Process and Progress of EU Economic Integration: the Financial Sector Christoph Walkner DG ECFIN, E1

Outline EU instruments for economic policy The case of the financial sector

EU economic integration: Instrument Mix National policies Co-operation, co-ordination EU legislation, Treaty changes

National actors responsibility Employment policy Taxes Amount and composition spending Pensions plus some co-ordination, co-operation

Rationale for co-operation, co-ordination Direct cross-border policy spillovers of national policies Indirect cross-border policy spillovers, via national policy affecting inflation rate, inducing ECB to change interest rates Avoiding free rider behaviour

The instruments of co-operation, co-ordination Information exchanges Best practices Policy dialogue Peer reviews Common rules, objectives and actions

Specific co-ordination, co-operation Instruments in economic policy BEPG (general guidance) –Cardiff process (Product and Capital markets) –Luxembourg process (Employment) –Cologne process (Macroeconomic dialogue) –Stability and Growth Pact (budgetary policies) Lisbon objectives (March 2000) –Strategic goal: EU most competitive economy –Spring Report (economic, social, environmental issues) –Open method of co-ordination (peer reviews)

The rationale for EU legislation: Multiple Nash-Equilibria Prisoners dilemma, enforcement Level playing field Easier to deal with outside world

The instruments of EU legislation: Non-binding Recommendations (Commission) Regulations, Directives (Council, Parliament) Treaty changes (exceptional)

Example: Financial Integration Rationale Legal instruments and progress The way ahead

Rationale Financial integration raises growth, as –Allocation of capital is improved –Higher efficiency of financial intermediation –More opportunities for risk-diversification –More consumer choice This lowers capital costs and improves productivity

Legal instruments: Maastricht Treaty Euro introduction –Common currency for more than 360 million persons –Single monetary policy: ECB, Eurosystem

EU legislation: Banking Banking financing still dominant in EU Single Licence (1993) –Opens EU market for all banks –Mutual recognition of home supervisory practices –Home country control plus co-operation between supervisory authorities –Harmonisation of laws and practices for banking (capital requirements etc.)

Banking integration Still spreads between national interest rates (mortgages, consumer credit) Two tier structure for bank liquidity: –Large banks cross-border –Smaller banks domestic Asset management more EU oriented –Portfolios of insurance, pension funds Consolidation, mainly along national lines

Cross-border M&As are lagging

FSAP, legislative and non-legislative measures: takeover directive market abuse directive prospectus directive ISD transparency directive (financial reporting)

Lamfallussy framework Problems of implementation lead to Lamfallussy four level framework: Level 1: adoption Level 2: implementing legislation Level 3: consistent transposition Level 4: consistent enforcement Extension of Lamfallussy framework to banking, insurance

Money and Financial Markets I Highly integrated: –unsecured money market (interbank lending) –Fixed income convergence sovereign yields Higher issuances (public, corporates) New products: euro denominated ABS/pan- European Pfandbriefe Rising outside euro area interest in market

Money and Financial Markets II –Derivatives interest rate swaps euribor based future contracts European index trading –Equity Markets Investor level, less on issuers Increasing correlation among national markets Higher standard deviation on national markets than euro wide

Money and Financial Markets III Less integrated: collateral –Foreign listing of equity, bonds –Cross-border trading of equity bonds –secured money market (repos, CP) Due to national regulations, contract laws and technical barriers

Equity market consolidation Euronext (Amsterdam, Brussels, Paris, Lisbon) plus LIFFE (London) NOREX (Stockholm, Helsinki, Copenhagen, Oslo, Iceland) Deutsche Bourse (Clearstream)

Technical barriers Clearing and Settlement (Giovannini) Payments Systems –Target –Retail Payment systems Regulation on cross-border payments in euro Banking initiative (PE-ACH)

Next Phase Corporate Governance Audit Reform Common Accounting Standards (IAS) Cross-border supervision Retail banking integration?

Conclusion Instrument mix for economic processes Financial sector integration progressing, still unfinished business Coming policy initiatives