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European Union unravels

05 July 2005  |  3577 views  |  0 Source: Chris SKinner, TowerGroup Chris Skinner BW

The euro is facing its most serious challenge since its inception in 1999 and, as a result, so is Sepa and the Financial Services Action Plan, says Chris Skinner

A critical component of Europe’s plans to be an economic powerhouse is to achieve a single, integrated financial market. This plan is being driven by 42 Directives which, combined, are known as the Financial Services Action Plan (FSAP). However, there has actually been little progress towards this unification of the financial markets. This may be viewed as bank resistance or, more likely, a fundamental question around the overall objectives of where Europe is heading. In light of the rejection of the European Constitution and the consequent political fall-out at the EU Budgetary meeting, is any of this worth discussing anyway?


When the European Commission introduced the concept of the euro currency, it implied a lot more than just dropping the French franc, the German mark and the Spanish peseta. There were cultural and infrastructural changes, as well as a need to change practices to enable transparent movement of currencies across borders. This need became a focused desire amongst European leadership to create a single financial market across the Euro-zone. This market would be the cornerstone foundation for making Europe a leading global economy by 2010.

After consultation with the industry, it was soon realised that creating such an integrated marketplace would not be simple. For example, it would require a complete restructuring of virtually all financial market activities within the region, from mergers and acquisitions to securities and settlements, from electronic transfers between deposit accounts to insurance sales.

Such change would not be simple, as domestic financial institutions had been making significant margins through cross-border activities for many years. These margins were not just represented by currency transaction handling, but any movement of financial instruments across borders from making a payment electronically to dealing in equities across different exchanges. If the European Commission were to make the European Financial Markets behave as one, then they would face considerable resistance. First, because it would imply significant infrastructural change and, therefore, cost. Second, because the nature of such change would be to reduce margins and profitability.

The only way to achieve change that requires increasing cost for reduced returns is to force it through via legislation, which is exactly what the European Commission realised when they created a set of legislative changes in the form of the Financial Services Action Plan, or FSAP.

The European Commission produced the first FSAP Consultation on 11 May 1999, as the euro was born. The Plan has three major objectives:
  • to create a single market for wholesale financial services
  • to provide an open and secure retail market
  • to establish leadership through a Eurozone-wide set of rules and regulation


The FSAP was subsequently adopted by the European Council in Lisbon in March 2000 and has been an ongoing source of discussion and dialogue, meeting and mediation, conference and consideration ever since.

For example, the plan now incorporates 42 regulatory directives, most of which have been accepted by governments but some are still to be implemented by the financial industry. For those who were not aware, here is a brief list of some of those key Directives:
  • Directive on Transparency Obligations for Securities Issuers
  • Directive on Investment Services and Regulated Markets (Upgrade Investment Services Directive)
  • Directive on Takeover Bids
  • Legal Framework for Payments Directive
  • 10th and 14th Company Law Directives
  • Risk-Based Capital Directive
  • Third Money-Laundering Directive
  • Directive on Insider Dealing and Market Manipulation (Market Abuse)
  • Regulation on the Application of International Accounting Standards
  • Directive on Financial Collateral Arrangements
  • Two Directives on UCITS
  • Directive on the Prudential Supervision of Pension Funds
  • Directive on the Distance Marketing of Financial Services
  • Directive on Insurance Mediation
  • Directive on the Reorganisation and Winding-Up of Insurance Undertakings
  • Directive on the Winding-Up and Liquidation of Banks
  • Electronic Money Directive
  • Directive on the Supplementary Supervision of Credit Institutions, Insurance Undertakings and Investment Firms in a Financial Conglomerate
  • Directive on Prospectuses
  • the Money Laundering Directive
  • the Investment Services Directive (ISD)


No wonder Europe’s financial institutions feel battered and beaten by regulation.

Add onto these Basel II, Sarbanes-Oxley and the domestic regulatory changes – such as the UK FSA’s recent changes to insurance company reporting and brokerage commissions – and you have a real mix of confusion, consternation and irritation caused by these regulatory overheads.

Nevertheless, by the end of last year, 39 of the 42 recommendations had been adopted by the governments of the European countries. Of these the two that are of most interest, as they imply the most significant changes in the next three years, are Sepa and MiFID.

Sepa – the Single Euro Payments Area – is not actually a Directive but a vision, although it will be recognised through the New Legal Framework for the Internal Markets, Directive sometime next year. Sepa represents the European Commission’s desire to have all euro payments treated as though they were being made within one country area (rather than twelve). As a result, all euro payments will be charged and processed as though they were domestic payments in the Eurozone countries.

Initially, that resulted in a lowering of margins. For example, the bank could no longer charge non-domestic customers €4 for withdrawing €100 from a euro cash machine (see Finextra, January: The future of European payments). Now, it looks like involving a lot more than just reduced margins.

As existing national clearing systems are dismantled, and new infrastructures come into play, the banking industry is faced with a significant bill to conform to the new Eurozone clearing and settlement systems and strucutres. For example, Target2, PE-ACH and PE-DD are all due to be in operation in 2008. As a result, most banking payments organisations will require some refreshment to move away from existing domestic ACH’s to the new structures. TowerGroup estimate that European banks will therefore need to increase spending on Payments Infrastructures from $6 billion per annum in 2005 to $10.5 billion in 2007-8 to achieve these infrastructural change requirements for Sepa, and at least half of this spend will be on new functionality to cope with the Sepa vision.

All that for increasing competition and reducing margin? Makes sense oui?

Similarly, MiFID is the Markets in Financial Instruments Directive due for implementation in 2007 after being pushed back six months (see Finextra, July: Best execution with best intentions).

MiFID implies massive changes to the sell-side operators’ business because it states that all investment banks, broker-dealers and securities firms must now prove best execution for all trades enacted on their clients’ behalf. In order to prove best execution, under MiFID’s terms, all organisations trading in Europe will need to keep all of the prices for all of the exchanges and sellers for all of the instruments that they deal in, throughout the day in real time and online, for the next five years.

This will create a need for huge amounts of storage and bandwidth. By way of example, JPMorgan Chase stated in 2004 that it backs up over a terabyte of communications per day for SEC purposes. Under MiFID, the bank will probably need to be storing petabytes (one million gigabytes) per day rather than terabytes. However, this is not an issue as storage is cheap, and getting cheaper by the day. As is bandwidth via Internet protocol communication systems.

A corollary implication of MiFID is not so easy to deal with as MiFID implies deeper shifts in market structures and pricing. For example, many investment bankers believe that MiFID will create a transparent playing field where buyers will be able to see all the pricing for equities and other investment instruments simply and easily. That is the intention of the Directive. As a result, sell-side banks will no longer be able to trade profitably off their own book, and margins will be squeezed until only a few key players exist. Those players will be the ones with European size and scale, who already operate a transparent book of business and know how to leverage technology to manage change. There are at most eight banks that fit that profile.

In fact, TowerGroup estimate that, under current terms and conditions of MiFID, it will cost European providers upwards of €5 billion to comply with this Directive to cover all of the infrastructural changes and the warehousing of data therein.

All that for increasing competition and reducing margin? It does not make sense, non.

So, should we be ‘oui’ or ‘non’ for the Financial Services Action Plan?

Well, if Europe were to continue in its formation as of 2004, then the FSAP made political sense. However, with the recent ‘non’ and ‘nee’ votes in France and Netherlands to the European Constitution, combined with the political in-fighting and back-biting of the EU leadership as seen at the Brussels EU budgetary meeting, then no, it does not make sense.

In particular, there are questions that are being raised more fundamentally around the euro’s future as a result of these recent developments. First, there was Germany’s Stern magazine reporting that the Bundesbank and German Finance Ministry were discussing scenario’s for moving forward if the euro should collapse and the Deutschemark needed resurrecting. Meanwhile, you have a political party now formed in Italy – the Northern Leagues – whose explicit focus is to destroy the euro. Add on to this Europe’s economic challenges in terms of unemployment, zero growth and fractious politics, and we see the results with an 11% drop in the value of the euro against the dollar in the first half of 2005.

The result is that the euro is facing its most serious challenge since its inception in 1999 and, as a result, so is Sepa and the FSAP.

Between the euro regulators managing 42 Directives into the financial markets and the euro politicians losing referendums and tempers, it is going to be interesting to see what happens over the next three years. In particular, what will happen to the FSAP?

The answer is that there are some real obstacles to overcome if the FSAP is to achieve the change to the industry it is attempting to mandate.

The first obstacle is the legitimacy of the nature of these Directives when Europe and the euro’s future are uncertain. Is it really worth shaking the industry up so hard when it may all be thrown to one side?

The second is the aggressive timelines for these Directives. Are banks really expected to be compliant with MiFID by April 2007 when the rules will not be issued with enough detail for implementation until the end of 2006?

The third will be the alignment of the pieces required to make the FSAP happen. How can a bank implement Pan European Payments Infrastructures when there is no legal framework in place to support them?

All of these obstacles can be overcome. However, with the European political landscape looking far more extreme than seen since Maastricht, it may be worth waiting a while before we tackle them.

Chris Skinner is a director of TowerGroup and founder of ShapingTomorrow.com.
Web links: www.towergroup.com and www.shapingtomorrow.com
Author's email: Chris Skinner

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