Mark W Olson: The European Union's financial services action plan
Testimony of Mr Mark W Olson, Member of the Board of Governors of the US Federal Reserve
System, before the Committee on Financial Services, U.S. House of Representatives, 22 May 2002.
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Thank you, Mr. Chairman, for the opportunity to speak today on matters relating to the operations of
U.S. banking organizations in the European Union. This is a time of significant change within the
European Union with the ongoing efforts to complete the single market in financial services.
I join with my colleagues here today in welcoming the European Union's plans to make its market
more efficient and transparent. The United States has always been a strong supporter of European
unity as well as market reforms that eliminate unnecessary regulatory burden and promote better
functioning of markets and financial systems.
The Financial Services Action Plan of the European Union includes proposals that are aimed at
achieving these same goals. The FSAP involves a series 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. To further these goals, a number of
directives have been or will be adopted that deal with issues such as money laundering, investment
services, implementation of new Basel capital rules and international accounting standards, and
supervision of financial conglomerates. I will deal with the latter three areas later in my testimony.
These directives, and all of the other measures being adopted in the FSAP, will affect U.S. financial
services firms with operations in Europe.
The FSAP is intended to modernize and enhance the efficiency and structure of the regulatory regime
for financial services within the European Union. To the extent that the FSAP achieves these goals,
U.S. firms are well-positioned to offer innovative and efficient services to customers throughout
Europe.
At the Federal Reserve, we follow with interest changes to foreign bank regulatory and supervisory
systems and seek to understand how these systems affect the banking institutions for which we are
responsible. This is especially important in the European Union, in which U.S. banking organizations
have substantial operations. As of December 2001, 27 U.S. banking organizations operate in the
European Union with aggregate EU assets of over $650 billion. Moreover, 66 EU banking
organizations conduct commercial banking and other financial services in the United States with
aggregate U.S. assets of over $1.7 trillion.
These figures demonstrate that globalization is not a new concept or recent process. As U.S. industry
has expanded its foreign operations, U.S. supervision has had to evolve to take account of the fact
that our banks operate in many different legal and regulatory environments. We have strengthened
existing cooperative relationships with bank supervisors in other countries and established new ones
as U.S. banks continue to expand their operations into other countries. At the Federal Reserve, we
conduct bilateral consultations with individual authorities and participate in international groups of
financial services supervisors. We engage our EU counterparts both bilaterally and through these
groups.
The Federal Reserve and the other federal banking agencies participate regularly in the Basel
Committee on Banking Supervision, which was formed in order to improve communication and
cooperation among supervisors of internationally active banks. Some of the key achievements of the
Committee include the 1988 Basel Capital Accord, which created for the first time an internationally
accepted standard for assessing levels of bank capital. The Accord replaced an uneven system of
national standards and has allowed banks to expand internationally on more competitive basis.
Similarly, the Committee adopted its Minimum Standards for Consolidated Supervision in 1992,
establishing the principle that a bank should be subject to a supervisory regime in which its financial
statements are consolidated and subject to review by home country authorities. Both the Capital
Accord and the principle of consolidated bank supervision have become the internationally recognized
standards that bank supervisors should aspire to meet.
Nine of the member states of the European Union are also members of the Basel Committee and a
representative of the European Commission participates as an observer. The Federal Reserve and
eight of these nine EU countries, and a European Commission observer, also participate in the Joint
Forum, a group established by the Basel Committee, International Organization of Securities
Commissioners (IOSCO), and the International Association of Insurance Supervisors (IAIS). The Joint
Forum discusses issues arising from the operation of financial services conglomerates and has
developed principles appropriate to the supervision of entities that operate within financial groups.
These group meetings, as well as many working group meetings on specific issues, provide regular
opportunities for U.S. regulators to meet and discuss issues of common interest with European
officials.
In addition to regular meetings of international groups, the Federal Reserve has longstanding
relationships with both national regulators in the European Union and staff of the European
Commission. For internationally active banking organizations with operations in both the United States
and the European Union, national supervisors may participate in joint examinations of particular
institutions, confer with each other on specific issues and meet periodically to discuss an institution's
operations or financial condition. Ongoing communication is recognized as critical for effective
supervision. Home and host countries' interests are both furthered by dialogue and strong supervisory
relationships.
Regular contact with Commission staff goes back to the 1980s when the EU considered and adopted
its Second Banking Directive, aimed at promoting the internal market by establishing the so-called
"European passport" for banks chartered in the EU. Under the passport, a bank chartered in one EU
country is entitled to establish branches in any other EU country under the authority and supervision of
its home country rules. Since that time, several U.S. banks have taken advantage of this early EU
regulation by establishing a local bank in a European member state, which then used the "passport" to
establish branches in other EU member countries.
European subsidiaries of U.S. banks are able to take advantage of the passport under the principle of
"national treatment." National treatment generally means that a country provides parity of treatment
between domestic and foreign-owned firms, resulting in equality of competitive opportunity. National
treatment has long been the prevailing practice with respect to foreign banks operating in the United
States and this practice was incorporated into statute in 1978 with the enactment of the International
Banking Act (IBA). This principle has also been incorporated in various trade agreements to which the
United States is a party, such as the North American Free Trade Agreement (NAFTA) and the General
Agreement on Trade in Services (GATS). The EU member states are also subscribers to the GATS
and consequently to the national treatment principle it contains.
Implementing national treatment can be difficult precisely because one country is trying to adapt its
own legal and regulatory structure to a foreign firm that is incorporated in a different home country
environment. This is a challenge the Federal Reserve has faced over the years as we seek to apply
U.S. laws that were adopted for a system of bank holding companies to foreign banks that generally
do not have a bank holding company structure. The United States also requires that a foreign bank be
subject to comprehensive consolidated supervision by its home country supervisor before it can buy a
bank in this country. Under this law, the Federal Reserve must evaluate supervision systems that are
different from our own and yet ensure that we are fairly applying the principle of national treatment.
U.S. private sector firms may be concerned about new regulatory and supervisory initiatives in the EU
because such proposals may require changes in existing operations and/or reporting standards. There
may also be a concern that initiatives designed for European firms or industries would not properly
take account of home country supervisory structures or regulatory practices. Foreign banks have
expressed similar concerns about U.S. regulatory initiatives in the past. At the Federal Reserve, we
have found that our open and transparent regulatory process is crucial in helping us to understand
how our proposals affect foreign banks and where problems arise, and gives us useful information for
evaluating the merits of particular complaints. We have at times proposed regulations on which foreign
banks and their governments, including the European Commission, filed adverse comments. These
comments helped us to reevaluate our regulations and to determine whether our supervisory and
regulatory objectives could be achieved in a different way, consistent with the principle of national
treatment.
With respect to the implementation of 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 seek to do so. Federal
Reserve staff has met with Commission staff to discuss a number of matters, including the application
of the financial conglomerates directives to U.S. banking organizations. The Federal Reserve is
committed to continuing the dialogue with the Commission on matters of mutual interest, both
bilaterally and as part of financial markets discussions led by the Treasury Department. We
understand that the Commission has begun to engage in industry consultation as part of the rule
writing process and we endorse a process that allows all affected institutions, including those that are
foreign-based, to participate actively in the process.
The FSAP has a far reaching agenda. I will comment briefly on three issues of particular interest to
U.S. banking organizations. With respect to the conglomerates directive, we understand that the
impetus for the directive came from the Joint Forum's principles for the supervision of financial
conglomerates. The three parent bodies of the Joint Forum (the Basel Committee, IOSCO and the
IAIS) were concerned that, although individual financial companies within a group might be subject to
prudential supervision, the consolidated financial group might not be subject to appropriate oversight.
This in turn could lead to relationships or transactions that could pose financial risk to the regulated
parts of the group. The Joint Forum's principles were developed to help assure that there are no
material gaps in supervisors' understanding of inter-affiliate relationships within a financial group that
could ultimately result in financial instability. We understand that the EU financial conglomerates
directive is concerned with this same issue.
In the United States, U.S. banking organizations have long been subject to consolidated supervisory
oversight. We believe that the Federal Reserve's supervisory programs and practices for bank holding
companies, including financial holding companies, are fully consistent with the requirements that are
contemplated under the EU's financial conglomerates directive.
With regard to the capital adequacy directive that is being developed for credit institutions and
investment firms in the European Union, we also believe that the ultimate product will not present
difficulties for U.S. banking organizations. The European Commission is mindful of the work that is
underway in the Basel Supervisors Committee to replace the existing Basel Capital Accord with a
more comprehensive risk sensitive framework for assessing an organization's capital adequacy.
When the EU issued its capital adequacy directive for public comment in 2001, commenters raised
concerns about the regulatory burden that would be imposed on institutions that would be subject to
both the EU capital rules and the Basel capital rules at the national level. The EU committee
responsible for the capital adequacy directive has recognized this potential burden and has taken
steps to ensure that the EU directive is as consistent as possible with the final revised Basel Accord.
Technical working groups of the Basel Committee have been communicating with the EU technical
drafting groups with the objective of harmonizing the two frameworks to the fullest extent possible.
The most sweeping changes in the Basel capital initiative are intended for internationally active
banking organizations. The EU capital adequacy directive is intended to apply to a much wider range
of institutions, both those with international operations as well as those that are purely domestic. Thus,
the capital adequacy directive will likely address EU specific issues for smaller institutions.
Internationally active European banks currently are subject to the Basel capital rules as they have
been adopted in individual countries, as well as to the existing EU capital adequacy directive. Some
differences between the two sets of rules do exist. Supervisors, however, are aware of these
differences and continually strive to minimize the associated regulatory burden on institutions.
Because the Basel revisions and the EU capital directive revisions are underway in tandem with
similar estimated time frames for completion, there is a good likelihood that the final products will be
substantively and significantly more consistent than the current Basel and EU capital rules.
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 plans to propose extensive enhancements to its standards later this year.
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. The most recent proposal of the Basel Committee to amend
Basel Capital Accord (called 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 its 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 and the Basel Committee's projects
with other international groups to promote sound global bank auditing practices.
In conclusion, I believe that the European Union should be encouraged to continue its program to
strengthen and modernize the rules under which financial services firms operate in Europe. This can
only increase competition, enhance efficiency and contribute to economic growth in the EU and
globally. We are pleased that the European Commission is broadening its consultation and comment
processes on proposals being considered under the FSAP. Supervisory and regulatory measures
benefit significantly from an open and transparent process in which affected companies may
participate. We would expect that the European Commission and member state national authorities
will apply the FSAP's measures to U.S. firms on a fair and national treatment basis.
U.S. banking organizations are dynamic and more than competitive with the rest of the world.
Accordingly, we are confident that U.S. firms will benefit from a strengthened and more efficient
European market for financial services.