Select Committee on European Union Forty-Fifth Report

CHAPTER 2: A single market in financial services

the benefits of a single market

14. A recent Report commissioned from London Economics by the European Commission[9], which looked exclusively at the integration of bond and equity markets, calculated that the creation of a single European Union financial services market would, by itself, lead to significant economic benefits. The Report suggested that full integration of EU financial markets would reduce the real cost of capital by 50 basis points for EU businesses, and result in a one off 1.1 per cent increase in GDP, or Euro130 billion in 2002 prices, over ten years for the EU as a whole.

15. Dr Friedrich Heinemann of the Zentrum für Europaïsche Wirtshaftsforschung (ZEW) in a report for the European Financial Services Round Table entitled "The Benefits of a Working European Retail Market in Financial Services", concluded that financial integration of retail financial markets between countries in the EU could result in an additional growth effect on EU GDP of at least Euro 43 billion annually (at 2002 prices).

16. The above research indicates substantial potential benefits from the full implementation of a single financial services market. The original Lamfalussy report itself concluded:

"it is not simple to quantify the net sum of these benefits, but potentially they are large".

17. Most of the evidence we received came from organisations facing the private costs of securing the wider benefits. EU economies in general are expected to experience a large collective benefit when a truly liberal internal market in financial services is achieved.

The Financial Services Action Plan

18. The Financial Services Action Plan (FSAP) is the vehicle intended to deliver these benefits by:

FSAP is only part of the process

19. However, the FSAP alone is only part of the process that will eventually lead to a single market in financial services. The Bank of England, for example, gives three reasons why the FSAP measures on their own are unlikely to deliver a single market in financial services (see paragraph 6):

Late Directives

20. Three elements of the FSAP have still to be brought forward by the Commission. They are:

The Commission is currently working on a revised Directive embracing the tenth and fourteenth Company Law Directives and on a Directive on Corporate Governance, both of which are expected to be submitted to the Council and European Parliament by the end of this year. We discuss the problems surrounding the Takeover Directive in Chapter 3 (see paragraphs 69-75).

Other elements needed to create a single market

21. According to witnesses there are a number of other elements which are essential building bricks in the construction of an internal market:

  • clearance and settlement[14],
  • some form of common principles for taxation [Q. 137 and Q. 148] [15] (i.e. not rates of taxation) and;
  • the proposed Directive on consumer credit [16] [Q. 74].

Clearance and Settlement

22. Clearance and real-time settlement systems for equities, corporate government bonds and exchange traded funds are essential elements of an internal market in financial services. The Commission was expected to issue a document in the summer of 2003 to identify what action was needed to establish an integrated settlement infrastructure. In the meantime, the governing Council of the European Central Bank (ECB), the Committee of European Securities Regulators (CESR) and Member States' central banks have set-up a joint Working Party to look at establishing standards for securities clearing and settlement systems.

23. There are, today, around twenty separate systems for fifteen domestic markets in the European Union compared to, effectively, one in the United States for a market of about the same size. The services of these systems are largely tailored to domestic settlement needs.

24. While domestic settlement is cheap and efficient, cross-border settlement is expensive and inefficient.

25. The European Parliament, calling on the Commission to impose a Directive on the clearing and settlement industry, suggested the separation of "core" and "value added" settlement services when performed by the same organisation.

26. One witness, CrestCo Ltd, part of the Euroclear Group which operates the settlement system for UK and Irish equities, corporate and (UK) Government bonds and exchange traded funds, state in their evidence that:

"we are concerned that by forcing entities to separate "core" and "value added" services (however defined) the opportunity and momentum for delivering efficient structures to cope with the demands of cross-border settlement will be lost ……Furthermore, we do not believe that the case has been made for a specific Directive in this area. We believe that the implementation of the Giovannini recommendations, the work of the ESCB/CESR on strengthened and consistent regulatory standards across the clearing and settlement industry, and the presence of an active competition regulator should all help to create an efficient and low-cost market for settlement services in Europe without further intervention from legislators[17]".

Giovannini Committee

27. The Giovannini Group, chaired by Dr Alberto Giovannini, was set up in 1996 to advise the Commission on issues relating to EU financial integration and the efficiency of euro-denominated financial markets. Its two most recent reports have focused on cross-border clearing and settlement arrangements in the EU securities markets. These reports found that EU infrastructure for clearing and settling cross-border transactions remained highly fragmented and were barriers to a single market in financial services. The Group's second report on EU cross-border clearing and settlements published in April 2003[18] identified three main areas for removing barriers through convergence:

  • national differences in technical requirements and market practice
  • national differences in tax procedures; and
  • issues relating to legal certainty.

28. The Committee did not examine these issues in detail in the course of this inquiry but we consider that an efficient and effective cross-border clearing and settlement system is a fundamental building block that has to be in place. We strongly support the work being done by the Giovannini Committee and we urge that an early decision be reached on whether EU legislation will be needed or whether the market alone could bring about a pan-European clearing and settlement system.

International Accounting Standards (See Box 2)

29. International Accounting Standards, also known as International Financial Reporting Standards (IFRS), are currently being negotiated[19] and are a core objective of the FSAP. It is important that these standards should be in place in 2005. There are two difficult areas: IAS standards 32 and 39 (which cover hedging), which have run into significant opposition from the banking and insurance industries and in particular from France. The other unresolved issue is whether non-EU issuers will be allowed to use their own accounting standards to raise capital in the EU. It is important that compatible standards are achieved between the EU and the US. In this respect, we welcome the work being undertaken as a result of the Norwalk Agreement[20].

French concerns about aspects of IFRS

30. We heard evidence from the Deputy Governor of the Banque de France in which M Hannoun set out his concerns about IAS 32 and IAS 39 and the effect these standards might have on prudential supervision [Q. 425-428].

31. M Hannoun offered an illustrative example whereby a company in financial difficulties might seek to use the IAS 39 "fair value option" to calculate its liabilities and its debts. The company would show a reduction of the accounting value of its debt and a corresponding improvement in net income - an accounting sleight of hand that could confuse the market as to the company's true value. M Hannoun also had problems with consolidation and argued that the provisioning rules in IAS 39 had to be consistent with the Basel II Framework (See box 3).

32. We put his concerns to the Financial Secretary to the Treasury. Mrs Kelly said:

"international accounting standards may have an impact on financial stability but it is certainly not the only way in which this impact would be felt. They have a huge impact on investment opportunities in Europe as well, and it would be wrong to look at just one aspect of their impact without looking at the broader picture" [Q. 508].

Box 2
International Accounting Standards ("IAS")

IAS, or International Financial Reporting Standards ("IFRS") as they are now named, are accounting standards which have been evolving over many years. The intention is that IFRS should be used and accepted internationally by the world's capital markets. This is subject to acceptance by individual countries. IFRS is promulgated by the International Accounting Standards Board (IASB).

The European Parliament and Council of Ministers passed IAS 2005 regulation requiring endorsed IFRS for accounting periods commencing on or after 1 January 2005 for EU incorporated and EU listed companies.

The endorsement process involves a proposal to endorse each IFRS standard in each official language of Member States by the Accounting Regulatory Committee (ARC). The private sector sponsored the creation of the European Financial Reporting Advisory Group (EFRAG) to provide advice to the European Commission and to the ARC.

IAS 2005 regulation contained a requirement to endorse all existing IFRS by December 2002, which has not yet been completed. The delay is due to absence of all necessary translations plus concerns over the acceptability of IAS 39 which would restrict hedge accounting in particular by banks.

EFRAG has reviewed all current standards and has publicly recommended that the ARC adopt them in full.

The ARC have now endorsed all standards except IAS 32 and IAS 39 both relating to (financial instruments). These standards are undergoing significant revisions, particularly in the area of hedge accounting. The IASB has been consulting very widely and held round tables with constituents so that it could learn about the concerns face to face.

The IASB has a very full agenda and currently is targeting to issue many revised standards and some new standards by the end of March 2004. These will be all mandatory standards that will be in force at 31 December 2005. Examples include new standards on business combinations, insurance and share based payments. Revised standards include pensions and deferred taxes.

The implementation of IFRS is a core part of the FSAP as it will mean that all listed companies in the EU will prepare financial statements on the same basis for the first time.

Source: specialist adviser

33. We are grateful to the Banque de France for explaining their concerns but we urge all parties to consider the importance of common accounting standards, not only in the interests of achieving an internal market in financial services in the European Union, but also in order to bring about compatibility of standards with the American and Asia-Pacific markets.

Consumer Credit

34. Lloyds TSB Group say in their evidence:

"the Commission did not consider this proposal [i.e. consumer credit] as a financial service issue but as a consumer protection issue. As a result, European parliamentarians generally believe this proposal is seriously flawed as it does not acknowledge sufficiently the practicalities of the markets"[21].

35. In his oral evidence, Mr Ian Mullen, Chief Executive of the British Bankers' Association acknowledged that the Consumer-Credit Directive was not part of the FSAP though it was allied to it. It was complicated by seeking to combine mortgages and financial services. He thought the Directive might be divided in two [Q. 74].

36. This was not an area that we looked into.


37. A number of witnesses argued that inherent in any effective cross-border trading within a single market in financial services was some form of agreement on the principles of taxation[22]. Again, the Committee did not examine this issue in this inquiry.

The Committee's decision to examine the FSAP

38. Nevertheless, even accepting the need for these additional measures, there is no doubt that the FSAP represents a considerable effort of political will on the part of the European Council, the Commission and the European Parliament to drive through the basic structure of a single market in financial services. Markets are dynamic and one witness argued that it was important to make the breakthrough in the form offered by the Financial Services Action Plan [Q. 136]. For this reason, the Committee concluded that it should concentrate on the progress achieved by the FSAP, consider the main issues that the process had thrown up, and ask whether or not these measures would be adopted on time.

Major themes from our inquiry

Cultural Differences

39. We were struck by the different administrative traditions across Europe distinguishing between those Member States where state regulation of markets has been customary and those that have favoured flexibility and where the regulators have sought to maintain as light a touch as possible consistent with the need to protect investors. These cultural differences can be seen in a purely technical form in the tension between the need for maximum harmonisation in some Directives and for flexibility, or subsidiarity, in others. We discuss this balance in Chapter 5.


40. The division between these two sectors of the market is often blurred but does raise the question as to whether there is a need to regulate the wholesale capital markets in a different way from the regulation of the retail markets. There appears to be a consensus that the need for consumer protection measures is probably greater in the retail markets and that the creation of a single market will take longer in this area. All Member States have retail financial services; only a few are host to the global capital markets. There is a problem, too, in that it is difficult to define what is meant by wholesale and retail in the context of financial services. More effort should go into seeking to clarify this distinction.

41. The fear, particularly among UK witnesses, was that the EU might try to extend the comprehensive regulation desirable for the retail market to the wholesale market, where many contend there was less need for it and where the imposition of such regulation could easily stifle the wholesale capital markets. Some witnesses suggested that certain Members States saw close regulation of the retail and wholesale markets as a means of protecting national champions[23]. If this were to occur, the EU would be the loser because the cost of capital would fall more slowly and there would be a risk that non-EU issuers would move elsewhere. It is likely to take many years before a true single market in retail financial services emerges. In the meantime, we expect change to be driven by the markets and we remain optimistic that many of today's perceived cultural barriers in this field will be eroded by the force of economic advantage.

After the FSAP

42. The Commission has indicated [Q. 321] that its major task after the adoption of the FSAP will be to concentrate on monitoring implementation and enforcing the Directives. This is an area we address in detail in Chapter 4 where we also consider the case for a European Regulator -"EUROSEC".

speed versus quality and the 2004 Deadline

43. In support of their written evidence, the Association of Private Client Investment Managers and Stockbrokers (APCIMS) attached a list of twelve of the key measures affecting retail and wholesale markets in the FSAP which were outstanding. At the time the evidence was submitted - 26 June 2003 - not one of the measures had been adopted and implemented and the original deadline of 2003 for achieving the goals for wholesale markets had not been met. The Investment Management Association (IMA) thought that in terms of enacting FSAP legislation by 2005, it was likely that the programme would be met if not then, at least shortly afterwards.

"However, IMA is concerned that this focuses too much attention on the speed with which legislation is enacted and insufficient attention on the quality of that legislation. In particular, we would not wish the quality of highly sensitive impending legislation to be compromised by an unnecessarily tight deadline (e.g. the Investment Services Directive, Capital Adequacy Directive, Transparency Obligations Directive, the Takeover Directive and Prospectuses Directive)".

44. This is a view echoed by other witnesses[24]. It was a question which the Committee addressed to witnesses whose oral evidence was heard[25]. The overall tenor of replies was that important legislation was being rushed. Some thought that because the FSAP was working to a politically-driven timetable[26], this was, perhaps, inevitable. Support for the timetable came from the users of the capital markets[27]. There was sense among UK witnesses that few other Member States were sufficiently close to the sophisticated capital markets to understand that bad legislation conceived to meet political deadlines could have serious repercussions and could impede the setting up of a single European market in financial services. We were, therefore, pleased to hear the Financial Secretary to the Treasury argue robustly for quality of legislation, "we are very aware that it is much more important to get it right than to meet a deadline [Q. 494]". However, success remains a hostage to political fortunes as we have seen in the matter of the Investment Services Directive (paragraphs 53-55).

45. Some witnesses attributed the slow start at the beginning of the process[28] to allegations of poor quality in the drafting of some of the earlier Directives combined with the Commission's failure to take expert advice [Q. 61] [29]. This was particularly the case for the Prospectus Directive. This was recognised and the Lamfalussy process was the EU's response. The Wise Men, in their report, underlined the paramount need for proper consultation. Lamfalussy is, in practice, just beginning its work in speeding-up the process of implementation. While some witnesses expressed doubts about whether or not the FSAP's current deadlines could be met, most thought that the important outstanding Directives, in particular, the Investment Services Directive, would go to the tape. It was not thought that delay on say, the Takeovers Directive, would substantively affect the outcome of the Financial Services Action Plan.

Commission's Resources

46. When we took oral evidence from the Director-General of DG Internal Market, Dr Alexander Schaub, he said that part of the problem for the uneven performance to date had been a lack of resources in his Directorate General. This lack of resources would become more acute when the Commission moved on to monitoring implementation and enforcing Directives. A surprising number of other witnesses also referred to what they considered to be a critical lack of adequate resources in DG Internal Market. These included Christopher Huhne MEP, the Secretary-General of the Federation of European Securities Exchanges, the Corporation of London, the FSA, Barclays Bank, London Investment Bankers Association, Aviva and the Institute of Chartered Accountants of England and Wales.

47. In her evidence, the Financial Secretary, while acknowledging that the issue of resource allocation was one for the Commission, said "we would argue pretty strongly that they should focus more resources on the implementation and enforcement procedure in the future, as well as thinking, as I said, about non-legislative ways of opening up opportunities for business across Europe." [Q. 525].

48. There would appear to be a serious matter of concern here which could affect how the single market in financial services develops. As Dr Schaub pointed out, the real key to success of the FSAP will come at the stage when Directives are implemented through transposition to national legislation and later in the matter of enforcement. The Commission's Directorate General for the Internal Market will have an important role to play in monitoring implementation and enforcement and should be properly resourced to do the job effectively.

Burden on companies

49. Finally, in a corollary to the issue of the pressure to complete the legislative process by the spring of 2004, the incoming Chairman of the United Kingdom FSA, Mr Callum McCarthy, reminded Government and the market of the existing and impending burden on companies as they scramble to adapt to the flood of legislation[30]. The Committee became aware of Mr McCarthy's speech late in the inquiry but in time for us to ask the Financial Secretary to the Treasury for her reaction to the issues Mr McCarthy had raised. Mrs Kelly said:

"In a way, Callum McCarthy was making some very sensible points about the implementation process …… we are committed to particular Directives to which we have signed up, but obviously we want to see them implemented in a sensitive way" [Q. 529-530].

50. We endorse the Minister's sentiments that the Directives should be sensitively implemented and that quality of regulation was more important than deadlines in the creation of a single market.

9   Quantification of the macro-economic impact of integration of EU Financial Markets - November 2002. Study by London Economics, in association with PricewaterhouseCoopers and Oxford Economic Forecasting. Back

10   Written evidence from HM Treasury - Page 156. Back

11   Written evidence from the Bank of England - Pages 178 and 179. Back

12   Written evidence from IMA - Page 204, written evidence from ProShare - Page 34, written evidence from FSA - Page 59 and written evidence from Prudential - Page 211. Back

13   Written evidence from IMA - Page 204, written evidence from ProShare - Page 34, written evidence from FSA - Page 59 and written evidence from Prudential - Page 211. Back

14   Written evidence from the London Stock Exchange - Page 3, written evidence from FESE - Page 110, written evidence from CrestCo - Page 187 and written evidence from Euronext - Page 133. Back

15   Written evidence from Michel Prada - Page 207, written evidence from IMA - Page 203, written evidence from LSE - Page 3, written evidence from FESE - Page 110 and written evidence from FSPP - Page 196. Back

16   Written evidence from Lloyds TSB - Page 205. Back

17   Written evidence from CrestCo - Page 189. Back

18 Back

19   Written evidence from ICAEW - Pages 197-201. Back

20   Norwalk Agreement

This agreement was reached between the US based Financial Accounting Standards Board (FASB) and the UK based International Accounting Standards Board (IASB) in Norwalk Connecticut on September 18 2002. In this agreement both the FASB and the IASB pledged to use their best efforts to:

· make their existing financial reporting standards fully compatible as soon as is practicable; and

· to coordinate their future work programmes to ensure that once achieved, compatibility is maintained.

The agreement sets out as matters of priority to achieve compatibility:

· undertake a short-term project to remove variety of individual differences between US GAAP and International Financial Reporting Standards (IFRS, which include International Accounting Standards);

· remove other differences between US GAAP and IFRS still remaining on 1 January 2005 through coordination of future work programmes;

· continued progress on joint projects already underway;

· encourage their respective interpretive bodies to coordinate their activities. Back

21   References to Lloyds TSB written evidence, paragraph 10. Back

22   Written evidence from Michel Prada - Page 207, written evidence from IMA - Page 203, written evidence from LSE - Page 3, written evidence from FESE - Page 110 and written evidence from FSPP - Page 196. Back

23   Written evidence from LSE - Page 2 and written evidence from LIBA - Page 16. Back

24   Written evidence from Prudential - Page 210, written evidence from Fidelity - Page 193, written evidence from the Corporation of London - Page 180 and written evidence from Stephen Revell -Page 214. Back

25   Q.15, Q.60. Q.201, Q.219, Q.300, Q.329, Q.397, Q.434, Q.464 and Q494. Back

26   Written evidence from FSPP - Page 195. Back

27   Written evidence from European Financial Services Roundtable/Aviva - Pages 41 and 42 and written evidence from Unilever - Page 68. Back

28   Written evidence from Lachlan Burn - Page 75 Back

29   Written evidence from QCA - Page 213, written evidence from the Bank of England - Pages 178 and 179 and written evidence from the London Stock Exchange - Pages 1 to 3. Back

30   Mr McCarthy's speech at Ditchley Park. Back

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