European integration and the Euro : Blazing the trail towards regional competition?


John Gilchrist*

Europe in a changing world

European Union (EU) has created the first significant step towards regional competition in a global economy. This topic will dominate the agendas of heads of state, champions of industry, financial institutions and the utilities operating at the centre of the world’s capital markets for many years to come. They are already operating in a roller coaster economy where governments change and so too fiscal and monetary policy, constantly tailored to fit the ‘style’ of the government of the day and the economic circumstances in which it finds itself. Further, many of the large industrial and services based organisations have become stateless and with deregulation, finance is de-coupling from trade. The EU is tilting the balance of political, trade and financial power. These are critical trends impacting governmental policy, creating boom bust economies overshadowed by inflationary and competitive pressures. Wealth creation, the process which brings together issuers, investors and buyers and sellers of securities and derivatives, will be a central issue in the new millennium; a major challenge for governments, trade and finance. The efficiency of the wealth creation process, good or bad, will impact each and every one of us. The societal consequence of the changes for our generation will be significantly greater than the historical equivalent of the impact experienced between the first developments in computing and the way it impacts our lives today.

Historical perspective

The foundation of the EU in 1957 and a plethora of subsequent integration initiatives have paved the way for competition on a regional scale. In some respects it was borne out of fear rather than ambition, its rationale based on three main factors:

It was these fears and principles which shaped the founding treaties of the EU, creating the desire for peace and increased economic wealth through the establishment of a common market. The visionary plans of Robert Schuman and Jean Monnet, which led to the creation of the European Community for Coal and Steel, had the implicit objective of creating an environment that would render impossible armed conflicts in Europe. Europe has made significant progress with the integration of the national economies. World-wide trade increased more than thirty-fold between 1958 and 1992 and trade between member states of the EU has increased more than the forty-fold since its creation. The degree of integration and inter-dependence becomes particularly evident when intra-European trade breaks down temporarily as was the case with French truck drivers’ strike in 1996 which led to a chain reaction in several European economies. The EU countries have become increasingly reliant on other members with over 60% of trade being intra-EU. This trade is conducted in fifteen currencies with organisations engaged in complex forex and hedging strategies to safeguard their profit line. The combined GDP of the EU is about USD 8.6 trillion with 10% or USD 860 billion of revenue relating to intra-EU imports and exports. The cost of multi-currency administration, forex and hedging is estimated at 1%; the savings associated with moving to a single currency would therefore be USD 8.6 billion. A single currency will make Europe more efficient, more competitive. Indeed, the EU would have a 40% share of world exports, far exceeding the USA with just over 10%; the euro could become the new trade currency, replacing the US dollar. If we also convert the outstanding debt of the major currency bond markets and the market capitalisation of the leading stock exchanges, 34% and 23% respectively of world markets would be euro; that percentage would grow very quickly as liquidity increased.

Economic integration - the pathway to regional competition

EU, with but a short history, has witnessed great change. It has become far more than just a trade bloc. Progress has been made in reconciling former hostile nations and in strengthening political union. That said, the introduction of a single currency, the euro, will be a major catalyst, restructuring the capital markets, laying the foundation for a radical restructuring of the world's capital markets.

What vision do we have for the euro? Do we aim to make it the preferred world currency for trade and investment or do we simply see it as nice to have for trade and travel; the two have very different implications for the financial institutions and utilities which are central to the capital markets.

Economic integration is frequently put on a par with the elimination of borders whereas globalisation is associated with the reduction of time and distance; this definition is too narrow. Globalisation is brought about and supported firstly, by the removal of restrictions in trade and capital movements and secondly, by information and communication technology. Technology has made quantum leaps over the years and we have become increasingly dependent on it; today it determines our way of life. For banks and other providers of financial services, globalisation means twenty four hour business operations world-wide. The capability exists to have communication and information made available globally within seconds as well as the simultaneous evaluation of financial data and electronic access to financial markets around the world. In future the investment process will include real-time settlement of the transactions carried out in these markets. But, the change to the capital markets process will go beyond real-time settlement; financial institutions will be operating in ‘virtual markets’ - EU and the euro will trigger that change.

In the global market scenario, the individual countries and their regional cooperatives will engage in competition with other countries and regions for internationally transferable capital and investment. Investors will take advantage of different domestic and regional practices, putting pressure on governments to adapt. Issuers, likewise, will have increased choice as to where they raise finance, selecting the lowest cost finance found in the most liquid markets. Off course such a market can be off-shore and in today’s world of burgeoning change the internet and cyberspace will further tilt the balance.

In the capital markets a country’s or a region’s competitiveness will be measured by its ability to attract issuers and investors by creating favourable conditions; the Euromarket, an off-shore market, has already created the right conditions. Highly liquid markets are used to create wealth which in turn leads to economic growth and higher tax revenues and prosperity through job creation. Competing means creating the right conditions to attract business; usually at the expense of others. EU, and the member countries within it, should be aware of this first commercial principle; compete externally, cooperate within. Europe must create a regionally strong and competitive capital market.

Is Europe competitive? According to a study conducted by the World Economic Forum, Europe trails behind Asia, the United States, Canada and New Zealand. European competitiveness needs to improve.

Improving EU competitiveness

There are three important issues requiring resolution from government, trade and finance:

The task of governments is to create a framework which allows and promotes entrepreneurship which is defined as taking initiative, assuming responsibility and taking risks; this is rewarded by profits or penalised by losses. Creating a framework means to limit state intervention in the economy only to activities which would lead to failures in the market i.e. applying the principle of ‘in favour of the market’. It has to be stressed that the regulators and the professional market players have a responsibility to protect the private investor and that ‘in favour of the market’ is for the professional market only. Entrepreneurship has a vital role. Without such a framework innovation is stifled and new business opportunities are suppressed, leading to a ‘brain drain’ as entrepreneurs invest and create employment in other regions.

The improvement in the competitiveness of Europe and the furthering of economic integration are closely linked. The European countries must work together to create a competitive governmental style as well as a trade and capital market bloc. Further, an economically integrated Europe needs a single currency, the euro. The euro has numerous well publicised advantages whereas sovereign pride and the baggage of history form the basis for concerns. The introduction of the euro cannot be delayed - either politically or economically. A delay would lead to a confidence crisis, undermining one of the main foundations for creating a truly competitive Europe. The ongoing debates over the ‘ins’ and the ‘pre-ins’ and continual references to potential delays in introducing the euro create uncertainty among market participants who are all making significant efforts to be prepared for the 1st January 1999.

Economic convergence in the EU is a major strategic opportunity where the fundamentals all point to a stable euro. In most European countries inflation has virtually become an outdated term, public budgets are in a consolidation phase, interest rate levels are low and the exchange rate mechanism of the EMS is working well. The interest rate difference of European government loans has decreased significantly over the last two years. Financial markets are planning for a timely start to monetary union and are acting accordingly. Further integration also means enlargement of the Union, including the countries of Central and Eastern Europe which have significant growth potentialities.

The welfare liability time-bomb

The demographic time bomb - that phenomenon attributed to ageing populations - is only a part of the challenge facing Europe and the world; welfare liabilities are the real challenge and they are a quantum leap in terms of magnitude of problem. Governments operating welfare state policies are being challenged. Many governments, already burdened by high levels of debt, high tax and rising unemployment, face a future challenge; a latent liability spanning education, health, pensions and unemployment.

In a regionally competitive world skills and knowledge will be critical success factors. Three factors back this statement:

Role of the capital markets

Wealth creation lies at the heart of economic growth and prosperity and the capital markets form the backbone of that process. Liquid capital markets which channel capital for the most efficient use, attracting issuers and investors from all regions; these are indispensable to resolve the welfare liability and social needs previously mentioned. For maximum regional contribution, capital markets require a first class market infrastructure, including efficient and cost effective new issues distribution, order processing, settlement of securities transactions as well as the availability of high quality custody services; they also require a global approach to risk management.

Settlement of cross-border securities transactions and custody services form the core business of the Cedel Group. The business environment for the Group has changed dramatically since it was founded in 1970. The Cedel Group has always been a global player with a world-wide presence; today it has customers in over 80 countries, links to 33 domestic markets, provides settlement services in 37 currencies and has employees with 30 nationalities. The Group is well acquainted with regionalisation; it has customers, links and employees from all EU member states. It is the only non-US organisation to be granted an exemption to clear and settle US domestic securities by the Securities and Exchange Commission. It has rapidly extended its coverage of Asian markets and is acting as advisor and project manager to the People’s Republic of China in the development of securities market practices and central securities depository.

How do we position in this new environment? We respond to this challenge through a large scale investment programme - more than USD 500 million in the next four years. The objectives are:

To make this investment project attractive to our shareholders we have decided to enter new markets. We will offer other banks and financial services providers the opportunity to transfer their securities processing to a newly created company and to build a global highway. The global highway will create a seamless link between securities transactions, settlement and custody of securities. Order, execution and confirmation of cross-border securities transactions, as well as their settlement, will be carried out within seconds and this at significantly lower cost and risk than is the case today. The Cedel Group was created ‘By the market for the market’ and this strategy is consistent with our founding principles; we help our customers to be more efficient, we help them to compete. In this way they avoid a multiplication of development investment with the related overhead cost. This is a concrete example of entrepreneurship and entrepreneurial initiative; EU and the various member states must strive to create such an ethos.

The future

It has to be accepted that an integrated Europe will form a relatively small peninsula between the borders of Asia and the Americas. That said, it has exerted more of an influence in world terms than any other region in the world. European languages, government forms and economic concepts, technologies and natural sciences, culture and philosophy have acquired world-wide recognition. For centuries Europe has produced world renowned statesmen, champions of industry, scientists, musicians and authors; many pioneering developments and inventions are the work of Europeans. The innovative power has always been a critical success factor; it is still present. Pessimists would leave us to conclude that the ‘old continent’ has had its day and that we should look to the emerging and re-emerging markets for opportunity. The EU with the euro as the preferred currency for trade and investment can regenerate Europe as a regional trade and capital market ‘hub’; it can compete and it can win. However, it needs to have a vision to do so; one aimed at the creation of regional economic prosperity, new employment and wealth creation.

It would be worthy if European government and opposition parties, regional leaders, champions of industry, trade unions, financial institutions and academia had a common understanding of the issues. It would be even better if they all agreed that there is an urgency to find a solution. At the moment we appear to have lost our way against the founders' visions; we must get back on track. If we cannot do this, can we really be sure that we are creating the right future for our children and for future generations? We have the ingredients and the opportunity to play a decisive role in the regional competition and globalisation scenario; we have an obligation to do so. It would be a tragedy if we fail.




About the Author: John Gilchrist is Director Corporate Communications Cedel Group and formerly the Group's Corporate Planner and Head of Product Strategy and Market Research. Prior to Cedel Group, John was responsible for establishing corporate and business planning during the 'Big Bang' at the London Stock Exchange.

* Director Corporate Communications, Cedel Group. L - 1331 Luxembourg