In a victory for the United Kingdom, a top court official this week agreed that an EU regulation banning short-selling was based on faulty legal grounds.

In March 2012, the European Union adopted a regulation on short-selling, giving the European Securities and Markets Authority (ESMA) the power to intervene in member states' financial markets to regulate or prohibit the practice. It was one of several measures taken in response to the financial collapse. U.K. lawmakers had unsuccessfully tried to block the legislation, and turned to the Court of Justice to annul the regulation two months after it was passed.

Niilo Jaaskinen, advocate general for the Court of Justice of the European Union, wrote that the emergency powers granted to ESMA to regulate or ban short selling in member states “go beyond what could be legitimately adopted as a harmonizing measure necessary for the establishment or functioning of the internal market.”

Jaaskinen did not argue that the European Union should not have the power to institute such regulations, but rather that lawmakers used the incorrect legal basis for the short-selling rules. Jaaskinen said ESMA is “uniquely empowered” to make legally binding decisions that may overrule national regulators. Those emergency mechanisms can be used when member states do not agree on how to proceed. However, Jaaskinen noted, “the outcome is not harmonization but the replacement of national decision-making with EU level decision-making. This goes beyond the limits of Article 114.”

Because the incorrect legal basis was used, Jaaskinen said the regulation should be annulled. Instead, lawmakers should have used a separate provision in the treaty requiring unanimity among the member states. Jaaskinen dismissed the other arguments made by the U.K. that ESMA's powers are too broad and not in keeping with EU constitutional rules. U.K. officials have said they did not have an issue with regulating short-selling but rather the way in which those rules came about.

Legal observers were split on what the opinion might foretell to other U.K. challenges to EU financial regulations, including its opposition to the financial transactions tax and securities trading rules.

Monica Gogna of Pinsent Masons said on her firm's blog, Out-Law.com, that the opinion indicates that ESMA must be careful not to overstep its authority, even in crisis situations.

“The findings re-affirm the view that member state sovereignty and the principle of unanimity among member states is of key importance, and that these principles should not be overridden even when there is panic in the marketplace,” Gogna wrote.

Alexandria Carr, a lawyer with Mayer Brown in London, told Bloomberg News that if the court concurs with Jaaskinen's opinion it would represent a significant development for EU law and “have immediate read-across to a number of dossiers currently being negotiated.”

Michael Wainwright, a partner at Eversheds LLP in London, told Bloomberg that the U.K. could lose its case if the court does not agree with the opinion. “If the U.K. was hoping that the decision might provide support for arguments to restrict the powers of the other new EU financial regulators, including on bank regulation, then this opinion provides little assistance.”

ESMA did not release a comment on the opinion.

Jaaskinen's opinion is not binding on the courts, but legal experts said the court often follows the recommendations by the advocate general. The judges will deliberate the case, with a decision expected in the coming months.

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