FSA CONFERENCE
6 MARCH 2003
Howard Davies
Chairman, Financial Services Authority

In London, the level of interest in the FSAP process has increased sharply over the last year. That interest has been stimulated, in part, by concern about the possible impact on the way business is done in the City of measures like the prospectus directive and, more recently, the investment services directive. And, more generally, firms in the UK have begun to appreciate that the FSAP will have a significant long-term impact on their business models both elsewhere in Europe and in the UK itself.

It has taken some firms rather a long time to appreciate the scale of this impact. For a time we felt like a voice crying in the wilderness when we tried to interest British institutions in the arcane detail of draft directives. But there is no doubt, now, that a consciousness raising exercise, to which the City Corporation have notably contributed, has borne fruit.

Along with this heightened interest has come heightened concern. The degree of concern varies significantly, depending on the measure under discussion. But I hear a general worry that we might be required, in the UK, to import models of regulation which are inconsistent with our traditional approach, incompatible with the needs of wholesale markets, unnecessarily detailed and in some cases protectionist in motivation.

How far are these fears justified? How much difference will the FSAP make to London’s financial markets, when it is completed in 2005? Will life as we know it come grinding to a halt?

Today’s conference should help answer some of these questions. They need to be addressed with care, and in some detail. Because the truth is that different parts of our financial markets will be affected in very different ways. In some cases, it is clear that there will be significant new opportunities for firms in London as a result of the FSAP. In other cases, the change will be modest, if indeed it is noticed at all. But there are other parts of the market where significant change may be necessary, not always for the best.

My own role, as the introductory speaker, is to try to give a rapid overview. In doing so, I will try to answer four headline questions:

1. What do we think of the aims of the FSAP: Is it a Good Thing?

2. How productive has the exercise been so far?

3. Do we have the structures and processes in place to deliver a successful outcome on time?

4. Against that background, what should the main priorities be now?

1. Is FSAP a Good Thing?

You might say that this question is above my pay grade. European heads of government, at the Lisbon summit, decreed that the single financial market should be created by 2005, so who am I to offer a view on that objective?

Nonetheless, it is reasonable for us, as the guardians of the UK’s financial system, to have a view on the shape of the programme and on whether it will hit the spot.

As for the objective itself, I have no difficulty whatsoever with the aim of creating a single financial market across the European Union. I believe that will be advantageous to Europe’s citizens, both in terms of the additional choice open to them in meeting their financial needs, and in terms of the stimulus to economic growth which a broader and deeper capital market will provide.

Some of the estimates of the economic growth impact of the single financial market should be taken with a pinch of salt. And many of the benefits will be achieved from creating a broader and deeper wholesale market. Benefits in retail markets will be harder to achieve, and will probably require more institutional consolidation than is currently on the horizon. But there is persuasive evidence to suggest that more cross border competition will stimulate efficiency and price reduction. In comparison with the United States, Europe’s financial markets remain fragmented. The average size of mutual funds is significantly lower, for example, and there appear to be higher margins built into many products available to European consumers. The capital raising process too, is still heavily influenced by national boundaries.

So I am a strong supporter of the overall objective of the programme. However, what began as a high minded objective has become a very complex process, and a costly one in the short run. Though we do not know how expensive the FSAP is for financial firms, since there is no requirement for cost benefit analysis to assess the impact of individual directives or regulations, as there is in the case of our domestic regulatory system.

The process is more expensive than it needs to be, partly because member states, and the Commission, have been too ambitious in the degree of harmonisation they have sought to achieve. In my view, an 80:20 analysis would suggest that the greater proportion of the potential economic gains of a single financial market can be achieved through focussing on mutual recognition of regulatory systems based around harmonised core standards. The effort to harmonise the details, whether in prospectuses, disclosure requirements, or customer suitability rules, is expensive and delivers diminishing returns.

That should not, however, be seen as any denigration of the achievements to date by the Commission. DG Markt has delivered a huge amount of useful material, with very modest staffing levels, and has undoubtedly driven the process forward with great skill and determination. And I do not dispute the view that, sometimes, it is necessary to get into detail in order to overcome barriers to trade and competition within the Union.

That leads me to the second question.

2. How well are we doing?

The Commission themselves can give a better answer than I can, in terms of the work plan and the progress thereon. A huge amount has been achieved, but there is a lot still to do and, with the European Parliament elections next year, achieving the full schedule of directives by 2005 will be touch and go, and there will be more difficulty in completing all of the detailed regulatory work which lies below these directives themselves.

Is it of more interest to ask about the effect on financial markets themselves? Here, I would say the picture is not always clear.

In wholesale markets it is probably true to say that we are moving towards a more integrated European approach. In many markets this trend is focussed on London, of course. The City is already the main centre for European equity trading, accounting for approximately 40% of all trades done in Europe.

Market consolidation trend has been underway for some time, and it would be difficult to disentangle the particular effects of the FSAP from the overriding commercial logic for consolidation and gravitation towards the deepest pools of liquidity. The FSAP will certainly underpin integrated wholesale capital markets, but did not create them.

There are, however, some developments which have been facilitated by the FSAP, or perhaps stimulated by the political commitment to create a more harmonised regulatory environment. I suspect that we would not have seen a merged entity like Euronext without such a commitment. It would have been far more difficult for regulators to oversee such a network in the past, before the basic work on agreeing common approaches to many elements of securities regulation had been done.

If we come to the retail markets, then for the time being we would have to acknowledge that the amount of genuine cross border business is relatively small. The picture varies from sector to sector. The UCITS directives (themselves not strictly a part of the FSAP) have stimulated cross border selling of mutual funds. But there is very little cross border retail banking so far, in spite of the initial promise of internet banking. And there has been relatively little in the way of cross border life insurance or pensions business. That may be partly attributable to regulatory obstacles, but also of course to different tax regimes, and to different structures of long term savings which in many cases have cultural roots which are not likely to be altered in the short run by regulatory changes.

We have recently undertaken research on cross-border shopping which confirmed this view. It showed that a broad distinction can be drawn between countries which focus on product regulation (for example, France) and those which focus on sales/provider regulation (for example, the UK). On the provision of advice, tied advice is reasonably common across the EU, but the UK’s dual system of tied and independent advice is not widely operated elsewhere. On pensions, the nature of state provision elsewhere in Europe means that many consumers are unused to private pension products (for example, only 5-7% of the working population in Portugal), which contrasts, as one might expect, with the experience in the UK.

The overall conclusion would have to be, therefore, that we are a long way from a single financial market for European consumers, and my suspicion is that regulatory harmonisation in itself is unlikely to deliver that single market.

I will come back, in a moment, to summarise the other complementary steps that might be necessary to stimulate greater cross boarder activity in the retail market. But let me, first, try to answer the third question, which asks whether we have the processes in place to deliver the FSAP.

3. Can we deliver the FSAP?

An enormous amount of intellectual energy has been devoted to answering this question. The Lamfalussy group of wise men, a couple of years ago, offered their conclusion. Their report was critical of the rhythm of progress then being made, which meant that the FSAP could never be completed by 2005. Directives took an enormous amount of time to agree, were inordinately detailed, and the processes were simply not going to deliver the volume of work envisaged.

As a result, Lamfalussy proposed a new committee structure, and a different approach to directives themselves. The pure milk of the Lamfalussy doctrine (which has not been followed in every respect) was that we should be looking, in future, at framework directives, with the detail fleshed out by a committee of European securities regulators made up of Europe’s national regulators, working together in a new and more intensive way.

I am not sure that the directives, in practice, have been as spare as Lamfalussy envisaged. But what has certainly worked is the new regulatory network. CESR, as it is modestly known, has begun to be an effective deliverer of what we might call secondary legislation. We can see the process working, for example, in relation to the market abuse directive where the regulators have articulated definitions of market abuse below a relatively straightforward directive.

This is easier to do in some areas, than in others. In particular, CESR can be very effective where the directive has been subjected to a proper basis of consultation, and where the market is therefore attuned to the likely outcome. In that context, it is possible for us quite quickly to build consensus on level 2 implementing measures, and a level 3 approach to regulation. That requires a lot of effort, and the resources we are putting into CESR are now considerably greater than they were a couple of years ago. But we are happy to do so, particularly since we have a very effective chairman in Docters van Leeuwen, and beneath that, an efficient and appropriately small secretariat, ably led by Fabrice Demarigny.

Under these circumstances, it is a little frustrating to some of us that the issue of further regulatory consolidation, and perhaps a single European regulator, continues to be raised. I think it is possible to envisage circumstances in which some kind of regulatory institution at European level might be appropriate, though I confess that I still have difficulty knowing quite what it would do, since the Commission seems set to retain its monopoly of proposing legislation, and national regulators will, for the foreseeable future, be the practical enforcers. But what is clear is that if we indulge ourselves now in exciting debates about future institutional structures, there is a risk that we take our eye off the ball. So for the time being, as practical people, we at the FSA focus on developing the regulatory network, and on delivering results.

My own view is that the existing structures and processes can deliver. If you look closely, most of what appear to be bureaucratic delays are, in fact, reflective of the difficulty of reaching political agreement. I do not say that in any spirit of criticism of the politicians concerned. There are very difficult issues here, involving significant national interests and strongly held views about how markets should be overseen. To outsiders, it may seem surprising that people could get so steamed up about the definition of best execution, or pre-trade transparency rules, but I can assure you that they do.

4. What should our priorities now be?

In answering my fourth and last question, about what our priorities should be from here, I will try to draw all together some of the conclusions from my answers to the previous three.

At a strategic level I would identify five priorities which, taken together, would I think, contribute to achieving the FSAP aims.

First, we are convinced that mutual recognition based on harmonised core standards is the best way to go. The trick, of course, is to identify just which standards need to be harmonised, and which can be left to local discretion without damaging the integrity of a single financial market. It would be helpful if, in relation to each directive, it could be agreed at an early stage just how far the harmonisation process needs to go. We lack a proper framework within which to make these decisions. The Lamfalussy Group set out some principles which ought to govern the preparation of directives in the future, which included the important notion of subsidiarity. But we have heard rather less about those principles than we have about other aspects of the Lamfalussy recommendations.

Second, and again taking my cue from the Lamfalussy report, we believe that it is necessary to set up comparable committees in banking and insurance to match CESR. An "in principle" political decision to do so has been made, but the practicalities require a lot of work, and are not proceeding as rapidly as they might. Those committees should have advisory panels, and should consult effectively.

Thirdly, it is important to analyse just what the barriers to cross border activity really are. As I have already said, many of them are not to do with drafting harmonised regulations. Sometimes they are attributable to the way in which those regulations are implemented in member states. We know ourselves of cases where regulatory approaches which deliver a single market have been agreed centrally, but where inconsistent additional requirements are imposed at local level which have the effect of negating European wide agreements. Yet, at present, those additional protectionist impositions are allowed to remain, and the enforcement effort seems weak.

This is a task which only the Commission can effectively perform, but of course the Commission need cases on which to work, and financial institutions seem surprisingly reluctant to bring cases forward in an official way, even though they complain bitterly to us from time to time. A new impetus behind the enforcement of those regulations that are currently in place might well deliver more benefits than drafting yet more harmonising measures.

Fourth, we should not forget that there are other important non-regulatory barriers which block the development of a single financial market.

There are tax and legal obstacles, for example. Even more important are the barriers to cross border acquisitions. In my view the single financial market will not achieve its full potential without significant European-wide financial institutions. Yet there are still countries in which it is quite impossible to buy a bank, or even a significant fund management operation. These informal barriers, sometimes imposed by prudential regulators, are too little discussed. The rhetoric surrounding the single market sometimes seem to be based on the view that if we could just produce the perfect directive, all our problems would be solved. But if major institutions, with the management and capital base able to handle a pan-European network, are prevented from assembling one through blatant protectionism, then that is a serious obstacle, which is denying European consumers the benefits of competition, and holding back economic growth.

Fifth, and last, we need to think harder about just what the obstacles are, from the consumers’ point of view. At present, for example, we are in the throes of negotiating a consumer credit directive, which would impose standardised requirements on disclosure information to consumers across Europe, even where the consumer credit markets are very different in terms of the nature of products, and the nature of the distribution and sales process. I personally doubt whether this initiative will in practice deliver a great deal of additional cross border activity.

Yet there are other areas which, to my mind, may have a more significant influence on consumers’ willingness to undertake cross border transactions, but where far less progress has been made. For example, the coverage of deposit protection schemes, which can be a very confusing area for depositors. Then there is the availability, or lack of availability of cross border access to Ombudsman schemes. Many people attach a lot of importance to the possibility of making a complaint, and having a redress mechanism in place, if they transact business across borders.

If we really want a pan-European retail market, then somehow we need to look at things from the consumers’ perspective, not from the viewpoint of a tidy minded legislator.

CONCLUSION:

I hope these points will be seen for what they are: constructive suggestions to make the FSAP process more effective, and not sniping from the sidelines. At the FSA we are not on the sidelines, we are thoroughly engaged in the process. But we do see some weaknesses, and some dysfunctional behaviour, which is getting in the way of a very laudable objective. I hope that today’s conference will assist in its twin aims of raising consciousness in London, among those who may still not adequately focused attention on what is going on, and of developing some suggestions for constructive change. I have set out my own ideas, but I am sure they will be supplemented by further suggestions from market participants and consumers during the day.

More Speeches: