THE BANKING INDUSTRY
The banking industry was one of the most highly regulated industries in the EU and operated with widely varied regulatory practices. In some countries laws and regulations restricted the right of non-resident banks and financial institutions to conduct business with residents.
Prior to the Single European Act (SEA) , there had been two major directives relating to the banking industry: the First Banking Directive on Coordination of Regulations Governing Credit Institutions of 1977; and the 1983 Directive on the Supervision of Credit Institutions on a Consolidated Basis.
The First Banking Directive required member states to establish systems for authorizing and supervising banks and other credit institutions that take deposits and lend money. It required such institutions to be licensed. Once licensed, they would be allowed to conduct business in other member countries provided they were authorized to do so by the host government and complied with the conditions and supervision applied to local banks. The host country principle on which the directive was based meant that a German bank in Spain, for example, could only do what Spanish laws allowed its own banks to do in Spain. The Directive on the Supervision of Credit Institutions on a Consolidated Basis (1983) established the common principle that bank activities were to be supervised on the basis of their world-wide activities.
Since the SEA, there have been a series of directives on the banking industry, most notably the Second Banking Coordination Directive of 1989 (SBCD). This was based on the Cockfield Report strategy of home country regulation and mutual recognition. It gave the right to banks to establish branches and to trade in financial services throughout the EU on the basis of a single licence obtained from the home-country authorities. The directive included some exceptions to home-country control.
The directive established the right of banks with head offices in other EU countries to pursue all the listed activities in a host country, including those which host country laws might forbid to local banks. Essentially, banks were allowed to participate fully in securities business either directly or through subsidiaries. The directive included rules regarding the exchange of information between home and host country regulators and harmonized minimum standards of authorization and prudential supervision. This included setting minimum requirements for the size of own funds (equity capital).
A number of other directives , ancillary to the Second Banking Directive were approved in 1989 and later years in order to meet the harmonization requirements for banking indicated above.
INSURANCE SERVICES
As with other financial services, the insurance industry has typically been highly regulated. Consumer protection is a very important issue in insurance and it is not surprising, then, that there has always been a tendency to regulate the insurance industry quite tightly.
From the beginning, the European Commission has acknowledged the additional problems associated with the long average length of contracts in life insurance by the issuing of separate directives for life and non-life insurance. Hence, 1973 saw the promulgation of the First Non-Life Insurance Directive with the First Life Insurance Directive following in 1979. Both of these directives followed the principle of host-country regulation. They established the right for companies to operate in other member states but harmonization of regulations across the EU was very slow. Several members strongly resisted attempts to open up their insurance markets to greater competition. In Germany, for example, non-German firms were required to have a local establishment and were taxed at rates which the European Commission considered discriminatory. In 1986 the European Court of Justice made a ruling that the restrictions imposed on insurance companies from other member states by Germany, France, Ireland and Denmark were partly illegal. In particular, the Court attacked the practice of requiring establishment and local authorization before a company could participate in the co-insurance of large risks situated outside of its home country.
The court ruling encouraged the European Commission to attempt to incorporate the home-country regulation principle into insurance directives. They were, however, inhibited from replacing the requirement of full harmonization of the rules regarding the authorization of companies by mutual recognition because of the sensitivity of the consumer protection issue in a significant part of the insurance industry. Consumer protection was one of the areas which, under the 1979 Cassis de Dijon court ruling, could be used to justify the rejection of the standards applied by other member states. The Commission tackled the problem by following the 1986 Court of Justice ruling which had made a distinction between the insurance of large risks and small commercial risks and personal insurance. It followed in the Freedom of Services Directive for Non-Life Insurance, for small-risk business the regulations of the country in which the policy-holder resides apply while for large-risk business the regulations of the country in which the company is licensed apply. Motor insurance was brought within the scope of the Non-Life directive by the Motor Insurance Services Directive of 1990.
The distinction between large and small risks could not be made in the Second Life Assurance Directive and so a different distinction was made to bring in an element of home-country regulation. Host-country regulation applied except where the initiative for a cross-border policy came from the policy-holder rather than the company - then the home-country regulation principle applied. In July 1994 the Third Non-Life Insurance Directive, the Third Motor Insurance Directive and the Third Life Assurance Directive came into force, introducing the full single passport, home-regulation regime to the insurance industry. Although home-country regulation applies, a role remains for host institutions. In practice, most insurance companies establish a local presence because of the need to provide follow-up customer sales and service.
FINANCIAL SERVICES
With the very rapid development of financial markets and the great increase in new financial products from the early 1970s onwards, the securities (or investment) industry, (which covers securities trading, unit trusts, broking and market-making, portfolio management, underwriting and investment advice as well as issues related to the access of companies to foreign stock exchanges and the quotation of securities on foreign stock exchanges) was becoming increasingly significant. However, it was also an area in which markets developed much more rapidly in some member states than others. This caused anxiety in some countries that increased competition across the EU would damage, if not destroy, their underdeveloped markets and institutions. Under these circumstances, progress towards a single market was bound to be slow.
Strong efforts were made in some segments of the industry from the late 1970s on, in regard to the harmonization of the different regulations of the member states on the admission of securities to stock exchange listing and the information provided to investors. In 1979, the Directive Coordinating the Conditions for the Admission of Securities to Official Stock Exchange Listing (79/279/EEC) set out the minimum conditions to be met by issuers of securities, including minimum issue price, a company's period of existence, free negotiability, sufficient distribution, and the provision of appropriate information to investors. Member states were free to impose stricter requirements. This was the first of four directives (the others followed in 1980 and 1982) which were designed to make it easier for companies to list their shares or raise capital on other EU stock exchanges. Directives concerned with information to investors covered the disclosure of large shareholdings in companies, the provision of information in prospectuses and insider dealing.
The new Cockfield Report and SEA principles of minimum harmonization, mutual recognition, a single passport, and home-country regulation were applied in two directives on the marketing of unit trusts in 1985 and 1988. These allowed a unit trust which had been approved in one member country to be sold anywhere in the EU without further authorization provided it met investor protection requirements in force in the host country.
The first major securities industry directive based on Cockfield principles was the Investment Services Directive (ISD) which came into force in June 1992. It extended the single passport principle to non-bank investment firms generally. This extension was essential because the SBCD had given this right to banks carrying out securities business but did not grant it to non-banks in this area. There was a particular problem because, the banking industry in some member states had traditionally been organized on universal banking principles whereas in other member states (notably the UK), the two forms of business had been separated. Thus, if the ISD had not been agreed, banks engaged in securities business would have been given a competitive advantage over non-bank firms. The ISD therefore provided for the removal of barriers to both the provision of cross-border securities services and the establishment of branches throughout the EU for all firms. It also liberalized the rules governing access to stock exchanges and financial futures and options exchanges.
The difference in the organization of banking and securities industries among member countries led to problems in relation to capital adequacy. If capital adequacy rules had not been extended to cover non-bank securities firms, then they, in their turn, would have been given a competitive advantage over banks engaged in securities business who were required to meet capital adequacy rules. However, it was widely argued that the same rules should not apply to both forms of business. This ultimately led to the Capital Adequacy Directive (CAD) of 1993 which applied to both investment firms and to the securities activities of banks.
DIRECTIVES/PROPOSED DIRECTIVES COVERING ALL THREE AREAS
THE E-COMMERCE DIRECTIVE
The E-Commerce Directive was adopted on 8 June 2000 and published in the Official Journal of the European Communities on 17 July 2000. The objective was to ensure that information society services benefit from the internal-market principles of free movement of services and freedom of establishment, in particular through the principle that their provision cross-border throughout the European Community cannot be restricted minimum information requirements. An essential element in achieving harmonisation will be the establishment of a user-friendly means of complaint and redress. Another area of importance is the harmonisation of conduct of business rules across Europe to ensure that minimum acceptable standards are imposed on suppliers in their home Member States.
THE UCITS DIRECTIVE
On 13 February, 2002, Directives 2001/107 and 2001/108 amending Directive 85/611 on the co-ordination of laws, regulations and administrative provisions relating to undertakings for collective investment on transferable securities ("UCITS") entered into force following their publication in the Official Journal. The timeline for adoption of implementing measures by member states is 13th August 2003 with application of these measures to be by 13th February 2004.
The new Directive introduces the concept of granting to the management company of a UCITS an EU passport, based on the application of home Member State supervision, to carry on in another member state the activity for which it has been authorised
The directive has two parts. The first part is relatively uncontentious in that it expands the range of fund structures, which can be established as UCITS and also expands the range of instruments which UCITS funds can invest in. The second and more complex part of the directive deals with a number of areas:
·Simplified prospectuses
·Minimum capital requirements
·The Management Company "passport"
The directive will introduce a more regulated environment for management companies of collective investment undertakings and will also establish equivalent market access rules and operating conditions, the "EU Passport". Management companies which conduct business which is under the management of UCITS in the form of unit trusts-common funds and of investment companies, will become professionals of the financial sector, rendering their services governed by the Investment Services Directive (ISD) 93/22, a regulation that they were excluded from previously. In summary, authorisation in the home state will be valid throughout the EU, subject to the home state prudential supervision and will require that the registered and head offices are located in the home state.
In its original form the directive sought to set minimum standards for a defined range of unit trusts which might then be marketed in the same way in all member states.its philosophy being that where consumers were adequately protected a 'European Passport' should take effect. The amendments make a fundamental change, liberalisation being what the rules are trying to achieve, by creating more variety of competition with the requirements for receiving a European Passport being reduced to a minimum in order to achieve the greatest possible freedom of movement. It is not inconceivable that these rules, still referred to as 'minimum' in the directive, may represent the accepted level of consumer protection in the EU, and result in a 'race for the bottom' because the lowest level of supervision could potentially have the greatest opportunity.
DISTANCE MARKETING OF FINANCIAL SERVICES
The aim of the proposed Directive is to ensure a high level of protection for consumers of retail financial services (insurance, banking and investment services) marketed by mail, by telephone, by fax or by electronic means such as the Internet. It should encourage consumer confidence in such services and provide financial service suppliers with a clearly defined legal framework valid for distance selling throughout the Single Market without hindrance.
The ongoing proposals relating to the Directive on the Distance Marketing of financial services has not been progressing well. Recently (April 2002) during a meeting of the European Parliament Committee on Legal Affairs and the Internal Market on the proposed Directive on Distance Marketing of Financial Services, over 100 amendments were proposed. However it was interesting to note that that the Committee did not delete various new minimum harmonisation clauses introduced by the Council which have previously been said to hinder the development of a harmonised financial services market in the European Union. The European Parliament's May 1999 Opinion supported the Commission's "maximum harmonisation" approach, according to which the proposed Directive would harmonise at a maximum level Member States' rules on distance selling of financial services. As a consequence, suppliers of financial services would be able offer their products throughout the Single Market, without the hindrance of having to comply with different national consumer protection laws on distance sales.
It remains to be seen what the final directive will look like, however at the moment it is possible that the previous maximum harmonisation policy may be eroded slightly in favour of a minimum harmonisation policy.
A SINGLE REGULATOR FOR EUROPE?
As things stand at the moment, we have companies involved in cross border business who report to regulators in15 separate member states, described very eloquently by Baron Alexander de Lamfalussy as "a remarkable cocktail of Kafkaesque inefficiency that serves no-one" . The push for European Financial Integration has been around for some time and progress over the years has seen key legislation, giving companies passport rights to sell their products across borders within the European Economic Area without further licensing in the host country, and the introduction of the Euro. As a result of this progress, supervisory structures have also had to change . Two approaches have been proposed to deal with the issues of regulation of the financial sector in Europe. The Lamfalussy Report proposes to bring about more coherence within national Jurisdictions and would be based on a committee of EU national regulators, replacing the Forum of European Securities Commissions (FESCO). This is the current EU approach.
The alternative is a US-style Securities and Exchange Commission (SEC) which would have some of the advantages & disadvantages of the UK's single regulator . This system would also speed up progress to a single capital market but would require much stronger legal harmonisation than Lamfalussy proposed and would not be as flexible.
Although neither development can be completely ruled out, the amount of major constitutional change required to facilitate such changes would be immense. The absence of a single European regulator is compensated for by the network of national regulators through the Committee of European Securities Regulators who oversee the implementation of relevant financial market directives in each member state.
The division between different types of financial institutions has become more and more blurred with the increase in the cross provision of financial services. Although there is much argument against regulating by activity rather than across all financial sectors together, there remains some basis in an arguement for an activity based regulation in the area of Banking. The countries who share the single currency of the Euro have a single monetary policy, a single currency, a single financial market but they don't have a single banking regulator, regulation being a national matter. For some years now, banks have been buying up subsidiaries in neighbouring countries and even merging across borders. It is not therefore unreasonable to expect the development of Pan-European Bank to emerge quite rapidly. Already Banks are being exposed to risks which originate from elsewhere in the Euro Zone and these risks to financial stability are becoming less and less confined to national borders. As the banking, insurance and the Investment industry progress towards some form of single regulator across all sectors this does not necessarily have to be in the form of a European Financial Services Authority or a European SEC, because Europe is simply not a UK, nor is it a US. A European FSA may not be adequate for a host of reasons, most importantly from a financial regulatory perspective. It would also be difficult to reconcile with the basic single market principles of subsidiarity, minimal harmonisation and home country control.
Nevertheless, here are a number of factors which point in favour of establishing a single national financial services regulator. First, the lines of distinction between different financial services have become increasingly blurred and therefore regulators should be able to examine the activities and compliance of firms as a whole and not just a specific area. Otherwise, there is a danger that crucial areas will either be overlooked entirely, or that muddled responsibilities will lead to a lack of clear guidance. In areas of overlap, the establishment of a single authority can also help to avoid duplication. However the argument in favour of a single regulator appears to be based on efficiency, not effectiveness. This would suggest that since there is evidence that the method of multiple regulators used in many countries works relatively smoothly it would be change for the sake of cost benefits to the industry and not change to facilitate a better regulatory structure albeit conceded that efficiency can some times equate to 'better'. Nevertheless as cross-functional interactions grow in number, the case for concentration at the regulatory level becomes stronger. The U.K. was not the first country to set up a single financial services regulator the concept having been tried and proved in various jurisdictions. The argument favoured at the national level for extending what appears to be the superior organisational solution to the international arena focuses on costs rather than
effectiveness. Cross-border conduct of business has grown at a similar pace to the pace of cross-functional business within countries. Securities firms are arguably among the most internationalised companies anywhere. Also, "lead" regulation appears to work somewhat less well at the international than at the national level as can be seen from the CSFB's troubles in Japan or the Barings disaster in Singapore. On the other hand, cultural and legal structures still differ very significantly, even within the EU, making it harder to set up and maintain a single regulator that would be sufficiently "close" to the markets. On balance, the counterarguments do not appear to hold much weight, while the lack of effective and cost efficient oversight through the "lead regulator" model appears to weigh very strongly in favour of a European financial services regulator.
It is my opinion that the best model for a European Financial Services Regulator is the UK regime. Although it has been said that the power afforded to the FSA is too comprehensive, its flexibility and informal approach have been approved of by many market participants. National barriers are blurring rapidly with the increase in cooperation between banks and clearing houses combined with the increase in the formation of alliances and mergers of businesses.
Developments towards a new form of European regulation has been driven by technological change, the creation of passports for many kinds of financial business and the intoduction of the Euro. Together these factors will make for easier cross-border transaction. The obstacles towards progress continue in the form of the establishment of cross border minimum standards relating to issues of distance marketing and E-commerce with heavier emphasis on issues of harminisation of accounting standards, prospectus requirements, standards for market trading, clearing and consumer protection.
