EN Official Journal of the European Union C 162/96

Opinion of the European Economic and Social Committee on Financial integration: the case of European stock markets (own-initiative opinion)

(2008/C 162/25)

On 16 January 2007 the European Economic and Social Committee, acting under Rule 29(2) of its Rules of Procedure, decided to draw up an own-initiative opinion on:

Financial integration: the case of European stock markets

The Section for Economic and Monetary Union and Economic and Social Cohesion, which was responsible for preparing the Committee's work on the subject, adopted its opinion on 24 January 2008. The rapporteur was Mr Lehnhoff.

At its 442nd plenary session of 13 and 14 February 2008 (meeting of 13 February 2008), the European Economic and Social Committee adopted the following opinion by 103 votes to 4, with 9 abstentions:

1. Conclusions and recommendations

1.1 The European Economic and Social Committee recommends that the European institutions step up their efforts to explain to the citizens of the EU the advantages that a harmonised legal framework for dealings in securities would offer to them. This will help counteract the still widespread ‘home bias’ that exists, where investors only invest in their own domestic market.

1.2 The Committee recommends that the Commission pay special attention in the ex-post evaluation of the Financial Services Action Plan (FSAP) announced in the White Paper on Financial Services Policy (1) to whether the many changes that have been made to the basic provisions of European law relating to on- and off-exchange trading venues are conducive to any meaningful integration of European stock markets and facilitate cross-border capital investment.

1.3 This applies above all to the impact of the Markets in Financial Instruments Directive (2), the Prospectus Directive (3) and the Transparency Directive (4) — which all feature as part of the Financial Services Action Plan — and also to ongoing efforts to facilitate the cross-border clearing and settlement of transactions in financial instruments (in this case in particular the implementation of the infrastructure operators' voluntary commitment under the Code of Conduct for Clearing and Settlement and moves by the European Central Bank to establish a uniform European clearing and settlement platform (Target2/Securities)).

1.4 The Committee thinks it is necessary to wait for this evaluation process before taking any additional or supplementary steps to promote integration. If the EESC deems it necessary it will come back with proposals to make progress on the integration of stock markets.

1.5 The 2005 communication on industrial policy (5) announced seven horizontal initiatives to support those of a sectoral nature. The Committee feels that efficient and accessible stock exchange markets at a cost that European companies, particularly SMEs, can afford should be added to the list of cross-sector measures. The MIFID Directive is supposed to improve the operation of these markets, but an all-round reflection on the role they have to play in promoting European competitiveness is essential because of the associated effects on the financial markets. The Committee regrets that the mid-term review of industrial policy (6) has not led to such a debate. Special attention should be paid to stock exchanges because of their central role in any market economy. The activities of the funds of sovereign issuers in emerging countries or countries that are richly endowed in natural resources must be the subject of a certain level of vigilance, particularly when they invest massively in the stock markets, as has been the case with the London Stock Exchange, where funds from Dubai and Qatar now hold 48 % of the securities traded. Generally speaking, the Commission should work together with the Member States and the supervisory authorities to improve the transparency of these funds, understand their motives and make sure they are not pursuing political objectives. Generally, ‘the EESC would urge the Commission to present, as soon as possible, its draft legislative provisions aimed at stepping up the information provided by institutional investors with regard to their policies in respect of investment and voting’ (7).

2. Arguments to support the opinion

2.1 Opinion remit

2.1.1 Financial integration is a basic component of European Economic and Monetary Union. Since the introduction of the euro, the integration of the European financial system has become an important goal. Most studies agree that such integration clearly has positive effects on the European economy.

2.1.2 In view of the substantial advantages that European financial integration can have for the entire economy, the present situation marked by insufficient integration of a number of market segments requires an unwavering commitment from all participants to continue this process until its completion.

2.1.3 The creation of integrated, competitive and effective financial markets is an essential element of the internal market and the Lisbon goals, so that the advantages for growth and jobs can be exploited fully.

2.1.4 All financial centres fulfil important public-service functions. Because of the major role which they play on domestic financial markets, stock exchanges are often equated with public institutions of national importance. The European stock exchange sector is dominated by traditional and frequently national actors. Despite some stock exchange mergers and alliances this market is still split up into a dozen different financial centres. However, the constraints and conflicts of a concrete geographical location are avoided by transactions being performed electronically.

2.1.5 Financial integration is above all else a market-driven process, though it also requires effective interaction between market forces and the actions of public bodies. Moreover, state authorities too in the EU must be firmly resolved to strengthen the process of integration. This particularly applies to the imperturbable will of national and European authorities to use a legal and regulatory framework that is designed to foster the integration of the internal market and financial stability.

2.1.6 The importance of European stock markets as a source of business finance has grown over time, sometimes spectacularly. A well developed stock exchange market will thus increase aggregate investment and reduce costs. The stock market can make a major contribution towards providing extra outside resources. So, the financial sector is also important because it ensures the allocation of resources, which enables other branches of the economy to grow further.

2.1.7 The highly disparate national rules of the financial markets represent an obstacle. Stock exchange mergers alone — as strategic aspects of financial adjustment — are not enough to fulfil the political requirements of orderly harmonisation.

2.1.8 For securities markets, such as those for bonds and shares, it is extremely important to continue integration of the infrastructures for clearing and settlement. The number of inadequately integrated clearing and settlement systems is still high.

2.1.9 At a time when monetary union actually favours a pan-European procedure for securities management, the continental European stock markets are in the paradoxical situation of being computerised but still burdened with high transaction costs. This contradiction is due mainly to the continuing excessively high costs for cross-border transactions.

2.2 General comments — European stock markets

2.2.1 Stock exchanges (securities markets) bring together supply and demand through financial instruments (i.e. they have a market role). From an investor's point of view, stock exchanges are forums for the buying and selling of financial instruments. For companies, stock markets are a key prerequisite for acquiring both own and outside capital. Thus, alongside credit financing by banks, stock markets are the central plank of entrepreneurship funding through the issuing of financial instruments. Without properly working stock market trading, the scope for the placement of new financial instruments would be extremely restricted. The emergence of a genuine European stock market can offer companies new possibilities for financing their business activities by issuing securities. This also applies for companies in countries where up to now stock trading has shown little liquidity, so that issues can only be carried out with limited success. In addition, a European stock market should help investors to move away from the concentration that is still evident on their respective home markets and profit from growth throughout the whole European Economic Area.

2.2.2 However, at an overall level, it should be noted that companies fund only a small part of their investments (gross fixed capital formation) from the stock markets. In addition, net share issues are negative in the United States and zero in the euro area. This cannot be explained by a variation in the number of listed companies because this has not varied substantially. But it may be due to the fact that companies buy back their own shares with the aim of increasing their earnings per share, which is the headline indicator on stock markets.

2.2.3 In order that stock exchanges might fulfil their public role, two things are needed: (i) there must be a transaction (i.e. trading); and (ii) the financial instrument must be exchanged for its monetary equivalent (i.e. clearing and settlement) (8). Although both aspects are needed for a stock exchange to function, the two — trading on the one hand and clearing and settlement on the other — are quite distinct operations and, in point of fact, are also conducted on two different technical platforms. Trading is organised by stock exchanges themselves, while clearing and settlement is conducted through central counterparties (CCPs) and central securities depositories (CSDs). The latter act as central facilities for holding securities and also conduct book-entry securities transfers (9).

2.2.4 Each Member State has at least one stock exchange (10). There are also multilateral trading facilities (MTFs) which, like stock exchanges, bring together purchase and sale orders through financial instruments and ‘internalisers’, who conclude deals directly with their clients. Clearing and settlement is conducted largely through national CSDs, which for certain services have a monopoly in their respective countries.

2.2.5 The large number of trading venues must not per se be seen as detrimental to the European capital market. On the contrary, effective competition between trading venues should, as a rule, mean lower transaction charges for investors in a market economy. It is therefore quite right that the Markets in Financial Instruments Directive (MiFID) (11) should also seek to boost competition between trading venues (12).

2.2.6 However, competition among trading venues can only work if European stock exchanges are, in fact, in a practical position to compete with one other. One obstacle to competition so far has been the so-called ‘concentration rule’ existing in many Member States, whereby all orders have to be placed on regulated markets — usually the local stock exchange. The possibility of such a national settlement has been taken away by the MiFID. A continuing obstacle to European competition may be that, given their history as purely national institutions, individual stock exchanges are able to offer only a limited, national range of tradable financial instruments. Competition would be impossible, for instance, if a German stock exchange were unable to trade in French financial instruments.

2.2.7 However, if the financial instruments traded on the major European stock exchanges are anything to go by, it is clear that, despite some potential legal barriers, there are no real obstacles to competition among trading venues. For instance, over 13 000 foreign financial instruments are traded on German stock exchanges (13). Even if comparable figures for other stock exchanges are not available, this example clearly shows that the conditions are in place for effective competition between trading venues. Any national legal obstacles become less important with the implementation of the financial services action plan (FSAP). Thus, with the Prospectus Directive the marketing of financial instruments throughout Europe is made possible through a single prospectus. The MiFID harmonises not only investor protection requirements, but also the rules for operations and trading on stock exchanges and off-exchange trading venues. Finally, the Transparency Directive standardises capital market information. It will now be the task of the European institutions to assess the concrete impact of the new basic legal conditions and correct any shortcomings. The aims of the FSAP, particularly the cross-border organisation of financial markets, will be the yardstick here.

2.2.8 The question can be asked whether, in terms of quality, competition between stock exchanges does not endanger price determination mechanisms (and thus the public operations of the exchanges) and whether this can be countered by a strict promotion of consolidations. At first glance, this does seem indicated, because of the dispersal of liquidity across a number of different trading venues. However, it does not necessarily follow that price determination is any the poorer simply because there are so many trading venues in Europe. Trade mechanisms, such as arbitrage trading, provide a counterbalance. Moreover, trading venues have been subject to extensive harmonised transparency requirements before and after trading since 1 November 2007 (MiFID, Article 27 et seq.). These are supposed to ensure the comparability of prices at different trading venues and thus counteract the fragmentation described earlier. As far as can be judged shortly after the implementation of the MiFID in the Member States, this approach seems to be working. Data streams from OTC trades are published and consolidated with the data from stock exchanges and MTFs by large financial information service providers, such as Project Boat, a consortium of nine investment banks. In this way a mutual influencing of prices at different venues is ensured. Consolidations between exchange owners are therefore not needed to boost liquidity.

2.2.9 Decisions for or against mergers or acquisitions are rather — as even Commissioner McCreevy put it — simply business decisions taken by the stock exchange operators, and they should therefore be strictly market-driven. From a political angle, the only important question is whether there are any legal obstacles to mergers or acquisitions and, if so, to what extent these can be overcome.

2.2.10 Mergers and acquisitions among trading system operators are subject to the same legal hurdles as any other mergers or acquisitions under company law. Current examples — such as the planned acquisition of the Borsa Italiana by the London Stock Exchange and the merger of the New York Stock Exchange and Euronext — show this to be true even beyond the European judicial area.

2.2.11 Particular legal difficulties may arise, however, in the establishment of a common Europe-wide trading platform. Obstacles include differing listing requirements, trading practices, tax provisions and accounting rules (14). No detailed analysis has so far been conducted into the importance of these obstacles, particularly in the wake of the adoption of the MiFID and the Prospectus Directive. However, there is good reason to doubt whether these obstacles are, in practice, so serious as to be insurmountable. The case of Euronext — the successful merger of the trading systems of the Amsterdam, Brussels, Paris and Lisbon stock exchanges — and the merger of exchanges in the Baltic and Nordic countries to form the OMX Nordic Exchange bear this out. Moreover it is clear, even a relatively short time after the adoption of the MiFID that, in future, stock markets will be facing increasingly tough competition from MTFs, which may be active in all Member States on the basis of a European passport. Examples here are the ongoing Turquoise initiative launched by seven investment banks and the Chi-X platform launched by Chi-X Europe Ltd in London in March 2007. This suggests that greater integration of European stock markets is not only possible, it should already have taken place in the near future (15).

2.2.12 The promotion of stock market integration should not, however, be misunderstood as a call for trading and settlement venues to be concentrated on one commercial pan-European platform. It should not be forgotten that both the new off-exchange trading platforms and the established stock exchanges are businesses geared to making a profit, and a monopoly would lead to worse conditions for issuers and investors (16).

2.2.13 The Committee recommends that the European institutions should look at alternatives to promoting integration through competition if stock exchange concentration might lead to access being made noticeably more difficult for regionally active small and medium-sized firms. It should be remembered that for small and medium-sized enterprises it is often easier to gain access to a regional stock exchange than to the large European stock exchanges. Regional investors can be reached more directly through a regional stock exchange because of the close local connection. The actual developments to be expected should therefore be assessed carefully and thoroughly to see whether stock exchange access is made more difficult for small and medium-sized enterprises. If this should be the case, a solution could lie in setting up one or more none-public stock exchanges that are particularly committed to the interests of small and medium-sized enterprises.

3. Specific comments — Clearance and settlement on stock markets

3.1 The main obstacle to a more efficient European stock exchange system, however, is felt to be not so much the traditional regional orientation of stock exchanges as the different clearing and settlement arrangements within Europe. In the vast majority of cases, these systems are organised along national lines and this makes the cross-border clearing and settlement of stock exchange transactions more difficult and expensive. (That said, the clearing and settlement arrangements in place for purely national securities transactions often provide effective and low-cost solutions that must not be ruined by any consolidation.) A range of key initiatives is already in place to overcome this fragmentation and thus to secure a more efficient system for European clearing and settlement.

3.2 Barriers to effective clearing and settlement arrangements for stock exchange transactions have been identified and analysed in the Giovannini reports (17), which suggest that national differences exist in particular in relation to technical standards and market practices and in the different national tax and legal bases (18). In the first of these areas, infrastructure operators and market participants (mainly banks), coordinated by the European Commission within the Clearing and Settlement Advisory and Monitoring Expert Group (CESAME), are currently working to find solutions (19). Uniform practices, such as standard public holidays on which the clearing and settlement systems are closed, are to a large extent already in place, while work is currently under way to secure further standardisation, for instance in the clearance and settlement of corporate actions.

3.3 Technical standards and market practices would also be harmonised to a large extent if a current plan to set up a Europe-wide platform for the clearing and settlement of securities transactions proves successful. In July 2006, the European Central Bank (ECB) and the national central banks in the euro area proposed a common European platform for the clearing and settlement of securities transactions (20). Since, at a technical level, this is linked to the existing Europe-wide payment platform Target, it has been dubbed Target2/Securities. In January 2007, the European Central Bank also published initial studies on the economic, legal and technical impact of the planned platform (21). The technical specifications for a system of this kind are currently being developed in conjunction with users (22).

3.4 In the future, the ECB would like to see the Target2/Securities system cover all securities transactions cleared and settled in central bank money. The planned platform is, in principle, to be rolled out in a uniform way across Europe, thus significantly simplifying cross-border securities clearing and settlement in particular.

3.5 If successful, Target2/Securities would overcome critical obstacles to cross-border securities clearing and settlement in central bank money in Europe. Assuming various factors are in place, this would also bring major cost benefits to the parties conducting a securities transaction.

3.6 The European CSDs, the central counterparties (CCPs) and the stock exchanges have also given the Commission an undertaking that they will comply with a range of measures set out in a code of conduct (23). The particular aim is to boost efficiency and interoperability among infrastructure operators. The costs of cross-border European clearing and settlement are expected to fall as a result. The first wave of commitments became operative at the start of 2007. Pricing has become more transparent thanks to the undertaking to publish standardised price lists, thereby making it easier for users to compare prices. Infrastructure operators have also pledged to improve access to their system and interoperability between systems. The manuals published at the end of June 2007 enshrine this obligation to such an extent that effective networking of systems is made possible. Given the very favourable assessment of the development of the Code of Conduct to date, and of its implementation in practice — as reflected, not least, in the speech given by Commissioner McCreevy to the European Parliament on 10 July 2007 — it would appear that a sound method is now in place to promote the cost-effective Europe-wide clearing and settlement of securities transactions.

3.7 Other than the initiatives outlined above, there is no need, from a policy perspective, for any additional action at the moment to promote consolidation of the stock markets. For now, it is important to await the conclusion of the various initiatives in place to help consolidate the European stock exchange environment, particularly in the clearing and settlement of transactions in financial instruments, and then to analyse their findings. If these moves prove a complete failure or if they do not ultimately result in more efficient European stock exchange trading, consideration could be given to whether further regulatory measures might not be brought in to remedy the situation.

Brussels, 13 February 2008. The President of the European Economic and Social Committee Dimitris DIMITRIADIS

(1) http://ec.europa.eu/internal_market/finances/policy/index_en.htm.

(2) Directive 2004/39/EC of the European Parliament and of the Council of 21 April 2004 on markets in financial instruments amending Council Directives 85/611/EEC and 93/6/EEC and Directive 2000/12/EC of the European Parliament and of the Council and repealing Council Directive 93/22/EEC, OJ L 145, 30.4.2004, p. 1-44.

(3) Directive 2003/71/EC of the European Parliament and of the Council of 4 November 2003 on the prospectus to be published when securities are offered to the public or admitted to trading and amending Directive 2001/34/EC, OJ L 345, 31.12.2003, p. 64-89.

(4) Directive 2004/109/EC of the European Parliament and of the Council on the harmonisation of transparency requirements in relation to information about issuers.

(5) COM(2005) 474 final: Implementing the Community Lisbon Programme: A policy framework to strengthen EU manufacturing — towards a more integrated approach for industrial policy.

(6) COM(2007) 374 final: Mid-term review of industrial policy.

(7) ECO/202 — The economic and social consequences of financial market trends — CESE 1262/2007 — OJ 2008/C 10/23 and INT/332 — Review of the Single Market — CESE 89/2007 — OJ 2007/C 93/06.

(8) The English term clearing and settlement is also frequently used in German.

(9) These depositories also have other functions connected with holding securities, e.g. corporate actions.

(10) A list of the various stock exchanges is given in the Commission's presentation of regulated markets (OJ C 38, 22 February 2007).

(11) Directive 2004/39/EC (OJ L 145, of 30 April 2004, p. 1).

(12) Cf. MiFID, recital 34 and the market transparency provisions set out in Article 27 et seq.

(13) Source: Deutsche Börse Info Operation, Total Turnover Foreign Shares, March 2007 www.deutsche-boerse.com/dbag/dispatch/de/notescontent/gdb_navigation/listing/50_Reports_and_Statistics/60_Order_Book_Statistics/INTEGRATE/statistic?notesDoc=/maincontent/Monatsstatistik+auslaendischer+Aktien&expand=1.

(14) McAndrew/Stefanadis, Current Issues in Economics and Finance (Federal Reserve Bank of New York), June 2002, 1.3 seq.

(15) See too ECB Monthly Bulletin November 2007, pp 67, 77 et seq.

(16) See too ECB Monthly Bulletin November 2007, pp 67, 74 et seq.

(17) Cf. http://ec.europa.eu/internal_market/financial-markets/clearing/communication_en.htm.

(18) For clearing and settlement, national rules for the transfer of ownership, the posting of securities (deposit law) and insolvency law are important.

(19) Cf. http://ec.europa.eu/internal_market/financial-markets/clearing/cesame_en.htm.

(20) Cf. http://www.ecb.int/paym/market/secmar/integr/html/index.en.html.

(21) Cf. http://www.ecb.int/paym/market/secmar/integr/html/index.en.html.

(22) Extensive information about this can be found on the European Central Bank website (www.ecb.int).

(23) Cf. http://ec.europa.eu/internal_market/financial-markets/clearing/communication_de.htm#code.