COMMISSION REPORT on the application of the export prohibition clause, Art. 7(1) of the Directive on investor-compensation Schemes(97/9/EC)

TABLE OF CONTENTS

Commission report on the application of the export prohibition clause, Art. 7(1) of the Directive on investor-compensation Schemes (97/9/EC)

1. Introduction

2. General principles regulating the cross-border validity of the cover within the EU

3. The export prohibition clause

3.1. Guidance for the reasoning on whether the export-prohibition clause should be extended or not

3.2. Justifications for maintaining the export prohibition clause

3.3. Justifications for not extending the export prohibition clause

4. Conclusions

ANNEX

1. Analysis of the main features of the compensation schemes set up in the EU Member States

1.1. Number and size of the existing schemes; membership

1.2. Amount and scope of the cover

1.3. Intervention of the scheme: triggering events and procedures

1.4. Financing and contributions

1.5. The top-up clause

2. LAW, ADDRESS OF THE SCHEME, PARTICIPANTS, STATUS

3. COVER AND CONTRIBUTIONS

COMMISSION REPORT

on the application of the export prohibition clause, Art. 7(1) of the Directive on investor-compensation Schemes (97/9/EC)

1. Introduction

The European Parliament and Council Directive 97/9/EC of 3 March 1997 on investor-compensation schemes (ICS Directive or ICSD) is one of the pillars of the European Framework for a Single Market in the financial services field. It has its origin in Article 12 of Directive 93/22/EC of 10 May 1993 on investment services (ISD). With the purpose of providing a European passport to investment firms based and authorised in one of the Member States, the ISD lays down prudential rules which investment firms must observe at all times, including organisational provisions aimed at preventing investment firms from using instruments and money belonging to investors. However, the ISD does not provide any protection to investors in case of fraud, breach of rules or other circumstances leading to the inability of an investment firm to repay money and return financial instruments to investors. This ultimate protection is therefore achieved, at a minimum harmonised level, through the ICSD.

The ICSD entered into force on 26 March 1997, the deadline for implementation in the Member States being 26 September 1998( [1]). In order to protect primarily small investors and maintain confidence in the financial system, it requires Member States to establish and recognise "investor-compensation schemes" to provide cover to investors' claims when an investment firm is unable to meet its obligations. Joining a scheme is a precondition for having an authorisation under the ISD; if the protection becomes unavailable, this authorisation shall be withdrawn ( [2]).

[1] Art. 15 of ICSD

[2] Art.5 (4) of ICSD

It should be pointed out that the ICSD applies to all investment firms, including credit institutions authorised to provide investment services. Moreover, the ICSD is modelled after the European Parliament and Council Directive 94/19/EC of 30 May 1994 on deposit-guarantee schemes (DGSD). Here, the purpose was to grant a minimum protection to depositors in the event of the closure of an insolvent credit institution. But, whereas in the DGSD a protection is provided for deposits arising from normal banking transactions, money claims arising from investment business carried out with a credit institution can be covered according to the provisions of the ICSD ( [3]).

[3] Art. 2 (3) of ICSD

This report complements the one prepared for the DGSD on the same subject, adopted by the Commission on 22/12/99.

2. General principles regulating the cross-border validity of the cover within the EU

A basic principle set out in the ICSD is that if an investment firm belongs to a scheme, the scheme will also cover its investors at branches set up in other Member States ( [4]). This provision extends to investment-compensation schemes the general principle of "mutual recognition". In other terms, the home country provisions applied to the head office of an investment firm are extended also to its EU branches; the assumption being that these form, within the Internal Market, a single entity subject to single authorisation and centralised supervision of its activities.

[4] Article 2(1) states that "Each Member State shall ensure that within its territory one or more investor-compensation schemes are introduced and officially recognised". Article 7 establishes the principle that "investor-compensation schemes - introduced and officially recognised in a Member State in accordance with article 2(1) - shall also cover investors at branches set up by investment firms in other Member States".

However, the Directive itself imposes two important exceptions to this principle. First of all, it states that, at least during a transitory period, and in order to avoid possible market disturbances, a scheme offering a higher or wider protection must downgrade its cover at branches located in other Member States where ICS are less generous. This clause, known as "export-ban" or "export prohibition clause", exists also for deposit-guarantee schemes ( [5]).

[5] Art.4 (1), 2nd sub-par., of DGSD for deposit-protection.

The second exception, known as the "topping-up" clause, is that an investment firm belonging to a scheme offering a lower or narrower protection will have the right to adhere to a host scheme in order to upgrade its cover at branches located in other Member States where ICS are more generous. A similar clause also exists for deposit-guarantee schemes ( [6]).

[6] Art.4 (2) of the DGSD.

Both clauses aim at avoiding unequal conditions of competition based on the cover offered to investors. The relevant difference is that the export prohibition clause reduces the level of protection for some investors, who would otherwise receive a higher protection, whereas the topping-up works in favour of an upgrade of the protection (though the decision to effectively increase the cover remains with the investment firm itself, which may decide not to join the host country scheme).

The export-ban clause represents a relevant exception to the principle of the Single Market for investment services, in that it discriminates between investors of the same investment firm in case of insolvency. In addition, it is estimated that market disturbances may be expected only for a short period of time. That is why the "export prohibition clause" is envisaged in the Directive only as a transitory measure and is due to expire at the end of 1999, unless the European Parliament and the Council decide otherwise, following a proposal from the Commission to extend its validity.

3. The export prohibition clause

According to art.7 (1), sub-par.2, of the Directive, the Commission is required to report on the export prohibition clause and to discuss the opportunity to extend its validity beyond 1999. The wording of this article is as follows:

"Until 31 December 1999, neither the level nor the scope, including the percentage, of the cover provided for may exceed the maximum level or scope of the cover offered by the corresponding compensation scheme within the territory of the host Member State. Before that date, the Commission shall draw up a report on the basis of the experience acquired in applying this sub-paragraph and Art.4(1) of Directive 94/19/EC ( [7]) referred to above and shall consider the need to continue those provisions. If appropriate, the Commission shall submit a proposal for a Directive to the European Parliament and the Council, with a view to the extension of their validity."

[7] The wording of the second and third subparagraphs of Article 4 od DGSD is as follows:

Reporting within the mentioned deadline is particularly important because it helps to clarify the legal framework which investment firms will face beyond 31.12.1999.

The present section focuses on the export prohibition clause, with the purpose of providing views in favour or against its prolongation, in the light of recent developments. In particular, sub-session 3.1 lists the criteria that should guide the reasoning on this issue; in sub-sessions 3.2 and 3.3, the main arguments in favour and against the prolongation of the validity of the clause are put forward and examined.

3.1. Guidance for the reasoning on whether the export-prohibition clause should be extended or not

We should start by pointing out that the wording of the export-prohibition clause in the ICSD stems from a compromise reached by the Commission and certain Member States for the DGSD during the negotiations related to that Directive ( [8]).

[8] This is explained very clearly in the Commission's report on the DGSD. In particular, session 2.1 underlines that, in the DGSD, the clause was the outcome of a compromise between the Commission, reluctant to accept the export prohibition, certain delegations, which on the contrary attached particular importance to this clause, and the Legal Service, which considered it to be admissible only as temporary.

At that time, some delegations were particularly concerned that "market disturbances" could be caused by branches of credit institutions established in a host Member State offering levels of cover higher than those offered by domestic credit institutions. In other words, it was feared that differences in the level of deposit protection could drain deposits from domestic institutions towards foreign institutions. There existed no evidence of this, as there was no evidence of how the new regulation on deposit-protection would have impacted on the preferences of depositors when choosing a credit institution. Similar reasons led, some years later, to accept an export-ban clause in the ISCD.

A common element of the two directives is that the export-ban clause is temporary in nature, that is, it is going to end unless the European Parliament and the Council decide otherwise, following a proposal from the Commission with a view to the extension of its validity. This aspect was emphasised in the European Court's judgement of 13 May 1997, related to the DGSD ( [9]): in rejecting the action for annulment of the clause brought by the German Government, the Court states, in particular, that "in view of the complexity of the matter and the differences between the legislation of the Member States, the Parliament and the Council were empowered to achieve the necessary harmonisation progressively".

[9] On this point, see the Commission's report on DGSD.

A second element can be appreciated comparing art. 7(1), sub-par.2, of ICSD and art.4(1), sub-par.3, of DGSD, both relating to the criteria that should guide the Commission when preparing its report on the export-prohibition clause. Both reports shall be drawn up "on the basis of the experience acquired in applying" this clause.

There can be a trade-off between the principle that the export-prohibition clause should be temporary and the consideration that any decision should be based on experience. In general, the longer the period of application of the clause, the longer the experience. The Commission should therefore try to hit a balance between the relevance attributed to the achievement of the Single Market for Financial Services, on the one side, and the necessity to avoid market disturbances arising from insufficient harmonisation of the basic rules, on the other side.

But, if we again compare the two directives, we can see that in the ICSD an additional criterion should be respected: whereas the DGSD states that the report shall be drawn up "on the basis of the experience acquired in applying" this clause, the ICSD stipulates that the Commission shall base its report also on the experience acquired in applying ... Art.4(1) of Directive 94/19/EC" ( [10]).

[10] Art.4(1) of the DGSD precisely deals with the export-ban clause in the field of deposit-protection.

The link with the DGSD is specially relevant in this respect. Though most of the Member States have now implemented the ICSD (14 out of 15), experience on how the provisions of the directive actually work is scarce. In most of the countries, the implementing measures were approved at the end of 1998/ beginning of 1999, and in some of them the framework was completed through administrative and government provisions in the final months of 1999. On the contrary, the credit institutions have benefited from a longer period to analyse the operation of this clause: Directive 94/19/EC was approved on 30 May 1994 and implemented by the Member States during 1995.

This means that the experience with the export-ban clause in the DGSD and the decision taken in the banking sector must be considered a key element for the Commission's decision on the ICSD.

3.2. Justifications for maintaining the export prohibition clause

The main argument put forward by certain Member States as a justification for maintaining the clause is that not enough experience is available yet on how the export-ban clause really works. In other words, neither credit institutions nor investment firms with branches in another Member State have, for reasons directly linked to their financial situation, been unable to meet their obligations, during the period under review ( [11]).

[11] See also the Commission's report on DGSD, session 3.2.

Following this reasoning, the possibility of market disturbances arising from different levels of the cover cannot be wholly ruled out today, as it could not be wholly ruled out when the Directive was approved in 1997 and therefore, the argument goes, the clause should be maintained in the future.

In particular, before lifting the ban, certain Member States would like to see more experience of the degree of the convergence process in the European financial market and on cross-border defaults under investor compensation arrangements; the concern being that practice in paying compensation can be more complicated than passing the implementing law and could result in differences from one Member State to the other.

3.3. Justifications for not extending the export prohibition clause

The principle of a Single Financial Market. The export clause is an exception to the principle of a single financial market and creates obstacles to the exercise of the right of establishment and to the freedom to provide services. Moreover, it introduces discrimination between investors of the same investment firm in case of insolvency and becomes incompatible with the fact that, from both a legal and a financial viewpoint, an investment firm and its branches should be regarded as a single entity. It was against this background that the Council and Parliament adopted the export prohibition clause only as a transitory arrangement. The exception's main justification was the complex and unclear situation existing before the adoption of the Directive.

The developments of the financial sector. The financial sector has changed considerably since the adoption of the Directive, both as a result of the harmonisation of investor-compensation schemes and as a result of financial integration.

First, concerning the harmonisation of compensation schemes, much has happened during the transitional period, which ends on 31 December 1999. A regulatory minimum level of cover (EUR 20 000) is established in all Member States and the coverage of all branches - wherever established - is acquired. It is worth considering that, before the approval of the ICSD, most Member States did not even have a compensation scheme for investors' protection. In comparison, the legislation in force today shows that levels of investor-compensation tend to converge for most Member States. In fact, by 1st January 2000, all Member States but four will have a compulsory compensation level of between EUR 20.000 and EUR 28.000 per investor. The only exceptions will be Denmark (for cash, EUR 40.000; for financial instruments EUR 20.000), Belgium (for cash, EUR 20.000; for securities EUR 20.000), France (EUR 70.000 for cash and EUR 70.000 for financial instruments) and UK (EUR 73.000) (see annex).

To sum up, the large differences that existed at the moment of adoption of the directive and which justified a temporary exception from the Single Market principle do no longer prevail. Consequently the principal justification to make an exception has disappeared.

The second trend in the financial market, which has important consequences for the evaluation of the export prohibition clause, is the process of financial integration. This development has been experienced in the banking market as well ( [12]). In the securities field, the growth of information technology and of electronic networks has been the main driving force for change; it has revolutionised the way in which securities markets and intermediaries operate. The process of globalisation in the economy has led to the internationalisation of financial portfolios and investment decisions. Technology has worked in favour of the elimination or circumvention of national boundaries.

[12] See the Commission's report on DGSD, session 3.3.

In the banking sector, competition has urged banks to embark on mergers and acquisitions to consolidate their position and be able to compete internationally. Securities firms belonging to banking groups have also been involved in this process.

The introduction of the Euro has triggered structural changes, eliminating exchange risk and putting the basis for increased financial integration and competition. Work on achieving a truly single market for financial services is going on through the implementation of the Financial Services Action Plan, which identifies concrete and urgent actions to "secure the full benefits of the single currency and an optimally functioning European financial market" ( [13]).To sum up, the factors for integration have been strong in the last few years and this is clearly going to continue.

[13] Financial Services - Implementing the Framework for financial markets: Action Plan. Commission Communication of 11.5.1999 COM(1999)232.

In the process of financial integration, the non-export clause is a residual element which splits the Single Market into national markets. It needs to be eliminated to promote a sound integration of the European financial market.

Estimate of potential disturbances. As for possible market disturbances resulting from the expiration of the export prohibition clause, experience can be drawn from the banking sector. Here, "no Member State has any objective and factual information which might be used to support concrete concerns that such risks are likely or significant. Nor are Member States able to specify or quantify the potential market disturbances for domestic institutions in the event of an expiration of the export prohibition clause" ( [14]).

[14] See the Commission's report on DGSD, session 3.3.

4. Conclusions

The investor compensation schemes in Member States have now been harmonised according to the principles and objectives of the Directive. Against this background, it seems disproportionate to prolong the export prohibition clause in order to avoid market disturbances that nobody could estimate or specify and which seem highly unlikely to happen.

A prolongation of the export prohibition clause would mean that the protection for such a remote risk would be considered more important than the completion of the Single Market for financial services.

The Commission is aware that not all the Member States have implemented the ICSD early enough to have benefited from practical experience with the operation of its provisions (see section 3). In this respect, the strong links between the ICSD and the DGSD should be considered.

First of all, because the ICSD is actually a transposition of the DGSD rules and principles in the securities field. Not only are the two directives complementary in some aspects (the 97/9/EC on investor-compensation schemes also applies to banks as far as investment services are concerned); they are also identical with regard to the articles concerning the cross-border provision of services. This is why any experience of problems or questions arising from the banks' side might be used to supply useful information for investment firms.

Secondly, there's an interest of the European regulator to have a comprehensive picture of how the "twin" directives work. In this regard, it is important to keep in mind that, though the DGSD was approved in 1994 and the ICSD only in 1997, the deadline for the Commission to produce the reports on the export-ban clause is the same (31/12/1999).

Moreover, the Commission is of the opinion that consistency with the DGSD should be preserved. Here, on the basis of the report adopted by the Commission according to art.4(1) of DGSD, the export-ban clause is going to expire for deposit-guarantee schemes. It would be difficult to justify, after 1999, the "export-ban" clause in the ICSD and not in the DGSD. As far as customers' protection is concerned, considering that some schemes cover both deposits and investors' claims, discrimination would be introduced between depositors and investors of the same foreign branch of an institution.

However, after the clause has expired (31 December 1999) the Commission will closely monitor the evolution of the situation, with particular attention to serious market disturbances, on the basis of elements supplied by the national authorities of Member States according to their preferences. The Commission can then consider the possibility of proposing appropriate legislative measures.

ANNEX

THE IMPLEMENTATION OF DIRECTIVE 97/9/EC

ON INVESTOR-COMPENSATION SCHEMES

IN THE EEA STATES

1. Analysis of the main features of the compensation schemes set up in the EU Member States

So far, 14 out of 15 Member States have formally implemented the Directive. The missing Member State is Luxembourg, which has informed the Commission that a draft bill was put to the Luxembourg Parliament in March 1999 and is still in the pipe line. The bill might be adopted by the end of 1999. In the following report, reference is made only to the 14 Member States which have notified implementation of the Directive.

1.1. Number and size of the existing schemes; membership

The Directive asks the Member States to ensure that within their territories "one or more ICS are introduced and officially recognised" and states that no investment firm may carry on investment business unless it belongs to such a scheme. The definition of "investment firm" is based on art. 2(1) of the ISD and includes credit institutions, if authorised to provide investment services.

In the case of credit institutions, the Directive considers that some claims might be subject also to the DGSD and stipulates that: (1) each Member State shall direct such ambiguous claims under one or other of these Directives; (2) no claim shall be eligible for compensation more than once.

These provisions have been implemented in 14 Member States. Most Member States have established only one scheme to provide compensation for investment services. In some of the Member States, the possibility to create additional private schemes is considered in the regulatory framework but has not been used so far. Germany, Spain, Ireland, The Netherlands and Austria have established more than one scheme but participation is linked to the type of the services provided, or to the nature of the institution. For instance, one scheme is for investment firms, the other/s for a specific category of banks. In Belgium, Denmark, France and Sweden, there is only one scheme which provides compensation to both investors and depositors (covering claims arising from ICS and DGS directives). As a consequence, it seems that, at this very early stage, investment firms and banks are not really free to choose the scheme to adhere to.

As far as credit institutions are concerned, two options have prevailed: one consists in the establishment of a comprehensive fund, covering a bank's depositors and investors. In the second option, the investor-compensation scheme covers cash claims only when arising from the provision of investment services whereas deposits are covered by a separate deposit-guarantee fund. Additional research is needed to verify how the first option is actually implemented and to make sure that no violation of either the DGSD or the ICSD occurs (for instance, in the calculation of the maximum cover per depositor/investor).

1.2. Amount and scope of the cover

The Directive stipulates that schemes should provide for a minimum cover of EUR 20.000 per investor's claim and, below this amount, of at least 90% of the claim. Some investors might be excluded from the cover, owing to their nature (professional or institutional investors) or on the basis of their relationship with the investment firm in trouble.

These provisions have been implemented in 14 Member States. In particular, all the schemes have established a maximum limit to the amount that can be paid per investor in case of a compensation claim. With few exceptions, this amount sticks to the minimum indicated in the ICSD (EUR 20.000). In particular, from 1/1/2000 on (which is the end of the "transitory" period) the covers are as follows:

- In most Member States the maximum cover per investor is EUR 20.000. Germany, Ireland and Finland also have a "90% of the claim" limit below EUR 20.000. Portugal (EUR 25.000) and Sweden (EUR 28.000) are not far from that amount.

- Denmark has a EUR 40.000 maximum cover for cash and a EUR 20.000 maximum cover for securities; Belgium has a EUR 20.000 maximum cover for cash and a EUR 20.000 maximum cover for securities; but these amounts also include the compensation for depositors (in case of a bank's failure).

- For two Member States, the cover is significantly higher than the minimum indicated in the ICSD: for UK, a EUR 73.000 cover is envisaged, with some percentage limits below this amount; in France, a double limit of EUR 70.000 for cash and EUR 70.000 for financial instruments is set (but the amount for cash also includes the compensation for depositors, in case of a bank's failure).

As regards the scope of the cover, the situation is less homogeneous. In Germany, Spain, The Netherlands, Austria and the UK, all the categories of investors listed in annex 1 of ICSD are excluded from the cover. This is not the case in the other Member States. Nevertheless, in all Member States, investment firms and institutions participating in the scheme are excluded from the cover. In some Member States, some kinds of derivatives are not covered. In Austria and Portugal, for instance, derivatives on commodities are not covered.

1.3. Intervention of the scheme: triggering events and procedures

With the purpose of concretely protecting investors, the Directive regulates in detail the development of the compensation procedure, establishing rules for customers' information and deadlines for payments. All the Member States have formally implemented these rules. However, considering that no compensation claim has arisen in any of the Member States falling under the provisions of the Directive, no experience is yet available on how the Directive actually works.

1.4. Financing and contributions

One aspect of special interest is the solvency of the scheme itself. The Directive does not regulate the way in which ICS are to be financed, but establishes the following principles: (1) the cost of the scheme must be borne by investment firms themselves; (2) the financing capabilities of the schemes must be in proportion to their liabilities; (3) the stability of the financial system must not be jeopardised.

There are in principle two kinds of schemes: those which periodically levy money and contributions from the participants; and those which only ask for commitments by the participants to pay certain amounts in case of compensation claims. In the first case, to make it easier for the fund to meet its obligations within the strict deadlines established in the regulation, a link is often established between the contributions levied and the value of financial instruments and money held by (or the number of clients of) the institutions participating in the scheme. The following additional mechanisms have also been envisaged by some Member States: supplementary contributions, to be levied when the assets of the fund are not sufficient to cover the claims; and borrowing facilities from banks or other schemes. Additional information is being collected to make sure that no violation of the mentioned principles occurs; for instance, when the borrowing facilities are provided by the Central Bank or a political body. For those funds which do not levy contributions from their members, a delay in the payment of compensation claims might occur if the resources of the fund are not immediately available. This option therefore deserves additional examination.

1.5. The top-up clause

All the 14 Member States have included the "topping-up" clause in their legislation, setting rules that enable branches of investment firms established in other Member States to participate in their schemes. For all of them, no experience is yet available on how the clause operates. Owing to the fact that the cover has been set at an amount close or equal to the minimum level in the Directive, it is estimated that no experience will be available, even in the future.

For the UK, 14 branches of European institutions have applied to take part in the scheme but half of the requests come from one of the countries which has only recently implemented the Directive (France). These institutions might therefore reconsider their position now that their Home State has implemented the Directive ( [15]). As for France, no application to the scheme has been received up to now, due perhaps to the fact that the ICSD was implemented only in late September 1999.

[15] France has in fact introduced an even higher level of protection than UK.

2. LAW, ADDRESS OF THE SCHEME, PARTICIPANTS, STATUS

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3. COVER AND CONTRIBUTIONS

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