Susan Schmidt Bies: US - EU regulatory dialogue
Testimony of Ms Susan Schmidt Bies, Member of the Board of Governors of the US Federal Reserve
System, before the Committee on Financial Services, US House of Representatives, Washington, DC,
13 May 2004.
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Thank you, Mr. Chairman, for the opportunity to speak today on matters relating to the informal
U.S.-EU Financial Markets Regulatory Dialogue. I would like to focus my remarks on the Dialogue's
role in helping us to monitor European-wide regulatory developments in financial services and
understand the effects on U.S. banking organizations operating in the European Union.
Background to the dialogue
As has been noted, the Dialogue was initiated by the Treasury Department in 2002, at a time of
significant regulatory developments in both the European Union and in the United States. At that time,
the European Union was continuing its efforts, begun in 1999, to establish a single market in financial
services by implementing the "Financial Services Action Plan" (FSAP). The FSAP consists of a
number of regulatory and legislative measures designed to achieve, among other things, a single
wholesale European market; open and secure retail markets; and state-of-the-art prudential rules and
supervision. On our side of the Atlantic, U.S. regulators were continuing to implement provisions of the
Gramm-Leach-Bliley Act and Congress was considering reforms that led to the adoption of the
Sarbanes-Oxley Act. These developments, which affected European financial services firms with U.S.
operations, naturally were of interest to staff of the European Commission.
From the outset, the Dialogue's purpose has been to foster a better mutual understanding of U.S. and
EU regulatory approaches and to identify potential substantive conflicts in approach as early in the
regulatory process as possible. The Dialogue consists of an informal discussion or explanation of
regulatory approaches, developments, and timetables, conducted at an experts level. This format has
served us well during the past two years. Although the Federal Reserve has regular contact with staff
of the European Commission in other groups on a range of issues, the Dialogue is the only venue
dedicated specifically to U.S.-EU regulatory issues.
Federal Reserve's interest in monitoring foreign regulatory developments
As the umbrella supervisor of U.S. bank holding companies and financial holding companies, the
Federal Reserve has a strong interest in the regulatory environments in which these firms operate
outside the United States. We have an established program of working with foreign supervisors at both
bilateral and multilateral levels. Through regular contact, we track changes to foreign bank regulatory
and supervisory systems and seek to understand how these systems affect the banking institutions we
supervise.
This is especially important in the European Union, where U.S. banking organizations have substantial
operations. As of September 30, 2003, thirty-four U.S. banking organizations operated in the
European Union with aggregate EU assets of more than $747 billion. As of December 31, 2003,
sixty-eight EU banking organizations maintained active banking operations in the United States, with
total third-party banking assets in their U.S. offices of $937 billion. As these figures suggest,
institutions from the United States and the EU are major participants in each other's markets.
The dialogue as an additional forum for monitoring EU regulatory developments
As the EU seeks increasingly to harmonize financial services rules across its internal market, the
regulatory role of the European Commission has grown correspondingly. In this environment, the
Dialogue complements the Federal Reserve's ongoing relationships and discussions with EU national
regulators.
The Dialogue, moreover, fills a role not presently served by any one of those ongoing relationships
and discussions. As the market for financial services becomes increasingly integrated, the interests of
banking, securities, and insurance regulators correspondingly are becoming more common and
intertwined. The Dialogue provides a forum for discussion of issues in each of these areas. The
regulatory discussions benefit from this sharing of different substantive perspectives. For this reason,
too, the Dialogue is an efficient forum for information exchange, which has great utility for supervisors
of large complex financial services organizations.
Global companies operate across many countries and must adapt their business and strategy to local
regulatory and supervisory requirements. It is now generally accepted in the U.S. and internationally
that a foreign firm that conducts business in a local market should receive national treatment, that is,
the foreign firm should be treated no less favorably than a domestic firm operating in like
circumstances. The United States adopted a specific policy of national treatment for foreign banks
operating in this country with the enactment of the International Banking Act of 1978.
As we have previously testified, implementing a policy of national treatment can be challenging.
Although large financial services companies operate in a globalized world, each is based in a specific
country whose economic regulation or supervisory approach will differ from those in other countries.
The challenge of providing national treatment arises as we seek to adapt our own regulatory system to
a foreign banking organization that operates under a different legal and regulatory structure. We
believe the Federal Reserve has successfully met the challenge in its treatment of foreign banking
organizations operating in this country. Part of that success can be attributed to our work with foreign
regulators and supervisors in seeking to understand the operating environment of the foreign banks
we regulate. The Dialogue contributes to that knowledge.
We are equally concerned that U.S. banking organizations receive national treatment in their foreign
operations. The Dialogue provides us the best opportunity to understand EU directives that affect
those operations and provides us with the ability to raise concerns directly with the staff that has
responsibility for the preparation and presentation of such directives.
The Dialogue provides a useful forum for information exchange between U.S. regulators and the
European Union over Europe-wide matters that have the potential to affect the application of national
treatment in particular situations. In implementing the FSAP in the European Union, the European
Union has an obligation to ensure that the rules adopted are consistent with the principle of national
treatment. It is our expectation that the European Commission and the member states will continue to
seek to do so.
Select issues discussed during the dialogue
The Dialogue has touched on a variety of issues in the past two years. Of particular interest to the
Federal Reserve and to U.S. banking organizations operating in the EU is the issue of the application
of the EU's Financial Conglomerates Directive to U.S. financial firms. This Directive, and others that
have been amended in connection with its adoption, establishes various supervisory requirements for
EU firms. Among other matters, it requires that the consolidated group be subject to supervision and
minimum capital standards by a member state authority. For firms that are headquartered outside the
EU, such as U.S. banking organizations, the directives require that the foreign financial firm operating
in EU markets must be subject to supervision at the holding company level by a competent home
country authority, which supervision is equivalent to that provided for by the provisions of the Directive.
The EU's national supervisors will be responsible for making equivalency determinations on a
groupby-group basis, in accordance with guidance issued by the European Commission. In the absence of
an equivalence determination, U.S. financial firms with EU operations could be subject to higher
capital and risk control requirements or be required to create an EU sub-holding company.
The European Commission is preparing guidance on what might constitute equivalent supervision by
third countries. In preparing this guidance, committees working under the auspices of the Commission
convened a technical group comprised of member state supervisors to provide input on issues to be
taken into account in verifying equivalence. The group sent questionnaires to home country
supervisors of financial organizations having operations in the EU, inquiring about the measures those
supervisors take to ensure that the entities they supervise are subject to consolidated supervision at
the top-tier level. The Federal Reserve and the Office of the Comptroller of the Currency prepared a
joint response on supervision of U.S. banking organizations with EU operations. We understand that
the EC's guidance is expected to be issued in the summer.
Member state lead regulators are expected to rely on the European Commission's guidance in
verifying equivalent supervision with respect to individual institutions. We anticipate that the European
Commission will keep us informed of member states' progress in this regard during the Dialogue and
also will alert us to the existence of and procedures for addressing any disparities in member states'
approaches. We fully expect that U.S. banking organizations will be found to meet the supervision
standard of the directive.
Another topic of discussion relating to banks has been the status of work on revisions to the Basel
Capital Accord (Basel II). The discussions within the Dialogue have not focused on technical issues
that have been under consideration within the Basel Committee on Banking Supervision (Basel
Committee), but rather have addressed the scope of application and implementation and timing
concerns. Specifically, the Dialogue has served as a useful venue for both the EU representatives and
the Federal Reserve participants to gain a better understanding of the implementation procedures that
are anticipated to be applicable in each jurisdiction. Staff has been able to ask questions about the EU
legislative process, and to explain in detail how the U.S. regulatory process functions. Understanding
the requirements and limitations of each others' legislative and regulatory processes has helped both
sides achieve, in my view, a better sense of the implementation challenges we all face and of the
commitment to see the process through.
With regard to the scope of application of the proposed new Accord, the Federal Reserve
representatives were able to provide information for the EU participants about the reasons the U.S.
banking agencies proposed to require only a core set of banks to apply the advanced approaches for
both credit risk and operational risk. As you know, one of the primary drivers behind this decision was
the U.S. banking agencies' collective view that complex, sophisticated organizations should be using
the most advanced risk measurement and management practices available and those techniques and
practices are recognized in the Basel II advanced approaches. The U.S. agencies also proposed
permitting other institutions to move voluntarily to the advanced approaches subject to the same
rigorous risk measurement and management requirements as core banks. Through the Dialogue, the
participants were able to discuss the U.S. approach and to compare it with the EU proposal to apply
Basel II to all of its banks and investment companies. These different implementation strategies will
raise some issues, and that is why the Basel Committee has created the Accord Implementation
Group to coordinate implementation across jurisdictions and work through home-host issues.
As noted, issues are not resolved during Dialogue discussions; that is not the purpose of the Dialogue.
But open communication that fosters understanding can feed back into the decision-making
discussions when they are held in other appropriate forums. With respect to Basel II implementation
and the Dialogue, in my view, the current structure will continue to serve a useful purpose - as
implementation issues are identified, the Dialogue can be a venue for candid, informal communication.
Participants can take back to their constituents the results of those discussions and the subject matter
experts can determine how best to address issues that are raised or respond to particular questions or
concerns.
The Dialogue has been useful in diffusing tensions over matters that have a direct impact on global
firms. This has been especially true with respect to issues under the Sarbanes-Oxley Act, a discussion
of which I shall leave to my SEC colleague. The Dialogue has also been helpful on less high profile
matters. Through discussions at Dialogue meetings, we were able to keep EC staff apprised of
developments relating to asset pledge requirements applicable to foreign banking organizations
having U.S. offices.
For more than forty years, federal and state bank licensing authorities have imposed an asset pledge
or capital equivalency deposit requirement on U.S. branches and agencies of international banks,
primarily for safety and soundness reasons. This requirement obligated such institutions to hold
certain negotiable securities at American custodian banks. In recent years, foreign banks were of the
view that such requirements were more onerous than necessary and sought a reduction in the level of
assets to be pledged. The matter was brought to the attention of European Commission staff who
raised it at the Dialogue. We were able to inform Commission staff of progress being made on this
front by state authorities in New York and elsewhere over a two-year period. New York changed its
asset pledge requirement in 2003, generally satisfying the concerns of foreign banks. The Dialogue
was a useful forum to keep Commission staff apprised of developments during this period.
International accounting
The FSAP also contemplates mandating adherence to international accounting standards. Currently,
banking organizations in the European Union may prepare their annual financial statements in
accordance with the accounting standards of the International Accounting Standards Board (IASB),
U.S. generally accepted accounting principles (U.S. GAAP), and/or national standards. The use of
U.S. GAAP is usually limited to those banking organizations or other companies whose securities are
publicly traded on U.S. stock exchanges and are registered with the Securities and Exchange
Commission. In many cases, these companies will also provide separate financial statements based
on their national accounting standards and disclosure rules. The European Union will require all EU
companies listed on EU exchanges that are currently following national standards to follow IASB
standards by 2005 and will require those EU companies that currently follow U.S. GAAP to adopt IASB
standards by 2007. The EU is also working to adopt international auditing standards for external audits
of EU companies, including banks.
The IASB is now independent of the international accounting profession and independently funded. It
has adopted many of the structural elements of the FASB in the United States, which are intended to
promote an independent, objective standards-setting environment. Many senior American accounting
experts serve on the IASB and its staff. IASB GAAP has many similarities with U.S. GAAP and the
IASB issued extensive enhancements to its standards last year and this year, with additional
improvements also issued as a proposal this year. For example, in recent months the IASB issued
major revisions to its standards for financial instruments, which are similar to U.S. GAAP and cover
many areas of banking activities. One aspect of these revisions by the IASB significantly improved the
guidance on loan loss allowances in ways that could lead to better bank reserving practices around
the world.
The Federal Reserve has long supported sound accounting policies and meaningful public disclosure
by banking and financial organizations with the objective of improving market discipline and fostering
stable financial markets. The concept of market discipline is assuming greater importance among
international banking supervisors as well. Basel II seeks to strengthen the market's ability to aid bank
supervisors in evaluating banking organizations' risks and assessing capital adequacy. It consists of
three pillars, or tools: a minimum risk-based capital requirement (pillar I), risk-based supervision (pillar
II), and disclosure of risks and capital adequacy to enhance market discipline (pillar III). This approach
to capital regulation, with its market-discipline component, signals that sound accounting and
disclosure will continue to be important aspects of our supervisory approach.
The Federal Reserve and the other U.S. banking agencies are also actively involved in the efforts of
the Basel Committee to promote sound international accounting, auditing, and disclosure standards
and practices for global banking organizations and other companies. For example, an official of the
Federal Reserve Board is a member of the Standards Advisory Council that advises the IASB and its
trustees on IASB projects, proposals and standards. The U.S. banking agencies have been active in
supporting the Basel Committee in its work with the IASB's technical advisory groups to enhance the
IASB's standards for financial instruments and bank disclosures. The Federal Reserve Board has also
been active in supporting the Basel Committee's projects with the International Federation of
Accountants (IFAC) and other international regulatory organizations, such as International
Organization of Securities Commissions (IOSCO), to promote substantial enhancements to global
standards and practices for audits of banks and other companies.
Although the Federal Reserve Board has been actively involved in addressing international accounting
and auditing issues primarily through our involvement in the Basel Committee's projects, the Securities
and Exchange Commission has had the primary role in discussing these matters with the EU
representatives as part of the Dialogue.
Cooperation on anti-money laundering and counter-terrorist financing issues
While not historically part of the U.S.-EU Dialogue, recent anti-money laundering and counter-terrorist
financing regulatory initiatives on both sides of the Atlantic have had a significant impact on banking
organizations, many of which operate globally. Because of the potential consequences of differences
in regulatory approaches in this area, governments have been in frequent contact. In the end, the
anti-money laundering provisions set forth in the USA PATRIOT Act and those contained in the EU
Anti-Money Laundering Directive are generally in harmony.
Part of this can be attributed to the Federal Reserve's and other U.S. and EU regulatory authorities'
mutual involvement in multilateral policy efforts to improve regulatory systems so to prevent these
crimes, such as the Financial Action Task Force and the Basel Committee's cross-border banking
group. On a practical level, supervisory dialogue and cooperation on anti-money laundering and
counter-terrorist financing also has been necessary due to the role the Federal Reserve frequently
shares with its EU counterparts as "home/host" supervisors of global banking organizations. However,
this cooperation is typically focused on providing assistance in order to fulfill supervisory mandates,
not to conduct money laundering or terrorist financing investigations, the authority for which typically
falls with law enforcement authorities.
While Bank Secrecy Act requirements, including the provisions added by the USA PATRIOT Act,
generally do not extend to foreign operations of U.S. banking organizations, the Federal Reserve is
interested in understanding the global operations of the banking organizations under Federal Reserve
supervision as a matter of safety and soundness. In this regard, the Federal Reserve relies upon
communication with supervisors from foreign jurisdictions, including EU member states, in which
banking organizations subject to Federal Reserve supervision have material operations.
Critical information obtained in the course of an examination, which may impact a banking
organization's operations in the foreign jurisdiction, is typically exchanged among relevant supervisors.
For example, when a Federal Reserve Bank conducts an on-site examination of a foreign banking
organization in the United States, and significant problems are identified with regard to its anti-money
laundering program, the Federal Reserve contacts the home country supervisor to discuss the findings
and to develop corrective action plans.
Moreover, the Federal Reserve may provide information to European Union member bank supervisors
when administrative penalties have been imposed or any other formal enforcement action has been
taken against a U.S. banking organization (whether or not it is related to anti-money laundering
requirements) if the Federal Reserve believes such information will be important to the host country
supervisor. The Federal Reserve expects the same from its counterparts.
Future of the dialogue
As is evident from the tenor of my remarks, the Federal Reserve has found the Dialogue to be a useful
vehicle for monitoring the rapid regulatory developments in the European Union and exchanging
information. We are committed to continuing discussions with the Commission on matters of mutual
interest, both bilaterally and as part of the financial markets regulatory discussions led by the Treasury
Department. The regulatory landscape in the European Union is certain to continue to develop rapidly
in the coming years, particularly with expansion of the European Union, member states'
implementation of the numerous FSAP measures needed to create a single market for financial
services, and the growing integration of our capital markets.
We at the Federal Reserve have an obligation to keep apprised of these developments on a timely
basis in order to fulfill our supervisory function and to ensure a level playing field for U.S. banking
organizations operating in the European Union. We are confident that continuing the Dialogue in its
present form would facilitate these objectives.
We are equally confident that other existing multilateral and bilateral exchange mechanisms are
appropriate venues for discussing policies and attempting to resolve disputes. In our view, formalizing
the Dialogue - for example, by elevating it to the principals level or expanding its mandate to include
policy-setting or dispute resolution functions - would be unnecessary and may impair the Dialogue's
utility.
The Federal Reserve believes that U.S. banks are second to none in their ability to compete when
they are given the opportunity of operating on a level playing field. Providing strong supervision at
home and participating in international regulatory and supervisory groups such as the Dialogue helps
assure that our banking organizations will continue to have such opportunities.