Financial integration: Where do we stand?
Speech by Jean-Claude Trichet, President of the European Central Bank,Paris, 3 December 2003
Ladies and gentlemen,
Pascal described the universe as "a circle whose centre is everywhere and whose circumference is nowhere". This definition can be applied fairly well to euro capital markets, which are global markets as a result of the international use of the euro. As such, they are not grouped around one financial centre alone, or even a single main financial centre, but around a constellation of financial centres spread over the euro area and beyond. Paris is naturally one such centre and I must say that I am delighted to be back here for the first time since my appointment as President of the European Central Bank for this inaugural forum on euro interest rate markets.
Although the decentralisation of euro markets is a reality, their segmentation should obviously not be seen as a foregone conclusion. On the contrary, with decentralisation the need to integrate different markets and different financial centres becomes even more pressing, and only through such integration can the single market be a reality.
The ECB's and the Eurosystem's interest in the process of financial integration
Therefore, we at the European Central Bank and in the Eurosystem attach great importance to pursuing the process of financial integration in Europe. The main reason why we are so interested in this is because the financial system evidently plays an essential role in the transmission of monetary policy. From this point of view, an efficient and broadly integrated capital market ensures that monetary policy is implemented consistently and effectively.
This holds true for the whole financial system, but especially for markets which are directly involved in the conduct of our monetary policy operations: the money market, of course, but also the bond market, since the vast majority of eligible assets which act as collateral in our credit operations are from this market.
A high level of financial integration is also desirable in view of our other key tasks, such as promoting the smooth functioning of payment systems or contributing to the maintenance of financial stability.
But perhaps the most profound and significant reason for our attachment to pursuing the integration process is that it could raise the non-inflationary growth potential of our economy. This causal relationship is instinctive in that as integration increases, there is a more effective allocation of savings to the most profitable investment plans, while frictions and transaction costs are minimised. In addition to this intuition, the impact of financial integration on the growth potential is now solidly supported by a considerable number of theoretical and empirical studies.
And finally, I do not really need to remind you that, in the more general context of the single market, financial integration is the objective of specific European policies that have been prioritised by the European Council. In this context, and in accordance with the obligations assigned to us by the Treaty, it behoves us to support these policies.
State of play
Given this background, I should now like to go back to the subject of my speech today by looking at "where we stand". As is always the case, there can be two different viewpoints. The first, which was dominant in the first couple of years following the introduction of the euro, was to highlight the considerable distance we have covered so far. The example most often given is the almost immediate integration of the money market – concerning both the interbank market and the derivatives market – at the beginning of 1999. The remarkable development of the bond market, excluding government securities, is also a result of this integration. Throughout 2002, bond issues from the private sector represented approximately half of all issues, whereas before the introduction of the euro the market was dominated entirely by public issues.
Moreover, the beneficial effects of integration have also been felt in the government securities market. If further proof were needed, I could mention the standardisation of issuance methods or even the development of common trading platforms across the euro area. The development of the different components of the MTS group, including of course the EuroMTS platform, is perhaps the best example of this.
Furthermore, integration is continuing to advance in areas where it appeared to have been delayed slightly, such as the repo market. Evidence of this progress can be seen in the creation of the EUREPO benchmark index, or in the development of a standardised legal document known as the "European Master Agreement" (EMA).
A more pessimistic viewpoint is to highlight the inadequacy, and in particular the apparent slowdown, of the process of financial integration over the past few years. In this regard, we could highlight the level of residual fragmentation of delivery-versus-payment securities settlement systems. In spite of the many consolidation efforts, there are still 20 or so national delivery-versus-payment systems in the European Union today, and roughly as many in the acceding countries set to join the EU next spring. This is not normal.
Therefore, the process of integration is already quite remarkable, despite the fact that it is incomplete. However, there are two reasons why, in my view, it would be wrong to interpret this situation pessimistically. First, it should be remembered that the period in which the easiest progress was made in terms of integration naturally came immediately after the changeover to the euro in 1999. As is reasonably logical to expect, what remains to be done is what is most difficult, though not impossible.
But, more importantly, as Saint-John Perse once famously wrote, "pessimism is not only a sin against nature, but an error of judgement as much as a desertion" (From "Sur l'optimisme en politique", an article which appeared in the Excelsior journal, 27 February 1935).
We should not look at the inadequacy of the process of financial integration, but rather understand the causes of this inadequacy and identify means to remedy it.
Two lessons arise from the road travelled so far.
The first is that integration can only be achieved if the barriers to cross-border financial activities are effectively abolished. This is the objective set by lawmakers in the Financial Services Action Plan (FSAP), launched by the European Commission in the spring of 1999. 36 of the 42 original measures proposed by the FSAP have now been adopted, and it is reasonable to expect the remaining measures to be adopted before the European parliamentary elections next spring. This is a major undertaking, the importance of which cannot be emphasised strongly enough.
The second lesson is that a legislative framework in itself is not sufficient to achieve an effective integration of the market. What this framework produces is a potential. It is then up to the different players involved, whether public or private, to exploit this potential. This is what has been done so far in many domains, and it would be advisable to carry on in this way.
With the finalisation of the FSAP, it seems to me that we have therefore reached a key moment in the integration of the European financial system. We have a body of legislation which is coherent and relatively comprehensive at European level. It is quite possible that there will be a need for supplementary legislation in the future. But what should retain people's attention and focus people's energies in the short term is undoubtedly the translation of the measures that have been adopted into realities, as well as the exploitation of the opportunities that these measures create. In a word, what is important is no longer so much the FSAP itself but the strategy to be applied post-FSAP.
And it is this last point that I would now like to emphasise.
The role of public policies post-FSAP
The adoption of the measures contained in the FSAP obviously does not constitute the end of the public authorities' involvement in the integration process. It is now crucial for the competent authorities to effectively implement at national level the measures adopted at European level in a coherent manner. As was stressed by the Lamfalussy Committee, the capacity of Community legislation to adapt flexibly to constantly evolving markets and the coherence of its application help to alleviate the burden on the financial institutions which are active across the single market. Therefore, as you know, the so-called "Lamfalussy" approach provides for the drafting of technical Community legislation, or "secondary" legislation, which can, if necessary, be amended through a simplified procedure. It also provides for closer cooperation between supervisory authorities in the area of financial regulation and supervision. This method seems to me likely to bring about a truly joint regulation and legislation from the point of view of those who ultimately count, i.e. market players, while fully respecting the principle of subsidiarity.
The implementation of the "Lamfalussy approach" offers what may be a unique opportunity to simplify the current regulatory framework while standardising its application. If this approach is adopted in full, it is reasonable to expect that the elaboration of European regulations combined with this strengthened cooperation between competent national authorities would lead to the development of a joint European handbook, an "EU Rulebook", comprising the technical measures applicable in terms of financial regulation. This European rulebook would provide the financial institutions with the reference that they perhaps lack today when they undertake cross-border activities.
A second issue on which public authorities are working is related to the supervision of financial institutions. Two strategic objectives should be highlighted here.
First, the strengthening of cooperation between competent authorities, in particular between supervisors and central banks, in order to supervise more effectively institutions which operate in several jurisdictions. This would also draw on the efforts at the very heart of the central banks' mission to ensure that financial stability is maintained. This strengthened cooperation would imply an intensified exchange of information, which is, moreover, already under way within the European System of Central Banks, and will also be developed in the context of the new structures created in accordance with the Lamfalussy approach.
I should now like to make an aside on the specific nature of the banking system, which is actually a source of particular, systemic risks directly associated with the maturity transformation carried out by banks and with their role in payment systems in particular. Therefore, given our responsibilities, it is essential that the ECB and the national central banks of the Eurosystem are actively involved in the regulatory process. It is just as important for central banks to work closely with the competent authorities in the area of supervision. The memorandum of understanding signed by central banks and banking supervisors on the principles of cooperation in crisis management situations is a perfect illustration of the efforts made in this domain.
I should also like to reiterate that financial integration brings about a change in the systemic risk transmission channels, notably as a result of a possible increase in the risks of cross-border contagion and, consequently, a change in the potential sources of financial instability. Given our responsibility in this field, we are paying particularly close attention to these implications of the integration process.
The second strategic objective is that it would be preferable if the procedures and obligations associated with banking supervision were to converge further, in order to lighten the burden on the institutions subjected to them. This could be done by means of a joint agreement between competent authorities on some transparent standards to be applied when the measures contained in the "rulebook" that I mentioned a moment ago are being implemented.
None of what I have just said detracts from the merits of arrangements under which national authorities are responsible for prudential supervision. Furthermore, the conditions for an in-depth cooperation are being developed precisely to ensure that such a decentralised organisation is still able to achieve the results expected in the context of an integrated financial system.
The role of the private sector post-FSAP
The points that I have raised so far form a long list of tasks incumbent upon the public sector to convert into a reality the potential for financial integration resulting from the FSAP. However, this is a responsibility which also behoves the private sector. I would like to say a few words on this point.
The first of the private sector's responsibilities is, naturally, to take advantage of the opportunities created by the single market, as you have successfully been doing up to now. If it is up to the authorities to create the environment of trust needed to undertake cross-border activities, it is finally up to you to "convert the try".
But there is also another area in which private initiative can, and in my view must, contribute to the process of market integration. This is the area of collective action, which is something I should like to explain in more detail.
The rules governing the proper functioning of the financial markets are not only enacted by public authorities. There are a considerable number of rules, perhaps the majority in fact, which are the result of the community of market participants itself. These rules include, for example, quotation conventions, conventions for calculating accrued interest, conventions for delivery versus payment and many other standards used by the market as a whole.
What sets these rules apart is the fact that the voluntary adhesion that they create is the result of network externalities. The more people that follow these rules, the more beneficial it is to apply them, not least because of the resulting increase in the number of potential counterparties. However, the use by two groups of market operators of different standards or conventions will constitute a real segmenting factor.
Therefore, to my mind, the adoption of common rules, conventions or standards by all market players is one way in which the private sector can, in its own interests, work effectively and together towards achieving greater financial integration. Public authorities can only facilitate collective action in this domain, not replace it. Moreover, the ECB and the national central banks of the Eurosystem have, on many occasions, acted as a facilitator, and we are, of course, willing to continue to help the market along this path if need be.
To illustrate this point, I will use the example of the creation of the EONIA when the euro was introduced. This index, which reflects the level of the overnight rate on the interbank market, is not the result of a legislative or regulatory decision, but of coordinated action between money market operators. The European Central Bank is involved in the calculation of this index, but only as a facilitator.
The reason I mention the EONIA is because it seems to me that its existence, as well as its adoption as a benchmark on the interest rate swap market, has been an important factor for the integration of this particular market segment. Furthermore, the results are well known by everyone: the market for interest rate swaps indexed on the EONIA is the most liquid and deepest of its kind in the world, and its contribution to managing the interest rate risk of all market players is considerable.
Given this amazing success, the question which needs to be asked is therefore whether all potential opportunities for collective action to deepen financial integration have been exploited. Our experience leads us to believe that this is not the case. For example, we could mention the commercial paper market, where the diversity of the conventions used is perhaps greater than is strictly necessary, although a group of market participants has taken the initiative to specifically reduce these differences.
In this context, the completion of the FSAP is perhaps also an opportunity not to be missed. If the legal or regulatory obstacles to cross-border activity are eliminated, the adoption of joint standards and conventions through collective action only becomes more desirable and more beneficial.
In order for this collective action to become a reality, market associations which are effectively pan-European in their constitution and objective are needed. However, I have the impression that the number of initiatives in this direction are increasing, and I find that a reason to be optimistic about European financial integration.
Therefore, the conclusion of the FSAP does not signal the end of the process of financial integration in Europe. It marks the end of a stage, and a decisive stage at that, but one which must be followed by other steps forward.
In order to achieve this, a strategy which is just as ambitious and coherent as the one which has been applied up to now must be applied post-FSAP. It will be up to the different players involved in this process, whether public authorities or market players, to jointly develop this strategy over the coming year. In any case, I believe that this strategy should include some of the elements that I have outlined today, namely:
First, close attention to coherence between the actions carried out by the various public authorities, as well as between the role of the public sector and the essential role of the private sector. Only will effective interaction between all those involved be likely to lead to even deeper integration.
Then, the need for rationalisation and simplification. This can be applied to the area of regulation and supervision, but also to the standards and conventions drawn up by the private sector.
Finally, the need for organisation and participation. In order for the policies which have been defined to be put into practice, market players must, in principle, be actively involved and organised effectively with a view to a permanent dialogue with the supervisory authorities in the best possible conditions.
Given the statements and initiatives which are appearing it seems to me that a consensus is being formed on these three points. This is the case, for example, for the market infrastructure, where a certain coherence and complementarity can be observed between the various activities in progress. The development of TARGET2 by the Eurosystem in particular, the strategy proposed by the Giovannini group in the area of delivery versus payment and the work carried out on the consolidation of technical platforms used by international central securities depositories based in Europe should all yield tangible results between 2005 and 2008. I would like to see the encouraging signs of a forthcoming acceleration of this process of European financial integration, which is already well advanced. The benefits of everything that has been achieved so far are so outstanding that there can be no doubt that it is in the interests of all concerned to continue determinedly along this road.
Ladies and gentlemen, thank you for your attention.