Financial Services Authority Conference 2004, London
19 May 2004
Speech by John Tiner

Introduction

1. I am delighted that City and Financial and the Corporation of London have taken the initiative to organise today's timely conference and that we have such an excellent range of speakers and participants, including key representatives from firms, the Commission, other Member States, Finance Ministries and, of course, other regulators. I am particularly pleased that Arthur Docters van Leeuwen, Henrik Bjerre-Nielsen and Jose-Maria Roldan, the Chairs of the three Lamfalussy level three committees, have been able to join us. I am also delighted that this conference coincides with the publication of the joint reports produced by HMT, FSA and the Bank of England on implementing the FSAP in the UK and on our future EU strategy. These very relevant documents follow hot on the heels of the four reports published by the Commission's expert groups on banking, securities, insurance and asset management.

2. The focus of EU regulation over the past 5 years has been on the creation of an appropriate regulatory environment for facilitating the growth of the Single Market for financial services. Now that the legislative phase of this programme has largely been completed, we all have the opportunity of transforming the new framework into operational reality through effective and timely implementation and consistent enforcement. You will hear a great deal in the first half of today's conference about why effective implementation and enforcement is so important. This is something that I wholeheartedly support, but I will leave the detail of what it means in practice for all of us here to other speakers.

3. Instead, I would like to share with you my view of why the shape of EU regulation in the future should be somewhat different than what we have seen in the recent past. When I say shape, I mean the key elements which I hope will characterise the EU's overall approach to regulation in the future.

4. So today I will cover three points:
Firstly: Why I think EU regulation should take a different form in the future.
Secondly: How I think future EU regulation will work in practice.
And finally: I will talk briefly about how we will know when we have an effective Single Market in Financial Services.

Why I think EU regulation is likely to be different in the future

Stocktake

5. I think it is helpful to start by summarising where we have got to with EU regulation so far. There has been a huge amount of legislative and policy development activity, which of course, provides the foundations for the single market. But it will take some time before the effects of the FSAP on financial market integration can be fully realised and measured. Regulatory changes on such a large scale are not going to occur overnight, and the benefits for the financial markets and its customers are unlikely to be realised until they are consistently implemented and enforced across all Member States.

6. So it seems to me that we need to take stock of the current level of integration and to give the markets and its customers time to adjust to the changes introduced by the FSAP. This is very much the message outlined in the joint HMT/FSA/Bank of England paper I mentioned a moment ago and I am much encouraged that this seems also to be the conclusion reached by the Commission's 4 expert Forum Groups, who were tasked to review the degree of integration in the EU's financial markets and make suggestions about the way forward.

Lessons from FSAP

7. I think the completion of the FSAP represents a huge achievement. In order to fulfil the Lisbon growth objective, the EU required a tool that could deliver results quickly across all financial services sectors and the FSAP has the potential to deliver much more of this than it is fashionable to acknowledge. But I also think that the FSAP has taught us valuable lessons about the digestibility of such a large legislative programme, over a relatively short time frame. Callum McCarthy highlighted last October the challenge posed by the implementation of so many EU Directives within a short time frame. We are currently working with HMT and firms and their trade associations, through the first wave measures which are ripe for implementation.

8. Before I move on to talk about how I believe EU Financial Services Regulation should be shaped in the future, I would first like to cover briefly, three European issues about which the FSA has some concerns:

9. Implementation of the Markets in Financial Instruments Directive.
It was particularly disappointing that the Council decided to publish the Markets in Financial Instruments Directive (previously known as ISD2) at the end of April rather than capitalise on the accession of the ten new EU countries and publish in October. Publishing in October would have left just under 12 months for firms to prepare in the certain knowledge of what will be required. Now 6 months has been lost from the timetable because of the April publication. I have to confess that the cost-savings-related reasons for this seem to me to pale into insignificance beside the problems the change causes for Finance Ministers, Regulators and firms alike. This is a real lost opportunity and suggests a lack of sensitivity by legislators and their officials of the enormous pressures firms are under in coping with the weight of new regulations. But we are where we are, and from a UK perspective we will be as pragmatic as we can in turning the MiFiD into FSA rules and guidance.

10. Credit for Consumers Directive
On the Credit for Consumers Directive, the UK's strong view is that mortgages should not be included. Secured loans are more complex and pose different risks to consumers than unsecured lending. Including mortgages in a "one size fits all" directive will mean creating standards that are inappropriate and disproportionate for other kinds of credit. We support the Commission's initiative in setting up the Mortgage Forum Group to examine the barriers to a cross-border market in mortgages. And, we think it is sensible to wait until this group has concluded before making final decisions on how that market can be developed. In our view, it is therefore premature for the Commission to reject Parliament's amendment to the text to remove mortgages from the CCD's scope.

11. International Accounting Standards
As you know, the European Commission is committed to requiring all EU listed companies to use International Accounting Standards for their consolidated accounts from 1 January 2005.

12. As the deadline is now so very close, I hope very much that the European Commission will move to formally endorse for use in the EU the two IASB standards on Financial Instruments (IAS 32 and 39). It is no secret that IAS 39 in particular is not a perfect standard and that the EU financial services sector has misgivings about potential volatility in earnings. However, especially in recent months there has been a full and transparent debate about the major concerns and I believe all parties have worked hard and collaboratively to understand and, where appropriate, accommodate these. It is my impression that there is a growing belief that it is better to accept the standard as it is currently drafted for use in 2005 and seek to improve it after that. The FSA shares that view. We are concerned that EU listed companies do not yet know how they will be required to account for the most important financial assets and liabilities on their balance sheets and the billions, or perhaps even trillions, of Euros in financial instruments not on the balance sheets. And we are only a few months from the start date. It is more important to have certainty at this stage than to strive for perfection.

13. The move to IASs in Europe is a major step towards a long term objective of a single set of globally applied accounting standards. The FSA strongly supports that objective, and the IASB's programme of convergence with US GAAP. However, it is important that the process of convergence should be a two way street, and that the FASB should take up the IASB's preferred solutions on some major issues.

14. As we move towards global standards, we need to develop regulatory mechanisms to foster consistent application, interpretation and enforcement of the standards. CESR, through its standing committee on financial reporting, CESRfin has made a great deal of progress on developing standards for enforcement and coordination among regulators, and IOSCO is starting to look at the same issues on a global basis. I am confident that there is a growing determination to make this process work, and so to avoid the development of a different version of IASs in each capital market.

15. Having digressed for a moment into three areas which concern us, I am now returning to my core subject, I think on balance the pressures of the Financial Services Action Plan have been challenging but broadly manageable.

16. But we are sensitive to the fact that no matter what barriers may remain in the EU, the industry needs time to adjust to the new regime. That is not to say that further legislation should be avoided altogether. For instance, I think it is required for a few priority areas such as insurance solvency, re-insurance, an EU version of the second Basel Accord and clearing and settlement. It is just that I think that in the future regulatory intervention is far less likely to be through legislative changes, but rather through increased use of other non-legislative tools, such as the Commission's competition powers, bilateral action or through codes of conduct. Where legislation is required in the future, it should have to pass a high cost benefit hurdle and then only be used where other solutions to a market failure are unlikely to produce an acceptable outcome.

How will regulation look different?

Improved quality

17. So how in practice will regulation look and feel and why will it be different?

18. The UK is dedicated to making sure the quality of EU regulation is improved. This process involves careful identification of what barriers remain to the creation of a single market and a more rigorous analysis of the contribution that regulation can make to removing these in a cost effective manner. In the past we have been too content to focus on removing obstacles, with insufficient regard to the costs involved. In the future once a barrier to market integration has been identified, we must then be able to demonstrate first that regulatory intervention has a role to play in its removal, and also that the inevitable costs associated with this are outweighed by the gains or can be justified by some other compelling arguments. Priority should be given to areas where it can most clearly be demonstrated that further integration of EU financial services is being held back. And, of course, there are some barriers that do not lend themselves to removal by legislation, such as differences in culture and language. So how might we prioritise our work in practice?

CBA

19. In order to make regulation more effective we need to invest more resource into producing evidence-based analysis. This, by the way, is not unique to EU processes. We need constantly to remind ourselves that regulation is only justified where there is a market failure and intervention can be shown to be an efficient way of remedying this. Before new ideas gain momentum or are allocated significant resource there needs to be an appropriately detailed analysis of the market failure so that the problem can be clearly defined and measured, and regulatory objectives targeted to address the problem. We should then establish a menu of policy proposals aimed at addressing the relevant market failure and conduct a CBA for each of these proposals. Good quality CBA, which should drive policy decisions not simply justify them, requires input from all the affected stakeholders, so consultation with firms, consumer associations, trade associations, will be a vital ingredient. Where a CBA for a particular policy is clearly positive, only then should the policy proposal be pursued. If the policy changes at any stage after the initial CBA, or significant developments in other areas affect the policy, the implications for the CBA need to be carefully considered. In the UK we also recognise that we need to move right away from giving any sense that CBA for EU legislation is undertaken purely as a means of post hoc justification for a particular policy.

Lamfalussy

20. The EU approach to legislation and supervisory cooperation is being shaped by the "Lamfalussy" process. Each of the four Lamfalussy levels plays a key role in the process, starting with a high level principles-based framework, through detailed implementing measures and effective common implementation, and convergence of supervisory practices and finishing with enforcement. I well understand that some member states find difficulty with principles and prefer detailed prescription. We will all need to work constructively and patiently with our EU colleagues as we build a framework around core high level standards.

21. The Lamfalussy supervisory networks form the backbone of EU regulatory co-ordination and information exchange and are doing much to facilitate the convergence of supervisory practices. Enthusiasm for this model on the securities side has led to the establishment of parallel committees for banking and insurance. From my own direct involvement in CEIOPS and CESR, I have every confidence that this model will be able to deliver an effective cross-EU regulatory supervisory structure and feel that this is the most cost-effective way to manage the implementation of the FSAP and what lies beyond it. I very much look forward to working closely with the banking committee, CEBS, and am delighted that London will act as host for this committee. However, the Lamfalussy committees will not, of, themselves deliver the Single Market – the market itself has the primary role to play in this regard. The relative success of this approach will rely on the enthusiasm of firms and investors to promote the Single Market and ensure that regulatory gaps are dealt with appropriately. It will also depend on the degree to which the process is efficient in terms of its resources and in terms of its flexibility to keep pace with market developments.

Regulatory tools

22. The appropriate choice of regulatory tools will be a key challenge over the next few years and it is one which we must get right. In this regard I would very much echo the views of the Forum Groups, that Member States should encourage the Commission to explore the full range of their tools when addressing remaining market failures. This is the approach we adopt in the UK and I can see no reason why it should not be equally applicable across the EU. For instance, making use of competition powers by intervening when firms behave in a way which damages the competitive environment, or forming partnerships with Member States on the implementation of legislation.

Global element

23. Regulation must, of course, also take greater account of the global nature of financial services. We cannot concentrate exclusively on Single Market issues, at the expense of the EU's global competitiveness.

Retail shift

24. Another challenge we face is how to approach potential barriers limiting financial integration in the retail sector, which is currently far less integrated than the wholesale markets. Here we face a "chicken and egg" situation. There is currently a very low level of cross border activity and demand for retail financial services. This is in part due to a number of factors, including cultural and linguistic barriers, different approaches to consumer savings habits and tax regimes. In these areas there is virtually nothing that EU legislation can do. It should therefore not attempt to try. On the other hand, demand might be expected to remain subdued until an appropriate retail regulatory framework is established. This raises the familiar question about the extent to which regulation should confine itself merely to enabling market forces to prevail or whether it has a more pro-active role in driving market structures. My view is that we should tread carefully until we have a better understanding of the issues which retail investors face in each Member State; conduct a well thought-out analysis of consumer needs and behaviours and develop a broader understanding of consumers' financial capabilities in different regions.

How will performance be measured?

Measuring integration

25. At what point we will know that an integrated market for financial services exists? How will we know we have been successful - how will we know when to open the champagne, sourced, of course, from several carefully selected vineyards from the newly enlarged EU.

26. Over the past year or so a good deal of useful work has been done to measure the level of integration achieved in the EU. A number of detailed studies have been conducted, including work by the Commission, the ECB, the Bank of England, and many others. They have provided conclusions on: recent market developments (such as an increase in cross-border services provided to other financial institutions); price-based indicators of integration (such as interest rate spreads for different market segments); and quantitative indicators (for instance, the level of cross-border loans to non-banks). There is not time today to go into the detail of how integrated EU markets have become. I would simply note that although the landscape has changed significantly, it has not done so evenly. I would also make the point that although quantitative analysis has an important role to play in this area, we should not underestimate the value of qualitative analysis.

Alternative tests

27. Let's pretend for a moment that we have addressed all the known material barriers to integration. What would indicate that the EU financial market was fully integrated? I don’t think it would be the actual market infrastructure (though essential for integration); it wouldn’t even be the fact that integrated markets had lowered the cost of capital for borrowers (though a valuable achievement); and it wouldn’t be based on the regulatory structures themselves. For me the indicators would be simple and would need to reflect the behaviour of firms and consumers. So I will offer a couple of alternative tests which would probably tell me that the Single Market was a reality

28. When I telephone my bank during one of my regular trips to other Member States, they ask me which language I require. This would tell me that we had pan-EU retail banks and that their customers came from all over the EU.

29. When TV commercials <during Coronation Street for instance> start advertising European retail banking services. I'm sure those of you here today from the major UK continental retail banks would relish such a challenge from your European neighbours.

30. When each UK household owns at least one financial product from a firm based in another Member State but which does not have a physical presence here in the UK (whether it's a mortgage, travel insurance, unsecured loan etc). And, needless to say, the households concerned would be able to point to demonstrable benefits from this diversified approach to meeting its financial needs.

31. But also from a business perspective…if my small business bank loan was from a firm based in another Member State or my fleet of cars was insured by an insurer from another Member State.

32. The point is that these alternative indicators would not be solely dependent on research provided by financial services experts and academics; they would be obvious and clear for all to see.

Conclusions

33. And so by way of conclusion…I think there is enough evidence, some of which comes from the lessons learned following the FSAP, others by looking at the overall EU environment and its current level of integration, that regulation will be different over the next few years. I expect there to be a change in the EU's overall approach to regulation; involving increased cooperation and convergence of practices brought about by the networks of regulators, with a more targeted and evidence-based approach to policy formation with detailed market failure and cost benefit analysis at its core, and finally by promoting the value of non-legislative measures, when other tools might more usefully provide a proportionate solution to whatever barriers remaining the way of achieving a fully integrated single market.

Wake up now!

Thank you.

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