«Summer 2014 Review of the Balance of Competences between the United Kingdom and the European Union The Single Market: Financial Services and the Free ...»
There are different types of competence: exclusive, shared and supporting. Only the EU can act in areas where it has exclusive competence, such as the customs union and common commercial policy. In areas of shared competence, such as the Single Market, environment and energy, either the EU or the Member States may act, but the Member States may be prevented from acting once the EU has done so. In areas of supporting competence, such as culture, tourism and education, both the EU and the Member States may act, but action by the EU does not prevent the Member States from taking action of their own.
When the EU does act, it must act in accordance with fundamental rights as set out in the Charter of Fundamental Rights, such as freedom of expression and non-discrimination, and with the principles of subsidiarity and proportionality. Under the principle of subsidiarity, where the EU does not have exclusive competence, it can only act if it is better placed than the Member States to do so because of the scale or effects of the proposed action. Under the principle of proportionality, the content and form of EU action must not exceed what is necessary to achieve the objectives of the EU Treaties.
This report focuses on the competences and legislation that affect the financial services sector, including banks, insurance companies, pension companies, asset managers and market infrastructure providers. It also considers the impact on end-users of the services and products provided by these firms – in other words, consumers and businesses – as well as impacts on the broader economy. In addition, the report focuses on EU competences related to the Free Movement of Capital and the impact of these on both the financial services sector and the broader UK economy. HM Treasury (HMT) has led on this report as the Government department responsible for financial services, macroeconomic issues and the efficient allocation of capital within the UK and UK-owned capital internationally.
Scope of this Report Some issues associated with financial services and the Free Movement of Capital are considered in other Balance of Competence reports. The reports published in July 2013 include The Single Market Synoptic report, which considers the Single Market as a whole, and the Taxation report, which covers the Financial Transaction Tax and other taxes relating to financial services. The reports published in February 2014 include the Trade and Investment report, which considers extra-EU foreign direct investment and broader securities investment, as well as extra- and intra-EU trade (including Free Trade Agreements), and the Research and Development report, which covers technological development in all sectors.
Introduction 11Reports published at the same time as this one also cover issues associated with financial services: the Single Market: Free Movement of Services report covers all areas of services aside from financial services; the Competition and Consumer Protection report covers issues relating to competition and consumer protection aside from financial services; the Energy report covers regulation relating to the wholesale energy market; the Fundamental Rights report refers to the European Commission’s proposal for the right to a basic bank account for all EU citizens; and the Single Market: Free Movement of Persons report considers issues related to the ability of UK nationals – including employees in the financial services sector – to work, access benefits and access services in other Member States.
The last set of reports, due for publication by end-2014, will also cover related areas: the Economic and Monetary Policy report will cover euro area integration; the Police and Criminal Justice report will look at financial crime issues; the Information Rights report will cover data protection issues, including the use of personal data by companies; the Voting, Consular and Statistics report will cover voting issues and the influence of the UK; and the Subsidiarity and Proportionality report will focus on these themes which are also considered as part of this report.
Chapter 1: Development of EU Competence
1.1 This chapter sets out the development of the single market in financial services and the Free Movement of Capital.
1.2 The EU’s founding treaty, the Treaty of Rome, came into force in 1958. In it, the original six Member States agreed to a customs union and to four freedoms: the Free Movement of Goods, the Free Movement of Persons (including that of establishment), the Free Movement of Services and the Free Movement of Capital. The Member States made limited progress in giving operational effect to these four freedoms, not least because of the need for unanimous decision-making. It was only in 1985 that the EU took sustained action to create a genuine Single Market, agreeing to 279 specific legislative measures to be brought into force by 1992 and by agreeing that this EU legislation would be agreed not by unanimity but rather by majority voting, with larger Member States having more votes than smaller ones.
Single Market: Financial Services
1.3 In the area of financial services, the EU necessarily operates within a framework of global standards due to the fact that financial markets are global. The nature of that globalisation has been profoundly shaped over the last thirty to forty years by the collapse of the Bretton Woods system, the removal of controls on capital movements, and the revolution in communications and computing technology.1 These developments have meant that markets have assumed a more central place in the functioning of economies, financial centres have become more concentrated and interlinked, the sectoral boundaries between banks, insurers and securities firms have broken down and the increase in the volume and speed of financial transactions has reduced response times for intermediaries, end users and public authorities. As a result, risks in one market may be quickly transmitted to other markets, as has been seen during the recent global financial and euro area crises.
The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world’s major industrial states in the mid-20th century (including the establishment of the International Monetary Fund and the World Bank), and was the first example of a fully negotiated monetary order intended to govern monetary relations among independent nation-states. The system came to an end in August 1971 when the US unilaterally terminated convertibility of the US dollar to gold and and saw the dollar become fiat currency. At the same time, many fixed currencies such as sterling also became free-floating.
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The Single Market: Financial Services and the Free Movement of Capital
1.4 The interconnected nature of markets and the risks they can generate require internationally agreed regulatory standards and a high level of supervisory cooperation and coordination. These are necessary to limit market fragmentation, the impact of regulatory arbitrage and the export of risk from one market to another.2 They encourage the development of common rules and supervision and thereby make it easier for supervisors to understand the health of internationally active firms, agree on a common supervisory programme for them and – where necessary – support resolution of firms across borders.
1.5 There are global standard setting bodies (SSBs) covering the banking, securities and insurance markets, as well as international bodies developing accounting standards and standards to combat money laundering and terrorist financing, many of which report to the G20 heads of Government and finance ministers and central bank governors.3 International standards are not legally binding. It is for each country to give effect to them within their jurisdiction as they see fit. Within the EU, it is EU institutions that must agree on any necessary implementation measures and thereby give effect to these international standards across the EU.
1.6 Until the financial and euro area crises, the focus of EU policy-making in financial services was on how to remove obstacles to the Single Market. The focus of global standard setters was on issues of market integrity and the safety and soundness of individual firms and market infrastructure providers, and on protection against financial crime and terrorist financing. Both EU policy-makers and global standard setters viewed issues of consumer protection as ones largely for national authorities and predominantly relevant in the EU to the extent that consumers needed to be protected against the risks related to ‘branching’, when a firm sets up a branch or provides services remotely.4 The EU’s single market in financial services, therefore, developed within a wider global framework of international standards that focused on the safety and soundness of financial institutions and the protection against financial crime.
1.7 As regards the deepening of the Single Market, the focus of EU policy-makers was on adopting rules that would result in the progressive elimination of obstacles to the free movement of financial services. These rules were based on the following policy
• Harmonised EU-wide minimum standards covering prudential and consumer protection requirements;
Regulatory arbitrage refers to differences in rules which confer a pricing advantage or penalty on market participants. Some differences may be accidental, but some may be deliberately designed to attract business.
Lower standards, however, do not necessarily attract business. The UK has for many years imposed high disclosure standards on issuers, and this greater transparency is held to be one factor making the UK an attractive market for investors.
The main SSBs are itemised in Chapter Three, footnote 65 and Figure Nine. See also HMG, Review of the Balance of Competences between the UK and the EU: Police and Criminal Justice, published in Semester Four. This will consider financial crime issues.
See, for example, Recitals 4-5 of Directive 89/646/EEC (2BCD), Recitals 1&2 of Directive 94/19/EC (Deposit
• Mutual recognition of those requirements by Member States in line with the judgment of the European Court of Justice (ECJ) in the seminal case of Cassis de Dijon;5
• The transfer of supervisory competences from one Member State to another, according to how the firm chose to structure itself in that market; and
• An assumption that all supervisors supervised thoroughly and competently and had an adequate set of powers and tools to do so.
1.8 The first Directives in the area of financial services did little more than require Member States to impose an authorisation requirement. The major step came in the 1990s when the EU developed its branching regime. This meant that where a firm chose to use its right to set up a branch or to provide services on a remote basis, for example, by telephone, e-mail or the internet, the local supervisor could not impose its own authorisation requirements or any prudential requirements.
1.9 Further segmentation of responsibilities followed, so that by the time of the financial crisis the supervisor in the Member State where the recipient of a cross-border service was based had only residual powers, and then only for consumers in areas such as unfair terms in consumer contracts.6 Supervisors in the country of the branch were responsible for enforcing obligations on the conduct of business, though not for the systems which in practice would determine how well those requirements were complied with. Supervisors of groups, rather than subsidiaries, were responsible for validating the complex models that determined whether a firm was sufficiently capitalised.
1.10 Until the financial crisis struck, the primary focus of EU policy-making was on agreeing common rules that would make markets more open and contestable, and thereby lower the cost of raising finance for the wider economy. In 1998, Member States agreed to accelerate the development of the single market in financial services through the adoption of a Financial Services Action Plan – an initiative that comprised 42 measures, not all of them legislative. The objectives of the Action Plan were to develop a single wholesale market, open and secure retail markets, and state of the art prudential supervision.
This French blackcurrant-based drink was at the heart of one of the ECJ’s most celebrated decisions. In 1979, Rewe-Zentral AG, one of Germany’s biggest food and drinks retailers, complained to the ECJ that the German authorities were making it difficult for the company to import and sell Cassis de Dijon. The Court ruled in the firm’s favour and declared that under European law, if a company is allowed to make a product freely available for sale in one European Community country, then it must be allowed to do so in all Member States. As Cassis de Dijon was obviously already freely available in France, the Court argued that all other European citizens also had the right to buy and drink it. The ruling allowed the Community to develop the important principle of mutual recognition which in turn paved the way for the launch of the Single Market in 1993. See Rewe‑Zentral AG v Bundesmonopolverwaltung fur Branntein Case C-120/78 .
Host States retained the right to supervise: branch liquidity in banks until the Capital Requirements Directive (CRD) IV; and branch systems and controls for securities firms until the Markets in Financial Instruments Directive (MiFID).
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1.11 At the same time EU policy-makers realised that the process of law-making required fundamental reform. The European Commission set up ‘a Committee of Wise Men’, chaired by Baron Alexandre Lamfalussy, which made a set of recommendations focused on better rule-making with enhanced consultation, the use of Directives setting out a framework of powers and objectives with the detail to be determined in subordinate legislation, and the creation of committees of national supervisors from the Member States to provide advice to the Commission and promote the convergence of supervisory practices and outcomes.7