An adviser to the EU's top court said in an opinion yesterday (12 September) that such an emergency power, part of an EU law introduced last year, went beyond what the watchdog could do under the EU treaty.
"The emergency powers granted by that article to the European Securities and Markets Authority (ESMA) to intervene in the financial markets of member states so as to regulate or prohibit short selling go beyond what could be legitimately adopted as a harmonizing measure necessary for the establishment or functioning of the internal market," European Court of Justice Advocate General Niilo Jaaskinen said in a statement.
Jaaskinen said the article in the EU's short-selling law granting ESMA such power should be annulled.
The power should have been based on a different part of the EU treaty which requires decisions to be taken on the basis of unanimity among member states, Jaaskinen said.
UK supports ban, but not ESMA powers
Such non-binding opinions from advocate generals are typically endorsed by the full court in a majority of cases.
Short-selling refers to the selling of shares that are not owned by the seller. The seller is betting that the price of the shares will fall so they can be bought back at a lower price.
The EU law seeks to coordinate short-selling bans and avoid the piecemeal measures taken by EU states, including Britain, during the 2007-09 financial crisis to shield banking shares.
The law gives ESMA the power to force member states to introduce a ban if there is a threat to the orderly functioning of markets and financial stability.
A spokesman for Britain's finance ministry said the UK supported the short-selling law and had engaged constructively with the European Commission, ESMA and other member states.
"Our legal challenge does not change this. We are seeking legal clarity on how powers given to ESMA to restrict or ban short-selling sit with the principles established under the existing case law," the spokesman said.
The European Commission, which drafted the law, and ESMA had no comment.
Britain received other boosts this week in its fight to limit the EU's ability to overrule national supervisors, part of a "new settlement" Prime Minister David Cameron wants with the bloc. He has promised a referendum by the end of 2017 on whether Britain should remain in EU.
UK also set to gain from Libor decision next week
Lawyers for member states said in an opinion leaked this week that plans by 11 countries to introduce a tax on financial transactions were illegal as they would impinge on Britain and others who have refused to take part.
Britain is challenging the transaction tax plans in the European Court of Justice.
A separate draft law on regulating benchmarks like London-based Libor, due to be published next Wednesday, has ditched an earlier plan to make ESMA the main supervisor of top benchmarks, which had annoyed Britain.
Britain is challenging at the ECJ a European Central Bank requirement for clearing houses that handle large amounts of euro-denominated securities to be based in the euro zone.
Simon Gleeson, a financial services lawyer at Clifford Chance in London, said the advocate general's opinion was on par with the legal advice on transaction taxes.
"It's advice that finds that member states have rights that need to be protected,"