Mutual recognition: integration of the financial sector in the European Community.
Since the beginning of 1988, momentum toward completion of the internal market in the European Community has increased markedly. The target date for establishing this market, which will allow the free movement of goods, persons, services, and capital within the Community, is December 31, 1992. The European Community has already taken legislative action in many important areas, including the liberalization of capital movements and the establishment of a framework for a Communitywide market for banking services. Currently, EC member states are taking steps to encourage industries to prepare for the more competitive post-1992 environment, and some governments are using the deadline to speed deregulation of their own financial markets. In the private sector, companies are developing strategic plans based on the creation of a unified European market; one result has been a wave of intra-European mergers and acquisitions.
The EC program for the financial sector is being developed and implemented at a time of increasing internationalization of financial services and markets. Technological change and innovation in instruments and services have played a major role in this process of internationalization. At the same time, market forces have both necessitated and facilitated greater international coordination with regard to supervision and regulation. This coordination has resulted in some movement toward harmonization of rules among nations (in particular, the Basle Accord on international bank capital standards) and easing of restrictive rules and practices by individual countries. Although the EC program for financial services and markets can be viewed as a part of this process of international coordination, the program is qualitatively different from what has been achieved beyond the Community. The EC approach to achieving internal financial integration is therefore of interest not only for its effect within the Community but also in relation to issues regarding international trade in financial services that are being addressed in forums such as the current Uruguay Round of the General Agreement on Tariffs and Trade (GATT), the Organisation for Economic Co-operation and Development (OECD), and the Bank for International Settlements.
The first section of this article discusses the development of the internal market program and the Community's use of the concept of mutual recognition. The second section provides an overview of the EC program for creation of a "European Financial Area," a term used by the EC Commission, the Community's executive body, to refer both to the removal of barriers to capital movements and to the establishment of a framework for a Communitywide market for financial services. The third section presents a conceptual analysis of the EC approach of mutual recognition as a means of achieving integration of the Community's financial sector. The concluding section considers the relevance of the principle of mutual recognition in the broader international context of approaches to domestic market access for foreign firms.
DEVELOPMENT OF THE INTERNAL MARKET PROGRAM
In the early 1980s, concern was widespread within the European Community that the EC countries were recovering very slowly, compared with the United States and Japan, from the recessions of the late 1970s and were being outstripped by the United States and Japan in new high-technology industries. The conventional wisdom was that, even though tariff barriers among the member states had been dismantled more than a decade earlier, nontariff barriers and market fragmentation within the Community were major impediments to EC economic growth. Partly because of this view, in the first half of the 1980s new initiatives were proposed to reactivate the process of European integration. Perhaps the most far-reaching of these proposals was the draft treaty establishing a European Union that the European Parliament adopted in early 1984. This treaty had no chance of ratification by the member states; but it encouraged the heads of the EC member states, who had previously renewed their commitment in general terms to the goals set forth in the 1957 Treaty of Rome, to take concrete action toward completion of the internal market.(1)
By the mid-1980s, steps toward further integration of the EC market had become easier to take because sustained economic growth had begun in most of the EC countries after the recovery from the 1982 recession. Moreover, the political situation had changed as governments that were more strongly committed to free markets than were their predecessors had come into power in the United Kingdom (in 1979) and in Germany (in 1982).
The 1985 White Paper
All of these political and economic developments created an environment in which the Commission that took office at the beginning of 1985, with Jacques Delors as its president, could move forward with proposals for economic integration (see the box "Institutions of the European Community"). By mid-1985, the Commission had prepared a white paper, Completing the Internal Market, which the European Council subsequently adopted as the basis for the EC internal market program.(2) The white paper identified 300 pieces of legislation (later revised to 279) that the Community would have to enact to remove restrictions or to harmonize laws of member states. It also set forth a timetable for the enactment of each proposal that called for the entire program to be in place by the end of 1992 (see the box "Forms of EC legislation").
The white paper also announced a new strategy regarding the harmonization of national laws and regulations. In place of the previous, unsuccessful attempt to achieve complete harmonization of standards at the Community level, the Commission adopted an approach involving harmonization of only essential laws and regulations (such as those affecting health and safety) for both goods and services. Under the Commission's new approach, the harmonization of essential standards provides the basis for mutual recognition by the member states of the equivalence and validity of each other's laws, regulations, and administrative practices that have not been harmonized at the EC level.(3) An essential element of such recognition is agreement not to invoke differences in national rules to restrict the access of goods and services.
Cassis de Dijon
A 1979 decision by the European Court of Justice interpreting the Treaty of Rome provided, at least with regard to products, the legal basis for the Commission's approach of mutual recognition. At issue was an article of the treaty that prohibits in trade between member countries not only quantitative restrictions on imports but also "all measures having equivalent effect." In Cassis de Dijon, the Court found that Germany could not prohibit the import of a liqueur that was lawfully produced and sold in France solely because its alcohol content, which was clearly labeled, was too low for it to be deemed a liqueur under German law.(4) The Court said that, even though German national rules would have applied equally to domestic and imported products, a member state may create a barrier to the import of a product only when such a barrier is necessary to satisfy "mandatory requirements" such as the prevention of tax evasion, the protection of public health, the ensuring of fairness in commercial transactions, and the protection of consumers. Moreover, any such rule must be an "essential guarantee" of the interest that is allowed to be protected. Without such a justification, a member state may not apply its own national rules to imported products that are lawfully produced and sold in other member states.
In other words, although the Court did not use the term, member states, by accepting each other's laws regarding the production and sale of a product, are to be governed by the principle of mutual recognition. In subsequent judgments overturning British standards for milk, German standards for beer, French standards for milk, and Italian standards for pasta, the Court has continued to apply the test set forth in Cassis de Dijon. With these decision, as well as with rulings in other areas, the Court has continued to play an important role in implementing the internal market program.
The Single European Act
Both the white paper's goal of implementing the internal market by the end of 1992 and the principle of mutual recognition were included in provisions of the Single European Act, a 1986 agreement among the EC member states that amended the Treaty of Rome.(5) Although the act, like Cassis de Dijon, does not use the term mutual recognition, it provides that the Council "may decide that the provisions in force in a Member State must be recognized as being equivalent to those applied by another Member State."(6)
A major purpose of the Single European Act, which became effective in July 1987, was to make EC decisionmaking more efficient and thereby to facilitate the completion of the internal market. To this end, the Single European Act replaced unanimous voting with "qualified majority voting" for the Council's adoption of most harmonization measures necessary to achieve the internal market. Under qualified majority voting, the number of votes that each member state exercises in the Council is weighted roughly according to its population. Fifty-four votes (out of a total of seventy-six) are required to adopt legislation. Fiscal measures, such as the harmonization of taxes, however, still require unanimous approval of the Council.
Other institutional provisions of the Single European Act were designed to strengthen the role of the European Parliament in EC decisionmaking; however, the Parliament's role remains primarily consultative rather than legislative. Under the new "cooperation procedure," which applies to most measures involving harmonization, the Commission and the Council must take into account amendments that the Parliament proposes. However, the Commission retains considerable power because a parliamentary amendment that the Commission does not support requires the Council's unanimous approval. If the Parliament rejects a measure in its entirety, the Council may enact it only by unanimous vote (see the box "The `cooperation procedure' ").
In other areas, the Single European Act set forth goals that the Treaty of Rome either had stated much more generally or had not included. In the monetary area, the act encouraged further cooperation among the member states to ensure the convergence of economic and monetary policies and made it clear that such cooperation might require institutional changes. The act also committed the member states to encouraging improvements in social policy with regard to the health and safety of workers, to strengthening the "economic and social cohesion" of the Community (that is, reducing regional disparities), to promoting research and technological development, and to preserving the environment.
The Legislative Program for Completing the Internal Market
In its 1985 white paper, the Commission classified into three groups the measures that would be necessary to complete the internal market:
1. Removal of physical barriers, such as customs checks at frontiers for goods and for individuals.
2. Removal of technical barriers, such as differences in essential national health and safety standards for individual products. Other goals include open access for bidding on public contracts, removal of restrictions on capital movements, removal of restrictions and harmonization of essential standards for the provision of financial services, recognition of educational and professional qualifications, abolishment of cartels in transportation, establishment of a Community policy for mergers and acquisitions and of a Community trademark and patent system, and development of a uniform policy on government subsidies.
3. Removal of fiscal barriers, such as differences in value-added tax rates.
The progress toward completion of the internal market has been impressive, particularly because what has already been achieved was only a few years ago generally viewed as unachievable. As of mid-July 1989, the Commission had submitted to the Council more than four-fifths of the 279 pieces of legislation identified in the white paper. The Council had acted on about half of the white paper measures: It had taken final action on 130 pieces of legislation (5 more await enactment), and it had adopted a common position on another 5 proposals. However, some of the remaining proposals--for example, harmonization of indirect taxes and removal of border controls--are particularly complicated or controversial.
CREATION OF A "EUROPEAN FINANCIAL AREA"
An important part of the EC program to complete the internal market is the creation of a "European Financial Area," which involves eliminating restrictions on the movement of capital among the member states and establishing a framework for a Communitywide market for financial services.
Removal of Restrictions on Capital Movements
Without the free movement of capital, the integration of securities markets and the cross-border provision of financial services would be impossible. At present, four countries--the United Kingdom, Germany, the Netherlands, and Denmark--have fully liberalized capital movements vis-a-vis both other member states and third countries (that is, countries outside the Community). Four other countries--Belgium, Luxembourg, France, and Italy--are already close to doing so.
Under a directive adopted in June 1988, eight EC member states must eliminate any remaining capital controls by July 1, 1990. (Spain and Ireland have extensions until 1992; extensions until 1995 are possible for Portugal and Greece.) This directive was the final step in a lengthy process of liberalization that began in the early 1960s, was set back by restrictions imposed by member states during the economic difficulties of the 1970s, and was reactivated in the early 1980s by a major Commission initiative. With regard to third countries, the 1988 directive states that the EC countries "shall endeavor to attain the same degree of liberalization" of capital movements that applies within the Community to capital movements to and from non-EC countries.
In response to concerns of some member states, the Community included safeguards in the plan for the removal of remaining capital controls. One involves creation of a new medium-term loan facility for member states experiencing difficulties with their balance of payments. Another consists of a clause permitting a member state to reimpose controls in the event of a serious exchange crisis. Under this provision, a member state could reimpose controls, subject to subsequent approval by the Commission, for a maximum of six months. Because the Community is already close to achieving the free movement of capital, the concern about safeguards does not appear to stem from a belief that the lifting of the remaining controls would trigger a crisis. Rather, it appears to stem from a concern that a commitment not to impose restrictions on capital movements could hamper response to a crisis generated by an exogenous shock. So long as capital is free to move in some way in response to market forces, the opening of an additional channel for such movement would, by itself, be unlikely to precipitate a major outflow.
Nevertheless, some countries, particularly France and Italy, are concerned that the removal of their remaining exchange controls will create a serious potential for tax evasion because of existing differences in taxes on interest and dividend payments within the Community. In early 1989, the Commission submitted proposals that would require member states to impose a minimum withholding tax of 15 percent on interest income paid to any EC resident on domestically issued bonds and bank deposits. However, the proposal appears to have been dropped as it became clear that the unanimity required for Council action could not be achieved.
Beyond financial integration, the liberalization of capital movements, together with other aspects of the internal market program, raises the issue of exchange rate relationships among the member states. Within the Community there is considerable debate as to whether the closer coordination of monetary policy and the strengthening of the European Monetary System will ensure sufficient stability of exchange rates or whether establishing an economic and monetary union will be necessary. In the context of the European Community, "economic union" refers not only to the integration of markets but also to some form of coordinated or perhaps centralized decisionmaking regarding macroeconomic policy objectives. A true monetary union would require irrevocably fixed exchange rates, which could take the form of a common currency, and some mechanism for conducting a common monetary policy, perhaps a European central bank.
At their June 1989 summit meeting in Madrid, the heads of the EC member states restated their determination "to progressively achieve Economic and Monetary Union." They agreed to begin, as of July 1990, the first of three stages recommended in the report of the Delors committee, which had been established at the Hanover summit meeting a year earlier, and to carry out preparatory work regarding subsequent stages. However, the details of the plan and the timetable remain unresolved. In any event, though economic and monetary union may be a longer-run consequence of completing the internal market, the achievement of such union is not part of the internal market program.
Financial Services and Markets
The EC plan to complete the internal market includes a comprehensive program for the financial sector. The program is designed to provide sufficient harmonization of essential rules to permit mutual recognition of the equivalence and validity of national rules and practices that have not been harmonized and to permit the acceptance of home-country control. This section offers an overview of the EC program for financial services and markets, including the EC reciprocity proposals.
Banking. The Second Banking Directive, on which the Council adopted a "common position" in July 1989, is viewed as the centerpiece of EC banking legislation because it is a comprehensive proposal dealing with the powers and the geographic expansion of banks within the Community. Under this directive, a credit institution could provide services throughout the Community--either through branches or across borders--under home-country control without obtaining an authorization from the host country.(7) The directive also sets forth a list of permissible activities for a credit institution (defined as an institution that receives deposits or other payable funds from the public and grants credits for its own account) that is based on a universal banking model and includes all forms of securities activities but not insurance activities.(8) If a bank's home country permits a listed activity, the bank may conduct that activity anywhere in the Community, regardless of host-country law.
The European Community plans to implement the Second Banking Directive no later than January 1, 1993, simultaneously with measures to harmonize bank capital standards similar to the framework developed by the Basle Committee on Banking Regulations and Supervisory Practices.(9) These measures consist of the "own funds" directive, which defines capital, and the solvency-ratio directive, which specifies risk-adjusted capital ratios. Additional harmonizing measures--including limitations on bank ownership of nonfinancial institutions, initial capital requirements, and provisions relating to the identity, extent of holdings, and suitability of major shareholders--are contained in the Second Banking Directive. Other measures, such as consolidated supervision and common accounting standards, are already in place. Measures relating to deposit insurance and to the reporting of large exposures are in the form of Commission recommendations (which are not binding), with legislation to be proposed in the future.
Investment Services. The EC program for the securities sector encompasses two areas: first, rules applicable to firms offering investment services to their customers; and second, rules applicable to the markets on which securities are traded. In general, the latter area involves more traditional objectives of investor protection and efficient market functioning whereas the former also involves systemic risks comparable to those in banking.(10)
The area of investment services presents more difficulties for the Community than that of banking because the process of international harmonization in investment services is much less advanced and no equivalent of the Basle Accord on bank capital standards exists for securities firms. Also, the regulatory structures for investment services vary much more among the member countries than do those for banking services, and there is no committee of regulators from different countries comparable to the Basle Committee on Banking Regulations and Supervisory Practices. Moreover, in investment services, even more than in banking, the European Community confronts the problem of trying to harmonize essential elements of national regulatory frameworks while those structures are themselves changing in response to globalization and innovation in the financial sector.(11)
In December 1988, the Commission proposed the Investment Services Directive, which is the counterpart of the Second Banking Directive. Under this directive, investment firms, like credit institutions, would be able to provide services across borders and establish branches throughout the Community without obtaining authorization from the host country. To ensure that investment firms are able to compete effectively in the host country, the directive also provides for the liberalization of rules governing access to stock exchanges and to financial futures and options exchanges.
In contrast to the Second Banking Directive, the proposed Investment Services Directive adopts a functional rather than an institutional approach to defining an investment firm. Wheras a credit institution is defined separately from the activities in which it is allowed to engage, an investment firm is defined as a firm that engages in any of the activities listed in the directive. These activities include brokering, dealing as principal, underwriting, market making, providing portfolio management services and investment advice, and providing safekeeping services (other than in conjunction with management of a clearing system) with respect to any of the instruments specified by the directive. The instruments specified are transferable securities (including unit trusts), money market instruments (including cerfiticates of deposit and Eurocommercial paper), financial futures and options, and exchange rate and interest rate instruments.
Investment firms that engage in these activities include firms that are also credit institutions that would be governed by the Second Banking Directive. The proposed Investment Services Directive takes account of this overlap by specifying that only certain articles of the directive would apply to investment firms that are also credit institutions.
The Commission is still trying to develop a directive on market risk for securities firms that would be the equivalent of the directives on capital adequacy for banking institutions. The Commission hopes that such a directive will come into force simultaneously with the proposed Investment Services Directive. The Market risk directive is also likely to set forth requirements for the securities activities of banks that would supplement the capital-adequacy requirements already in place.
Securities Markets. The EC program with regard to securities markets has been under way since the early 1980s, and a number of directives have already been enacted. These directives are designed to break down barriers between national stock exchanges by increasing transparency and ensuring access for issuers to securities markets throughout the Community. One group of measures deals with listed securities and includes a 1987 directive providing for mutual recognition of the "listing particulars" (that is, disclosure documents) of the company's home country. A directive dealing with unlisted securities other than Eurosecurities, enacted in April 1989, provides for mutual recognition of prospectuses among the member states. Both directives provide that the Community may enter into negotiations with third countries to achieve mutual recognition of home-country disclosure requirements that extends beyond the borders of the Community.
The EC program for securities markets includes a directive regarding insider trading, on which the Council of Economic and Finance Ministers adopted a common position in June 1989. The Commission has also issued a recommendation that relates to a European code of conduct for securities transactions. Although the 1985 white paper discussed creating an electronically linked, Communitywide trading system for securities of international interest, no specific proposals have been put forward.
An EC directive on cross-border sales of a particular securities product--open-ended unit trusts or "undertakings for collective investment in transferable securities" (UCITS)--will become effective in October 1989. At that time, UCITS (which are similar but not identical in legal form to mutual funds) that meet the minimum standards set forth in the directive may be sold throughout the Community under home-country control. However, individual member states may continue to impose their own rules with regard to marketing and advertising, provided that such rules are applied on the basis of national treatment and can be justified by the "public interest." To date, no proposals regarding harmonization of tax treatment of unit trusts within the Community have been put forward. As a result, upon implementation of the directive, unit trusts marketed by entities located in Luxembourg, which will continue to benefit from tax treatment more liberal than that in other member states, may be be sold throughout the Community.
Insurance. In contrast to the banking and securities sectors, the insurance industry in the European Community, other than in the United Kingdom, has been relatively protected from outside competition and has not been part of any globalization process. (Reinsurance, which has traditionally been an international business, is the exception.) In general, the member states have imposed a multitude of restrictions on insurance services provided through branches or agencies and on services provided across borders. Because existing barriers to the creation of a Communitywide regulatory framework are much greater for insurance than they are for the rest of the financial sector, in the insurance sector it appears to be politically necessary for the Community to proceed more slowly toward the harmonization that is necessary to permit mutual recognition and home-country control. Accordingly, the directives for insurance that were proposed or adopted in 1988 are much less far-reaching than those for banking and investment services.
In contrast to the banking and investment services directives, both the Second Nonlife Insurance Directive (enacted in 1988) and the proposed Second Life Insurance Directive deal only with the cross-border provision of services and do not provide for Communitywide branching of insurance companies under home-country control. Unlike branches of EC insurance companies will continue to be authorized and regulated by the host state in accordance with provisions of EC directives, although the home state has responsibility for ensuring that the company meets overall solvency standards.
Moreover, again in contrast to the directives on banking and investment services, the insurance directives adopted or proposed during 1988 distinguish among customers on the basis of the degrees of protection that is deemed to be required. The nonlife insurance directive provides liberalization only for wholesale customers; specifically, the cross-border provision of services under home-country control is permitted only for "large risks," defined primarily in terms of sales, assets, and the number of employees. Similarly, the proposed life insurance directive provides liberalization only for individuals who take the initiative in seeking life insurance from a company in another state.
Reciprocity. The Second Banking Directive and the proposed Investment Services Directive contain reciprocity clauses, as does the proposed Second Life Insurance Directive. (The Second Nonlife Insurance Directive, which was enacted earlier, does not contain a reciprocity clause, but the Community reportedly plans to amend the directive to include one.) Under the EC reciprocity provisions, a non-EC financial firm would not be permitted to establish or acquire a subsidiary in any member state unless the firm's home country granted reciprocal treatment to similar financial institutions from all member states. The meaning of the reciprocity clauses and the circumstances under which they might be applied have been the subject of considerable discussion both within the Community and abroad.(12)
The reciprocity clauses apply only to entry to the EC market through the subsidiary form of organization. Direct branches of non-EC financial institutions would not be subject to EC reciprocity requirements. Such branches would not benefit from the provisions of the directives permitting Communitywide expansion and would continue to be authorized and regulated separately by each host state. Existing subsidiaries of non-EC financial institutions would, in general, be grandfathered and would be treated like any other financial institution in the member state in which they were chartered.
The reciprocity provision in the Second Banking Directive is expected to serve as the model for the reciprocity provisions in the other financial services directives. Under this provision, before the effective date of the directive and periodically thereafter, the Commission would make a determination--analogous to the studies on national treatment in the banking and securities sectors conducted by the U.S. government--regarding the treatment of EC banks by third countries. The reciprocity provision distinguishes between two sets of criteria under which the Commission could take action on the basis of such studies or "on the basis of other information:" one that could be used to limit or bar entry to the EC market or to begin negotiations with the threat of such action and another that could be used as a goal in negotiations without any threat of retaliatory action.
The first set of criteria is being widely interpreted as reciprocal national treatment, although the concept of effective market access is also included. The EC Commission has stated that the standard will be "genuine national treatment," that is, de facto as well as de jure national treatment. If it determines that EC credit institutions in a third country "do not receive national treatment offering the same competitive opportunities as are available to domestic credit institutions and that the conditions of effective market access are not fulfilled," the Commission may initiate negotiations with the third country to achieve such treatment. The Commission may also require a host member state to "limit or suspend" decisions on applications by banks from the third country for up to three months. The Commission may take the latter action only in accordance with a complicated "comitology" procedure that provides a role for the Banking Advisory Committee and for the Council, with veto power granted to a simple majority of the Council.(13) An extension of the three-month period would require a qualified majority vote of the Council.
The second set of criteria involves treatment comparable to that offered by the European Community. If the Commission finds that a third country does not grant EC banking institutions "effective market access comparable to that granted by the Community to credit institutions from that third country," it may submit proposals to the Council for an appropriate mandate to negotiate such access. The Council would act on such proposals by a qualified majority. The Commission is not granted any authority to limit entry on the basis of this standard.
The reciprocity provision in the Second Banking Directive is generally viewed as an improvement over earlier versions because it no longer contains an automatic review procedure, it includes a grandfathering provision, and no sanctions appear to be contemplated against countries that provide EC banks with national treatment. U.S. officials have, however, consistently expressed their concern about the unfortunate precedent being set by the introduction of any kind of reciprocity provision--even reciprocal national treatment--for financial services.(14)
THE CONCEPT OF MUTUAL RECOGNITION
The goal of the internal market program for the financial sector is to create a single, unified market by removing barriers to the provision of services across borders, to the establishment of branches or subsidiaries of EC financial institutions throughout the Community, and to transactions in securities on Community stock exchanges. In determining the best method of achieving these goals, the Community must decide what principles should be used to establish a regulatory, supervisory, and tax structure that would both facilitate the integration of Community financial markets and satisfy the public policy interests of the member states with regard to safety and soundness, monetary policy, market stability, and consumer and investor protection.
The starting point for the Community was the principle of nondiscrimination, a term that in this context refers to the prohibition of discrimination between domestic and foreign residents based on nationality. (By contrast, in the context of trade and capital movements, nondiscrimination usually refers to the prohibition of discrimination among foreign residents of different nationalities; the concept is similar to that of a most-favored-nation clause, that is, benefits of any liberalization must be extended to all foreign countries on a nondiscriminatory basis.) Although the right of establishment and the right to provide services in other member states without being subject to any restrictions based on nationality were set forth in the Treaty of Rome, legislative action by the Community and decisions of the European Court of Justice have been necessary to give practical effect to these rights.
Nondiscrimination by an EC member state amounts to offering national treatment to individuals and firms from other member states. Under a policy of national treatment, foreign firms have the same opportunities for establishment and the same powers with respect to their host-country operations that their domestic counterparts have; similarly, foreign firms operating in a host country are subject to the same obligations as their domestic counterparts. The OECD's National Treatment Instrument defines national treatment as treatment under host-country "laws, regulations, and administrative practices...no less favorable than that accorded in like situations to domestic enterprises." The expression "no less favorable" appears to allow for the possibility that exact national treatment cannot always be achieved and that any adjustments should be resolved in favor of the foreign firm; the wording is not meant to endorse an overall policy of "better than national treatment." The principal purpose of a policy of national treatment is to promote competitive equality between domestic and foreign banking institutions by allowing them to compete on a "level playing field" within the host country.
If the European Community had adopted national treatment as an approach to financial integration, the result would have been a level playing field for foreign and domestic institutions within each national market. But, even though each country's rules would have been applied on a nondiscriminatory basis, twelve separate markets with different rules in each would still have existed. Moreover, although national treatment removes barriers to the provision of services by ensuring fair treatment for entry and operation within a country, it does not by itself address two important issues: the extent to which multinational cooperation or agreement is necessary to regulate and supervise financial activities conducted internationally and the de facto barriers created by the lack of multinational harmonization of regulatory structures. The Community's program attempts to deal with these issues.
One approach, which, as noted previously, the Community originally used with regard to products, is to require member states to modify their differing national laws and regulations in order to implement comprehensive, uniform standards established by the Community. This approach of complete harmonization was abandoned as involving too much detailed legislation at the Community level and as totally impractical to achieve within any reasonable period.
The Community's solution was to adopt the approach of mutual recognition. This approach requires each country to recognize the laws, regulations, and administrative practices of other member states as equivalent to its own and thereby precludes the use of differences in national rules to restrict access. The concept of mutual recognition goes well beyond that of national treatment. Under a policy of mutual recognition, some member states in effect agree to offer treatment that is more favorable than national treatment to firms from other member states.
Mutual recognition cannot simply be decreed among a group of countries with widely divergent legal systems, statutory provisions, and regulatory and supervisory practices. Mutual recognition of rules that differ as to what a country regards as essential elements and characteristics would be politically unacceptable. As a result, a crucial prerequisite for mutual recognition is the harmonization of essential rules. If member states consider certain rules essential but cannot reach agreement on initial harmonization, they may agree explicitly to exclude such rules from mutual recognition and home-country control until agreement can be reached.
In the financial sector, the process of harmonization involves identifying the rules that are essential for ensuring the safety and soundness of financial institutions and the rules that are essential for the protection of depositors, other consumers of financial services, and investors. It also involves determining how detailed the harmonization of these rules must be. For example, one question is whether specifying that the major shareholders of a financial institution must be determined to be "suitable" by home-country authorities is sufficient or whether more specific criteria are needed.
A corollary of mutual recognition is home-country control. If national laws, regulations, and supervisory practices that have not been harmonized at the EC level are to be accorded mutual recognition, home-country rules and supervisory practices must be accepted as controlling the operations of branches and the cross-border provision of services by financial institutions. However, the principle of home-country control adopted by the Community is not absolute. In accordance with judgments of the European Court of Justice and with EC directives, the host country retains the right to regulate branches or the cross-border provision of services to the extent that doing so is necessary to protect the public interest.
In practice, the division of responsibility between home- and host-country regulators may be rather complicated. In general, the EC directives that have been proposed or adopted in the area of financial services provide for home-country control for initial authorization and for ongoing prudential supervision. However, various aspects of the day-to-day conduct of business could be subject to host-country control on a national treatment basis under, for example, consumer protection laws that are necessary to protect the public interest but have not been harmonized by the Community. In some directives, such host-country control is strictly limited or is prohibited either because the extent of harmonization of investor protection rules at the EC level is considered sufficient (as in the cases of securities prospectuses and unit trusts) or because the wholesale customers covered by the directive are deemed not to require host-country protection (as in the case of cross-border nonlife insurance services). As a result, under the EC directives on securities markets, a company headquartered in Greece and listed on the Greek stock exchange could, for example, be listed on the London stock exchange under Greek rules that satisfied the EC minimum standards but provided prospective British investors with less information than that required of a U.K. firm.
The European Court of Justice has already played a major role in establishing a public interest test for host-country regulation and in determining whether that criterion has been met, and it will undoubtedly continue to do so. In the case of banking, the public interest of the host state appears to be particularly strong because of the role of banks in the credit, monetary, and payments systems and because banks are within the so-called safety net of deposit insurance and of lending of last resort by the monetary authorities. Rather than relying on the overall public interest exception to home-country control, the Second Banking Directive includes explicit exceptions for rules relating to the conduct of host-country monetary policy. In line with the Revised Basle Concordat, an exception to the principle of home-country control is also provided for the supervision of liquidity. In practice, of course, questions are likely to arise as to whether particular regulations are addressed toward liquidity or solvency.
Provision of Services through Subsidiaries, through Branches, and across Borders
Analyses of issues relating to international trade in financial services usually draw a distinction between providing services through the establishment of subsidiaries and branches and providing them directly across borders. In general, more attention has been devoted to issues of establishment, whereas the cross-border provision of services has been viewed within the context of removing exchange controls. Recently, however, particularly within the Organisation for Economic Co-operation and Development, where much of the multinational work on trade in financial services has taken place, increased attention has been given to cross-border services that are not within the scope of the liberalization of capital movements--for example, portfolio management and investment advice.
The conceptual grouping of services into those provided through the establishment of subsidiaries and branches and those provided across borders is not of critical importance when both are being discussed in the context of a policy of national treatment. However, within the European Community, where the overall approach to intra-Community trade in services is mutual recognition, the conceptual grouping does matter. In the insurance sector, the EC directives retain the conventional line between services provided through branches and subsidiaries and those provided across borders. In directives concerning banking and investment services, however, the EC Commission has in effect drawn a line between services provided through subsidiaries and those provided through branches or across borders.
Under the EC program for financial integration, subsidiaries of financial firms headquartered in other member states will continue to be governed by the principle of national treatment. (The right of a bank from one member state either to establish or to acquire a bank in another member state is, at least in theory, guaranteed by the Treaty of Rome.) As a result, such subsidiaries are treated in the same manner as other incorporated entities in the host state. For example, a German banking subsidiary of a U.K. bank could branch throughout the Community under German rules with respect to permissible activities.
The EC approach to the provision of services through branches and across borders is quite different. Mutual recognition and home-country control are made possible through the harmonization of essential rules applicable to the parent banking or investment firm. Such harmonization includes, for example, general criteria for home-country authorization and supervision; the establishment of minimum capital requirements for banks and investment firms; and, for banks, agreement on a list of activities considered integral to banking.
Under a regime of mutual recognition and home-country control, the powers of, for example, a Greek branch of a U.K. bank would be determined by U.K. rules in accordance with the list specified by the Community, not by Greek rules. Similarly, Greek branches of banks from other EC countries would be governed by their respective home-country rules. As a result, a branch of a bank from another member state could receive treatment that is better than national treatment from Greece. Alternatively, if the bank's home country had rules with respect to bank powers that were more restrictive than those of Greece, the bank's Greek branch could receive treatment that is worse than national treatment in Greece.
In theory, a Greek bank (or a bank from any EC country) could establish a subsidiary bank in London, and the London subsidiary could branch into Greece under home-country (that is, U.K.) control. The Greek branch of the London subsidiary of a Greek bank might thus have broader powers to conduct activities in Greece than would its parent bank. Some EC officials assert that in practice this situation would not arise because the prior consultation among the supervisory authorities regarding the establishment of subsidiaries that is required by the Second Banking Directive would prevent such byzantine organizational structures. In any event, the potential for such structures could lead to increased pressure for regulatory convergence.
The EC approach of mutual recognition could result, at least in the short run, in competitive inequalities and fragmentation of markets. With regard to financial services, however, the Community assumes that over the longer run market forces will create pressure on governments that will lead to a convergence of additional national rules and practices that have not been harmonized at the EC level. Pressures for regulatory convergence within the Community would arise both from the absence of restrictions on capital movements and from the regulatory advantages enjoyed by branches of banks and of investment firms from other member states and also by the head offices of such banks and investment firms in providing services across borders.
In the financial sector, the Community is using the principle of mutual recognition as a pragmatic tool that, together with market forces, is expected to result in a more unified, less restrictive regulatory structure. The process is interactive: Mutual recognition requires initial harmonization, and additional harmonization results from mutual recognition. In adopting the approach of mutual recognition in the financial area, the Community is in effect using trade in financial services as a lever to arbitrage the regulatory policies of the member states.
Regulatory convergence is particularly likely to occur with regard to bank powers because the Community has reached a theoretical consensus on what activities are permissible for banks. In effect, the member states have agreed upon a goal for regulatory convergence. Banks permitted by their home country to engage in any of the activities listed in the Second Banking Directive are specifically permitted to engage in such activities anywhere in the Community through a branch or through cross-border provision of services. As a result, although the Community has not required governments to give their banks the powers on the list, it has created a situation in which regulatory convergence toward the EC list of activities as a result of market forces seems almost inevitable.(15) Other areas, particularly if the model for convergence has not been specified in advance, could be more complicated.
An example of the absence of agreement on a goal for regulatory convergence, namely, that credit institutions should be permitted to become members of stock exchanges, may explain a notable exception to the principle of mutual recognition in the EC proposals for the financial sector. Under the Commission's proposals, in accordance with the principle of mutual recognition, a host state must ensure that a branch of an investment firm that is a stock exchange member in its home state is permitted to become a member of the host country's stock exchange. By contrast, a branch of a credit institution, even if the credit institution is a member of a stock exchange in its home country, is governed by a policy of national treatment. As a result, if a host member state does not allow its own credit institutions to be members of its stock exchange, it is not obligated to admit a branch of a credit institution chartered in another member state. Such a credit institution could gain access to the host-country exchange only through a subsidiary investment firm or through a branch of such a firm.
Competitive pressures associated with cross-border provision of services, together with the absence of restrictions on capital movements, might over time also contribute to some convergence of regulations that remain exclusively under host-country control. One likely area of convergence is the elimination of any remaining interest rate ceilings, although the primary factor in removal of such limitations may be the ongoing process of deregulation in this area, including the development of alternative financial instruments. Another possible development is some move toward convergence of the effective tax imposed by reserve requirements, that is, the level of such requirements and the extent, if any, to which interest is paid on reserve balances. However, other factors, such as differences in corporate taxation among the member states, also effect the relative tax treatment of banks.
Besides leading to a regulatory convergence that would liberalize rules such as those relating to bank powers, market pressures could lead to competition in laxity among supervisory authorities. Such competition could occur either with regard to standards that have not been harmonized or that have been harmonized only in general terms or with regard to the enforcement of agreed-upon standards. Moreover, market pressures could prevent governments from imposing or maintaining standards stricter than the minimums set forth in the directives, even though governments are usually permitted to do so. The EC view is that no major problems will arise with regard to competition in laxity because the scope of harmonization is sufficiently broad and because the minimum standards that the Community has adopted are sufficiently high.
Problems would also be less likely to arise the greater the theoretical agreement among the member states as to the line between liberalization and laxity--that is, the distinction between national rules that have primarily the effect of imposing barriers to trade in services and national rules that are necessary for prudential purposes or for consumer protection. For example, a consensus exists within the Community that permitting all forms of securities activities to be conducted in a bank or its subsidiary is a positive, liberalizing measure.
A different possibility is that the market may place a value on national standards that are more stringent than those required by EC directives. Whereas governments are obligated to accord mutual recognition to differing national standards that have not been harmonized, private firms and individuals are under no such obligation. Indeed, in a more competitive marketplace, firms and individuals may have even greater scope to exercise their preferences. For example, customers might consider a strictly regulated bank or securities firm of one member state to be preferable to institutions authorized and supervised by authorities of another member state even though the latter institutions might offer a price advantage.
The financial sector may be particularly suited to the interactive process of mutual recognition and harmonization of regulatory frameworks. One reason is the existence, apart from the EC program, of an ongoing internationalization of financial services and markets. This process has already led to cooperation among the major industrial countries with regard to bank supervision and to agreement on basic harmonization of national standards with regard to bank capital. Thus, market pressures for regulatory convergence in the banking sector exist well beyond the borders of the Community.
Another reason the financial sector may be particularly suited to an interactive process of basic harmonization and mutual recognition is that the rules apply primarily to the providers of financial services; by contrast, in the product sector, standards apply principally to the products themselves. Partly because of the intangible nature of the service being provided, the financial sector can adopt quickly to changes in the regulatory or market environment. Technological developments can be rapidly assimilated, and innovation in instruments or practices can occur with considerable speed. This situation contrast sharply with that of the product area, in which long periods of research and development may be necessary or even a simple change in standards can require a lengthy period of implementation.
As a result, in the financial sector the approach of harmonizing some basic standards and letting market forces produce additional harmonization appears easier. If market forces do not produce further harmonization and if the member states agree that such harmonization is necessary, it can probably be accomplished at a later stage without major dislocations. However, because of the substantial public policy interests involving macroeconomic policy, safety and soundness, and stability of markets that are inherent in the financial sector, in addition to consumer protection, a greater degree of harmonization than is necessary in the nonfinancial sector may be required to make mutual recognition and home-country acceptable to the member states. In any event, after the implementation of the EC program for basic harmonization of the framework for financial services, remaining differences in national rules that create significant barriers could be removed not only as a result of market pressures or additional harmonization but also as a result of actions brought before the European Court of Justice.
Judgments of the European Court of Justice
In 1986, the European Court of Justice addressed in four insurance cases some of the issues relating to the use of mutual recognition for financial integration within the Community. In its judgments, the Court provided guidance as to the degree of harmonization of essential elements it considered necessary for mutual recognition and home-country control in the insurance sector and established a test for determining the legality of host-country restrictions on the cross-border provision of services.
The Court dealt with the issue of the extent to which a member state may impose authorization and other requirements on an insurance company that is based in another member state and wishes to offer cross-border services.(16) The Court found that "the insurance sector is a particularly sensitive area from the point of view of the protection of the consumer both as a policy-holder and as an insured person." As a result, the Court said, in the field of insurance "imperative reasons relating to the public interest" exist that may justify restrictions on the freedom to provide services. The Court emphasized that such restrictions must apply equally to foreign and domestic firms (that is, on a national treatment basis) and that the restrictions could not be justified if the public interest were already protected by the rules of the home state or if less restrictive rules could achieve the same result.
In examining the extent to which the public interest justified restrictions on the cross-border provision of insurance services, the Court distinguished among types of customers on the basis of the degree of protection deemed to be needed. For small policyholders, the Court determined that existing Community legislation did not provide sufficient harmonization to justify a claim that the public interest was already protected by the home state. Moreover, the Court found that the requirements the host state imposed were not excessive. However, with regard to authorization and other requirements for the coinsurance of large, commercial risks that were at issue in two of the cases, the Court found that such restrictions could not be justified because such policyholders did not require the same degree of protection as that required by the smaller policyholders.
The insurance decisions confirmed that the principle of mutual recognition and the obligation of member states not to erect barriers that had been established in Cassis de Dijon extended to services as well as to goods. The judgments also established the public interest test and a method for applying it to determine the legality of any barriers to the provision of services across borders. In directives on banking and investment services, the EC Commission has in effect extended the Court's public interest test to apply also to host-country restrictions on services provided through branches, and the directives refer specifically to the public interest criterion for host-country rules in both cases. This extension is a logical consequence of the conceptual grouping of these two forms of provision of services discussed above. The Court's decisions have been generally interpreted to mean that a member state may continue to apply its own rules on a national treatment basis only if the rules can be justified by the public interest test and if Community legislation has not already provided harmonization of basic rules in the relevant areas.
Supranational Structure of the Community
In considering mutual recognition as the approach to financial integration within the Community and its relevance in contexts beyond the Community, one must remember that the member states have agreed to use it as a tool to achieve an integrated market in the context of a structure that, though not a federation, is a rather powerful supranational structure to which the member states have already transferred a significant degree of sovereignty. The customs union with its common external commercial policy is the basis of the internal market, but the internal market is much more than a customs union. It involves a supranational legislative process under which supranational rules ensuring the free movement of goods, persons, services, and capital are adopted and the harmonization of basic laws, regulations, and practices at a supranational level can be achieved. Moreover, a member state is obligated to implement or enforce all EC rules, including those it opposed in the Community legislative process. Community law is accepted as prevailing over national law, and both judgments and preliminary rulings of the European Court of Justice based on Community law are binding and enforceable in the member states. (The principle of supremacy of Community law was not explicitly stated in the Treaty of Rome, but it has been confirmed by the European Court of Justice in judgments interpreting provisions of the treaty.)
The European Community is also more than a single, unified market. Other aspects of the Community addressed either by the original Treaty of Rome or by the Single European Act include social policy, economic and social cohesion, research and development, the environment, and economic and monetary union. The Single European Act also refers to the goal of a "European Union," although there is considerable disagreement within the Community as to what such a union would entail.(17)
These institutional and political characteristics of the European Community are extremely important in considering whether the approach the Community is using for internal financial integration is applicable to removing barriers and achieving a more integrated regulatory structure for financial services and markets beyond the Community. A basic question is how much multinational harmonization would be required and the extent to which sovereignty might need to be surrendered to use the principle of mutual recognition more broadly among nations.
The radical difference between what the Community is trying to achieve and other types of economic arrangements between nations is illustrated by a comparison with the U.S.-Canada Free Trade Agreement. Unlike a customs union, the Free Trade Agreement has no common external tariff or commercial policy, and its goals are limited to eliminating bilateral tariffs, reducing many nontariff barriers, liberalizing investment practices, and providing ground rules for trade in services, which in the financial sector are based on the principle of national treatment. The agreement has no commitment to a single, unified market. It entails a limited dispute-settling mechanism (from which financial services are excluded) that does not involve a sacrifice of national sovereignty, and it does not provide for supranational legislative or judicial functions.
Conclusion Although the framework for the entire internal market, or even for the financial sector alone, may not be in place by the end of 1992, a sufficient number of measures will probably have been adopted and implemented such that the internal market may be completed by the mid-1990s. An important development for achieving this goal has already occurred: Market participants are basing their plans and governments are framing their policies on the assumption that the internal market will be completed. The commitment by the more developed EC countries to use EC structural funds to assist poorer countries and regions is likely to be important in determining the willingness of the poorer countries not only to support legislation to establish the internal market but also to implement it during what might be a difficult transitional period of industrial restructuring. A further issue, which has not yet been resolved, is what steps the Community may need to take regarding social legislation.
The goal of free capital movements within the Community is close to realization; by mid-1990, eight countries are expected to permit the unrestricted movement of capital. The integration of the EC financial sector--banking, investment services, securities markets, and insurance--is already well advanced, to some extent because this process is part of a larger trend toward the globalization of financial services and markets and toward increased international cooperation and coordination among regulatory authorities. The financial sector may be particularly suited to the EC approach of mutual recognition and home-country control. The banking sector presents the fewest difficulties because the major industrial countries have already achieved basic harmonization with regard to consolidated supervision and capital standards. Investment services are more difficult because of much greater disparities in national regulatory structures and because of the lack of a multilateral agreement on market risk that is equivalent to the Basle Accord on risk-based capital.
Securities markets involve complex national rules about the disclosure of information, but market pressures have already led some EC and non-EC securities regulators to explore the possibility of recognizing disclosure requirements of other countries. The insurance sector may be the most difficult of the financial sectors to integrate. Except for reinsurance, the insurance industry is currently much less international in character than the banking and securities industries: More barriers protect domestic markets, and less consultation and cooperation take place internationally among regulators.
Within the European Community, application of the principle of mutual recognition in the financial sector is expected to lead to market pressures for additional harmonization of national regulatory structures. A possibility always exists that the initial harmonization of what are considered basic standards and supervisory practices will be insufficient to prevent market pressures leading to competition in laxity among national regulatory authorities; however, the market could also place a value on more stringent regulation and supervision. Although making adjustments to the degree of harmonization in the financial sector may be easier than in other sectors, the financial sector may require greater initial harmonization to make mutual recognition acceptable because of considerations relating to safety and soundness, monetary policy, and market stability.
In considering the applicability of mutual recognition beyond the Community, one must keep in mind that within the Community mutual recognition involves political compromises to achieve a common goal and that it has been accepted and implemented within an established supranational legislative and judicial structure. Even within this framework, many issues are unresolved with regard to the extent to which national sovereignty is transferred to the Community, particularly with reference to the powers of the Commission and to concerns about the democratic foundations of Community institutions.
Both the approach of mutual recognition used within the Community and the reciprocity approach being adopted for third countries are relevant to the question of the interaction and appropriate relationship of different national regulatory structures in response to the internationalization of financial activity. The 1985 white paper did not address the external dimension of the program to complete the internal market, and the approach to treatment of third-country institutions has been developed in the context of individual directives. Although the Council has now adopted a common position on a reciprocity provision for banking services, some ambiguities remain. For purposes of entry and negotiations with the threat of retaliatory action, reciprocity appears, at a minimum, to mean reciprocal national treatment; the criteria also include the concept of effective market access, which, while ambiguous, may refer both to national treatment and to the liberalization of host-country financial structures. For purposes of negotiating goals without the threat of retaliatory action, the reciprocity provision appears to include not only the concept of effective market access but also the concept of treatment comparable to that of the home country. Such a goal could be viewed as the equivalent of an attempt to extend the principle of mutual recognition to countries outside the Community without having established on a more international basis the foundation for mutual recognition that exists within the Community.
If mutual recognition were to be used beyond the Community to achieve financial integration, agreements among nations on basic rules and on goals for regulatory convergence would be necessary. At present, mutual recognition is being explored as a basis for financial integration outside the Community only with regard to disclosure requirements for securities and only among countries in which existing rules may be sufficiently similar so that negotiated harmonization would not be necessary. Moreover, any agreements in this area, in contrast to those in banking and investment services, would involve primarily investor protection rather than safety and soundness. In the areas of banking, investment services, and insurance, national treatment, as embodied in the OECD Codes of Liberalisation and the National Treatment Instrument, is in general the currently accepted approach. Whether national treatment, effective market access, or some other concept may become the accepted approach if any agreement is reached on trade in financial services in connection with the current Uruguay Round of GATT negotiations remains to be seen.
Concerns have been expressed outside the Community that the EC internal market program for the financial sector could, in the worst case, impede both the internationalization of financial services and markets and the movement toward increased regulatory cooperation and convergence. For example, if some non-EC financial firms were to be placed at a competitive disadvantage in EC markets, pressures could be created for retaliatory measures in the firms' home countries. Within the Community, the program for completion of the internal market might be associated with increased political pressures for a more protectionist policy on external trade. Reciprocity provisions and other barriers to international trade in goods or services could be established and strictly interpreted as a political response to what is likely to be a difficult period of industrial restructuring during which efficient producers of goods or services increase their market share and inefficient producers (if not subsidized by their governments) are forced out.
One hopes however, that the internal market program will have beneficial effects externally as well as internally. In the financial sector, because the EC program is based on mutual recognition, which goes well beyond national treatment, completion of the internal market will create a coordinated regulatory framework for financial services and markets and thereby remove existing barriers to Communitywide competition that result from nondiscriminatory differences in national rules. Besides deregulation mandated by EC directives, actual or potential competition could create pressure for liberalization of rules in domestic markets that are currently highly regulated and restricted. Although it is possible that the EC reciprocity provisions could lead to the creation of new barriers for third-country institutions, it is also possible that the liberalizing measures being taken within the Community will serve as a catalyst for further international progress with regard to trade in financial services. To date, the internationalization of financial services and markets has both necessitated and facilitated increased regulatory and supervisory cooperation and coordination. The EC internal market program could be a significant contribution to this process.
Institutions of the European Community
The Commission is the executive branch of the European Community and has responsibility for proposing legislation and for ensuring implementation of EC law by the member states. Commissioners are appointed by agreement among the governments of the member states for four-year terms.
The Council of Ministers, which consists of representatives of the governments of the member states, is the decisionmaking body and enacts legislation proposed by the Commission. The presidency of the Council rotates among member states every six months. Participants at Council meetings change on the basis of the subject being considered. For example, if banking legislation is being considered, the Council participants are the economic and finance ministers. The "European Council" consists of the heads of state or government and meets semiannually.
The European Parliament, which is elected directly by the citizens of the member states, has an extremely limited legislative function. It does, however, have the final approval over the EC budget and over applications for membership in the Community and, with regard to other matters, a consultative role in Council decisions.
The European Court of Justice consists of thirteen judges appointed by agreement among the governments of the member states for six-year terms. In general, the Court has original jurisdiction in cases in which the Commission or another Community institution is a party. Other actions are brought in national courts but are referred to the European Court of Justice for preliminary rulings on matters of EC law; such rulings are binding on the national courts. (An EC Court of First Instance was created in 1988 to hear actions brought against Community institutions by EC staff or by private parties in certain technical areas; the European Court of Justice has appellate jurisdiction in such cases.)
Forms of EC legislation
EC legislation can be in the form of regulations or of directives. A regulation is binding in its entirety and is directly applicable throughout the Community without any implementing legislation by the member states. By contrast, a directive is addressed to the member states, which are obligated to ensure that the result set forth in the directive is achieved but have discretion as to the details of implementation.
Most of the EC internal market legislation is in the form of directives. Each directive specifies a date by which member states must conform their national laws to the provisions of the directive; typically the states have two years to do so. Therefore, to complete the internal market by the end of 1992, directives would need to be enacted by the Community by the end of 1990.
If a member state does not conform its laws in accordance with an EC directive, not only the EC Commission but also in many cases an individual or a company may take legal action against the member state. An individual or a company may invoke rights under EC law in national courts under the principle of "direct effects," which was developed by the European Court of Justice and has become an important mechanism for ensuring implementation of EC legislation.
The "cooperation procedure"
The cooperation procedure, which is used only for measures that may be adopted by a qualified majority of the Council, involves two readings of the legislation by the European Parliament. When the EC Commission submits a proposal to the Council, the proposal is also sent to the Parliament for a first reading. After obtaining Parliament's opinion and receiving any revisions proposed by the Commission, the Council adopts a "common position." The Council must then submit its common position to Parliament for a second reading.
If the Parliament accepts the proposal (or fails to act within three months), the Council must adopt the measure in accordance with its common position.
If the Parliament rejects the Council's common position, the Council may adopt the proposal only by a unanimous vote.
If the Parliament proposes amendments, within one month the Commission must reexamine the proposal and submit to the Council a revised proposal that either incorporates the Parliament's amendments or justifies their omission. The Council may adopt the Commission's revised proposal by a qualified majority. Unanimity is required for the Council to adopt Parliamentary amendments that were not accepted by the Commission or otherwise to amend the Commission's revised proposal. If the Council does not adopt the revised proposal within three months, the proposal is deemed not to have been adopted.
(1)The treaty that established the European Economic Community (EEC), which is one of three European Communities established under three separate treaties, is generally known as the Treaty of Rome. The European Coal and Steel Community was established by a 1951 Paris treaty, and the European Atomic Energy Community was established by another Rome treaty in 1957. The team European Community is commonly used to refer to all three European Communities; the EC institutions are common to all three Communities. (2)Commission of the European Communities, Completing the Internal Market: White Paper from the Commission to the European Council (Luxembourg: Office for Official Publications of the European Communities, 1985). (3)The term mutual recognition was used in the Treaty of Rome only with regard to professional qualifications. Specifically, the treaty called for the Council to issue directives for "the mutual recognition of diplomas, certificates and other evidence of formal qualifications." See Treaty Establishing the European Economic Community as Amended by the Single European Act (hereafter Treaty of Rome), art. 57. Treaties Establishing the European Communities, abridged ed. (Luxembourg: Office for Official Publications of the European Communities, 1987). (4)Rewe-Zentral AG v. Bundesmonopolverwaltung fur Branntwein (Cassis de Dijon), Case 120/78, 1979 Eur. Ct. Rpts. 649, 1979 Common Mkt. L. Rpts. 494. (5)The member states of the European Community are Belgium, Denmark, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, and the United Kingdom. (6)This authority is granted in the context of a provision requiring the Commission, together with each member state, to draw up during 1992 an inventory of national laws, regulations, and administrative provisions within the scope of the internal market program that have not been harmonized. See Treaty of Rome, art. 100b, added by article 19 of the Single European Act. See generally Jean De Ruyt, L'Acte Unique Europeen: Commentaire (Brussels: University of Brussels, Institute of European Studies, 1987). (7)The term cross-border services refers to the provision of services by a credit institution located in one member state to consumers of these services in another member state without the establishment of a branch in the host state. Within the European Community, before the recent series of measures to remove remaining exchange controls, such controls were a major barrier to the provision of banking services across borders. At present, some host-country restrictions on products or instruments, as well as national rules prohibiting the solicitation of business by foreign entities, also have the effect of limiting the provision of banking services a cross borders. (8)The listed activities are as follows: (1) accepting deposits or other payable funds from the public; (2) lending, including consumer credit, mortgage lending, factoring, and financing of commercial transactions; (3) financial leasing; (4) providing money transmission services; (5) issuing and administering means of payment (for example, credit cards, travelers checks, and bankers drafts); (6) issuing guarantees and commitments; (7) trading for own account or for account of customers in (a) money market instruments (checks, bills, certificates of deposit, and so forth), (b) foreign exchange, (c) financial futures and options, (d) exchange and interest rate instruments, and (e) securities; (8) participating in share issues and providing services related to such issues; (9) providing management consulting services and advice with respect to investments, mergers, and acquisitions; (10) money brokering; (11) providing portfolio management and advice; (12) safekeeping and administration of securities; (13) providing credit reference services; and (14) providing safe custody services. (9)The committee comprises the bank supervisory authorities from twelve major industrial countries: Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Sweden, Switzerland, the United Kingdom, and the United States. The Basle guidelines provide for partial implementation of minimum risk-adjusted capital ratios by year-end 1990 and full implementation by year-end 1992. (10)See generally Organisation for Economic Co-operation and Development, "Arrangements for the Regulation and Supervision of Securities Markets in OECD Countries," Financial Market Trends, vol. 4 1 (Paris: OECD, November 1988), pp. 17-38. (11)For a discussion of regulatory approaches to financial services, see Tommaso Padoa-Schioppa, "Th e Blurring of Financial Frontiers: In Search of an Order" (paper presented atCommission of the European Communities Conference on Financial Conglomerates, Brussels, March 14-15, 1988). (12)For an analysis of the different concepts of reciprocity and their relation to the approach of mutual recognition being used as the basis for integration within the Community, see Sydney J. Key, "Financial Integration in the European Community," section III.B.. (13)Under the comitology procedure used in this situation, the Commission must submit its proposed action to the Banking Advisory Committee, which consists of representatives of the central banks and finance ministries of the member states. If a qualified majority of the committee approves the Commission's proposed action, the Commission may proceed. If such approval is not obtained, the Commission must submit its proposal to the Council, which may either approve the measure by a qualified majority vote or amend the proposal by a unanimous vote. If the Council does not act within three months, the Commission may proceed--but only if a simple majority of the Council does not oppose the measure. (14)See, for example, Manuel Johnson, Vice Chairman, Board of Governors of the Federal Reserve System, "Altering Incentives in an Evolving Depository System: Safe Banking for the 1990s" (remarks before the Conference on Bank Structure and Competition, Federal Reserve Bank of Chicago, Chicago, Illinois, May 4, 1989); and M. Peter McPherson, Deputy Secretary of the Treasury, "Global Competition in Financial Servies: A View from Washington" (speech before the Fifth Annual San Francisco Institute of the National Center on Financial Services, University of California, Berkeley , March 2, 1989). (15)Some member states may continue to require certain securities activities to be conducted in subsidiaries; but, in contrast to the situation within the United States, such subsidiaries may be held by the bank itself and may be funded by the bank. (16)Re Insurance Services: EC Commission v. Germany, Case 205/84, 1987 Common Mkt. L. Rpts. 69; Re Co-insurance Services: EC Commission v. France, Case 220/83, 1987 Common Mkt. L. Rpts. 113; Re Co-insurance Services: EC Commission v. Ireland, Case 206/84, 1987 Common Mkt. L. Rpts. 150; Re Insurance Services: EC Commission v. Denmark, Case 252/83, 1987 Common Mkt. L. Rpts. 169. The cases also presented the issue of whether a host country could in effect ban the provision of cross-border services in insurance by requiring a company to have a permanent establishment in the host state. The Court held that "the requirement of a permanent establishment is the very negation of [the freedom to provide services]" and would require justification as an "indispensable requirement," a justification the Court found not to exist in this case. EC Commission v. Germany, 1987 Common Mkt. L. Rpts. at 107-08. Similarly, in the coinsurance cases, the Court also struck down requirements that the leading insurer have an establishment in the host state. (17)See Jacques Delors, President, European Commission, statement before the European Parliament regarding the Council meeting in Hanover (31 O.J. Eur. Comm. [Annex, No. 2-367] 137, July 6, 1988), and "The Main Lines of Commission Policy," statement before the European Parliament (Strasbourg, January 17, 1989). But see also Margaret Thatcher, Prime Minister, United Kingdom, speech at the College of Europe (Bruges, September 20, 1988).
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|Author:||Key, Sydney J.|
|Publication:||Federal Reserve Bulletin|
|Date:||Sep 1, 1989|
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