Tackling the crisis: EU’s legislation and regulations

(Part III)

In the third article on measures taken by the Union institutions to tackle the crisis in Europe, the legislative and regulatory measures are discussed. Together with the economic policy measures (previous part II), it gives an overview on the European Union's stance in using policy and law for dealing with critical issues.

It has to be mentioned from the start that the EU legal instruments have a rather limited effect on the whole range of practical mechanisms in tackling economic and financial issues. In fact, the legal rules are being under discussion only during the mid-2010 period, when the crisis entered its second phase. One of the most dangerous and complicated issue of “legal involvement” was a potentially threatening idea of the new Lisbon Treaty's potential revision, the idea detested by numerous member states.

Therefore, the main EU legal instruments, i.e. those described in the Lisbon Treaty have been taken quite cautiously as the legal possibilities implied in it have rather restricted influence on the process of crisis' elimination. “The Lisbon Treaty, said Commissioner Maros Sefcovic, responsible for inter-institutional relations and administration, is extremely limited and targeted on one issue: to allow for a permanent crisis mechanism in order to safeguard the financial stability of the euro area on a long-term basis. It would involve no transfer of powers to the EU level”. (1)

The Regulatory issues discussed in this chapter, are dealing only with some of the economic and financial aspects of the crisis; it has to be added that the common rules in the Union are not quick in preparation. The regulatory framework, above all, is concerning the EU financial supervision. Intensive discussions among the member states during 2009-10, have led the Commission to propose stronger financial supervision in the EU. In line with the recommendations made by Jacques de Larosiere, the Commission proposes to reinforce both macro- and micro-prudential supervision. This is to be achieved by setting up two bodies, i.e. European Systematic Risk Council (ESRC) and European System of Financial Supervisors (ESFS); the latter on a temporary basis until 2013.
The ESRC is to monitor and assess risks to the stability of the financial system as a whole. It would provide early warning of systemic risks that may be building up and, where necessary, recommendations for action. The creation of an ESRC would address one of the fundamental weaknesses highlighted by this crisis: the exposure of the financial system to interconnected, complex, sectoral and cross-sectoral systemic risks.
The ESFS created a platform for transformation of existing EU Committees for the banking securities and insurance and occupational pensions sectors into a single control body.
The ESFS is to be built on shared and mutually-reinforcing responsibilities, combining nationally-based supervision with centralisation of specific tasks at the European level in order to foster harmonised rules and coherent supervisory practice and enforcement.
This network is based on the principles of partnership, flexibility and subsidiarity and should aim to enhance trust between national supervisors by ensuring that host supervisors have an appropriate say in setting financial stability and investors' protection policies so that cross-border risks can be addressed more effectively. The new system will streamline the Baltic States' financial sector too.

Europe's two new financial supervisory watchdogs are to be established in 2011: o ne will look for systemic risks, the other will watch over individual financial institutions. The existence of cross-border banks requires that a pan-European financial regulator be created.

Governor of the Bank of England since 1991, Mervyn King will be the deputy of the European Systemic Risk Board, which will monitor financial stability (the nomination acknowledged the importance of the British financial industry in Europe).

Another new watchdog's institution is the European System of Financial Supervisors (with an annual budget of € 68 mln (to compare: the UK financial regulator spends ? 323 mln a year and the US regulator almost $1bn). The biggest concern is the balance of power between the ESFS and the financial regulators in the member states. The intention is to write a “single rule book” in case the national regulators disagree.

The new institutions' establishment raised some concern in some member states over the extent to which the new pan-EU authorities would help enforce common rulebooks for 3 financial spheres: banking, insurance and securities markets. Commission is of an opinion that proposed laws clearly prohibited the new authorities from taking decisions that could impinge on individual countries' “fiscal responsibilities”. As an additional safeguard, any country believing this principle had been breached could appeal to the Commission.

Table. EU financial regulation: 2008-2010 accounts  

October 2008: European Commission asks former French central banker Jacques de Larosiere to advice on overhaul of financial supervision in Europe.

February 2009: De Larosiere report recommends improvements including a new “systemic risk” board at the macro-level, and new European supervisory agencies for banking, insurance and securities markets at the micro-level.

March 2009: De Larosiere gets broad endorsement but some countries, including the UK, express reservations. Some worries appeared about possible split of fiscal responsibility from supervisory responsibility.

May 2009: European Commission details plans for implementing the proposals. Says it wants new system in place in 2010.

June 2009: EU finance ministers give outline approval but with caveats on fiscal responsibility and binding mediation. EU leaders follow suit.

September 2009: European Commission unveils draft legislation to implement the changes.

The board will have no direct powers, but will meet regularly and report to EU finance ministers and leaders. De Larosier Report.

October 2009: the European Council agreed a coordinated plan for fiscal stimulus and consolidation.

March 2010: EU-2020 strategy adopted by the European Council (25-26 March, 2010).

May 2010: new European stabilization mechanism (together with IMF) approved with € 750 bln in loans and guarantees for member states in crisis. Mario Monti Report on Single Market.

July 2010: stress test performed for 91 European banks.

September 2010: Commission proposed economic governance reform package.

November 2010: further economic and financial decisions in the EU Council's meetings.

December 2010: European Council (16-17 December) made a decision to introduce “limited amendments to the Lisbon Treaty with establishing a permanent mechanism (from January 2013) for eurozone financial stability; member states' approval is expected at the end of 2012.

Main lesson from the financial crisis was that national supervisory structures were sufficient to supervise internationally active banks; here the present suggestions are an important step in the right direction. A next step is that powers to regulate cross-border banks should be brought together at a European level to ensure effective oversight.

The EU legislative proposals have concentrated on two main aspects. On the one hand, it will create of a new “European Systemic Risk Board”, which will warn about threats to financial stability. Its main members will be the 27 central bank governors in the EU member states, as well as the president and vice-president of the European Central Bank.

Separately, there will be a new “European System of Financial Supervisors”, which will oversee individual banks and financial firms too.

Day-to-day supervision will remain with national supervisors. However, three existing pan-EU co-coordinating committees will be upgraded into new European Supervisory Authorities for the banking, insurance and securities sectors respectively.

These will develop harmonised rules and common approaches to supervision. Nevertheless, they will also ensure “consistent application” of the rules, and be able to co-ordinate and take some decisions in emergencies.

Legislation and financial coordination. At the EU summit (March 2010) the guaranteed security for the Greek's solution was agreed between the EU and IMF on the level of € 23 bln (the final decisions on EU financial and governance issues were taken in the EU summit in June 2010). The IMF's “invitation” to solve the Union's problems was the result of the inadequate Treaty's provision (forbidding the EU members being bailed-out by the “family”) and the German government persistent advise (meaning that the latter does not have to open a wider-credit line, which it would have done otherwise).

The “salvation sum” for Greece at the level of € 23 bln is, in fact, a small amount: Greece's deficit to international lenders on both sides of the Atlantic accounts for about € 300 bln. About two-thirds of Greece's public debt is connected to German, French and other European financial institutions. Besides, Greece did not ask for any “rescue instruments”, hence the agreed sum, which is in fact a coordinated bilateral loan package: one-third IMF and two-thirds eurozone members.

The move represented EU guaranteed solidarity; again, as about 60 years ago, the Franco-German alliance saved Europe from a disaster. This time it was both financial and economic in essence and, which is more important in cooperation with international donor, i.e. IMF. The latter makes the salvation remedy truly an international one. There is a vital thing too: the united European front has shown a firm solidarity in economic governance regardless of initial doubts. The eurozone made the right decision in the end, after exhausting all other alternatives.

At the same time, it showed a new sign of cooperation; even J.-C. Trichet, head of the European Central Bank, first opposed the idea of involving the International Monetary Fund; finally, he praised the agreement.

The salvation scheme has been a significant step in several aspects. First, it showed that a united European front could be formed when needed. Second, the plan acknowledged the importance of fiscal discipline by adopting the “economic governance task force” (Germany insisted on the IMF's backing). Third, the plan acts as a firewall, preventing financial contagion spreading in Europe.

The biggest problem is whether Greece, with debt already at 113 per cent of the GDP and 9,3% of budget deficit (in November 2010), can sustain its debt burden: the country still owes € 272 bln to cover interim deficits. Furthermore, as the eurozone tightens its belt, the ECB will be able to keep interest rates lower for longer; that does not strengthen the euro, in the first place. (2)

Experts recognise the correct EU-16 eurozone states' move to give IMF the lead role in assisting Greece. After much dispute, eurozone leaders decided to ask the IMF to finance a rescue package for Greece, one-third funded by the Fund and two-thirds funded by other EU members. The agreement between France and Germany, which made this outcome possible, proves that co-operation is conceivable, even in such contentious areas. Germany managed to save her country's vital interest in maintaining a co-operative relationship with its neighbours and partners.

The IMF's role was important in the crisis.  When the EU  invited the IMF, the latter served as a “competent outsider”, which could reach a relatively impartial judgement on a successful plan; the Fund, as is known, offered support only when it firmly believed the reform package from Greece could have a success. France and Germany in their “salvation accord” also sought to commit the EU to “economic governance”, which in present situation means: due attention to internal imbalances, structural impediments to adjustment and control of fiscal deficits. This crisis has revealed deep fault lines inside the eurozone. In their agreement at the Marsh summit, the EU governments have rightly taken short-term remedial action (though restructuring of sovereign debts in Greece must still be possible in the end).

The deal sealed in Brussels at the summer summit in 2010 had assured Greece of a financially guaranteed solidarity, which looked as a classic Franco-German double-act. “The deal looked on the face of it awfully old-fashioned; it was a deal made between Paris and Berlin, and then presented as a fait accompli to other members of the eurozone, as well as to the rest of the EU members”. There was muttering among the smaller eurozone member states about the high-handed manner in which it was presented. “We are happy with the contents, but we don't want the way this deal was reached to become a precedent,” said a Finnish official to the Financial Times. (3)

Financial services: EU legislation in force. As to October 2010, the Union legislation in force accounted to about 300 legislative acts (mainly regulations and directives). The EU efforts to regulate financial services and capital market during 2010 are available at the Commissioner M. Barnier website. (4)

The EU financial services sector includes three major areas of regulations: banking, insurance and securities, which are included in the so-called general financial services policy issues. Besides, the Commission exercises political initiatives in the area of retail financial services, occupational pensions and payment services. The EU policies in this sector are aimed at ensuring efficient financial markets infrastructures, e.g. well-functioning cross-border clearing and settlement processes, promoting proper supervision of financial conglomerates and at preventing corporate and financial malpractice.

Looking at the legislation in force, the general trend in the Commission during last decade (mainly since 2001) is clearly seen: out of about 300 new regulations and directives adopted, most of them (one fifth of the total) deal with financial reporting : about 60.

This include Regulation 1606/2002 on application of international accounting standards and reporting, i.e. IFRS and IAS and other five regulations adopted in 2003–04. A number of additional rules were adopted in 2005–6 regulations and directives; then, four in 2006, and only 3 in 2007. The start of the crisis resulted in additional Commission's legislative activity: eight regulations in 2008 and 15 (!) regulations in 2009 (plus one directive); during only 9 months in 2010, seven new regulations were adopted.

The activity in other spheres of financial services were more modest, except, probably, insurance and pensions – 32 legal acts, mostly directives; securities markets – 27 (again, mostly directives; the last regulation 12/12 was adopted in 2008 on prospectuses and advertisements).

In company law, corporate governance and financial crime, about 25 – mostly directives, were adopted, including an old Regulation 2137 from 1985 on European Economic Interest Groupings (EEIG), Regulation 2157/2001 on European Company (SE) and Regulation 1435/2003 on European Cooperative Society (SCE). About 23 regulations and directives were adopted in industrial property rights, 18 – in public procurement, 11 – in professional qualifications (including 4 regulations), 9 – in copyright law, etc. (5)

EU Financial Conglomerates Directive. Financial groups that are active in one or more country and operating in numerous financial sectors, e.g. real estate, insurance, investments, etc. are known as financial conglomerates. Due to their size, they are of systemic importance to both national and the EU's economy. However, they can often make a negative impact on economic development, which happened in the Baltic States. The EU efforts in August 2010 showed a common drive towards some regulations.

Financial conglomerates are financial groups that are active in one or more country and operate in both the insurance and banking business. Due to their size (they are often large and complex), financial conglomerates are often of systemic importance to both national and the EU's economy. The financial conglomerates can provide a strong impact – often negative – on economic development; that was highlighted during recent financial crisis in 2008–09. A number of financial conglomerates had difficulties and governments in numerous EU member states had to resort to large financial injections in order to keep these financial conglomerates afloat.

The initial Directive ( Financial Conglomerate Directive, 2002/87/EC gives national financial supervisors additional powers and tools to watch over these financial institutions).

Currently, supervision in the EU is mainly done at the national level. Any financial institution wanting to operate in another member state's banking sector needs an authorisation from the national financial supervisor (and to comply with the relevant national banking regulations). The same applies to legal entities that want to operate in the insurance sector: such entities need to be authorized as insurance companies and must comply with the relevant insurance regulation. Supervision rules also allow for a group of authorised banking entities to be subject to consolidated banking supervision. Similarly, in the insurance sector, a group of authorised insurance entities can be subject to insurance group supervision.

Financial conglomerates are often active in numerous banking, investment and insurance business and operating in several EU member states. The Financial Conglomerate Directive (2002/87/EC) gives national financial supervisors additional powers and tools to watch over these firms. Foe example, the Directive requires supervisors to apply supplementary supervision on these conglomerates, in addition to the specific banking and insurance supervision.

The need for supplementary supervision arises when a financial group (i.e. conglomerate) consists of several legal entities that are authorised to do business in banking, insurance or other sectors in the financial services. Quite often, the number of legal entities within a conglomerate can reach 500 or even a thousand entities. They are controlled by a parent company, where all the decisions regarding business strategies, internal governance, group-wide risk management etc. are made. While a parent entity can be a regulated entity itself, such as a bank, investment or an insurance company, it can also take the form of a holding company.

Therefore, supplementary supervision focuses on the following problems:

• Multiple use of capital : supervisors are to make sure that capital is not used twice or more within a conglomerate. For example, funds may not be included in the calculation of capital on both the single financial entity and the parent company.
• Group risks : they arise from the group's structure and which often are not related to specific banking or specific insurance business. They refer to risks of contagion (when risks spread from one end of the group to another), management complexity (managing more than several hundred or a thousand legal entities is a far more difficult challenge than managing 20 legal entities).
• Risk concentration: the same risk can materialize in several parts of the financial conglomerate, and at the same time; and
• Conflicts of interest: for example, when  one part of the group has an interest in selling an exposure, while another part of the group has an interest in keeping that exposure.

The 2002 Financial Conglomerates Directive allows national supervisors to monitor those risks, for example by requiring conglomerates to provide additional reporting. Supervisors can also require conglomerates to present additional risk management or internal governance measures. The Directive also requires supervisors to cooperate across sectors and across borders in order to control possible group risks.

During the present financial crisis, the Commission evaluated the effectiveness of the 2002 Financial Conglomerates Directive. It found that supplementary supervision, as stipulated in the Directive, could not be carried out on certain financial groups because of their legal structure. In some cases, national financial supervisors were left without the appropriate tools because they had been obliged to choose either banking or insurance supervision under the sector-specific directives or supplementary supervision under the Financial Conglomerates Directive as the definitions for banking and insurance holding companies in the sector-specific directives and for mixed holdings in the Conglomerates Directive were mutually exclusive. The main objective of the revision of the Directive is to correct this unintended consequence of the current rules. (6)

Therefore, the Commission proposed in 2010 amendments to the 2002 Directive; these amendments can be summarised in the following way:

• Under the current rules, supervisors have to choose which supervision they apply when a group acquires a significant stake in another sector and when the parent entity is a holding company. The proposed changes require that the sector-specific (banking and insurance) supervision and supplementary supervision could be applied on the conglomerate's parent entity, even if it concerns a holding company.
• Banking supervision would therefore remain applicable even if the banking group acquires a significant stake in an insurance business.
• Similarly, insurance supervision would also remain applicable if the insurance group acquires a significant stake in a banking business.
• When justified by potential group risks as a whole, financial supervisors should be allowed to identify a group as a financial conglomerate and apply supplementary supervision. The identification process of financial conglomerates should allow for risk-based assessments, in addition to existing definitions relating to size ("quantitative indicators").
• Under the current rules, the balance sheet figures are determinative when identifying conglomerates. This approach sometimes results in a list of conglomerates that are not necessarily exposed to group risks, while groups that are evidently exposed to group risks are not always included within the scope of supplementary supervision.
• Financial supervisors should be allowed to waive a group from supplementary supervision if it is small (less than € 60 bln of total assets) and if the supervisor assesses the group risks to be negligible, even if the small group meets the quantitative indicators. This should enable supervisors to allocate their resources to the supplementary supervision of larger and systemically important conglomerates.

The proposed revision of the 2002 Financial Conglomerates Directive also amends the relevant banking and insurance supervision legislation, namely two Capital Requirements Directives (2006/48/EC and 2006/49/EC) and the Directive on Supplementary Supervision of Insurance Undertakings in Insurance Groups (98/78/EC). The Commission is also currently reflecting on how to connect the present proposals with the Solvency II and III initiatives, which represent the next generation of supervisory rules for the EU insurance and reinsurance companies.

The legal aspects of crisis prevention. The main objective of the new Commission's initiative is to restore the full spectrum of supervisory tools and powers, regardless of the legal structures of financial conglomerates. This ultimate consequence of the current proposal is felt as most urgent. Nevertheless, the initiative will also strengthen the effective supervision of financial conglomerates. The Commission believes that supplementary supervision of large, complex groups, operating in several countries, can only be effective if the same supervisory approach is applied consistently across all EU member states

Therefore, the European Financial Supervision Authorities' are involved. As regards financial conglomerates operating in several EU countries, closer coordination between national financial supervisors will be required, particularly through the new European Financial Supervision Authorities. (7) The proposals were negotiated between the Council and the European Parliament. The new European Banking Authority (EBA) and the new European Insurance and Occupational Pensions Authority (EIOPA) are to form a Joint Committee to oversee cooperation and coordination between national supervisors in the case of financial conglomerates.

In assisting the Commission's proposal on further supplementary supervision, the Joint Committee is also expected to look into extending the scope of supplementary supervision to non-regulated entities such as Special Purpose Entities. These are legal entities where assets are stored off the groups' balance sheets. During the crisis, it became clear that contagion and risk concentration originated also from non-regulated parts of financial conglomerates. This issue has been highlighted also on international level in the context of the G-20 and G-8 work. It is the Commission's intention to continue to work on this issue and present further amendments to the Directive on Financial Conglomerates as regards this matter as well as other issues linked in particular to the new European supervisory structures.

The changes in the EU financial law will take effect after the proposal is passed through the European Parliament and the EU member states, as well as through the Council's procedures. The Commission hopes to see the changes enter into force during 2011. (8)

Franco-German domination. The presently enlarged EU-27 is very different to what it was when France and Germany dominated decision-making 30 years ago. The Franco-German motor is no longer a balanced two-stroke engine; only on matters of economic development, at least, Germany now dominates. For example, as the share of trade in GDP, Germany is presently the better state in the world with 5,5%; even in China it is 3,5%, to say nothing about the UK with negative 2% and the USA with negative 2,5%. (9)

The German present position is undoubtedly that of the European leader. Germany's requirements concerning salvation of other member states were plain and simple: first, the International Monetary Fund must be substantially involved in any rescue; second, Greece must have exhausted its capacity to borrow from the market; and third, the other eurozone states must commit to far tougher sanctions for budget indiscipline.

Stability of the euro and solidarity are two sides of the same coin, which was the message from the EU Commission and the member states, when they criticised previous insistence on “stability” above all other virtues.

Nicolas Sarkozy, the French president, has got too a “mechanism” for rescuing countries in crisis, e.g. such as Greece, which was vetoed by Germany at the last moment, though some ideas of improving “economic governance” were included. The Lisbon Treaty's change, which the German government greatly favoured, was almost off the agenda for a while (to the relief to both The UK and France).

However, the French President claimed that Franco-German alliance was a relief for all of Europe showing that the two powers could agree, which was sign of strengthening the European cooperation.

Euro stability. Germany has been the strongest supporter of the stable euro. Notable, that the European Union does not have a common financial policy; it has had convergence criteria instead adopted at the time of Maastricht and Amsterdam Treaties (1993-99). Present euro-crisis has shown that this is not enough. Common “safety net” from the EU and IMF is to secure the euro's stability in the world as a second strongest currency, which received an additional push from the eurozone states. The reason is simple; Germany's strong economy stays as security to other countries' crumbled economy. On another side, it makes Greece easier to sell her sovereign bonds to cover the debts.

Euro for small countries. There are numerous discussions about the pros and cons of euro for small countries, e.g. that of the Baltic States. Important to remember that these countries, as well as other EU members, are deemed to introduce the common currency due to the Treaty provisions and the countries' accession obligations.

During long discussions in 2009-10, the main argument has become apparent: euro for small-currency states could be rather advantageous enjoying “protection” in a family of common currency union. Some of the biggest advantages, however, are: contribution to the GDP growth (about 0,5-1%), stable exchange rate and lack of devaluation fairs.

Estonia has shown a good example for stable political and economic aspects in development towards euro: from January 2011 it introduced common currency as the 17 th eurozone state.

EU Strategy for a post-crisis period. At the Brussels Economic Forum (May 2010), Olli Rehn, European Commissioner for Economic and Monetary Policy underlined the EU main economic strategy efforts aimed at enhancing growth through smart consolidation and structural reforms in post-crisis period. The Commission expressed belief that based on the new EU strategic choices and effective coordination, the main guidelines of EU progress in sustainable growth, healthy public finances and a return to high employment is within the Union's reach.

The Commissioner underlined that since May 2009, the European economy is slowly recovering from its deepest recession ever. As the EU 2010 forecast points out, the economic recovery is now in progress, even though it is still rather modest and fragile. While massive fiscal stimulus was necessary, the crisis produced high levels of deficits and debt. In combination of speculative short-selling, this has caused turbulence in the sovereign debt markets. (10)

The critical issue in EU is whether the real-economic recovery can sustain the renewed financial turbulence; that's what the Commission is recently been working for. Safeguarding financial stability in the euro area has required exceptional measures, such as the creation of a European Financial Stabilisation Mechanism, and a backstop of up to 500-bln euro. However, a continued vigilance is still needed. Addressing the EU mid-term and long-term challenges, the member states need to implement structural reforms that will not only cover the lost ground, but permanently increase the productivity growth and capacity to create jobs.

Stabilisation efforts and reforms. The Commission has done some simulation, using EU's macroeconomic model, on the impact of coordinated structural reforms in the EU.

If the EU-27 member states can implement ambitious structural reforms in the coming 5 years, the Union's has a potential for an over 2 percent annual growth rate in up to 2010. That could create over 10 mln jobs and reduce unemployment to around 3 per cent by the end of the decade.

Whereas, without such reforms, the EU would stagnate, with the average output growth at best at around 1,5 per cent and with a level of unemployment (even after cyclical recovery), at 7-8 per cent up to 2010.

While subject to normal uncertainty of long-term projection, these assessments suggest the order of magnitude of the costs of a non-reforming Europe.

The result, in the case of no reforms, would be an over 6 % lower level of GDP and 4,5 % higher level of unemployment at the end of the decade. This would erode the foundations of the EU social market economy and drain the resources from people in need of support. (11)

The reforms the Commission has envisaged are the reforms whish vary from a member state to member state. They include making the most of the EU's single market, in particular:

• In services sector,
• In making it attractive for people to move from inactivity to activity and from low-productivity jobs to higher productivity jobs,
• In making the tax and benefit systems more conducive for employment growth;
• In making more focused investments in knowledge and innovation,
• In simplifying the regulatory environment for enterprises to provide additional growth.

The reform issue is primarily about the political skill to build a societal consensus on the necessary reforms in the member states.

Economic policy challenges. Beyond the immediate preventive steps, the EU-27 needs focusing on creating foundations for sustainable, smart and inclusive economic growth. In this effort, the Commission envisages three broad policy challenges:

•  First, to get the right fiscal exit strategy: a withdrawal of the counter-cyclical fiscal stimulus is to be accompanied by substantial fiscal consolidation to reverse the adverse trends in public debt. Recently, several EU member states, e.g. Spain and Portugal, have presented significant new measures of fiscal consolidation. Besides, the EU needs “smart consolidation”, which calls for a coordinated differentiation among the member states. While accelerated fiscal consolidation is the immediate priority for the countries with no or little fiscal space, others with better fiscal space can maintain less restrictive stances in the short-term, for the sake of growth and jobs in Europe.

•  Second, simultaneously with fiscal consolidation, the EU has to implement structural measures in economy that will lift European potential growth. The big risk is that once the recovery gets more robust, the member states will sit idly in self-complacency and forget the structural reforms. That would lead the EU to a sluggish recovery and even a lost decade. Sustainable recovery means much more than that, as low investment activity and an increase in structural unemployment have already lowered potential for growth in the coming years, argued the Commissioner.

•  Third, the member states must invest in the low-carbon economy and green growth. It is better to be ahead of the curve in striving for a smart and green economic transformation, in particular at a time of rising trends in global demand for fossil fuels. The EU can meet these challenges only by making a profound change in the member states' economic policies.

The Commission's “EU-2020 strategy”, which was endorsed by the European Council in March 2010, is aimed at modernising European social market economy and achieving sustainable growth. To succeed with this strategy, the member states need to introduce a truly European dimension in the EU economic policymaking. With this in mind, the Commission presented in May 2010 an ambitious set of proposals to reinforce the economic governance in Europe. The idea is to strengthen preventive budgetary surveillance, to address macro-economic imbalances and to set up a permanent and robust framework for crisis management. These proposals received broad support in the Task Force headed by the Council's President, van Rompuy.

European debt resolution mechanism (EDRM). Debt restructuring in numerous EU states, together with extensive cut spending and increase in revenues, needs a sustainable mechanism for effective debt resolution. The EDRM would serve a good deal other EU countries-creditors, both within and outside the euro-zone. Present critical situation in three southern-European states with unsustainable debt (Greece, Spain & Portugal) raises questions concerning obligations for creditors; most of them are, actually outside European region. Both crisis prevention and debt resolution needs an adequate financial and economic mechanism for tackling with the problems.

Sovereign debt's solvency has become a big issue in these countries due to a dangerous combination of high current debt levels, large primary fiscal deficits, high interest rates and negative growth prospects. Some experts approach these factors as serious arguments against states' inability to repay their debt entirely, even if they implement in full the large and protracted budgetary adjustment. Other eurozone countries, and those outside the zone, face difficulties of a similar nature and urgency. In particular, “the issue has a strong EU-wide dimension for Greece, as public debt is largely held by residents of other EU countries. So the question arises: how should the eurozone deal with debt restructuring by one of its members?” argued writers from Bruegel, the Brussels-based European think-tank. (12)

The issue of EDRM, though being generally recognised in Europe, is considered too early to contemplate restructuring other countries debt. The main reason has been the “risk of contagion” (hence the need to see thorough actions taken by Greece government and their results). The best strategy is still regarded the actions by the EU and IMF to implement a stabilisation package which accompany and foster all other domestic efforts. (13)

The need for EDRM  was great: creation of a mechanism for orderly debt reduction is not a simple issue; it makes a messy outcome more likely as each creditor country stands behind its banks and insists for too long on full repayment. The issue is as well difficult in the EU, though it is driven by strict legal rules. Despite different economic interests, EU member states are more likely to accept the kind of supranational statutory mechanism rejected at global level.

Shared interests in terms of the European single market or single currency, should hopefully prevail, and make the EDRM more realistic.

The most difficult question is institutional; nobody really knows what EU institution could and should deal with competences in decision-making and arbitration. The spirit of the new EU's Lisbon Treaty, as well as that of the stability and growth pact and new EU-2020 strategy, suggest that the final say in fiscal matters must belong to the European Council, i.e. Council of member states' “sectoral” ministers. The Council should act only on the basis of proposals from two main EU institutions in charge of preparing assistance programmes (the European Central Bank, with prime responsibility for the stability of the euro and the European Commission, which represents the common European interest), and the IMF, whose role is to ensure consistency between European and global practice in dealing with the financial and economic crisis.

New EU's rules in financial services. The Commission has underlined the necessity to forge a new deal between the financial sector and society in order to restore trust in the finances. The Commission in 2010 has reiterated its intention to strike a new deal between financial regulations and the society's needs. Taxpayers who are paying the bill of bailing out the banks need a security to back the real economy and change the “old financial sector”.

A "new deal" between the world of finance and society in restoring trust is urgently needed, argued Michel Barnier, member of the European Commission responsible for the Internal Market and Services in Brussels, 26 April 2010 (see Commission's website). The economic situation in Europe is still quire critical. To start changes, the Commission is to assess the consequences of the EU' economy fall in 2009 by about 4 per sent; recovery is taking hold, but remains very fragile. From the start of the crisis, the Commission played a key role leading and coordinating the “fire-fighting”, both within the EU and at international level. Presently, the Commission is turning from fire fighters to architects of a new financial system. First foundation stones, including a package of proposals to reshape financial surveillance at European level, have been done in Spring 2010 in the form of a new EU-200 Strategy.

From the EU-2020 Strategy to financial services: regulatory aspects.

In the essence of the EU move out of crisis are the changes in the existing financial sector; these changes can be done more affective through policy and law means.

Most important is Internal Market–Services Directive. The EU Ministers adopted conclusions on Services in the Internal Market and Market Monitoring in February 2010. These conclusions recall that, despite remarkable successes, the full potential of the Single Market is not exploited. Pending the Commission proposals for re-launching the Single Market (and taking due account of the Mario Monti report), the conclusions stress that the deepening of the Single Market should be a key element of long-term EU strategy for sustainable growth, i.e. Europe-2020 strategy.

In the short term, the Council calls for the completion of a comprehensive and ambitious implementation of the Services Directive. The conclusions also highlighted the importance of the 2010 mutual evaluation exercise foreseen by the Services Directive, which aimed identifying, where needed, additional initiatives. They encourage Member States to participate actively in this exercise. Finally, the conclusions gave their support to the market monitoring and smart regulation initiatives as evidence-based tools to further deepen the Single Market in the context of the Europe-2020 strategy.

The Commission's EU-2020 strategy contained proposals, which formed a structural and long-term response to the crisis, proposals that aimed at creating a new order in financial services, contributing at the same time to job-creation and sustainable growth. The crisis has forced the Commission to reconsider some of the fundamental assumptions about the financial sector in the EU-27.

Several “old assumptions” have to be reconsidered: first, a common assumption that markets, when left to themselves, act rationally; second, that financial innovation is always useful and generates profit; third, that transparency is not that important, and finally, that the best way to run business with jobs and growth was a complete government's “laissez faire”.

The Commission's idea was to build a completely new “architecture”, where the financial sector can again be at the heart of sustained and long-term growth.

With this assumption in mind, the Commission suggested the following steps:

• Prudential reforms and improved supervision;
• Changes to capital and liquidity requirements in order to reduce the likelihood of banking failure;
• Dealing with large systemically important banks with actions to reduce or manage the complexity of the financial sector;
• To change the culture of governance in order to create a better and efficient corporate governance;
• More transparency and better risk management, first of all at corporate level with more effective external checks and controls;
• Consideration of all the measures to be taken in order to increase consumer protection.

These EU objectives were in line with the G-20 roadmap for getting out of the crisis and the EU is leading the way on implementation of G-20 commitments.

Some other measures have been taken too; for example, the Regulation on Credit Rating Agencies is already in force. The EU has made proposals on hedge funds and private equity in 2009. These proposals were not optimal and the final agreement depends on all member states more flexible approach. As to supervision, the Commission put in place a new framework of European Supervisory Authorities for banking, insurance and securities to be adopted in January 2011. The issue is very sensitive and with a due flexibility, a quick and important agreement among EU-27 members is possible. In 2011, a new European Systemic Risk Board starts its work for a better anticipation of possible crises' occurrences.

Looking ahead. The Commission intends to tackle the derivatives market in June 2010 in order to make the sector more transparent with greater harmonisation of derivative's products, e.g. registration in trade repository and compulsory clearing via Central Clearing Parties.

The EU-27 member states need better and more capital; hence, the Commission received about 150 replies to its consultation papers on CRD IV (Capital Requirements Directive). It will make the necessary proposals by the end of the year on bank capital requirements and will take account of the latest thinking at international level, including issues of liquidity management, leverage ratios, and pro-cyclicality.

The EU's consumers need a revised the Directive on Deposit Guarantee Schemes, as well as the investor compensation rules. The EU also needs to give SEPA – the Single European Payment Area – a renewed momentum and the binding end-dates are important in this regard.

Since the beginning of September 2010, the EU-27 states have been involved in devising financial regulations that would correspond to post-crisis environment in Europe. Already in October, the Commission published a shake-up plan for the EU financial sector to be implemented from January 2011.

The member states “principally approved” in early September 2010 the EU's idea to an overhaul of the banks' sector supervision. While praising the agreement on the EU financial supervision package, they warned however that new pan-European Union watchdogs would need to exercise their powers cautiously.

Some warned that the suggested three new EU-level watchdogs – for the banking, insurance and securities markets sectors – would use their powers over national institutions and markets with care. Under the proposals, these watchdogs will not supervise companies or markets directly, leaving this to national authorities. But they will be required to draw up common technical rules and standards and could acquire additional legally binding powers – including over individual companies – in “emergency situations”. (14)

Experts stressed the importance of the “fiscal safeguard” incorporated into the agreement, which would prevent the watchdogs from imposing decisions that affect budgets in member states. Thus, the UK government officials said, they believed the final package, secured after months of negotiation, was a very good outcome for UK; however, the UK would like to scrutinize final details later.

French officials said they were satisfied and a “real architecture” for European financial supervision had been created, although the final deal falls short of their ambitions for ­centralised pan-European powers. The European Central Bank is also likely to have been pleased by the outcome, which gives it a central role in assessing future risks to Europe's financial system and allows the ECB president to chair a new European Systemic Risk Council for the first five years. Officials declined to comment publicly, however.

The reaction suggested that the proposed legislation could get more formal backing when EU finance ministers meet in Brussels on Tuesday. The legislation could then be put to the European Parliament this month. EU officials were hoping to have the approval process completed by the end of September so that the new watchdogs can get up and running by 1 January 2011. But soothing concerns in the City of London, which is nervous about supervisory powers shifting away from the UK, might take much longer. In particular, there are fears that Brussels will now attempt to give more powers to the new watchdogs though other legislative initiatives that are in the pipeline – in areas ranging from derivatives to short-selling rules.

The supervisory package concept was agreed in principle; but it was circumvented through numerous other legislative proposals from Brussels, in which control is being wrested away from national regulators.

EU financial services: final agreement. The result means that three new pan-European watchdogs, to oversee the financial services sector, will come into being in January 2011, a year for the EU official introduction of numerous financial supervisory bodies.

A new “European Systemic Risk Board”, made up mainly of central bank governors from the EU-27 member states chaired, initially, by the European Central Bank governor, will warn about threats to financial stability. The legislation creating these bodies has already been approved by EU finance ministers, making the backing from the European parliament the last major hurdle needed before it could come into force.

The vote in the Parliament on 21 September 2010 was extremely positive: about 600 MEPs were in favour of changes and only 20-30 voting against.

“We made it, the supervisory architecture train has left the station,” said Sharon Bowles, the British Liberal Democrat MEP who chairs the parliament's economic and monetary affairs committee and was heavily involved in the political negotiations which secured the package.

“This is ambitious legislation to protect citizen's financial interests and a big step for European economic integration,” said Jose Manuel Garcia-Margallo, a Spanish MEP and the same committee's vice-chairman. (15)

But some MEPs also warned that the task of beefing up Europe's regulatory structures in the financial services area was far from complete and stressed that the new watchdogs would need resources to operate effectively.

The three new watchdogs will oversee supervision in the banking, insurance and securities markets sectors respectively. Day-to-day oversight of individual companies and market will remain the job of national supervisory agencies. But the new “European Supervisory Authorities” will be charged with drawing up harmonised technical standards for them to apply, mediate in the event of disputes between national regulators, and acquire significantly greater powers if member states decide that an “emergency” situation exists.

The new ESA for securities markets will also oversee credit rating agencies operating in Europe directly. In addition, EU officials propose to give it a pivotal role as they introduce new rules on over-the-counter derivatives and require deals to be reported to centralised data banks or “trade repositories”.

Their creation has been controversial, with some countries, such as the UK, keen to ensure that they do not intrude too far into domestic regulation. The final legislation, therefore, results from lengthy negotiations, with various safeguards designed to allay these fears.

The ESAs will also be relatively small organisations for the foreseeable future: officials in Brussels think staffing levels at each will be around 100 people in three years' time.

European Alternative Investment Directive: a critical phase in preparation

After more than a year of disputes, the European Commission has finally prepared for further discussions a Directive's draft concerning regulatory rules for hedge funds and private equity. On 17 th of May 2010, the European Parliament's financial committee – a first among EU institutions – voted on the proposal with the Council's meeting of EU finance ministers (Ecofin configuration) the next day, despite British attempts to postpone it.

The directive initiates from long-standing concerns raised by the European Parliament's Socialists, and other critics of hedge funds and private equity activity. The proposal intends to crack down on two issues: a) trading that destabilises the financial system, and b) on buy-out funds that load companies with debt.

It was said in an initial suggestion that the prime idea was “to avoid activities that were purely speculative and without any economic or social benefit”. In spite of the fact that most of private equity and hedge funds are perfectly respectable, some problems exist, e.g. when companies were bought and broken up.

The hedge funds importance for the global financial stability is crucial: about 30 biggest hedge funds in the world have more than 1 trillion euros in assets (!), which can easily destabilize financial market in any part of the world.

At its core, the directive seeks to impose standards and regulatory oversight on a large share of “shadow banking system” that had largely gone unsupervised. There are several competing AIFM's drafts but all require funds to seek government authorisation, hold adequate capital and make disclosures to regulators and their investors. Many of the proposals are relatively basic and already required by the UK's financial regulations.

Thanks to the heavy redrafting of proposed European Union rules for hedge funds, private equity funds and other “alternative investment funds”, there are now numerous different legislative texts of the AIFM's directive in circulation, both in the European Parliament and among member states. Among common aims are the following:

- to ensure that all funds operating outside the traditional regulated sector are subject to supervisory oversight; some states, e.g. the UK, encourage and regulate the managers of alternative funds aimed at institutional investors, while others simply ignore them.

- the alternative funds would have to apply for authorisation and then provide certain levels of disclosure to regulators and investors.

- the drafts call for minimum capital requirements, a limit on total borrowing (depending on fund type) and require managers to conduct their business according to certain standards. Some drafts also include constraints on pay policies.

- the AIFMD requires fund assets to be independently valued and kept by a depository bank that would be held liable in case of financial problems. Private equity funds usually sought and easily received exemptions from this but member states remain deeply split over the depository rule. Some, like France, where investors were badly hit by the US Bernard Madoff fraud, is pushing hard for more investors' protection, while the UK funds and investors view the proposal as too expensive.

- Finally, the disputed “third country” rules, determining the rules for the managers and funds based outside the EU concerning the professional investors' market in the EU. One drafts suggestion is to reserve access for EU-based funds, while allowing individual states more say in whether professional investors can access funds managed outside the EU. Another suggestion is aimed at allowing the “outside funds” to sign up to EU principles as long as their home country meets basic rules on transparency, taxation and money laundering.

Experts in the European Commission are trying hard to draw up a coherent set of rules to satisfy a diverse and complex group of market players. The Commission drafted the directive without the usual extensive preparatory work, i.e. that of inviting industry consultations to impact the outcome. Some say that this approach to drafting was generally flawed. The situation in the UK's financial market made the discussion worse: the collapse of several British banks undercut London's claim to leadership in financial services. The Labour government was initially distracted; and the Conservative party, then in opposition, lacked influence in Brussels since withdrawing from the main centre-right coalition. (16)

The AIFM debate offers crucial lessons for both politicians and the financial services industry:

•  The first is the danger of starting out with ill-prepared draft legislation. The Commission seems to take consultations over planned rules for the derivatives markets seriously;

•  The second is the power of lobbying and coordinated campaigning has shown how effective it could be. Private equity has already secured several important exemptions, and more lobbying is expected when parliament and the Council of Ministers merge their versions of the text later this year.

Above all, the debate has underlined how crucial the European legislation has become to the financial services sector as regulators try to find a balance between two different visions of the financial system: a markets-based, Anglo-American model, and a more regulated, bank-focused approach familiar in Continental Europe.

Effect on European-American competition. Since the initial AIFM's directive idea, it has drawn criticism in Europe and the US from all actors involved: not only hedge funds and private equity funds but also investment trusts and funds that invest in venture capital, property and commodities. Many pension funds and institutional investors, though not directly covered by the proposed fund management legislation, are worried, arguing that the directive will drive up costs, reduce investor choice and provide unfair conditions for companies that have private equity investors.

Some say that anyone with savings or investments in funds, investment trusts and real-estate funds, as well as those with pension fund to have a negative impact by the directive. It will drive up the costs of investing and drive down expected returns.

Others argue that the directive would also add reporting requirements to many medium-size companies that happen to have private equity or venture capital investors.

European politicians argue that the directive is too lax doing little to avoid the sources of the next financial crisis. Besides, there is a mandate from the G-20 leading nations to bring in rules to provide control over all players in the financial market.

The US Treasury secretary, Tim Geithner warned in March 2010 that the prposed European legislation could cause a transatlantic rift, raising concerns that it “would discriminate against US firms and deny them the access to the EU market that they currently have”.

His opinion was supported in a letter to the European Parliament in mid-May from numerous profesional organisations, e.g. the Investment Management Association, the National Association of Pension Funds in the UK and the Alternative Investment Management Association, which warned that there were real risks that the directive would provoke retaliatory action in the jurisdictions outside the EU, which would damage the European financial services industry and the whole of the European economy.

Taxation policy and financial sector. The European Commission revealed in October 2010 the idea of introducing a duty on the financial sector. The Commission's efforts reflect a two-sided approach: from a global level, the Commission supports the idea of a Financial Transactions Tax (FTT), at the EU level, the Commission recommends introduction of a Financial Activities Tax (FAT).

Keeping in mind the European financial sector's needs to make a fair contribution to public finances, and the EU-27 governments' urgent needs for new sources of revenue in the current economic climate, the Commission has put forward a two-sided approach for financial sector's taxation.

1) At the global level, the Commission supports the idea of a Financial Transactions Tax (FTT), which could help fund international challenges such as development or climate change.

The FTT is expected to produce about € 60 bln revenues a year.

2) At the EU level, the Commission recommends that a Financial Activities Tax (FAT) would be the preferable option. The FAT is expected to produce about € 25 bln revenues a year.

The Commission argues that if carefully designed and implemented, an EU FAT could generate significant revenues and help to ensure greater stability of financial markets, without posing undue risk to EU competitiveness. Commission's official opinion was expressed by Algirdas Semeta, Commissioner for Taxation, Customs, Anti-fraud and Audit (Brussels, 7 October 2010). Taxing the banks: global and EU approach. The Commission has supported the idea of a Financial Transaction Tax (FTT) at a global level; this ides will be discussed at the G-20 summit at the end of 2010. If ambitious global objectives are to be achieved, in areas such as development aid and climate change, international partners will need to agree on global financing tools. A Financial Transactions Tax, FTT would tax every transaction based on its transaction value, resulting in substantial revenues. The Commission believes that a well-implemented, internationally applied financial transaction tax could be an attractive way of raising the necessary funds for important global policies.

At the European level, the Communication suggests an introduction of a Financial Activities Tax (FAT), which would target the profits and remunerations of financial sector companies.

In this way, it would tax the corporations, rather than each actor involved in a financial transaction (as is the case with the FTT). Following in-depth analysis of possible options for taxing the financial sector, the Commission is of the opinion that the FAT would be the best instrument for an appropriate taxation of the financial sector and the need to raise new revenues in the EU-27.

A fair contribution from the financial sector. In order to assess whether a new financial sector tax could be fully justified, the Commission examined the current contribution of this sector to public budgets.

1. It concluded that that there are good grounds for introducing the financial sector taxes: firstly, the financial sector was a major cause of the financial crisis and received substantial government support over the past few years. It should therefore properly contribute to the cost of re-building Europe's economies and bolstering public finances.

2. Secondly, a corrective bank tax could complement the essential regulatory measures (including the bank levy and resolution fund) designed to enhance the efficiency of financial markets and to reduce their volatility.

3. Third, given that the financial sector is exempt from value added tax (VAT) in the EU, such tax would ensure this sector is not under-taxed if compared to other economy sectors. In sort, a new tax could help to ensure that the financial sector makes a fairer and more substantial contribution to public finances; it would provide additional sources of revenue and would help create a stable and more efficient financial sector. (17)

Under the proposals, three new EU-level watchdogs – for the banking, insurance and securities markets sectors – will draw up common technical rules and standards, while not supervising companies directly. However, there are concerns among some finance executives, especially in the UK, that the new watchdogs will permit Brussels to pursue greater centralised control of controversial activities such as derivatives and short selling. (18)

There will also be tighter requirements on financial institutions to register derivatives. Mr Barnier denied that the introduction of tighter financial supervision could put Europe at a competitive disadvantage: “the Americans are doing the same reforms in parallel that we are proposing. We don't have enough supervision at the moment. People must adapt,” said Mr. Barnier and added that the UK was still a centre of strength for Europe but that was in the interests of Europe and the City to be an example of supervision”. (19)

Among the suggestions, however, were broader view of the Commission's tax officials on the merits of taxes on financial transactions or on financial activity. The latter could be levied on profit and remuneration at financial firms, or on returns from risky activities.

Suggestions did describe in precise way the desirability of such taxes, which could raise billions of euros annually, or their relative merits. But officials acknowledged that the impact and feasibility of a transaction tax “remained largely uncertain in many cases” and tax avoidance and unintended consequences could be problematic. (20)

A financial activity tax would make financial services more expensive and cut the size of the financial services sector, the paper says. Nevertheless, commission officials say they want to get a better sense of the policy goals that member states believe such taxes could advance – ranging from helping to bolster national budgets to damping excessive risk-taking.

France, Germany and the UK are already committed to introduce bank levies based on bank assets; Germany is even willing to dedicate funds raised to future bank resolutions. The UK is adamant that proceeds should go towards general budgetary needs.

Technical differences are already causing some friction. For example, the British government's plan to include the balance sheets of foreign bank subsidiaries operating in the UK has caused disquiet in Germany. The French tax is likely to be focused more narrowly and raise substantially less than the UK levy. Germany and France are also pushing for international agreement on a financial transaction tax while the UK is less enthusiastic. (21)

As to financial supervision, already in September 2010, the EU finance ministers have given the green light to the proposed overhaul of the EU's patchy system of financial supervision – meaning that four new pan-European bodies to bolster national supervisory structures are set to start operating in January 2011. The pact – which creates three EU-wide supervisory authorities for banking, insurance and securities market, as well as a European Systemic Risk Board to warn about threats to financial stability – was approved by the European Parliament at the end of September. At this meeting, finance ministers also agreed to submit national budget plans to the European Commission and EU-27 governments for vetting – a move aimed at strengthening governance across the Union in the wake of some member states' critical conditions. However, they failed to reach consensus on whether new taxes should be levied on Europe's banks or financial services sector, an issue that creates sharp divisions among European governments.

For example, Olli Rehn, the EU economic and monetary affairs commissioner, was of an opinion that the budget-vetting initiative was a major improvement in the EU's economic governance architecture. He also promised to toughen actions against member states that ran excessively lax budgetary policies saying that the same level of commitment from all member states is expected on moving to a more rules-based enforcement of the growth and stability pact, including more and more effective incentives and sanctions, which will kick in at an earlier stage. There had been concerns in the UK that the vetting process might mean Brussels would see budgetary plans before they were presented to the House of Commons. The UK Chancellor of the Exchequer, George Osborne, assured that Britain's submissions would follow soon. However, lack of agreement on the bank tax has shown splintered views on what kind of levy might be desirable and how any proceeds should be used. Both EU ministers and Commission's officials differed in their assessment of future moves; although several EU finance ministers supported the UK's argument that it was up to national governments to decide how proceeds from any bank levy were deployed. The EU Commissioner, Michel Barnier, suggested, first to see at least some of the proceeds to mandated national “bank resolution funds”. Quite notable, that discussions made progress from “just talks” earlier in 2010. (22)

Together with the mentioned communication, The European Commission published a set of clarification papers concerning the perspective issue of financial sector taxation (Brussels, 7 October 2010)  and clearing up the FTT's idea. The deliberations on the Commission's proposal went the following way:

•  The essence of the financial transactions tax, FTT. A financial transaction tax (FTT) is a tax applied to financial transactions, usually at a very low rate. Financial transaction means any exchange of financial instrument between two or more parties. The financial transaction tax would apply only to stocks and bonds, working as a currency transaction levy; these are two examples of a “arrow base FTT”. At the opposite end of the spectrum a very broad base financial transaction tax would be introduced, which applies to all financial instruments including derivatives and structured instruments.

•  The essence of the financial activities tax, FAT. A financial activities tax (FAT) is a tax on profit and remuneration, which applies to all activities of a financial sector company (e.g. bank or insurance company). It can tax all profit and wages; it can be specifically view economic rents (rent-taxing FAT) and/or profits gained through riskier activities (risk-taxing FAT). In contrast to an FTT, where each financial market actor is taxed according to transactions, the FAT targets financial corporations. This decision was presented to the G-20 meeting in the IMF's report on financial sector taxation in June 2010. (23)

•  The options in taxing the financial sector. Already at the European Council in June 2010, it was agreed that the EU should lead efforts to set a global approach for introducing systems for levies and taxes on financial institutions with a view to maintaining a world-wide level playing field. The European Parliament and some member states have also called for the idea of financial sector taxation. After a wide public debate on the various possibilities for taxing banks in Europe and at global level, as well as in-depth analysis of the issues, the Commission intends to arrange discussions on financial sector taxation in order to come up with the best approach. By putting forward options for a European approach, the Commission aims to avoid new obstacles to the “internal market”, which could be created through a patchwork of different national bank taxes. The Commission has always supported the idea of a global financial transactions tax to fund global challenges.  

Reasons for a new tax. Among the numerous reasons behind the introduction of a new tax on the financial sector, the following were considered most appropriate.

• First, the banks played a central role in creating the recent economic crisis, and it is generally agreed that they now need to make a fair and substantial contribution to the costs of recovery.
• Second, a new tax on the financial sector would raise important and much-needed revenue. The Commission has concluded that the financial sector is probably under-taxed compared to other sectors. Therefore, it would be justifiable to introduce a new financial sector tax which could help meet current revenue needs.
• Third, some taxes with their “corrective” characteristics could help positively influence market behaviors and help prevent future crises. The Commission will, however, take into consideration the cumulative impact of taxes and regulation in order to ensure their complementarities and to allow the financial sector to fulfill its role in the "real" economy.

The financial services have been constantly treated preferentially: e.g. they are generally exempt from VAT due to difficulties in measuring the taxable base. A number of studies suggested that this situation could lead to the under-taxation of financial services. (24) In addition, the Commission has taken into account the privileged position that the financial sector enjoys in the economy compared to other sectors, the fact that it has benefited from economic rents and the implicit protection it has received from governments. These factors also need to be considered when weighing up what would constitute a fair contribution by the financial sector to public finances.

Therefore, the Commission supported a global financial transactions tax. The economic crisis was global in its causes and effects; responding to it, and recovering, requires global solutions. If ambitious global objectives are to be achieved, in areas such as development aid and climate change, international partners will need to agree on the global financing tools.

Given the potentially high revenues a global FTT could generate (some mentioned about € 60 bln a year!), it is an attractive funding solution for numerous global objectives. Economic analyses also show that a financial transaction tax, in addition to the revenue it could raise, may prevent certain market behaviors (such as high speed trading) if implemented globally. Therefore, it would offer a “double dividend” in that it could help to raise important revenues while also contributing to more stable and efficient financial markets.

Some possible revenues raised from a global FTT were estimated: if applied at global level, and at a rate of 0,1%, tax revenues from a financial transaction tax are predicted to be around € 60 bln (without derivatives). Some even say that values of more than ten times this amount are expected if derivatives are included. Although for various reasons, these figures are not considered to be highly reliable. (25)

Global and European “financial taxation”. The Commission considers that the FAT is more preferable option for Europe than the FTT; the Financial Transactions Tax is a tax more suited to global application – there are considerable risks (particularly of relocation) in its unilateral introduction. Therefore, the risks are considerably lower with the FAT, because profits and wages are less mobile than trading. The FAT appears to offer the advantages of being able to raise revenue and ensure a fair contribution from the banks, without the high risks associated with the FTT.

The Commission's analysis suggests that the FAT is more suited for the European rather than for the global level, as it would fit better with the specificities of European economic and taxation situation. The FAT is not really a tax that could uniformly apply in every region of the world, given the different approaches to taxation internationally. Hence, a financial transactions tax would, by its nature, be much easier to apply globally. (26)

The European Commission has thrown its weight behind the introduction of a financial activities tax in Europe, which would tax profits and remuneration at banks and other financial services companies, as it considers ways to raise money from the financial sector. In October 2010, officials in Brussels said that the alternative idea – a financial transaction tax – was less suitable because of a “high” risk that business would simply move to other regions in the world. (27) The Commission argues that at this stage, there is greater potential for a financial activities tax at the EU-level. For example, tax officials in Brussels argue that the financial sector has received large amounts of public support through “financial crisis injections” and yet it is taxed relatively light. EU tax officials present their views to the EU leaders' summit in late October 2010, with an in-depth impact assessment for policy initiatives in 2011. (28)

General approach to taxation policy and law –both in financial sector, innovations and industry- is ultimately the major issue in discussion among politicians and specialist in the years to come. Besides, taxation is more than a purely economic issue. For example, the Irish long-standing policy of keeping taxes on business at almost lowest in the EU level (12,5% compared to more than 30% on EU average) brought prosperity to this country: its GDP rose from 80% of European average in 1997 to 134% in 2007. (29) But the issue is closely connected to the Irish “sense of sovereignty”. On top of it, taxation according to EU law remains a national prerogative. Hence, if Ireland decides to keep low corporate rate, it has to find other ways to cover the deficits.

These issues are difficult to resolve: they need both a new way of approaching “European solidarity” and a new approach to “tax sovereignty” of the EU member states.

At the EU summit at he end of 2010 (during 16-17 December 2010) the EU member states' leaders agreed to change the temporary “risk mechanism”, initially created to bailout weakest economies in the EU (Greece, Ireland, etc.) valid until 2013 into a permanent one. Hoverer, it would require changes in the new Lisbon Treaty. Most probably, these changes concerning “minor” treaty's amendments could be introduced without popular referendums in the member states.

Eugene ETERIS, European Correspondent

References

1. See: Maros Sefcovic, Speeches: European University Institute in Florence, 12 November 2010.

2. Arguments on the theme can be seen in experts' opinion in Financial Times, 26 March 2010, and in a special section in Financial Times on Greece crisis in September 2010.

3. See: Peel Q., Hall B., Pignal S. Deal shows Merkel has staked out strong role. – Financial Times, 26 March 2010.

4. See: http://ec.europa.eu/commission_2010-2014/barnier/headlines/topics/financial_services/index_en.htm#top 

5. See: http://ec.europa.eu/dgs/internal_market/docs/acquis_en.pdf

6. See: Press Release Memo/10/376; Brussels, 16 August 2010.

7. Additional information on supervision:

- http://ec.europa.eu/internal_market/finances/committees/index_en.htm

- http://ec.europa.eu/economy_finance/thematic_articles/article15861_en.htm

8. More information on the issue:

http://ec.europa.eu/internal_market/financial-conglomerates/supervision_en.htm

9. See: IMF, World Economic Outlook, October 2010.

10. See: Olli Rehn, European Commissioner for Economic and Monetary Policy. The Commissioner's SPEECH/10/257, May, 2010.

11. See: The EMU Commissioner's website and Eurobarometer, Autumn 2010.

12. See: Pisani-Ferry J. and Sapir A. Europe needs a framework for debt crises. – Financial Times, 28 April 2010.

13. About 10 years ago, for the first time, the issue of sovereign debt restructuring gained attention (e.g. when some emerging economies like Argentina, faced severe public debt crises). At that time the debate rotated about how to manage and resolve such crises, with a central issue of how the sovereign debt restructuring cope with an internationally diverse and diffuse creditors. At that time, two solutions were suggested. First, a contractual reform, making it easier for the private sector to restructure debts by imposing collective representation clauses: the idea was eventually adopted in 2003 when Mexico first issued bonds with collective action clauses. Second, a solution, originally proposed by Anne Krueger, the then IMF first deputy managing director, aimed at creating a sovereign debt restructuring mechanism that would provide a statutory framework for debt crises.

14. See: Tait N. EU finance regulation shake-up welcomed. – Financial Times, 3 September 2010.

15. Citation is from the Tait N. article in Financial Times, 22 September 2010.

16. See: Tait N. and Wilson J. Fund managers wary of EU vote. – Financial Times, 6 May 2010.

17. The Commission's Communication, see: http://ec.europa.eu/taxation_customs/index_en.htm

18. See: Sanderson R., Blitz J. No escape from tighter EU financial supervision. – Financial Times, 5 September, 2010.

19. See: Tait N., Wiesmann G., Hall B. Push for common approach on bank tax in EU. – Financial Times, 6 September 2010.

20. Ibid. – Financial Times, Push for common approach on bank tax in EU – 6 September 2010.

21. Financial Times. Editorial: EU go-ahead for regulatory shake-up – 7 September 2010.

22. See: Tait N. EU go-ahead for regulatory shake-up. – Financial Times, 7 September 2010.

23. See: http://www.imf.org/external/np/g20/pdf/062710b.pdf.

24. On new financial tax, see, for example:

- Genser and Winker (1997) "Measuring the Fiscal Revenue Loss of VAT. Exemption in Commercial Banking",

- Huizinga (2002) "A European VAT on financial services? Economic Policy",

- De la Feria and Lockwood (2009) "Opting for Opting-In? An Evaluation of the European Commission's Proposals for Reforming VAT on Financial Services".

25. - De la Feria and Lockwood (2009) "Opting for Opting-In? An Evaluation of the European Commission's Proposals for Reforming VAT on Financial Services"; In: http://www.imf.org/external/np/g20/pdf/062710b.pdf.

26. See: European Commission (2010), Staff Working Document on the Taxation of the Financial Sector: http://ec.europa.eu/taxation_customs/index_en.htm.

27. See: Tait N. Brussels backs financial activities tax. – Financial Times, 7 October, 2010.

28. See: Financial Times, -Editorial Comment: The moving target of bankers' bonuses, 7 October, 2010.

29. Barber T. Pressure on corporate tax threatens Irish industrial policy. – Financial Times, 18 November 2010, p.2.

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