13.3 The European Union and nancial regulation

The independent review of the FSA announced this week is unlikely to answer that question

directly. The National Audit Ofce’s report will be more of a time-and-motion efciency study

than an attempt to judge the watchdog’s overall success in applying its powers. But it is already

clear that the FSA has dealt with many of the concerns expressed when it came into being. At the

time, the risks of setting up a ‘super-regulator’ seemed evident. Sceptics warned that the new

authority would be too heavy-handed; it would be unable to deal with the differing priorities of

wholesale and retail nancial services providers and customers; it would hamstring the growth

of the City.

There are those who believe the FSA has too frequently succumbed to those risks. Bigger

customers of the authority – notably banks and insurers – have a tendency to complain about

heavy-handedness. The FSA’s consumer panel pointed out earlier this week that the regulator

had not championed retail customers’ interests sufciently in ve areas of concern.

But critics tend to forget that six years is not a long time for a new regulator to establish

a strong and consistent reputation. The FSA has shown enough youthful exibility to change

course if attacks against it are justied – its reform of its enforcement processes last year is one

example. Yet it has already demonstrated a maturity that has made it a model for other regulators.

Far from diminishing the attractiveness of the UK as a nancial centre, the FSA has become

an asset, often cited (at least privately) by foreign bankers as a reason for doing business in and

with the City.

Credit for the level-headed approach must go to the FSA’s leadership, which has avoided the

temptation to use the wide powers of the original legislation to create an overbearing regulator.

True, the FSA has not yet been tested by a big nancial catastrophe or scandal. As Sir Callum

McCarthy, its chairman, outlined yesterday, it also faces challenges in reversing the growth of

rules and encouraging, in its own staff as well as in those they regulate, greater condence in

a principles-based approach. Vigilance, robust self-criticism and external review will always be

necessary. But Sir Callum, Sir Howard Davies, his predecessor, and their management teams

have set the FSA on a positive course that even the most incompetent future leaders of the

authority will have difculty reversing.

Source: Leading article, Financial Times,22 June 2006

13.3The European Union and nancial regulation

The 1957 Treaty of Rome, setting up the European Economic Community, set as

targets the dismantling of all non-tariff barriers and the free movement of goods and

services among members. This included nancial services and required the progress-

ive abolition of all restrictions on the freedom to supply services, such as banking,

insurance and communications services, across frontiers. It was to be accompanied

by the free movement of labour and capital. All discrimination based on nationality

was to disappear. However, progress towards these goals was very slow. One major

barrier to the achievement of these aims related to the regulation of nancial markets.

A single nancial market across the whole of the European Union clearly required

the harmonisation of the regulatory systems of the different countries.

Harmonisation of nancial regulations:Requires that all countries agree precisely on a

common set of laws.

381

....

FINM_C13.qxd 1/18/07 11:39 AM Page 382

Chapter 13 • The regulation of nancial markets

However, few members were prepared to make concessions regarding their own

arrangements. In the absence of harmonisation, great importance was attached to

the issue of which regime should apply to a rm when it opened branches in other

countries or sold services across borders – the regulations of the home country of

the rm or those of the host country in which the rm was locating. The Treaty

of Rome had supported host country regulation, and governments and national

regulatory authorities clearly preferred this. The political sensitivity of the nancial

sector meant that national governments wished to oversee the prudential standards

of all rms in the domestic market, whatever their country of origin. They were

also reluctant to allow national markets in nancial services to be dominated by

foreign institutions. This led everywhere to action to prevent foreign institutions

from competing with domestic nancial institutions. Host country regulation made

it relatively easy for governments to do this because rms generally need to locate

in a country in order to provide nancial services within it. Cross-border trade from

outside a country, while possible, is much less important in nance than in trade

in goods.

To be fair, support for host country regulation did not depend only on fears of

foreign competition and on domestic consumer protection issues. In addition, worries

existed over competitive distortions resulting from home country regulation, with

rms of different nationalities operating in the one country facing regulations of

differing degrees of severity and thus with different levels of compliance costs.

Yet again, home regulation encourages competitive laxity – in the absence of the

harmonisation of regulations, rms are tempted to locate their head ofces in the

member states with the most producer-friendly regulations.

The early directives on nance from the Council of Ministers were concerned

only with the goal of capital mobility and, in particular, with the foreign exchange

restrictions on capital movements. The rst attack on these restrictions saw the

unconditional liberalisation of capital movements associated with foreign trade,

foreign direct investment and operations in listed securities. However, governments

remained free to impose any restrictions they chose on capital movements related to

dealings in money market instruments, short-term nancial credits and transactions

in bank deposits, while those deriving from the buying and selling of unit trusts and

unlisted securities, long-term commercial credits and medium-term nancial credits

were granted only conditional liberalisation. Even in areas where freedom from

restrictions was specied, the directives had little impact. Although they were bind-

ing on member governments, the choice of method of achieving the end result

was left to individual governments and this allowed scope for many differences in

interpretation and practice.

Nonetheless, there was extensive liberalisation of nancial markets in the 1960s

regarding direct investments, commercial credits and the acquisition of securities on

foreign stock exchanges. Yet the 1970s saw this trend reversed in several member

states, largely because of the turmoil in international currency markets in the 1970s.

Consequently, only a moderate advance towards capital mobility occurred before

1980. In 1979, the UK removed all foreign exchange controls, and in the following

few years Germany, the Netherlands and Luxembourg followed suit. Then, as the

382

....

FINM_C13.qxd 1/18/07 11:39 AM Page 383