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

Published by the Government Accountability Office on 1990-05-23.

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


                         United States General Accounting Office /PwF~

-‘- GAO                  Testimony


     For Release         European Community; U.S. Financial    Services’
     OI 1 Del ivery      Competitiveness under the Single.Market    Program
     Expected at
     Cl:33 a.m . EDT
     M ay 23, 1990

                         S ta ternent of
                         Allan I. Mendelowitz,  Director
                         Trade, Energy, and Finance Issues
                         National Security ELInternational Affairs    Division

                         Before the
                         Subcomnittee on Commerce, Consumer, and Monetary
                           Affairs,  Comnittee on Government Operations
                         House of Representatives


     GAO/T-NSIAD-90-45                                                   GAO Form 160 W/87)

    M r.     Chairm an         and M embers of the                  Subcom m ittee:

    It     is    a pleasure          to be here            today         to discuss              our assessm ent                       of how
    the      European          Com m unity's           Single       M arket         Program          m ight         affect             U.S.
    financial           firms.          Overall,         we believe                that      the     Single              M arket
    Program         m eans that            greater       opportunities                    will      exist          for         U.S.
    financial           firms      to      expand       their       already           considerable                  business              in
    the      European          Com m unity.            Contrary          to    initial             concerns,              it     appears
    as though           U.S.      financial            firms      will        face        relatively               few Com m unity-
    imposed         restrictions              that      would       prevent           them         from         participating                  in
    these        opportunities.

    Concerning           your      specific            interest          in the           E.C.ls       potential                 effect            on
    U.S.        insurance         firms,       we found           that        in m ost European                     countries,                 the
    insurance           industry           continues            to be one of the                    m ost        strictly
    regulated           segm ents          of the       economy.              As a result,                     foreign          insurers
    --both        m embers and nonm embers                       of the        Com m unity                --     generally              play        a
    m inor       role    in national             m arkets.              Accordingly,                insurance                  has been
    the      m ost difficult               financial            sector        to     liberalize                 under          the     Single
    M arket       Program .


    The European               Com m unity,          com posed          of    12 nations,              plans             to     create         a
    single        European         m arket       by 1992.               The Com m unity              envisions                  a single,
    integrated           m arket        for    the      unrestricted                m ovem ent         of people,                     goods,


    services,             and capital             among its              member states.                      Initiated         in     1985,
    the         Community          aims      to complete                this     Single             Market      Program        by the
    end of          1992.          While       a majority               of the         initiatives              necessary           to
    create         this       single         market            have been enacted,                     many of the             most
    troublesome               issues         remain            unresolved.              Our report,1                 released         today,
    focuses          on certain              aspects            of the         European             Community's          Single
    Market         Program,            such as

            -     the     potential            opportunities                   and challenges                  for    financial
                  firms       presented           by changes                 in the          Community          and

            -     how U.S.          government                 agencies         are working               to    assure        U.S.
                  financial            firms      full          and fair         access             to European          markets.

    An integrated                  Community            rivals          the United              States         and Japan            as the
    world's             largest        market:           it     will     have --             with     325 million             people,          a
    gross         national          product            of      $4 trillion,              an amount             matched        annually
    in trading               volume        on bond and equity                      markets,              and an insurance
    market         that       accounts           for          roughly        a quarter              of world         premiums.

    U.S.         financial          firms       have a considerable                           stake       in Community
    countries,               chiefly         conducting                wholesale             financial          activities.
    Continued             access        to     Community               markets         is,     therefore,             important           to
    their         global          business        strategies.                   U.S.         banks       are active           in every

    1EURCPEAN COMMUNITY: U.S.                                  Financial  Services'   Competitiveness                                    Under
    the Single Market Program                                  (GAO/NSIAD-90-99,    May 21, 1990)
Community        country,           holding           over     $210 billion,                or roughly         5
percent,       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.             And,     while        only         a
few U.S.       insurance            companies           operate          in the       Community         today,           the
1992 program            has sparked                 renewed        interest.

OPPORTUNITIES AND CHALLENGES FOR U.S.                                     FIRMS

Looking       first       at the       opportunities                  afforded        by the       1992 program,
firms      incorporated             in the           Community,          including           subsidiaries            of
U.S.-owned            financial            firms,      will        be able       to directly           benefit             from
new powers            and market            access.            Further,          any financial            firm       with         a
presence        in the       Community,               such as branches                of U.S.         financial
firms,      can profit             from       the     increased          demand for           financial            services
as a result            of economic             expansion            and restructuring                 under        the
Single      Market        Program.

Financial         institutions                incorporated              in a Community             country          will
obtain      "single         passports          I1 to     freely        branch        into     any other
Community         country          or freely           offer        services         and products             across
borders.         With       this      freedom,           institutions              will      be able      to
consolidate            operations             and standardize                  products.          Financial           firms,
in many instances,                  will       also      enjoy        a broader           range    of powers.                  For
example,       the       1992 program                endorses         a universal            banking      model,

whereby        banks             will       be permitted               to offer              a wide         array       of financial
services,            including                  securities            activities.

Despite        these             new opportunities,                         however,          many U.S.              financial            firms
do not        plan         to expand beyond                     their             existing         wholesale            operations             in
Europe.         Many factors                      drive        this         decision,             such as limited                 capital
for     new investment,                         fears     of     increased              competition,                and other
business        considerations.

This      choice           is     particularly                 true         for     U.S.         commercial           banks,        for
which       new, more stringent                           capital            adequacy             requirements,              and the
lingering            effects              of bad loans                made to developing                          nations,        limit
capital        available                  for     new ventures.                      In this          latter         respect,        some
banks       believe              that       a better           alternative                 for     their          limited        capital
available            for         new investment                  would            be opportunities                   presented            by
the     relaxation                 of     interstate             banking             restrictions                 in the     United

In addition,                unlike              other     U.S.        financial              firms,         U.S.      banks       must
contend        with             certain          U.S.     laws        and regulations                      that      limit       their
overseas        competitiveness.                              For example,                 U.S.       law restricts               the
mixing        of banking                  and securities                    activities             in the United                 States,
and regulations                         constrain         U.S.        banks'          overseas             securities
activities.                 With          the      increasing               importance             of asset
securitization                     and private                placement              as ways to             finance
development,                U.S.          banks         are    increasingly                  at a disadvantage                    compared

to Community             banks.            Community            banks         are not          similarly             restricted
under       the    Community's              universal            banking             model.


As     a result         of the         evolving          divergence             between             the     U.S.'         and the
CommunityIs             approaches             to bank powers,                  there          is    a greater             urgency
to     resolve         the    issue        of how broad                U.S.     bank powers                 should         be.
While       we still          believe          that      this        decision           is     ultimately             a
judgmental             one,     Congress          should         consider             the      competitive                prospects
for     U.S.      banks       in a post-1992                Europe            when rendering                  its     decision.

Turning         to our        assessment              of the         executive              branch's          efforts         to aid
U.S.      financial           firms,        we found            that     generally              the        response         was
timely         and coordinated.                   U.S.      government                agencies             ensured         that       U.S.
financial          sector           interests          were treated                  fairly         in the          emerging
European          Communityls              single        market.              This      treatment             was most
evident          in a successful                effort          to overcome                 a restrictive
reciprocity             provision           in an early                version          of Community                 banking
legislation.                 U.S.      firms      were      initially                concerned             that      the
Community          might        erect       barriers            to non-Community                      firms         through       a
restrictive             reciprocity             provision.

Through          a variety           of means,           U.S.        government               agencies            banded
together          to    lobby        the    Community            early         in     its      legislative
@ 'decision-making*@
      ry                             process,            Most        concerns           over        U.S.      financial

firms'          access           to the           Community           were eliminated                when the              Community
eventually               adopted            a less          restrictive            form      of reciprocity                  in    its
final       banking              legislation.                  This        provision         will         more than          likely          be
replicated               in the          Community's              securities               and insurance
legislation.                     While       it      is     impossible            to    isolate           the     effect        of U.S.
government               efforts            from      other        factors,            such as the              change       in
Community           leadership,                    member state               objections,            and private                sector
efforts,           U.S.          financial            firms       were generally                  pleased          with      the      U.S.
government's                actions.


Mr.      Chairman,             you have expressed                          particular           interest           in how well
U.S.       firms        fare        in the          international                 insurance          market          and how well
the      U.S.      government                has assisted                  U.S.    insurance              firms      overseas.

The world's               private            insurance            market          totals        roughly           $1 trillion
annually           in     life       and non-life                 policy          premiums.               The European
Community           is     the       second           largest          global          market       for     private
insurance           after          the       United          States,          accounting            for     approximately                22
percent          of the           world       market.             The U.S.             market       generates
approximately                    43 percent               of the       world's          premiums,           while          Japan
generates           another              20 percent.

According           to an insurance                         industry          study,        growth         in the          European
insurance           market           will          likely       continue           to outpace              that      in the        U.S.'

insurance        market.               Diminishing            reliance             on public          social         insurance
systems        in Europe           is     expected       to        increase          the     demand for              private
insurance        there.

The Community's                 ultimate          objective           is      to create          a single            market
for       insurance          similar       to that       for         banking         and investment                  services,
whereby        insurance           companies          established                  in any Community                  country
would       be able          to provide           services           freely         throughout           the        European
Community.             Insurers           would     be subject                to similar          rules         and
regulations            in     each of the           member states                   in which          they      opened an
office.         Policyholders               would       be able            to cover          their       risk        by
choosing        among insurers                throughout              the      Community.

Progress        toward          this      Community           goal      is     lagging,          however.             The
greatest        success          has been in the                   area       of non-life             insurance,
especially            for     industrial           and commercial                   policies.            The First             Non-
Life       Insurance          Directive,           implemented                in    1973,       permits         Community
non-life        insurance              companies        to     freely          establish             subsidiaries              or
branches        in     any other           Community           country.              However,          they         are   still
subject        to the         official        authorization                   and laws          of that         other
Community        country,              known as the            host        country,          and cannot              offer
cross-border                services.

The Second Non-Life                      Insurance       Directive,                 passed       by the         Community
in     1988 and due to go into                       effect          on June 30,             1990,        is    a
significant            step      toward       allowing             non-life          insurance           companies             the


    freedom          to provide               cross-border                  services.                 The directive             allows
    Community               insurance             companies           lx        offer        their       big     commercial           and
    industrial               customers,              known as large                     risks,         their       services          freely
    throughout               the     Community,              subject             to the          rules         and regulations                 of
    their          own home country.                        After       June        1990,            Community         insurers           will
    no longer               need an established                       presence               in a particular                Community
    country          to      sell        insurance           to     large          risks         there.          Non-life         insurance
    services           provided             to     retail         consumers               was not          similarly

    In the          life      insurance              sector,          a directive                    allowing        freedom         of
    establishment,                   paralleling               the         1973 non-life                  directive,          was
    adopted           in     1979.          While       a proposal                 to     also        liberalize          the     offering
    of      life      insurance             on a cross-border                       basis            was introduced             in    1988,
    the       directive             is    still       in the          European               Parliament,             and there            is     no
    way of knowing                   when or if              the      directive               will        be finalized.

    The European                Commission              recognizes                 that       the      steps       I just       mentioned,
    as well          as the          others          currently              in place,                are not       enough,        alone,              to
    fulfill           its     goal        of creating               a single              insurance             market.         Therefore,
    the       Commission             is     in the          process             of drafting               directives,           which,           if
    passed,          will       allow         Community             insurers              to operate             on a single
    license.                They will             be free         not       only        to    set      up branches            in other
    member states,                   but      also      to     sell         a full           range        of products           anywhere
    in the          Community             on the        basis         of a single                    authorization            and subject
    to only          one supervisory                    authority.


    As I stated            earlier,           foreign      insurance           companies        typically        play        a
    minor      role     in national             markets.           A 1989 European               insurance
    industry          study     noted         that      the weighted           average        share    of    foreign
    insurers          amounts         to only        7.5 percent.

    BARRIERS FACED BY U.S.                       INSURANCE FIRMS

    The report          noted         that     even in countries                with     relatively          few legal
    restrictions              on market          access,      such as Great              Britain       and the
    Netherlands,              foreign         insurers'      market          share      is    relatively        small.
    Among the          existing          barriers         to the      free      flow     of    insurance        services
    we have noted              are

        --     "buy     nationall             government       procurement              practices;

        --     high     concentration                and cartel        practices:

        --     member state              restrictions          on the          placement         of contracts           with
               insurers         not      established          in that          state;

        --     differing          tax        regimes,      which      affect         premiums,        profits          and
               reserve         levels;

        --     product         restrictions:

        P- differing              treatment             of reserves          and investment            supervision:

         --     differing          marketing             rules;        and

         --     consumer         national           preferences              and language           barriers.

The EC Commission                       is      hopeful       that      many of these             barriers         will
disappear               under      the       Single        Market       Program.          However,          it    recognizes
that           insurance         liberalization                will      continue         to     lag     behind       the       other
financial               sectors.

Our work            revealed            that      only      a handful           of U.S.         insurers         are active
in the           Community.               These       firms       mostly       provide           property         and
casualty             insurance            for     business            and industrial             customers.
Generally,               they      have sought              to portray           themselves             as European             firms
by incorporating                    in       one member state                 from which          they      branch
elsewhere               in Europe.

The limited                 penetration             of Community              insurance          markets         by U.S.
insurance               companies            can be partly              attributed         to the          barriers
already            noted.          However,           the     insurance          companies             themselves           have
not           evinced       a great          deal     of    interest          in the      Community.              A recent
survey           reported          that         80 percent            of U.S.       insurance           executives           have
little           or no notion                of the market              potential         of the         Community.
Other           reasons         given        by insurance              executives         for     the      low U.S.
penetration                 in Europe            include          (1) the       domestic         orientation              and
conservative                 nature          of the        industry          in general,           (2) the        current

saturation             of the       insurance            market,      especially               in northern          Europe,
and     (3) competing               opportunities              in the        Far East.

With     the      growing          prospect        of a single             market        in the         Community,
there       are    indications               of some increase                in U.S.           insurance          industry
interest.              Several        U.S.     insurers,           including            both     life      and non-life
insurers,          are beginning               to establish               themselves            in the         Community.
Based on our discussions                          with     representatives                 of the U.S.
insurance          industry           in the       Community,             at least         eight        U.S.      companies
are establishing                   distribution            alliances            with     Community             banks      and
insurance          companies           or opening            new offices.

Most     of the         activity         is    expected           to occur         in the        southern
Community          countries           such as Spain,               Italy,         and Greece,             whose
economies          have been less                 developed         than        those      of other            Community
member states.                  As the        economies           of these         countries             grow,     demand
for     insurance          is      expected        to     increase.             For example,              as consumer
incomes        rise,       the      perceived            need for         insurance            coverage          to protect
survivors          may increase.                  In addition,             domestic            regulation          in these
countries          has been especially                      restrictive            historically                and foreign
penetration             low.        Therefore,            as more efficient                    foreign         insurers         are
permitted          to enter           these       countries,           profit          opportunities              are

While     the    U.S.      government               generally              has provided                 an effective
response        to Community                  financial            services            initiatives,               the
insurance        sector          has been somewhat                        of an exception.                     The Department
of Commerce claims                     lead      responsibility                  for      protecting              U.S.
insurance        interests              before         the    Community,                but      its     activities              thus
far     have been primarily                      informational.                   While          the     Treasury
Department        has responsibility                         for     financial                issues       associated             with
the     1992 program,             it     is      clearly           not     as    active          in     insurance             as it
has been with            banking              and securities                issues.

Commerce's        Foreign              Commercial            Service            aids      U.S.         insurers          in
establishing            their          businesses            and instructs                  them on local                 business
practices       but      does not              focus       on regulatory                  treatment            issues.
Cognizant        State      Department                 and Treasury               officials              overseas             have
focused     primarily             on commercial                    and investment                 banking,              at the
expense     of the         insurance              sector.

The relative            neglect          afforded            the         insurance            sector       by the U.S.
government        can be attributed                        to several                 factors:           the      small
presence        of U.S.          insurance             companies            in the            Community,           the        absence
of a federal            insurance              regulator,                and the         less      advanced             status        of
the     Community's             insurance           initiatives.
                                                    -o-            -o-          -0-

Mr.   Chairman,    this     concludes   my prepared   remarks.    I would   be
happy   to answer       any questions    that   you or the   members of the
Subcommittee      may     have.