13.4 The problems of globalisation and the growing complexity of derivatives markets

Thus, in the Freedom of Services Directive for Non-Life Insurance, the regula-

tions of the country in which the policyholder resides apply for small-risk business,

while for large-risk business the regulations of the country in which the company

is licensed apply. Large-risk business was dened to cover policies for companies

with more than 500 employees or more than £15m turnover. Motor insurance was

brought within the scope of the Non-Life Directive by the Motor Insurance Services

Directive of 1990.

The distinction between large and small risks could not be made in the Second Life

Assurance Directive, so a different distinction was made to allow an element of home

country regulation. Host country regulation applied except where the initiative for

a cross-border policy came from the policyholder rather than the company – then

home country regulation applied. That is, it is assumed that if a consumer seeks

a cross-border policy, he is aware of the regulatory differences between his own

country and the country that has authorised the company to trade. Host countries

also retained responsibility for the regulation of branches of foreign companies,

although ‘well-established’ companies covering large risks were, under the terms of

the directive, simply required to notify the host authorities of their intention to

provide services in the host country.

Despite continued resistance from some members and problems over the distor-

tion of competition by different tax relief treatment on premiums, the Commission

pushed ahead and in July 1994 the Third Non-Life Insurance Directive, the Third

Motor Insurance Directive and the Third Life Assurance Directive came into force,

introducing the full single passport, home regulation regime to the insurance indus-

try, although derogations giving extra time for implementation were granted to Spain,

Portugal and Greece. Although the home country regulation now applies, a role

has been retained for host institutions. In practice, most insurance companies will

establish a local presence because of the need to provide follow-up customer sales

and service. Local rules on sales techniques and advertising apply but cannot be used

to discriminate against foreign companies. In certain circumstances, host states can

exercise control over particular products, for instance mandatory third-party motor

insurance. Finally, policyholders will be protected by the application of domestic

contract law.

13.4	The problems of globalisation and the growing complexity of derivatives markets

A major development causing problems for regulators has been the globalisation of

nancial markets. Since 1980, there has been rapid growth in the stock of cross-border

bank assets and cross-border securities transactions. A quarter of stock market trades

world-wide involve either a foreign security or a foreign counterparty. Both the size

and the interdependence of markets now pose problems. The Bank for International

Settlements (BIS) has warned that essentially local events might have disruptive

implications for the whole international nancial system. The globalisation of the

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Chapter 13 • The regulation of nancial markets

banking industry, for example, led to a great increase in international interbank

lending and increased dramatically the possibility that the collapse of a bank in one

country could cause serious losses for banks in other countries.

Globalisation has also caused fears of competitive laxity among national regu-

latory authorities. A national authority may feel that regulation which is too strict

would leave its own country’s rms at a competitive disadvantage in comparison

with rms based in countries with less stringent rules. Since much of the nancial

services industry is footloose, strict regulation in one country may cause rms to

move their operations to other countries, possibly resulting in a considerable loss

of income and employment to the country attempting to operate a responsible

regulatory regime. To the extent that regulations are loosened everywhere and/or

that rms do move to more poorly regulated areas, the level of systemic risk through

contagious nancial disorders may be increased.

Financial innovation and rapid technological change in the nancial services

industry have posed yet more problems for regulators. The development of screen-

based trading systems, securitisation and the rapid growth in the availability of new,

sophisticated derivatives have all complicated the job of the authorities. Particular

concern has been expressed over the growth of off-balance-sheet risk and the risk

posed by fast-changing on-balance-sheet positions. The traditional regulatory, account-

ing and legal framework for nancial organisations, which depended on the regular

scrutiny of balance sheets, has been left behind by such developments.

Securitisation:Transformation of non-marketable assets into marketable instruments.

Because of these various concerns, a standing committee of bank supervisors under

the auspices of the BIS was established in December 1974. The committee comprised

representatives of the bank supervisors of the eleven Group of Ten (G10) countries*

together with Luxembourg. Its formal title was the Committee on Banking Regula-

tion and Supervisory Practices, but it is better known as the Basel Committee. It

sought to link together the regulatory regimes in different countries in order to ensure

that all banks were supervised according to certain broad principles.

The initial task of the committee was to draw up guidelines for the division of

responsibilities among national supervisory authorities. This led to the Basel Con-

cordat of December 1975. The Concordat distinguished between ‘host’ and ‘parent’

authorities and between branches and subsidiaries of foreign banks. Under the

Concordat, the supervision of foreign banking establishments was to be the joint

responsibility of parent and host authorities. Host authorities were to be respons-

ible for the supervision of the liquidity of foreign banks. Solvency was to be the

responsibility of the parent authority in the case of foreign branches and of the host

authority in the case of foreign subsidiaries. Great stress was laid upon the exchange

of information between host and parent authorities.

* US, UK, Japan, Germany, France, Italy, Canada, Netherlands, Belgium, Sweden and Switzerland.

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