The EU's legislative phase of its financial services action plan is all but completed Alasdair Murray charts the progress and what comes next.

When Charlie McCreevy formally takes office as the new European commissioner for the internal market on 1 November 2004, he will find the completion of the EU's financial services action plan near the top of his 'to do' list. Financial services companies have largely welcomed the appointment of the experienced former Irish finance minister to the Commission post. Businesses hope that Mr McCreevy will prove a safe pair of hands and steer the EU closer towards its ambitious goal of creating a single market in financial services.

The EU has now all but completed the legislative phase of its financial services action plan (FSAP). The action plan is an attempt to reduce the legal obstacles which prevent businesses from selling their services seamlessly across the EU.

On paper, at least, the FSAP is a success. The EU has reached agreement on 39 of the plan's 42 measures. Of the three outstanding measures, only the capital adequacy directive can be described as very important. And the EU is not to blame for the delay: the Commission was not able to issue a draft directive until July 2004, when discussions on global guidelines on bank capital (the so-called Basel II accord) were completed. Overall, the EU deserves credit for delivering such an ambitious legislative action plan on time.

However, financial services companies, particularly those based in the City of London, have become increasingly critical of the quality of the legislation. In a frantic effort to meet the 2005 deadline, member states sometimes reached less than satisfactory compromises on key legislation.

At other times, the EU has reneged on its commitment not to produce overly detailed or cumbersome legislation. Bogged down in endless rows over the fine print of new directives, the EU risks losing sight of the plan's potential economic gains. As a result some firms, and even the British government, appear to have lost confidence in the EU's ability to deliver a competitive single market for financial services.

It is too soon to judge whether the legislative measures will prove a success, as the Commission admits in its latest progress report on the action plan. The Commission, member states and regulators must now focus on the effective implementation and enforcement of this raft of new legislation.

In particular, the FSAP could still founder on residual protectionist behaviour by national regulators and governments. Moreover, the EU still has to finalise important legislation in a number of sectors not covered by the original action plan. In particular, the EU has yet to reach agreement on rules designed to create a single market for reinsurance firms.

The Commission, Council of Ministers and European Parliament displayed an unusual degree of political goodwill to ensure the FSAP was finished on schedule. Many of the measures contained in the plan were of a technical nature and provoked little controversy. But when member states and MEPs came to discuss the most important directives, such as those on investment services, prospectus and takeovers, political differences soon re-emerged.

As a result, EU governments are in danger of losing sight of the many positive elements of the FSAP, such as the pensions and collateral directives which should help cut costs for firms doing cross-border business.

The ISD dispute

In November 2003, Italy - which at the time held the EU's rotating presidency - forced through a protectionist amendment to the text of the investment services directive, despite the strong opposition of Britain, Ireland, Sweden, Finland and Luxembourg. This amendment threatened to impose costly disclosure rules on investment banks that trade shares on their own books.

The City of London claimed that such measures, which seemed designed to protect the Italian and other smaller stock exchanges from investment bank competition, would cost EU businesses up to EUR450m a year due to higher share trading costs.

The dispute over the ISD has also overshadowed the economic gains that other parts of the EU's action plan will deliver. For example, the European Federation for Pension Retirement (EFRP) estimates that the pensions directive will save multinational companies as much as EUR10bn a year. Similarly, the collateral directive will reduce the costs of cross-border financial transactions.

Ultimately, the real damage of the ISD affair is likely to prove political as much as economic. Until the Italian amendments, the City of London had assumed that as by far the largest financial services sector in Europe its views would take precedence. But its defeat over the ISD has left a bitter taste, and many City firms now seem to have lost faith in the EU's ability to deliver a competitive single market in financial services.

The British government, which was once the most enthusiastic proponent of the FSAP, has now come out against any further major EU financial services legislative initiatives. The ISD row seems to have reinforced a latent scepticism within the powerful British Treasury - with potentially damaging repercussions for other aspects of the UK's fractious relationship with the rest of Europe.

Taking stock

The FSAP will not be enough on its own to create a fully functioning single market in financial services. But the EU should pause to take stock before proposing a second action plan. Many financial firms fear that they will suffer from regulatory indigestion, while they spend the next few years implementing 14 major legislative measures.

Moreover, businesses are concerned that new institutional arrangements - based on recommendations made by the Lamfalussy group of experts - are not working as well as had been expected. Lamfalussy aimed to speed up the passage of financial services directives by reducing the volume of legislation which needed to pass through the EU's long-winded codecision procedure (where the Commission proposes draft legislation and the Council and European Parliament jointly decide). Now the Council and the European Parliament are supposed to concentrate on reaching agreement on the broad principles of new legislation. Meanwhile, the Commission - aided by a series of expert committees - prepares the detailed 'technical' rules necessary to implement the new directives. This system should ensure the EU can respond more swiftly than in the past to innovations in the financial services sector, such as new products, or resolve minor problems with rules and regulations.

However, firms complain that the Commission and the member states still produce overly complex directives. Businesses also want the Committee for European Securities Regulators (CESR) - and the other 'Lamfalussy committees' recently established for the insurance and banking sectors - to consult more extensively with the private sector before drawing up the detailed rules for new legislation.

The Commission has begun a thorough review of the FSAP, indicating that its immediate priority is to ensure that the legislation is effectively implemented in the member states. In particular, the Commission has promised to do more to help member states turn the new legislation into national rules and regulations. Commission officials have established a single point of contact in each finance ministry and will provide support through regular meetings.

The Commission's initiative to help member states transpose the FSAP directives is welcome. But many financial services firms remain unconvinced that the Commission can prevent governments from adding protectionist measures when they implement key directives into national laws. For example, pension fund trade associations have expressed concern that some member states are imposing extra restrictions on how company pension funds may invest, thereby limiting the benefits of the pensions directive.

Similarly, the Lamfalussy committees should carefully monitor implementation by the national regulators. The committees should produce a report each year that examines the degree of regulatory convergence across the EU and suggest areas where the Commission might need to take further action.

This is particularly important in the far less developed financial markets of Central and Eastern Europe. The new members will struggle to implement the FSAP, given that many do not even comply with long-standing EU rules on financial services, such as those on capital adequacy requirements and deposit insurance. The committees should encourage a system of exchanges between national regulators to help spread best practice throughout the member states. Such a scheme should help raise standards not just in the new member states but right across the EU.

The internal market directorate-general (DG) also needs to devote more resources to ensuring member states fully enforce the new legislation across the EU. The Commission has recently set up a dedicated enforcement team to try and prevent member states from bending the rules. However, many financial services firms argue that the Commission still does not see enforcement as a priority.

The internal market DG, which leads the Commission's work on the single market, is the epitome of a legislative department. Thus the most able officials secure promotion by working hard on new legislation, and then move on to drafting fresh directives, leaving the less glamorous work of helping member states with transposition or enforcement to others.

Commissioner McCreevy should make clear that the tasks of implementation and enforcement are just as valuable as that of drafting directives.


In May 2004, four expert groups reported to the Commission with suggestions for the post-FSAP agenda. The consensus was that businesses have little appetite for further legislation. This view is echoed in a recent report from the British Treasury which insists that the Commission "needs to be much more cautious about legislating on financial services in the future. Another FSAP is neither necessary nor desirable."

In the immediate future, the Commission is proposing some modest further legislation for most of the financial services sector. Aside from completing the outstanding elements of the action plan, the Commission has proposed two new directives designed to open up clearing and settlement systems to more competition. Cross-border clearing and settlement services undoubtedly remain too expensive. However, some analysts question whether the EU needs to resort to legislation, as opposed to deploying its competition powers to open up the market. The Commission may also propose legislation designed to create a cross-border market in retail investment funds (known in EU jargon as UCITS). The industry complains that existing EU rules have failed to create a single market.

However, reinsurance firms could face a bigger regulatory shake up with the Commission pushing forward the first EU rules and regulations specifically aimed at the sector. In February 2004, the European Commission published a draft directive designed to establish common rules for reinsurers in areas such as capital requirements and regulatory supervision. In particular, the directive would ensure that reinsurers are covered by the 'home country' principle, meaning that a firm regulated by one EU member state can operate right across the EU without having to register with every other supervisory authority. The Commission hopes the new rules will also help in discussions seeking 'equivalence' for European firms operating in the US.

In the longer term, the Commission may find it difficult to resist pressure to bring forward a more ambitious legislative agenda, if not a fully-fledged 'FSAP II'. The existing FSAP has focused on the securities markets and has not done a great deal to shake-up the EU's sheltered retail financial services sector.

Some banks are now proposing that the EU should adopt a retail financial sector action plan. EU leaders are likely to find this idea attractive: any measure that cuts costs in the personal banking sector would appeal directly to voters. Retail markets are considerably less integrated than securities markets, with products and consumer protection rules varying widely across the EU.

However, this lack of integration means that any harmonisation is likely to prove even more complex and politically contentious. Firms operating in relatively liberal markets, such as the UK, fear that any attempt to harmonise rules would result in the EU introducing more restrictive regulations in the guise of protecting consumers.

Some governments, most notably that of Germany, have indicated that they would like to see the EU working towards the creation of a single European regulator: a 'Euro SEC' or 'Euro-Fed' (ideally located in Frankfurt).

They see the CESR, and the new banking and insurance committees, as a step towards this goal.

The assumption is that the EU's new financial services regulatory framework will encourage some harmonisation but will not remove all the barriers to a single market. In particular, regulatory supervision will remain highly fragmented with 60 bodies responsible for overseeing EU and national securities market rules in the 25 member states. Thus at some point in the future, businesses and governments could conclude that this relatively informal regulatory system is insufficient, and that the Union needs a permanent central body to oversee national regulators and police the single market.

However, the case for a single European regulator is far from proven, while the technical and political obstacles to its creation mean there is little hope of progress in the immediate future. The establishment of the Lamfalussy committees should help to drive gradual regulatory convergence across the EU. The private sector may also support integration by choosing to base their operations in those member states where regulators are most attuned to the market's needs. The EU should postpone any grand new ambitions and focus on delivering its existing promises.