European Community: U.S. Financial Services' Competitiveness Under the Single Market Program

Published by the Government Accountability Office on 1990-05-21.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                 United   States   General   Accounting   Office

GAO              Report to the Chairman, Subcommittee
                 on Comrkerce, Consumer, and Monetary
                 Affairs, Committee on Government
                 Operations, House of Representatives

llay 1990
                 U.S. Financial Services’
                 Under the Single
                 Market Program

National Security and
International Affairs Division

B-23877 1

May 21, 1990

The Honorable Doug Barnard, Jr.
Chairman, Subcommittee on Commerce,
  Consumer, and Monetary Affairs
Committee on Government Operations
House of Representatives

Dear Mr. Chairman:

This report responds to your request that we assess how the European Community’s (EC)
Single Market Program might affect U.S. financial firms. It examines the extent to which U.S.
financial firms participate in ECmarkets, the potential opportunities and challenges
presented by changes in the Community, and how U.S. government agencies are working to
assure full and fair access to European markets.

As agreed with your office, we did not obtain formal agency comments on this report. As
also agreed with your office, we plan no further distribution of this report until it is released
at a hearing of your Subcommittee on May 23,199O. At that time, we will send copies to the
Secretary of the Treasury, the Secretary of State, the Secretary of Commerce, and the United
States Trade Representative. We will also make copies available to others upon request.

This report was prepared under the direction of Allan I. Mendelowitz, Director, International
Trade, Energy, and Finance Issues, who may be reached on (202) 275-4812. Other major
contributors are listed in appendix II.

Sincerely yours,

Frank C. Conahan
Assistant Comptroller General
Executive Summary

                   The European Community of 12 nations plans to create a single Euro-
Purpose            pean market by 1992. The Chairman of the Subcommittee on Commerce,
                   Consumer, and Monetary Affairs, House Committee on Government
                   Operations, asked GAO to assess how the Community’s Single Market
                   Program might affect U.S. financial firms. This report examines the
                   extent to which U.S. financial firms participate in European Community
                   markets, the potential opportunities and challenges presented by
                   changes in the Community, and the efforts of U.S. government agencies
                   to assure full and fair access to European markets.

                   The Community envisions a single, integrated market characterized by
Background         the unrestricted movement of people, capital, goods, and services across
                   its member states’ borders. The Community aims to complete this pro-
                   gram by the end of 1992. However, some steps towards unification have
                   already occurred, while others will not be completed for some time.

                   New opportunities exist for U.S. financial firms to expand their consid-
Results in Brief   erable business in the European Community. At the present time, U.S.
                   firms should face relatively few Community-imposed restrictions. This
                   openness is due, in part, to U.S. government agencies’actions, which
                   made U.S. interests known to the Community.

                   New powers and market access granted by the 1992 program will partic-
                   ularly affect retail (consumer) markets, and any financial firm with a
                   presence in the Community could benefit from the increased demand for
                   financial services.

                   Many U.S. financial firms, however, do not plan to expand beyond their
                   existing wholesale (commercial and interbank) operations. Factors such
                   as the burden of meeting increased capital adequacy standards for
                   banks and the problem of allocating limited capital among competing
                   investment alternatives will drive their decisions.

                   In addition, some U.S. financial firms, notably banks, contend that U.S.
                   laws and regulations on certain activities impose serious obstacles to
                   expansion. These restrict the kinds and amount of business U.S. finan-
                   cial firms may conduct, potentially putting them at a disadvantage to
                   European competitors.

                   Page2                                     GAO/‘NWWW     European   Co~~~unity
                          Ehcutive   Summary

Principal Findings

U.S. Participation        U.S. financial firms have a considerable stake in their Community opera-
                          tions, particularly in Community wholesale markets. U.S. banks are
                          active in every Community country, holding over $200 billion, or 5 per-
                          cent, of total Community bank assets among their hundreds of branches
                          and subsidiaries. U.S. securities houses rank among the world’s largest
                          in their Euromarket activities. While only a few U.S. insurance compa-
                          nies operate in the Community, the 1992 program has sparked renewed

                          U.S. financial firms no longer fear that the Community’s Single Market
                          Program will deny them access or limit participation in Community
                          financial markets. U.S. government, private sector, and media concern
                          over “reciprocity” provisions in draft Community legislation has largely
                          faded in the last year, though protectionism could resurface at any time.

Opportunities             The formation of a unified financial market in Europe offers many new
                          opportunities and benefits for financial institutions and Community con-
                          sumers. The Community will rival Japan and the United States as one of
                          the world’s largest markets, with 325 million people, a gross national
                          product of $4 trillion, $3.9 trillion traded annually on bond and equity
                          markets, and an insurance market that accounts for roughly a quarter
                          of world premiums.

                          The European Community’s Single Market Program is a part of the
                          deregulation of Community member states’ domestic financial markets,
                          that should enable institutions to consolidate operations and offer more
                          products. Firms offering investment services should also benefit from
                          increased corporate financial activity, such as expansions, restructur-
                          ing, and mergers and acquisitions.

Factors Limiti .ng U.S.   In general, U.S. financial firms do not plan to expand their presence or
Participation             activities in the Community. Many U.S. banks, for example, are con-
                          strained by capital limitations. Relaxation of interstate banking restric-
                          tions in the United States has created opportunities for banks to expand
                          domestically, and many banks view such expansion as a better use of
                          their capital. US. banks are particularly concerned that legal limits on
                          the mixing of banking and securities activities in the United States and

                          Page 3                                    GAO/‘NSIAD9M9   European   Community
                  Executive   fhmnuuy

                  regulatory limits on their overseas securities activities put them at a
                  competitive disadvantage compared to Community firms that can offer
                  both kinds of services under the Community’s universal banking model.
                  For further discussion of U.S. banking laws and regulations, see Bank
                  Powers: Issues Related to Repeal of the Glass-Steagall Act (GAO/GGD-~S-37,
                  Jan. 22,1988).

U.S. Government   The U.S. government has responded in a timely fashion to protect US.
Activities        financial sector interests in the emerging European Community single
                  market. This action was most evident and important in the response to a
                  restrictive “reciprocity” provision in an early version of a Community
                  banking directive. The US. government’s response was one of several
                  factors that led the Community to soften its stance.

                  The Community’s endorsement of the universal banking model for its
Matters for       more open financial markets gives greater urgency to the ongoing con-
Congressional     gressional debate over how broad U.S. bank powers should be. The deci-
Consideration     sion to modify the existing regulatory requirements is a judgmental one.
                  In weighing the pros and cons of the existing structure, consideration
                  should be given to the impact of these requirements on the ability of
                  U.S. banks to compete in the Community after 1992.

                  As requested, GAO did not obtain official comments on a draft of this
Agency Comments   report. The views of responsible officials were obtained during GAO'S
                  work and are incorporated in the report where appropriate.

                  Page 4                                    GAO/‘NS’IADWW   European timm~ty
Page 5   GAO,‘NSIAD9@99   European   Community

Executive Summary                                                                                        2

Chapter 1                                                                                             8
The European            Basis for the Single Market Program                                           8
                        The Single Market Framework for Financial Services                           11
Community’s Single      Financial Services Directives                                                16
Market Program          Potential Roadblocks to Integration                                          20
                        Objectives, Scope, and Methodology                                           21

Chapter 2                                                                                            24
U.S. Participation in   EC Marketplace Rivals That of the United States                              24
                        Importance of the Financial Services Sector in the EC’s                      26
EC Financial Markets         Economy
                        U.S. Financial Institutions in the European Community                        29

Chapter 3                                                                                            34
Access to the           U.S. Firms Foresee Increased Opportunities in the EC                         34
                        U.S. Institutional Strategy: Generally Not One of                            39
European Community           Expansion
Appears Open, but       Factors and Impediments Affecting U.S. Firms’ Strategy                       41
Other Factors May       Conclusions
                        Matters for Congressional Consideration
Limit U.S. Financial
Firms’ Participation
Chapter 4                                                                                            54
The Appropriateness     Many U.S. Government Agencies and Private Sector                             54
                            Groups Are Monitoring the EC’s 1992 Program
of the U.S.             The U.S. Government Provided an Early and Coordinated                        57
Government’s                Response
Response                Future Concerns and the Framework for Response                               61

Appendixes              Appendix I: Status of Single Market Program Legislation                      66
                        Appendix II: Major Contributors to This Report                               72

Tables                  Table 2.1: Share of World Insurance Volume Represented                       29
                            by the EC, North America, and Japan (1960-85)

                        Page 0                                   GAO/‘NSIADW99    European   Community
          Table 2.2:Frequency of U.S. Securities Firms Among Top                      31
              Ranked Participants in Selected International
              Financial Markets (1988)
          Table 3.1: Cross-Border Mergers (January Through June                       36

Figures   Figure 1.1: The EC’s Cooperation Procedure                                   12
          Figure 2.1: Gross National Products of the EC, United                        24
              States, and Japan (1988)
          Figure 2.2: Population of the EC, United States, and                         25
              Japan (1988)
          Figure 2.3: The Size of the Bond Market in the EC, United                    27
              States, and Japan (December 1987)
          Figure 2.4: The Size of the Equity Market in the EC,                         28
               United States, and Japan (December 1987)


          EC        European Community
          ECU       European Currency Unit
          EMS       European Monetary System
          EMU       Economic and Monetary Union
          GAO       General Accounting Office
          GATT      General Agreement on Tariffs and Trade
          OECD      Organization for Economic Cooperation and Development
          UCITS     Undertakings for Collective Investment in Transferrable

          Page 7                                    GAO/‘TVS~~99   European   f3mmn.nlty
The European community’s Single
Market Program

                       The European Community (EC) has embarked upon a plan to create a
                       single European market characterized by the unrestricted flow of goods,
                       persons, services, and capital. The EC’Sobjective is to create a more effi-
                       cient European economy with lower prices, higher wages, and greater
                       productivity. This goal will be accomplished through a series of legisla-
                       tive steps removing existing technical, fiscal, and physical barriers. Most
                       of these steps are to take effect by January 1,1993, hence the popular
                       name “EC 1992.” Key to this process are the integration and liberaliza-
                       tion of the EC’Sfinancial services sector because of its leading and far-
                       ranging effect on other sectors.’

                       The Treaty of Rome, signed in 1957, signaled the beginning of European
Basis for the Single   economic integration. By establishing a common market, the ECintended
Market Program         to bring the economic policies of member states closer together. The
                       treaty called for the free movement of goods, persons, services, and cap
                       ital within the Community but did not establish a framework to achieve
                       it. The treaty initially focused on providing the grounds to eliminate
                       tariff barriers and promote tax harmonization. The creation of the Euro-
                       pean Monetary System (EMS)Zin 1979 helped stabilize Community
                       exchange rates and paved the way toward future cooperation.

                       Despite these steps toward integration, many internal barriers remained.
                       Many Europeans believed that relatively slow European economic
                       recovery from the global recession of the 1970s was, in part, caused by
                       multiple trade barriers and overly protected markets. The EC’Sdepen-
                       dence on world trade and the increasing internationalization of world
                       economies also added impetus to the EC’Splan to unify its markets.

                       The EC’SSingle Market Program was formally launched in 1985 with the
                       EC’SWhite Paper “Completing the Internal Market.” This paper identi-
                       fied barriers, proposed a series of 300 measures (later reduced to 279)
                       necessary to abolish them, and set forth a regulatory framework to

                       ‘For an assessment of how the Single Market Program may affect U.S. small and medium-sized mer-
                       chandise exporters, see European Single Market: Issues of Concern to Exporters (GAO/NSIAD90-60,
                       Feb. 13, 1990).

                       *The EMS established a new currency, the European Currency Unit (ECU), which is a basket of E~ID
                       pean currencies consisting of specified amounts of the currencies of 10 of the 12 member states. The
                       12 member states include Belgiuq Denmark, fiance. Greece, Ireland, Italy, Luxembourg, the
                       Netherlands, Portugal, Spain, the United Kingdom, and West Germany. The EMS also employs an
                       exchange rate mechanism that limits to certain defined bands the variance between member states’
                       currency exchange rates.

                       Page 8                                                   GAO/WSIAD-90-99     European   community
                  chapter 1
                  The European Community’s      Single
                  Market FVogram

                  achieve a single European market. Most of these measures are in the
                  form of directives.3

                  The White Paper set a timetable for enactment of each measure and
                  required the entire program to be in place by the end of 1992. Once a
                  directive is adopted, member states are typically given 2 years to con-
                  form their national laws to it. Thus, to complete the internal market by
                  the end of 1992, most of the directives would have to be adopted by the
                  end of 1990.

                  The Single European Act of 1987 reaffirmed the White Paper’s objec-
                  tives and accelerated the market integration process. It changed the way
                  EClegislation is passed for most Single Market Program initiatives by
                  requiring only a weighted majority of member states to approve the
                  adoption of a proposed directive.4 Previously, unanimity was required,
                  and one member state could block legislation. The act also established
                  greater consultation among the various ECinstitutions during the legisla-
                  tive process.

EC Institutions   The European Community consists of four supranational institutions:
                  the ECCommission; the Council of Ministers; the European Parliament;
                  and the European Court of Justice. The EC Commission is the executive
                  branch: it drafts and proposes legislation and enforces the implementa-
                  tion of Community law. The Commission, while representative of the
                  various member states, is largely nonpartisan. This arrangement con-
                  trasts with the Council of Ministers, the EC’Smain decision-making body,
                  which represents the views of individual member states. The Council
                  consists of ad hoc groupings of cabinet-level officials from the member
                  states, e.g., for the financial services sector, the Council consists of the
                  finance ministers of each member state. Legislation proposed by the
                  Commission must be approved by the Council before it becomes law. The
                  European Parliament is more populist than the other bodies, as repre-
                  sentatives of this body are directly elected by Community citizens.
                  While the Parliament has limited legislative power because it cannot ini-
                  tiate or enact legislation by itself, it can make amendments to proposed
                  directives; as a result, the Council and Commission are sensitive to the

                  “An EC directive requires member states to ensure that their national regulation conforms to the
                  directive’s objectives but leaves them free to decide how it should be implemented. EC regulations, on
                  the other hand. are used more sparingly and supersede existing national law.
                  4Known as “qualified majority voting,” voting weights are assigned to each state loosely according to
                  its population and economic power. Social and tax matters still require unanimous approval under the
                  Single Market Program.

                  Page 9                                                    GAO/‘NSL4D9O-99      European   Cmmunity
                           chrpter 1
                           The European Community’s Single
                           Market   Fkogmm

                           Parliament’s concerns. The European Court of Justice ensures that EC
                           legislation is interpreted and applied according to the principles of IX
                           law. As the Single Market Program progresses, the Court of Justice will
                           play an increasingly important role in interpreting and enforcing Com-
                           munity law.

The Single Market’s Law-   Under the Single European Act, the ECfollows a more complex and more
Mak :ing Process           consultative process in enacting legislation than it did before. In this
                           process, known as the Cooperation Procedure, a Commission proposal
                           must pass through a number of steps before enactment. As it proceeds
                           through the steps, a measure is affected by a host of internal and exter-
                           nal influences and can change substantially. The Cooperation Procedure
                           essentially operates as patterned in figure 1:l. (see pages 12 and 13)

Economic and Monetary      The single market in financial services is one step toward a longer-term
Union (EMU)                ECgoal of greater unification of monetary and fiscal policy. In 1989, the
                           President of the Commission, Jacques Delors, released a report propos-
                           ing three stages for achieving an Economic and Monetary Union. The
                           EMUgoes beyond the Single Market Program in proposing fixed
                           exchange rates among national currencies and the eventual creation of a
                           single European currency and central bank.6 At the European Commu-
                           nity’s Madrid Economic Summit in June 1989, leaders of the 12 EC
                           nations agreed to an intergovernmental conference to amend the Treaty
                           of Rome and to begin the first stage of the EMUprocess on July 1,199O.

                           5The Del013committee report propcees a threestage     process
                           ( 1) Greater EC member state coordination of economic and monetary Policy, requiring all members to
                           join the EMS.

                           (2) A transitional phase, establishing an institutional framework to set economic objectives and
                           budget deficit limits for member states. This step includes setting up a European system of central
                           banks similar to the U.S. Federal Reserve System.

                           (3) Locking exchange rates and instituting rules on nuawconomic and budgetary policy. This *P
                           requires establishing one central bank to make FX-wide monetary Policy and creating a single Em
                           pean currency.

                           Page 10                                                   GAO/‘hIS~~           European Gmm~ty
                           chapter 1
                           The Euro-    Chnmdty’e   Single
                           MArket Progmm

                           The Single Market Program emphasizes (1) the unrestricted movement
The Single Market          of capital within the Community, (2) the goal of eventual freedom for
Framework for              financial firms to operate throughout the Community under the same set
Financial Services         of regulations, and (3) the use of reciprocity to open other countries’
                           markets to ECfirms. The EC’Saim is to provide enough financial regula-
                           tion to ensure banks’ safety and soundness while at the same time
                           allowing flexibility and not imposing overly burdensome regulation.

Unrestricted Movement of   A single market for financial services would not be possible without the
Capital                    unrestricted flow of capital among nations. Free capital movement
                           means that a resident of one ECmember country can use the financial
                           services of any other member state, including banking, stock exchange,
                           and real estate markets. This freedom allows capital, whether intended
                           for savings or investment, to move to the most efficient and competitive
                           marketplace. The ECseeks to achieve this freedom by removing currency
                           exchange controls and other discriminatory barriers on capital transfers
                           and their underlying transactions (i.e., trade in goods or provision of
                           services) and by abolishing discriminatory measures such as taxation of
                           certain investors.

                           PAge 11                                  GAO/‘IWlAD~    Enropean   Commnnity
                                              ChApter 1
                                              The European Community’s      Siie
                                              MArket ProgrAm

Figure 1 .l: The EC’s Cooperation Procedure

                                                  Commission makes

                                                     Council begins

                                                       First reading
                                                    Opinion rendered
                                                      (no time limit)

                                                    Council adopts a
                                                   common positlon by
                                                     qualified majority

                                                 Parliamenl   reviews and

                                              Page 12                              GAO/NSIADW99   European   Community
                       chapter 1
                       The European Community’s          Single
                       Market Program

                          Council     makes de&Ion
                                    on proposal

1. Adopts the Act In                                                3. Adopts amended
  accordance with                                                 version, but unanimity
                                                                  required withln 3 mos.

                         Commission   reviews EP
                           May revise proposal


                       Page 13                                                             GAO/‘NSIAD9099   European   Community
Single Passport for   Central to the liberalization of financial services under the Single Market
Financial Services    Program is the concept of a “single passport.” Once a financial firm is
                      established and licensed in one member state, its home country, that
                      firm can use a single passport to offer financial services in any other
                      member state, or host country. With a single passport, a firm is free to
                      render its services anywhere in the Community, either directly across
                      borders or through branches. In turn, consumers of financial services
                      will be able to select the institutions offering the lowest cost and best
                      services regardless of where they live.

Mutual Recognition    The EChas specified a minimum level of regulation, beyond which coun-
                      tries are free to regulate their markets as they see fit. Known as
                      “mutual recognition,” this element requires a minimum level of harmo-
                      nization, or essential equivalence, to ensure the safety and soundness of
                      the financial system. For instance, the Second Banking Directive
                      requires all M: banks to have a minimum capital base, a minimum level
                      of shareholder disclosure, and a maximum limit on the degree of equity
                      participation in nonfinancial firms.

                      Mutual recognition also entails home country control, i.e., a financial
                      firm has the same powers and is subject to the same home country
                      supervision and regulatory limits regardless of where its services are
                      rendered under the single passport. In general, a host country only has
                      authority to supervise branch liquidity or marketing-related activities.
                      Mutual recognition has important ramifications because regulation can
                      vary between countries. If a home country’s rules are more liberal than
                      those in host countries, its financial firms will be able to offer a wider
                      range of services and will not be subject to the same regulatory costs as
                      would the host countries’ own financial firms. The expected result under
                      competitive circumstances will be that member states’ regulation will all
                      eventually converge to the same minimum essential standards and the
                      widest range of permissible powers. This process is known as “regula-
                      tory convergence.”

                      Perhaps the best example of the impact of regulatory convergence will
                      be in the banking sector. The EC’SSecond Banking Directive allows
                      banks a broad range of permissible powers, including participating in
                      securities-related activities, based on the universal banking tradition6
                      found in some ECcountries. It is fully expected that those member states
                      that do not currently follow a universal banking concept will eventually

                      “Universal banks perform both banIdng and securities-related activities.

                      Page 14                                                   GAO,‘NSL4D9W9    European   Community
              Clupter 1
              The European commnnity’s Single
              IMArket Progmm

              permit broader bank powers so that their domestic banks are not placed
              at a competitive disadvantage vis-a-vis other ECbanks operating in their

Reciprocity   The EC’Sapplication of reciprocity for financial services has evolved
              from a protectionist and potentially mutually restrictive form to one
              that is liberal. The original provision introduced in the Second Banking
              Directive of early 1988 appeared to seek identical, or mirror-image reci-
              procity, that is, U.S.-owned bank subsidiaries in ECmarkets would be
              permitted only those activities granted to &owned banks in the United
              States. This provision was one of the primary reasons the United States
              feared the rise of a protectionist EC,or “Fortress Europe.” The EC,how-
              ever, reasoned that in a financially interdependent international envi-
              ronment, its financial firms should enjoy fair access and equivalent
              treatment in other world markets.

              Further fears arose, owing to the ambiguity of the reciprocity language
              in the banking directive and its interpretation by a prominent member
              of the Commission. That member reasoned that reciprocity could be
              imposed retroactively, i.e., non-m banks already in the ECwould not be
              “grandfathered” or allowed to do business in accordance with the new
              law. Non-m firms were also concerned about the automatic review pro-
              cedures outlined in the provision, which required automatic suspension
              of applications from all non-Ec financial institutions pending reciprocity
              review by the Commission. These firms feared this requirement would
              delay and impede their ability to enter the EC,acquire other financial
              institutions, or restructure their businesses in the EC.

              But the Council of Ministers adopted new language in the Second Bank-
              ing Directive on December 15, 1989. The new language provided a sub-
              stantially revised and more liberal reciprocity provision to be effective
              in 1993. The ECintends to seek reciprocal national treatment with effec-
              tive market access. This goal means that U.S. banks would be granted
              the same opportunities in the EC as ECbanks are granted, as long as EC
              banks are not discriminated against in the United States. The automatic
              review procedure was eliminated. If the ECdetermined that ECbanks are

              Page 16                                    GAO/'NSIAlHO-99   European Ckmmon.ky
                           clulpter 1
                           The European Community’s      Single
                           Market Program

                           not treated equally in the United States, then the ECwould seek

                           The reciprocity provision in the Second Banking Directive has received
                           much attention, in part because the EChas stated that the form reciproc-
                           ity takes in the banking sector will be used as the model for treating
                           investment services and insurance as well.

                           Of the approximately 30 directives relevant to the Single Market Pro-
Financial Services         gram’s financial services area, the 9 discussed in this section are key to
Directives                 the program and are critical in understanding its impact on U.S. finan-
                           cial firms. They are intended to integrate ECmarkets and open them to
                           competition. For the status of these and other EC 1992 directives, see
                           appendix I.

Second Banking Directive   The Second Banking Directive establishes the key principles upon which
                           the EC bases its regulatory framework: a single banking license, home
                           country control with mutual recognition, and reciprocal national

                           The single banking license allows any bank authorized in one member
                           state to provide a broad array of financial services,8 similar to those con-
                           ducted by universal banks, in any other member state. Non-a banks are
                           also eligible for the single banking license, as long as they incorporate an
                           ECsubsidiary in any one of the member states.

                           ECbanks’ activities outside their home country will be subject to super-
                           vision and regulation by their home country. The primary exceptions to

                           7Acaxding   to the current proposal, 6 months before the directive is implemented on January 1,1993,
                           the Commiss’1011will draft a report examining the treatment given to EC banks in third countries. In
                           those circumstances where EC banks are not afforded effective market access comparable to that
                           granted by the EX to credit institutions from a foreign country, the Commission may submit a propo
                           sal to the Council for negotiations to seek comparable competitive opportunities. In those instances
                           where EC banks do not receive national treatment, the Commiss’ion may initiate negotiations to rem-
                           edy the situation.
                           ‘The list of permitted activities under the single banking license are (1) deposit @king and other
                           forms of borrowing, (2) lending, (3) financial leasing, (4) money transmission services, (6) issuing and
                           administering means of payment (credit cards, travellen checks), (6) guarantees and commitments,
                           (7) trading for their own or customers’ accounts in money market instruments, foreign exchange,
                           financial futures and options, exchange and interest rate instruments, and securities, (8) participation
                           in share issues and the provision of services related to such issues (i.e., underwriting), (9) money
                           brokering, (10) portfolio management and advice, (11) safekeeping of securities, (12) credit reference
                           services, and (13) safe custody.

                           Page 16                                                    GAO/‘NSIhD90-99      European   Community
                      ch8pter 1
                      The European community’s   Single
                      Market Program

                      home country control are conduct of business rules and control of mone-
                      tary policy. Supervisory authorities in the host country will retain pri-
                      mary oversight over branch liquidity and exclusive responsibility for
                      monetary policy. The host country will also have authority over market-
                      ing of services within its boundary. Finally, the host country could
                      apply additional restrictions, but only in rare circumstances affecting
                      the public interest.

Capital Adequacy      The Commission proposed two directives dealing with capital adequacy
Directives            for banks: the Own F’unds Directive, which defines qualifying capital;
                      and the Solvency Ratio Directive, which determines the quantity of the
                      qualifying capital that is required. The Council adopted the former on
                      April 17, 1989, and the latter on December 18, 1989. Both of these direc-
                      tives are to be implemented in conjunction with the Second Banking
                      Directive on January 1,1993.

Investment Services   The proposed Investment Services Directive is structured very similarly
Directive             to the Second Banking Directive, but applies to nonbank financial firms
                      not covered by the banking directive. The directive is based on the same
                      principles as the Second Banking Directive regarding a single passport,
                      mutual recognition, and home country control.

                      The ECintends to implement its directive at the same time as the Second
                      Banking Directive, so that there is no period during which investment
                      firms will be at a competitive disadvantage to banks. However, member
                      states that do not have domestic investment service firms (i.e., if these
                      services are provided by universal banks) may not be as eager to press
                      for timely passage of the Investment Services Directive.

                      Under the proposed Investment Services Directive, ECinvestment firms,
                      like banks, will be free to open branches or to offer their services across
                      borders to any other member state, subject to the same set of regulations
                      as they would be under home country control. The single passport gives
                      any K-authorized firm access to member state stock exchanges. The
                      host country retains control for conduct of business rules and compensa-
                      tion methods to protect investors in case of investment firms’ default or

                      Page 17                                   GAO/‘NSLAD90-99   European   Community
                       Ckapter 1
                       The European Canmunlty’s      Single
                       Market Program

                       The directive lists permissible activities in which these firms may
                       engage and instruments that they may sell9 Competitive pressures will
                       force regulatory convergence; thus, those countries that currently do not
                       permit some of these activities are likely to broaden permissible powers.

                       The proposed directive still contains the original and restrictive reci-
                       procity language that first appeared in the banking directive. However,
                       the ECpromises that the directive will be revised by the Commission in
                       line with the current reciprocity provision in the banking directive.

                       The EC said it intends to introduce another directive addressing capital
                       adequacy provisions for investment firms. However, there is a lack of
                       agreement on a basis for assessing capital adequacy standards for
                       investment firmsLo

UCITS Directive        The principal directive concerning funds management is the Directive on
                       Undertakings for Collective Investments in Transferrable Securities
                       (ucrrs). These undertakings are more commonly known in the United
                       States as mutual funds. Under the UCITS Directive, once a fund is author-
                       ized in an EC home country, it can be freely sold throughout the remain-
                       der of the Community. The directive applies to both unit trusts and
                       investment companies. It was adopted by the ECin December 1985 and
                       implemented by most member states on October 1,1989 (Greece and
                       Portugal have until April 1992 to implement it).

Insurance Directives   Both life and non-life insurance companies had the freedom to conduct
                       business in the EClong before the Single Market Program was initiated in
                       1985.” But this freedom, unlike banking and investment services, has

                       sPermitted activities include brokerage; dealing as principal; market making; portfolio management;
                       arranging and underwriting transferrabie securities; investment advising; and safekeeping and
                       administration. Salable instruments include transferrable securities; money market instruments;
                       financial futures and options; and exchange rate and interest rate instruments.
                       “‘British, U.S., and Japanese regulators propose that base capital requirements be held to a minimum,
                       but subject to close scrutiny and continual adjustments based on market value of security provisions
                       and other factors. German regulators take the opposite tack, pushing for a much larger base capital
                       requirement (as German banks have) but greater freedom to conduct their activities.
                       ’’Life insurance includes whole, unit, and term life policies. Non-life includes insurance against acci-
                       dent, sickness, damage to and loss of property, liability (e.g., motor vehicle), credit, and suretyship.
                       Under 1964 and 1978 EC directives, firms active in reinsurance and coinsurance markets already
                       emoy freedom of establishment and provision of cross-border services within the EC.

                       Page 18                                                     GAO/‘NSIAD90-99      Enropem    community
                   chapter 1
                   The European Canmunlty’s       Single
                   Market Program

                   always been subject to authorization by the host country. The Commis-
                   sion now wants to apply the single passport concept to insurance

                   The EChas achieved greater progress in liberalizing non-life insurance
                   than in liberalizing life insurance. The First Non-Life Insurance Direc-
                   tive, implemented in 1973, coordinated member states’ laws governing
                   the establishment of insurance businesses. The directive covers how
                   insurance firms should be legally formed; what the supervision and
                   cooperation among states should be; what the restrictions on providing
                   insurance should be; what the rules on fiscal soundness should be; and
                   what the procedures for setting up branches and subsidiaries through-
                   out the ECshould be.

                   The Second Non-Life Insurance Directive, scheduled to be implemented
                   on June 30, 1990, expands upon the first by establishing specific rules
                   on the provision of cross-border insurance services. However, unlike the
                   banking and investment services directives, home country control is
                   only applicable to wholesale customers, or to large risks.12 The host
                   country still supervises non-life insurance services provided to individu-
                   als, known as mass risks.

                   As for life insurance, a directive allowing freedom of establishment was
                   adopted in 1979, but there have been no proposals as yet on provision of
                   services. A key ECofficial told us that once capital movement is
                   unrestricted and alternative savings and investment vehicles are availa-
                   ble, it will become increasingly difficult for domestic insurers to compete
                   without liberalization.

Capital Movement   Two EC directives have been key to the market integration process: (1) A
Directives         1986 directive ensuring free capital movement for long-term commercial
                   transactions, bond issues, and unquoted securities;L3 and 2) a 1988 direc-
                   tive eliminating all restrictions on short-term and long-term transfer of
                   capital, or of underlying transactions, and eliminating other discrimina-
                   tory measures, such as certain taxes on investments. The latter proposal

                   ‘%arge risks are defined with reference to the nature of the risk, including aviation, marine, and
                   transport, and also to the size of the policyholder, who should meet two of the following minimum
                   thresholds: (1) It should have assets of 12.4 million ECUs ($13 million); (2) it should have sales of
                   24 million ECUs ($25.2 million); and (3) it should have more than 500 employees.
                   ‘“See appendix I. Capital movements directive adopted by the EZCCouncil on November 17,1986.

                   Page 19                                                     GAO/‘NSIhDw)-99      European   Community
                        chapter 1
                        The European Community’s     Single
                        Market F’mgmm

                        will go into effect for most countries on July 1, 199O.l* Thus, a resident
                        of one ECmember state will have unrestricted access to banking ser-
                        vices, stock exchanges, real estate markets, and other financial services
                        in all Ec countries.

                        The European Community is making significant progress in completing
Potential Roadblocks    the Single Market Program. However, the process is far from complete.
to Integration          Many uncertainties and potential problems remain. Less economically
                        developed member states that may not currently be able to compete
                        with more developed states could try to slow progress toward financial
                        integration. An economic recession within the Community could increase
                        protectionist sentiment. Problems remain in harmonizing member states’
                        tax rates and in coordinating home and host country controls. The ques-
                        tion of reciprocity could reemerge. Finally, concern is increasing that
                        member states are failing to implement approved directives, by legisla-
                        tion, promptly.

Tax Harmonization       Without the harmonization of tax rates among member states, the inte-
                        gration of the financial markets will not be complete. Harmonization of
                        indirect tax rates, such as the value added tax (VAT), is especially
                        important because it affects the costs of goods and services. Differing
                        indirect taxes such as taxes on interest and dividend payments could
                        distort capital flows and encourage tax evasion. Member states have not
                        reached agreement on how to harmonize indirect tax rates. Political sen-
                        sitivities to cede fiscal sovereignty, as well as the difficulties anticipated
                        in administering proposed schemes, have slowed progress. Difficulties in
                        reaching an agreement have been compounded by the need to obtain
                        unanimity on tax issues, as required under the Single European Act.

Home and Host Country   Coordinating home and host country regulatory controls is crucial to the
Control                 overall regulatory framework for EC 1992. Host countries would have
                        the greatest regulatory control over the insurance sectors and the least
                        control over the banking sector. In theory, giving supervisory authority

                        ‘*Council Directive of June 24, 1988. for the implementation of article 67 of the Treaty of Rome. To
                        be implemented by all EC countries by July 1, 1990, with the exception of Spain, Ireland, Greece. and
                        Portugal, which are granted an additional 2 years. The Federal Republic of Germany, the
                        Netherlands, the United Kingdom, and Denmark already allow free movement of capital. Belgium,
                        Luxembourg, France, Italy, Greece. Portugal. Ireland, and Spain still have one or more restrictions
                        that must be abolished under the directive.

                        Page 20                                                   GAO,‘NSI.AIMO-99    European   CcmmtiQ’
                           Chapter 1
                           The European Community’s   Single
                           Market Program

                           to the home country’s regulator is very appealing in an integrated mar-
                           ket. However, actual implementation could be difficult. U.S. financial
                           firm representatives, consultants, and ECregulators were uncertain
                           about how and where to draw the dividing line between home and host
                           country control. The directives themselves are open to interpretation.
                           For example, it is unclear whether the Second Banking Directive can
                           require banks from other EC countries to comply with local conduct of
                           business rules since these rules may be perceived as providing consumer
                           protection and thus be for the “public good.” Basic conditions that must
                           be satisfied before home country control becomes workable are (1) the
                           ability of ECmember state regulators to supervise their own institutions,
                           and (2) the adequacy of minimum essential requirements used in this

Delays in Implementation   As the number of directives adopted by the Council grows, so too do the
                           backlogs in passing the necessary implementing legislation in the mem-
                           ber states. The Commission reported in June 1989 that of the 68 mea-
                           sures that should have been implemented by that date, only 2 had been
                           incorporated into the national legislation in every member state. This
                           backlog also creates a substantial administrative burden for the Com-
                           mission, which is responsible for monitoring and enforcing the imple-
                           mentation of directives.

                           Within the financial services sector, where the EC’Ssuccess in passing
                           directives has been swifter than in other areas, the implementation of
                           directives at the member state level is also lagging. The directive
                           allowing Communitywide sale of mutual funds was passed by the ECin
                           1985 and became effective on October 1, 1989. However, according to an
                           ECofficial, just 2 weeks prior to its effective date, the directive had been
                           enacted by only 2 countries within their own legislation.

                           The Chairman of the Commerce, Consumer, and Monetary Affairs Sub-
Objectives, Scope, and     committee of the House Committee on Government Operations asked us
Methodology                to assess the potential impact of the EC’S deregulation of financial ser-
                           vices on U.S. financial institutions. Of particular interest to the Subcom-
                           mittee at that time was the E’S possible application of reciprocity
                           provisions to bar U.S. firms from the Community.

                           To satisfy the Subcommittee’s overall objective, we established three
                           subordinate objectives. First, we sought to identify the nature and
                           extent of U.S. financial firms’ participation in the ECmarkets. Second,

                           Page 21                                    GAO/NSIAD90-99   European   Community
ckapter 1
The European Community’s      Single
Market Program

we attempted to identify the opportunities and challenges a single mar-
ket in Europe may present to U.S. financial firms. Third, we sought to
determine how appropriately the U.S. government is working to assure
full and fair access for U.S. financial firms to European markets.

To identify the extent to which U.S. financial firms participate in EC
markets and, thus, what is at stake for the U.S. financial industry, we
collected data in both the United States and in Europe on the number,
size, and activities of U.S. firms in the EC.We also collected data on the
overall size and importance of EC financial markets. We obtained infor-
mation from U.S. and European regulators, U.S. embassies and missions,
the European Community, U.S. trade associations, U.S. and EC consul-
tants, financial periodicals and reports, and international bodies and
experts. We also met with representatives of U.S. banks, securities
firms, and insurance companies in five ECfinancial capitals and the
United States to identify the variety of activities and markets in which
they participate.15

To identify the potential opportunities and challenges a single market
might present for U.S. financial firms, we sought the views of U.S. finan-
cial firms in the EC and the United States. We also interviewed EC and
U.S. government officials, consultants, and other experts, and reviewed
their publications to gain a consensus of opinion concerning opportuni-
ties, challenges, and resultant strategies. Additionally, because U.S. laws
and regulations have a considerable impact on U.S. financial firms’ over-
seas activities, we identified key U.S. regulations and analyzed their

To determine how the U.S. government has responded to the needs of
the U.S. financial industry, we identified which U.S. governmental bod-
ies monitor developments in EC financial markets. We analyzed their
roles and responsibilities and how they responded to and coordinated
with the financial community at large. We asked representatives of the
U.S. financial community, the EC,consultants, and the U.S. government
how they viewed the U.S. government’s response.

Our work was conducted between March 1989 and January 1990 in
accordance with generally accepted government auditing standards. The

151nthe EC, we interviewed U.S. fiiancial firm representatives in London, England; Brussels,
Belghun; Frankfurt, West Germany; Paris, France; and Madrid, Spain. In total we interviewed rePre-
sentatives of 37 US. banks, securities firms, and insurance companies in the EC. These firms
represent a broad range of size, activities, and level of commitment in the EC. In the United States, we
met with New York headquarters representatives of financial firms.

Page 22                                                    GAO/‘NSWW99          European   C~mmunfh’
The European Cmnmunity’s   Single
Market Program

House Subcommittee Chairman requesting this review asked that GAO
not request official comments on a draft of this report. The views of
responsible officials were obtained during GAO’S work and are incorpo-
rated in the report where appropriate.

Chapter 2

U.S. Participation in EC Financial Markets                                                                                 d

                                          An integrated EC economy, the goal of the EC’SSingle Market Program,
                                          would be one of the world’s largest economies, with the financial ser-
                                          vices sector forming a key component in that economy. An integrated EC
                                          market will consist of 325 million people and have a gross domestic
                                          product over $4 trillion. It is estimated that the removal of internal bar-
                                          riers to create this single market will stimulate an additional 4.5 percent
                                          growth in the overall economy.

                                          U.S. financial firms have long been active in European financial markets
                                          and have established networks of institutions throughout the EC.U.S.
                                          banks hold 5 percent of the EC’Sbanking assets, U.S. securities firms are
                                          leaders in a number of European investment markets, and U.S. insur-
                                          ance companies are increasing their presence in the M: in anticipation of
                                          new opportunities. Therefore, these firms have a keen interest in the
                                          emerging single market and how it will affect their operations.

                                          The gross national product of the ECalmost matches that of the United
EC Marketplace Rivals                     States and nearly doubles that of Japan (see fig. 2.1); the population of
That of the United                        the ECnearly equals the combined populations of the United States and
States                                    Japan (see fig. 2.2).

Figure 2.1: Gross National Products of
the EC, United States, and Japan (1988)
                                          6   Dotkn in Trillions

                                              EC          United   Japan
                                          Source: Salomon Brothers Inc.

                                          Page 24                                   GAO/‘NSL4Lh9@99 European   Community
                                           Chapter 2
                                           U.!3. Participation     in EC Financial   Markets

Figure 2.2: Population of the EC, United
States, and Japan (1988)                   400     Population in Millions








                                                   EC            United     Japan

                                           Source Salomon Brothers Inc

                                           The United States has strong economic ties with the 12 members of the
                                           EC.Bilateral trade between the United States and the ECtotaled approxi-
                                           mately $150 billion in 1987, representing one-third of all global trade.
                                           The EC'S member states purchase one-quarter of all U.S. exports and
                                           receive 40 percent of all U.S. foreign investment.

                                           The Single Market Program not only will foster further integration of
                                           America’s largest export market but also will increase the size of that
                                           market as well. An Ec-sponsored study of the medium-term gains from
                                           the Single Market Program’ estimated that market integration could add
                                           to the EC’Sgross domestic product from between 4.5 to 7 percent and
                                           create between 1.8 and 5 million additional jobs. Combined with a
                                           favorable set of government measures, the study estimated that the
                                           average added effects could lead to a medium-term rise in gross domes-
                                           tic product of 7 percent, with the creation of approximately 5 million
                                           additional jobs. The study estimated that the impact of liberalizing

                                           ’Four mqor aspects of the Single Market Program were analyzed; these included (1) removal of CUS-
                                           tams barriers, (2) opening of procurement markets, (3) liberalization of financial services, and
                                           (4) supply-side effects created by businesses’reaction to market integration and tougher competition.
                                           The estimated cost of all inefficiencies and barriers and thus the size of potential gains tu be realized
                                           upon the removal of the barriers exceeds 200 billion ECI’ ($228 billion).

                                           Page 26                                                     GAO/NSIAD-90-99      European    Comnunity
                     chapter 2
                     U.S. Partidpation   in EC Finandd   ruarketa

                     financial services alone is calculated to contribute an additional 1.5 per-
                     cent to the EC’Sgross domestic product and nearly 500,000 additional

                     The financial services industries (banking, securities, and insurance)
Importance of the    play a unique, pivotal role in energizing the overall ECeconomy as major
Financial Services   employers and contributors. In addition, the EC’s financial markets con-
Sector in the EC’s   stitute a significant portion of the global financial market.
Economy              The significance of the financial services sector to the total ECeconomy
                     is illustrated by measures of its contributions to employment, value
                     added to production, and output.2 In 1986, employment in the banking,
                     finance, and insurance industries totaled over 3.1 miIIion, representing
                     3 percent of the total work force in the EC.In the same year, the value
                     added component constituted 6.6 percent of the combined ECgross
                     domestic product and, based on an EC survey of 8 of the member states,
                     totaled 200 billion ECUS($228 billion).3 The earnings rate of the financial
                     services sector was twice the EC’Saverage. Based on the EC’Ssurvey,
                     bank loans and stock market capitalization in the ECcountries are esti-
                     mated to total 142 percent (or $6.1 trillion) and 116 percent (or $6.0 tril-
                     lion) of the EC’Sgross domestic product, respectively.4

Banking              The EC’Sbanking industry is among the world’s largest. m-based banks,
                     for example, represented 2 of the top 10 banks in the world in 1987,
                     44 of the top 100, and 162 of the top 600.5

                      Banks in ECmember states constitute a larger source of direct lending to
                      nonbanks than do banks in any other individual country. They account
                      for 34 percent of the world total, just ahead of the Japanese banks. U.S.
                      banks, in contrast, account for only 7 percent of direct lending, less than
                      either French or West German banks alone.

                      ‘The value added by the fiicial  swvkes sector equals the total value of financial firms’ output
                      (measured by wages and profits) less the value of inputs purchased from other firms.
                      3Dollar value based on currency rates prevailing on November 30,1989: 1 ECU = d 1.1392.

                      4Dollar figures are based on Community gross domestic product as of December 1988.

                      5Ftanbga are bawd on the size of asets in 1987.

                      Page 26                                                   GAO/‘NSIAlMlW9      European   community
                                          Chapter 2
                                          US. Partidpation           In EC Finrndrl   Marketi

Securities                                The combined ECsecurities markets are comparable in size to those in
                                          the United States and Japan. Figures 2.3 and 2.4 compare the capitaliza-
                                          tion of EC,United States, and Japanese bond and equity markets. At the
                                          end of 1987, the EC bond market was three-fifths the size of the U.S.
                                          market, and larger than the Japanese market.6

Figure 2.3: The Size of the Bond Market
in the EC, United States, and Japan
                                          5.0        Dollara in Trillions
(December 1987)




                                          2.5              .
                                          2.0                                     \

                                          1 .o


                                                     EC          Unltod     Jmn
                                          Source: Salomon Brothers Inc

                                          “Because the sizes of the bond and equity markets are expressed in dollars, the relative relationships
                                          of the markets will vary with the value of the dollar versus other currencies,

                                          Page 27                                                    GAO,‘NSIADW99        European   Community
                                            chapter 2
                                            US. Participation      in EC Financial   Markets

Figure 2.4: The Size ot the Equity Merket
in the EC, United States, and Japan         3.0   Dolhn In Trillbn8
(December 1987)                             2.8

                                                   EC           United   Japan

                                            Source: Salomon Brothers Inc

                                            The capitalization of ECequity markets was also approximately three-
                                            fifths the size of the US. market, but only one-half the size of the mar-
                                            ket in Japan.

Insurance                                   The EC accounts for approximately 22 percent of the $1 trillion private
                                            insurance market in the world, making the ECthe second-largest global
                                            market after the United States. In comparison, the US. market gener-
                                            ates approximately 43 percent of the world’s premiums, while Japan
                                            generates approximately 20 percent. Approximately 60 percent of EC
                                            premiums are from non-life insurance policies; life insurance accounts
                                            for approximately 40 percent of the insurance market and is the faster-
                                            growing sector. Since 1965, the insurance market in Europe has grown
                                            at a faster rate than the U.S. market. Table 2.1 illustrates the relative
                                            share of the world’s insurance markets between 1960 and 1985.

                                            Page 28                                            GAO/NSIANU&99   European   timmhty
                                      Chapter 2
                                      U.S. Partidpation    in EC Pinandai   Markets

Table 2.1: Share of World Insurance
Volume Represented by the EC, North   Figures in percent
America, and Japan (1960-85)                                                                                Share
                                                                                       1960          1970           1960          1965
                                      EC                                                18.4         21.2            27.3          22.2
                                      North America                                     72.0         63.5            46.9          50.4a
                                      Japan                                              2.2          7.0            13.7          17.3
                                      Other                                              7.4          8.3            12.1          10.1
                                      Total                                            100.0        100.0           100.0         100.0
                                      aData for 1985 represent the United States and Canada only
                                      Source: Commwon of the EuroDean Commutxtles.

                                      While the share of the global insurance market represented by the EC
                                      member states increased 48 percent between 1960 and 1980, the EC’S
                                      global market share declined between 1980 and 1985. A significant por-
                                      tion of this decline is due to the appreciating value of the dollar over the
                                      same period.

                                      According to an insurance industry study, the prospect that growth in
                                      the European insurance markets will continue to outpace the U.S. insur-
                                      ance market is good. The development of public social insurance systems
                                      in Europe has slowed; this slowdown is expected to increase demand for
                                      private insurance. On the whole, public insurance systems have been
                                      more important in Europe than in the United States. This fact explains,
                                      in part, why the percentage of private insurance premiums in the gross
                                      domestic product of Europe is only 4.9 percent, whereas in the United
                                      States it is 7.5 percent.

                                      U.S. financial institutions have a large and active presence in the EC
U.S. Financial                        financial markets. Among U.S. financial institutions, U.S. banks have
Institutions in the                   been active in Europe the longest and have the largest stake in the EC.
European Community                    Many U.S. securities firms have entered the EC in the last 20 years and
                                      are now among the leaders in product innovation, investment expertise,
                                      and sales. The presence of the U.S. insurance industry in ECstates is
                                      small, but growing. In all three financial sectors, most U.S. firms in the
                                      ECare active in the wholesale markets serving large institutions.

U.S. Banks in the EC                  Officials told us that the overseas presence of U.S. banks grew over the
                                      last 25 years in part because U.S. banks abroad did not need to comply
                                      with U.S. reserve requirements, and their deposits are not subject to

                                      Page 29                                                  GAO/TWAMW-99     European    Community
                            Chapter 2
                            U.S. Partidpation   in EC Pinandal   Marketa

                            Federal Deposit Insurance Corporation assessments. U.S. banks, there-
                            fore, expanded their overseas networks to conduct international bank-
                            ing in Euromarkets, where they were free from U.S. monetary
                            regulations and capital controls.

                            U.S. banks have a presence in every ECmember state. At the end of
                            1988,33 U.S. banks were operating a total of 149 branches throughout
                            the EC; 17 U.S. banks owned subsidiaries in the EC.The combined assets
                            of these branches and subsidiaries totaled over $2 10 billion and repre-
                            sented approximately 6 percent of the banking assets of the EC.

                            The highest concentration of U.S. branches and subsidiaries, as well as
                            approximately 66 percent of their assets, is in the United Kingdom. In
                            1986, U.S. banks in the United Kingdom, the largest banking market in
                            the EC,accounted for 11 percent of bank assets there. U.S. banks are
                            also well represented in the next-largest market in the EC,West
                            Germany. In 1987, U.S. banks in West Germany operated more branches
                            and subsidiaries (20) and conducted a higher percentage of business vol-
                            ume (21 billion ECUS,or $24 billion) than did banks from any other for-
                            eign country.

                            Though the U.S. banks still maintain a large presence in the EC,their
                            position has declined during the 1980s. Several U.S. banks have sold
                            retail networks to IX banks, and others have exited or are phasing out of
                            particular markets, such as securities trading and underwriting, com-
                            mercial paper, and government bonds.

U.S. Banks Most Active in    Within the wholesale banking market, U.S. banks are deemphasizing
Wholesale Markets            their traditional commercial lending activity and stressing investment
                             banking activities instead. The large multinational corporations that for-
                             merly sought loans from international banks now meet their capital
                             needs directly in the securities markets. U.S. banks have adapted to the
                             changing financial environment by targeting niche markets. For exam-
                             ple, in 1988 US. banks constituted 9 of the top 20 lead managers of
                             syndicated loans internationally. In the same year, U.S. banks also rep-
                             resented 7 of the top 20 dealers of Eurocommercial paper and Eurocer-
                             tificates of deposit. U.S. banks are also among the leaders in the
                             Eurobond markets. Niche markets include mergers and acquisitions,
                             investment management, and leveraged buy-outs, U.S. banks also con-
                             tinue to participate in traditional international banking activities, such
                             as foreign exchange and securities trading, leasing, and trade financing.

                             Page 30                                       GAO/NSLADgo-93   European   Community
                                           Chapter 2
                                           US. Partidpation    in EC Finandal    Markets

                                           Only one U.S. bank is actively pursuing the European retail market.
                                           Most US. banks exited from this banking business because of low prof-
                                           its. During the 198Os, U.S. banks sold retail networks in Belgium,
                                           France, Italy, Spain, and the United Kingdom.

                                           Several U.S. banks are entering new markets in Europe as regulatory
                                           controls in the ECare liberalized. Some U.S. banks are also beginning to
                                           market life insurance, while others are marketing mutual funds.

U.S. Securities Firms in the               Nearly all major U.S. securities firms are present in the financial mar-
EC                                         kets of the EC.For example, 9 of the top 10 U.S. securities firms, ranked
                                           by total broker-dealer capital, have a presence in the EC,as do 17 of the
                                           top 25 U.S. firms. In London, the EC’Sleading securities market, U.S.
                                           firms operated a total of 56 offices in 1988. However, we were unable to
                                           determine the exact number, locations, or size of these firms in the rest
                                           of Europe. This lack of data may be a result of the federal government’s
                                           limited oversight responsibility for the foreign activities of U.S. securi-
                                           ties firms.

                                           As is illustrated in table 2.2, U.S. securities firms are successful in a
                                           number of activities in the EC’Swholesale markets. They are among the
                                           top managers of international equities and advisers on mergers and
Table P.P:Frequency of U.S. Securities
Firms Among Top-Ranked Participants in                                                                                            Number of U.S.
Selected International Financial Markets   Market                                                           Measure               securities firm8
(1988)                                     Lead manager9 International equities                             Top   10b                                5
                                           Lead and co-lead managers International equities                 Top   20b                                7
                                           Mergers and acqursitions advisers worldwtde                      Top   25’                               12
                                           Mergers and acquisitions advrsers Europe buying                  Top   ZOb                               11
                                             Into the U.S.
                                           Mergers and acqulsitrons advisers U.S buying                     Top 5b                                     5
                                             Into Eurooe

                                           aLead managers organize the syndtcate and typlcally take on a majority of the risk In return for a higher
                                           blnstltuttons ranked by value of transactions
                                           ‘lnstitutlons ranked by number of transactions
                                           Source Euromoney, February, March 1989

                                           Page 31                                                     GAO/NS1AD90-99       European    Community
                            Chapter 2
                            U.S. Pnrtkipation   in EC Flnandal   Bfarkets

                            U.S. securities firms face competition from the investment subsidiaries
                            of U.S. commercial banks, European universal banks, specialized firms
                            in the EC,and financial firms outside the EC.Industry consultants told us
                            that one of the advantages U.S. firms have in operating in the EC is their
                            “European” composition. U.S. firms in the IX are said to be more
                            inclined to develop a cosmopolitan team representing several member
                            states than might a securities firm indigenous to an ECmember state.
                            Therefore, the proposals developed by U.S. firms could be perceived by
                            ECclients to contain less potential bias.

U.S. Securities Firms Are   US. securities firms in the ECserve two types of clients: institutions and
Active in Both Wholesale    individuals. Institutions include member state governments, EC and mul-
                            tinational corporations, and insurance and pension funds. U.S. firms
and Retail Markets          provide a variety of investment banking and brokerage services, includ-
                            ing fee-based advice (mergers and acquisitions, investments), securities
                            underwriting, sales and trading, corporate finance, and equity place-
                            ments. Brokerage activity has historically served clients with U.S.
                            investment products. With the liberalization of exchange controls, the
                            firms are expanding their portfolios to include European and Japanese

                            Representatives of the financial community in Europe told us that U.S.
                            institutions have a reputation within the EC for product innovation.
                            Financial products and practices first developed in the United States
                            have been introduced to the European market by U.S. institutions (e.g.,
                            futures, options, and swaps).

U.S. Insurance Companies    U.S. insurance companies have only a limited presence in the ECmarket
in the EC                   because of market forces and a general lack of interest on the part of
                            U.S. companies. For example, in West Germany, the largest national
                            insurance market in the EC,the market share of U.S.-owned companies
                            in 1984 totaled only one-half of 1 percent, based on gross premium reve-
                            nue. In most EC countries, the insurance industry is one of the most
                            strictly regulated segments of the economy, and it has been the most
                            difficult financial industry to liberalize under the Single Market Pro-
                            gram Because the insurance sector is one of the most closed sectors in
                            ECmember state economies, foreign companies usually play only a minor
                            role in the national markets. For example, in the major national markets
                            in Europe, the average market share of foreign firms is approximately
                            9 percent. A leading industry analyst observed that, even in relatively

                            Page 32                                         GAO/‘NSL4LMM9   European   Community
Chapter 2
U.S. Partidpation   in EC Finandal   Markets

open markets within the EC,the presence of foreign insurers is small due
to language and cultural barriers.

The low penetration of U.S. companies in the ECis indicative of the lack
of foreign penetration by American insurance companies worldwide.
Though 6 U.S. insurance companies are among the 15 largest in the
world,7 only 1 percent of total premium revenue for the U.S. insurance
industry is derived from foreign sources. In 1985, worldwide investment
by U.S. insurance companies totaled only $7.9 billion, or 3.4 percent of
total foreign investment by U.S. business. Of the foreign investment of
U.S. insurance companies, however, 70 percent occurred in Europe.

A lack of interest by U.S. firms in the ECmarket partly explains the
small presence of U.S. companies. A recent survey reported that 80 per-
cent of U.S. insurance executives have little or no notion of the market
potential of the EC.Other reasons given for the low U.S. penetration in
Europe included (1) the conservative nature of the industry and the lack
of inclination to explore new territories; (2) the existing saturation of
the insurance market, especially in northern Europe; and (3) the pres-
ence of competing opportunities in the Far East.

The primary business for the few large U.S. insurers in the ECis prop-
erty and casualty coverage for large industrial clients. In our interviews
with representatives of US. insurance companies in Europe, however,
we were told that the U.S.’ presence may grow. Several U.S. companies
have plans either to establish operations in the ECor to buy existing
companies in the EC.These new entrants are targeting both the life and
non-life markets. We were told that the most attractive markets in the
ECare in the southern member states-Spain, Italy, Greece-where, his-
torically, domestic regulation has been more restrictive and foreign
insurance penetration has been low.

‘Based on overall business in dollars in 1987.

Page 33                                          GAO/‘NSL4Lb9O-99 European   Community
Accessto the European community Appears
Open, but Other Factms May Limit U.S.
Financial Firms’ Participation
                       U.S. financial firms are apparently assured access to the EC’Sfinancial
                       markets in spite of initial concerns that the Community might bar them
                       from operating there. Whether or not these concerns were well founded,
                       both U.S. financial firms and the U.S. government actively lobbied EC
                       and member state governments for equal access to Community markets.
                       Firms also took organizational steps to insulate themselves better from
                       the possibility of exclusion; some are still considering taking such steps.

                       We found little reason to believe that U.S. financial firms will face overt
                       discrimination in ECmarkets after the implementation of the Single Mar-
                       ket Program. However, the EC’Sprogram for developing a single market
                       is far from complete, and some unsettled issues remain that still could
                       alter this current mood of optimism.

                       U.S. firms do not plan to expand their presence within the EC.Numerous
                       other obstacles and strategic variables could influence their global strat-
                       egies and limit their ability or desire to participate in Europe. US. finan-
                       cial firms are particularly concerned about U.S. regulatory restrictions
                       on their overseas activities and the cost and availability of capital,

                       The 1992 program offers more opportunities than it does barriers, in the
U.S. Firrns Foresee    view of a majority of representatives of U.S. financial firms we inter-
Increased              viewed. U.S. financial industry executives, their consultants, and market
Opportunities in the   experts foresee a more open and liberal financial market in the ECnow
                       that the issue of reciprocity has apparently been resolved. They antici-
EC                     pate new and expanded opportunities in specific market sectors, such as
                       retail and private banking or insurance and investment products, and
                       across sectors, such as in the benefits to be derived from the freer flow
                       of funds and the consolidation of operations. U.S. financial firms believe
                       that they are well positioned to benefit from these opportunities because
                       of their international networks and experience operating across borders,
                       their expertise and their product innovation, and the breadth of services
                       they offer.

Retail Banking         Historically in the EC,retail markets have been heavily protected
                       through domestic regulation; some countries (e.g., Spain and Italy)
                       restrict foreign acquisitions or participation in domestic banks and the
                       marketing of banking services by foreign institutions across their bor-
                       ders. These and other restrictions in retail banking result in wide price
                       differentials among countries for equivalent banking products. By mak-
                       ing it easier to establish banking offices and by allowing the sale of

                       Page 34                                     GAO,‘NS~90-99   European   ckmm~ty
                           chapter 3
                           A-      to the European Community Appears
                           Open, but Other Factors May Limit US.
                           Finandal Firms’ Partidpation

                           banking products across national borders, the Second Banking Directive
                           may create profitable opportunities for foreign banks to exploit these
                           price differentials. The increased competition arising from new foreign
                           bank activity may also reduce costs for the consumers of financial ser-
                           vices as well as stimulate the introduction of new products and services.
                           All this activity can be expected to further increase consumer demand
                           for financial services in the Community.

                           However, as noted in the prior chapter, most US. banks are no longer
                           active in retail markets, having sold many of their retail franchises in
                           recent years. U.S. banks, with few exceptions, now operate almost
                           exclusively in wholesale banking markets, which we were told already
                           are largely deregulated and are not expected to offer new opportunities
                           akin to those expected in retail banking.

Private Banking Services   Offering private banking services for high-net-worth individuals is an
                           attractive venture for banks and investment houses. The full liberaliza-
                           tion of capital movement under the Single Market Program will offer a
                           wider range of cross-border investment possibilities, including U.S.
                           investment products, to EC investors. This liberalization will, therefore,
                           boost the demand for private banking services.

                           U.S. banks and U.S. securities firms that offer brokerage services
                           already are actively providing private banking services. U.S. securities
                           firms market U.S. investment products, where the actual accounts are
                           held in the United States and only transactions and servicing are per-
                           formed in the Community. For U.S. banks, offering private banking ser-
                           vices is attractive because these services generate high fee income
                           without a large capital commitment. This fact is especially important in
                           light of the new worldwide capital adequacy requirements for banks

Mergers and Acquisitions   Corporate finance, specifically the financing and facilitation of corpo-
                           rate mergers and acquisitions, is expected to be a highly profitable
                           activity in the EC. Many EC businesses anticipate the need for greater
                           expansion and market penetration as a result of more open and competi-
                           tive markets after 1992. Concurrently, other ECbusinesses that doubt
                           their competitiveness after 1992 see this as an excellent time to sell their
                           firms. The following data provide an idea of the magnitude of corporate
                           mergers already taking place on a cross-border basis (see table 3.1).

                           Page 35                                     GAO,‘NSIAD90-99   European   Community
                     chapter 3
                     Access to the European Cmnmunity Appears
                     Open, but Other Factors May Limit US.
                     Financial Firms’ Participation

Through June 1989)   EC nation of acquired                            Value of deals
                     company                                       (ECUs in millions)a                 Number of deals
                     United Kingdom                                                5,956                                  101
                     France                                                        2,299                                   91
                     Italy                                                         2,039                                   52
                     West Germany                                                  1,774                                   90
                     Spain                                                         1,084                                   65
                     The Netherlands                                                 511                                   47
                     Portugal                                                        310                                   12
                     Belaium                                                         180                                   27
                     aOne European Currency Unit (ECU) IS roughly equivalent in value to $1 14
                     Source: The 1992 M&A monthly’s European Deal Revlew.

                     Many U.S. institutions and consultants predict continued growth in this
                     area. U.S. financial institutions that have built merger and acquisition
                     experience in the United States expect to benefit from these increased
                     cross-border mergers. U.S. businesses’European acquisitions, totaling
                     3.6 billion ECUS($4.1 billion) during the first half of 1989, create a natu-
                     ral customer base for these U.S. financial firms.’

                     The ECis near agreement on a merger policy that will reduce the barri-
                     ers national governments are able to impose on large cross-border merg-
                     ers. The takeover policy would give the ECthe power to rule on large
                     mergers and leave decisions on smaller takeovers with the member
                     states involved.2 Passing clear ground rules for takeovers in the ECwill
                     facilitate the expansion of firms through mergers and acquisitions and
                     perhaps further increase the demand for merger and acquisition

Insurance Products   Opportunities for U.S. insurance companies in the EC’Sinsurance sector
                     are reflected in several important measures of potential ECinsurance
                     demand. First, as of 1985, premiums per head in Europe were roughly
                     one-third of those in the United States. Second, for the period 1970-85,
                     the average real growth rate in premiums was higher in Europe than in
                     the United States, 4.3 percent versus 3.2 percent, respectively, despite

                      ‘Among all acquiring nations, the value of U.S. acquisitions in Europe trailed only those made by
                      French firms during this period.
                      %nder the current proposal, the European Commission would review a merger if it exceeds all three
                      of the following thresholds: (1) worldwide combined turnover exceeds 5 billion ECUs ($5.7 billion),
                      (2) inter-EC combined turnover exceeds 250 million ECUs ($265 million), and (3) not more than
                      66 percent of the turnover of either partner is in any one member state.

                      Page 36                                                   GAO/‘NSL4B9O-99     European   Commnnity
                   chapter   3
                   Accessto the EnropeMComnndtyAppeara
                   Open, but Other Factors May Limit U.S.
                   Finandal Firms’ Partidpntion

                   equal growth rates in gross national product. This greater demand for
                   insurance in Europe is reflected in a larger income elasticity of insur-
                   ance demand in Europe as compared with the United States.3 Though
                   other factors, such as differences in our social insurance and legal sys-
                   tems, may account for the greater demand figures in Europe, they would
                   seem to indicate that the U.S.’market is relatively more saturated than
                   Europe. This conclusion is supported by U.S. insurers we interviewed in
                   the EC.They anticipated increased growth, especially in lower-tier EC
                   countries, as the Single Market Program’s impact is felt.

                   To date, the greatest progress in liberalizing insurance markets under
                   the Single Market Program has occurred in the non-life sector for large
                   risk (industrial and commercial) customers. U.S. insurers are concen-
                   trated in this sector and should benefit when the freedom granted by the
                   Second Non-Life Insurance Directive to market policies across Commu-
                   nity borders is implemented in most member states by July 1990.

                   Market participants and experts believe, however, that the greatest
                   opportunities in the EC insurance industry will not occur until the life
                   insurance sector is liberalized and companies are free to promote life
                   insurance products across borders. The life insurance industry has been
                   heavily regulated to ensure consumer protection. This regulation has
                   produced wide price differentials among EC countries for similar prod-
                   ucts. For example, in Portugal, basic life insurance is priced 10 times
                   higher than a comparable policy in the United Kingdom. Market oppor-
                   tunities will be available to those firms able to offer competitively
                   priced insurance products following liberalization.

Investment Funds   Growth is also likely in demand for new investment vehicles, such as
                   UCITS (or mutual funds), pension funds, and Employee Stock Ownership
                   Plans as a result of the EC’SSingle Market Program. Currently, the mar-
                   ket for these investment products in Europe is half the size of the U.S.
                   market. In fact, U.S. mutual fund industry assets of $810 billion in 1988
                   are almost equivalent to mutual fund assets in the rest of the world com-
                   bined. Given a comparatively higher savings rate in the EC than in the
                   United States, investors in the ECare likely to seek out new investment
                   products as they become increasingly available. The EC’SUCITS Directive

                   31ncomeelasticity of insurance demand measures the relationship of the percentage change of insur-
                   ance demand to the percentage change of the gross national product. For the period 1970436,U.S.
                   income elasticity of insurance demand was roughly 1.3. In Europe, only Italy has a lower elasticity

                   Page 37                                                  GAO/WXAB!4O-39      European   Community
                         Chapter 3
                         Open, but Other Factma May Limit U.S.
                         Flnandal Firms’ Partidpetion

                         permits cross-border selling of funds, subject only to host country super-
                         vision of their marketing, once the funds are authorized in one member
                         state. Such authorization should increase sales of these investment prod-
                         ucts. U.S. institutions, with their prior experience in marketing and
                         packaging these products in the United States, should benefit from these

Free Capital Flows and   The scheduled elimination of exchange controls in the ECis essential to
Financial Market         achieve integration of EC financial markets because of its cross-se&oral
                         impact on all financial services. The freedom to offer services across
Developments             borders is, for the most part, irrelevant, unless investors, borrowers, and
                         intermediaries can transfer capital freely across borders. Exchange con-
                         trols are a primary, but not the only, constraint on capital movement.
                         Experts say that other barriers to free capital movement, such as
                         restricted access to foreign brokership licenses, discriminatory taxes on
                         purchases of foreign securities, and limitations on balance sheet hold-
                         ings of foreign securities, indirectly limit capital movement. The EC’S
                         1992 program will also remove these restrictions.

                         The free movement of capital should offer new and increased opportuni-
                         ties for providers of non-m financial products, including those from the
                         United States. For example, some U.S. securities firms in Spain intend to
                         market US. products to Spanish citizens once exchange controls are
                         lifted there. Currently, Spanish citizens may only invest outside Spain
                         through a Spanish bank, subject to withholding taxes on their

                         A single capital market should also stimulate further development of
                         derivative products, such as futures and options and securitized assets.
                         U.S. financial institutions have a reputation for expertise in such sophis-
                         ticated products and should profit as a result. For example, one U.S.
                         investment firm, with considerable experience in the US. mortgage-
                         backed securities market, recently entered into an agreement with a
                         major French bank to assist it in developing a mortgage-backed securi-
                         ties operation.

Cost Savings From        The integration of the ECshould enable financial firms to reduce their
Consolidation            administrative costs by consolidating some of their activities. Harmoniz-
                         ing accounting and financial reporting standards for banking, securities,
                         and insurance firms will allow greater consolidation of accounting and
                         information systems. The integration of markets and the ability to offer

                         Page 38                                    GAO/‘NSIAD-93-33   European   Commnnity
                             chapter 3
                             A-      to the European Community Appeua
                             Open, but Other Factors May Limit U.S.
                             Finanti    Firms’ Partidpation

                             services from a centralized location after 1992, coincident with improve-
                             ments in information technology, enable further consolidation of admin-
                             istrative functions. Some U.S. institutions have already begun to
                             consolidate these functions, while others plan to do so in the near
                             future. In some instances, the consolidation will lead to cutbacks in per-
                             sonnel, which could be incorrectly interpreted as a retreat from the mar-
                             ket, even though volume and profit levels are increasing.

                             Most U.S. financial firms that we contacted do not plan on expanding
U.S. Institutional           their presence in the EC as a result of the Single Market Program. Several
Strategy: Generally          banks already in the Community are scaling back their commitment and
Not One of Expansion         retreating from some activities and countries altogether. Other U.S.
                             banks that might seem likely candidates for new entry into the Commu-
                             nity expressed little interest at this time. Securities firms, while perhaps
                             more optimistic about the Single Market Program, have not translated
                             their interest into specific plans for expansion. Only in the insurance
                             industry did we find evidence of increased entry by U.S. firms.

U.S. Commercial Banks        In contrast to their ECcompetitors, U.S. banks are not expanding in the
Are Targeting Their          EC despite the new opportunities anticipated under the 1992 program.
                             Instead, U.S. banks are using their limited capital resources to target the
Opportunities                most profitable niche markets and opportunities, while also restructur-
                             ing their operations to reduce costs. In some cases, this restructuring has
                             led to reductions in staffing or withdrawal from some relatively unprof-
                             itable activities. Also noteworthy has been the sale of some U.S. banks’
                             retail operations in Europe.

                             Representatives of some large regional banks told us that they had no
                             interest in expanding into the EC at present, These banks see better
                             opportunities available in the United States, such as those arising from
                             the removal of U.S. interstate branching restrictions, than might exist in
                             the EC.

U.S. Securities Firms Seek   While securities firms are optimistic about their prospects in the ECafter
Little Expansion             1992, most do not plan on expanding there. Generally, U.S. securities
                             firms are responding more to member state changes in regulation than to
                             the EC'S Single Market Program changes. In Spain and Prance, stock
                             exchanges and domestic securities markets will become more accessible
                             to foreign entry, in part as a response to 1992 liberalizations. To meet
                             local requirements in these countries, U.S. securities firms are forming

                             Page 39                                    GAO,‘h’SIAD90-99   Eumpean   CYmnmunity
                        Chapter 3
                        Aceem to the European Cmumunity Appears
                        Open, but Other Factors May Limit US.
                        Fhandal   Firm& Partidpation

                        separately capitalized and locally incorporated brokerages in order to
                        underwrite and trade domestic securities. West German experts told us
                        that several U.S. securities firms established German banking subsidiar-
                        ies following the recent relaxation of German law, which now permits
                        foreign-owned German banks to underwrite domestic Deutsche mark
                        issues. U.S. securities firms are also looking toward the formation of a
                        German futures and options exchange in the early part of 1990.

                        In the United Kingdom, where the securities markets are larger and
                        more global in character than elsewhere in the EC,U.S. securities firms
                        are generally larger and more knowledgeable about the Single Market
                        Program’s potential impact. Even so, their actions have been more
                        defensive than expansive, Some U.S. securities firms, which had previ-
                        ously operated in London as branches, have established separately
                        incorporated U.K. subsidiaries. Their reasons for doing so are to respond
                        to the concerns of U.K. regulatory authorities that their activities be
                        under some form of supervision and to ensure against reciprocity provi-
                        sions, should they reemerge in the Community, by establishing an EC

U.S. Insurance Firms’   With the growing prospect of a single market in the Community, there
Limited Presence May    are indications of increased U.S. insurance industry interest in its mar-
P  Wr\Xll
                        kets. Both life and non-life U.S. insurers are establishing themselves in
                        the EC;those already established in the EC are reorganizing to prepare
                        for the single market.

                        Our discussions with representatives of the U.S. insurance industry in
                        the Community indicated that at least eight U.S. companies were either
                        expanding their networks within the EC,establishing distribution alli-
                        ances with EC banks and insurance companies, or opening new offices.
                        Several other U.S. insurers were studying possible entry into the Com-
                        munity. Some companies planned to enter the large-risk non-life insur-
                        ance market, which has been the most attractive to U.S. firms in the EC
                        to date. Most of this activity is expected to occur in the southern-tier EC
                        countries, where penetration by insurance companies has traditionally
                        been low.

                        Two large U.S. international insurers already in the Community have
                        recently reorganized. They are attempting to portray themselves better
                        as “European” and to guard against reciprocity by employing a “hub-
                        and-spoke” strategy. They have established a primary headquarters
                        subsidiary (the “hub”) in the EC,with the remaining network of

                        Page 40                                    GAO,‘NS~gO-93   European   community
                           Chapter 3
                           Access to the European Community Appears
                           Open, but Other Factora May Limit U.S.
                           Finandal Firms’ParticipatioIl

                           branches and subsidiaries (the “spokes”) in Europe reporting to the
                           European headquarters. Through this organizational structure, U.S.
                           insurance companies are able to qualify for the single passport, portray
                           a unified European corporate image, and centralize data and administra-
                           tive functions while still maintaining a local presence.

                           U.S. insurance companies have a greater incentive than banking and
                           security firms to establish a subsidiary base in the Community. This is
                           because branches of non-m insurance companies must meet both EC-
                           wide and home country solvency and other requirements, whereas
                           branches of ECinsurance companies need only adhere to their home
                           country requirements.

                           U.S. financial firms are not expanding in Europe to the same degree as
Factors and                their EC competitors, although they have equal access to the single mar-
Impediments    Affecting   ket and its new opportunities. However, their reluctance may be strate-
U.S. Firms’ Strategy       gically sound, considering possible impediments and other
                           considerations U.S. financial firms must also factor into their plans. The
                           following section discusses factors institutions cite as affecting their
                           intentions. We did not attempt to weigh the relative importance of vari-
                           ous factors, given that no two institutions are entirely alike. However,
                           U.S. regulatory restrictions on the overseas securities activities of U.S.
                           banks ranked as a primary consideration for a large majority of U.S.

U.S. Bank Law Restricts    A majority of U.S. bank officials with whom we spoke in the ECbelieved
the Nature and Extent of   that U.S. bank laws and regulations placed them at a competitive disad-
                           vantage in relation to ECbanks. Regulation K was singled out as having
U.S. Banks’ Securities     the most detrimental effect. Regulation K4 restricts the absolute and rel-
Activities                 ative size of certain activities of nonbank subsidiaries overseas, most
                           notably their securities dealing, distribution, and underwriting.

                           The Glass-Steagall Act” separates commercial and investment banking in
                           the United States and does not permit nonbank activities to be con-
                           ducted within the bank itself. The Glass-Steagall Act applies only to U.S.

                           ‘Regulation K was issued by the Board of Governors of the Federal Reserve System under the author-
                           ity of the Federal Reserve Act, the Bank Holding Company Act of 1956, the International Banking
                           Act of 1978, the Bank Export Services Act, and three International Lending Supervision Acts

                           “The Gla~~Steagall Act is contained in sections 16.20,21. and 32 of the Banking Act of 1933
                           (12 USC. Sec. 24, 377. 378, and 78).

                           Page 41                                                 GAO,‘NSIAD9O-93     European   Ckxmnunity
               chapter 3
               Acceea to the European Cknnmunity Appears
               Open, but Other Factora May Limit US.
               Flnandal Fimd Participation

               domestic banking activities. International operations permissible for
               U.S. banking institutions overseas are set forth in Regulation K and
               allow U.S. banking organizations to be more competitive in foreign mar-
               kets by permitting them to do a broader range of securities activities
               overseas than is permitted in the U.S. market. However, Regulation K
               limits the absolute and relative size of such activities, unlike the EC’S
               regulatory framework, which is increasingly shifting toward universal
               banking. The Glass-Steagall Act indirectly affects U.S. overseas banking
               operations since the volume restrictions provided for in Regulation K
               depend, in part, on the restrictions on domestic equity underwriting
               imposed by Glass-Steagall. U.S. banks have also insisted that their
               inability to offer the same range of services in both domestic and inter-
               national markets has hindered their efforts to compete with foreign

Regulation K   Regulation K limits have become more burdensome in recent years
               because of trends in corporate and investment finance. Demand for
               banks’ intermediary role in providing long-term loans has waned during
               the 1980s as corporate borrowers have increasingly gone directly to
               investors for funds in order to reduce their borrowing costs7 This
               increased demand from the banks’ customers for alternative financing
               vehicles has been matched by the banks’ efforts to reduce their lending
               activity and boost fee income. In part, this action reflects U.S. banks’
               attempt to increase their profitability and, in part, it is a reaction to
               newly imposed capital adequacy standards that require increased capi-
               tal to back increases in bank assets.

               The complexity and size of financial placements have also grown in
               recent years. Today, financing packages are increasingly requiring a mix
               of debt and equity. These placements often require the underwriter to
               assume a portion of the equity. U.S. bank representatives stated that
               they are unable to compete with large ECuniversal banks for new corpo-
               rate customers, or even retain their present customer base, without the
               ability to lead or participate substantially in equity underwriting and
               distribution. Currently, Regulation K limits equity underwriting by U.S.
               banks to $2 million per issue per subsidiary. Another provision of the
               regulation limits the amount of investment by U.S. banks in a subsidiary

               “For a discussion of Glass-Steagall, see the GAO report, Bank Powers: Issues Related to the Repeal of
               Glaaa-Steagall Act (GAO/GGD88-37,       January 22,1988).
               ‘Net international bond offerings grew from $28 billion in 1980 to $126 billion in 1986, while net
               international bank lending decreased from 6160 billion to $106 billion during the same Period.

               Page 42                                                    GAO/?WABW           Enropenn   community
                           chapter 3
                           Aceem to the European Commmi~    Appeara
                           Open, but Other Factma May Limit US.
                           Finandal Firma’ Partidpation

                           joint venture or portfolio investment to a total of $16 million, or 6 per-
                           cent of the investor’s capital and surplus. Some banking institutions
                           have interpreted Regulation K as permitting up to $16 million per issue,
                           or 6 percent of the institution’s capital and surplus.

                           According to bank officials, two methods are used to partially circum-
                           vent the equity underwriting limits of Regulation K. The first is a con-
                           sortium approach, whereby the bank owns up to the maximum
                           6 percent in a consortium of the associated underwriting risk. In the
                           other method of circumvention, a bank merely spreads a placement, up
                           to $2 million per subsidiary, around its international subsidiaries to a
                           maximum of $16 million per issue. U.S. banks must, therefore, forsake
                           any amount in excess of $16 million to competitor institutions or
                           attempt to pass through these positions by the end of each day.s

                           In addition, the size of individual placements has grown. A representa-
                           tive of one leading U.S. bank told us that the $16 million limit has not
                           been adjusted for corresponding increases in the size of under-writings.

Regulation K Forces More   Regulation K prohibits U.S. member banks from conducting any non-
Costly Organizational      bank activities in overseas branches. Such activities are restricted to
                           subsidiaries, although these subsidiaries can conduct a full range of
Structure                  banking activities as well. The requirement that these activities take
                           place within a subsidiary, together with the volume restrictions noted
                           above, has led to costly and complex organization structures for these
                           institutions, according to bank representatives. This result, they feel, is
                           in conflict with the philosophy of the EC’SSecond Banking Directive,
                           which endorses a universal banking model, under which banks are free
                           to conduct a wide range of activities within the parent bank or its
                           branches. Most ECcountries follow this approach, while other member
                           states are expected to assume the directive’s broader powers through
                           the process of regulatory convergence discussed in chapter 1.

                           Our discussions with officials in Spain and France revealed that finan-
                           cial regulatory reform in these countries creates disadvantages for U.S.
                           banks as compared with their ECcompetitors. The latter are free to con-
                           duct the same activities without the additional organizational, licensing,
                           or capital requirements of establishing subsidiaries able to conduct non-
                           banking activities.

                           “Regulation K limits apply only to closeofday positions; therefore, banks are required to sell any
                           intraday holdings in excess of $15 million by the end of the day.

                           Page 43                                                   GAO,‘NSlAD~99        European   Chnn~unky
                       chapter 3
                       Accem to the European CommuniQ’ Appeara
                       Open, but Other Factors May Limit US.
                       Finandal Firms’ Partidpation

                       Spain’s securities markets have recently been deregulated, in anticipa-
                       tion of 1992. As part of this deregulation, banking and securities mar-
                       kets have been opened to foreign financial firms, including those from
                       the United States.

                       Securities underwriting in Spain requires an agency license. This license
                       is automatically granted to banks, including the branches of FE universal
                       banks that conduct securities activities.” However, U.S. banks are only
                       permitted to conduct underwriting activities within a subsidiary under
                       U.S. law and, according to bank officials, these subsidiaries are not
                       viewed as banks by Spanish regulatory authorities. Therefore, U.S.
                       banks’ securities subsidiaries do not receive this automatic license
                       approval. The U.S. banks’ securities subsidiaries must, therefore, apply
                       for separate licenses that require an investment of 700 million pesetas
                       ($6 million) in capital.lO This cost is not incurred by their EC competitors.

                       One U.S. bank manager complained that these additional requirements
                       and costs take away the flexibility to ease into underwriting activities
                       while building a client base. Instead, a high minimum capital investment
                       must be committed from the start with the hope that adequate return on
                       investment can later be generated to justify it.

                       U.S. banks in France are faced with a similar predicament. While FL
                       banks are free to conduct investment banking activities within the bank
                       itself in France, U.S. banks can only conduct these activities in subsidi-
                       aries. Accordingly, US. banks have established French subsidiaries,
                       referred to as Article 99 investment companies (or societe financiere),
                       with a 7.6 million French francs ($1.2 million) capital requirement for
                       each company.”

Restrictions on U.S.   Bank officials have noted that U.S. interstate branching restrictions
Interstate Banking     under the McFadden Act and the Douglas Amendment to the Bank Hold-
                       ing Company Act have resulted in a U.S. banking industry that is more

                       “Officials stated that in addition to the agency license needed to conduct securities activities in Spain,
                       separate licensing and capital requirements must be met to obtain a broker or broker-dealer license to
                       operate on the Madrid Stock Exchange. Foreign participation in these brokerships is currently limited
                       to 30 percent, increasing to full ownership in 1992. Only two of the U.S. institutions we interviewed
                       have purchased a broker participation licensed in the exchange.

                       “‘lking an exchange rate of 120 pesetas to $1. in effect on November 30. 1989

                       ’‘Using an exchange rate of 6 French francs to L 1, in effect on November 30. 1989

                       Page 44                                                      GAO/NSIAlMO-99       European   Community
                          Chapter 3
                          Access to the European Community Appears
                          Open, but Other Factora May Limit U.S.
                          Finandal Firms’ Partidpation

                          fragmented than Europe’s Slowly, states are relaxing branching restric-
                          tions on a regional basis, but some U.S. international money center
                          banks are still excluded from these regional compacts.

                          The banking sector in Europe is more concentrated than in the United
                          States, in part because of geographic restrictions limiting expansion in
                          the United States. For example, of the world’s top 600 banks in 1987 as
                          measured by total assets, 162 are from the EC,while only 28 are from
                          the United States. The EC’S1992 program will likely increase banking
                          concentration in the Community, as ECbanks expand their presence
                          from a national to a European scale. Thus, U.S. banks will encounter
                          even larger and more powerful ECcompetitors while facing handicaps
                          from restrictions on their ability to grow domestically. These develop-
                          ments have led not only bankers but other observers, including the Fed-
                          eral Deposit Insurance Corporation, to argue that present restraints are
                          no longer appropriate in today’s financial marketplace.

Securities and Exchange   U.S. disclosure requirements make U.S. markets less desirable to foreign
Commission Disclosure     issuers and U.S. investment products less attractive to foreign investors,
                          according to U.S. institutions active in EC securities markets. Bankers
Requirements              told us that the Securities and Exchange Commission requires that their
                          financial statements adhere to US. generally accepted accounting prin-
                          ciples. Thus, some foreign issuers must maintain a separate set of
                          accounting records and release more information than they would if
                          they raised funds in EC markets. For example, some issuers may hesitate
                          to disclose management compensation, as required by the Securities and
                          Exchange Commission, owing to the prevalence of kidnapping in some
                          countries. As ECsecurities exchanges grow and improve, corporate issu-
                          ers may increasingly turn to them as an alternative to US. capital mar-
                          kets to avoid U.S. disclosure and other requirements.

                          We were told that some EC investors, particularly high-net-worth indi-
                          viduals, are reluctant to invest in U.S. products and, therefore, to deal
                          with the U.S. firms that market them, because of Securities and
                          Exchange Commission disclosure requirements. According to some U.S.
                          investment services firms, mandatory disclosure of acquisitions either in
                          excess of 5 percent of capital or following a takeover deters those inves-
                          tors who prefer anonymity.

                          Page 45                                    GAO/NSIADSO-99   European   Community
                         Chapter 3
                         Access to the European Community      Appeam
                         Open, but Other Factma May Limit      U.S.
                         Flnandal Firma’ Participation

Some EC and Member       The liberalizing nature of the 1992 program does not mean that all the
State Impediments May    barriers presently encountered by U.S. financial firms in the ECwill
                         immediately disappear or that others will not be erected. For example,
Remain                   U.S. banks will encounter the dilemma of whether to continue to con-
                         duct most of their activities in a branch structure in the EC for cost con-
                         siderations or to opt for an Ec-incorporated subsidiary network in order
                         to enjoy the single passport and other freedoms. The Single Market Pro-
                         gram also should not eliminate the dominance of some ECfinancial firms.
                         Finally, because the EC’Sliberalization will be an uneven and imperfect
                         process, some opportunities may not be forthcoming until sometime
                         after 1992.

The Organizational       U.S. banks have created separate subsidiaries in the ECto conduct non-
Dilemma for U.S. Banks   bank activities, but a majority of their overseas banking activities are
                         conducted in branches, rather than subsidiaries, primarily for cost rea-
Operating as Branches    sons However, under the Single Market Program, branches from third
                         countries are not entitled to single passport powers. In addition, they
                         may face further member state capital and other requirements.

                         Thus, U.S. banks that operate in the EC as branches of their U.S. parent
                         bank will not benefit from the new powers available under the EC’SSec-
                         ond Banking Directive, including the single passport power to offer ser-
                         vices freely across borders and to establish branches anywhere in the EC
                         without obtaining prior authorization. These freedoms and expanded
                         powers will only be available to banks incorporated in the EC,while non-
                         EC branches will remain under the authority of individual member

                         Second, even after the 1992 program is complete, some countries, nota-
                         bly Germany, may continue to set capital requirements for branches of
                         non% banks.*2 Member states remain free to apply these requirements
                         under the EC’SFirst Banking Directive. In applying these separate capi-
                         tal standards, non-m branches are treated like stand-alone subsidiaries
                         for capital adequacy purposes.

                         “‘Non-EC banks with branches in West Germany are concerned that they will have to meet capital
                         requirements not prescribed for branches of EC banks. The United States has raised this issue with
                         the EC, but was told that this was a bilateral German-US. problem and did not concern the EC. The
                         U.S. Peawry Attache in Bonn believes that basing different requirements on country of origin is
                         discriminatory, and that it is a violation of U.S.German treaty obligations. According to the ‘TreasurY
                         Attache, this dispute has not been resolved.

                         Page 46                                                    GAO/NSIAD~99        European   commonity
                           chapter 3
                           Acceea to the European CommuniQ Appear
                           Open, bnt Other Factore May Limit U.S.
                           Finandal Firma Partidpntion

                           Third, it is uncertain how non-M: branches will be treated in matters
                           other than those concerning capital requirements. The First Banking
                           Directive states that non-m branches may not receive more favorable
                           treatment than ECbranches. This provision would seem to indicate that
                           where host country regulations are more lenient than the EC’S,there will
                           have to be a “leveling up” of host country requirements. Furthermore,
                           each member state will be free to apply its own reciprocity provisions
                           against non-rzc branches.

Local Consortiums Remain   Close relations, legal and otherwise, between financial services suppliers
Powerful                   and their customers and a high level of industry concentration dominate
                           particular market sectors in some EC states. The result is that individual
                           institutions are able to wield considerable economic power. This power
                           is strengthened by ties among government, industry, and the financial
                           community in some EC countries in the form of interlocking directorates,
                           as well as in equity holdings.

                           It is difficult to separate the impediments for foreign firms posed by
                           special supplier/customer relationships from the natural advantages
                           enjoyed by any domestic institution in its home market. While U.S.
                           financial firms generally stated that they are not experiencing overt reg-
                           ulatory discrimination, the influence and power EC financial firms wield
                           in their home markets are often far greater than U.S. firms enjoy in the
                           United States. Consortiums, or evidence of high industry concentration,
                           are present in Spain, France, and West Germany-three        of the four
                           countries we visited.

                           In Spain, close ties are presumed to exist between domestic banks and
                           industry, based on Spanish banks’ large equity holdings in nonfinancial
                           firms. Non-life catastrophic insurance is controlled by an industry car-
                           tel, which U.S. insurers are hoping will disappear after 1992. In addi-
                           tion, a government-owned insurance company until recently had a
                           monopoly on the coverage for state-owned industries. Though state
                           owned industries may now obtain coverage from private sources, the
                           traditional arrangements are expected to change slowly.

                           In West Germany, the “Big Three” private German banks (Deutsche,
                           Dresdner, and Commenbank) wield considerable power. The universal
                           banking structure has allowed German banks to take large equity posi-
                           tions in some of Europe’s biggest corporations. For example, officials
                           stated that Deutsche Bank owns 28 percent of Daimler Benz, one of

                           Page 47                                   GAO/WZAD~93    Ehuqean   Cmnmmity
                              Accem to the European Cmnmunity Appears
                              Open, but Other Facturn May Limit U.S.

                              Europe’s largest corporations. I3 German banks’ power extends well
                              beyond their voting rights because of the proxy votes they control under
                              their customers’ accounts.

                              One leading U.S. institution in West Germany complained that German
                              banks’ power has been institutionalized in the syndication of German
                              debt. I4 No foreign bank is allocated more than 1 percent of each syndica-
                              tion and, in total, foreign banks are limited to 20 percent, whereas
                              Deutsche Bank alone is given a 16 percent share.

                              France is the most heavily concentrated major banking market in the EC,
                              containing large, domestic, often state-owned institutions. The three
                              largest banks are all owned by the government. The next three largest
                              were only recently privatized. In 1987, the 5 largest banks in France
                              controlled nearly 80 percent of total banking assets in France, represent-
                              ing over half of the entire financial system. This extent of concentration
                              leads some analysts to believe that short of outright acquisition, the
                              large French banks’ domestic position is impregnable.

Some Impediments May          As explained in chapter 1, the Single Market Program, by the EC’Sown
Remain, While Others W ‘ill   design, does not standardize all ECregulations for financial firms and
                              markets. Rather, the EC’Splan is to establish m-wide minimum essential
Only Slowly Disappear         standards, allowing competitive market forces eventually to bring about
                              an equilibrium level of harmonization. The interim result may be a slow,
                              sometimes uneven, integration process. This process could, in some
                              instances, work to the disadvantage of U.S. firms. Some member states
                              may not remove some barriers for a while in order to protect domestic
                              firms or to ensure safety and soundness.

                              Officials said that the EC’S 1992 program does not eliminate member
                              state restrictions on the types of foreign investment products that
                              domestic firms may invest in or on the types of products that may be

                              “‘Under the Second Banking Directive, an EC bank’s ownership in stock of any nonfinancial firm is
                              limited to 15 percent of bank capital and 60 percent in aggregate. West Germany, however. is opposed
                              to this restriction, which could force divestitures by German banks.
                              ‘%ovemment debt in West Germany is sold via a consortium rather than a free auction system, as
                              used in the l’nited States.

                              Page 48                                                  GAO,‘NS~W99         European   Ckmmdty
                          chapter 3
                          Open, but Otbez Factom May Limit U.S.

                          sold. For example, West German insurance companies, the largest insti-
                          tutional investors in Germany, are prohibited from investing the major-
                          ity of their assets in foreign investment products.15 Insurance companies
                          in Germany, foreign and domestic, are also restricted in the types of
                          products they can sell. For example, certain types of insurance that are
                          sold in the United States and for which U.S. insurers have developed a
                          market edge, such as cancer insurance or corporate officers’ and direc-
                          tors’ liability insurance, cannot be sold in West Germany.

Business Considerations   While not discriminatory, there are certain “natural” advantages
                          enjoyed by domestic institutions in their home markets that act as barri-
                          ers to foreign firms. The barriers that U.S. financial firms encounter
                          affect their strategic planning for new market entry or expansion.
                          Among the advantages naturally accruing to domestic institutions are
                          the loyalties and cultural links with domestic customers, familiarity
                          with the local language, and knowledge of legal and regulatory norms.
                          These ties are especially important in retail markets. For example, a
                          domestic bank’s easier access to retail deposits can result in a lower cost
                          of funds than is available to foreign banks, which typically rely on more
                          expensive interbank loans. A U.S. bank manager in Spain said that U.S.
                          banks also have a difficult time attracting qualified personnel.

Other Factors Influence   In tandem with 1992 developments, a number of international market
U.S. Financial Firms’     and regulatory trends are also occurring that could affect U.S. financial
                          firms’ participation in the EC. For banks, the Basle Committee’s new cap-
Strategies                ital adequacy standards, less developed country debt burdens, and new
                          market opportunities opening in the United States affect their strate-
                          gies. Greater competition and increasing trends toward market speciali-
                          zation are other factors that affect the strategies of all financial firms,
                          including banks.

                          ‘“Similar restrictions apply to Italian life insurance companies and to French mutual funds, called

                          Page 49                                                   GAO/NSIAD9O-99       European   Community
                            chaptfs 3
                            Open, but Other Facto- May Limit U.S.
                            Finandal Fim~’ Partidpation

New Capital Adequacy        The world’s major banks, including those from the United States, are
                            bound to adhere to a minimum standardized capital adequacy ratio
Requirements Raise Ban .k
                            beginning in 1991 .I6 Many banks do not meet this minimum ratio and,
                            therefore, may have to raise more capital or reduce their assets, or both.
                            Those banks under most pressure to meet capital adequacy guidelines
                            are being forced to sell off portions of their organization to raise capital
                            and reduce their asset base. Cutbacks have already occurred in U.S.
                            banks’ EC retail operations, which tend to require large amounts of fixed
                            capital. Raising new capital has been hampered by U.S. bank stocks’
                            poor performance in recent years. U.S. money center banks’ earnings
                            have lagged behind both regional banks’ and the Standard & Poor’s
                            600 stocks’ earnings. Because bank stocks have become a less desirable
                            investment, it is more difficult for these banks to raise needed capital.
                            These concerns may lead even relatively healthy U.S. banks to be more
                            cautious in approaching new and unproven markets or activities.

Less Developed COWntry      U.S. banks’ profitability, especially the earnings of international money
Debt Problems Have          center banks, is being reduced by increased loan loss provisions on less
                            developed country loans made during the 1970s. Banks’ exposure to
Reduced Banks’              these loans has raised their cost of capital by reducing stock market val-
Profitability               uations. This exposure has also expended key management resources,
                            has possibly made management more wary and cautious of new ven-
                            tures, and has cut into banks’ profit because of the need to set aside
                            specific reserves. Some U.S. banks are substantially increasing their
                            reserves for these loans, but doing so requires capital that might other-
                            wise have been used to expand in the EC.Meanwhile, ECbanks have not
                            suffered as greatly from less developed country loan problems. Accord-
                            ing to a U.S. consultant, ECbanks had the strength of their retail bank
                            profits to cover their reserves. In addition, different requirements for
                            set-aside reserves in some ECcountries, notably West Germany,
                            encouraged early action on these loans.

Domestic Opportunities      U.S. banks told us that the ECis not the only investment alternative
Compete for Attention and   available to them. Many of the US. international money center and
                            regional bank officials we interviewed are targeting their capital
Funding                     resources toward new domestic opportunities where they expect returns

                            ‘“Under the 1988 Basle Convergence Agreement, the Group of Ten (G-10) countries, actually consti-
                            tuting 11 countries, including Belgium, Canada, fiance, Italy, Japan, Luxembourg, the Netherlands,
                            Sweden, the United Kingdom, the United States, and West Germany, have agreed to a standardized
                            formula for calculating capital ratios of banks. Beginning in 1991, b&    should have a minimum
                            capital base of 7.26 percent of risk-adjusted assets. In 1993, the minimum ratio increases to 8 percent.

                            Page 60                                                    GAO/‘NSIADfIO-93     European   Community
                           Chapter 3
                           Access to the European CommuniQ Appears
                           Open, but Other Factora May Limit US.
                           Flnandal Firma’ Partidpation

                           on investment will be greater. The resolution of the savings and loan
                           crisis will allow banks to diversify and to expand by buying failed
                           thrifts at distressed prices. Interstate barriers are falling in many states,
                           providing opportunities for U.S. banks to expand to other parts of the
                           United States. Indeed, the anticipated expiration in 1992 of interstate
                           branching restrictions in California may offer greater opportunities than
                           does the EC.In addition, representatives of some insurance companies
                           and banks told us that the Far East offers more attractive investment
                           opportunities than those available in the Community.

Increased Competition in   As a result of the EC’SSingle Market Program, increased competition,
the EC Is Expected         both from EC and non-m financial firms, is expected by most U.S. finan-
                           cial firms, consultants, and experts with whom we spoke. Deregulation
                           should, as a matter of course, lead to greater competition among finan-
                           cial institutions. ECfinancial firms are expected to meet those competi-
                           tive challenges not only by expanding their presence in other EC
                           countries, but also by becoming more competitive at home to ensure
                           their customer base. Expansion by EC financial firms across borders and
                           into other market sectors is a natural outgrowth of the enlargement of
                           the EC’Smarketplace from national boundaries to EC boundaries. Expan-
                           sion is generally taking one of two routes: directly through merger or
                           acquisition, or indirectly via strategic alliances. At the beginning of the
                           Single Market Program (1984-1987) there was a notable increase in the
                           number of ECmergers, minority acquisitions, and joint ventures in the
                           banking sector. For example, the number of bank mergers nearly
                           doubled, from 18 to 35, during this period. Because the number of
                           attractive acquisition candidates is limited, financial firms in the EC are
                           also looking to build cross-border alliances. Alliances allow firms to
                           expand their product distribution without a significant loss of manage-
                           rial control.

                           Increased competition from other non-m countries, notably Japan, is
                           also anticipated as 1992 approaches. Leading Japanese institutions have
                           been established in London for some time. Japanese financial institu-
                           tions have also established banking affiliates in Frankfurt to gain a foot-
                           hold in the important Deutsche mark sector. U.S. regulatory authorities
                           now anticipate that the Japanese will relax restrictions on the overseas
                           securities activities of their banks.” If so, the United States will be the

                           “Current restrictions on the securities activities of Japanese banks are detailed under article 66 of
                           Japanese banking law. Experts say its provisions separating banking and commerce are broadly simi-
                           lar to those in the U.S.’Glass-Steagall Act.

                           Page 51                                                   GAO/‘NSlAIMO-93     European   Ckmmunity
                            Chapter 3
                            Access to the European Community Appear
                            Open, but Other Factors May Limit U.S.
                            FinandaI Finns’ Participation

                            last major financial power to retain this separation of commercial and
                            investment banking. Furthermore, increased demand for financing from
                            the Japanese manufacturing sector in Europe, which is actively
                            expanding in the ECprior to 1992, will undoubtedly mean increased bus-
                            mess for Japanese financial firms.

Financial Firms Are Wary,   The deregulation of the U.K.‘s financial markets in 1986, often referred
Following the U.K.‘s “Big   to as the “Big Bang,” led to intense competition there. As a result, many
                            segments of the U.K.‘s market quickly became saturated. For example,
Bang”                       in the U.K.‘s equities market, the number of market-makers (dealers)
                            rose from 5 before the Big Bang to 32 not long after. The market decline
                            in October 1987 contributed to these firms’ losses. Therefore, U.S. finan-
                            cial firms may be wary about entering new markets with a large finan-
                            cial commitment, especially when intense competition is expected.

                            The EC’Sprogress in liberalizing its markets under the Single Market Pro-
Conclusions                 gram has provided ample evidence to the international financial commu-
                            nity that a single market in Europe is likely to emerge. Estimating how it
                            may affect the U.S. financial services industry this early in the process
                            is, nevertheless, very difficult. Some key EC financial services directives
                            still require final passage. Additional directives, notably in the insur-
                            ance sector, will have to be proposed and adopted in order to achieve a
                            fully liberalized and integrated market. Even once all the directives are
                            finalized, much will still depend on how the member states implement
                            them. And, finally, the directives by themselves will not dictate the final
                            form of post-1992 EC financial markets; internal and external economic,
                            political, and technological variables will also weigh heavily on the pro-
                            cess and its result.

                            This report has tried to identify the most likely impact of the Single
                            Market Program on U.S. financial firms in Europe. The evidence and our
                            analysis strongly indicate that the sizable stake U.S. financial firms
                            have built in the EC will not be jeopardized by overt ECactions to bar
                            them. Nor is the EC likely to restrict the future entry of other U.S. finan-
                            cial firms not already there. Therefore, U.S. firms should benefit from
                            the new and expanded opportunities offered by the single market.

                            Equal access and expanded opportunities alone, however, may not be
                            enough to ensure that U.S. financial institutions will prosper in a post-
                            1992 Community. This is especially true for U.S. banks, which have the
                            greatest stake in the EC among U.S. financial firms, but are also facing

                            Page 52                                     GAO/NSIADW93   European   Community
                Chapter 3
                Access to the Eumpean community   Appears
                Open, but Other Factora May Limit US.
                Finand    Firm2 Participntion

                the greatest challenges. During the 198Os, U.S. banks have seen their
                global dominance fade for several reasons, such as poor international
                lending practices and the competition posed by nonbank financial

                The evolving divergence between U.S. and ECregulatory philosophies
                now poses an additional challenge to U.S. banks that operate in the
                Community. EC banks are organized under a regulatory structure that
                allows them to compete better and to profit more easily from broader
                powers under the Single Market Program. U.S. banks, by contrast,
                remain governed by a regulatory philosophy that prohibits universal
                banking. These regulatory developments under the Single Market Pro-
                gram are occurring against the backdrop of fundamental shifts in corpo-
                rate and investment finance away from the traditional activities
                permitted U.S. banks and toward those that are still impermissible or
                restricted. As a result, U.S. banks are likely to face larger, better capital-
                ized, and more diverse ECuniversal banks armed with broader powers
                and capabilities under the Single Market Program.

                The EC’Sendorsement of the universal banking model for its more open
Matters for     financial markets gives greater urgency to the ongoing congressional
Congressional   debate over how broad U.S. bank powers should be. The decision to
Consideration   modify the existing requirements is a judgmental one. In weighing the
                pros and cons of the existing structure, consideration should be given to
                the impact of these requirements on the ability of U.S. banks to compete
                in the EC after 1992.

                Page 53                                      GAO,‘NSLAIMO-93   European   Community
The Appropriateness of the U.S.
Government’s Response

                      Generally, the U.S. government has responded in a timely and coopera-
                      tive fashion to protect U.S. financial sector interests in the emerging EC
                      single market. US. agencies organized early to identify the primary
                      issues and to develop a coordinated policy response. Reciprocity served
                      as the primary test of the adequacy of the U.S. government’s ability to
                      defend U.S. interests and, while US. intervention was not the only fac-
                      tor, it helped to soften the EC’Sstance. U.S. financial firms generally
                      view the U.S. government’s efforts favorably.

                      Numerous U.S. agencies and private sector groups have an active inter-
Many U.S.             est in the EC’Sprogram to integrate its financial markets. The U.S. Trea-
Government Agencies   sury Department is responsible for forming policy and monitoring,
and Private Sector    assessing, and directing the U.S. government’s response to the EC’S1992
                      financial services directives, including banking and securities issues, as
Groups Are            well as for monitoring the general macroeconomic implications for the
Monitoring the EC’s   United States of the EC’Sprogram. Treasury representatives stated that
1992 Program          they keep the other agencies informed of developments and consult
                      them when necessary, but they are primarily responsible for responding
                      to 1992 financial sector developments.

                      Within Treasury, the Office of Assistant Secretary for International
                      Affairs is most active in directing Treasury’s efforts. Treasury relies on
                      its financial attaches located in London, BOM, Paris, and Rome to report
                      and to disseminate information. In the other U.S. embassies and mis-
                      sions in ECmember countries not staffed with an attache, Treasury
                      relies on Department of State personnel to perform the same activities.

                      Many other agencies and private sector groups are also involved in mon-
                      itoring developments in the EC’Sfinancial sector, including the Depart-
                      ment of Commerce, the U.S. International Trade Commission, the Office
                      of the U.S. Trade Representative, the Federal Reserve Board, the Office
                      of the Comptroller of the Currency, the Securities and Exchange Com-
                      mission, the Federal Deposit Insurance Corporation, and the Congres-
                      sional Research Service.

                      These U.S. government agencies have also enlisted the support of pri-
                      vate sector associations and groups with an interest in European finan-
                      cial markets. These groups include the Bankers Association for Foreign
                      Trade, the American Bankers Association, the Investment Companies
                      Institute, the International Insurance Council, the Industry Sector Advi-
                      sory Committee, the National Association of Securities Dealers, the Busi-
                      ness Roundtable Task Force, and the U.S. Chamber of Commerce, along

                      Page 64                                    GAO/‘NSIAD90-99   European   ‘hmmuniQ
                             chapter 4
                             The Appropriateness of the US.
                             Government’s Ref3ponse

                             with various American Chambers of Commerce throughout the

U.S. Policy Coordination     The U.S. government is coordinating its overall efforts on ECsingle mar-
                             ket issues through the Trade Policy Review Group’s EC Internal Market
                             Task Force. This task force, formed in February of 1988, is a committee
                             of 16 executive branch agency representatives chaired by the Office of
                             the U.S. Trade Representative. It reports directly to the cabinet-level
                             Economic Policy Council. The task force is divided into 10 functional
                             working groups and has 3 main objectives: (1) to understand the nature
                             of the EC’S1992 program and the directives proposed to implement it;
                             (2) to keep the U.S. government current on events as they occur; and
                             (3) to identify and address potential problem areas. Treasury has not
                             participated at the working group level, but does represent banking and
                             investment issues at task force meetings and coordinates regularly with
                             the relevant task force members.

                             Seeing a need for coordination specific to financial services issues, the
                             Secretary of the Treasury established a subcabinet level group in Sep-
                             tember 1989, called the Policy Group on European Monetary Reform
                             and Financial Liberalization. Chaired by the Under Secretary for Inter-
                             national Affairs, it includes the Departments of State and Commerce
                             and the Office of the US. Trade Representative, with the Federal
                             Reserve Board, the Securities and Exchange Commission, the Office of
                             the Comptroller of the Currency, the Federal Deposit Insurance Corpo-
                             ration, and other financial regulators serving in an advisory capacity.
                             According to a senior Treasury official, the group is both devising a
                             strategy for dealing with the EC’Sfinancial market integration and
                             focusing on the structure and competitiveness of the U.S.’financial
                             industry. The group will also report on the broad implications for the
                             United States of EC efforts toward economic and monetary union.

Overseas U.S. Government     While U.S. policy for responding to the ECis formulated in Washington,
Agencies Are Active in the   D.C., the front lines of action are the U.S. embassies and missions in the
                             EC,in particular the U.S. Mission to the European Community in
EC                           Brussels, Belgium. These embassies and missions are responsible for
                             information gathering, reporting, and implementing U.S. policy. Agency
                             headquarters direct embassy and Mission officials to collect views and
                             information as well as to lobby on behalf of American interests.

                             Page 65                                    GAO/‘NSIAD90-99   European   Camunity
chapter 4
The Approprhteneaa  of the US.
Government’6 Response

For m-related matters, the U.S. Mission to the European Community is
the focal point for U.S. government activities. The Mission represents,
reports to, and acts on behalf of many different agencies with interests
in the EC.For financial services, the Mission reports to and represents
the interests of the Treasury, Commerce, Federal Reserve, U.S. Trade
Representative, and Securities and Exchange Commission. Even though
the Mission is relatively small compared to the EC,and its position is
that of an outsider, numerous U.S. government officials stated that it
has been very useful and serves as a crucial conduit for U.S. policy.

The Mission is staffed by an ambassador and 23 Department of State,
Agriculture, and Office of the U.S. Trade Representative officials1 A
single State officer monitors EC financial services and monetary issues,
with the assistance of a local national economic specialist. State has
been criticized by some Members of Congress for not adding more and
diverse staff to the Mission in light of its growing importance and
responsibilities. In reply, State argues that additional staff at the Mis-
sion-already one of the larger U.S. Missions-may not be cost-effective
in light of current budget constraints, but it has agreed to add one mid-
dle-level officer and possibly more in the future to help with the increas-
ing work load. The Mission was also criticized for not staffing a
Treasury financial attache to handle financial services. Mission officials
counter that it is more important to act as an integrated unit and that
semiautonomous agency personnel might hamper that coordination.
Treasury was satisfied with the current arrangement at the Mission and
believed it was doing a good job handling financial services issues
related to EC 1992. While we did not evaluate either the adequacy or
appropriateness of the Mission’s staffing, our general impression was
that both the former and the current Mission foreign service officers
responsible for financial services were well informed and capable.

In addition to the U.S. Mission to the EC,American interests in the Com-
munity are represented by U.S. embassies in the 12 member states. Some
public and private sector officials stated that lobbying member state
governments is as important as, or perhaps more important than, lobby-
ing the EC Commission. This view is based on the fact that the Ec-a
collection of 12 separate countries-requires    a qualified majority of

‘As of June 1989, this staff includes a deputy chief of mission; seven economics officers, one of whom
IS responsible for the financial services sector; seven political officers; including a single market coor-
dinator; five agricultural officers; two public affairs officers; and a customs attache.

Page 66                                                      GAO/NSlAIWO-99       European    Community
                        Chapter 4
                        The Appropriateness  of the U.S.
                        Government’s lksponae

                        member states, and sometimes full unanimity, to pass legislation. Indi-
                        vidually influencing member states, some believe, can be more success-
                        ful than attempting to influence the unelected Commission.

                        Finally, American interests are also represented in other multinational
                        arena, such as the U.S. Missions to the Organization of Economic Coop-
                        eration and Development (OJSCD), the General Agreement on Tariffs and
                        Trade (GATT), and the annual economic summits of G-72 leaders. These
                        U.S. Missions to the OECD and the GAIT, which also monitor financial sec-
                        tor developments, coordinate with the U.S. Mission to the ECon EC-
                        related matters.

                        While the rapidity with which the EC has moved on its 1992 program
The U.S. Government     has surprised many, even some members of the Commission, the U.S.
Provided an Early and   government was able to monitor events and coordinate its various agen-
Coordinated Response    ties in most cases to act swiftly enough to protect U.S. interests. The
                        EC’Sinclusion of reciprocity as part of its financial services framework
                        has provided, thus far, the greatest threat to U.S. interests and thereby
                        has tested the effectiveness of the U.S. government’s ability to protect
                        those interests. And while the U.S. government’s response was one fac-
                        tor among many influencing the ECto modify its stance on reciprocity,
                        the revision is much more favorable to U.S. financial firms and the U.S.
                        government. U.S. financial firms operating in the EC generally view
                        favorably the manner in which the U.S. government acted. The excep-
                        tion we noted was that this coordination was not as evident regarding EC
                        actions affecting the insurance sector. Despite the passage of the White
                        Paper in 1985 and the Single European Act in 1987, it was not until the
                        ECsurmounted budget disagreements in early 1988 that progress on the
                        Single Market Program accelerated. Shortly thereafter, in March 1988,
                        the U.S. Mission to the ECreported potential issues of concern in a series
                        of seven cables to headquarters agencies. One of these cables high-
                        lighted potential problems for U.S. financial firms.

                        Given the numerous U.S. agencies involved in EC single market issues
                        and the magnitude of these issues, the need for coordination is self-
                        evident. In August 1988, the Trade Policy Review Group’s EC Internal
                        Market Task Force issued general policy guidance to interested agencies

                        ‘The Group of Seven (G-71, which includes the United States, France, Japan, West Germany, the
                        United Kingdom, Canada and Italy, convenes at the annual economic summit, where the natlom are
                        usually represented by their finance ministers or central bankers.

                        Page 67                                               GAO/NSIAIMO-99      European Community
              Chapter 4
              The Appmpriatenesa  of the U.S.
              Government’s Response

              and overseas posts identifying the major EC 1992 concerns and the man-
              ner in which the US. should respond to them. During the same period,
              the Deputy Secretary of the Treasury delivered a major address high-
              lighting U.S. government concerns, and he also contacted the finance
              ministers of all the ECmember states. In October 1988, Treasury offi-
              cials visited the European Community in Brussels to voice their con-
              cerns regarding some aspects of the fiiancial services directives.

U.S. Policy   The US. government sent general guidance that speaking with a single
              voice, or common line, is the most effective way to communicate U.S.
              concerns to the EC and that all communications, including public state
              ments and private communications with the EC and member states,
              should adhere to this common line. In this way, the US. government
              emphasized major U.S. policy positions in its discussions with the M: and
              member states and minimized conflicting signals.

              This guidance also emphasizes the importance of systematic lobbying of
              ECmember states through US. embassies and the U.S. Mission to the
              OECD. The U.S. embassies and missions keep up with ECdevelopments,
              collect member state views, and communicate elements of the U.S.’com-
              mon line on ECmatters. Ample evidence of these activities was found in
              regular cable traffic at the U.S. Mission to the EC,U.S. embassies in
              Europe, and the Department of State.

              U.S.-ECinteraction takes place at two levels: a dialogue between high-
              ranking officials, and a working level of contacts among specialists. The
              uppermost level of U.S.-ECcommunication begins with ad hoc meetings
              between the U.S. President and the President of the Commission.3 It con-
              tinues with ad hoc and formal ministerial level meetings between the
              U.S. Secretaries of State and Treasury and the U.S. Trade Representa-
              tive and its European counterparts; ambassadorial contacts in member
              state countries; and regular subcabinet level and assistant secretary
              level meetings with ECofficials.

              At the working level, U.S. officers in the U.S. Mission to the EC,other
              overseas posts, and Washington agencies maintain a regular dialogue
              with their working level contacts in Brussels, host member states,
              through OECD meetings, and the ECdelegation in Washington. These con-
              tacts are extremely important for early monitoring of ECdevelopments
              and for influencing draft legislation.

              31n 1989, Presidents George Bush and Jacques Mars met twice.

              Page 68                                               GAO/‘NSIADso-99   Ehropean   commnnity
                             Chfspter 4
                             The Appropriatemesa of the US.
                             Govemment’s Reqonse

                             The U.S. government also recognizes the importance of involving the
                             U.S. private sector in communicating U.S. interests. Private sector
                             involvement not only allows for an early exchange of information,
                             which benefits both the U.S. government and the private sector, but also
                             adds another channel for communicating U.S. concerns to the EC.The
                             American Chamber of Commerce’s ECCommittee in Brussels is among
                             the best examples of this private sector activism. This committee ana-
                             lyzes and comments on draft EClegislation and regularly lobbies the EC
                             on behalf of U.S. interests. Treasury asked the Bankers Association for
                             Foreign Trade to organize and to represent the views of U.S. interna-
                             tional banks to the Community. In April 1989, the Association released a
                             paper highly critical of the EC’Sapproach to reciprocity.

Gap in U.S. Government       The sole exception we found to the United States’ providing an effective
Coordination for Insurance   framework for responding to EC financial services initiatives is in the
                             area of insurance. Perhaps owing to their relatively small presence in
Issues                       the Community and the lack of a federal insurance regulator, insurance
                             matters have not been a priority of the U.S. government. The Depart-
                             ment of Commerce claims responsibility for insurance matters in the EC,
                             but its activities thus far have been primarily informational. Treasury,
                             although not responsible for the insurance sector, has been monitoring
                             insurance directives in terms of their relationship to other financial ser-
                             vices directives.

                             Commerce’s Foreign Commercial Service aids U.S. insurers in establish-
                             ing their businesses and instructs them on local business practices but
                             does not monitor issues dealing with regulatory treatment.

Reciprocity Tested the       The first and, thus far, greatest test of the U.S. government’s coordi-
Effectiveness of U.S.        nated policy for protecting American interests came with the EC’Sinclu-
                             sion of a restrictive reciprocity provision in an early version of the
Government Policy and        Second Banking Directive. The U.S. government employed all facets of
Coordination                 its coordinated policy approach in successfully lobbying the ECto liber-
                             alize these provisions. While it is impossible to quantify or to isolate the
                             effect U.S. government efforts had in relation to other factors-such as
                             the change in ECleadership, member state objections, and internal and
                             external private sector efforts- the end result is a less restrictive form
                             of reciprocity that should preserve access for U.S. financial firms to FL

                             Page 69                                     GAO/‘NSIADW99   European   community
                        Chapter 4
                        The Appropriateness of the US.
                        Government’s Response

Arguments Employed bY   The position espoused by the U.S. government in fighting the inclusion
the U.S. Government     of reciprocity in ECdirectives is based on a number of precepts and
                        arguments. The most fundamental argument has been the threat reci-
Before the EC           procity poses for continued free trade among nations. Treasury cau-
                        tioned the Commission that using reciprocity as a tool to fight
                        protectionism by other countries would only encourage a trade war
                        among financial markets, affecting not just the individual countries
                        involved, but also the world’s financial system.

                        Treasury also reminded the ECthat adherence to mirror-image reciproc-
                        ity would undermine the single market’s commitment to a free and open
                        market. Denying U.S. firms’ access to the Community could generate
                        protectionist pressures against EC firms in the United States, an obvious
                        concern to those EC countries with a sizable stake in U.S. financial

                        Treasury also argued that the practical implementation of reciprocity is
                        overly burdensome. Reciprocity was abandoned in the United States
                        because it would have required multiple rules and regulations specific to
                        each of the more than 60 countries that operate banks in the United
                        States, all based on the treatment of U.S. banks located in over
                        70 countries.

                        EC and member state officials were also cautioned by the U.S. govern-
                        ment that the EC’Sreciprocity provisions run counter to IX and member
                        state obligations under bilateral treaties of Friendship, Commerce, and
                        Navigation, the OECD’SCode of Liberalization of Capital Movements, and
                        the EC’Sown Treaty of Rome. The United States maintains that ECmem-
                        ber states would violate such outstanding treaties between the United
                        States and most ECmember states were reciprocity to be invoked against
                        U.S. firms. Under these treaties, U.S. companies are entitled to national

                        The OECD’SCode of Liberalization for Capital Movements is an agree-
                        ment among all OECDmember states to gradually eliminate barriers to
                        capital movements. While the EC is not a signatory to this code, its mem-
                        ber states are. State Department officials stated that any reciprocity
                        provisions imposed by the ECcould put member states in violation of
                        several of the code’s provisions. In September 1988, the OECDSecretariat
                        found the EC’Sproposed use of reciprocity violates this code.

                         The US. government has taken the position that denying access to U.S.-
                         owned, but EC-incorporated, subsidiaries also violates the EC’Sown

                         Page 60                                  GAO/NSIMHO-99   European   Community
                           Chapter 4
                           The Appropriateness of the U.S.
                           Government’s Response

                           treaty obligations. Under article 58 of the EC’STreaty of Rome, “Compa-
                           nies or firms formed in accordance with the law of a member state and
                           having their registered office, central administration, or principal place
                           of business within the community shall . .. be treated in the same way as
                           natural persons who are nationals of member states.” US. government
                           officials interpret this statement to mean that U.S. firms incorporated in
                           the EC should be assured access to the EC,regardless of the access or
                           powers afforded EC firms in the U.S.

Private Sector Views of    U.S. financial firms with a presence in the ECgenerally stated that the
U.S. Government Response   U.S. government responded in a timely and effective manner to their
                           concerns about the EC’Ssingle market program. This view is based pri-
                           marily on their initial concerns over the EC’Sstance on reciprocity and
                           the belief that the U.S. government response was an influence in liberal-
                           izing that provision. As noted in the prior chapter, most of the U.S.
                           financial firms that we interviewed felt confident the revised reciprocity
                           clause would not threaten their ability to enter the ECmarket and enjoy
                           the benefits of the single market. However, these firms warn that the
                           U.S. government must continue to track the reciprocity provision and
                           other ECinitiatives affecting U.S. interests, and they urge the United
                           States to remain vigilant in defending their interests.

                           U.S. financial firms vary widely in their degree of knowledge concerning
                           single market initiatives. Private sector associations lobby the ECto pro-
                           mote their interests, and some U.S. financial firms also lobby their inter-
                           ests directly before the EC. These firms complimented the U.S.
                           government’s response most highly.

                           Generally, responsible U.S. government agency officials view favorably
Future Concerns and        the EC’S efforts to liberalize its financial markets, However, while the
the Frmework for           primary concern over reciprocity has largely abated, these officials
Response                   believe it is important to look to the future and assess what new issues
                           may emerge and to ensure that the U.S. government is poised to react.

Emerging Concerns          Based on our discussions with U.S. financial firms and government offi-
                           cials, there are a few EC initiatives underway that could put U.S. finan-
                           cial firms at a disadvantage and that, therefore, bear close scrutiny.
                           Among these concerns are the possible reemergence of reciprocity in

                           Page 61                                    GAO/‘NSyLD90-99   European   Community
                           Chapter 4
                           The Appropriateness of the U.S.
                           Government’s Response

                           other directives; the present delays in the implementation of the Invest-
                           ment Services Directive; the lagging liberalization of the insurance sec-
                           tor; and the broader impact of the European Monetary Union.

Ongoing Concerns About     While the apprehension by U.S. officials and private sector industry
EC Reciprocity Proposals   groups about the reciprocity provision in article 9 of the Second Banking
                           Directive has largely subsided, U.S. agencies and regulators remain cau-
                           tious. These officials are dismayed that a reciprocity concept is still
                           being embraced by the Community, albeit in a milder form. Access to the
                           ECmarket is still based on U.S. treatment of EC firms, under which the EC
                           may negotiate with the United States if it does not offer, in the EC’S
                           view, effective market access and competitive opportunities comparable
                           to those granted by the Community to non-Ec banks. While the immedi-
                           ate practical effect of this provision may be limited, the precedent this
                           sets for the global financial services industry nevertheless disturbs U.S.

                           The use of reciprocity, as espoused by the EC,versus the standard of
                           national treatment (or equality of competitive opportunity), as applied
                           in the United States, are competing concepts within the current GAIT
                           negotiations. Outstanding GAIT agreements do not cover financial ser-
                           vices, but they are among the primary topics under the current round of
                           GAIT multilateral trade negotiations, referred to as the Uruguay Round,
                           slated for conclusion at the end of 1990. Within the Uruguay Round, the
                           U.S.’position is that financial services should be based upon the princi-
                           ple of national treatment. The EChas proposed a different approach in
                           GATT negotiations, based on the “effective market access” principle. This
                           concept presumes that national treatment alone is not enough to permit
                           market penetration, especially if national treatment coexists in a
                           restrictive and highly regulated environment. The United States fears
                           that the EC’Sposition would restrict the liberalization of world financial

                           Furthermore, the possibility still exists that a stricter reciprocity provi-
                           sion could be included in the Investment Services Directive or in the Life
                           and Non-Life Insurance Directives. While EC assurances are that the
                           more liberal reciprocity provision in the Second Banking Directive will
                           be copied for these other directives, changes in U.S.-ECrelations, or man
                           protectionist elements in the EC,could alter these intentions.

                           Page 62                                     GAO/NSIAIHO-99   European   Communi~
                            Chapter 4
                            The Appropriatenew  of the U.S.
                            Government’s Response

Problems Caused by          The EC has stated that the banking and investment services directives
Delays in the Investment    will not only be parallel in design but also will be implemented simulta-
                            neously, so as not to create an “unlevel” playing field between banks
Services Directive          and investment services firms. However, while the banking directive has
                            been adopted and is on schedule for implementation on January 1, 1993,
                            the Investment Services Directive is much further behind, with a num-
                            ber of hurdles yet to jump. Some U.S. securities firms in London are
                            especially troubled by the possibility that the Second Banking Directive
                            might be implemented before the Investment Services Directive. In that
                            event, firms that conduct only investment services would not have the
                            single passport power to branch freely and to offer services across bor-
                            ders. They would, therefore, be at a competitive disadvantage to banks,
                            which could use their single passport to conduct investment services
                            under the banking directive. U.S. securities firms (and some British
                            merchant banks) would be notably disadvantaged by this inequity, since
                            investment services in most other EC countries are offered primarily by
                            banks, which would not suffer from any delays in the implementation of
                            the Investment Services Directive. This latter fact leads some to believe
                            that these countries will not be eager to move quickly on the Investment
                            Services Directive.

The EC’s Insurance Sector   The liberalization of the EC’Sinsurance sector lags behind that of the
Liberalization Is Lagging   banking and securities markets. The ECis further away from agreeing on
                            a single license for the offering of insurance services than for the other
                            financial sectors, partly because of national tendencies toward protect-
                            ing domestic insurance industries. These delays trouble U.S. government
                            and private sector officials because of the significant opportunities they
                            foresee should the insurance sector be liberalized.

European Monetary Union     The EC’S program to create a unified financial market by 1993 is only a
                            step toward greater European Monetary Union. The leaders of the EC
                            reaffirmed their movement toward this goal in July 1989, entering into
                            the first of three stages towards implementing monetary union. Such a
                            union could have a considerable impact on U.S. monetary policy and on
                            the global economic system. Progress in achieving such a union is, there-
                            fore, of keen interest to some U.S. government officials monitoring EC


                            Page 63                                   GAO/‘NSIAD9o-99   European   Ckmmunity
                           chapter 4
                           The Appropriateness of the U.S.
                           Government’s Besponse

U.S. Government Strategy   As the EC’SSingle Market Program for financial services evolves, the
for the Future             U.S. government will continue to use the framework and policy
                           explained earlier in this chapter, primarily through Treasury’s Policy
                           Group on European Monetary Reform and Financial Liberalization.

                           In addition, Treasury has begun work on a 1990 National Treatment
                           Study, which will include a first-time assessment of the EC’Streatment
                           of U.S. banks and securities firms. This study is due to Congress by
                           December 1, 1990.

                            Page 64                                  GAO/NSLADSO-99   European   Communit
Page 66   GAO/‘h’SIAD-90-99   European   Community
Appendix I

Status of Single Market Program Legislation

                The listing below represents the status (to January 1990) of the primary
                legislative steps necessary to the completion of a single market for
                financial services outlined in the M=Commission’s White Paper of June
                1985, “Completing the Internal Market.” This does not represent an all-
                inclusive list of Ec financial services legislation.

                and other financial institutions
                Adopted by EC Council: December 8,1986
                This directive intends to harmonize consolidated accounting practices
                for banks, including their format, nomenclature, and terminology for
                their accounting documents.

                Council Directive on the obligations of branches established in a member
                state by credit institutions and financial institutions, having their head
                offices outside that member state, regarding the publication of annual
                accounting documents
                Adopted by ECCouncil: February 2,1989
                This directive establishes the sufficiency of consolidated accounting
                documents, and the accounting information required within the docu-
                ments, for branches of banks from other countries. It effectively elimi-
                nates the requirement for publication of separate annual accounting
                documents for each branch.

                Proposal for a Directive on the freedom of establishment and the free-
                dom to supply services in the field of mortgage credit
                Planned adoption by ECCouncil: 1990
                This proposed directive would allow credit institutions to grant mort-
                gage credit secured by real property situated anywhere in the

                Proposal for a Directive on the coordination of laws, regulations, and
                administrative provisions relating to the reorganization and dissolution
                of credit institutions
                Planned adoption by ECCouncil: 1990
                This proposed directive coordinates the practices for the dissolution of
                credit institutions. The institution’s home country would have primary
                jurisdiction and apply its law throughout the Community.

                Council Directive on the own funds of credit institutions
                Adopted by EC Council: April 17,1989
                This directive establishes Communitywide standards for own funds

                Page 66                                    GAO/WSIADgo-ft9   Eumpem   ‘kmmnit!
             Appendix I
             Statas of Shgle Market   Program Legislation

             (capital) of credit institutions. Own funds constitute the numerator for
             the solvency ratio, which is the subject of a separate Council directive.

             Commission Recommendation concerning the introduction of deposit-
             guarantee schemes in the community
             Adoption by ECCouncil: not necessary for recommendation
             This recommendation suggests that those member states that do not
             have a deposit guarantee scheme draw up a scheme according to pre-
             scribed conditions. This recommendation supplements a proposed direc-
             tive [COM (85) 7881 that requires each member state to cover the
             depositors of all authorized credit institutions, including depositors of
             branches of credit institutions that have their head offices in another
             member state. Until such time as all member states have a scheme, those
             member states with a scheme will be required to cover their branches in
             other member states. A directive has been proposed to replace this

             Commission Recommendation on monitoring and controlling large expo-
             sures of credit institutions
             Adoption by ECCouncil: not necessary for recommendation
             This recommendation attempts to protect depositors by recommending
             that member states require institutions to report large or excessive
             exposure concentrations to a single client or group of clients. A directive
             has been proposed to replace this recommendation.

             Second Council Directive on the coordination of laws, regulations, and
             administrative provisions relating to the establishment and pursuit of
             the business of credit institutions and amending Directive 77/780/EEC
             Adopted by ECCouncil: December 15,1989
             The Second Banking Directive is key to the single market for financial
             services. The directive grants a single banking license to authorized
             credit institutions to freely branch or offer services across ECborders.
             Prudential supervision of each institution is governed by the home coun-
             try of authorization.

             Council Directive on the coordination of laws, regulations, and adminis-
iecurities   trative provisions relating to Undertakings for Collective Investment in
             Transferable Securities (ucrrs)
             Adopted by ECCouncil: December 20,1985
             This directive harmonizes member state laws pertaining to UCITS (similar
             to open-ended mutual funds in the United States) and allows their mar-
             keting on a Communitywide basis.

             Page 67                                        GAO/TWAD9O-99   European   Community
            Status of Single Market   Program Letckbtion

            Council Directive amending, as far as concerns the investment policy of
            certain Undertakings for Collective Investments in Transfer-i-able Securi-
            ties, Directive 85/6 11 /EEC
            Adopted by ECCouncil: March 22,1988
            This directive liberalizes requirements for the investment in UCITS issued
            by the same issuer and specifies certain fiduciary responsibilities for the
            supervision and safekeeping of assets.

            Council Directive on the information to be published when major hold-
            ings in the capital of a listed company are acquired or divested
            Adopted by ECCouncil: December 12,1988
            This directive harmonizes reporting and disclosure requirements, espe-
            cially regarding takeover attempts, for companies whose shares are
            listed on an official Community stock exchange.

            Council Directive on the coordination of the requirements for the draw-
            ing-up, scrutiny, and distribution of the prospectus to be published
            when securities are offered to the public
            Adopted by ECCouncil: April 17,1989
            This directive provides minimum essential standards for the contents of
            a prospectus of newly offered securities (both on and off exchange).

            Second Council Directive on the coordination of laws, regulations, and
Insurance   administrative provisions relating to direct insurance other than life
            insurance, laying down provisions to facilitate the effective exercise of
            freedom to provide services
            Adopted by ECCouncil: 6/22/88
            This directive amends the First Council Directive for non-life insurance
            by liberalizing cross-border insurance services for large commercial and
            industrial risks. This directive also provides for home country control
            for large risk insurance.

            Council Directive on the coordination of laws, regulations, and adminis-
            trative provisions relating to legal expenses insurance
            Adopted by EC Council: June 22,1987
            This directive harmonizes member state requirements for insurance
            against legal expenses.

            Council Directive amending, as regards credit insurance and suretyship
            insurance, the First Directive 73/239/EEC
            Adopted by EC Council: 6/22/87
            This directive amends the First Council Directive (DIR 73/239/EEC)

            Page 68                                        GAO,‘NSIAD9O-99   European   Communil
Appendix I
Statu9 of Single Market   Program   Legidation

with regard to credit insurance by requiring firms that offer credit
insurance to establish equalization reserves.

Proposal for a Council Directive on the coordination of laws, regulations,
and administrative provisions relating to insurance contracts
Planned adoption by ECCouncil: 1990
This proposed directive harmonizes and sets minimum standards for the
laws, regulations, and provisions for non-life insurance contracts.

Proposal for a Council Directive on the coordination of laws, regulations,
and administrative provisions relating to the compulsory dissolution of
direct insurance undertakings
Planned adoption by ECCouncil: 1990
This proposed directive seeks to harmonize member states’ treatment of
insurance contracts in the event of an insurance company’s dissolution.

Proposal for a Council Directive on the annual accounts and consoli-
dated accounts of insurance undertakings
Planned adoption by ECCouncil: 1990
This proposed directive seeks to harmonize the financial reporting stan-
dards of community insurance companies.

Proposal for a third Council Directive on the approximation of the laws
of the member states relating to insurance against civil liability in
respect to the use of motor vehicles
Planned adoption by ECCouncil: 1990
This proposed directive seeks Communitywide, compulsory third-party
liability motor vehicle insurance.

Proposal for a Council Directive amending, particularly as regards
motor vehicle insurance, DIR 73/239/EEC and DIR 88/357/EEC relating
to direct insurance other than life insurance
Planned adoption by EC Council: 1991
This proposed directive seeks to allow freedom of services for motor
vehicle liability insurance throughout the Community.

Proposal for a second Directive on the coordination of laws, regulations,
and administrative provisions relating to direct life insurance, laying
down provisions to facilitate the effective exercise of freedom to pro-
vide services and amending DIR 79/267/EEC
Planned adoption by EC Council: 199 1
This proposed directive seeks to establish the framework for freedom of
Communitywide services for the life insurance industry.

Page 69                                          GAO,‘NSIAD90-99   European   ccmmunity
                       Appendix I
                       Status of Single Market   Pmgram   Legislation

Capital Movements      mentation of Article 67 of the Treaty of Rome, on the liberalization of
                       units in Undertakings for Collective Investments in Transferable Securi-
                       Adopted by ECCouncil: December 20,1985
                       This directive liberalizes capital movements for transactions involving

                       The following legislative steps are not listed in the White Paper time-
Additional Financial   table but are generally considered to be part of the Single Market
Services Directives    Program.
and Proposals

                       Council Directive on a solvency ratio for credit institutions
Banking                Adopted by ECCouncil: December 18,1989
                       This directive, patterned after the Basle Convergence Agreement,
                       requires that banks maintain their own funds (capital) in a prescribed
                       level to their risk-adjusted assets.

                       Council Directive coordinating regulations on insider dealing
Securities             Adopted by ECCouncil: November 13,1989
                       This directive harmonizes member state rules against insider trading.
                       The directive prohibits knowingly taking advantage of inside informa-
                       tion to buy or sell securities on an exchange market.

                       Proposal for Council Directive on investment services in the securities
                       Planned adoption by ECCouncil: 1990
                       This proposed directive parallels the Second Banking Directive and
                       would provide freedom of establishment and services for securities-
                       related activities throughout the Community by authorized investment
                       firms. The authorization and prudential supervision of the investment
                       firm would be provided by the home country.

                        Proposal for Council Directive, amending Directive 80/390/EEC, in
                        respect of mutual recognition of stock exchange listing particulars
                        Planned adoption by EC Council: 1990
                        This proposed directive amends earlier requirements harmonizing the
                        requirements for drawing up and distributing listing particulars and

                        Page 70                                         GAO/NSIAIWO-99   European   Communi
                    Appendix I
                    Statua of Single Market   Program Legislation

                    requires the mutual recognition of other member states’ prospectus
                    approvals for entry into any Community exchange.

                    Council Directive, amending the Directive of May 11,1960, on the imple-
Capital Movements   mentation of article 67 of the Treaty of Rome, liberalizing operations
                    such as transactions in securities not dealt in on an exchange and other
                    capital and securities transactions
                    Adopted by ECCouncil: November 17,1986
                    This directive lifted exchange controls on direct investment, short- and
                    medium-term trade credits, and some capital and securities transactions.

                    Council Directive on the liberalization of capital movements
                    Adopted by ECCouncil: June 24,1988
                    This directive eliminates all remaining capital restrictions in most EC
                    member states by July 1, 1990.

                    Page 71                                         GAO/‘NSIAIMM9   European   Community
Appendix II

Major Contributors to This &port

                        James McDermott, Assistant Director
National Security and   NinaPfeiffer&alUamr
International Affairs   Cynthia Kite,‘Intern
Division, Washington,
                        John Tschirhart, Project Manager
European Office         Paul Aussendorf, Evaluator-in-Charge
                        Jeffrey K. Harris, Evaluator

 (486008)               Page 72                                GAO/NHAIM@99   European   Communir
Requests for copies of     GAO   reports   should be sent to:

U.S. General Accounting      Office
Post Office Box 6015
Gaithersburg, Maryland       20877

Telephone   202-275-6241

The first five copies of each report       are free. Additional    copies are
$2.00 each.

There is a 254, discount    on orders for 100 or more copies mailed to a
single address.

Orders must be prepaid by cash or by check or money               order made
out to the Superintendent of Documents.
United States                         First-Class Mail
General Accounting  Office          Postage & Fees Paid
Washington, D.C. 20548                       GAO
                                      Permit No. GlOO     i
Official   Business
Penalty    for Private   Use $300