factor to be considered was whether ESMA’s decision actually contributed or amounted to greater harmonisation in Europe. In Mr Jääskinen’s opinion, the outcome of the powers afforded to ESMA under Article 28 was actually “not harmonisation… but the replacement of national decision… with EU-level decision making”.

The court’s decision overriding the advocate general’s advice also highlights a significant shift in the balance of power – away from individual states towards EU-wide harmonisation. By contrast the UK has argued that agencies such as ESMA have overstepped legal boundaries and are now operating outside the range of their powers.

Brussels’ increasing power

The CJEU’s decision is final and therefore there is no possibility of an appeal. As a result, ESMA has the power to ban or restrict short selling in the UK. Similar rulings could be made in the future to dismiss challenges on laws such as short selling in other European financial hubs and further restrict the purview of independent financial regulators.

Currently the UK has a number of legal challenges pending in relation to the financial transactions tax, bankers’ bonus caps and the European Central Bank’s policy requiring clearing houses for euro-denominated assets to be located in the eurozone. These challenges have been made on the basis of a variety of legal arguments, however the common theme is that European institutions are acting outside the scope of their original powers – in just the same way as the UK’s original challenge to short selling.

It seems likely that the short-selling decision has reduced the prospect of success of any further challenges to the binding nature of European regulatory powers, raising serious concerns over UK institutions’ ability to compete in the global financial market.

Tim Dolan is partner and Kelly Burley is an associate in the financial markets group at international law firm King & Wood Mallesons SJ Berwin.

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