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Financial Sector Legal and Regulatory Toolkit : Part Four: Regional Financial Integration
I. European Financial IntegrationFinancial integration among EU states is the most developed of any region, the result of objectives set over a long period since the 1950s, in particular to the creation of a single internal market in financial services. Advances in integration have transformed major markets among professional intermediaries, but Europe’s trade in retail financial services remains fragmented and not yet subject to regional competition. This is the result of strong national socio-economic norms that reform and regulation find difficult to overturn, although the introduction of the euro may have induced greater similarities in national retail financial markets (Sørensen and Gutiérrez 2006). In analyzing European experience, a number of stages can be identified. At the first stage, European officials recognized the potential benefits of and barriers to European financial integration. An influential 1966 study was first to address impediments to the functioning of Europe’s national markets and their openness to foreign borrowers, identifying a home bias towards national governments and other domestic borrowers achieved through regulations on permissible investment by banks and insurers. Further, few companies were listed outside their domiciles. EU founding treaties provide for free movement of goods, services, workers and capital, and freedom of establishment. In theory, investments may be made without restriction across national borders. However, these initial ideals did not begin to have real meaning until the mid-1980s, the second stage of EU financial integration focusing on harmonization to minimum standards. Today’s level of integration has been achieved in these dimensions partly due to supportive rulings of the European Court of Justice, and markets have become considerably harmonized (Tertak 2006), so that national legislation over most market segments now reflects regionally initiated developments. Member states must adhere to certain precepts so that decisions and legislation passed at the EU level will directly affect those in individual states, while national governments may be liable in damages for failing to implement EU legislation to the detriment of their citizens. In a more technical sense EU experience shows how collaboration and political integration may encourage the adoption of sound principles and practices. The concept of mutual recognition and a system providing a single regulatory license for financial intermediaries now allow EU directives to set minimum norms without hindering competition. The EU legislative framework for financial markets seeks equivalence among disparate regulatory and legal systems, so that regional initiatives recognize national legal and regulatory regimes (Steil 1996). Rule harmonization proved impossible for many activities and the European Commission adopted principles first outlined in a 1985 white paper (the basis of the second stage of development) (European Commission 1985) that led to the Single European Act. This stipulated a common internal market based upon mutual recognition and common minimum standards, made applicable by EU directives and brought into effect through domestic law. Member states would recognize each other’s law, regulations and authorities, structured along common minimum standards, enabling the freeing of the trade in goods and services without need for prior harmonization (see Steil 1996). The system also uses minimum regional requirements to limit competitive deregulation by state actors and regulatory arbitrage by commercial parties. National financial regulation in Europe has intensified in recent years due to a combination of the needs of government and pressure from harmonization, access deregulation, and prudential re-regulation inherent in the process of market opening developed under the Maastricht Treaty for unhindered capital mobility. The EU framework for financial services provides minimum standards for financial intermediaries, securities regulation, accounting, company law, and regulation of institutional investors, based on intermediation being unfettered by national borders or restrictions on activity, and an open internal market. However, harmonization leaves the framework incomplete since it augments rather than replaces existing national laws. Today’s single market is manifested in “passport directives,” by which an authorized intermediary may generally be able to supply services overseas directly or through a foreign branch without maintaining a permanent presence in its target market. The passport’s aim is to promote competition and allow intermediaries to choose how they deliver products or services into any part of the internal market (Fraser and Mortimer-Lee 1993). Passport directives in financial services define the intermediary to which they apply, its activities or market segment, the conditions for initial and continuing authorizations, the division of regulatory responsibility between the home (domicile) state and the host (target) state, and aspects of dealings with non-EU member states (see Fraser and Mortimer-Lee 1993, 93). Such free movement of capital to facilitate European monetary union became effective through the Maastricht Treaty in 1994. This provided an impetus for states to implement prior financial services directives and led to members other than Ireland and the United Kingdom adopting legislation that was foreign to their traditional market practices. The introduction of the single currency in 1999 had a further catalytic effect on the nature of market flows and activity. Following the introduction of the euro, EU members were forced to turn once again to increasing levels of regulatory convergence, a process which is ongoing and represents the third stage of development. Prior to this degree of political consent, commercial interests may have been a force for financial integration, if only among professional intermediaries. Until the 1990s introduced a high common level of regulatory intensity, the Eurobond markets and eurocurrency interbank markets were permissive institutions that arose as a result of national legal and regulatory impediments to capital flows of all kinds. Eventually their scale began to rival national markets in banking and securities, leading to protracted negotiations in the early 1990s between industry representatives and regulators that resulted in offshore activity infiltrating national markets and subsuming many disparate local practices. The process became entrenched with the introduction of the euro.
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