Description
In spite of considerable progress toward European capital market integration following the completion of the Single Market and the introduction of the Euro, national borders still constitute a considerable de facto barrier for retail financial markets.
EFR Study Benefits of a Working EU Market for Financial Services 1
Friedrich Heinemann
Mathias Jopp
The Benefits of a Working European Retail Market
for Financial Services
Report to European Financial Services Round Table
Executive Summary
Benefits of a Working EU Market for Financial Services
1. Introduction
In spite of considerable progress toward European capital market integration following the com-
pletion of the Single Market and the introduction of the Euro, national borders still constitute a
considerable de facto barrier for retail financial markets. Direct cross-border business between
financial service suppliers and end consumers is still the exception. Against this background this
report addresses the following questions:
– How powerful is the integrating effect of ongoing market trends like internet and cross-
border mergers and acquisitions?
– Which benefits could be realised if a higher level of integration could be achieved?
– Which obstacles are mainly responsible for incomplete integration?
2. Deficits of retail market integration
Although stringent legal impediments to cross-border activities in banking and insurance no
longer exist different indicators show a relatively low openness of national markets. The market
shares of foreign banks in individual EU countries are relatively small compared to other wealthy
industrial countries.
Entry into national banking markets is largely occurring through mergers and acquisitions
(M&A). Case studies on multinational banks reveal that factors like high fixed costs of market
entry make greenfield investment less attractive than M&A based access strategies.
The picture is not very different for the insurance sector where direct crossborder sales without
physical presence in the target market play only a marginal role. Again, cross-border M&As are
EFR Study Benefits of a Working EU Market for Financial Services 2
the predominant entry strategy. In addition, integration indicators show a markedly lower inte-
gration level for the life than for the non-life insurance market.
European fund market data on the number of registered foreign funds seems to indicate a larger
degree of integration. However, since many of these “foreign” funds are of the Luxembourg or
Dublin “round-trip” type, this indicator is misleading. Market shares of true foreign funds only
reach significant levels in big markets like Germany while some small markets are effectively
completely dominated by domestic fund suppliers.
The impact of the internet on the integration of retail markets for financial services does not meet
optimistic expectations even in the case of the most developed e-finance market, the market for
online brokerage. The analysis of price differences and direct cross-border activities dispells illu-
sions: although the internet is increasingly becoming an alternative distribution channel it does
not by itself overcome fragmentation of retail financial markets in the EU.
3. Potential integration benefits
The report advances the following arguments and quantified estimates on the beneficial conse-
quences of further integration of financial services markets for consumers and the economy in the
EU as a whole:
– Product choice would increase, in particular for consumers in small countries who today suf-
fer most from incomplete retail market integration. In these countries, the supply of available
funds for example could be augmented by a factor between 10 and 20.
– There is considerable scope for falling prices resulting from a higher integration level in fi-
nancial retail markets. Economies of scale could be realised. Calculations for the fund indus-
try indicate a large cost savings potential: on the assumption that integration would lead to an
average fund size in Europe similar to that of the US, there would be a cost saving potential
of about 5 billion Euro annually given the present size of the EU fund industry. These cost
savings would be particularly helpful in the ongoing European reforms of pension systems
since fund products will play an important role for funded old-age pensions.
– Private borrowers could benefit substantially through lower interest rates. A simulation for
the period of falling interest rates in the second half of the nineties shows: if competitive
pressure in a more closely integrated financial market forced banks to adjust mortgage inter-
est rates more quickly to falling market rates private borrowers would benefit. In terms of a
100,000 Euro mortgage loan these integration savings in interest payments would have
amounted in the period 1995–1999 to annually 2,550 Euro in Italy, 1,690 Euro in Spain,
1,580 Euro in Portugal and 790 Euro in Ireland.
– Retail market integration would probably also reduce the well-known home bias in private
investors’ portfolios. Performance calculations for national, European and world portfolios
show that investors could significantly increase the Sharpe ratios of portfolios. Often the
Europe-wide diversification is already sufficient to harvest all the benefits of international di-
versification.
– Furthermore, a larger degree of financial integration would be associated with higher eco-
nomic growth. Theoretical considerations and insights from the relevant empirical literature
back the assumption of a significant link between financial integration and growth. World-
wide cross-country samples show that differences in financial integration between countries
EFR Study Benefits of a Working EU Market for Financial Services 3
amounting to one standard deviation of the relevant integration indicators can explain annual
growth differences of 0.5 – 0.7 per cent. Although these results do not cover all present EU
member states they indicate roughly the potential for growth through financial integration: in
terms of the EU GDP of the year 2000 the lower per cent figure of 0.5 would mean an addi-
tional growth effect of 43 billion Euro annually. A quantification of potential employment ef-
fects associated with more financial integration is difficult to make. They crucially depend on
the flexibility of labour markets and the progress in labour market reforms.
– Finally, more financial integration is rewarded by a growing international role of the Euro
because the efficiency of a currency’s financial markets is among the determinants of its
global acceptance. A greater acceptance of the Euro could in turn lead to additional benefits
due to higher seigniorage, falling liquidity premiums and transaction costs.
4. Obstacles
A number of obstacles impedes the development of unified financial retail markets in Europe.
There are policy-induced obstacles like different taxation, consumer protection or supervision
arrangements that are capable of alteration, and there are natural obstacles like differences in lan-
guage and culture that can not realistically be addressed by national or European policymakers.
The impact of the different types of obstacles varies according to product type.
– For insurance products, a lack of confidence in the long-run reliability of unknown foreign
suppliers is a particularly relevant obstacle. Furthermore, discriminatory tax practices and na-
tional differences in consumer protection due to different national policies and interpretations
of the “general good” are important obstacles in the insurance business.
– The internet-based financial retail business is confronted with the following obstacles in
cross-border activities: the need to design a variety of national marketing strategies, market
peculiarities related to regulatory differences in consumer protection and supervision, the
high costs of cross-border payments, the problems of cross-border identification of new cus-
tomers, the heterogeneity of technical systems of stock exchanges and the consumer prefer-
ence for “handshake”, the physical meeting with the agent of a new supplier.
– Since successful management of asymmetric information problems is crucial for successful
credit business, limited cross-border access to public credit registers and private credit bu-
reaux is a particular integration obstacle for the credit market.
– For funds the outdated definition of UCITS in the directives limits crossborder marketing of
innovative fund products. In addition, the burden of registration in a target market raises the
costs for entering a national market. Furthermore, host country responsibility for supervision
of advertising and marketing together with tax discriminations hamper the emergence of a
unified fund market. The problems are aggravated by distribution channels that are still bi-
ased in favour of domestic fund companies.
– There is the danger that new obstacles are created as a consequence of national pension re-
forms. The German example shows that very specific national requirements on new pension
products can constitute additional barriers to entry for foreign suppliers.
EFR Study Benefits of a Working EU Market for Financial Services 4
5. Some policy conclusions
A strategy based on an attitude of “wait and see” is not justified because ongoing market trends
indicate that integration is unlikely to be completed without adjustments to the regulatory frame-
work. The substantial potential benefits for consumers and economic growth clearly show that it
is worthwhile to push hard for more integration of retail financial markets. Any integration strat-
egy should aim to simplify direct cross-border contact between suppliers and consumers.
This contact would speed up convergence of prices and promote a wider product choice every-
where in the EU. The need for political action also comes from the delicate fact that the “costs of
non-Europe” are higher in smaller and poorer member countries than in the bigger and richer
ones. While the Financial Services Action Plan and other legal initiatives properly address a
number of integration obstacles, more needs to be done. Proposals for reforms are listed below.
This is not an exhaustive list of recommendations. It briefly addresses the most burning issues; a
detailed specification of the reform options would certainly need further analysis.
– It is important to devote more effort to ending discriminatory tax practices that currently
shelter some national retail financial markets from foreign competition, and which do not
conform with the EU Treaty. Examples concern the markets for life insurance and investment
funds.
– Differences in consumer protection rules among the 15 EU countries render a pan-European
marketing strategy and standardised products impossible. This issue is a critical policy-
induced obstacle and could best be addressed by the creation of a consistent uniform level of
protection with harmonisation on that basis. Three specific recommendations are:
· The debate on derogation from the principle of home country control in the e-commerce
directive should be reopened.
· Furthermore, the interpretation of the “general good” provision should be harmonised
and/or restricted.
· There is a need to arrive at a unified definition of pension products in order to improve the
conditions for developing a pan-European market for this high potential market segment.
– With FIN-NET the Commission has initiated an important infrastructure for creating con-
sumer confidence in the legal safety of cross-border financial services. However, the exis-
tence of FIN-NET so far is not common knowledge. An information campaign is necessary to
make this network of European ombudsmen better known and better understood, at least to
the financial media and the staff of banks and insurers.
– With regard to supervision, there are short-, medium- and long-term options:
· In the short-run it would be helpful if the supervisory committees devoted more effort to
the consistency of rule-books, the standardisation of reporting requirements and the har-
monisation of supervisory practice.
· In the medium-term a serious reform debate should be initiated, reflecting the possible
advantages of a two tier supervisory system where multinational companies could opt for
supervision on a European level.
· With a long-term perspective, more thought could be given to the possibility of estab-
lishing a single European supervisory authority, especially if effective cooperation among
25 to 30 national agencies after enlargement proves to become too difficult.
EFR Study Benefits of a Working EU Market for Financial Services 5
– There is a huge gap between the vision of the EU as the most dynamic economy in the world
and the reality of still fragmented EU-markets. In order to reduce this gap, the whole process
of European regulation of financial services needs to be speeded up and member-states have
to overcome their national policies of preserving market barriers or even re-establishing new
ones. Otherwise it will be impossible to achieve the strategic objective of the Lisbon-process
of a more deeply integrated European Union which will be able to match the challenges of
globalization and to secure full employment by 2010.
– Finally, while the study has shed light on important aspects of the enduring “cost of non-
Europe” further analysis is required. Two issues deserve to be looked at more closely given
their enormous complexity: First, the implication of national pension reforms for integration
and second, the adjustment of consumer protection regulation to the changing needs of the
internal financial retail market.
doc_347598434.pdf
In spite of considerable progress toward European capital market integration following the completion of the Single Market and the introduction of the Euro, national borders still constitute a considerable de facto barrier for retail financial markets.
EFR Study Benefits of a Working EU Market for Financial Services 1
Friedrich Heinemann
Mathias Jopp
The Benefits of a Working European Retail Market
for Financial Services
Report to European Financial Services Round Table
Executive Summary
Benefits of a Working EU Market for Financial Services
1. Introduction
In spite of considerable progress toward European capital market integration following the com-
pletion of the Single Market and the introduction of the Euro, national borders still constitute a
considerable de facto barrier for retail financial markets. Direct cross-border business between
financial service suppliers and end consumers is still the exception. Against this background this
report addresses the following questions:
– How powerful is the integrating effect of ongoing market trends like internet and cross-
border mergers and acquisitions?
– Which benefits could be realised if a higher level of integration could be achieved?
– Which obstacles are mainly responsible for incomplete integration?
2. Deficits of retail market integration
Although stringent legal impediments to cross-border activities in banking and insurance no
longer exist different indicators show a relatively low openness of national markets. The market
shares of foreign banks in individual EU countries are relatively small compared to other wealthy
industrial countries.
Entry into national banking markets is largely occurring through mergers and acquisitions
(M&A). Case studies on multinational banks reveal that factors like high fixed costs of market
entry make greenfield investment less attractive than M&A based access strategies.
The picture is not very different for the insurance sector where direct crossborder sales without
physical presence in the target market play only a marginal role. Again, cross-border M&As are
EFR Study Benefits of a Working EU Market for Financial Services 2
the predominant entry strategy. In addition, integration indicators show a markedly lower inte-
gration level for the life than for the non-life insurance market.
European fund market data on the number of registered foreign funds seems to indicate a larger
degree of integration. However, since many of these “foreign” funds are of the Luxembourg or
Dublin “round-trip” type, this indicator is misleading. Market shares of true foreign funds only
reach significant levels in big markets like Germany while some small markets are effectively
completely dominated by domestic fund suppliers.
The impact of the internet on the integration of retail markets for financial services does not meet
optimistic expectations even in the case of the most developed e-finance market, the market for
online brokerage. The analysis of price differences and direct cross-border activities dispells illu-
sions: although the internet is increasingly becoming an alternative distribution channel it does
not by itself overcome fragmentation of retail financial markets in the EU.
3. Potential integration benefits
The report advances the following arguments and quantified estimates on the beneficial conse-
quences of further integration of financial services markets for consumers and the economy in the
EU as a whole:
– Product choice would increase, in particular for consumers in small countries who today suf-
fer most from incomplete retail market integration. In these countries, the supply of available
funds for example could be augmented by a factor between 10 and 20.
– There is considerable scope for falling prices resulting from a higher integration level in fi-
nancial retail markets. Economies of scale could be realised. Calculations for the fund indus-
try indicate a large cost savings potential: on the assumption that integration would lead to an
average fund size in Europe similar to that of the US, there would be a cost saving potential
of about 5 billion Euro annually given the present size of the EU fund industry. These cost
savings would be particularly helpful in the ongoing European reforms of pension systems
since fund products will play an important role for funded old-age pensions.
– Private borrowers could benefit substantially through lower interest rates. A simulation for
the period of falling interest rates in the second half of the nineties shows: if competitive
pressure in a more closely integrated financial market forced banks to adjust mortgage inter-
est rates more quickly to falling market rates private borrowers would benefit. In terms of a
100,000 Euro mortgage loan these integration savings in interest payments would have
amounted in the period 1995–1999 to annually 2,550 Euro in Italy, 1,690 Euro in Spain,
1,580 Euro in Portugal and 790 Euro in Ireland.
– Retail market integration would probably also reduce the well-known home bias in private
investors’ portfolios. Performance calculations for national, European and world portfolios
show that investors could significantly increase the Sharpe ratios of portfolios. Often the
Europe-wide diversification is already sufficient to harvest all the benefits of international di-
versification.
– Furthermore, a larger degree of financial integration would be associated with higher eco-
nomic growth. Theoretical considerations and insights from the relevant empirical literature
back the assumption of a significant link between financial integration and growth. World-
wide cross-country samples show that differences in financial integration between countries
EFR Study Benefits of a Working EU Market for Financial Services 3
amounting to one standard deviation of the relevant integration indicators can explain annual
growth differences of 0.5 – 0.7 per cent. Although these results do not cover all present EU
member states they indicate roughly the potential for growth through financial integration: in
terms of the EU GDP of the year 2000 the lower per cent figure of 0.5 would mean an addi-
tional growth effect of 43 billion Euro annually. A quantification of potential employment ef-
fects associated with more financial integration is difficult to make. They crucially depend on
the flexibility of labour markets and the progress in labour market reforms.
– Finally, more financial integration is rewarded by a growing international role of the Euro
because the efficiency of a currency’s financial markets is among the determinants of its
global acceptance. A greater acceptance of the Euro could in turn lead to additional benefits
due to higher seigniorage, falling liquidity premiums and transaction costs.
4. Obstacles
A number of obstacles impedes the development of unified financial retail markets in Europe.
There are policy-induced obstacles like different taxation, consumer protection or supervision
arrangements that are capable of alteration, and there are natural obstacles like differences in lan-
guage and culture that can not realistically be addressed by national or European policymakers.
The impact of the different types of obstacles varies according to product type.
– For insurance products, a lack of confidence in the long-run reliability of unknown foreign
suppliers is a particularly relevant obstacle. Furthermore, discriminatory tax practices and na-
tional differences in consumer protection due to different national policies and interpretations
of the “general good” are important obstacles in the insurance business.
– The internet-based financial retail business is confronted with the following obstacles in
cross-border activities: the need to design a variety of national marketing strategies, market
peculiarities related to regulatory differences in consumer protection and supervision, the
high costs of cross-border payments, the problems of cross-border identification of new cus-
tomers, the heterogeneity of technical systems of stock exchanges and the consumer prefer-
ence for “handshake”, the physical meeting with the agent of a new supplier.
– Since successful management of asymmetric information problems is crucial for successful
credit business, limited cross-border access to public credit registers and private credit bu-
reaux is a particular integration obstacle for the credit market.
– For funds the outdated definition of UCITS in the directives limits crossborder marketing of
innovative fund products. In addition, the burden of registration in a target market raises the
costs for entering a national market. Furthermore, host country responsibility for supervision
of advertising and marketing together with tax discriminations hamper the emergence of a
unified fund market. The problems are aggravated by distribution channels that are still bi-
ased in favour of domestic fund companies.
– There is the danger that new obstacles are created as a consequence of national pension re-
forms. The German example shows that very specific national requirements on new pension
products can constitute additional barriers to entry for foreign suppliers.
EFR Study Benefits of a Working EU Market for Financial Services 4
5. Some policy conclusions
A strategy based on an attitude of “wait and see” is not justified because ongoing market trends
indicate that integration is unlikely to be completed without adjustments to the regulatory frame-
work. The substantial potential benefits for consumers and economic growth clearly show that it
is worthwhile to push hard for more integration of retail financial markets. Any integration strat-
egy should aim to simplify direct cross-border contact between suppliers and consumers.
This contact would speed up convergence of prices and promote a wider product choice every-
where in the EU. The need for political action also comes from the delicate fact that the “costs of
non-Europe” are higher in smaller and poorer member countries than in the bigger and richer
ones. While the Financial Services Action Plan and other legal initiatives properly address a
number of integration obstacles, more needs to be done. Proposals for reforms are listed below.
This is not an exhaustive list of recommendations. It briefly addresses the most burning issues; a
detailed specification of the reform options would certainly need further analysis.
– It is important to devote more effort to ending discriminatory tax practices that currently
shelter some national retail financial markets from foreign competition, and which do not
conform with the EU Treaty. Examples concern the markets for life insurance and investment
funds.
– Differences in consumer protection rules among the 15 EU countries render a pan-European
marketing strategy and standardised products impossible. This issue is a critical policy-
induced obstacle and could best be addressed by the creation of a consistent uniform level of
protection with harmonisation on that basis. Three specific recommendations are:
· The debate on derogation from the principle of home country control in the e-commerce
directive should be reopened.
· Furthermore, the interpretation of the “general good” provision should be harmonised
and/or restricted.
· There is a need to arrive at a unified definition of pension products in order to improve the
conditions for developing a pan-European market for this high potential market segment.
– With FIN-NET the Commission has initiated an important infrastructure for creating con-
sumer confidence in the legal safety of cross-border financial services. However, the exis-
tence of FIN-NET so far is not common knowledge. An information campaign is necessary to
make this network of European ombudsmen better known and better understood, at least to
the financial media and the staff of banks and insurers.
– With regard to supervision, there are short-, medium- and long-term options:
· In the short-run it would be helpful if the supervisory committees devoted more effort to
the consistency of rule-books, the standardisation of reporting requirements and the har-
monisation of supervisory practice.
· In the medium-term a serious reform debate should be initiated, reflecting the possible
advantages of a two tier supervisory system where multinational companies could opt for
supervision on a European level.
· With a long-term perspective, more thought could be given to the possibility of estab-
lishing a single European supervisory authority, especially if effective cooperation among
25 to 30 national agencies after enlargement proves to become too difficult.
EFR Study Benefits of a Working EU Market for Financial Services 5
– There is a huge gap between the vision of the EU as the most dynamic economy in the world
and the reality of still fragmented EU-markets. In order to reduce this gap, the whole process
of European regulation of financial services needs to be speeded up and member-states have
to overcome their national policies of preserving market barriers or even re-establishing new
ones. Otherwise it will be impossible to achieve the strategic objective of the Lisbon-process
of a more deeply integrated European Union which will be able to match the challenges of
globalization and to secure full employment by 2010.
– Finally, while the study has shed light on important aspects of the enduring “cost of non-
Europe” further analysis is required. Two issues deserve to be looked at more closely given
their enormous complexity: First, the implication of national pension reforms for integration
and second, the adjustment of consumer protection regulation to the changing needs of the
internal financial retail market.
doc_347598434.pdf