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3.28 The evidence also considered that the ability of capital to flow freely across borders is vital not only for the financial sector, but also for all other sectors where businesses operate across multiple jurisdictions. Free Movement of Capital and payments give businesses the freedom to make ordinary commercial transactions, arrange funding and make crossborder investments.33 Firms can access a wider range of markets, reduce the cost of financing their business and reduce their operating risks. GlaxoSmithKline commented that EU initiatives have made cross-border payments faster and cheaper, and also simplified their cash management practices.34
3.29 The UK has a long tradition of open capital markets’ policies. As noted in Chapter One, the UK removed all exchange controls in 1979, a full 15 years before Article 63 TFEU prohibited restrictions on the Free Movement of Capital and on payments within the EU.
As a result, the impact of the TFEU on the UK’s domestic capital policies has been limited, and so the development of the Free Movement of Capital largely relates to the opening up of national markets in other Member States to competition.35
3.30 The next section considers the impact of the Treaty freedom on the UK. To do so, it first assesses the extent to which the freedom achieves its objective of opening up capital markets across the EU. It then considers the impact of the fundamental freedom on movements of capital between the UK and countries outside the EU, noting that the Treaty freedom is more wide ranging and binding than other international frameworks.
Functioning of the Fundamental Freedom
3.31 The Free Movement of Capital under Article 63 TFEU is not an absolute freedom. Member States may intervene in the movement of capital on the basis of a number of specific public policy concerns, notably: macroprudential regulation and capital controls; tax differentiation; public policy, public security, national security and defence; and financial sanctions (see Figure Seven).36 ACT, submission of evidence, p2 and GlaxoSmithKline, submission of evidence, p1.
GlaxoSmithKline, submission of evidence, p1.
This has also been underpinned by Economic and Monetary Union, an area that will be addressed in HMG, Review of the Balance of Competences Between the UK and the EU: Economic and Monetary Policy, published in Semester Four.
Restrictions placed on the movement of capital and payments to achieve foreign policy objectives were
Source: European Commission
3.32 Apart from the area of financial sanctions, the last decade has seen incremental additional limitations on the ability of Member States to intervene in the Free Movement of Capital to achieve public policy goals.37 While some stakeholders noted the potential adverse impact on the UK national interest, others welcomed the removal of restrictions in helping to reduce the number of remaining barriers to the single market in capital. The views of respondents are set out below on the areas where restrictions on the Free Movement of Capital still apply: prudential measures; tax differentiation; and public policy. There is then a consideration of how the Free Movement of Capital under Article 63 TFEU differs from other multilateral and bilateral agreements on the Free Movement of Capital.
3.33 The financial crisis in particular highlighted the need for banks to hold more capital and for regulators to identify and take action to limit bouts of excessive financial sector exuberance or pessimism. In order to protect financial stability, prudential measures can be introduced as an exception to the Free Movement of Capital. Prudential measures include macroprudential regulation, which involves varying the regulatory requirements on financial institutions throughout the financial and economic cycle when threats to financial stability emerge, as well as capital controls.38 As a result of ECJ rulings and EU Directives.
Within the UK, the Bank of England’s Financial Policy Committee (FPC) sets macroprudential policy. The FPC has stated that its initial set of macroprudential policy tools will include the ability to vary the amount of additional capital required across the banking sector in general and with respect to particular exposures banks have in a particular lending sector.
A counter-cyclical capital buffer is a requirement for banks to hold additional capital when risks are considered to be building in the system, while the Sectoral Capital Requirement is limited to particular exposure classes. 44 Review of the Balance of Competences between the United Kingdom and the European Union:
The Single Market: Financial Services and the Free Movement of Capital
3.34 A few stakeholders noted that this exception is not without limit with regards to macroprudential regulation. When macroprudential authorities intend to put in place certain new measures, they are required to notify the European Parliament, the Council, the Commission, the European Systemic Risk Board and the European Banking Authority, setting out the reasons for the measures. Acting by qualified majority, the Council has the power, subject to certain criteria, to reject the national macroprudential measures proposed. However, it is envisaged that the rejection by Council of any national macroprudential measure will be the exception rather than the rule. Other measures require less onerous procedures.
3.35 Reaction to the discretion afforded to macroprudential policy-makers was mixed. For example, Fresh Start expressed concern over the potential restriction on the ability of the UK ‘to introduce more stringent regulation than the EU currently proposes, for example regarding capital requirements for banks [...] [given] the significant exposure of the UK economy to the banking sector – banking assets are 500% of GDP’.39 On the other hand, HSBC was more generally concerned about national regulatory actions constraining banks cross-border activities and fragmenting the Single Market, and argued that ‘many of the obstacles to capital flows are due to the existence of national discretions in EU rules and in prudential supervisory practices’.
3.36 There is broad international consensus that, in a limited set of circumstances involving capital inflows or outflows that are very large relative to the national economy,40 formal, temporary controls on external capital flows can be beneficial for financial stability.41 Cyprus implemented strict controls on the transfer of capital outside of the country to prevent bank depositor flight, following the bail-in of bondholders and depositors in the two largest Cypriot banks in March 2013. This is, to date, the only EU Member State with previously fully liberalised capital flows to impose generalised capital controls. A number of stakeholders emphasised the view that capital controls should remain reserved for only very exceptional circumstances and that Cyprus’s existing restrictions should be removed as soon as possible.42 Tax Differentiation
3.37 Article 65 of the Treaty sets out that the Free Movement of Capital does not prevent Member States from distinguishing between tax-payers who are not in the same situation, regarding their place of residence or location of their capital investment.43 However, a series of judgments by the ECJ has limited this discretion. In fact, the ECJ has determined See, in particular, Fresh Start, submission of evidence, p2 and p11. BBA, submission of evidence, p15, also noted this as a ‘significant change’ in the ability of Member States to influence capital flows.
In exercise of the public policy exception in Art 65(1)(b), countries like the UK – which have their own, free floating currency and deep, well-developed financial systems – are not likely to be subject to substantial risks as a result of sudden large capital inflows or outflows. If such flows do occur, such countries should be better able to manage them using market and more nuanced regulatory responses.
For example see: IMF, The Liberalization and Management of Capital Flows: An Institutional View (2012).
Available at: www.imf.org/external/np/pp/eng/2012/111412.pdf. Accessed June 2014.
See: BBA, submission of evidence, p15; IRSG, submission of evidence, p21; and Sharon Bowles MEP, submission of evidence, p24.
In accordance with TFEU, taxation competence remains largely at the Member State level. In the area of direct taxation (broadly, a charge on the income, profit or property of people or companies), EU-level action is only justified where it would ‘directly affect the establishment or functioning of the Single Market’ (Article 115 TFEU). Member States must also exercise their competence in line with the fundamental freedoms. For further information see HMGs, Review of the Balance of Competences between the UK and the EU: Taxation (2013).
Chapter 3: Impact on the National Interest 45that differential tax rates relating to the same tax instrument based solely upon the location of capital or residence of the individual are discriminatory and breach one or more of the four freedoms.44
3.38 However, as with other areas, Member States can still justify discriminatory tax measures on overriding public interest grounds. Dr Thomas Horsley (Liverpool Law School) commented that these include ‘securing the cohesion of the tax system’ and ‘effective fiscal supervision’. Nevertheless, he added that obstacles to the Free Movement of Capital may not be justified on purely economic grounds.45
3.39 Standard Life remarked that, ‘the reserved nature of tax law can cause the Single Market to act in a suboptimal manner and can act as a de facto restriction on capital flows’. Paul Morton (Head of Group Tax, Reed Elsevier) further suggested that the ECJ’s action in limiting the grounds on which a discriminatory tax measure can be justified had had a broadly positive impact for businesses, although the ECJ process was not always clear to UK businesses which could give rise to uncertainty in both the run-up to a judgment and the interpretation. He also noted that particular rulings do not translate immediately into uniformity across the EU.46
3.40 Following the implementation of Article 63 TFEU, numerous controls remained in place relating to the direct investment in private companies deemed important to national public policy, security and defence objectives.47 In many cases, these controls were exercised by ‘golden shares’ held by Governments in particular companies. These golden shares enabled EU national Governments to maintain rights to name board members or have veto rights on commercial decisions without the level of ownership in the company that would conventionally confer such rights. The UK has called for these arrangements to be removed where there is no very significant national security and defence justification for continued controls by national Governments.
3.41 More widely, ICAEW considered that there are a number of examples where Member State action has obstructed a change in ownership. Examples put forward include E.ON’s bid for Endessa in 2007 and Yahoo’s bid for a majority stake in Dailymotion in 2012.48 See for example the Manninen case, where the ECJ ruled that a Finnish tax-payer should be granted a tax credit by the Finnish state on a dividend paid by a Swedish company, which had been taxed in Sweden, as such a credit would have been available upon a dividend paid by a Finnish company, taxed in Finland, and the differential treatment discouraged the Free Movement of Capital. Case C-319-02 Manninen .
Dr Thomas Horsley, Liverpool Law School, submission of evidence, p6.
Paul Morton (Head of Group Tax, Reed Elsevier), submission of evidence, pp1-2, minutes from meeting with HMT on 23 January 2014.
Article 65(1)(b) TFEU sets out that, notwithstanding the right to the free movement of capital and payments, Member States may take measure that are ‘justified on grounds of public policy’, while Article 346 TFEU allows Member States to take action to protect their vital security interests which are connected with the production of, or trade in, arms, munitions and war material.
See annex of ICAEW, submission of evidence, p6.
46 Review of the Balance of Competences between the United Kingdom and the European Union:
The Single Market: Financial Services and the Free Movement of Capital Capital Movements Between the UK and Third Countries
3.42 Among the EU’s four fundamental freedoms, the Free Movement of Capital is unique in also applying to movements between Member States and non-EU countries, known as ‘Third Countries’.49 There are, however, some small caveats to TFEU’s extension to Third Countries. The EU can adopt measures on the movement of capital to and from Third Countries which involve direct investment (including investment in real estate), establishment, the provision of financial services or the admission of securities to capital markets.50 Where these measures constitute a step backwards in terms of the liberalisation of capital movements to and from Third Countries, the Council can still agree their adoption, provided this is done unanimously, although this option has not been exercised to date.51 Furthermore, unlike for intra-EU movements, the Treaty permits the continuation of any existing Member State restrictions52 which were already in place on 31 December 1993.53