Working paper a single market in financial services


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Financial services – banking and insurance sector – represent a significant percentage of EU GDP and have a high potential for employment expansion. As the European situation is characterised by a significant degree of fragmentation in both the economic and legislative dimension, the goal is to achieve a market-driven mechanism in order to pass from a fragmented framework to a specialised one, in which the geographical dimension is overtaken by a sector-based focus. This relates to both the wholesale and the retail financial markets.

The long-term goal of the action to achieve a single market in financial services is to create and develop an efficient capital market. This will both reduce the cost of raising capital and make possible a much faster response to the specific needs of operators on financial markets. Faster response times are critical to achieve competitiveness, and to maintain a competitive advantage, especially for businesses linked with the new economy.

Equity supply has more than doubled over the last decade, due to privatisation and liberalisation, and to the corporate restructuring which has been boosted by the introduction of the single currency. Issuers are becoming more proactive because they are spontaneously offering themselves for market listing.

Investors, for their part, are becoming enthusiastic at the performances of pan-European equity funds, letting national ones to stagnate. Many issuers have raised funds from short-term investors, rather than stable institutions. But the result has been volatile pricing, because many shareholders bought stocks only to resell them later, and make short-term easy profits. This has driven prices down. In this framework, stock market indices have turned from relative objective indicators of market performance to reflections of investment portfolios.

IPO volume reached high levels mostly due to the technology, media and telecommunications  TMT  sectors. This opened up new sources of capital and converted retail investors into venture capitalists.

It has been observed that retail investors buying financial products  for example life insurance  do not look for the best deal. Normally they follow sentimental recommendations or focus on one known company. The sophistication of the customer is still relative low in terms of information usage.

The cult of equity investment is spreading. In particular, it is becoming a good mechanism for allocating long-term capital within economies. Yet the stock market capitalisation of the EU is approximately half of that of the US. The percentage of cross-border trading is limited and private savings  20 per cent of GDP  are not invested efficiently. As a result, job creation limited, because returns on private savings and investment decisions are not optimised. The capitalisation of European investment and pension funds and insurance instruments account alone for more than the EU’s GDP.

The current wave merger proposals is one of the major market-driven forces moving towards specialisation. However, it is not a question of establishing linkages between different technical and operational gateways or strategic linkages between markets, but of achieving an environment within which specialised segments on the supply and the demand sides can operate efficiently. Moreover aborted merger proposals have demonstrated how nationalistic feelings and different economic interests can result in incomplete merger plans. Merger proposals need to involve the creation of a central cross-market counterparty for Europe’s securities markets in order to achieve a complete merger of the settlement and clearing functions.

High-technology specialised markets, which are supposed to represent the major source of risk capital and therefore source of future employment possibilities, are characterised generally by a high degree of volatility. Volatility in individual stocks is directly linked to an increase in investment risk. Big markets are still dominated by public-sector borrowers and by mutual banks that show little enthusiasm for stock market flotation.

Volatility can be explained, on the one hand, by the increased speculative activities of hedge funds; and, on the other hand, by an insufficient liquidity in the market. Stock markets have also been competing to trade in the stocks of start-ups in the new economy, and have lowered their listing standards to achieve the goal. This raises the issue of positioning high-volatility stocks, such as technology stocks, in venture capital portfolios rather than on publicly listed markets. Nevertheless this would not permit the wide development of a risk capital market. The creation of specialised stock markets is therefore essential.

Beside the creation of the necessary conditions for the development of an efficient capital market, easy access to it has to be guaranteed on competitive terms. Mutual recognition of prospectuses and prudential and supervisory rules based on the principle of the home Member State, would encourage issuers and intermediaries to trade and deal easily cross-border, at lower costs and without discrimination towards foreign financial products.

Beside the implementation of the Financial Services Action Plan, every action undertaken at Community level has to face a trade-off between the maximum harmonisation of business rules within a home-country control system, and a minimum harmonisation approach within a system of national rules in the host country.

There may be situations in which the mutual recognition of the provision of services and products may result in investors suffering from discriminatory behaviour towards foreign companies or service providers because the products offered and authorised by one Member State may not be authorised in another. The result is that, when the mutual recognition of practices based on the principle of the home Member State does not provide an environment based on perfect competition, harmonisation may be required.

On the supply-side, investors must be able to access free investment opportunities without being hampered by legal, administrative or information barriers, nationally or internationally. Better disclosure conditions, the elimination of investment restrictions and the harmonisation of tax treatment throughout the EU, would permit institutional investors, who currently manage a significant amount of savings, to increase potential returns on investment.

Removing tax distortions, in particular, would increase the free movement of capital which is determinant for risk capital formation. Higher returns would reduce the risk-adverse behaviour of retail investors and permit institutional investors to channel savings into more productive investment forms. Personal savings are currently one of the worst-used resources in the Community. The capacity to channel financial resources would give institutions such as pension funds or life insurance companies a much more significant role in the investment.

Another factor is the current development of the “new economy”, including the operational and legislative framework to which services and operations on the Internet or through electronic networks are subjected. Consumers taking the initiative of accessing web sites operated by financial service providers in another Member State, for example, should be aware that the web site operates under the laws of the foreign country.

The taxation of services or products supplied and delivered through wire is becoming increasingly difficult because of the different fiscal treatments and the difficulty of following the track of the products or services supplied through the electronic network. This is partly due to the high volume of transactions performed, the rapidity of the performances and the unsupervised framework of action under which electronic networks act.

Fiscal policy is in fact one of the major chances Europe has to achieve full employment. After years of negative employment performance in the Community, Europe has a chance to turn its labour markets around. Workers have been undergoing a high degree of wage restraint. In the last few years the increase in wages has lagged behind the advance in nominal domestic product. One direct effect is that employment is rising faster than it has done in the past, even in upswings of the economic cycle. As the fiscal austerity after the qualification for monetary policy has been partly achieved, governments have the possibility of making substantial reductions in taxes, especially on labour so that unions will continue the current wage moderation policy.

Governments have taken the chance to implement directly employment initiatives such as minimum wage policies or initiatives for young people for the creation of temporary work. Nevertheless such efforts have had relatively little impact on productivity, and structural improvements have been limited. This underlines the relative superiority of a market-driven approach compared to a government-based one. Furthermore, previous experience underlines the fact that employment strategies have been generally nationally, and to a lesser extent regionally, focused. Nevertheless a wider market-driven approach is overtaking the national dimension and leaving employment performances mostly dependent on a Community and regional level.

Tax harmonisation and the reduction of regulatory and administrative burdens is improving the business environment; however Europe is lacking the development of service markets. Europe’s employment deficit is partly determined by a service gap relative to other economies e.g. the US. The growth of the “new economy” is increasing the need to remove barriers to the trading and supplying of new products. Most of these will have to be conceived as services rather than goods, and most of the traditional ones will have to be reoriented and rethought in order to be supplied as services.

For example a company such as already performs quite well through electronic networks in the short run. However, it will meet difficulties in the longer run, when the volume of transactions increases too much for deliveries of the products to be made in an adequately short timeframe. The distribution channel has not been reorganised in order to match the new economy context.

The most competitive companies will be those which, understanding the fact that a “new economy”-based demand does not match a traditionally-based supply, will reorient their products. If books cannot be delivered in an adequate timeframe, the offering of books in electronic form, which can itself be downloaded, can represent the solution. Furthermore, agreements can be made through which the payment of an annual charge creates a long-term relationship with the customer. In order to achieve a more service-oriented focus, which will be competitively more relevant, the simple supply of products, i.e. books, music, etc., can be linked to future services such as the supply of upgrading for electronic products, i.e. upgrades of vocabularies, encyclopaedias, etc..

The natural development of this approach creates a constant flow of physical products and transforms them into services. Many traditional products, commercialised through traditional methodologies, can be reoriented.

The trend toward globalisation and the knowledge-driven economy has accelerated. The challenge of innovation has been largely taken over by innovative ventures such as high growth companies based on advanced technologies. But whether a company is technology-based on not, uniform and common conditions have to be created in order to allow every kind of company and business to adapt to the new changing environment, and to invigorate the entire economic and social fabric. This because every company has the potentiality to achieve a competitive position if basic conditions are present.

In traditional sectors too, these developments are likely to generate employment opportunities. Low-technology industries are “buying in” innovation from suppliers and advisors. Traditional businesses have the possibility of reconverting their operations to increase sensitivity towards the natural environment, which will be one of the leading sources of demand for new products and services and of employment possibilities.

Innovation does not have to be directly founded on research. It can also be linked to new management and investment methods, which can be performed as much by low- as by high-technology-based companies.

The transfer of technology to SMEs, and the development of their capacity to absorb the technology, is a pillar innovation. Clustering is therefore mostly encouraging; but where technology “valleys” cannot be created, either because the related businesses and companies are geographically separated or because of the lack of specific resources, technology-specific competence networks have to be created.

Globalisation is acting on three sectors. It is creating

  • an internationalisation of commerce, which has overtaken productivity growth;

  • the internationalisation of capital flows; and

  • growing information flows.

The effects of a development have to be judged on the basis of the structural changes they create both in the short and in the long run. Even if the more visible and short-term related changes are currently to be seen in the high-technology sector, the major effects will be observed in the traditional sectors, as restructuring processes take place.

Local employment activity does not generally arise spontaneously. The obstacles to achieve financing for start-ups are increasing the need to develop specialised risk capital markets. Some financing measure are relative unknown, such as micro-credits, local investment capital and resources of corporate foundations which have to be adequately publicised in order to achieve in awareness from small investors. A unified system for the sponsorship of alternative financing methods should be outlined.

The private sector is the main driving force behind economic activity in Europe. The net job creation potentialities are currently in the service sectors, especially those that address local needs. There is therefore a need to develop and support entrepreneurship at local level, in particularly in start-ups and SMEs which face difficulties in financing themselves. The competitive position of these companies is dependent on the competitive position of the territory and the business in which they are involved, as well as on the availability of human and social resources.

The lack of skilled workers is one of the major problems for the new economy. It increases the mismatch between demand and supply in the labour market. A direct result is pressure on wage-costs as firms compete for scarce skills. This calls for more investment in learning throughout the entire working period, including both training in basic education and upgrading training. Though the direct provision of public finance for companies risks distorting competition and the crowding out of the private sector, fiscal incentive to increase the training of employees is probably necessary.

Finally, if productive employment is to be increased, ways must be found to improve the competitivity of companies other than by cost-cutting reductions in the labour force. One important possibility lies in improved asset management.

But this will not be achieved without more efficient capital markets; and the key to this, in turn, is improved integration at the European level.

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