House of Lords - European Union

Select Committee on European Union Fifth Report

CHAPTER 7: FINANCIAL SERVICES

119. This section addresses the issues relating to the Single Market in financial services, an area in which the Committee feels that the lack of progress has been disappointing. Our inquiry coincided with the Commission's consultation on retail financial services, which resulted in proposals for measures on retail financial services in the Commission's review of the Single Market[27], and inevitably this aspect featured prominently in the submissions received, and therefore, in our findings.

OVERVIEW OF REGULATORY DEVELOPMENTS

120. During most of the 1990s, efforts in the financial services sector were largely focused on achieving a smooth transition to the single European currency, with the broader issue of the functioning of the EU financial markets having a lesser priority. In May 1999, the Commission published a Communication containing a Financial Services Action Plan (FSAP)[28], which the Lisbon European Council endorsed in March 2000.

121. The FSAP is a set of 42 legislative measures intended to fill gaps and remove barriers to create a legal and regulatory environment supporting the integration of EU financial markets. It has three aims:

the creation of a single EU wholesale market for financial services and products;
the creation of an open and secure financial retail market; and
implementation of state of the art prudential rules and supervision.

122. The FSAP was largely completed by its 2004 deadline, with 39 of the 42 measures adopted.[29] The next stage of FSAP involves the implementation of the measures into national law, as some of the measures were only due to be implemented by late 2007. Witnesses agree that "it is too early to assess the full costs of the programme … let alone the benefits to the economies of Europe attributable to the FSAP" (FSA p 16).

123. Since the FSAP focused mainly on the wholesale market, the Commission identified the completion of the retail financial services market as one of its key priorities. In May 2007 it published a Green Paper on Retail Financial Services, which set out its objectives of furthering integration in EU retail financial services markets by:

ensuring that properly regulated open markets and strong competition deliver products that meet consumers' needs, offering choice, value and quality;
enhancing consumer confidence by ensuring that consumers are properly protected where appropriate, and that providers are financially sound and trustworthy; and
empowering consumers to make the right decisions for their financial circumstances through improved financial literacy; clear, appropriate and timely information; high-quality advice; and a level playing field between products perceived as having similar characteristics.[30]

124. On 20 November 2007, as part of the Single Market review, the Commission outlined a number of initiatives in the area of the retail financial services in response to the consultation on the Green Paper[31]. These initiatives included the publication of a White Paper on Mortgage Credit, which recognised the importance of the mortgage credit sector for consumers and the economy as a whole, as demonstrated by the sub-prime mortgage crisis in the United States.

OVERVIEW OF MARKET DEVELOPMENTS

125. In addition to the regulatory developments, a series of market developments have contributed to the integration of the EU financial services sector, including the ongoing consolidation of trading services in the EU, such as the Euronext/New York Stock Exchange merger; the OMX/Nasdaq merger and the London Stock Exchange/Borsa Italiana merger.

126. In the retail banking sector, there has been significant cross-border banking consolidation. Most recently, in the largest EU cross-border banking merger to date, a consortium of Royal Bank of Scotland, Fortis and Banco Santander acquired the Dutch bank ABN Amro.

127. In addition, a number of market-led reforms are due to be implemented to tackle fragmentation in the retail banking sector. The Single Euro Payments Area (SEPA) will include pan-European euro-denominated credit transfer and direct debit schemes and a pan-European framework for payment cards (applicable to all Member States including non-eurozone members). In particular, SEPA is designed to ensure that cross-border payments are as cheap and easy as domestic payments.

The Wholesale Sector

128. Integration has been achieved to a greater extent in the EU wholesale financial services sector. The Commission stated that this focus was intentionally adopted because a well-functioning wholesale sector was considered of strategic importance "as an engine for economic development" (Q 208).

129. Many witnesses concurred that, at this stage, "there is little need for more legislation in the wholesale area" (Barclays p 198). Rather, evidence was submitted that "at a time when the financial services industry is facing a period of enormous and costly institutional change as a result of the impact of the FSAP, it needs a substantial period to consolidate these changes effectively" (City of London Corporation p 213). This is, of course, only possible once all 42 FSAP measures are fully transposed into national law across the 27 Member States. Furthermore, some of the measures, notably the Markets in Financial Instruments Directive (MiFID), have only recently come into force[32].

130. Far from requiring new legislative proposals, it was suggested to us that the Commission should focus on implementation and on "ensuring that Member States are honouring their obligations equally" (APCIMS p 196). Evidence from British Bankers' Association (BBA), among others, indicated that implementation across the EU was patchy, especially with regard to MiFID (Q 117)[33]. However, despite concerns that only a few Member States would be in a position to meet the deadline for implementing MiFID, the Commission has recently announced that a majority of Member States have complied.[34]

131. A consistent theme was the failure of some Member States to implement EU directives in a timely and consistent manner, the effect of which is to undermine the impact of the initiatives and potentially to place those market participants in Member States who are compliant at a competitive disadvantage.

132. Although the Commission can initiate infringement proceedings against Member States under Article 226 of the EC Treaty, some witnesses felt that "Commission remedies are not always sufficient for enforcement" (Santander p 233). Other witnesses suggested that "The tools are available, but the Commission could devote more resource to studying the manner in which EU legislation has been implemented, and in its choice of the tools at its disposal" (Barclays p 201).

133. A number of witnesses, including APCIMS, suggested that "industry led solutions are in general far preferable to legislative initiatives where the outcomes can have unpredictable and unwanted conclusions" (p 197) and that the Commission should address any remaining barriers in this sector by using such solutions.

134. The EU Code for Clearing and Settlement may provide an example of self-regulation working successfully. On 7 November 2006, three main industry associations in the EU clearing and settlement sector signed the Code, which aimed at enhancing transparency and increasing competition in the post-trade EU clearing and settlement sector. The Code seeks to reduce the high cost of cross-border post-trade services in the EU. Following a Communication in 2004, the Commission mooted the need for a framework Directive imposing a range of obligations on the market, such as accounting separation and equal access. The Code was adopted by market participants in order to avoid the prospect of a directive. As the Code is currently being implemented by the market, it remains to be seen if it will lead to a reduction in the costs of cross-border clearing and settlement services in the EU[35]. If it does not then "the whole voluntary approach to reform will be open to doubt" (CBI p 219).

The Retail Sector

135. In contrast to the EU wholesale sector, there has been less integration of the EU retail banking sector. Witnesses largely attributed this to "different languages" (BBA Q 116) and "different consumer behaviour and legal frameworks" (Barclays p 198). We suspect that protectionism, at least in some Member States, also played a part.

136. The fragmented nature of the EU retail banking sector was also confirmed by the Commission's investigation into the EU retail banking sector which found that national competition barriers were widespread and that costs to companies and consumers were unnecessarily high. In addition to concluding that the sector was generally fragmented along national lines, the Commission also found a number of other factors (such as price rigidity and customer immobility) suggesting that competition in the EU retail banking market may not be working effectively.[36]

137. In terms of market-led developments, due to practical difficulties arising from organic growth (e.g. the establishment of branches in another Member State) or the provision of cross-border services (i.e. the bank and customer being located in different Member States), cross-border banking consolidation is expected to be the most effective means to integrate further the EU retail banking sector, subject to the principles of fair competition.[37]

138. As cross-border consolidation has, however, to date been driven by opportunities offered in specific markets, such as Banco Santander's purchase of Abbey, rather than by changes in EU legislation, some witnesses indicated that the Commission and, where applicable, NRAs should focus on "removing barriers which prevent or restrict market entry or the development of effective competition for retail products" (Barclays p 200).

139. The Commission has already taken some action to create such a level playing field. For example, in response to the resurgence of economic protectionism across the EU, as well as launching proceedings against a number of Member States,[38] the Commission has also revised the regulatory framework for the review of EU banking mergers to limit the discretion of NRAs. On 13 March 2007, the European Parliament and the Commission reached a compromise on a proposed directive limiting the duration of any review to 60 days and requiring NRAs to publish the grounds of any decision. It remains to be seen whether the directive will be sufficient to remove any hindrances to cross-border banking consolidation.

140. However, more needs to be done by the Commission to ensure that banks have equal access to other markets. There is particular support from market participants for the Commission's proposals in its final findings on the EU sector inquiry and the White Paper on Mortgage Credit to provide increased access to credit databases.[39]

141. Although there is support for facilitating access to markets, some witnesses have urged the Commission to undertake thorough analysis before initiating any legislative proposals. In this respect, previous regulatory initiatives in the EU retail banking sector have been criticised for failing to assess benefits for consumers as part of the legislative process. The Consumer Credit Directive, for example, failed to "tackle key elements such as taxation, recovery process and protection of collateral harmonisation" that would have led to lower prices and higher quality of services and an "increase in cross-border activity" (Santander p 232). No impact assessment was undertaken as part of the regulatory process and a post-adoption study by the Commission has concluded that the Consumer Credit Directive will not achieve an internal market.[40]

142. Angela Knight suggested that "too often there is a leap to, 'What can we do? Where shall we do it? There must be this barrier or that barrier. Let's create a directive.'" (Q 118). Rather, consumer research should be carried out first. However, the regulatory approach alone is considered insufficient. Barclays stated that "We believe that a single market cannot be created through legislation alone and we welcome the increasing use of competition policy—and other non-legislative tools— … as a means of opening markets" (p 199). This approach can be seen in enforcement actions against individual banks under Articles 81 or 82 of the EC Treaty and the review of financial services mergers falling within the scope of the EC Merger Regulation.

143. There are some signs that the Commission has listened to the calls from market participants. As part of the response to the consultation on the Green Paper on Retail Financial Services, the Commission has demonstrated a willingness to undertake further analysis and consultation before proposing any initiatives.[41] For example, the Commission recognised that further studies are needed in relation to product tying and the access to and availability of credit data. In addition, as advocated by the BBA, the Commission has encouraged a market-led solution in order to encourage switching between banks similar to the UK banking code.

Conclusions for Financial Services

144. Well-functioning financial markets play a significant role in delivering a range of benefits for individuals in the EU.[42] At a macro-economic level, the Committee believes that completing the Single Market in financial services is a crucial part of the Commission's overriding objective of achieving more and better jobs in a more innovative and attractive Europe. Deep, liquid, dynamic financial markets will also ensure the most efficient allocation and provision of capital and services throughout the European economy. The Single Market in financial services is intended to provide increased competition and greater financial stability.

145. In addition, if investors can invest throughout the EU on the basis of clear and comparable information from securities issuers and without unnecessary red tape or additional costs compared to the cost of investing in their own Member State, then that investment is more likely to be allocated on the most efficient basis in terms of anticipated returns. In turn, if businesses have access to more abundant and cheaper capital, they can finance expansion more easily and produce their goods and services more efficiently, which ultimately means lower prices for consumers. Well-functioning markets will also optimise the value of savings and pensions for individuals.

146. Single Market measures to date have largely targeted the wholesale sector and there is, among market participants and stakeholders, a clear desire for a regulatory pause. Such a pause will allow the impact of the measures to date to be assessed. The Commission should use such a pause to focus on its monitoring role and encourage the timely and consistent implementation of EU directives.

147. Although integration in the EU retail banking sector is less advanced due to the characteristics of the sector, it is important for any initiatives to have a consumer-oriented approach in order to deliver tangible benefits to end-users by opening access to national markets. As part of this approach, research and consultation must be the starting points before legislative proposals are launched. The Commission has recognised that further studies and consultation should be undertaken before proposing any legislative proposals.

148. Following such research and consultation the Commission should be more willing to develop a combination of market-led and regulatory instruments to be pursued in order to further the integration of the EU retail banking sector.

27 'Initiatives in the area of retail financial services', Accompanying document to the Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions, SEC(2007) 1520. Back

28 Financial Services: Implementing the framework for financial markets: Action Plan, Communication from the Commission. Back

29 FSAP Evaluation: Part I: Process and implementation, Commission (p 3). Back

30 'Green Paper on Retail Financial Services in the Single Market', Commission, COM(2007)226. Back

31 'Initiatives in the area of retail financial services', Accompanying document to the Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions, SEC(2007) 1520. Back

32 MiFID came into effect on 1 November 2007. Back

33 The Commission has already taken action against Member States for failing to take sufficient measures to implement MiFID (see Commission Press Release IP/07/547 'Commissioner McCreevy urges Member States to ensure rapid implementation of Markets in Financial Instruments Directive ("MiFID"), 24 April 2007); see also FSAP Evaluation: Part I: Process and Implementation', (Annex B), for details of transposition of FSAP directives as at 15 January 2007. Back

34 See Commission MEMO/07/439 'Markets in Financial Instruments Directive (MiFID): Frequently Asked Questions', 29 October 2007. Back

35 The Commission is expected to deliver a report to Ecofin in early 2008 on the Code's impact and enforceability. Back

36 See Commission Press Release IP/07/114 'Competition: Commission sector inquiry finds major barriers in retail banking', 31 January 2007. Back

37 See the UK response to the Green Paper on Retail Financial Services (paragraph 12). Back

38 See Commission Press Release IP/05/1595, 'Free movement of capital: Commission opens an infringement procedure against Italy in the issue of acquisition of stakes in domestic banks', 14 December 2005, and European Commission Press Release IP/06/227, 'Mergers: Commission launches procedure against Poland for preventing Unicredit/HVB merger', 8 March 2006. Back