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 Remarks By United States Treasury Assistant Secretary Quarles Harvard Symposium on Building the Financial System of the 21st Century: An Agenda for Europe and the United States Eltville, Germany



I am delighted to participate again in this Symposium. Being an after dinner speaker at the first session presents opportunities and risks.   The opportunity is that I can talk about any topic without fear of repeating what others have said.   Risks, in that I am standing between you and a good night's sleep after such a wonderful meal. I will seize the opportunity by talking about the US-EU Informal Financial Markets Regulatory Dialogue.   I will try to minimize the risks by being as brief as possible.

The three messages I would like you to take away tonight are that (1) the dialogue is moving to the next stage; (2) markets are driving this process; and (3) convergence is happening.

The US-EU Financial Markets Regulatory Dialogue began three years ago.   The Treasury, the lead in the United States , is joined by the SEC, the Federal Reserve, and other regulators on an ad hoc basis, in meetings with the European Commission. The dialogue works informally, quietly and professionally.  

About 1-1/2 years ago, I spoke about the attributes of the Dialogue to this Symposium.   There was polite applause, but I detected a certain skepticism.   During the last year and a half, the weight of opinion has shifted.   By all accounts, the Dialogue has proven its worth. By promoting quiet discussion and understanding, and avoiding hectoring or public brinkmanship, the Dialogue has assisted in problem solving, has evolved to focus on implementation and forward looking issues, and has helped deepen cooperation.        

In the first two years of the Dialogue, both sides were frankly reactive, because there was a lot to react to.   Both needed to respond quickly to events as they arose.   We sought to address "spillover effects" of legislation adopted for domestic regulatory reasons on both sides of the Atlantic , but with distinct implications for international firms.   The Financial Conglomerates Directive and the Sarbanes-Oxley Act are the two best examples.   Give and take on both sides allowed implementation to proceed, taking into account special attributes of each other's markets without sacrificing the letter and spirit of the legislation.

We were able to work thorough the issues because we share similar objectives of promoting dynamic and sound global capital markets, although each side goes about its business differently.   Through frequent discussion and taking each other's views into account, we worked through difficult issues and engendered mutual trust.

With passage of much of the EU's Financial Services Action Plan, the focus of the Dialogue has broadened to include the practicalities of the Plan's active implementation.   This will prove every bit as challenging as the work already completed.  

Implementation of Basle II, which you will discuss tomorrow, is one example.   It has been taken up at all Dialogue sessions.   While the Basle Accord Implementation Group is charged with addressing implementation details, the Dialogue has provided a useful reminder that the basic rationale for such an international agreement is to promote fair competition among major financial institutions.   In this respect, the EU's capital adequacy directive should incorporate provisions emerging from Basle , including those being developed on trading books of investment banks.   

Other hot implementation issues include the Market in Financial Instruments Directive (MiFID), in which details of the implementing measures should respect the delicate compromises reached on that legislation--particularly regarding internationalization of trades--and the Prospectus and Transparency Directives on which I will comment later.    

Problem solving and reaction will always be part of the Dialogue.   But having gotten past the first wave of reaction, the Dialogue has been able to shift gears.   We have developed a forward-looking agenda that identifies key issues for building an increasingly integrated transatlantic capital market.  

The United States well knows from its history that innovative and flexible financial markets not only provide the capital needed to fuel investment, but they also discipline economic agents and reward efficiency. "Growth" has been a buzzword of the Bush Administration; we want to see a global economy with vibrant growth in many economies, rather than the uneven pattern that now holds.    We are well aware of the many studies in Europe showing that full implementation of a liberal pan-European financial system will boost EU growth by at least one percentage point per annum in a decade's time.   US firms are also some of the key European financial institutions that can make higher sustained growth a reality.  

For all of these reasons, we are also watching closely many aspects of European capital market development. The depth of our interest might surprise some observers, but it should come as no surprise to you.   For example, we are keenly interested in Europe 's progress on clearing and settlement, mutual funds, corporate governance, auditing supervision, takeover bids, and insurance.   On the takeover directive, the erection of barriers to US investment in Europe under the guise of "reciprocity" or "national champions" could impede European economic dynamism.   On insurance, both reinsurance as well as the Solvency II project to strengthen capital adequacy standards, Dialogue participants are actively exchanging views.

Banking issues, such as retail banking, mergers and acquisitions, and a legal framework for payment services, are other topics to be taken up soon.   We are keenly interested in the Commission's efforts to promote cross-border retail banking mergers and competition in Europe .   The advent of inter-state banking in the United States is a parallel and it is one that bolstered our economy's dynamism. These are all areas that hold significant promise for reducing transaction costs and bringing benefits to consumers.  

We want to broaden the reach of the Dialogue, while retaining its informal nature. We will be continuing to reach out to the academic community, private sector, member state governments and legislatures.  

As implementation issues are now coming to the fore, it is natural that the EU supervisory committees develop their own cooperative dialogues with their US counterparts.   CESR has dialogues with the SEC and US CFTC; the US National Association of Insurance Commissioners is engaging with the newly created Committee of European Insurance and Occupational Pension Supervisors; and officials of the Committee of European Banking Supervisors already have visited Washington for initial consultations with US bank regulators.   The Dialogue will be infused with the substance of the work concerning each of these supervisory dialogues.

My second proposition tonight is that markets are driving the agenda.   Markets are always ahead of the regulators, and frankly that's how it should be.   It's analogous to the advice that my father provided me that "if you don't miss at least two or three planes a year, you're spending too much time in airports."   If the regulators aren't a little behind the market in a few areas at any given time, they would be stifling innovation and evolution.   The regulators' task is to promote investor protection, while ensuring that prudential and supervisory activities do not stifle efficiency gains.   For effective regulation, the regulators must work with the markets.   The global trend toward transparency is key to letting regulators and markets achieve the right balance.   Open and full consultation with markets is essential.   Politics is inevitable in our societies, but if politics are allowed to trump sound policies, we will all be hurt.

While EU financial markets are big, they are not fully integrated.   Thus, implementation of enacted directives and the Commission's follow-on measures that it will propose this summer are of critical importance. In order for Europe to reap the fruits of a single capital market, regulators in each member state must implement these measures in identical fashion and enforce them consistently.   Markets are pushing for this � demanding streamlined reporting requirements and supervision to gain efficiencies at the EU level.  

In the United States , large US banks increasingly hold the preeminent share of assets.   In Europe , as consolidation and mergers take hold, especially cross-country, concentration will also strengthen.   And it is not just Europe and the US � several years ago, there were 16 major banks in Japan .   Now, Japanese bank balance sheets are becoming stronger and "conglomerization" � to use a Japanese term of art that I'm fairly sure is not an English word � is taking root with three large banking entities taking hold.  

While markets are increasingly global, regulation is national.   Moreover, regulatory requirements are increasing � understandably in the light of recent developments.   But these requirements can be duplicative across jurisdictions, thus piling up additional costs for global institutions.   Limiting client operations, or segmenting them into different accounts to deal in different financial products subject to different regulatory regimes, is costly and inefficient.   Financial firms and their clients understandably demand better.

So, how do we square this circle � how do we match the global reach of markets with the national orientation of regulation?   The reality is that supervision is already going global and it is doing so through convergence.   As policy-makers, we have a duty to ensure that convergence orients itself around high quality standards and not a race to the bottom.

Four years ago there was an interesting analysis of the politics of international capital market harmonization. The hypothesis was that a dominant financial center serves as a "regulatory anchor," basically making decisions that the rest of the world would have to emulate for competitive reasons.   In essence, the US was viewed as the dominant center.

With the policy measures under its Financial Services Action Plan, the EU is in the process of creating a second "dominant" center.   Data in the IMF's most recent Global Financial Stability Report paint the picture.   The sum of stock market capitalization, debt securities and bank assets in the EU was nearly $47 trillion in 2003; in the US the total was around $41 trillion.   Together they account for two-thirds of the world total.  

One risk of having a second pillar in the international financial regulatory system is that we could lose the "anchor" that has helped us to avoid a race to the bottom.   Two large regulatory centers could engage in competition to attract capital that leads to excessively low regulation.   Under certain conditions, the two sides could also engage in the opposite behavior, seeking to exceed one another with ever-higher levels of regulation that could frustrate innovation and efficiency in the financial markets.   Our cooperation in this and other forums is an important means by which we can avoid these pitfalls.

A few years ago, very few people would have known the alphabet soup of international regulation � BCBS; IOSCO, IAIS, etc.   Now, these organizations are known quantities.   Their activities are also on the plate of the world's financial officials.   In March, I attended the Financial Stability Forum meeting in Tokyo , which heard progress reports from each of the key supervisory bodies.

And the regulatory alphabet soup does not just exist at the global level.   It also exists at the US-European level. CESR and the SEC are working on credit rating agencies, and on implementation and enforcement of IAS.   CESR and the CFTC developed a common work plan on transatlantic derivatives. CEIOPS and NAIC are working on information sharing and re-insurance issues, and the PCAOB with European auditing supervisors.  

I already discussed the "conglomerization" underway among global banks.   Consolidated comprehensive supervision and Basel II are a natural reflection of this process.   So is the fact that the Financial Conglomerates Directive was patterned on the principles of the Joint Forum and that Europe 's Solvency 2 Directive is striving to emulate Basel II.   Convergence has far to go, but the trend is unmistakable.

In that regard, let me touch on convergence for listings in the US and European market.   Endorsement of IAS by the EU followed improved IASB governance and IASB's improvement of its accounting standards. Requiring the 7,000 EU listed companies to use IAS was a dramatic move that gave a push to accounting convergence.   And I am pleased to note that the SEC is working on a roadmap for accepting IFRS accounts without reconciliation in the US in the next few years.

Meanwhile, the IASB and FASB are making progress on the convergence exercise for global accounting standards, pursuant to the Norwalk Agreement.   Japan is closely following these developments.   While I doubt accounting and auditing practices will ever be identical in our jurisdictions, I hope that if accountants worldwide follow a similar standard, and follow that standard similarly, then accounting statements could become in time broadly similar throughout the world.   Such convergence � in terms of principles and practice � could lay the basis for ushering in a truly global capital market. It is important not to cast doubts in the public mind about the integrity and technical strength of accounting standard setting by interjecting politics into the process.  

In this context it is disappointing to see the old canard -- "reciprocity" � reappear.   For years, US firms have listed securities in the Euromarkets on the basis of statements using US GAAP.   Some now argue that US firms listing in Euromarkets should be required to follow IAS because the SEC does not recognize the IAS accounts prepared by EU firms.   I think such an approach would be a mistake.   Such a shortsighted policy would only hurt the depth and liquidity of the Euromarkets.  

To conclude, we strongly support Europe 's FSAP and are committed to working with Europe to promote a strong Transatlantic Capital Market anchored in best global practices. The US-EU Financial Markets Regulatory Dialogue is thriving and moving on to the next steps; it is evolving to meet new challenges posed by markets; and it is supporting regulatory convergence between the US and Europe.   I am looking forward to remaining engaged with all of you on these issues and to hearing the ideas that come out of this conference.

Thank you.


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