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Ladies and gentlemen,
I am honoured to address this important conference on developments in the European financial services sector. I would like to focus my remarks today on three main themes.
- The first theme will be the current state of progress in creating a single market for financial services in Europe;
- The second theme will be the link between financial integration and improving the economic welfare of Europe's citizens; and
- For my third theme, I will turn briefly to an increasingly hot topic. This is the implications of financial integration for EU supervisory arrangements in the years to come.
Current state of progress in financial integration
Let me begin by reviewing progress to date in the process of European financial integration.
Financial integration has been an economic policy objective of the EU since the late 1960s, but received a powerful impetus with the introduction of the euro in 1999. The most obvious effect of the euro on the EU financial system has been the elimination of exchange-rate risk on the bulk of cross-border flows. In this way, the euro has stimulated demand for cross-border financial instruments and services, creating the potential for very large and liquid markets. The euro has also impacted on the EU financial system more indirectly. In the absence of exchange-rate risk, the remaining obstacles to financial integration – notably in the field of regulation – have come to the fore. Not surprisingly, therefore, the creation of a common regulatory framework for our financial markets has been at the top of the EU policy agenda in the past eight years.
The Financial Services Action Plan (FSAP) has been the blueprint for a common EU regulatory framework and was almost fully implemented at EU level over the 1999-2005 period, and it is now in the process of being transposed by the Member States. With implementation of the FSAP underway and nearly eight years after the introduction of the euro, how can we assess the state of integration in the EU financial system? The available evidence confirms that the EU financial system has become much more integrated, although integration is progressing unevenly across different sectors.
We can make several observations:
- The pace of integration has been faster in the case of financial products with agreed definitions, common conventions and common infrastructure. Among this category, the most dramatic examples have been the euro-denominated inter-bank and derivatives markets, which became fully integrated immediately after the launch of the euro.
- Progress in integration has been slower in EU securities markets. Some of these markets are still highly fragmented due to differences in national regulations, market conventions, taxation, and legal frameworks.
- Such obstacles to integration have also been evident in the context of cross-border consolidation of financial intermediaries and infrastructure.
- Consumers are beginning to see the benefits of progress in integration, although not to the full extent yet. Among the positive developments, I can mention that as a result of financial market integration in the euro area, the cost of cross border payments has been considerably reduced. For example, the average cost of transferring €100 to another country has been cut from €24 to €2.4. Furthermore, consumers now enjoy increased access to capital at lower costs. Thanks to EMU, the average interest rates for loans for house purchases decreased by more than half in the euro area between 1995 and 2005.
On the basis of such an assessment we can conclude that "our glass is half full". The introduction of the euro and the implementation of the FSAP have already helped tackle fragmentation in the EU financial sector. However, sources of fragmentation remain and these must be addressed in the coming years.
The Commission White Paper on Financial Services Policy in 2005-2010 has set the agenda for the coming years, giving high priority to the transposition of the FSAP into national law, as well as to continuous ex-post evaluation of existing policies and rules. This is essential to ensure that financial integration becomes a reality and does not just exist in theoretical form. The White Paper identifies a number of key areas where there may be a need for further efforts:
• A first area is clearing and settlement, where cross-border transactions are far more costly than domestic transactions, due to technical, legal and fiscal obstacles. The Commission has assisted the clearing and settlement industry to establish a voluntary code of conduct, which is designed to eliminate sources of inefficiency in cross-border activities. This non-regulatory initiative is significant not only for the clearing and settlement industry. If successful, it could act as a model for integration in other areas of the financial sector.
• Secondly, there is ongoing work on a new Solvency Directive, which will overhaul EU regulation and supervision in the insurance area. The objective is to put in place a more risk-based framework, which will draw on lessons learned during the equity-market correction in 2000 and respond to the emergence of the insurance sector as a major component in the financial system.
• Thirdly, I would like to highlight the issue of EU supervisory arrangements. As a counterpart to an increasing activity of Mergers and Acquisitions across borders, greater clarity and transparency in supervision practices is needed from the perspective of financial-system efficiency and stability. The objective here is to ensure that EU supervisory arrangements keep pace with the reality of more integrated financial markets – and I will return to this topic later in my remarks.
• Other initiatives relate to the integration of retail financial markets, where I would like to mention initiatives in the fields of mortgage credit, consumer credit; and on payment services, notably to facilitate the creation of a single EU payment area (SEPA) by 2010. Work in this area is crucial to deliver direct benefits to EU citizens and avoid the impression that only big business gains from financial integration.
• The investment fund industry is another area, where further work may be needed, building on the reports published in July 2006. These reports analyse the main challenge facing different segments of the EU investment fund industry and focus on retail investment funds (UCITS), hedge funds and private equity. The regulatory framework for each of these types of investment fund needs to be reviewed for different reasons, including the need to facilitate private funding of pensions, investor protection and financial-system stability.
• Finally, looking globally beyond the EU, there is a need to build on our experience in financial integration in the context of international dialogue on financial markets. Formal dialogue is already well established with the United States and Japan and will be further developed with the growing new economies such as China and India.
Financial integration and economic performance
With all this work to do, it is useful to recall why further efforts to complete financial integration are so necessary. This brings me to my second theme of financial integration and the performance of Europe's economy.
In general, the financial systems of the 27 Member States function efficiently in a national context. The problem is that these national financial systems combine inefficiently when operating on a larger scale, creating significant opportunity costs for the EU economy. By integrating the various national financial systems, it is hoped to raise the level of financial development in the EU as whole and to increase the overall efficiency of its economy. The importance of financial development for long-term economic performance has been clearly demonstrated in the economic literature in recent years.
In 2002, the European Commission published two complementary empirical analyses, which attempted to quantify the likely impact of financial integration on the EU economy. Taking a macro-economic approach, the first study concluded that fully integrated markets could raise the level of EU GDP by about 1% over 10 years. The second more microeconomic study estimated that access to more developed and integrated financial market would increase growth in the value-added in EU manufacturing by up to about ¾ %, over a similar period.
I do not need to remind an audience such as this of the many pitfalls in this type of econometric estimation. Nevertheless, these figures broadly confirm the importance of financial integration in improving efficient functioning of the EU economy. A more efficient economy will, of course, bring tangible benefits for all EU citizens in terms of higher wealth, increased employment, lower costs of borrowing and a wider choice of financial products at more competitive prices.
Let me elaborate further on the specific relevance of financial integration for the functioning of the euro-area economy.
As I have mentioned earlier, EMU and the introduction of the euro provided a powerful stimulus to the process of financial integration. However, this relationship is not one-sided. The success of the euro depends crucially on the extent to which the smooth functioning of EMU is supported by a single financial market.
In this context, our "2006 EU Economy Review" released last November highlighted several aspects that emerged as particularly important for the actual and potential role of the financial sector in EMU adjustment processes. For instance, it appears that current account imbalances in a number of countries have been driven to a large extent by developments in the financial markets. This largely reflects the general reduction in risk premia and loosened credit constraints, while asset price movements in some Member States have contributed to fuel consumption and inflation. Moreover, it is evident, and to some extent expected, that the elimination of exchange rate risk has reduced the market pressure towards completing the necessary fiscal adjustment to reach balanced budgets.
At the same time, under the EMU framework without national interest and exchange rates, country-specific shocks may result in wider and/or longer cycles of adjustment in Member State economies. This has been one feature of the first years of EMU. In view of this, there is increased scope for financial markets to smooth income shocks and facilitate stronger and sustained economic growth across countries. Better integrated financial markets can hence play a significant macroeconomic role.
Overall, it seems that all EU Member States can profit considerably from an integrating financial system in the EU, but it should be borne in mind that in the process of further integration risks for macro-economic and financial stability must be minimised.
Financial integration and supervisory arrangements
This brings me to the third and final theme of my remarks: EU financial integration and the future of prudential supervision.
Financial integration promotes the internationalisation of market operations. This trend, in turn, requires increased interaction between financial intermediaries and supervisory authorities in multiple jurisdictions. Faced with this situation, there is a growing demand among intermediaries to centralise their risk management. As a result, we see a progressive divergence between operational and legal structures of financial institutions.
In contrast to the rapid internationalisation of operations among financial intermediaries, we find rather static and still predominantly national-based EU supervisory structures. The result is inefficiency in supervision, significant deadweight costs for the financial industry and increased risks for financial stability. If the EU financial sector is to be safe and efficient, something must change. Needless to say, supervisory structures should adapt to the new financial-market reality and not the other way round. It is essential, therefore, that the EU supervision framework keeps pace with the changing economic and financial environment.
I am aware that pressure for streamlining EU supervisory arrangements has been mounting within the financial industry. Various possible models have been discussed. These range from intensified use of the so-called level-3 committees of the Lamfalussy framework, to the establishment of lead supervisors and even the creation of a single EU supervisor. It is not my intention to discuss the relative merits of such proposals today. Instead, I will focus on the substantial preparatory work that needs to be done before any such changes can be realistically contemplated.
Whatever the merits of the various proposals, I believe that it is essential to distinguish between on the one hand the importance of convergence in supervisory procedures and practices and on the other hand possible steps to improve the institutional arrangements for supervision. The current EU supervisory arrangements are characterised not only by national segmentation but also by major differences in supervisory practices and in the allocation of supervisory responsibilities. These differences exist both among supervisory agents and between supervisory agents and other policy agents. Even more fundamental differences exist in the context of national arrangements for deposit guarantee schemes. Moreover, there remains no true concept of "burden sharing" in the area of financial supervision and stability arrangements among EU Member States. This effectively means that the allocation of any possible budgetary costs in managing or resolving a cross-border financial crisis would rely solely on the voluntary behaviour of Member States.
These divergences represent very substantial shortcomings in the framework conditions within which any streamlined EU supervisory arrangement would be required to operate. Without substantial convergence in supervisory procedures, responsibilities and policy tools, no streamlined structure – however coherent on paper – will be able to function in practice. Indeed, in such conditions of divergence, a streamlining initiative to enhance efficiency and stability could have the effect of giving Member States a false sense of security on the effectiveness of the EU framework to prevent, manage and resolve potential financial crisis.
There is considerable work to be done before we can entertain notions of radical change to the current EU supervisory structures. This work has already started, but must be carried through to completion in a reasonable timeframe. The need for strengthening the effectiveness of EU supervisory arrangements in a cross-border context must be accepted by all Member States, if we want to create an efficient and stable framework for the financial sector that will underpin our aspirations to make the EU the most dynamic economy in the world. These aspirations clearly cannot be met if the EU financial system is hobbled by inefficiencies relating to supervisory structures. Such inefficiencies only hinder the financial industry from profiting fully from synergies in the Single Market.
Conclusion
Ladies and gentleman,
Let me conclude by re-stating the significant progress we have made in financial integration in the past eight years. However, we are probably no more than half way towards the goal of a single market in financial services. It is important that we persevere in our efforts to achieve this objective. The benefits of further integration - in terms of improving the economic welfare of Europe's citizens and supporting the competitiveness of our economies in a globalised world – are too great to let this opportunity pass. Of course, integration implies a need for profound change in the EU financial sector. These changes will extend beyond the private sector to the institutional arrangements that regulate and oversee the behaviour of financial actors. There is still resistance to acknowledging the need for such changes and to accepting the necessary adjustment costs. But let me once again stress how essential progress will be in ensuring the longer-term prosperity of Europe.
Thank you for your attention.
