March 9, 2006
JS-4106

Remarks of
Deputy Assistant Secretary for International Monetary
and Financial Policy Mark Sobel
U.S. Treasury Department
At the European Union Studies Center
Graduate Center, City University of New York
“Finding Common Ground: Inside the
US-EU Financial Dialogue”

It is a great pleasure to speak to the European Union Studies Center of the City University of New York.  I thank Dr. Kaufmann for graciously inviting me and for his kind introductory words. 

Tonight, I would like to speak about a process I have been involved in for four years – the US-EU Financial Market Regulatory Dialogue (Dialogue).  It is a good process.  It is a nitty-gritty process.  Many observers who have delved into its details have found the agenda – not to be pejorative – slightly soporific.  Be that as it may, the Dialogue is important, and the stakes are large for global financial markets.  Let me tell you about the international setting for the Dialogue; its history and objectives; the agenda, its importance and the challenges ahead; and the process.

The International Setting

The US-EU Dialogue is a product of the transformation sweeping global financial markets.  Cross-border global capital flows are growing exponentially and new financial products, which enhance welfare, are being invented every year. 

Financial sector consolidation is taking hold.  In the United States, interstate banking and consolidation have become a reality. Glass Steagall gave way to Gramm-Leach-Bliley.  A wave of consolidation has swept major banks, and a handful of banks hold the bulk of the system's assets and are responsible for nearly all international activity.  In Japan, many major banks have given way to three mega-banks.  In Europe, large banks such as HSBC, Deutsche Bank, BNP, and ING are global players.  Though intra-European bank consolidation has far to go, progress is being made with the strong backing of EU Internal Markets Commissioner McCreevy.  It is seen in the transactions between the Spanish bank, Santander, and the UK bank, Abby; the Italian bank, Unicredito, and the German bank HVB; and the infamous Banco Antonveneta takeover by ABN Amro.

Securities markets are being transformed.  Stock market trading around the world is going electronic.  Exchanges are merging.  OTC trading is growing.  The distinctions between banking and securities business are further eroding.  Securities regulation and corporate governance are being revolutionized, as seen in the Sarbanes-Oxley legislation and the National Market Structure Review in the U.S., and in the Markets in Financial Instruments Directive (MIFID) and the Corporate Governance Action Plan in Europe. 

The EU, following the advent of the euro, launched a bold Financial Services Action Plan – the FSAP – aimed at creating an integrated pan-European financial market.  The FSAP's dramatic vision is no less than to take 25 different financial regimes and fuse them into one in a mere decade.  The stakes are clear – several studies have concluded that full implementation of the FSAP would raise the EU's growth rate by one percentage point plus in a decade's time – that's about $130 billion per annum in current dollars.  Strong European growth is essential for Europe to manage its economic destiny, and to lessen the world's unhealthy reliance on the U.S. economic engine.  The United States is a strong supporter of the FSAP, and anchoring it in the global financial system.

Regulation is inherently a national activity aimed at promoting financial stability and investor protection.  But it should be as "light" as possible to accomplish its objectives; it should encourage market discipline, and not stifle market dynamism. It also must take globalization into account.  Global firms face different legal and financial regimes in each country of operation and this can prove costly.  They would prefer one set of rules to apply to their business.  In this connection, regulators have strengthened their cooperation in global standard-setting bodies – including the Basle Committee on Banking Supervision, the International Organization of Securities Commissions, and the International Association of Insurance Supervisors.     

This is a cursory list.  But the bottom line is that these changes are having profound effects on the global financial system, capital flows, and the daily lives of policy-makers.  

The Dialogue – History, Objectives 

The Dialogue began four years ago. The participants in that meeting had no clue as to what that gathering would spawn during the next four years. 

On the U.S. side, I have chaired the Dialogue on behalf of Treasury, along with my wonderful and outstanding colleagues from the SEC and Fed; other agencies, especially the National Association of Insurance Commissioners (NAIC), have participated on an ad hoc basis.  It is a team effort.  The European Commission staff represents Europe. 

The initial gathering involved SEC and Fed presentations to European regulators on how U.S. regulators conducted consolidated supervision, as a means of helping Europe reach a judgment that U.S. supervision was "equivalent" for the purposes of the EU Financial Conglomerates Directive (FCD).  Absent such a judgment, U.S. firms operating in Europe would have been forced to undertake complex and costly legal changes in their organizational structures and deploy capital inefficiently.  The U.S. also engaged the Commission in a broader review of the FSAP and its global impacts.  Likewise, the Commission asked about U.S. financial sector developments. 

Shortly thereafter, Enron and World Com hit U.S. financial markets. Sarbanes-Oxley ensued.  Just as the FCD had ramifications for U.S. firms' operations, so Sarbanes-Oxley had spillover effects on European firms.  We met again, and then again and again.

We realized early on that we shared the common objective of helping facilitate the smooth functioning of global capital markets.  But we also recognized that we did things differently because of diverse legal, historical and cultural traditions.  Our first challenge was to manage spillover effects in order to achieve our common objectives.  

Since that time, the technical teams have met two to four times a year and reviewed: FSAP measures and U.S. financial sector developments and their global impacts; common international financial issues such as hedge funds and credit rating agencies; and our dialogues with other quarters of the world.  Participants see and communicate with each other throughout the year.  Our technical discussions have become "virtual".

Pulling together some of these strands, what do I see from the U.S. perspective as the key objectives that discussion in the Dialogue can help promote?

• Promoting strong growth, both globally and in Europe.
•  Facilitating movement toward greater convergence of U.S., EU and global financial market policies and regulation around high quality practices.
•  Helping Europe fuse 25 financial systems into one, and anchoring European financial markets in the global system.
•  Managing spillovers.
• Ensuring that U.S. firms face a level playing field in Europe.

The Agenda and Its Importance

The U.S. and the EU are the world's largest two economic areas.  Capital movements between them are enormous.  As Bernhard Speyer laid out in an excellent Deutsche Bank Research publication last November:

•  In 2003, the EU and U.S. accounted for 80 percent of the world's FDI outflows and 60 percent of the inflows.
•  60 percent of U.S. foreign corporate assets are in Europe and 75 percent of Europe's are in the U.S.
•  The EU and U.S. together account for two-thirds of global stock market capitalization and bonds outstanding worldwide.
• The Securities Industry Association of America finds that its largest members receive 20 percent of their net revenues from Europe and employ 35,000 Europeans.

The issues the Dialogue grapples with are at the cutting edge of the global financial landscape, and both sides have their concerns.  Let me start with a few the U.S. has raised, and in doing so, let me underscore that while I will remark on aspects of banking and securities issues, these issues are solely in the domain of our independent regulators.  

Financial Conglomerates Directive (FCD): The FCD was discussed for two plus years in the Dialogue. These discussions informed the SEC's rule proposal formalizing the SEC's supervision of broker dealers on a consolidated group-wide basis.  The Office of Thrift Supervision also is now playing a lead supervisory role in the context of the FCD. 

Transparency:   Two of the initial FSAP measures were released without adequate consultations with market participants.  The U.S. observed that while regulators must ensure appropriate investor protection, they are always a step behind dynamic markets, that market participants know their business better, that good rule-making requires open consultations, and that if afforded an opportunity to weigh into the process participants are more likely to buy into the final product.  Since then, the Commission has become more transparent and open to consultation.  I have actually heard market players fret about consultation fatigue.  Better consultation fatigue than consultation deprivation.  

MIFID:  MIFID will govern the execution of investor transactions by exchanges, other trading systems, and investments firms in Europe.  Firms will then have a "passport" to operate EU-wide on the basis of home supervisory authority.  MIFID's enormity is obvious.  Some European countries required that any securities trading take place on exchanges – the so-called "concentration rule".  Others allowed firms to "internalize" transactions, a practice familiar in the UK and the United States.  In the end, after much debate, a delicate compromise was reached allowing "internalization" throughout the EU and putting the "concentration rule" aside.  This was progress.  Not surprisingly, since then there has been continued active discussion about the conditions under which internalization could take place.   The U.S. side has monitored this debate.  The devil lies in the details.  We stressed in the Dialogue that the goal is about rewarding innovation and allowing regulation to support different market practices in a neutral manner and that the terms under which internationalization is permitted are critical for the future vibrance of European financial markets.  Brussels agrees.

The Commission has raised many issues with us.

Sarbanes-Oxley (SOX):  As Secretary Snow has stated, SOX came quickly upon us, but it was a necessary response to serious corporate governance weaknesses in the U.S.  SOX did indeed give rise to spillover effects, and in its wake, the SEC thoroughly discussed with the EC such issues as auditor independence, loans to bank executives and directors, certification of financial statements by CEOs and CFOs, auditing of internal controls, and standards related to audit committees.  While the letter and spirit of SOX were fully observed, EU concerns were generally accommodated.  The PCAOB and the Europeans are working out arrangements for cooperation on inspections.

Accounting Equivalence:  In 2002, Europe took the dramatic step of requiring all EU publicly listed companies to adopt International Financial Reporting Standards (IFRS) in preparing their financial statements for years ending in 2005 and beyond.  Information requirements in various EU directives permit non-EU issuers to publish financial statements based on accounting standards other than IFRS, if the European Commission has deemed these standards "equivalent".  U.S. firms for decades have listed in Europe on the basis of financial statements using U.S. GAAP.  Unless the EC acts, however, starting in January 2007, U.S. firms listed in Europe will be required to "reconcile" U.S. GAAP financial information to IFRS.  

Non- U.S. issuers listed on U.S. exchanges which publish financial information on the basis of accounting standards other than U.S. GAAP have long been required by the SEC to "reconcile" their financial information to U.S. GAAP.  U.S. firms listed on European exchanges clearly do not want a reconciliation requirement to arise.  And Europeans have questioned why the SEC could not accept IFRS statements going forward for public listings, especially as it was expensive to reconcile existing statements to U.S. GAAP? 

Last year, then SEC Chairman Donaldson and Charlie McCreevy agreed on a landmark "roadmap" for the United States to accept IFRS statements as a basis for U.S. public listings as early as 2007 and no later than 2009.  SEC Chairman Cox recently confirmed this agreement.  In the "roadmap," the SEC set forth several markers, especially the consistent implementation and enforcement of IFRS across the 25 member states.

Discussion has arisen as to how to handle the question of equivalence for U.S. GAAP for U.S. firms listed in Europe beginning in 2007.  The SEC is not likely to be in the position of eliminating the reconciliation requirement by the beginning of 2007, simply because more time will be needed to study the consistency of IFRS accounts and their application.  Recognizing this, Commissioner McCreevy has stated his intention to propose a postponement of a decision on the equivalence of U.S. GAAP with IFRS for two years to align it with the roadmap.  He has stressed the importance he attaches to such a postponement.  We welcome Commissioner McCreevy's proposal.

Deregistration/Delisting of Securities in the U.S.: Many Europeans have lamented that though EU firms listed in the United States can delist from exchanges, if they have a small number of U.S. investors they are still subject to onerous reporting requirements and cannot deregister.   From here, they argue that the U.S. capital market is a "roach motel" or the "Hotel California" -- one can check in, but not out.  To add spice, some argue that they want out because the cost of SOX is high.  Putting hyperbole aside, SEC officials indicated that it is certainly not their intent to "trap" issuers in the U.S. market, that rules concerning de-registration were developed decades ago, and that the SEC would table proposals making it easier for foreign companies to terminate SEC registration and reporting requirements.  This was done late last year.  The comment period on the rule proposal just closed.  European firms and officials have submitted comments.  

Reinsurance:   In the United States, insurance regulation is delegated to states, and for an unlicensed non- U.S. reinsurer to conduct business in a state, it must post collateral of 100 percent of its obligations to assure regulators it could meet its obligations if it became insolvent.  Let's be clear – the U.S. reinsurance market is wide open:  foreigners account for nearly 85 percent of the market.  But several EU reinsurers have argued that the cost associated with raising capital to meet collateral requirements is excessive.  In the meantime, the EU is working on implementing a new Reinsurance Directive, which sets uniform EU standards in this area for the first time and will end member state collateral requirements by 2009.  Many in Europe see this development as a precursor to abolishing or modifying U.S. collateral requirements.  Earlier this week, the Executive Committee of the NAIC directed its Reinsurance Task Force to develop alternatives to the current framework pertaining to reinsurance collateral by December 2006 and to consult with international regulators in so doing.  The issue is a difficult one, but good talks are underway in the NAIC and between the NAIC and Europe.

Together, the EU and U.S. also exchange information through the Dialogue.

Basle 2:  Both the US and EC have provided information on their plans and timelines for implementing Basle 2, recognizing that technical issues are dealt with in the Basle Committee's Accord Implementation Group.  These talks have been valuable in helping the US understand the legal processes and timetable for European implementation of the so-called Capital Requirements Directive, and for Europe to understand US decisions with respect to the scope of application of Basle 2 to US banks.  More recently, with Europe slated to begin implementing Basle 2 in 2008 and the US in 2009, the Dialogue has provided a venue for bringing attention to technical "gap year" issues. 

 Clearing, Settlements and Payments in Europe: Clearing and settling transactions and making payments within European countries is inexpensive, but cross-border transactions can cost 5 to 10 times more.  The ECB has estimated that European firms could save $60 to $120 billion per annum in costs with a more efficient cross-border payments system.  The US is watching these areas closely -- they hold the promise of major welfare gains for Europe but also may give rise to spillover issues.

 Investment Issues: The Dialogue has also been a forum for discussing transatlantic investment. As cited previously, investment flows between our two economic areas are enormous.  The United States has strongly commended the Commission for its staunch defense of the principle of creating an integrated economic space in Europe for M&A and underscored that notwithstanding complex legal provisions of the Takeover Directive, Europe should clearly state that reciprocity vis-à-vis third countries be avoided, lest unnecessary uncertainty deter badly needed investment.  More generally, we have commended Commissioner McCreevy for his efforts to promote cross-border M&A among European financial institutions, and we have also stated that the world is better served by global – not national – champions.

This is a snapshot of the Dialogue.  I hope you will take away that the Dialogue is technical, but the issues it considers are critical to the health of global capital markets. 

For the future, the U.S. and EU will continue to face challenges.  The Dialogue will need to: continue discussing problems which inevitably arise; focus on a forward-looking and cooperative agenda that identifies issues looming on the horizon and work to address these in a way that enhances global welfare.  Further, it will need to continue to reach out within the confines of the Dialogue's informal structure to legislatures, member states and market participants to keep them informed of our work and seek their input.  

 The Process

 Let me address the "process" of the Dialogue.  The Dialogue occurs at the "technical" level.  The participants agreed from the outset that discussions should be informal, low-key, and two-way in nature.  Either side can put any item on the agenda.

It was recognized that financial market regulations cannot be negotiated.  Why? Regulators are independent; each regulator's fundamental duty is to protect its own investors and the safety and soundness of its institutions; regulators must follow domestic processes in implementing regulations such as filings through the Federal Register and taking on board comments.  We also recognized that we would not always see eye-to-eye, but that the way to address differences was to continue discussing them, avoid public recrimination, and agree to disagree if need be, while moving ahead.  That said, by holding periodic discussions, the exchanges of view have been able to infuse policy and rule-making with additional insights, sensitize officials on both sides to the other's thinking and ways of conducting business, and ultimately improve the quality of the end product.  The participants at the table have considerable trust in the process.  

As the Dialogue's technical-level discussions have taken hold, senior officials have also increasingly met.  Secretary Snow spent a week last June discussing the Dialogue with European officials in Brussels and several countries.  He has seen Commissioner McCreevy four times in the last year.  The European Financial Services Committee – a high-level policy body with officials from the 25 member states – invited the Fed, SEC and Treasury to a meeting in Brussels last September. SEC Commissioners are increasingly in Brussels for discussions.  Members of the Board of Governors of the Federal Reserve engage often with EC Commissioners.

 The Dialogue is taking hold in other ways. If a European rule is adopted but implemented and applied 25 ways, it is questionable whether progress is being made. To facilitate harmonization, Europe formed the Committee of European Bank Supervisors (CEBS), the Committee of European Securities Regulators (CESR) and the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS).  U.S. regulators meet with these new European groups to discuss issues of common interest.  

The U.S.-EU Financial Market Regulatory Dialogue is alive and well.  It is no longer just an episodic meeting of lowly bureaucrats.  It has facilitated multiple informal and unstructured contacts among senior officials and experts.  It has dramatically increased understanding on both sides of the Atlantic!   

Dr. Kaufmann, you asked me whether the Dialogue is a success and if it could be a model for other regulatory discussions.  I will let others judge whether the Dialogue is successful.  From my vantage point, the Dialogue works for its participants.  Whether the process of the Dialogue can be translated into other regulatory arenas is for others with a better knowledge of their realms to determine.  I do think that regulators of, and participants in, wholesale financial markets accept competition and innovation, and do not view the world through a zero sum prism.  The push for financial globalization and global standards adds impetus to international regulatory cooperation.  In addition, the inability to "negotiate" financial regulations may be a plus.  But these properties may not be readily transferable to other realms of regulatory endeavor, where hard-working officials on both sides of the Atlantic have rolled up their sleeves to do the best job possible and toil just as earnestly as we do. 

Conclusion

In a recent book, "The Vital Partnership", Professor Simon Serfaty of the Center of Strategic and International Studies argues that the U.S. and EU partnership, while at a crossroads, is as essential now as in the past, and will be conditioned going forward, inter alia, by the forces of globalization and European integration.  The U.S.-EU Financial Market Regulatory Dialogue is only a microcosm.  But it shows that the EU and U.S. have strong mutual interests and can work closely together in building a more dynamic world economy.   If the U.S. and EU can lead and cooperate on financial markets when cross-border flows between them are some two-thirds of the world's total, others countries will take notice.  By aiming at facilitating regulatory convergence around high quality global practice, strengthening global competition and growth, and helping foster the emergence of a more integrated European marketplace, the U.S.-EU Dialogue is an important contribution in the construction of the architecture for the global financial markets of the 21^st Century.   There is much to do.