Memorandum from the Financial Services
1. The purpose of this Memorandum is to
update the Committee on regulatory issues arising from the EU's
Financial Services Action Plan (FSAP). In particular, the Memorandum:
Outlines the background to the preparation
of the FSAP, at the instigation of the European Heads of Government
Summarises recent developments in
preparing legislation under the FSAP and examines some current
initiatives likely to influence the post-FSAP agenda (section
Comments in more detail on two of
these initiativesthe Report from the Financial Services
Committee to ECOFIN on Financial Integration (17 May 2004; FSC
4156/04) and the reports of four expert "Forum groups"
of industry practitioners (section D).
Notes the position on an integrated
retail market for financial services in the EU (section E).
2. Negotiation and implementation in the
UK of EU legislation is, of course, the responsibility of HM Government.
The vehicle for implementing Directives affecting financial services
is (for the most part) rules made by the FSA. For this reason
we work very closely with the relevant Government Departments
(mainly Treasury) in the relevant EU fora. Our work is guided
by our statutory objectives: maintaining confidence in the UK
financial system, promoting public understanding of the financial
system, securing the appropriate degree of consumer protection
and helping to reduce financial crime. The Financial Services
and Markets Act requires us to take into account the international
character of financial services and the UK's competitive position.
We aim to promote a well regulated wholesale market which is efficient,
orderly and fair and to help retail consumers achieve a fair deal.
3. To help achieve our aims in these truly
global markets, we continue to devote significant resources to
policy development at the European and international levels. We
are committed to producing better regulation in the EU, in recognition
of the need to facilitate competition and innovation and maintain
the competitive position of the EU, and of the UK within it. We
believe that better regulation will be best achieved by cooperation
with other EU financial regulators through the "Lamfalussy"
committee networks. These networks will play a critical role in
identifying whether, and if so where, new measures are needed
to achieve a more effective EU regulatory environment. In doing
this, we see a need for greater use of cost-benefit analysis and
impact assessments of any new measures.
4. Our principal focus is now on timely
implementation and effective enforcement of FSAP measures. We
have worked to implement several major pieces of EU legislation,
including directives on Insurance Mediation, Distance Marketing,
Financial Groups and Market Abuse. Our general approach is to
implement directives straightforwardly and in a way which does
not introduce additional layers of regulation (known as "superequivalence")
unless a rigorous case can be made that such superequivalence
is in the interest of maintaining appropriate standards in UK
5. The financial services directives will
have a significant impact on issuers, firms, investors and consumers.
We are aware of the heavy implementation burden on firms and have
urged them to consider the implications for their business. To
facilitate this process we are working with the Treasury to sequence
our implementation work and where possible to produce joint consultation
papers to lessen the burden on firms.
6. In June 1998, the Cardiff European Council
invited the European Commission to table a framework for action
to develop the Single Market in financial services. In May 1999,
the Commission published a Communication containing a Financial
Services Action Plan which was endorsed by the Lisbon European
Council in March 2000. The purpose of the FSAP was to produce
a set of measures intended by 2005 to create a legal and regulatory
environment which would support the integration of EU financial
markets. The FSAP focused on three specific objectives:
to create a single EU wholesale market;
to achieve open and secure retail
to revisit prudential rules and structures
7. The programme of legislation set out
in the FSAP is now almost complete. It has been accompanied by
a new approach to developing and adopting EU financial services
legislation, based on the recommendations of a Committee of "Wise
Men", chaired by Baron Alexandre Lamfalussy. The "Lamfalussy"
approach was adopted on 6 June 2001 for securities measures, and
since its formation a number of the FSAP measures have been adopted
using this new process.
8. The Lamfalussy Committee recommended
a four-level decision-making process for EU securities legislation:
High-level framework legislation
is proposed by the Commission and adopted under the "co-decision"
procedure (level 1).
The framework legislation is supplemented
at level 2 by more detailed implementing measures, adopted by
the Commission and endorsed by a qualified majority of Member
States. The detailed level 2 legislation is prepared by the Commission
on the basis of advice provided by representatives of national
supervisory authorities, acting through level 3 committees. In
finalising their advice, the level 3 committees consult extensively
with providers and users of financial services.
The level 3 committees also work
together to facilitate consistent implementation of Community
law and to foster supervisory convergence and best practice.
Finally, at level 4, the Commission
ensures that Member States are complying with the applicable legislation
and pursues enforcement where required.
9. The system is designed to provide for
greater flexibility to modify the applicable legislation as and
when market and supervisory developments require it. These new
arrangements also ensure that open consultation procedures, expert
regulatory input and greater transparency are an integral part
of the legislative process.
10. Although initially introduced for securities
legislation, this approach has now been extended to cover legislation
on banking, insurance and pensions and asset management. Two new
level 3 committees have been formed. The Committee of Banking
Supervisors (CEBS) and the Committee of European Insurance and
Occupational Pensions Supervisors (CEIOPS) will fulfil for banking
and insurance the role which the Committee of European Securities
Regulators (CESR) has been undertaking in the securities field.
C. RECENT DEVELOPMENTS
11. Good progress has been made in the legislative
phase of the FSAP. This is only the first stage, however; effective
implementation of the measures included in the legislative programme
is an essential next step. With the completion of the legislative
programme, the attention of all interested parties has turned
to the extent to which the objectives for the single market have
been met, identification of the remaining gaps and barriers and
the means by which these might be addressed.
12. In May 2004 the UK authoritiesHM
Treasury, the Bank of England and the FSApublished two
papers setting out their contribution to this discussion. We have
supplied the Committee with copies of both documents. Firstly,
The EU Financial Services Action Plan: Delivering the FSAP
in the UK reviews the progress of the FSAP, sets out in some
detail the state of play on individual measures, and provides
an explanation of how EU financial services legislation will be
implemented in the UK. Secondly, After the EU Financial Services
Action Plan: A new strategic approach sets out five UK priorities
for guiding action in future. These are as follows:
There should be better implementation
and enforcement of EU measures affecting the financial sector.
Greater consideration should be given
to alternatives to EU regulation.
There is a need for a "better
regulation" approach, including the use of market failure
and cost-benefit analysis, as well as full consultation with financial
The Lamfalussy arrangements now need
to be fully developed to reach their potential.
There needs to be full recognition
of the global nature of financial services.
13. At the EU level, two particular initiatives
are likely to play a key role in influencing the form and content
of the post-FSAP agenda.
14. Firstly, the Financial Services Committee
(FSC), comprising senior officials from EU Finance Ministries
presented a report to the June ECOFIN meeting of Finance Ministers
[FSC 4156/04, 17 May 2004]. The report assessed the current state
of financial integration and offered advice on the next steps
in completing the Single Market in financial services.
15. Secondly, the Commission established
four expert groups of industry practitioners and other market
users from the Banking, Securities, Insurance and Pensions and
Asset Management sectors. These expert "Forum groups"
were asked to assist the Commission's work in assessing the state
of integration of European financial markets. The Forum groups
have produced reports proposing how to advance financial market
integration. These have been the subject of wide consultation
and a high-level conference in June. Public consultation is continuing
until early autumn, after which Commission officials will prepare
recommendations for the new Commission.
16. Inevitably, the FSC report and the reports
of the Forum groups reflect the particular priorities and preoccupations
of their respective authorship. However, a number of themes and
key points in common do emerge and these seem likely to inform
the work programme on financial services when the new Commission
comes into office on 1 November. Encouragingly, the UK priorities
detailed above have also been largely picked up by the FSC and
Forum group reports.
D. THE STATE
THE FSC AND
17. This section outlines the principal
recommendations which emerge from the FSC and Forum group reports.
Key points are set out in italics below, followed by FSA reaction
Full and consistent implementation and effective
enforcement of all FSAP measures must now have priority.
18. This is a key priority. Full implementation
and enforcement of the FSAP measures in all Member States is essential
before the FSAP programme as a whole can be judged to be a success.
The legislation can only make a difference to the efficiency and
openness of markets if it is fully and consistently implemented
throughout the EU.
19. Although some of the FSAP directives
have been implemented in the UK and other Member States, the majority
of the measures will need to be implemented over the next two
to three years. All the directives require (or have already been
the subject of) action in the UK. This represents a significant
challenge for the legislative authorities and firms in the UK.
The FSA's role will be to make new rules in accordance with the
procedures set out in the Financial Services and Markets Act.
20. The FSA is working closely with HMT
to ensure the consistent and prompt implementation and effective
enforcement of the FSAP measures. In particular, we are seeking
to ensure that implementation is effective, proportionate and
consistent, making use of consultation and cost-benefit analysis
at an early stage. A minimum approachwhich does not go
beyond that which is necessary to comply with the directivewill
be the general policy approach. Superequivalence in the implementation
of measures will be the exception and will need to be fully justified
on cost benefit grounds. The UK authorities are committed to consulting
closely with the financial sector throughout this process and
will aim to provide adequate lead time (at least three months
of certainty and, where possible, six months) before firms are
required to operate within the new rules.
21. Implementation of the FSAP measures
will be a substantial challenge for firms. To take full advantage
of the opportunities presented by the new legislative environment,
senior management need to prepare for the strategic implications
of a more integrated financial services market. At the micro level,
they will need to ensure that their business practices and systems
are compliant with the new rules. The effect of this will undoubtedly
place a heavy demand for implementation resources on authorised
firms over the next few years.
The Lamfalussy committee structure is of central
importance in ensuring effective implementation of financial services
legislation and in promoting supervisory convergence and co-operation.
22. The Lamfalussy arrangements have made
a good start. Within the securities field, in particular, CESR
has already played an important role in providing technical advice
on a number of FSAP directives, including those on Market Abuse,
Prospectuses and Markets in Financial Instruments.
23. There are significant challenges ahead,
however, if the arrangements are to work well in practice. The
new Level 3 committees (CEBS and CEIOPS) need to establish themselves
quickly and prioritise their work effectively to meet the demands
of providing technical advice on a significant amount of level
2 legislation. All three committees will also need to focus increasingly
on implementation issues and the convergence of supervisory practice.
Further co-operation on enforcement will also be required.
24. Notwithstanding this forthcoming period
of intense activity for the committees, it is important to remember
that these are still relatively new arrangements and that they
will need time and space to demonstrate what they can achieve.
The FSA fully supports the Lamfalussy arrangements and the transparency,
consultation and technical expertise which they bring to the EU
legislative process. We believe the arrangements will lead to
closer links between national regulatory authorities and promote
a co-operative, practical approach to finding solutions to everyday
regulatory problems. The UK is keen to emphasise and develop a
broad approach to the work of the level 3 committees in particular.
While advising on legislation and developing detailed rules is
an important function, we would wish to see them using a broad
range of regulatory and supervisory tools to facilitate supervisory
convergence and co-operation.
25. The FSA acknowledges the considerable
effort that will need to go into making the system work at each
of the four levels. We are fully committed to providing appropriate
support and resources. FSA is an active participant at a senior
level in all three committees, with FSA Chairman Callum McCarthy
as a member of CESR, Chief Executive John Tiner as a member of
CEIOPS and Managing Director Clive Briault as a member of CEBS.
FSA is also committed to providing suitably experienced personnel
both to serve on the Committees' working groups and to work as
secondees within the secretariats.
Further measures towards integration should be
based on a systematic analysis of remaining obstacles and the
impact of any measures which may be taken to address them. Legislation
should only be introduced where it is demonstrably appropriate.
26. This is consistent with the message
which the FSA has been communicating for some time and which we
aim to apply to our domestic policy formation. Regulation imposes
costs on market participants and it is important to be able to
demonstrate that the benefits of individual regulatory measures
justify such costs. It is important that decision-making disciplines
are fully integrated into the Commission's approach to any future
work programme on financial services. In particular, the Commission
needs to use market failure and cost benefit analysis when assessing
whether legislation is appropriate. The UK will also keep up pressure
on the Commission to consider the range of possibilities offered
by non-legislative policy options. Finally, the UK is strongly
of the view that, while legislation may have an important role
in removing barriers to the development of a single market, its
role is essentially an enabling one. Once barriers are removed,
the extent to which a single market develops and the pace of this
are matters for the market itself. There is no role for regulation
in forcing the pace in this regard.
27. The Commission's 2002 Better Regulation
Action Plan introduced a system of extended impact assessments
for all significant proposals. An initiative by the Irish, Dutch,
Luxembourg and UK Presidencies of the EU (Joint Initiative on
Regulatory Reform, January 2004) offers further proposals to enhance
the impact assessment process. These initiatives offer a good
basis for improving the quality of new legislation.
The importance of promoting financial stability
and market integrity
28. Co-operation among EU supervisors, central
banks and finance ministries will be key to ensuring the right
framework is in place to address financial stability and market
integrity concerns. This needs to be accompanied by dialogue with
key international players. In those areas such as accounting and
auditing standards which are best addressed at the international
level, it is essential that the EU plays an active part in the
negotiation and conclusion of the relevant international agreements.
29. The FSAP recognised the need to modernise
the EU's accounting directives and there is clear agreement in
Europe that a single set of consistently applied accounting standards
is crucial to the development of integrated EU capital markets.
The EU is committed to require all listed European groups to use
International Accounting Standards for their consolidated accounts
from 1 January 2005. The process of endorsing the standards for
use in the EU works reasonably efficiently in most cases, but
has run into major problems on the standards on financial instruments
(particularly IAS 39 Financial Instruments: Recognition and
Measurement). The continuing uncertainty about the extent
and timing of a standard on such an important topic is potentially
damaging for market confidence and does not create a good precedent
for the way in which difficult and controversial issues will be
dealt with in the future. The European Commission has suggested
that it might remove some paragraphs of IAS 39 to overcome some
of the banking sector's concerns and so achieve consensus. The
FSA is clear that it would not be in the interests of markets
and investors for the Commission to seek to change the detail
of an accounting standard that has been set by an independent
internationally respected standard setter. We would prefer some
form of deferral of the endorsement decision which would allow
companies to apply the standard on a voluntary basis.
30. The FSA would also highlight three important
FSAP sectoral initiatives which are still under negotiation and
which will be crucial to ensure that prudential requirements for
EU financial services firms are flexible, efficient, relevant
31. The Capital Requirements Directive (CRD)
will implement, in the EU, the proposed new Basel Framework that
updates the existing capital adequacy rules for banks and will
extend those rules to other credit institutions and investment
firms in the EU. Basel II and the CRD represent an important opportunity
to make capital requirements more risk-sensitive and to enhance
the practice of risk-based supervision, including improved dialogue
between firms and their regulators and greater transparency.
32. Solvency 2 offers the opportunity to
update the capital regime for insurance firms in the EU, improve
the distribution of capital among regulated firms and provide
incentives for better risk management. The UK has, in a domestic
context, been placing prudential requirements for insurance on
a more realistic basis. Solvency 2 provides the opportunity for
extending such an approach throughout Europe.
33. The Reinsurance Directive will bring
pure reinsurers within the regulatory net across the EU and encourage
the development of robust international standards on reinsurance
34. We see these initiatives as helpful
to ensure that the EU financial framework is sound, flexible,
efficient and capable of evolution in line with changes in regulatory
approach and in industry risk management practice. Working with
the Treasury, we will continue our efforts to secure favourable
outcomes in all of these initiatives, both during the negotiation
and in subsequent implementation phases.
The global dimension is of key importance
35. Both the FSC and the Forum group reports
highlight the importance of recognising the global nature of financial
services. In view of London's position as Europe's largest financial
centre, it will be essential to ensure that all future EU financial
sector policy initiatives are framed with appropriate regard to
their global impact. This will help to ensure that European financial
services firms remain competitive and that London is able to compete
effectively to maintain its pre-eminent position within Europe
36. Dialogue with key global centres, particularly
the US, will remain an integral element of future strategy. It
is important that, in developing policies that potentially have
a global impact, the authorities in the EU and other global financial
centres are aware, at an early stage, of each others' thinking.
An encouraging start has been made. In particular, dialogue has
brought the EU and US closer to agreement on key issues such as
auditor registration and accounting standards issues. This now
needs to be built upon, both to widen the dialogue to include
relevant and timely input from other key players (for example,
the level 3 committees, the financial sector and its users) and
to create a more forward-looking agenda which can anticipate issues
and exploit opportunities for global convergence.
37. This approach should help to foster
understanding and promote greater openness and integration. Such
co-operation is vital to addressing global financial problems.
It will also offer the EU the possibility of promoting FSAP objectives
on the world stage.
Areas for future action
38. Clearing and settlement arrangements
within the EU currently fail to provide efficient processing of
cross-border transactions and impede the development of a fully
functioning single market. The FSC report invites the Commission
to propose an initiative in this area, on the basis of its recent
Communication. The Commission has committed to conducting a full
impact analysis of any initiative.
39. We are inclined to support a framework
directive in this area to tackle the market and regulatory failures
which have been identified, providing any directive could be shown
to promote a competitive and innovative clearing and settlement
market and can be justified on the principles of good regulation.
Our own preliminary analysis suggests that there are indeed some
barriers to the effective operation of an EU market for clearing
and settlement which may require a public policy intervention.
We believe such an intervention should be narrowly focused on
enhanced rights of access and choice and a common regulatory framework
for addressing systemic risk.
40. In addition to this, the FSC report
highlights four key general areas which are particularly influential
in the financial services sector and which might be the subject
of further examination within the post-FSAP framework: general
consumer protection, private law, competition policy and taxation.
41. This provides an important reminder
that the achievement of financial integration within the EU will
depend upon a range of factors which go beyond the legislative
programme set out in the FSAP. At the level of specific legislative
initiatives, there are a number of single market provisions which
affect financial services, but which do not form part of the FSAP,
such as the Electronic Commerce Directive, the Unfair Commercial
Practices Directive and the Consumer Protection and Co-operation
Regulation. Action by the Commission to iron out ambiguities stemming
from compromise positions and to identify and address inconsistencies
between existing Directives (the FSC report alludes to the need
to do this in respect of the e-commerce framework) will be a useful
contribution to creating a more certain legal environment in which
business can undertake financial services within the EU.
E. AN INTEGRATED
42. A single EU retail market remains a
considerable way off. The FSC report does not explicitly propose
any specific action plan to address this, although, it does indicate
that general consumer protection, taxation and private law should
be the subject of further examination within the post-FSAP framework.
None of the Forum reports comes out in favour of a specific retail
market action plan. Indeed, they urge the EU to take a very cautious
approach, based on careful analysis of the existing barriers and
adhering to better regulation principles. The FSA's view is that
many of the barriers are not removable through financial services
43. We will keep pressure on the Commission
to conduct an in-depth review of retail financial services markets
and consumers across the EU, so that the context and requirements
for change can be fully understood before any proposals (legislative
or non-legislative) are made in this area. While supporting the
objective of a single market for retail financial services, we
believe that the authorities' role in promoting this should be
confined to identifying and, where possible, removing barriers
to this using the tools available to them if these are appropriate.
It is up to the market itself to deliver an appropriate degree
of integration within this framework.
8 September 2004