Ownership restrictions in undertakings in the field of securities

1. Introduction

Reference is made to your Letter of formal notice of 17 July 2003 concerning Norwegian provisions restricting share ownership and voting rights in undertakings in the field of securities. The EFTA Surveillance Authority (ESA) argues that the Norwegian provisions on ownership and voting rights in stock exchanges, central securities depositaries and clearing houses are contrary to article 40 of the EEA-agreement and the EEA-rules corresponding to Council Directive 88/361/EEC (Capital Movements Directive).

We maintain, as is also stated in our letter of 12 February 2003, that the Norwegian provisions in question are in full conformity with applicable EEA-law. To the extent the provisions in question constitute a “restriction” on capital movements, they are the least restrictive measures to ensure independent and neutral stock exchanges, central securities depositaries and clearing houses. For your information, the question whether to amend these ownership provisions were explicitly discussed in the preparatory works to the Act that abolishes the general 10 per cent rule for financial institutions, see Ot.prp. nr. 50 (2002-2003) page 34. However, both the Government and Parliament opted to differentiate between stock exchanges, central securities depositaries and clearing houses on the one hand, and financial institutions on the other hand. This will be elaborated further below.

We have no objections to ESAs presentation of applicable Norwegian law. Further, we acknowledge that the European Court of Justice has expanded the concept of “restrictions” on capital movements in recent years. However, we do question whether the same concept of a “restriction” can be used in an EEA-context, see further under section 3. In any event, we will argue that the relevant ownership rules can be justified under the doctrine of the general good (in section 4). We will explain the relevant interests of general good that are at stake. Furthermore, we will explain why the Norwegian ownership rules constitute a suitable and proportionate mean to ensure the attainment of these interests.

However, before we enter the more legalistic part of our answer, we would like to seize the opportunity to give some general remarks on the recent process of “privatisation” of certain service providers in the Norwegian financial market.

2. General remarks on the “privatisation” of certain service providers in the Norwegian financial market

The core function of the securities market is to provide credit and risk capital, and to enhance an efficient allocation of capital. The market can only function to this end if the market participants (investors and issuers) have confidence in the way the market operates. Such confidence is dependent on general trading rules that prohibits unfair trading practices (i.a. prohibition on insider dealing and market manipulation) and correct behaviour of the intermediaries that operates in the market. Provisions to this end are found in the Act on securities trading of 1997. Furthermore, the investors must be confident that the market place itself is properly regulated. In Norway, this aspect is regulated in the Stock Exchange Act of 2000. Finally, investors need to be confident that they receive the instruments that are bought in the market, and sellers need to receive the corresponding payments. These aspects are dealt with in the legislation on registration, clearing and settlement, i.a. the Act on registration of financial instruments of 2002 (regulates the central securities depositaries) and the Act on securities trading chapter 6 (regulates clearing houses).

In order to create confidence among market participants that stock exchanges, clearing houses and central securities depositaries operate in the best interest of their customers, Norway has imposed certain ownership limitations on these institutions. These rules not only ensure the independence and neutrality of the institutions, but also remove any doubt that the institutions are not operating in an independent and neutral manner. It is necessary to be absolutely certain that such institutions operate in a neutral manner because they perform official functions in the financial market, for example through the authority to impose fines. We will discuss these issues further in section 4 of this letter.

In our opinion, the abovementioned regulations have created a modern regulatory framework for the provision of infrastructural services to the financial markets.

An important issue in relation to the regulation of the stock exchange and the central securities depositary has been whether or not these institutions, which used to be organised as self owned institutions (foundations), should be permitted to convert into public limited companies. The assessment of this issue was complex. Some argued that the public importance of these institutions should lead to the conclusion that the institutions should be denied to convert into public limited companies. Others argued that such institutions should be allowed to convert, i.a. to give them access to the capital markets and the possibility to participate in structural reforms (i.e. mergers or conglomerates). The Government concluded that the stock exchange and central securities depositary (organised as foundations) should convert into public limited companies, since this would give the companies access to capital and the possibility to participate in structural reforms in the securities market. A prerequisite for this assessment was that the public limited company should be subject to i.a. ownership rules and other strict operational requirements, so as to ensure that the “public concerns” related to a conversion were adequately met. These assessments are explained further in Ot.prp. nr. 73 (1999-2000) and Ot.prp. nr. 39 (2001-2002).

It would amount to a paradox if a Member State that chooses to demutilise core functions of its financial infrastructure, should be banned from imposing certain ownership provisions on the resulting private undertakings – when the alternative would have been to keep the institutions in their mutual form, thus effectively blocking any private participation in the institution.

3. EEA-concept of a “restriction” on capital movements

Non-discriminatory ownership rules in the financial sector were thoroughly assessed in the EEA-negotiations. Indeed, the rule was considered of such importance that it was the subject of an explicit question from the EFTA-side in a letter of 23 October 1990 to the Commission (in relation to financial institutions). The question (no. 22) was as follows:

“As regards companies of a certain nature, inter alia, financial institutions, may a non-discriminatory upper limit on individual ownership be fixed, e.g. 10 per cent ?”

In the reply dated 7 March 1991, the Commission stated the following:

“Prudential considerations, for example, could be advanced for non-discriminatory upper limits on individual ownership in the financial sector. We would presume that these measures would be applied to all holdings and not just new holdings”.

On the background of this clear answer, the Norwegian Government did not ask for specific derogations in the EEA-agreement to maintain ownership rules in the financial sector. It follows from the relevant documents presented to Parliament that Norwegian authorities presupposed that non-discriminatory ownership rules could be upheld when it decided to ratify the EEA-agreement, see also our letter in a related issue of 22 March 2001.

Even though the exchange of letters and the Parliament documents concerned financial institutions, they have bearing on the interpretation of a “restriction” in relation to ownership rules in the financial sector in general.

4. The doctrine of general good

4.1 General

In the alternative (i.e. even if the measures are considered to constitute a “restriction” under applicable EEA-law), it is submitted that the Norwegian measures are legitimate. Non-discriminatory restrictions on fundamental freedoms may be justified under explicit Treaty-provisions, or under the doctrine of mandatory requirements. As it is generally recognised that the doctrine of mandatory requirements provides a wider set of available justifications than the explicit Treaty-provisions, the discussion in the following is restricted to the former.

The European Court of Justice and the EFTA-Court have consistently held that national measures liable to hinder or make less attractive the exercise of fundamental freedoms guaranteed by the Treaty must fulfil four conditions: they must be applied in a non-discriminatory manner; they must be justified by imperative requirements in the general interest; they must be suitable for securing the attainment of the objective which they pursue; and they must not go beyond what is necessary in order to attain it.

The Norwegian measures in question are not discriminating against foreigners in law or in fact. In the following, we will explain why the measures are justified by imperative requirements in the general interest (section 4.3). In section 4.4 and 4.5, we will argue that the measures are both suitable and proportionate in ensuring the attainment of these interests.

4.3 Legitimate interests

The measures in question are considered important to ensure independent and neutral providers of infrastructure services, and thus to preserve the good reputation of the Norwegian financial sector. This objective was explicitly recognised to be in the “general interest” by the European Court of Justice in C-384/93 Alpine Investments BV. The more specific interests at stake will be explained further in the following.

The ownership rules ensure that providers of infrastructure services to the Norwegian financial markets actually act independently and neutral. Equally important, the rules create confidence among investors and other users that these institutions indeed act in such a way. The latter aspect of independence and neutrality supports the imposition of clear and transparent rules in order to achieve these goals, see further under section 4.5 (on proportionality).

The legislative basis for ownership rules for stock exchanges, CSDs and clearing houses differ somewhat from the legislative basis of the ownership rules for financial institutions (the ownership rules for financial institutions are amended, see more information in our letter of 24 September 2003). The reasons for maintaining ownership rules for financial institutions were i.a. a need to avoid a structure in which owners could exercise undue influence on the credit allocation of the institution concerned. In relation to infrastructural institutions, the need to avoid undue influence from owners is considered important to ensure that the owners (or entities related to the owner) do not receive favourable treatment when they act as customers of the institutions. Thus, the argument related to credit allocation is less relevant in this context. Furthermore, the need to avoid cross ownership between competing institutions that were an important basis for the previous regime for financial institutions carries less weight in relation to the infrastructural institutions that have (close to) natural monopolies in their respective markets. This difference in legislative basis in the two situations is explicitly discussed in the preparatory works of the Stock Exchange Act (NOU 1999:3 page 195 and Ot.prp. nr. 73 (1999-2000) page 67) and the Central Depositary Act (NOU 2000:10 page 69 and Ot.prp. nr. 39 (2001-2002) page 47). Thus, the reason for maintaining ownership rules in relation to these institutions is based on the specific characteristics of these institutions.

The main basis for the ownership rules is the need to establish trust among the market participants that the market place, the CSD and the clearing house acts in a neutral manner. Through rules that limits the possibility for some owners or groups of owners to have dominant influence in the institutions concerned the risk that the owners exercise undue pressure on the running of the institution is reduced. The risk that market participants can suspect favourable treatment of an owner in his capacity as a user of the institution is also reduced. By ensuring equally influential owners, focus will necessarily be on ensuring the well functioning of the institution, as this goal per se is the only common goal of all the owners. In a situation where one owner or a group of owners is more influential than the others, this goal is not necessarily the only goal of the owners. In such a situation, there will be an inherent risk that the owner might use the influential position to gain favourable treatment in relation to other users in his capacity as user of the institution. These aspects of the ownership rules are also discussed in the preparatory works mentioned above. The core functions of these undertakings require independence. One cannot run an effective stock exchange if investors could raise the issue whether the exchange treats some investors (with more or less concrete links to large owners of the exchange) better than other investors, in relation to i.a. ongoing reporting, the matching of trades, listing requirements or the assessment of prospectuses. The same applies to a central securities depositary, which is responsible for both the registration of ownership (and limited rights) in a number of financial instruments, and the settlement of all trades related to listed shares in the Norwegian market. A clearing house has similar functions of clearing and settlement in relation to financial derivatives. One thing is the negative consequences such claims could have for the institution itself. Far more damaging are the potential repercussions such claims could have on the confidence on the Norwegian financial market as a whole. Being a small market, we are especially dependent that foreign investors trust that all investors are treated equally in their contact with these institutions.

Stock exchanges and central securities depositaries conduct public tasks within their respective domains. For example, a stock exchange might impose fines if an issuer or an investor breaches either public requirements (i.a. on disclosure) or the internal rules of the stock exchange. A central securities depositary organises the ownership to shares in all Norwegian listed companies, which undoubtedly is a task within the public domain. If an owner of a stock exchange or a CSD acquires control of the institution, other market participants might question whether these public tasks are conducted in a neutral manner, or whether the institution uses these public tasks to the advantage of an influential owner, e.g. if the stock exchanges chooses to impose a fine on a competitor of the influential owner. Even a suspicion of the latter would be extremely damaging for the general confidence in the Norwegian securities market. The independence of stock exchanges is also an important element in the discussion of the future regulation of European securities market. An important issue in the recently adopted Prospectuses Directive is whether competent authorities or stock exchanges should approve prospectuses. In Norway, this task is today entrusted with the stock exchange. In the new regime (imposed in the Directive), the main responsibility of approving prospectuses must lie with the competent authority, but this may be delegated to the stock exchange under certain conditions. We have not yet decided whether or not we will use the option to delegate the competence to approve prospectuses to the stock exchange. A prerequisite for any delegation would that the stock exchange can act independently in relation to its owners in conducting such public tasks. The ownership rules are an important element in this respect.

Furthermore, these institutions have (for the time being) more or less natural monopolies in their respective markets. Thus, one cannot depend on market forces to “neutralise” the negative effect a discriminating institution would have inflicted on itself and the market in general. This reinforces the need to ensure independent and neutral institutions through clear and transparent rules.

4.4 Suitability

In our view, restrictions on ownership and voting rights are suitable means to secure the attainment of independent and neutral providers of infrastructure services to the Norwegian financial market. ESA seems to disagree that the measures are suitable to this end.

First, ESA argues that holdings exceeding certain thresholds do not entail a risk of abuse of control which would threaten the integrity of the market. In our opinion, it is not unreasonable to assume that the acquisition of a major shareholding in such institutions will grant the acquirer a major influence in the undertaking, thus threatening the independence and neutrality of the undertaking – or at least the investor’s perception of its neutrality and independence in relation to this investor or others connected to him.

Furthermore, ESA seems to be concerned with the predictability of potential investors. However, ESA’s concern is related to the discretionary possibility for the Ministry of Finance to grant exemptions from the main rule, and not to the main rule it self (which must be considered to be clear and predictable). In our opinion, the main rule (i.e. the ownership and voting restrictions) should be considered a suitable mean of ensuring predictability and transparency. It follows from the relevant preparatory works that the possibility to grant exemptions shall only be used in exceptional circumstances. Thus, we find ESA’s concern relating to predictability to be unfounded.

4.5 Proportionality

In its letter of formal notice, ESA question whether the Norwegian measures are proportionate, i.e. whether they go beyond what is necessary to achieve the objective pursued. As a general comment, we would maintain that the proportionality test is relative in relation to the freedom being exercised. ESA seems to advocate a “strict” proportionality test. However, it should be noted that the European Court of Justice has recognised that a restriction is more likely to be found proportionate when applied against an undertaking working permanently within a territory (under the freedom of establishment), than a restriction applied against undertakings working only temporarily within the territory (under the freedom to provide services), see C-76/90 Sager. This is in conformity with the Commission’s Interpretative Communication on the freedom to provide services and the interest of the general good in the second banking directive (SEC (97) 1193 Final page 24-25. It is considered more burdensome for an occasional service provider abroad to comply with different national regulations, than for an established undertaking. The same underlying reasoning applies in relation to capital movements. The “pure” capital movements (e.g. acquisitions of minor posts) are more easily dissuaded than capital movements also involving an establishment. In the latter situation, other considerations than the non-discriminatory measure in question will decide whether or not the acquisition will be made. In C-251/98 (Baars), the European Court of Justice found that a shareholder is “established” in the sense of article 43 EC (article 31 EEA) when the holding “gives him definite influence over the company’s decisions and allows him to determine its activities”. The Norwegian provisions in question regulate the holding of 10/20 to 100 per cent of the shares in a financial institution. A shareholding in this interval might give “definite influence” over a financial institution under Norwegian law. Thus, it is submitted that the EEA-rules on establishment are relevant when assessing the Norwegian provisions on ownership in financial institutions, in addition to the EEA-rules on the free movement of capital. Thus, to the degree the Norwegian measures constitute a restriction on capital movements, they will normally also constitute a restriction on the freedom of establishment. Consequently, a less strict proportionality test should apply compared to a situation where only capital movements are dissuaded. This approach is also consistent with art. 58 (2) EC, under which restrictions on capital movements are allowed if they are justified under the freedom of establishment.

The “strict” approach favoured by ESA is sought justified by reference to European Court of Justice in C-54/99 (Eglise de scientologie). However, the restriction in that case applied only towards foreigners investing in France. It is settled case law that discriminatory measures are submitted to a much stricter assessment than non-discriminatory measures when is comes to justification under Community law. The same should apply in an EEA-context. Thus, it is submitted that the case referred to by ESA is of minor relevance when assessing the justification of non-discriminatory measures.

The next step is to apply the relevant proportionality test to the Norwegian provisions on ownership in financial institutions.

ESA maintains that there appears to be “less restrictive ways of safeguarding these aims, inter alia regulatory measures that would ensure prudent, impartial and neutral business conduct of owners of the mentioned institutions, and appropriate sanctions in case of non-compliance with these rules”. We suppose the system ESA has in mind, is a system in which the potential owners are required to apply in advance before the holding exceeded certain thresholds, and where the competent authorities shall assess whether the owners are “suitable” to acquire the relevant holding (as is the system for financial institutions and investment firms).

In relation to an assessment of the alternative systems of ownership control, it is interesting to look at how other countries have chosen to address these issues. It should be mentioned that the basis for making comparisons is rather limited. There are two reasons for this. First, there is no secondary EEA-legislation regulating the ownership of stock exchanges, central securities depositaries or clearinghouses. Second, only a few countries have gone so far in demutulising their financial infrastructure as the Nordic countries.

The other Nordic countries seems to have opted for a system based on prior authorisations, i.a. a system in which the suitability of the owner is assessed on a case by case basis. We have not conducted a total comparative analysis at this stage, but we can point out certain special characteristics of these systems. In Sweden, the stock exchange and the clearing house is organised as limited companies. Owners of more than 10 per cent in these institutions are subject to a prior authorisation procedure. Furthermore, the supervisory authority (Finansinspektionen) is given the power to suspend all voting rights to shares exceeding 10 per cent of the share capital, if the ownership is deemed detrimental to the well functioning of the institution, see the Swedish Act on Stock Exchanges and Clearing Houses of 1992 chapter 11. There are no further indications as to when this discretion might be used. In addition, no one can vote for more than a fifth (i.e. 20 per cent) of the shares represented at the general assembly, see the Swedish Company Law Act Chapter 9. The statutes of the company can decide to derogate from this provision, but this requires a majority of more than two thirds of the votes and the capital represented at the General Assembly. In Denmark, there is also a system of prior authorisation for these institutions (stock exchanges, clearing houses and central securities depositaries). Furthermore, the supervisory authority (Finanstilsynet) has the power to suspend all voting rights of a single shareholder holding more than 10 per cent of the capital, if the holding “might impede the well functioning” of the institution, see the Danish Securities Act § 10.

We do not consider these provisions to be against the free basic freedoms of the Treaty, neither are we aware that any other body has held this view. However, we do not consider them to be less restrictive on the basic freedoms than the Norwegian provisions in question. In this relation, we would like to point out that there is no indications that the foreign ownership 1The relevant capital movement in question is the holding of investors from other EEA-states. in Norwegian institutions are more “restricted” than in the comparable institutions in other Nordic countries. Indeed, our preliminary inquiries on the subject indicate that the level of foreign ownership in these institutions is higher in Norway than in other Nordic countries (with discretion based systems):’

• The Norwegian stock exchange (Oslo Børs Holding ASA) has a foreign participation of 27,8 % (as of 2 October 2003), whilst the corresponding numbers for Sweden/Finland (OMHEX), Denmark and Iceland is 32,1 %, 4,7 % 2This number does not include indirect holdings. and 0 % respectively. As to the ownership in OMHEX (which is a Swedish holding company that owns the Finnish and Swedish exchanges), the “foreign” participation also includes Finnish owners. Thus the real “foreign” participation (i.e. owners from other countires than Sweden and Finland) is probably significantly lower than 32,1 %.
• The Norwegian clearing house (NOS ASA) has a foreign ownership of 29,8 %. The clearing houses in Sweden and Denmark are owned 100 per cent of the stock exchanges (see above).
• The Norwegian CSD (Verdipapirsentralen ASA) has a foreign ownership of 28, 32%, whilst the corresponding numbers for Sweden and Denmark are 0,24 % and 0% respectively. The Finnish CSD is owned by the stock exchange, see above.

Moreover, we maintain that the Norwegian system is better suited than a discretion based system (as they have in other Nordic countries) to address the abovementioned concerns regarding neutrality and independence, as we do not foresee a practical situation in which an investor will be deemed suitable to acquire a major holding in the institutions concerned. Any acquisition of a major holding of an investor or issuer that operates in the Norwegian market or in related markets (that might be Nordic markets), or any person with legal or economic links with such investors or issuers, might impede the independence and neutrality of the relevant institutions, or in any event, the perception in the market that the institution acts in a neutral or independent manner 3However, undertakings which are submitted to a similar regulatory framework as the infrastructure institutions concerned (i.e. other stock exchanges etc) are considered to be “suitable” per se, at least as regard stock exchanges and central securities depositors. Thus, in these instances the relevant acts provides an explicit derogation from the ownership rules.. If an investor in a discretion based system should be deemed suitable (which we do not see as a practical situation), one would have to control his behaviour on an ongoing basis. In Sweden and Denmark, this is regulated through a rather “open ended” provision that gives the supervisory authority the competence to suspend all voting rights exceeding 10 per cent of the investor concerned. We do not see this as a practical solution. First, there is a real risk that the supervisory authority finds evidence of undue influence too late. Even a single instance of undue pressure on the CSD or the market place, may cause immense damage on the reputation of the market as a whole. This damage will not be repaired by the subsequent suspension of voting rights. Second, there is a risk that the supervisory authority establishes too high a threshold before they intervene (i.e. suspends voting rights), as this will be an explicit recognition that undue pressure has been exercised. This is a serious allegation that requires some hard evidence, and the allegation alone might have grave consequences for the market confidence.

Furthermore, a discretion based system which rarely will be used to grant authorisations does not enhance predictability or transparency. On the contrary, if most applications for authorisations will be denied, this should be clearly reflected in the regulatory framework (through a maximum cap on ownership).

Thus, to the extent the Norwegian provisions on ownership in stock exchanges, central securities depositaries and clearing houses amount to a “restriction” on capital movements within the EEA, we maintain that these provisions constitute suitable and proportionate measures to attain interests of general good, considering i.a the need to maintain confidence in the market place, the public tasks entrusted with these institutions and the fundamental position these institutions have in the financial infrastructure.

5. Conclusions

We consider the ownership rules for stock exchanges, central securities depositaries and clearing houses to be in accordance with relevant EEA-law.

Yours sincerely,