1. INTRODUCTION

The lack of cross-border consolidation in the financial sector was highlighted by Finance Ministers at the informal ECOFIN Council of 10-11 September 2004 at Scheveningen. The situation varies across Member States and there is some concern that obstacles which are incompatible with Treaty freedoms may exist. Financial sector consolidation is lagging behind, suggesting obstacles to investment.

The provisions of Articles 56 and 43 of the Treaty on the freedom of capital movements and the right of establishment are directly applicable in the context of intra-EU (1) direct investment in the financial sector (2). Recent rulings by the European Court of Justice (ECJ) on direct investment have advanced the understanding of those principles. The Treaty freedoms grant basic and wide-ranging rights …

These ECJ rulings have also given a strict interpretation of possible exceptions to the Treaty freedoms, notably of those exceptions related to general interest and prudential considerations, which are the most relevant for the financial sector. … with limited exceptions.

The fundamental Treaty principles of free movement of capital and the right of establishment impact on the detailed framework set out in secondary legislation for the financial sector. Where Member States, as is legitimate in the framework of subsidiarity, adopt supplementary rules beyond those outlined in secondary legislation, those rules and practices must be compatible with general Treaty principles. In particular, it is of the utmost importance for the completion of the internal market that discretionary powers available to supervisory authorities in matters relating to authorisation and supervision of financial intermediaries are used exclusively to protect the interest for which they were foreseen. Otherwise compatibility problems with primary EC law may arise. Overriding Treaty principles and ECJ case law have to be borne in mind.

This Communication aims to reduce the risk of divergent legal interpretation in this area. Thus, on the one hand, it will give Member States an opportunity to refine, where necessary, their laws and administrative behaviour. On the other hand, it aims to make financial institutions fully aware of their rights stemming from the Treaty in the area of intra-EU direct investment. In no way does it presume that such risks exist across the EU, nor does it prejudge the interpretation that could be given by the European Court of Justice. The aim of this communication is to outline rights and obligations.

2. THE FUNDAMENTAL TREATY PRINCIPLES

The relevant Treaty provisions governing the freedom of capital movements are enshrined in Articles 56 to 60 of the EC Treaty. In particular, Article 56 of the Treaty provides that ‘all restrictions on the movement of capital between Member States shall be prohibited’. The Treaty provides for total freedom of capital movements.

Direct investment in the form of participation in an undertaking by means of a shareholding, or the acquisition of securities on the capital market, constitute capital movements for the purposes of Article 56 of the Treaty. Direct investment is characterised, in particular, by the possibility of participating effectively in the management of a company or in its control (3). Certain national rules limit this possibility and have consequently been identified as restrictions to the freedom of capital movement: rules limiting the acquisition of shareholdings (4) or restricting in some other way the scope for participating effectively in the management of a company or in its control (5), furthermore rules that are liable to deter investors of other Member States and consequently affect access to the market (6) or that make a direct foreign investment subject to prior authorisation (7). Article 56 of the Treaty goes beyond the mere elimination of unequal treatment on grounds of nationality (8). It clearly covers all forms of intra-EU cross border investment.

The acquisition of controlling stakes in a domestic company by an EU investor from another Member State, in addition to being a form of capital movement, is also covered by the right of establishment. Article 43 of the Treaty, governing the right of establishment, provides that ‘restrictions on the freedom of establishment of nationals of a Member State in the territory of another Member State shall be prohibited… Freedom of establishment shall include the right to set up and manage undertakings, under the conditions laid down for its own nationals’. Thus, nationals of other EU Member States should be free to acquire controlling stakes, exercise voting rights and manage domestic companies under the same conditions laid down in a given Member State for its own nationals (i.e. the application of the ‘national treatment’ principle to other EU investors). The acquisition of a controlling stake by an EU investor is also covered by the right of establishment.

With respect to intra-EU investment in the financial services' sector, both Treaty freedoms apply in parallel in cases of direct investment, whereas for portfolio investment, it is the freedom of capital movements that applies. For the purposes of the present Communication, a separate examination of the measures at issue in the light of the Treaty rules concerning freedom of establishment is consequently not called for and it is sufficient to focus on the freedom of capital movements, Article 56 EC. In these cases establishment is inextricably linked to capital movements.

3. SPECIFIC EXCEPTIONS PROVIDED FOR IN THE TREATY OR BY ECJ CASE LAW

Exceptions allow Member States to introduce restrictions to general Treaty rules. They are expressly mentioned in Treaty provisions or have been admitted by the European Court of Justice on the basis of the Treaty. The free movement of capital, as a fundamental principle of the Treaty, may be restricted in two respects only: by Community or national rules which are justified by exceptions contained expressly in the Treaty (9) or by overriding requirements of the general interest developed by the ECJ on the basis of the Treaty (10). Restrictions to the freedoms may be possible …

Article 58(1)(b) of the Treaty contains a specific Treaty carve-out referring to prudential measures. It permits Member States ‘to take all requisite measures to prevent infringements of national law and regulations, in particular in the field of … the prudential supervision of financial institutions’. Article 58(2) also permits the application of restrictions on establishment which are compatible with the Treaty (11). Article 58(3), nevertheless, affirms that all these exceptions shall not constitute a means of arbitrary discrimination or a disguised restriction on the free movement of capital. So, while prudential supervision is a specific exception to the freedoms, it is circumscribed by the same qualifications applicable to other restrictions. These are outlined below as overriding Treaty principles. For example, regarding cooperatives, Member States can establish national provisions allowing their supervisory authorities to oppose a cross-border merger when forming a European Cooperative Society. Such opposition in the context of prudential supervision in the sense of Article 58(1)(b), however, can only be based on grounds of public interest. In order to justify such public interest considerations in the light of Article 58(3), national supervisory authorities should ensure that these institutions with a particular statute always act fully in accordance with that statute. …on prudential grounds…

With respect to overriding requirements of the general interest as justification for restrictions on the free movement of capital, it needs to be stressed that existing case law is limited and gives little positive guidance as to this wide ranging concept: Among the few overriding requirements that have been found by the European Court of Justice to justify restrictions one can find the protection of consumers (12). It is settled case-law, however, that economic grounds can not serve as justification for obstacles prohibited by the Treaty (13). In cases decided by the European Court of Justice, Member States have unsuccessfully (14) argued e.g. the need to safeguard the financial interest of a Member State (15) or the intention to promote the economy of the country (16). With respect to the provision of services, the Court has recently clarified that a commercial bank does not qualify as a public service provider: it ruled that a group of commercial banks which operate in the traditional banking sector and which are not claimed to carry out any of the functions of a central bank or similar body, are not undertakings whose objective is to provide public services (17). … or on the basis of general interest requirements

4. SECONDARY LEGISLATION ON PRUDENTIAL SUPERVISION

In the area of prudential supervision, EU secondary legislation (18) has established a number of core principles to ensure the probity and soundness of financial institutions. These include compliance with the ‘fit and proper’ requirement and the solvency requirements. These core principles are essential to a secure and dynamic EU financial sector. Directives cover the core principles of supervision …

EU secondary legislation, however, has not gone beyond a certain degree of harmonization of the specific relevant provisions. It, therefore, enables Member States to apply supplementary rules and administrative practices to the common rules set down in EU directives. … and ensure a certain degree of harmonisation.

But when national rules are more restrictive than EU secondary legislation, conflicts with the Treaty freedoms may appear. Essentially, those national rules may involve more restrictive determinations of the soundness of financial institutions, approval thresholds and administrative procedures. When legislating or creating or enforcing administrative practices, Member States must respect both, the basic freedoms guaranteed by the EC Treaty in addition to ensuring compliance with the directive (19). Supplementary national measures and practices must still respect the Treaty.

5. THE OVERRIDING TREATY LIMITS

Member States must exercise their powers in prudential regulation consistent with fundamental Treaty principles (20). Although EU secondary legislation permits various authorisation requirements for legitimate purposes and permits Member States to impose additional requirements, the ultimate control still lies with the European Court of Justice in the light of the Treaty freedoms in Articles 56 and 43. Ultimate control here lies with the European Court of Justice.

In this context it should be recalled that any exceptions to the Treaty rights of the free movement of capital and the freedom of establishment must be interpreted restrictively and their scope cannot be determined unilaterally by the Member States without any control by the Community institutions (21). Thus, while prudential considerations are specifically mentioned as possible exceptions to the freedom, they, along with other exceptions, are circumscribed by the same qualifications that condition other restrictions. Exceptions to Treaty freedoms are construed narrowly by the Court.

Measures liable to hinder or make less attractive the exercise of fundamental Treaty freedoms must fulfil four conditions (22): — they must be applied in a non-discriminatory manner; — they must be justified by imperative requirements in the general interest; — they must be suitable for securing the attainment of the objective which they pursue; and — they must not go beyond what is necessary in order to attain it. Any restrictions must be:

Article 56 of the Treaty goes beyond the mere elimination of unequal treatment on grounds of nationality (23). In this context, Article 58(3) expressly states that the exceptions to Article 56 shall not constitute a means of arbitrary discrimination or a disguised restriction on the free movement of capital. In the case of cross-border investment in the financial sector, EU secondary legislation clearly recognises the prudential supervision needs of the supervisor of the target institution (24). But these have to be applied in the light of the prohibition of arbitrary discrimination or a disguised restriction stipulated in Article 58(3) EC. However, none of these qualifications should be insurmountable tasks for any EU financial institution, which is already subject to similar requirements in its home country, and wishes to acquire a participation (controlling or otherwise) in a financial institution in another Member State. — non-discriminatory

In order to be proportionate, national legislation must be suitable for securing the objective which it pursues and must not go beyond what is necessary in order to attain it (25). With respect to the latter aspect (‘what is necessary to attain the objective’), according to ECJ case law, a system of prior administrative approval (26) is only proportionate to the aim pursued if the same objective could not be attained by less restrictive measures, in particular a system of declarations ex post facto (27). Regarding ex-ante approval systems in the prudential area, these considerations are relevant with respect to the burden of the procedures involved (e.g. formalities of the application: deadlines and delays applicable, degree of quantity and quality of information required as well as documents to be provided) and the time taken to get such an authorisation given that these vary considerably across Member States. — Suitable and proportionate

To obtain legal certainty a system of prior administrative approval must be based on objective, non-discriminatory criteria which are known in advance to the undertakings concerned, and all persons affected by a restrictive measure of that type must have a legal remedy available to them (28). This requires e.g. that reasons be given for the refusal of an application that are concrete enough to allow for a court to come to a decision on their legality and correct application. Also, any imprecise or undefined criteria must be regarded as contrary to the principle of legal certainty because imprecision prevents individuals taking full advantage of their rights deriving from Article 56 of the Treaty (29). — Provide legal certainty

With respect to authorisation procedures, investors need to be given clear indication of the specific, objective circumstances in which prior approval will be granted or withheld (30). Investors need to be aware of the criteria applicable to the authorisation decision and, independent of the degree of formality this decision may take, they need to receive the information necessary to comprehend on which basis it has been taken. In the financial sector, it is a well established, legitimate and useful practice for supervisors to nurture informal contacts with financial institutions operating in their country. But it is a requirement that all decisions be subject to judicial review and therefore objectively motivated (31). The transparency required is lacking where oral advice of the authorities not to apply for approval in cases of cross-border investment is used as a substitute for a documented refusal of authorisation which could be subject to judicial review and such a practice is neither in conformity with the wording, or the spirit, of Community regulation. — Follow transparent procedures

6. FURTHER COMMISSION STEPS TO FACILITATE CROSS-BORDER CONSOLIDATION

There is a need to make authorisation procedures clearer and more transparent. The Commission is working together with Member State authorities at all levels in order to achieve the necessary consensus around the degree of cooperation and detail that should underpin such authorisation procedures. The Commission will come up with proposals on the revision of Article 16 of the Consolidated Banking Directive 2000/12/EC in the first half of 2006. The corresponding provisions in Article 15 of the Insurance Directives (2002/83/EC and 92/49/EEC) are being examined within the framework of the Solvency II project. In parallel areas, early agreement on more precise and transparent supervisory approval rules for major shareholdings is imperative.

Moreover the Commission is carrying out an open consultation with Member States and the financial sector in order to identify other possible obstacles beyond those linked to prudential supervision that could hinder cross border consolidation in the EU financial sector. It may make proposals on the elimination of such obstacles where appropriate at a later date. There is a need to review wider obstacles to financial consolidation.

Where the Commission identifies breaches of Community law in respect to direct investment by EU financial institutions, it will, where sufficient evidence is available, pursue infringement cases vigorously, as it has already done in other areas of barriers to intra-EU direct investment. The Commission will challenge any breaches of the EU freedoms …

Finally, the Commission has launched sectoral competition enquiries into retail financial services and insurance. The objective is to enhance competition in these markets. Special attention will be given to the identification of obstacles to the provision of cross-border services and entry barriers, both in the form of regulation as well as more ‘typical’ antitrust issues. … and is also investigating competition in the retail financial markets.

7. CONCLUSIONS

This Communication aims to remind Member States of the relevant basic Treaty freedoms in the area of cross-border investment in financial institutions and the requirement for strict proportionality in any restrictions to these freedoms which might be necessary to protect imperative requirements in the general interest. It also emphasises the need for full transparency in all such decisions. It encourages financial institutions to document instances of what they may consider as unjustified barriers to the integration process. In the light of the considerations developed above, the Commission will enter into a continuing dialogue with Member States in order to identify obstacles to the free movement of capital as well as the freedom of establishment in the financial sector. The Commission is currently working with stakeholders to refine EU secondary legislation in the area, as well as investigating other barriers which may exist and discourage integration. It will ensure that the fundamental freedoms of the Treaty can be realised in a harmonious manner in this area.