Select Committee on European Union Forty-Fifth Report

Appendix 6 Cost/benefit analysis of the European Commission's Financial Services Action Plan (FSAP)

Executive Summary

One of the major criticisms of the Financial Services Action has been that insufficient cost-benefit analysis has been carried out on the directives. For example, HM Treasury, the Financial Services Authority and the Bank of England wrote in ""The EU Financial Services Action Plan: A Guide", July 2003:

"Many market experts consider that the Commission should analyse in more detail the cost-effectiveness of proposed new FSAP measures, and the interaction between them. Their impact needs to be considered, not just on market behaviour and the efficiency of financial markets within the EU, but also on the EU 's global competitiveness, and in particular in relation to the US."

  • The Commission's "impact assessments" for each measure are inadequately detailed, especially in financial terms.
  • However, some detailed estimates have been made of the overall benefits of European financial integration. These add up to an annual benefit to the EU economy after 10 years of at least €189bn.
  • To outweigh this public benefit, the annual private cost of each of the 40 measures would have to be nearly €5bn.

The consultancy OC&C estimates the cost to the EU of the currently proposed Investment Services Directive to be up to €450m per annum.

The Commission analyses make no attempt to estimate the costs involved in securing the assumed benefits.

Graham Bishop, Specialist Advisor

October 2003

The Benefits

The Lamfalussy report concluded the following benefits to EU financial integration:

On the issue of the size of these benefits, the report concluded, "It is not simple to quantify the net sum of these benefits, but potentially they are large". However, recently two reports have attempted such quantification.

London Economics produced a "Quantification of the Macro-Economic Impact of Integration of EU Financial Markets" for the European Commission. Specifically, they investigated "the extent to which the merging of the presently still regionally-fragmented liquidity into a single liquidity pool would reduce the cost of equity and bond finance for businesses in Europe, help stimulate investment and expand productive capacity." So their focus was exclusively on integration of wholesale markets. Their conclusion was

"The level of EU-wide real GDP is raised by 1.1%, or €130 billion in 2002 prices, in the long-run. The press release states that "the long-run" is "defined as over a decade or so".

ZEW/IEP produced a report for the European Financial Services Round Table entitled "The Benefits of a Working European Retail Market for Financial Services". Their focus was exclusively on the retail side. Their conclusion was "World-wide cross-country samples show that differences in financial integration between countries amounting to one standard deviation of the relevant integration indicators can explain annual growth differences of 0.5 - 0.7 per cent. Although these results do not cover all present EU member states they indicate roughly the potential for growth through financial integration: in terms of the EU GDP of the year 2000 the lower per cent figure of 0.5 would mean an additional growth effect of 43 billion euro annually." 

The benefits set out in the two reports are additive because the first report looks exclusively at the integration of bond and equity markets, while the second looks at retail markets. The wholesale benefit is €130 billon after 10 years. The retail benefit (if we also express in 2002 prices) is €59-83 billion annually - with no timeframe given. But if we assume the same timetable, after 10 years the annual benefit is at least €189bn/ £134bn.

Commission "impact assessments"


For each new proposal for a directive, the Commission is required to produce an assessment of the "impact on business with special reference to small and medium-sized enterprises". This involves providing answers to the following template of questions:

Sample of Commission Impact Assessments

Though the impact assessments conducted by the Commission are fairly short, they are too long to all be included in their entirety. Possibly the most important question in the Commission's Impact Assessment template is "4c", "What economic effects is the proposal likely to have on the competitiveness of business?" The following table sets out the answer for the 15 directives for which this analysis has been done. A spreadsheet is available from those who wish to read all the impact assessments.

Impact Assessments - A Private Sector Example

Ian McKenzie and Andy Sparks of OC&C Strategy Consultants published a study on "The Potential Impact of ISD2 Article 25" in August 2003. Its objectives were:

1. To identify and, to the extent possible, quantify the impact of the Article 25:

(i) As originally drafted (Note that this is the major thrust of this paper);

(ii) As per the compromise amendments that are emerging (as at mid-July)

2. To investigate the extent to which "off-exchange" trading is a likely to be detrimental to the effectiveness and efficiency of equity markets. We have addressed this by:

(i) Estimating the actual extent to which 'true' off-exchange trading currently occurs

(ii) Investigating the extent to which such principal trading can provide economic benefit to investors (as opposed to passing orders through to a central market on an agency basis)

Their main conclusions are:

In terms of quantifying the cost of the compromise proposals, OC&C conclude:

"While the narrowing of scope to the most active/systematic providers of principal execution appears a welcome step, the shift to normal/standard market size would move the impact of Article 25 directly onto the (core) institutional market. Without the ability to choose counterparties or the ability to price improve, those Firms who are caught by this provision will probably find it unattractive to continue to provide principal liquidity, This loss of liquidity would cause deterioration of prices for institutional clients (which might be worth €375- 450m (around £300m) per annum) and loss of price immediacy."

This last figure was cited by the Chief Secretary to the UK Treasury, Paul Boateng, in his argument against the political agreement reached by the European Council on the ISD on October 7th 2003.

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