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Let me start by describing the broader perspective in which European Financial Markets are evolving. I will then define some key elements for the Commissions’ Financial Services policy, before turning to our work on Investment Funds.
Europe’s needs
Europe is facing new challenges.
Sluggish growth;
Slow job creation;
A huge waste of economic and human potential.
Global competition from new economies is posing a new challenge. Services sectors are not immune from this. Oil prices are rocketing... sapping even further the recovery of the European economy. On the social front, the ageing population is a time bomb - threatening the subsistence of national social security systems.
These challenges, however, offer opportunities. We must confront them positively. In a spirit of “can do, will manage, can succeed”.
Let us avoid at all costs the negative knee-jerk reactions, the protectionist reflex... those are the recipes of abject failure.
All the more reason to harness fully the growth enhancing potential of the financial sector.
More efficient financial markets are vital to allocate resources better, reduce costs and increase returns for all market players. This will boost capital formation; investment; economic growth. The potential for gains in the asset management industry are considerable – worldwide, and in the EU. Globally we are talking about a € 45 trillion capitalised industry, greater than € 10 trillion in the EU. For investment funds, annual savings of up to € 5bn alone may be achievable as a result of better exploited economies of scale.
The role of regulation
I regard the EU framework as an enabler, that opens new markets, increases choice and generates opportunity. Creating the right regulatory framework for business to succeed. In the past, policy and regulatory barriers have fragmented financial markets and hampered the growth of financial institutions on a pan-European basis. The FSAP sought to address the greatest stumbling blocks. Further work is needed to improve the ability of the EU financial sector to play its full part. We have not exhausted the benefits of a true single market for financial services. But I am not talking about a swathe of new legislation. The FSAP has been, in most respects, a great success. A huge programme, delivered on time – which now must be implemented.
Good regulation is vital for Europe. Markets need sound and stable rules to develop. Investors need clear and enforceable rules which build confidence in the system. But when faced with new challenges, regulation is not always the best solution. For this reason, when considering and evaluating new measures, I’ve asked my services to carry out impact analysis of all possible options, including that of not acting.
In some cases market forces can be expected to lead to an optimal outcome. In the investment fund sector, initiatives such as the development of codes of conduct, fee disclosure or fund-processing standards can help markets to function better. In other cases national authorities may be best placed to act to address local problems that do not require an EU level response. Thus, the need for Commission action will always have to be demonstrated.
While we can be proud of what we have achieved over the last few years, we should not pretend that further European financial regulation can develop in isolation: the international perspective is of vital importance. Geographical borders are increasingly permeable to financial transactions. Enhanced cooperation with our partners is, and will be, a must in the future. I’m glad that fora such as today’s conference, bring together industry players from both sides of the Atlantic. At the EU level, a structured dialogue is already on-going with the US authorities. Further dialogues are being established with other global players. Now, having established lines of communication, the focus should be on making these exchanges as fruitful as possible.
Priorities in the next years
I have not come to Brussels with the objective of leaving a huge legacy of new legislation. I am committed to making existing measures work properly. The adoption and ongoing implementation of the Financial Services Action Plan has entailed intense regulatory activity over recent years. The FSAP has done what it set out to achieve - a framework that would facilitate the pan-European development of the financial sector. Markets are beginning to respond to the removal of regulatory road-blocks.
Also at the institutional level: the creation of networks of regulators – CESR, CEBS, CEIOPS – strengthens our capacity to deliver consistent implementation. This may be the greatest legacy of FSAP. The Lamfalussy system – a big success – must not be allowed to fall victim to institutional power struggles.
Now, my focus is firmly on making it work. Regulation, if it is not implemented effectively and enforced responsibly, is useless. Much remains to be done on this front. The EU single market can only develop effectively if actors understand the need for cooperation and regulatory convergence, and work together to find common rules. And to stick to those rules once they have been agreed.
The emphasis should not only be on speed of transposition, but also on quality. Ensuring a level playing field is the key to Europe’s success. For this, the day-to-day implementation of EU rules should be done in a consistent and coherent way. The Commission is determined in its efforts to ensure that European market players can enjoy all the advantages that the EU regulatory framework offers them.
Thus, the period ahead will be one of consolidation. The few planned initiatives in this “Post-FSAP” phase aim to complete unfinished business, rather than to create more legislative upheaval. Ongoing work includes the Capital Adequacy Directive, the Company Law directives, the new legal framework for Payments and the Solvency II framework. We have, in consultation with stakeholders, also identified a limited number of areas in which further integration may be needed to exploit the untapped potential of the relevant markets including clearing and settlement and mortgage credit, on which we have recently published a Green Paper.
In the area of securities clearing and settlement the industry has been good in highlighting the problems, particularly those resulting from fragmentation. But it has been less good in making progress in solving them.
I am stating the obvious but it bears repeating: what we need is a more liquid pan-European market with lower costs for all. Cross-border trading remains expensive, sometimes prohibitively so. Cross-border clearing and settlement costs can still be up to 6 times more than those of domestic settlements. People debate the multiples. No-one defends the current levels of cross-border costs. We are talking about big money: certainly much more than the amounts which Heads of State and Government are wrangling over in the EU budget negotiations, especially when one calculates the impact of these potential cost reductions on the economy.
The time has now come for all interested actors to take their responsibilities and collectively put their foot on the gas. The Commission will play its part, but the market also needs to contribute. So do national regulators and Member State governments.
Some market participants argue that the creation of consolidated structures in the EU, such as a single pan-European Central Counter Party [CCP], could help the development of the European capital market. At face value, this is an interesting prospect. I can see that there could indeed be cost savings and improved efficiencies. If so, everyone should, of course, get a share of the benefits.
As in other areas, it is essential that we do not behave in a way that undermines the development of deeper, more liquid capital markets or which undermines competition or the safety of systems. I include Member State governments, their domestic authorities and market participants in this. The market should act on its convictions and take the lead. It should come up with concrete suggestions which should be discussed openly. We all need to work together.
The Commission is taking a close look at the economic case for action. We will decide whether any European legislation, or other intervention, is necessary on that basis and in the light of developments in the market. The next 6 months are crucial. As far as I am concerned, the clock is ticking.
Another area identified for particular attention is Asset Management (especially) investment funds.
The investment funds industry
The investment funds industry is of strategic importance. Not only because of the role it can play with regard to the challenges I mentioned before. But also because of its size and dynamism.
In Europe, the growth in assets and the number of funds has been coupled with greater market integration. UCITS has been a key factor in this evolution. Between 1998 and 2003, the number of cross-border funds doubled. In recent months, they are attracting an increasing portion of net inflows into European funds. UCITS manage today € 4.3 trillion or some 75% of the European investment fund industry’s assets.
In this context, Luxembourg is a success story. It has established itself as the market leader. Luxembourg funds represent 25% of all UCITS assets and 60% of net sales. But leaders can not afford to relax. Benefits and responsibilities often evolve in parallel. Funds authorised in Luxembourg are offered to investors across the EU.
We all agree that great potential exists for further growth of this industry. So in this regard, Luxembourg has both the opportunity to develop further; and a responsibility to lead by example. Maintaining investors’ trust in the reliability of the sector is of utmost importance to fully exploit this potential.
In recent years, structural changes affecting products and distribution are changing the risk features of the industry. Some of these changes do not respect regulatory boundaries. Cross-jurisdictional/pan-European responses may be needed.
How can we help?
So in specific terms, how can the Commission help the EU investment fund sector? The Green Paper on the European framework for investment funds sets out the broad issues. Most of these are not new. But where and how are we best placed to intervene? The on-going public consultation and the planned open hearing will answer this. Your input will be crucial. This is a first chance to shape the debate on the future direction of EU level policy.
The debate launched by the Green Paper
One of the main conclusions of our Green Paper is that, at this stage, there is no compelling case for fundamental legislative overhaul of the UCITS framework.
There are three main reasons for this preliminary conclusion:
- Firstly: Though there may be major inefficiencies with the existing framework, UCITS has proved to be a reliable, understandable, and popular retail product, with increasing cross-border market penetration.
- Secondly: UCITS III revisions have only recently expanded the scope and opportunity for UCITS funds and managers. These changes should be given a chance to prove themselves. µ
- And thirdly: In accordance with the Commission’s better regulation agenda, we must first determine the scale and impact of the structural changes currently affecting the marketplace, and the degree to which EU action is warranted, before coming to conclusions as to whether or if we need to replace the UCITS framework
So instead of overhaul, we‘ve identified short-term measures to ensure consistent implementation and more efficient operation of existing rules. Some steps to streamline the operation of the UCITS passport are already being undertaken; with the help of the Committee of European Securities Regulators (CESR). Examples of this important work include the discussions on eligible assets and on the simplification of the notification procedure – two core building blocks of the UCITS framework. Concrete results are expected to materialise in early 2006. Results which must deliver a more effective UCITS regime.
However, the Directive’s original design is already 30 years old (1976). The environment in which UCITS has evolved has radically changed in the meantime. New actors, products, processes, have emerged. Investor needs and preferences have shifted. There is also a perception that the current product-based framework is not able to keep pace with financial innovation and that it imposes restrictions on creative and competitive products. Does this framework limit the opportunities for product providers and for investors?
I think it would be wrong for us to just wait and see.
So, with your help, we must test views on the future of the UCITS Directive. Does the existing legislation represent a viable long term basis for the development of the industry?
Four areas of change
I’d like to underline four areas where I see developments taking place in the industry – four areas on which I encourage you and other stakeholders to respond.
The first is fund distribution. New distribution models offer investors greater access to a wider range of products. However, this can entail additional layers of actors between the fund promoters and the investors, blurring the responsibilities towards consumers and increasing the cost of the product.
There exists also the risk that the way the fund promoter remunerates the distributor may influence the offer and/or advice provided to investors. My initial response would be that the Markets in Financial Instruments Directive may serve as a guide to clarifying the boundaries and respective responsibilities of different actors within the value chain.
The second one is market efficiency. A series of studies remind us of the potential cost savings, if only we could exploit the economies of scale of a more integrated market. Cross-border mergers, fund pooling, enhanced freedom for the industry to organise itself on a pan-European basis; or the development of common operational standards appear as possible solutions that need to be tested: are they viable? What steps can be taken to unblock these possibilities?
As a third area, my services will closely monitor the risks and opportunities of new investment strategies. Concerning alternative investments, and the rapid growth in the hedge fund sector, I can already say that I am not in favour of an EU regime for hedge funds. I do not want to constrain this innovative, liquidity providing sector for the sake of bureaucratic elegance. It is the responsibility of Member States’ central banks to keep under review bank lending to hedge funds to ensure there is sound practice.
Valuation of hedge funds needs to be effective, it needs to be improved, and it needs to be independent.
We need to reflect on what happens if all the elephants run to the exit at the same time.
Reflect, not legislate.
Consider, not pen a law.
However, we may find some currency in pursuing a more harmonised approach towards private placement for sophisticated investors. We also need to look carefully at whether retail investors are equipped to deal with the risks of some hedge fund based investments that are available to them. However, I have said before and I want to repeat it now that I have a strong preference for Member States taking real initiatives to step up the financial education of their citizens. This I believe can be a much better protection against folly than regulatory overload in terms of excessively long and turgid health warnings on products or funds that are drafted by regulators and that in my view are often of little practical value.
Finally, arbitrage from similar instruments – outside the scope of the UCITS legislation, and often subject to less strict rules, can potentially be detrimental to the fund industry and investors alike. In our consultation we seek to understand the substance to these concerns. New products are continuously being designed to meet the needs of more discerning and more demanding investors. Investors must be able to make informed choices between a wider array of funds competing for their custom.
How can we and/or the Member States support informed and enlightened choice by investors across different types of saving product? And what is the role of education versus regulation ?
Your contribution
We count on the high quality of the forthcoming responses, your responses, as a means of moving forward. We need substantive and commercial analysis from you. What are the potential costs and benefits of the options presented in the Green Paper? We will then assess the case for eventual formal action in the light of the better regulation approach and in keeping in mind alternatives to regulation. Is there a single market case for change? Is there a market failure or an overwhelming regulatory risk? Which are the most cost-effective measures? Looking across the Atlantic may provide clues that will help us find some solutions. In some aspects, such as cost-effectiveness, the US market may serve as a benchmark. The US has also recently undertaken efforts to improve their own mutual fund framework and we will try to learn from their experience.
Conclusion
Ladies and Gentlemen, let me conclude. I am not keen to legislate. I do not exclude proportionate intervention if the case is made and if action at the EU level is justified. In the asset management area, I have not made up my mind yet. UCITS legislation has been the focal point for the successful development of the European fund market. Now, the fund industry is facing a period of profound structural change. It has still to be proved that the UCITS framework is unable to deliver. That further regulatory action is needed.
The final outcome of this consultation will very much depend on your participation in the on-going debate. Will the short-term measures described in the Green Paper be enough? If not, where should the emphasis be, and what should be the scope of possible actions? What should be the role of regulators and what should be left to the industry and to financial education in Member States?
Let me remind you that an open hearing on these issues will be held in Brussels on October 13th. The Green Paper consultation will close on November 15th. Please mark these dates in your diaries - your participation will be key in the shaping of a more efficient European framework for investment funds. Thank you in advance for your contribution.
