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The EU’s Role in the Regulation of Financial Services


The 1985 European Commission White Paper on reform of the internal market, drawn up by the then British Commissioner Arthur Cockfield, proposed measures to begin the process of creating a Single Market in financial services, to be adopted by 1992. These concerned banking regulation, insurance and investment.

That programme of activity was later followed by the Financial Services Action Plan (FSAP), which sought to take the development of a Single Market in these services a stage further. The first plan ran from 1999 to 2005; a second programme is now running until 2010. The FSAP represented a step-change in the creation of a Single Market for financial services and posed considerable challenges for the sector.

These developments are discussed in this paper; the more recent issues concerning financial services regulation that have arisen from the 2007/08 financial crisis will be the subject of a later paper when the Commission’s proposals are more fully developed.

The Single Market after 1985

The 1985 White Paper set out three basic principles to be followed in the free movement of financial services across the EU: the harmonisation of essential standards; mutual recognition amongst the regulatory authorities; and home country control – that is a financial institution’s branches would be regulated by the authorities in the Member State where it had its head office.


In order to enable banks to operate across national borders without having to be separately authorised by the regulators in each Member State, a common set of criteria for assessing the solvency of banks had to be adopted. The First Banking Directive of 1977 had applied the principle of non-discrimination against businesses from other Member States to the banking sector – i.e. a bank from one Member State that wished to operate in another Member State had to be able to do so on equal terms to domestic banks. The Second Banking Directive of 1989 provided for minimal capital requirements for all retail banks and set out the procedure under which home country regulators would control branches of an institution in another Member State.

The "European Passport", created by the second of these two directives, listed those services that could be carried on in another Member State once an institution had been approved by its home country regulator. This provision enabled banks to operate across the entire EU without having to seek the approval of regulators in each country; this was a major achievement in opening up competition in the banking sector.


The Single Market for insurance services was developed using the same principles that applied to the banking sector - harmonisation and mutual recognition. A 1973 directive had abolished restrictions on EU companies establishing non-life insurance businesses in other Member States. Later directives extended the scope of the Single Market in insurance, for example, to that relating to motor vehicles, reinsurance and other sectors. Car owners are now, for example, covered for their civil liability when they take out car insurance in any EU Member State when using their car in another Member State.


The approach to investment services was similar to that of the other two sectors. The Investment Services Directive provided for a system of regulation based on single authorisation, reciprocity with third countries, common prudential rules and co-operation amongst the various national regulators. Although part of the Single Market programme of 1985-1992, it was not in fact in force by 1 January 1993 but introduced later. Capital requirements for investment providers were harmonised by a later directive.

Benefits of the 1992 programme

Measuring the benefits of the initial programme of financial services legislation is difficult because it was only one factor influencing the rapid development of financial services at the end of the 1980s. The abolition of exchange controls by Member States at that time - which liberalised capital movements – was in effect the delayed implementation of one of the Treaty of Rome’s four basic freedoms of movement, that of capital. The development of new technologies and the reunification of Germany also had profound effects on the sector but the 1992 programme did enable companies to expand their businesses into new markets and to reduce the regulatory burden if they operated in more than one Member State.

The development of the Single Market programme in financial services was an important victory for those in the EU who wanted to open up the internal market to competition from companies based outside the EU. Non-EU companies have the right to operate in the financial services market in the EU on the same basis as home country companies.

An important point is that the EU’s financial services legislation applies also to Iceland, Lichtenstein and Norway because although they are not EU Member States, they are members of the European Economic Area. They have observer status on key EU committees that consider legislative proposals in this field and they contribute bilaterally to the cost of those committees. Switzerland – which is not in the European Economic Area – nonetheless participates in some of the EU’s financial services work. For example, Switzerland is a member of the Single European Payments Area, an EU initiative to enable payments in euros to be made within and between countries on the basis of a common set of rules.

The Financial Services Action Plan (FSAP)

The beginnings of a Single Market in financial services were a significant step forward for the EU but introduction of the euro, and other developments in the sector, led the European Council in October 1998 (during the British Presidency) to call on the Commission to produce a framework for further action.

The Commission’s 1999 published framework said that prudential rules did not need significant change but wholesale financial services (i.e. capital markets used by those dealing in large amounts of money, mostly in the form of interbank lending) were being driven to modernise by the onset of the euro.

The framework also sought a fully integrated financial services market, which it said required the elimination of disparities in the tax treatment of savings, and better co-ordination between national regulators. The goal of the FSAP was summed up in four strategic objectives:

  • a single EU wholesale market;
  • open and secure retail markets;
  • state of the art prudential rules and supervision;
  • and wider conditions to create an optimal single financial market.

The Commission was directed to produce a plan for the legislation necessary to implement those measures on which there was consensus. A large number of measures were proposed for the first plan (42 in the end), from 1999 to 2004. These included in respect of wholesale markets:

  • establishing a common legal framework for integrated securities and derivatives markets – this meant updating the Investment Services Directive and measures to tackle market manipulation;
  • removing the remaining barriers to raising capital on an EU-wide basis – by replacing national rules that made it difficult to offer securities;
  • establishing a single set of financial statements for listed companies – helping companies to raise capital across the EU by adopting a single set of reporting standards;
  • a coherent legal framework for supplementary pension funds – responding to the development of funded pension schemes by creating proper safeguards;
  • providing the legal certainty to underpin cross-border trading in securities - ensuring that collateral could be accepted on a cross-border basis;
  • secure and transparent environment for cross-border restructuring – this required legislation on takeovers and a common framework of company law.

The proposed measures in respect of retail financial services were mostly focused on removing the administrative and other barriers to customers purchasing such services across borders. They included:

  • information and transparency measures – so that people could invest their savings across borders with confidence;
  • better redress procedures – so that consumers could resolve problems that cross borders more easily;
  • electronic commerce regulation – so that people could trade across borders easily safely;
  • reducing the cost of crossborder retail payments – tackling the problem of high charges for low-value credit transfers in the banking system.

The drive towards faster integration of financial services was given a boost by the adoption at Lisbon in March 2000 of a wider programme to boost the competitiveness of the EU economy. At that meeting of the European Council the heads of state or government declared that:

"Efficient and transparent financial markets foster growth and employment by better allocation of capital and reducing its cost".

They went on to say that,

"it is essential to exploit the potential of the euro to push forward the integration of EU financial markets".

The meeting called for the completion of the Single Market in financial services to be accelerated and demanded a "tight timetable" for the necessary legislation.

In order to ensure that the often complex legislation required was prepared as quickly and effectively as possible, the EU adopted in 2001 the recommendations of a report by Alexandre Lamfalussy, a former general director of the Bank for International Settlements. This meant that the EU adopted framework legislation on a proposal from the Commission but the details were filled in later by four expert committees, representing different parts of the sector. Initially applied to the securities sector, the Lamfalussy procedure was extended in 2002 to all financial services.

When the Commission published a Green Paper in 2004 taking stock towards the end of the FSAP period, it identified 22 measures which had been introduced since 1999. There is insufficient space here to consider all the directives brought forward but three of them are examples of the legislation considered.

1. The Market Abuse Directive

Adopted in 2004, the directive aimed to give investors confidence that markets would be protected against manipulation or abuse. It updated existing EU legislation on insider trading and set out a harmonised system for dealing with insider trading and other forms of market manipulation. At the same time it recognised the need for the buy back of shares on occasions and made appropriate provision.

The Directive came in for criticism from the Governor of the Bank of England in 2007 when he claimed that it had prevented the Bank from lending covertly to Northern Rock to ensure it stayed solvent. It was subsequently established that in fact the directive was not at fault but that the British Government had adopted more stringent requirements than the EU required when it had transposed the directive into British law. A recent study (see below) found that the directive had been effective in reducing market abuse.

2. Taxation of Savings Directive

Popularly known as the "withholding tax", this was directed at the lack of a level playing field in the taxation of interest within the EU and in other countries. The aim of the tax is to reduce tax evasion by ensuring that the citizens of one Member State do not avoid tax by investing their savings in another Member State and so distort the Single Market. The tax is withheld at source and passed back to the country where the citizen is resident.

The EU has negotiated agreements with a number of tax havens by which they introduced this tax at a rate of 20 per cent on the interest of depositors who are EU residents. Bank deposits and bonds are the two types of account so taxed and the revenue is passed anonymously to the EU resident’s Member State.

3. Markets in Financial Instruments Directive (MiFID)

This important measure was an essential because it establishes common rules to enable investment companies to compete with one another across the EU. Its passage through the legislative process was controversial, with objections from a number of Member States (including the UK) to the inclusion in 2003 of what they saw as a protectionist amendment designed to protect smaller investment banks against competition. Although this change was partially reversed in the European Parliament, critics of the Directive feared that it might lead to a reduction in competition rather than an increase.

EU Financial Services Policy 2005-2010

Measuring the impact of the FSAP is not easy, not least because of the varying rates of implementation of the directives in Member States. Whilst MiFID attracted critical comment, the pensions industry, for example, estimated that the pensions directive would save multinational firms as much as €10 billion a year.

A report to the Commission in March 2009 prepared by independent consultants CRA International, which evaluated the benefits of the FSAP from 1999-2007, identified a number of benefits including:

  • a sharp reduction in cost of cross-border payments;
  • the insurance sector had become more professionalised and there was both greater disclosure and enhanced consumer protection the majority of Member States;
  • improved management of pension assets;
  • MiFID had led to a number of new trading venues opening, particularly in London, and a reduction in trading costs.

The study also identified problems which are preventing the completion of the Single Market, notably significant differences in implementation practice in different Member States. In the case of the Takeover Directive, for example, they found that some Member States had implemented it in such a way that its intended effect was seriously undermined, making cross-border takeovers less and not more likely.

The conclusions of the study referred to above reflected a wider consensus that following the legislative phase of the FSAP, there needed to be a period of consolidation with fewer initiatives. The Commission set out its objectives in a December 2005 White Paper. These can be summarised as:

  • consolidate existing progress, ensure implementation and effective enforcement;
  • make the principles of better regulation part of policy making in this sector;
  • to enhance the convergence of supervision in the EU;
  • to create greater competition, particularly in retail markets;
  • to increase the EU’s influence in the globalising of capital markets.

The White Paper included a list of tasks and measures needed to improve things, spaced out over the 2005-10 period. They included several training and co-ordination initiatives in order to improve both the implementation of existing legislation on financial services and to ensure its effective enforcement. Improving transparency and accountability and better quality regulation were also key themes.

Assessment & Future Policy

The 2007-08 financial crisis has made it hard to accurately assess the impact of Single Market measures on the growth, development and stability of financial services in the EU. The dramatic events of the last two years have also raised profound questions about the nature and effectiveness of financial regulation, including cross-border regulation. Difficult questions about the EU regulation of hitherto unregulated aspects of financial services, such as hedge funds, will have to be addressed. The tendency towards greater international regulation is likely to increase, making it necessary for the EU to take into account agreements in, for example, the G20, which relate to financial services.

The liberalisation of capital markets, the growth of mutual recognition and improved opportunities to trade across borders have all resulted from the EU’s work in this sector. But much remains to be done to make the legislation effective in practice across the whole of the EU. Protectionist tendencies remain in some Member States and the Commission will need to be rigorous in ensuring that the common rules are properly enforced. There is some way to go before the EU can claim to have a truly Single Market in financial services.


October 2009

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