CEPR ECONOMIC POLICY ROUNDTABLE
8 NOVEMBER 2002, BRUSSELS
Harmonisation and Integration:
Regulation of EU Cross-border Financial Integration
Remarks by David W Green
Head of International Policy Co-ordination,
Financial Services Authority, London
Ladies and Gentlemen,
I am delighted to have been invited by Richard Portes to speak on this topic of major current
interest in front of such a well-informed audience.
Our discussion comes at a time when there is enormous ferment over the future shape and
direction of Europe. The prospect of enlargement becomes increasingly imminent. The
Constitutional Convention draws closer to formulating its recommendations. The current
debate on the best techniques for regulating the European financial services sector also comes
at a time when potential opportunities to exploit the technological advances which could
facilitate much greater cross-border activity have widened significantly. In turn such activity
is promoted by the creation of the Single Market and stimulated further, for a large proportion
of business, by the elimination of exchange risk and the associated costs of dealing with
separate currencies resulting from the creation of the euro.
The enhanced potential for such activity has raised questions about the actual prospects for
the scale and pace of increased cross-border integration; about when and by how much
differences in the environment – whether fiscal, legal or regulatory – should be narrowed;
and about whether such narrowing, quaintly dubbed harmonisation, a word of ambiguous
meaning which some have suggested should be banned from use in the EU legal context,
should follow market developments, as is often recommended in financial regulation, or
should precede them with a view to stimulating changes in market behaviour. These
questions in turn raise others about how and by whom decisions on all of this should be
taken, a topic which I will not pursue further in these remarks.
I speak from the viewpoint of someone who has been engaged for the vast bulk of their career
on financial stability issues within a central bank, and currently works within a single
integrated regulator engaged across the full range of prudential and conduct of business
issues in all aspects of financial services. Inevitably I have had to be selective in determining
where to focus my comments.
I intend to dwell on two propositions which might be characterised as a good news story
followed by a bad news story. My first proposition is that, in relation to the implications for
prudential soundness of firms of cross-border integration, some current concerns about the
adequacy of arrangements for regulation may be exaggerated or at least do not perhaps focus
on the most pertinent issues. My second, somewhat less encouraging proposition, is that
insufficient attention is currently being given to the respective weight of costs and benefits in
deciding when and where to make legislative or other changes in order to unify regulation,
perhaps particularly in relation to conduct of business at the retail level.
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Turning to the first, the arrangements for supervising the financial soundness of cross-border
groups within Europe may in practice be more robust than some people suggest. While it is
true that the creation of cross-border operations, whether through subsidiaries or branches,
and perhaps mixing banking and insurance, is a new experience in some parts of Europe, the
phenomenon in itself is not at all new in principle. In particular, still within Europe, there
have been major cross-border operations into and out of London, for many years, many of
them involving very sizeable inter-bank relationships. The creation of the euro has certainly
modified the pattern of inter-bank flows, creating concentrations where perhaps none existed
before, but the phenomenon is not particularly new at the wholesale level, where London
operates as the main EU inter-bank centre, though not, of course, the only important one
(with, incidentally, nearly a quarter of total business of banks in the UK denominated in
euro). Similarly there have been a number of acquisitions of significant retail and insurance
operations cross-border in the last few years, but again this is not without precedent. Large
EU-based financial firms have owned extensive retail operations in many parts of the world
outside Europe for many years.
It is not always understood that there are arrangements in place to look at the financial
soundness of such groups as a whole. The principle is that a single lead or co-ordinating
supervisor should be responsible for safeguarding the soundness of the whole of the group
using well-established principles of consolidated supervision. Indeed, if a banking group
structure cannot be deemed supervisable, this constitutes grounds for refusing to allow such a
group to operate, a lesson enshrined in EU law following the BCCI experience. Furthermore,
agreement is effectively in place for the extension at EU level of the principles of
consolidated supervision to financial conglomerates combining banking and insurance.
There has been some talk of the need for a new agency to supervise pan-EU conglomerates,
but it is not entirely clear what the gap is which it is claimed needs to be filled. And many of
the most important groups also have very sizeable operations outside the EU. Within Europe,
cross-border branches have for the last ten years been subject to supervision by the home
country supervisor and, where there are cross-border subsidiaries, arrangements are in place
for exchange of information between home and host supervisors. This information exchange
is supported by a committee, the Groupe de Contact, consisting of all European banking
supervisors, which can discuss any common issues or problems which may arise. Bilateral
MoUs are in place between all relevant pairings of EEA supervisory authorities. There
should be no gaps.
This may be all very well when things are calm, people may say, but what will happen in a
crisis? Does not the cross-border angle complicate things? And what about the impact of a
cross-border crisis on the payments system and other possible systemic effects?
Here again, there are mechanisms in place. The EU central banks and banking supervisors
meet together regularly in the ECB’s Banking Supervision Committee, which has agreed
arrangements for information exchange between the supervisory and central banking
functions within Europe whenever and wherever the need arises. Furthermore, arrangements
for co-ordination of crisis liquidity support are in place within the Eurosystem, as the ECB
described some years ago, most fully in a lecture by Tommaso Padoa-Schioppa given in
London in February 1999.
What central banks and supervisors cannot do is to provide solvency support. This can only
be provided, once the protection given by deposit compensation arrangements for retail
depositors are exhausted, by the fiscal authorities. Thus, I think that the interesting question
is not whether there is a gap in the supervisory or central banking arrangements, but what
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principles should govern the distribution of the burden on taxpayers of bailing out creditors of
an insolvent financial firm active in multiple jurisdictions in Europe. Speakers at the ECB’s
Second Central Banking Conference in Frankfurt a couple of weeks ago drew attention to the
fact that this was an issue for governments, even if it is one that, whether for moral hazard
reasons or because of the inherent difficulty of prejudging the needs in any particular case,
they are unlikely to want to address publicly.
My second main topic relates to how much should be done to alleviate obstacles to crossborder financial services transactions taking place within Europe. By this I mean obstacles
that limit a cross-border trade taking place that would be, from the point of view of both
consumers and firms, a better deal than the trade taking place on a national basis. What
might such obstacles be? Returning for just a moment to the earlier discussion, while there
are indeed a few quite large financial groups with significant cross-border retail operations
within Europe, it may very well not be accidental that those groups are typically within
regions with cultural and especially language ties – in Benelux, in the Nordic countries and
that part of central Europe which includes Bavaria, Austria and immediately neighbouring
countries.
There seem, perhaps, to be factors which restrict the development of both cross-border
presences and cross-border trade. Indeed, at a recent meeting of the Banking Supervision
Committee we discussed the fact that two trends which had been widely expected to emerge
had not in fact done so. Although the creation of the euro had been expected to lead to an
upsurge in the pace of cross-border bank mergers, in fact there had been remarkably little
activity, even though domestic consolidation has continued. Another striking feature has
been the slow-down in the pace of internet offering of financial services, one of the
techniques thought most likely to promote cross-border trade. There may be various reasons
why these changes have not yet come about, not least the condition of individual economies
within the EU and the knock-on effects for confidence. And growing familiarity with the
euro and the implementation of the e-commerce directive may yet bring changes.
Nevertheless, this slowness in the pace of development raises the question of whether there
are natural obstacles to cross-border trade in financial services of greater magnitude than
hitherto supposed. Intuitively, differences in language would certainly appear to be a rather
fundamental one, at least at the retail level, and there are others. This would include the lack
of knowledge of other countries’ legal systems or of their complaint and redress
arrangements. The high cost of retail cross-border payments is a familiar issue which is
currently receiving attention, and recent studies have found that tax arrangements play a
major role in deterring both cross-border sales and branching. Other obstacles, such as
obtaining secure legal title to collateral, can be significant. These factors tend to be more
powerful at the retail rather than the wholesale level, as is exemplified by the different levels
of integration observed to date.
When Lamfalussy’s Wise Men were studying the obstacles to the creation of a single capital
market they quite quickly identified numerous obstacles to trade in securities which lay
completely outside the remit of financial supervision and regulation. They cautioned that
simply changing financial regulation would not of itself necessarily result in increased
cross-border business. Nevertheless, they identified a number of areas of regulation in
relation to securities issuance and investment where change at the EU level might materially
improve the potential for cross-border business. These proposed changes essentially relate to
different stages in the securities production chain, starting with common accounting standards
for issuers, common prospectus arrangements, common issuance arrangements, common
trading standards, including protection against market abuse, improved clearing and
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settlement arrangements and common investor protection standards. Work is well in hand on
all of these, though the various pieces of draft legislation do not always emerge in the most
logical order, so that the wider picture is sometimes obscured.
What the effort to derive common standards has unearthed is the vast diversity of existing
arrangements, even for wholesale corporate securities markets. This has effectively started a
renewed debate about how much harmonisation – that word again – is appropriate to produce
the economic benefits desired. On the one hand, in some categories of regulation, not much
advantage is gained unless arrangements are made identical. Simply changing them to
something less different than before, though still not the same, will not bring economies of
scale or improve capacity for comparison of product or price, so that there may not be much
benefit from increased competition. In other categories, enforcing uniformity could very well
inhibit legitimate competition and innovation, as well as imposing disproportionate costs. It
is thus not always evident whether resistance to uniformity is protectionist or
pro-competitive.
The vigorous debate on the future of European securities markets has thus laid plain that
there is not yet a uniform vision of what the single capital market might look like.
Furthermore, the differences between the visions have major implications for financial
intermediaries and for markets, depending on their likely capacity to adjust and benefit from
a changed environment.
Lurking behind resistance to change lie differences of view as to whether the outcome should
be a single, more or less seamless integrated equities market, in some visions geographically
located in a very small number of centres, in others effectively virtual. Or whether there is
perhaps a natural need for, or political desire for the preservation of national capital markets.
Minds have been concentrated yet further by the recent emergence of blueprints for a single
financial market which effectively recommend that anything which can be the same should
be the same, including taxation. Such visions depend for their appeal on the prospect that
there will be efficiency gains from removing artificial barriers.
Such visions have in turn drawn forth reaction in the form of renewed requests to look more
closely at when harmonisation promotes competition and when it does not. There is also a
demand for the costs as well as the benefits of harmonisation to be examined more
thoroughly.
In relation to the promotion of competition and proportionality of costs and benefits,
examples have emerged in recent legislative drafts – for instance in the debate about the
Prospectus Directive – of measures which could set maximum harmonisation at levels which
may damage competition, particularly globally, and which may frustrate super-equivalence of
a character which could enhance rather than destroy competition. Great care needs to be
taken to understand the issues raised in such situations and to identify those circumstances
where common standards can be beneficial and those where they are counterproductive.
In respect of proportionality of costs and benefits, there have also been measures proposed
where it seems probable that the extra burden of regulation, or simply the costs of change,
may be disproportionate to the likely benefits resulting.
Disproportionate cost seems more likely to arise in measures affecting the retail markets. If
the proposition is correct that there are substantial other obstacles to cross-border retail
financial services business, then harmonising regulation at a European level may involve the
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costs of substantial change without bringing about much benefit in terms of increased
cross-border competition in availability or price of products. Measures have to be very well
targeted if they are to produce benefits overall, given the overall size of the retail market.
Furthermore, to the extent that businesses do wish to establish in a number of member states,
harmonisation which does not lead to identical arrangements may mean that there are reduced
economies of scale for cross-border groups. The requirement to add many slightly different
wrappers to a basic product in order to sell it across the EU could become prohibitive.
All of the above does not mean that ways should not be found of enhancing competition and
innovation, but it could also suggest that one of the most effective way of achieving this is
through cross-border merger or acquisition. This implies that agreement on a cross-border
Takeover Directive, including inhibiting the frustration of cross-border takeover of financial
services firms for protectionist reasons, could provide the greatest benefits in terms of
enhanced competition in both product and price.
The general conclusion I would draw from the above discussion is that, in reviewing new
legislation to enhance the single market in financial services we need to pay rather more
attention than in the past to some important tests of where change is necessary and where it is
not. As it happens, the Lamfalussy committee provided us with some of these tests in their
report and we would do well to embody them in our day-to-day thinking. I quote directly
from page 16 of their report where they set out some overarching principles to be applied to
all European financial services legislation. The aim should be

“To ensure appropriate levels of consumer protection proportionate to the different
degrees of risk involved;

To respect the subsidiarity and proportionality principles of the Treaty;

To promote competition and ensure that the Community competition rules are fully
respected;

To ensure that regulation is efficient as well as encouraging, not discouraging, innovation;

To take account of the European as well as the wider international dimension of securities
markets.”
We need to apply these principles to each element of regulation separately in order to
determine whether we should be aiming for complete standardisation, harmonisation at
differing degrees or whether subsidiarity and leaving national arrangements in place is the
right answer.
We also need to work actively with practitioners and with consumers to understand more
precisely just what the real barriers are, how they might best be dismantled and in what order.
It was perhaps unwise to describe the second part of my remarks as “bad news”. What I
meant was that we need to recognise that the complexity and diversity of the many different
facets of European financial markets is, even in respect of regulation, a good deal more
extreme than perhaps many of us recognised and that there may be greater “natural” obstacles
to a single market than perhaps we have acknowledged. We should be realistic in
understanding that there are limits to what the single market in financial services can achieve
over the medium and perhaps even long term. However, this does not mean that there are not
areas where great benefits may not still be achieved for firms, for borrowers and for
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investors, with positive consequences for economic growth as a whole. And, as I have
outlined above, we have tools to enable us to distinguish which changes in regulation are
likely to bring benefits and which not. It just remains for us to use them effectively.
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