The Challenges of Integration in Europe Alberto Giovannini

2 The European Financial Market  In Europe the financial system is and will be in foreseeable future an essential strategic pillar for development  It will be the mechanism through which the market economy will adapt over time to changing opportunities, and the mechanism that will induce more competition in industry and services  Currently, the European financial system is faulty at the core, in that its core design is fragmented  Institutions like the ECB and the EU Commission are working to facilitate the development of basic financial market infrastructures that are consistent with the above-mentioned strategic view

3 Clearing and Settlement: The Core  Clearing and settlement (C&S) are key to the construction of the European securities market:  C&S define the securities market, while organized exchanges are much lighter;  Currently C&S is a fundamental hurdle to the creation of an integrated securities market.  C&S infrastructures are inconsistent across EU member states.  The inconsistencies derive from:  The presence of national monopolies providing C&S services, created in the interest of national efficiency (when cross border transactions were by and large not allowed);  The largely independent development of standards, conventions, rules regulations and laws, mostly due to the above.

4 Size of the Market Source: European Central Bank

5 Volume of Transactions Source: European Central Bank

6 Number of Providers Source: European Central Bank

7 Structure

8 Costs of Transactions Source: European Central Bank

9 Is There Agreement on Reform?  The so-called Giovannini reports put together existing wisdom on the causes and effects of fragmentation in European financial markets.  The EU Commission has adopted this analysis as well as the proposals for managing reform.  EU institutions now recognize C&S is a priority:  Parliament views C&S reform essential for prosperity (Contribution of the European Parliament to the Commission's Legislative and Work Programme 2006);  The Commission has included C&S among the highest priorities for efficiency-inducing reforms (within so-called Lisbon Agenda).  Just a few years ago these institutions did not even know what C&S were!  The European Central Bank is committed in contributing to the creation of efficient post-trading infrastructures

10 The Top-Down Precedents  DTCC?  Holding company consolidating the National Securities Clearing Corporation (NSCC) and the Depository Trust Company (DTC). This often-cited integration was due to the concern that NSCC and DTC would start to overlap in the functions they provided, thus creating conflict and unnecessary complexity, the two former institutions were created by disassembling existing siloses, and horizontally integrating clearing and settlement platforms  ESCB/ECB?  The creation of this institution—which also manages the system of cash payments in the Euro area—has been a very efficient and glitch-free project.

11 The Reform Strategy  Framework: the sum of standards, conventions, regulations and laws whose difformities and inconsistencies create barriers to cross-border C&S.  Architecture: actual structure of C&S—how many suppliers, what activities they perform, how much specialization, how large relative to the market.  The EU reform strategy is to concentrate on framework, not on architecture.  This is done for several reasons: 1. Without the appropriate framework, C&S would be inefficient, whatever the architecture; 2. In addition, even if all barriers were eliminated, there is not, so far, a universally preferred architecture model for C&S; 3. The EU Commission believes markets are, in principle, capable of delivering the appropriate architecture on their own.

12 Basic Structure of the Reform Process  There is very significant exchange of information and consultation among the private sector and authorities, the EU Commission in particular;  CESAME is the place where information on the progress of the different initiatives is broadly discussed; it posts on the internet all relevant material and information;  There is a structured set of actions to be undertaken, and a published list of responsible institutions for each individual action;  Significant work is being carried out in two parallel groups, dealing with legal certainty and tax compliance, respectively;  All of this:  to minimize the risk of capture;  to achieve convergence of views on the agenda, except of course for the different legitimate private economic interests.

13 Commission’s Own Reasoning on Authorities’ Initiatives

14 Uncertainties  Will a directive become effective too late?  Will a directive be distorted through the political process?  Are there other forms of intervention, like issuance of guidelines, preferred?

15 Assessment  C&S too important to be without a clear regulatory framework, that only a directive can provide  Directive sets a standard, even if slow to become effective, it focusses all market participants  Bundling of essential services with value-added services and the resulting implicit subsidies should not be allowed, bundled services should be offered alongside with unbundled services; siloses should be open; integration should be horizontal  Providers of infrastructure services should strive to minimize costs, not maximize profits; prices of core services should be standard, as the services themselves are.

16 An “Easy” Reform…  Everyone wants integration and consolidation of C&S:  private markets see the phenomenal gains to be made from more efficient securities trading throughout Europe;  authorities see the pro-competitive and pro-growth effects of an efficient financial system, of which C&S represent the most fundamental functions;  The removal of barriers and the likely consolidation do not constitute threats to:  the needs of member states to enforce national rules effectively;  the need to maintain an adequate degree of democratic accountability;  individual rights.

17 …Is Being Challenged  The combination of the non-invasive, framework approach of the EU Commission with the active lobbying of service providers can cause delays/diversions  Structurally, EU reform is complicated by the bi-dimensionality problem: the interaction of industry interests with country interests can also produce distorted outcomes  These challenges can only be met with one attitude: LEADERSHIP