"The euro and the dollar - pillars in global finance" - Speech by EU Commissioner Almunia

Summary: "The euro and the dollar - pillars in global finance" - Speech by EU Commissioner Almunia (17 April 2007: New York)

Almunia at NYSE

Speech by Joaquín Almunia, European Commissioner for Economic and Monetary Affairs, "The euro and the dollar - pillars in global finance", Federal Reserve Bank of New York and European Commission, New York

Ladies and gentlemen,

Let me begin by thanking the Federal Reserve Bank of New York for co-organising this event.

The title of today's conference reflects the role of the United States and Europe as the two dominant players in the international financial system. With this in mind, I will focus my remarks on the dramatic changes underway in Europe's financial sector.

First, let me begin with a review of recent economic developments in Europe.

Recent macro-economic developments in the EU

The European economy performed well in 2006. Economic activity was strong throughout most of the year and ended on a high note. The full-year economic growth rate was 3%, which is the highest rate recorded since 2000. This recovery has brought a welcome end to a period of below-par economic performance.

Domestic demand has risen sharply in Europe, amid a surge in investment spending and a pick-up in private consumption, due to the steady improvement in the performance of the labour market, where the unemployment rate has fallen to its lowest level in more than a decade. Of course, activity in Europe has also been supported by sustained high economic growth in emerging Asia, and particularly China, as well as the milder than expected slowdown of the US economy.

Europe's economic recovery has come at a time when our main central banks have been gradually withdrawing liquidity from the economy. This normalisation in the monetary policy stance - after several years of very low short-term interest rates - has been necessary to keep inflation pressures contained. Nevertheless, monetary and financial conditions remain very favourable by historical standards and asset markets have been generally buoyant.

So far in 2007, Europe's economy remains robust. Our current baseline scenario indicates an annual growth rate of 2.7 percent, only marginally below the figure for 2006. But this scenario is not without downside risks. The economic data coming from this side of the Atlantic has not been entirely reassuring of late. And, the recent turbulence in equity markets illustrates the extent of investor sensitivity to adverse economic news. Nevertheless, I remain bullish about global economic and financial conditions and about the prospects for a sustained economic recovery in Europe. Such a recovery should be supported by the programme of economic reforms that Europe is putting in place to raise the productive potential of our economy.

The importance of financial integration for economic performance in the EU

One of the major economic reform initiatives in Europe over the past decade has been the integration of the Member-State financial systems. The economic rationale behind financial integration is straightforward. There is ample theoretical and empirical evidence to suggest a causal link between financial development and economic growth. By allocating financial resources and risk efficiently over time and space, the financial sector allows real-sector activity to expand and develop optimally. If the financial sector is constrained in performing this task, there is a consequent cost in terms of sub-optimal economic performance and welfare loss.

In general, the financial systems of the EU Member States function efficiently in a national context. The problem is that these national financial systems do not combine efficiently, creating significant opportunity costs for the EU economy. As such, there is still significant scope for increases in economic efficiency through financial integration. By making the EU economy function more efficiently, financial integration will be an important instrument for fostering the creation of wealth and employment.

Current state of progress in financial integration

Given the economic benefits of having an integrated European financial market, it is essential that there is steady progress in what is often a complex integration process. Let me outline the progress we have made so far.

1999 was a seminal year for the financial integration process. In that year, the introduction of the euro eliminated currency risk on the bulk of cross-border flows within Europe, stimulating demand for cross-border financial instruments and services.

Also launched in 1999 was the Financial Services Action Plan (FSAP), the blueprint for a common regulatory framework for the European financial-services market. The plan comprised 42 legislative and non-legislative measures targeted at a wide range of financial activities. Implementation of the Plan has been completed at the European level and the various legislative measures are now being transposed into law in the Member States.

With implementation of the FSAP well underway, and eight years after the introduction of the euro, evidence confirms that the EU financial system has become much more integrated. However, integration is progressing unevenly across different sectors:

- Overall, the pace of integration has been faster in the case of financial products with agreed definitions, common conventions and common infrastructure. Among this category, the most dramatic examples have been the euro-denominated inter-bank and derivatives markets, which became fully integrated immediately after the launch of the euro.

- Progress in integration has been slower in securities markets. Some of these markets are still highly fragmented due to differences in national regulations, market conventions, taxation, and legal frameworks. Moreover, such obstacles to integration have also been evident in the context of cross-border consolidation of financial intermediaries and infrastructure.

- Finally, while the wholesale market has been the main target of the FSAP measures, European citizens have also benefited from financial integration. The cost of cross-border payments has been considerably reduced in the euro area. For example, the average cost of transferring €100 to another country of the area has been cut from €24 to €2.40. Furthermore, consumers enjoy increased access to capital at lower costs, with the average interest rates for loans for house purchases more than halved in the euro area between 1995 and 2005.

Clearly, the introduction of the euro and the implementation of the FSAP have already helped tackle fragmentation in the EU financial sector. Nevertheless, important sources of fragmentation remain. These must be addressed in the coming years, to deliver a single EU financial system that will support a more productive use of capital and higher economic potential.

Ongoing initiatives to foster financial integration and stability

To this end, Europe has established its priorities for action in financial integration over the next five years. Transposing the legislative measures of the FSAP into national law in a timely and consistent way is high on the agenda together with continuous ex-post evaluation of the implementation of these measures.

We have also identified a number of key areas requiring further efforts:

A first area is clearing and settlement, where cross-border transactions in the EU are far more costly than domestic transactions, due to technical, legal and fiscal obstacles. The Commission has assisted the clearing and settlement industry in establishing a voluntary code of conduct, which is designed to eliminate sources of inefficiency in cross-border activities.

- This non-regulatory initiative is significant not only for the clearing and settlement industry. If successful, it could act as a model for integration in other areas of the financial sector. In parallel, the European Central Bank has proposed a common European platform for the settlement of securities transactions - the "Target2- Securities" project.

- Following the Basel II reform of the regulatory capital regime for banks, there is ongoing work on a corresponding regime for the EU insurance sector. The so-called Solvency II Directive will overhaul existing EU regulation and supervisory arrangements in the sector.

- Other initiatives relate to the integration of retail financial markets. Work in this area is crucial to deliver further benefits to EU citizens and avoid the impression that only big business gains from financial integration. In particular, a new Directive on payment services, which has recently been approved by EU finance ministers, will introduce a single set of rules and greater competition into the European market for payment services. For consumers, this means using credit and debit cards abroad at reduced cost and with greater ease, and quicker and cheaper transfers from one EU country to another. The directive also represents a significant step towards the creation of a single euro payment area (SEPA) by 2010. We estimate that this major project, scheduled to be launched next year, will save the European economy between 50 and 100 billion euros annually. SEPA will inject competition into the financial sector, cutting costs and increasing choice for citizens.

- Finally, the investment fund industry is another area where integration efforts may be needed with retail investment funds, hedge funds and private equity coming under particular scrutiny. The regulatory framework for each of these types of investment fund needs to be reviewed for different reasons, including the need to facilitate private funding of pensions and investor protection, but also to preserve financial-system stability. In this respect, the G7 has recently highlighted the need to better monitor the implications of the rapid growth in the hedge fund industry. While acknowledging the positive role of hedge funds in the smooth functioning and development of financial markets around the globe, I believe it is right to discuss the associated risks at the EU and global level.

The issue of EU arrangements for financial stability requires particular attention as improvements in this domain are clearly needed. As financial integration promotes the internationalisation of market operations, EU supervisory arrangements must keep pace with the reality of more integrated financial markets. However, the current EU supervisory arrangements are segmented and major differences exist in supervisory practices and in the allocation of supervisory responsibilities. These differences present significant deadweight costs for the financial industry and increase risks for financial stability. Supervisory structures should therefore adapt to financial market evolutions. We have started a process to move in that direction.

Relevance of European Financial Integration for the US market

Before concluding, let me touch upon the relevance of European financial integration to the United States and the rest of the world. The scale of financial flows around the world leaves us in no doubt about the interdependencies that now exist in the global financial system. I began by saying that the US and Europe are the two dominant players. This is confirmed by simply looking at the scale of financial flows between the two economies.

Let me quote just a few statistics: the US and EU account for a combined 80% of all foreign direct investment in the world, 80% of the international debt securities market and 65% of the cumulative international equity issuance since 1987.

Regarding the interdependent relationship between the US and the euro area, the geographical breakdown of the euro area's international investment position illustrates that the respective bilateral shares of FDI investment of the US and the euro area were about 20%. And the scale of cross-border holdings is impressive. Euro area investors held US equities and debt securities with a value of over 1.3 trillion euro at the end of 2005, about one third of all foreign securities holdings in the euro area.

For these reasons European financial integration is not a local matter. The factors driving integration in European financial markets - such as liberalised capital movements, advances in information technology and innovation in financial products and techniques - are also at play at the global level.

In a context of global financial integration, adopting rules and standards that suit Europe or the US alone cannot be the objective. If the benefits of global financial integration are to be exploited fully, we must take into account how our European rules and standards interact with those elsewhere. Similarly, the US authorities must bear this global dimension in mind, as they seek to manage the development of their domestic financial market.

With this need for global consistency in mind, the importance of a productive EU-US financial regulatory dialogue should be clear to all. Here the recent initiative for a transatlantic economic partnership has the potential to give new impetus to transatlantic economic cooperation.

Conclusion

Ladies and Gentlemen, let me conclude. In Europe, we have been pioneers in the field of international financial integration for more than two decades. But our task is far from complete. While the euro has taken its place alongside the dollar as a pillar of global finance, the single European currency is not yet underpinned by a true single European financial market. I believe that we have much to learn from the success of US financial markets, which continue to dominate the international financial system. However, I believe that the US markets may have a few things to learn from Europe's experience too. What is certain is that cooperation is crucial, because Europe and the United States share a joint responsibility to lead in the creation of an efficient and safe global financial system.

Thank you for your attention and enjoy the Conference.

Ref: SP07-406EN
EU source: European Commission
UN forum:
Date: 17/4/2007

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