Introduction

The provision of services by investment firms and banks is subject to matters covering prudential, contractual and conduct of business rules. Prudential rules regard the minimum licensing and capital requirements; contractual rules apply to the conclusion of agreements between intermediaries and their clients, and conduct of business rules relate the norms of behaviour firms have to respect (Tison 2002). This was the case under the first European directive covering investment services – the 1993 Investment Services Directive (ISD) – and also applies to the directive currently in force – the Markets in Financial Instruments Directive (MiFID).

Policy intervention in these areas is necessary to ensure that firms perform their crucial economic role without endangering financial stability or hampering investor confidence. To be effective, legislative requirements should be accompanied by appropriate supervisory and enforcement powers – respectively powers to control the rules are respected and to intervene in case these are breached. When firms extend their operations beyond national borders, the allocation of rule-making, supervisory and enforcement powers becomes critical to avoid regulatory arbitrage and to ensure that misconducts are readily detected and controlled. If illicit acts are not identified and prevented promptly, they risk spilling over into other national markets.

Against this background, a regulatory level playing field, a proper allocation of responsibilities and coordinated supervision are crucial elements for the smooth functioning of the market. In addition, by responding to firms' need for legal certainty, a well-designed regulatory and supervisory architecture lowers compliance costs and fosters crossborder activities.