The financial chapter of the Internal Market

William Harris Burland *

1. Introduction

At this stage in 1993, well into the first year of the "completed" internal market, it is appropriate to reflect both back to the past and forward to the future. Looking back reminds one that the concept of the internal market was not invented in 1985 at the time of the Commission's landmark White Paper: "Completing the Internal Market".

Indeed, in the case of financial services, the foundations were already being laid from 1973 with the first banking and insurance directives; the first phase of liberalisation of capital movements was earlier still. Nevertheless, 1985 was a very important milestone because the White Paper of that year, and its list of the specific measures required to complete the market with its matching timetable of actions needed by the EC institutions and national governments up to the end of 1992, acted as a major catalyst for accelerated progress. Accelerated procedures, introduced to make this possible under the Single European Act of 1986 and the extended use of majority voting, have resulted in a great leap forward in both the quantity and quality of financial services legislation. Indeed, so far as the "1992 Programme" (i.e. the programme set out in the 1985 White Paper) is concerned, this has now been completed in respect of financial services with the formal adoption by the Council in May 1993 of the Investment Services Directive.

2. Objective

Essentially the main objective has been to give practical effect to three of the fundamental freedoms of the 1957 Rome Treaty, namely freedom of capital movement, freedom of establishment and freedom to provide services across borders. It is worth noting that the 1957 Treaty established a close link between these by providing that "The liberalisation of banking and insurance services connected with movements of capital shall be effected in step with the progressive liberalisation of movements of capital".

3. Technique

It will therefore be clear that progress had to be made on both the capital movements and the financial services fronts more or less simultaneously and this was indeed achieved. Capital movements were further liberalised by a 1986 directive and then completely liberalised by the 1988 directive, now implemented by 11 Member States and due to be implemented by Greece from 1994. As for financial services the technique used has been based on the concept of "home country control" which recognises that the supervision of the overall financial soundness of a financial institution can best be carried out by the competent authorities of the country which is home to the head office. In order to ensure high standards of supervisory rules and a "level playing field" for the market this is accompanied by minimum harmonized standards of a prudential nature, as embodied for example in the directives on the solvency ratio for banks and the capital adequacy rules for investment services.

These two elements - home country control and minimum harmonized standards - are the foundations of the technique known as mutual recognition on which the completed internal market in financial services now rests. What this means, in effect, is that Member States recognise the licences (to carry on regulated financial services activities) issued by other Member States as being valid within their own territories, thus leading to the "single E.C. licence" for banking already in effect from 1st  January 1993. The same technique has been used for investment services and insurance although the single licences for these will come into existence at a later date.

4. Main effects of the reform (1) - Freedom of establishment

Freedom of establishment is a Treaty right flowing from Article 52 EEC Treaty. This was indeed available before the recent reforms but only on the basis of non-discriminatory treatment of branches of other EC banks as compared with banks in the host country. Branches of EC banks in host countries were obliged to conform with all host country supervisory regulations, as though they were themselves locally incorporated banks.

This approach was economically inefficient in at least two respects. First the branch in the host country could be (and in most Member States was) obliged to provide and maintain locally an amount of so called "endowment capital" related to its local business activity (a costly technique). Second the host country rules relating to the scope of permitted banking activity were paramount, thus frustrating to a large extent the potential for innovation by new entrants in the markets of host countries.

Following the reforms of the 1992 programme both of these major restrictions are swept away; endowment capital is now a historical footnote and the minimum scope of permitted banking activity throughout the E.C. has been agreed and defined. A Member State may choose to be more restrictive than this minimum towards some or all of its own banks but must recognise the licences issued by other Member States for any or all of the "core banking activities"; thus the significance of the "EC single licence" concept.

5. Main effects of the reform (2) - Freedom to provide cross-border services

"Freedom of services" is also a Treaty right under Article 59 EEC Treaty, but as already noted it was linked to freedom of capital movements. Until the reforms of the 1992 programme there was no EC secondary legislation dealing with it. The position achieved now for cross-border banking, from 1st January 1993, is essentially the same as for freedom of establishment (without the requirement for a local establishment). Banking services forming part of the list of core banking activities may be provided across the border without a host country establishment by a bank whose home country "single licence" covers those activities. The position of investment services firms and insurance companies will essentially be the same when the relevant directives (already adopted) are implemented.

6. Potential limitation on the two freedoms

The main potential limitation on the full practical exercise of these internal market freedoms, is the need for the financial institution concerned to respect applicable local (host country) laws which are justified by reference to "the general good". Thus, for example, if in the interests of consumer protection, local financial institutions in a given Member State are not permitted to grant floating rate loans to individuals for house purchase it could be argued that the rule should also restrict financial institutions from other Member States who wish to offer their own types of mortgage facilities on this local market. I make no specific prediction here about the outcome of this particular hypothetical case. Inevitably however the delicately balanced mechanism of the directives will be a catalyst for change, as the burden of challenging a financial product which is lawful on the producer's home market will fall on the host state.

7. Significance of the internal market programme

There is no doubt that over the years 1985-1992 a major change has occurred in the financial services market in the E.C. Elements of de-regulation and re-regulation have been undertaken simultaneously at a very intense pace. The regulatory structure in all 3 sectors is now fully up to date and is generally considered far more modern than that of our main competition, especially the USA. It is impossible to assess the macro-economic benefits at this stage and it is unfortunate that the completion of the programme has been overtaken by recession.

However, two personal observations could be made. How much worse might the present recession have been without the undoubted boost which the 1992 programme has had over recent years? How much slower the recovery might be without the completed internal market structure on which to build it?

8. The European Economic Area, Enlargement and Eastern Europe

The internal market was of course by no means the only major change in Europe in the years leading up to 1993. Talks with the EFTA countries have resulted in agreement on the extension of the main benefits of the internal market to these countries within the European Economic Area. The withdrawal of Switzerland has somewhat delayed entry into force of the agreement. Meanwhile four of the EFTA countries have applied for membership and negotiations are already under way for their entry around 1995.

Finally and perhaps least predictable back in 1985, the Community is currently negotiating extensive co-operation agreements with a number of East European States which did not even exist as sovereign states at that time. Technical assistance is being provided in the financial area, including the basic functions of central banking and payment systems.

9. Maastricht, monetary union and the future

A high priority will continue to be given to the internal market in the financial area and in particular to improving its functioning. The work currently being done by various E.C. institutions on payment systems is an example of this. In addition much remains to be done to prepare for stages 2 and 3 of EMU. Stage 2 of EMU begins on 1st January 1994 and central bankers are devoting considerable resources to the preparation for the tasks assigned under the new treaty to the European Monetary Institute. In the banking field it seems likely that the subject of payment systems will assume increasing importance. The internal market for investment services and insurance will increasingly develop as the implementation dates for the corresponding internal market measures fall due. While awaiting such time as the conditions are right for monetary union the most promising strategy for economic progress would appear to be the full exploitation of the possibilities offered by the internal market, a process which is still only just beginning.


* Commission of the European Communities - Directorate General Internal Market and Financial Services - Financial institutions - Payment systems and application of legislation. Rue de la Loi, 200.- 1049 Brussels. The views expressed in this paper are not necessarily those of the Commission.