Differing regulation across the European Union member states has meant a single competitive cross-border market has been hard to attain. Can MiFID and IORP create the much-needed harmonisation?
Although the mission of the European Union government is to create a single competitive cross-border environment, the sea of regulation surrounding this is causing problems for the financial services industry.
There are few EU financial services companies with more than a foothold outside their traditional geographies. Mortgages, loans and pensions are solely the preserve of local providers.
So, what prevents world class banks and insurers operating across Europe, providing identical services from Poland to Portugal? This would surely bring down prices and increase choices for everyone.
A legal minefield
Most of the problems lie in the vast array of different regulations. Taxation of income from capital - one of the major factors governing investment decisions - is still far from being a level-playing field. Tax rates can, and do, seriously alter the relative returns on financial assets and are at least as important in restraining investment as transaction and settlement costs.
Capital gains tax rates across the EU still vary widely. The capital gains tax rate in Lithuania is 6.3%, in Denmark it is 43.8%, while the EU average is 25.8%. Different classes of investment and individual capital allowances also vary. Although differential taxes on residents and non-residents are slowly being swept aside in European Court judgements, any decision to invest across borders is complicated by this uneven tax burden.
National capital markets are far from integrated. There are more than 30 exchanges and some 20 national clearing and settlement institutions. This sort of inefficiency may be costing up to E3.2bn a year. The real cost in lost business is immeasurable.
If Europe really wants more investment, then its member states need to allow financial institutions to build the systems that take compliance seriously but do not stand in the way of increased competition.
The minefield of more than 60 regulators and all the associated procedures not only adds hugely to cost, but is also unbalanced. Advisers in the UK must complete at least five examinations and be approved by the Financial Services Authority's (FSA) vetting process. By comparison, Spain has no such process and takes no steps at all to regulate this market. The fragmented legislation governing what financial products may offer means limited offshore bonds in Spain, no hedge funds in Belgium, no annuities in Poland and no non-status mortgages in France.
A new era
Alongside governments, the private sector must play its part in improving efficiency and competitiveness by consolidating its own infrastructure - for instance, by pruning trading platforms and payment, clearing and settlement systems.
Governments and state bodies should allow this process to take place unhindered. They must realise the days of building national champions have long gone. The UK has certainly got the message as companies that were once thought of as national success stories are now owned or headquartered abroad. There are plenty of examples: Spain's Santander acquired the UK high street bank Abbey, France's Pernod Ricard gulped down drinks group Allied Domecq and China's Nanjing seized control of Rover. A third of UK-listed companies are not owned by UK investors.
These larger groups can compete better globally. In a free market, anyone can buy a stake in foreign companies providing they can live with the problems raised here.
With regard to regulation, companies that have Ucits products must comply with relevant EU laws to hold the Euro-pean passport.
Ucits funds make up 70% of the E5 trillion worth of assets managed by the European fund industry. There are nearly 29,000 of them in the EU with more than 16% sold on a cross-border basis. But the rules are interpreted differently by the member states creating a barrier to an efficient 'passport' regime.
Ucits is a qualified success but it took a long time in coming and is now obsolete. The first directive was issued in 1985 and was met by a wall of national obstacles that took until 2001 to demolish. That pace is just too slow for effective market reform.
With its 'vanilla only' formula, Ucits does not meet the needs of today's investors. It is the nature of financial markets to continuously invent new products yet the strait-jacket of Ucits restricts choice, increases compliance costs and has been used to protect domestic companies.
However, looking at the positives for Europe, two other EU directives are designed to make cross-border trading easier. The Markets and Financial Instruments Directive (MiFID) should bring dramatic change to EU markets, harmonising much of the national legislation designed to protect the customer. This harmonisation will cost more in IT systems, training and implementation but it will also make it easier for firms to compete in foreign markets.
The other directive, Institutions for Occupational Retirement Provision (IORP), seeks to provide a framework for institutions that provide pre-funded occupational pensions. It harmonises rules in areas such as prudential supervision, capital adequacy, investment risk management and crossborder operations.
Will these directives work? It depends on how much these individual states and regulators goldplate their implementation or put in rules above what is required. Each national regulator feels compelled to tamper with directives, the rules governing their local application and the zeal with which they are applied. No matter how well-meant, every minor change presents another obstacle to free trade and undermines the whole point of the exercise.
Should the finance industry care about yetmore Brussels directives? In this case, it should care a great deal. MiFID has been fast-tracked to deliver reform rather more quickly than the 16 years of procrastination that it took Ucits. Success here will do much to open up financial markets to cross-border competition, but will also demonstrate that directives can deliver benefits in a commercial timescale.
Financial services providers are nothing if not innovative. Independent private wealth managers are seeing great opportunities in pan-European financial services catering for the complex tax and investment needs of clients. The UK is the financial centre for Europe and should see enhanced competition as an opportunity to develop products and services that are not hamstrung by unnecessary red tape.
There needs to be recognition that if the pot grows, everyone gets a bigger share. In this marketplace, freedom should be allowed to reign.key points
Sea of regulation causes problems for financial services industry
National capital markets are far from integrated
Ucits funds make up 70% of funds
To promote 'long-term investment'
Switching 'hard and expensive'
Smaller funds still packing a punch
To drive progress