Abstract
This Selected Issues paper for euro area policies analyzes the product market regulation and benefits of wage moderation. The paper identifies structural shifts in the relationship between wages and unemployment rates—a “wage curve”—in 20 industrial countries. It reviews euro area and cross-country developments in labor costs and their bivariate relationship with unemployment rates and business GDP. The paper also examines aspects of the European Central Bank’s monetary analysis, within the context of their overall two-pillar policy framework, and issues surrounding its use.
IV. The Integration of European Financial Markets 74
A. Introduction
96. This chapter reviews the state of integration of Europe’s financial markets, drawing mainly on existing assessments, as well as the major remaining obstacles. Whenever convenient, the paper illustrates ongoing financial integration with the convergence of prices of similar financial products, the crossborder correlation of returns, and developments in crossborder financial flows. But the focus is mainly on how developments in the architecture of financial markets have advanced integration, including as a result of the EU Financial Sector Action Plan. Section A reviews the evolution in the markets for money, government and corporate bonds, securitization, interest rate derivatives, and equities. It concludes with a review of post-market infrastructures and retail finance. Section B discusses the FSAP and the evolving regulatory landscape. Section C concludes.
B. The Current State of Financial Integration in Europe75
Money Markets
97. The interbank money market is basically fully integrated, which is crucial for the conduct of a single monetary policy and to integrate financial markets. Domestic interbank money markets fully converged, merging into a single, unified euro interbank money market with the launch of the euro. This was the result of careful preparation, including the development of area-wide reference rates (EONIA and Euribor) and the building of cash payment system infrastructures (TARGET and EURO1).76 According to ECB survey data, cross-border interbank transactions (measured by the number of counterparties) represented about 54 percent of all interbank transactions in 2004.77
98. However, repo markets remain largely segmented along domestic lines.78 This reflects mainly the fragmentation of crossborder security clearing and settlement procedures rooted in differences in domestic legal and tax frameworks, technical requirements, and market practices. Some means are available to overcome hurdles (e.g., the Correspondent Central Banking Model—CCBM—for the monetary authorities and the triparty repo for market participants). Nevertheless, this fragmentation raises the cost of cross-border repo transactions, limits the pool of collateral that is effectively and readily available to market participants, and thus impairs the efficiency of the euro money market.79
99. Furthermore, fragmentation also affects the market for short-term securities, notably those of financial and corporate issuers. Key factors are the multiplicity of settlement circuits and differences in legal frameworks and disclosure requirements applying to issuers. As a result, well-established domestic markets and a newer, euro Commercial Paper (CP) market in London—where issuance of private CP has increasingly concentrated—operate side by side with few connections. This euro CP market has proved very dynamic and innovative, growing significantly in size and reaching a stock of securities of about euro 400 billion by June 2004.
100. For a truly euro area-wide money market to emerge, further changes are thus necessary. The Undertakings of Collective Investment in Transferable Securities (UCITS III) directive, which awaits implementation, is expected to harmonize the investment rules applying to money market funds and removes limitations on investment in commercial paper and other short-term securities. In addition, issuance practices and market conventions are still heterogeneous. In response, proposals to enhance standardization of money market securities, such as the Short-Term European Paper (STEP) project, have been put forward by market participants. Whether the short-term securities market can be integrated without active support of European and national domestic authorities, however, remains an open question.80
Government bond markets
101. EMU has fostered a deeper, more liquid, complete, and increasingly integrated government bond market. The convergence of yields shows the degree of integration of euro-area government bond markets. Furthermore, in the wake of EMU the volatility of yields has declined significantly and has been increasingly driven by common factors. Of course, some yield differences should be expected to persist because government bonds in the euro area are not perfect substitutes: countries carry different credit risks and there is no area-wide “bail out” mechanism.
102. Monetary union undid the segmentation that national currencies created in sovereign debt markets, introducing direct competition for an increasingly international pool of investors. The challenge for public debt managers is therefore to secure the attractiveness not only of their own debt, but more generally, of the euro government bond market, combining competition and cooperation.81 The harmonization of secondary market conventions, new issuance policies (the publication of auction calendars, the promotion of fungible benchmark issues, and the increased use of syndication), and active debt management on the secondary market have contributed to increasing the homogeneity, transparency and liquidity of public debt markets. Simultaneously, competing government debt issuers have expanded the range of products offered to investors.82
103. The transformation of secondary market infrastructures, notably growing electronic trading, has facilitated the integration of government bond markets, including the narrowing of spreads. The MTS network has become the main cash trading platform for European government bonds. It provides real time quotations from selected market makers to a wide range of professional participants, and automated electronic execution. Through market making obligations imposed on the participating dealers these platforms contribute to enhancing the liquidity and transparency of the secondary market. The characteristics of these electronic platforms, in particular liquidity arrangements and the organization of pre-trade transparency, may raise important issues regarding the resilience of the liquidity offered by these platforms, including somewhat “artificial” liquidity.83 Specifically, an important question in the context of the Financial Services Action Plan (FSAP) and the discussions surrounding the implementation of the Directive on Financial Markets Instruments (MiFID), is how pre-trade transparency affects the supply of liquidity, including the activities of large market participants.84
Corporate bond markets
104. EMU turned largely currency-driven domestic markets, dominated by highly-rated financial issuers, into an integrated and more diversified euro market. Issuance of non-government bonds by euro-area players grew significantly in years surrounding the introduction of the euro: non-government bond issues jumped from euro 273 billion in 1998 (less than 26 percent of the US volume) to euro 657 billion in 1999 (more than 74 percent of the US level), and stabilized in following years.
105. Investment strategies of institutional investors underscore the area-wide nature of the corporate bond market. The adoption of the euro has been associated with a large increase in the asset share of internationally investing bond funds, mostly at the time of the changeover. A similar shift took place in the investment policies of pension funds and life insurance companies. By 2003, in all euro-area countries more than half of the assets of bond funds were invested with an area-wide strategy. As a result, the role of country-specific factors behind bond prices and spreads relative to international and industry-specific factors has been declining. In Denmark, Sweden, and the United Kingdom, by contrast, the share of bond funds with a Europe-wide strategy has remained stable between 1998 and 2001.
106. The integration of investment banking activities has mainly benefited Europe’s larger corporations. Underwriting fees on corporate bond issues have been declining as investment banks realized economies of scale and barriers to entry in the underwriting businesses fell.85 The high degree of competition that characterizes the conduct of investment banking activities in Europe today is, to a large extent, related to the greater role played by US investment banks, which have expanded their market share. This situation of growing integration and competition in the provision of investment banking services for large corporations contrasts significantly with the fragmented financial markets facing Europe’s small and medium-sized enterprises.
Securitization markets
107. Securitization, virtually non-existent in the mid-1990s, has been expanding rapidly but remains underdeveloped.86 A key obstacle to a deeper market is the absence of a common legal framework for pan-European securitization programs. The securitization landscape in Europe appears more like an aggregation of local markets, based on the use of different techniques and instruments. The United Kingdom’s dominant share in European securitization (assets originating from the United Kingdom represented 43.2 percent of ABS issuance in 2004 and close to 56 percent of MBS issuance) and, at the other end of the spectrum, the marginal volume of cash securitization originating from Germany (3.3 percent of the volume of new issuance) illustrates this situation.87 In the securitization market, maybe more than in other market segments in Europe, the need to overcome differences in legal frameworks and market fragmentation has translated into the development of “high-tech” financial products, based on sophisticated financial engineering.
108. Covered bond markets, by contrast, have a stronger footing in Europe. Balance sheet securitization represents an important segment of European financial markets: the size of the EU covered bond market stood at more than euro 1.5 trillion at the end of 2004, representing around 20 percent of the total European bond market. From Germany, the covered bond model has spread across Europe, including the United Kingdom.
Interest rate derivatives markets
109. Interest rate derivatives developed significantly since EMU.88 The growth of over-the-counter (OTC) euro-denominated futures has been especially significant at the short end of the market, where the development of liquidity management tools went hand in hand with the high degree of integration in the euro interbank money market.89 For exchange-traded derivatives, the transition to euro-denominated contracts after a period of fierce competition between exchanges and products, has ultimately resulted in the concentration of liquidity and activity in two sets of contracts: the Euribor-based 3 month Euronext-Liffe contract, and the series of German government debt-backed contracts developed by Eurex-Deutsche Boerse.
Equity markets
110. In equity markets, the strength of integration trends is less clear-cut. Equities show an increased correlation of price movements across countries and a convergence of premiums.90 This might reflect an increased synchronization of fundamentals among euro-area countries as well as the fact that the larger, listed firms are increasingly globally-operating companies. At the same time, the correlation of sector returns appears to have risen as well.
111. Consolidation of trading infrastructures is proceeding but significant fragmentation remains. The three main trading platforms—Euronext group,91 which ties markets of different sizes in a decentralized but technically uniform trading environment, Deutsche Boerse Group, and the London Stock Exchange—offer different organization models. Competition between established stock exchanges and from new trading devices (multilateral trading facilities and the internalization of orders) benefits issuers and investors through a decline in trading costs. Nonetheless, the current situation remains unsatisfactory in many respects. Competing platforms can result in a fragmentation of liquidity, a risk which the trading architecture promoted by the recent MiFID might amplify.
Post-market infrastructures
112. Inefficiencies in the clearing and settlement of cross-border securities transactions and the absence of a clear, widely agreed model for the future organization of the industry represent a major hurdle toward an integrated area-wide financial market. In contrast with market participants, who have adopted an increasingly global approach to European financial markets, clearing and settlement infrastructures remain organized around pre-existing domestic structures. In 2001, the Giovannini group identified 15 barriers to cross-border securities transactions, arising from differences in technical requirements, market practices, domestic tax procedures, and domestic laws and regulations (Appendix IV.B). The group proposed a global strategy combining actions by market participants and public authorities to remove these barriers. The removal of these barriers will not necessarily dictate how the structures of the clearing and settlement industry will evolve, but can be expected to increase the pressure for the consolidation of post-market infrastructures.
113. The post-trading treatment of transactions is complex and a source of additional costs and delays for crossborder transactions. European and non-European investors seeking to diversify their portfolios across Europe face largely identical technical difficulties in the settlement of their crossborder transactions and have expressed similar discomfort with the current situation. Different crossborder clearing and settlement channels are available.92 Global custodians and ICSDs appear to be the most common venue for crossborder transactions in European financial markets, as they offer a single entry point, in particular for non-euro resident investors who have no “natural” base in any euro-area country. As a result of the fragmentation, crossborder clearing and settlement involve multiple intermediaries. This raises costs, magnifies credit and operational risks, and contributes to delays for market participants.93
114. Consolidation in the clearing and settlement industry has taken different forms at the domestic and European levels, but remains incomplete. The Euronext/ClearnetLCH/Euroclear partnership illustrates the horizontal approach to consolidation among institutions providing similar services. This approach contrasts with the more vertical consolidation in the Deutsche Boerse group, where trades concluded on the Xetra (cash) or Eurex (derivatives) platforms are cleared, netted, and settled through subsidiaries of Deutsche Boerse.
115. Given the importance of clearing and settlement arrangements for achieving a truly integrated financial market, the European Commission has now focused on the issue. The MiFID is expected to contribute to improving crossborder clearing and settlement efficiency, as it extends the rights of market intermediaries (investment firms and banks) and regulated markets to access Central Counterparties and Securities Settlement Systems located in other member states under non-discriminatory conditions. Furthermore, investment services providers are now granted the right to choose the settlement location for their transactions (but not the right to choose their clearing location), thus eliminating the need to maintain multiple memberships in Securities Settlement Systems. This partial opening to more competition, however, will need to be complemented in a forthcoming framework directive to further advance integration.
Retail finance
116. Retail financial services, for individuals and small and medium-size businesses, remain highly fragmented. Limited convergence of interest rates—to the extent measurable given the diversity of products—suggests that the market for consumer loans shows very little integration. By that measure, the mortgage market appears somewhat more integrated, possibly reflecting collateralization, which reduces the need for monitoring and enables securitization and competition. Nonetheless, crossborder activity remains marginal (only 1 percent of European consumers are believed to take mortgage loans from other member state institutions). While the costs of mortgages appear to be fairly uniform across countries, available mortgage products differ across national markets.94 Integration has begun in the market for time deposits but not for savings deposits, possibly because of the role of taxation and regulation.
C. The FSAP and the Evolving Regulatory Landscape
Key aspects of the Financial Services Action Plan
117. The purpose of the Financial Services Action Plan (FSAP) is to remove regulatory and market barriers that limit the cross-border provision of financial services and the free flow of capital within the EU. The FSAP is a multi-faceted approach that addresses the major issues of financial market organization, seeking to create a level playing field among market participants and to support the integration of European financial markets (Appendix IV.C). The FSAP and the additional measures that have been agreed in response to market developments are the backbone of the future architecture of European financial markets.95 They comprise a number of interlocking projects and directives, three of which are particularly far-reaching with respect to the development of markets.
118. The Markets in Financial Instruments Directive (MiFID) is, to a large extent, the cornerstone of the FSAP. The MiFID has the potential to strongly reshape European financial markets, starting with equity markets. The directive will provide securities firms with an updated EU passport, allowing them to offer a range of financial services across member states on a “home country control” basis. Key features of the directive are the promotion of open market architecture, competition between regulated and unregulated markets, and the search for a balance between market efficiency and investor protection, in particular through complex order execution and transparency rules. Following requests from the Member States and industry, the EU Commission proposed on June 20, 2005 to extend the transposition and implementation deadlines for the MiFID by six months each, thus delaying full implementation by a year until April 30, 2007.
119. Two further directives—the prospectus and transparency directives—are particularly important. They seek to unify the rules imposed on issuers regarding financial information. The absence of harmonized financial disclosure rules for European corporations and the general shortcomings in available financial information have frequently been pointed out by international investors. Together with the unification of the accounting framework, these directives seek a significant improvement: investors (particularly retail investors) will benefit from better and more homogeneous information, while issuers will be able to issue across EU markets on the basis of a single prospectus.96 Regarding bond issues, the disclosure requirements imposed on issuers vary depending on whether they are deemed to target wholesale or retail investors.97 There are fears that this new framework may prove excessively cumbersome and expensive, particularly for non-European companies. Some companies are already choosing to list their shares and eurobonds in venues that are unregulated in the sense of European Directives.98 By offering investors and issuers additional choice, these developments should contribute to the completeness of European financial markets. A risk, however, is that they foster the creation of opaque, unlisted markets that would weaken the benefits of the new framework for investor protection.
The Lamfalussy process
120. The so-called Lamfalussy process is the major vehicle for the design and the implementation of the FSAP regulatory work. Its objective is to speed up the legislative process, deliver more uniform and better technical regulation, and facilitate supervisory convergence. Initially limited to the securities markets, the Lamfalussy process was extended in November 2003 to the banking, insurance, and pension sectors as well as to the mutual funds industry. It is organized in four layers:
The core principles of legislation take the form of directives and regulations adopted by the political bodies, the European Council and the Parliament (Level 1), on the basis of proposals prepared by the Commission.
Technical implementation of framework directives and regulations is done by the European Commission, on the basis of recommendations made by high level regulatory committees (Level 2), in consultation with Level 3 committees, and users and experts from the industry.99
The implementation of EU legislation at the national level is the task of expert committees composed of national regulators and central banks (Level 3).100 Level 3 committees are responsible for supporting a consistent day-to-day implementation of EU legislation, by issuing guidelines and reviewing national regulatory practices.
Compliance with and enforcement of legislation by member countries is mainly the responsibility of the European Commission (Level 4).
121. It will take several years for the benefits of implementation measures to fully materialize and thus it is too early to draw strong conclusions on the impact of the FSAP and Lamfalussy process. The adoption of most Level 1 legislation is an initial success for the Lamfalussy framework. Level 2 and 3 committees are now taking the center stage, with responsibility for the technical transcription of framework directives and their implementation in member states. For developments on the ground, much will depend on how Level 2 and 3 committees, particularly the latter, conduct their work. The role of such committees will be especially important in areas where the principle of the single passport granted by the home country has to be implemented, and where cross-border competition can be seriously undermined by host-country regulation. At both Level 2 and 3, a significant further strengthening of cooperation between national authorities will be required to avoid risks of “renationalization” of regulation (Level 2) and to ensure the convergence of supervisory practices (Level 3), in lieu of a single “federal” regulator/supervisor.
122. The implementation of MiFID illustrates the operation of the FSAP and the Lamfalussy process and offers a major test. The directive is a compromise between initially significantly diverging domestic approaches to market regulation. Key will be the ability of the Committee of European Securities Regulators to foster genuine cooperation by national authorities in the design of the implementing measures to achieve a convergence of supervisory practices, preserve the directive’s cohesion, and avoid its dilution.
D. Summary and Outlook
123. The establishment of EMU has been a major force in the transformation of financial markets in Europe. The dynamics associated with the creation of the euro, the removal of exchange rate risk and restrictions on holdings of foreign assets, and the implementation of a common monetary policy have significantly accelerated the pace of financial integration. From the point of view of market participants integration should allow access to the entire market without the need for establishing local presences and comply with different sets of rules. These are essential conditions for the development of crossborder flows and an efficient functioning of financial markets. The FSAP and the Lamfalussy process seek to put these conditions in place, by building a common rules book for financial service providers and securities markets and by seeking the convergence of supervisory practices.
124. However, the progress with respect to integration has been uneven. The contrast between the growing integration of wholesale financial markets and the continued fragmentation of retail-oriented financial services is striking, although the latter are expected to benefit indirectly from integration of the former. In general, unsecured markets (e.g., the interbank money market) exhibit a much higher level of integration than securities and collateralized markets. Among securities markets, bond markets appear more integrated than equity markets. The former are essentially over-the-counter (OTC) markets, targeting primarily institutional investors, while the latter are largely regulated markets, with an active base of retail investors. Whether cash or derivatives, OTC markets, which are more flexible, have been spearheading financial innovation in Europe.
125. Furthermore, various critical issues have yet to be addressed and the Commission’s “Green Paper on Financial Services Policy (2005–10)” is proposing key steps:
The creation of an integrated and barrier-free clearing and settlement system is a crucial element for the completion of an integrated and efficient European capital market. The obstacles to efficient cross-border settlement are not only technical but also legal, grounded in differences in national corporate laws. Therefore, removing these barriers will ultimately require complementary actions by market participants and public authorities. This process should be market-driven, whenever possible, rather than following a centrally-imposed blueprint. However, different market players may have different interests—as traders, asset managers or providers of brokerage and custody services—and thus a collective vision may not emerge, leading to the loss of important, network-related returns to scale. At this stage, the authorities should, as a first step, foster effective competition and choice by promoting and enforcing the principles of interconnectivity and unrestricted access to post-market services.
The existing single market framework for investment funds needs further development, especially given Europe’s need for retirement savings ahead of the looming demographic shock. The European fund management industry is believed to represent over euro 10 trillion in assets, roughly the size of EU-15 GDP. Despite a succession of regulatory steps, including the recent UCITS III directive, the asset management industry in Europe still operates in a largely fragmented environment, where legal and tax barriers hamper the development of crossborder investment products. In 2003, only 18 percent of investment funds, representing 31 percent of assets under management, were considered “true” crossborder funds. The industry has identified some priorities, including simplifying notification procedures for “passporting” funds; facilitating crossborder fund mergers; recognizing asset pooling techniques; allowing flexibility in the choice of depository and fund administrators; and eliminating discriminatory tax barriers.101 But this process is likely to take time. The creation of a “26th regulatory regime” (i.e., investment products that would largely “bypass” national regulations in favor of a common body of core European rules in terms of investor/consumer protection) could accelerate the provision of cross-border investment services and foster the convergence of national regulations.
An EU framework for alternative investment vehicles may be required too. Considering the evolution of the financial services industry and the changes in asset markets in recent years, the scope of the single passport for investment companies may need to be adjusted and complemented to cover hedge funds, private equity and venture capital funds, and real estate and commodity funds. Specific regulations covering these funds have been implemented in various European countries in recent years, in a rather uncoordinated and unharmonized way, adding to the fragmentation of the industry.
The benefits of financial integration have been hardly felt on retail markets up to now, and the FSAP contains few retail-oriented initiatives.102 In retail finance, language and legal systems, in particular consumer protection issues, play an important role. Since retail financial products are not standardized, these background elements complicate the integration process, and make the outcome of regulatory initiatives far less certain. Considering the significant information asymmetries in retail credit markets and the limited effect of deregulation and technological progress on crossborder retail business thus far, a local presence may well remain necessary to access new retail markets. Ensuring that obstacles to crossborder consolidation in the banking sector are effectively removed will therefore have to remain a priority for EU authorities.
126. Progressing towards deeper financial integration in the “post-FSAP” period will require renewed efforts. The European Commission has acknowledged that there would not be an “FSAP-2.” But the work on integrating markets will continue, as proposed in the Green Paper, particularly with the implementation of the many ongoing initiatives. The Lamfalussy process is the key tool to achieve a homogeneous implementation of FSAP regulations, but the success of the process cannot be taken for granted. The Lamfalussy approach (in particular Level 2 and 3 committees) relies heavily on consensus-building and the willingness of different stakeholders to move forward. An important concern is that the whole process can be derailed by “national interests” or lose momentum as regulatory fatigue takes its toll. Carefully calibrating the articulation of Level 2 and 3 committees, and maintaining the dynamics of regulatory and supervisory convergence will have to remain among the top priorities of the Commission.
127. Keeping up the pace of eliminating legal and regulatory hurdles will be challenging. Issues related to taxation and differences in legal systems—notably between civil and common law approaches—are now among the main obstacles to further integration. The purely technical obstacles to financial integration have been or are being addressed. Tax and legal obstacles, however, will be much harder to overcome. Thus, the progress in removing legal and tax-related obstacles to deeper integration will likely slow relative to the rapid pace of the past 10-15 years.
128. As the integration of European financial markets deepens and markets develop, new risks for financial stability may emerge. New risks for financial stability may emerge in the period ahead as financial markets continue to grow in size and complexity at a time of ongoing transition to a more integrated market. This may facilitate the spreading of shocks across countries. In addition to completing the existing technical agenda to limit or eliminate remaining obstacles and sources of friction, a thorough and rapid convergence of regulatory and supervisory doctrine and practices is crucial to managing these risks. Such a convergence should improve the ability of the authorities to weather crisis situations. Also, it would enhance the attractiveness and effectiveness of European financial markets in intermediating between savers and investors.
APPENDIX IV.A
Euro Area: Three-Month Interest Rates 1/
(In percent)
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: Bloomberg L.P.1/ Three-month interbank borrowing rates. For euro area, the domestic borrowing rates are replaced by EURIBOR starting January 1, 1999.Euro Area: Three-Month Interest Rates 1/
(In percent)
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: Bloomberg L.P.1/ Three-month interbank borrowing rates. For euro area, the domestic borrowing rates are replaced by EURIBOR starting January 1, 1999.Euro Area: Three-Month Interest Rates 1/
(In percent)
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: Bloomberg L.P.1/ Three-month interbank borrowing rates. For euro area, the domestic borrowing rates are replaced by EURIBOR starting January 1, 1999.
European Union: Long-Term Government Bond Spreads 1/
(In basis point)
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: Bloomberg L.P.1/ Spread between yield on 10-year government bond and 10-year German government bond.European Union: Long-Term Government Bond Spreads 1/
(In basis point)
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: Bloomberg L.P.1/ Spread between yield on 10-year government bond and 10-year German government bond.European Union: Long-Term Government Bond Spreads 1/
(In basis point)
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: Bloomberg L.P.1/ Spread between yield on 10-year government bond and 10-year German government bond.
European Union: Long-Term Government Bond Spreads 1/
(In basis points)
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: Bloomberg L.P.1/ Spread between yield on 10-year government bond and 10-year German government bond.European Union: Long-Term Government Bond Spreads 1/
(In basis points)
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: Bloomberg L.P.1/ Spread between yield on 10-year government bond and 10-year German government bond.European Union: Long-Term Government Bond Spreads 1/
(In basis points)
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: Bloomberg L.P.1/ Spread between yield on 10-year government bond and 10-year German government bond.
Euro Area: Euro-Denominated Nonfinancial Corporate Bond Issuance
(In billions of euros; issuance in national currencies before 1999)
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: Dealogic Bondware.Euro Area: Euro-Denominated Nonfinancial Corporate Bond Issuance
(In billions of euros; issuance in national currencies before 1999)
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: Dealogic Bondware.Euro Area: Euro-Denominated Nonfinancial Corporate Bond Issuance
(In billions of euros; issuance in national currencies before 1999)
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: Dealogic Bondware.
European Securitization
(Issuance in billions of euros)
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: ESF Securitization Data Report.European Securitization
(Issuance in billions of euros)
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: ESF Securitization Data Report.European Securitization
(Issuance in billions of euros)
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: ESF Securitization Data Report.
Three-month Interest Rate Future Contracts: Evolution of Open Interest 1/
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: Datastream.1/ In Euribor equivalent number of contracts.Three-month Interest Rate Future Contracts: Evolution of Open Interest 1/
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: Datastream.1/ In Euribor equivalent number of contracts.Three-month Interest Rate Future Contracts: Evolution of Open Interest 1/
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: Datastream.1/ In Euribor equivalent number of contracts.
Open Interest: 10-Year Treasury and 10-Year Euro Bund 1/
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: Datastream.1/ Prior to 1999 data refer to German Bund; in Euro Bund equivalent number of contracts.Open Interest: 10-Year Treasury and 10-Year Euro Bund 1/
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: Datastream.1/ Prior to 1999 data refer to German Bund; in Euro Bund equivalent number of contracts.Open Interest: 10-Year Treasury and 10-Year Euro Bund 1/
Citation: IMF Staff Country Reports 2005, 266; 10.5089/9781451813029.002.A004
Source: Datastream.1/ Prior to 1999 data refer to German Bund; in Euro Bund equivalent number of contracts.Distribution of European Corporate Bond Issuers by Whole Letter Rating
Distribution of European Corporate Bond Issuers by Whole Letter Rating
| 1985 | 1990 | 1995 | 2000 | 2002 | 2003 | |
|---|---|---|---|---|---|---|
| Aaa | 17 | 59 | 50 | 59 | 61 | 59 |
| Aa | 2 | 73 | 152 | 247 | 274 | 244 |
| A | 10 | 43 | 180 | 328 | 363 | 385 |
| Baa | 1 | 2 | 31 | 135 | 180 | 191 |
| Ba | 1 | 3 | 13 | 34 | 33 | 44 |
| B | 1 | 1 | 8 | 63 | 65 | 67 |
| Caa-C | 0 | 0 | 1 | 19 | 30 | 22 |
| Investment grade | 30 | 177 | 413 | 769 | 878 | 879 |
| Speculative grade | 2 | 4 | 22 | 116 | 128 | 133 |
| All issuers | 32 | 181 | 435 | 885 | 1006 | 1012 |
Distribution of European Corporate Bond Issuers by Whole Letter Rating
| 1985 | 1990 | 1995 | 2000 | 2002 | 2003 | |
|---|---|---|---|---|---|---|
| Aaa | 17 | 59 | 50 | 59 | 61 | 59 |
| Aa | 2 | 73 | 152 | 247 | 274 | 244 |
| A | 10 | 43 | 180 | 328 | 363 | 385 |
| Baa | 1 | 2 | 31 | 135 | 180 | 191 |
| Ba | 1 | 3 | 13 | 34 | 33 | 44 |
| B | 1 | 1 | 8 | 63 | 65 | 67 |
| Caa-C | 0 | 0 | 1 | 19 | 30 | 22 |
| Investment grade | 30 | 177 | 413 | 769 | 878 | 879 |
| Speculative grade | 2 | 4 | 22 | 116 | 128 | 133 |
| All issuers | 32 | 181 | 435 | 885 | 1006 | 1012 |
APPENDIX IV.B
Main Barriers to Cross-Border Clearing and Settlement of Securities (Giovanntni Reports)
Main Barriers to Cross-Border Clearing and Settlement of Securities (Giovanntni Reports)
| Nature and form of Barriers | Impacts |
| Technical Requirements, Market Practices | |
| Information technology and interfaces: lack of standardization (connection and messaging protocols, reporting requirements) among platforms | Multiplication of back office interfaces (duplication of costs), investors constrained in the choice of custodians |
| National clearing and settlement restrictions: Investors required to use designated domestic systems, or exclusive links between the different elements of a national securities market. | Market participants prevented from centralizing their clearing and settlement operations |
| Domestic rules related to corporate actions, beneficial ownership and custody of securities: Management of corporate actions and definition of beneficial ownership differs from one country to another | Impediment to the centralization of settlement and custody, difficulties in the treatment of open transactions |
| Impediments to remote access to national clearing and settlement systems: Rules may differ for the cash and security legs of a transaction | Remote access unworkable in practice, or remote participants at a disadvantage |
| Differences in settlement periods and operating hours: Differences in operating hours, either between national systems, between cash and security settlement systems, or within a settlement system | Mismatches in the settlement of obligations, requiring specific funding arrangements |
| Securities issuance practices: Uneven capability across securities market to allocate ISIN numbers in real-time | Absence of an efficient same-day distribution mechanism |
| Restrictions on the location of securities: Requirement/practice to deposit issues/settle trades in local systems | Issuers constrained in the placement of their issues |
| Restrictions on the activity of primary dealers: Primary Dealers required to set up a local presence and use local settlement systems | Inability to centralize cross-border settlements |
| Tax Related Barriers | |
| Domestic withholding tax regulations: Need to use a local agent for the provision of withholding tax services | Uneven playing field between intermediaries |
| Organization of transaction tax collection: Collection of transaction tax through the local settlement system | Constraint on the choice of a settlement system |
| Legal certainty of transactions: National differences in the legal treatment of securities, the definition of the finality of securities&transfers, the legal treatment, and availability, of netting, conflicts of applicable law | Uncertainties in the legal status of transactions |
Main Barriers to Cross-Border Clearing and Settlement of Securities (Giovanntni Reports)
| Nature and form of Barriers | Impacts |
| Technical Requirements, Market Practices | |
| Information technology and interfaces: lack of standardization (connection and messaging protocols, reporting requirements) among platforms | Multiplication of back office interfaces (duplication of costs), investors constrained in the choice of custodians |
| National clearing and settlement restrictions: Investors required to use designated domestic systems, or exclusive links between the different elements of a national securities market. | Market participants prevented from centralizing their clearing and settlement operations |
| Domestic rules related to corporate actions, beneficial ownership and custody of securities: Management of corporate actions and definition of beneficial ownership differs from one country to another | Impediment to the centralization of settlement and custody, difficulties in the treatment of open transactions |
| Impediments to remote access to national clearing and settlement systems: Rules may differ for the cash and security legs of a transaction | Remote access unworkable in practice, or remote participants at a disadvantage |
| Differences in settlement periods and operating hours: Differences in operating hours, either between national systems, between cash and security settlement systems, or within a settlement system | Mismatches in the settlement of obligations, requiring specific funding arrangements |
| Securities issuance practices: Uneven capability across securities market to allocate ISIN numbers in real-time | Absence of an efficient same-day distribution mechanism |
| Restrictions on the location of securities: Requirement/practice to deposit issues/settle trades in local systems | Issuers constrained in the placement of their issues |
| Restrictions on the activity of primary dealers: Primary Dealers required to set up a local presence and use local settlement systems | Inability to centralize cross-border settlements |
| Tax Related Barriers | |
| Domestic withholding tax regulations: Need to use a local agent for the provision of withholding tax services | Uneven playing field between intermediaries |
| Organization of transaction tax collection: Collection of transaction tax through the local settlement system | Constraint on the choice of a settlement system |
| Legal certainty of transactions: National differences in the legal treatment of securities, the definition of the finality of securities&transfers, the legal treatment, and availability, of netting, conflicts of applicable law | Uncertainties in the legal status of transactions |
APPENDIX IV.C
FSAP: Main Issues in Wholesale Financial Markets and Prudential Supervision
FSAP: Main Issues in Wholesale Financial Markets and Prudential Supervision
| Themes | Content |
| Market Abuse | Harmonized rules on the prevention of insider dealing and market manipulation on regulated and unregulated markets |
| Financial Markets Instruments | Regulation of the authorization, behavior and conduct of business of securities firms and exchanges |
| Prospectus | Single passport for issuers of equity and debt securities on the basis of the prospectus approved by the regulatory authorities of the issuer’s country |
| Transparency | Financial reporting and dissemination of information by securities issuers. Security providers required to provide detailed semi-annual information, and quarterly updates |
| Accounting | Implementation of IFRS |
| Regulation of UCITS depositaries | Progressive reduction in differences in national rules regarding the depositaries of assets in UCITS, including depositaries’ liability, the convergence of prudential requirements, transparency and investor information |
| Implementation of UCITS directives | Content and presentation of the simplified prospectus; clarification on the use of derivatives instruments by UCITS and the need to adapt risk management standard and investor protection |
| Occupational Pension Funds | Guidance principles for asset allocation, in line with the “prudent person rule,” and call for the elimination of discriminatory tax provisions |
| Settlement Finality | Reduction of systemic risk in payment and securities settlement systems |
| Status of Collateral | Increased legal certainty regarding the validity and enforceability of collateral arrangements backing cross-border transactions |
| Cross-Border mergers | Rules governing take-over bids and the protection of minority shareholders |
| Statutory Audit | Clarification of the duties and responsibilities of statutory auditors, independence and ethics; Criteria for national public oversight of the audit profession |
| Capital Framework for Banks and Investment Firms | Implementation of Basel II |
| Financial Conglomerates | Identification of &significant financial groups& and designation of a supervisory co-coordinator for each conglomerate |
| Reinsurance Supervision | Harmonization of supervisory methods, removal of the remaining barriers for intra-EU cross border reinsurance activities, and increased protection of policy holders |
| Insurance Solvency | Creation of a consistent risk-based insurance solvency system |
FSAP: Main Issues in Wholesale Financial Markets and Prudential Supervision
| Themes | Content |
| Market Abuse | Harmonized rules on the prevention of insider dealing and market manipulation on regulated and unregulated markets |
| Financial Markets Instruments | Regulation of the authorization, behavior and conduct of business of securities firms and exchanges |
| Prospectus | Single passport for issuers of equity and debt securities on the basis of the prospectus approved by the regulatory authorities of the issuer’s country |
| Transparency | Financial reporting and dissemination of information by securities issuers. Security providers required to provide detailed semi-annual information, and quarterly updates |
| Accounting | Implementation of IFRS |
| Regulation of UCITS depositaries | Progressive reduction in differences in national rules regarding the depositaries of assets in UCITS, including depositaries’ liability, the convergence of prudential requirements, transparency and investor information |
| Implementation of UCITS directives | Content and presentation of the simplified prospectus; clarification on the use of derivatives instruments by UCITS and the need to adapt risk management standard and investor protection |
| Occupational Pension Funds | Guidance principles for asset allocation, in line with the “prudent person rule,” and call for the elimination of discriminatory tax provisions |
| Settlement Finality | Reduction of systemic risk in payment and securities settlement systems |
| Status of Collateral | Increased legal certainty regarding the validity and enforceability of collateral arrangements backing cross-border transactions |
| Cross-Border mergers | Rules governing take-over bids and the protection of minority shareholders |
| Statutory Audit | Clarification of the duties and responsibilities of statutory auditors, independence and ethics; Criteria for national public oversight of the audit profession |
| Capital Framework for Banks and Investment Firms | Implementation of Basel II |
| Financial Conglomerates | Identification of &significant financial groups& and designation of a supervisory co-coordinator for each conglomerate |
| Reinsurance Supervision | Harmonization of supervisory methods, removal of the remaining barriers for intra-EU cross border reinsurance activities, and increased protection of policy holders |
| Insurance Solvency | Creation of a consistent risk-based insurance solvency system |
References
Adjaouté and Danthine, Equity Returns and Integration: Is Europe Changing? Oxford Review of Economic Policy, Vol 20, N° 4, 2004.
Allen, Chui and Maddaloni, Financial Systems in Europe, the USA, and Asia, Oxford Review of Economic Policy, Vol 20, N° 4, 2004.
Artus, Unification of the Euro Zone’s Sovereign Bond Market: the Favorable Effect and the Unfavorable Effect. Economic Research N° 2005-14, January 7, 2005.
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Bris, Koskinen, Nilsson, The Euro is Good After All: Corporate Evidence. Yale ICF Working Paper N° 02-26, August 2002.
Chailloux, Les Opérations de pension livrée tripartites, Banque de France, Monthly Bulletin, N° 133, January 2005.
Deutsche Boerse Group, The European Post-Trade Market, an Introduction, February 2005.
European Central Bank, Euro Money Market Study 2004, May 2005.
European Central Bank, The euro bond markets study, December 2004.
European Commission, Clearing and Settlement in the European Union - The Way Forward, Communication from the Commission to the Council and the European Parliament, April 2004.
European Commission, Financial Services, Tenth Report, June 2002.
European Commission, Financial Integration Monitor 2004, April 2004.
European Commission, FSAP: Progress and prospects. Final report from the Asset Management Expert Group, May 2004.
European Commission, Green Paper on Financial Services Policy (2005-2010), May 2005.
Freiras, Hartmann and Mayer, The Assessment: European Financial Integration, Oxford Review of Economic Policy, Vol 20, N° 4, 2004.
Giovannini Group, Cross-Border Clearing and Settlement Arrangements in the European Union, November 2001, Second Report on EU Clearing and Settlement Arrangements, April 2003.
Heinemann, Schroder, Schuler, Stirbock and Westerheide, Towards a Single European Market in Asset management, ZEW, May 2003.
Internal Market Directorate General, The Integration of the EU Mortgage Credit Markets, Report by the Forum Group on Mortgage Credit, December 2004.
International Securities Market Association, European Repo Market Survey N° 7, June 2004.
Madhavan, Porter, Weaver, Should Securities Markets be transparent?, January 2000.
NERA Economic Consulting, The Direct Costs of Clearing and Settlement: An EU-US Comparison, June 2004.
Pagano and Von Thadden, The European Bond Markets Under EMU, Oxford Review of Economic Policy, Vol 20, N° 4, 2004.
Remolona, Micro and macro Structures in Fixed-Income Markets: the Issues at stake in Europe, Workshop of the ECB-CFS Research Network on Capital markets and Financial Integration in Europe, ECB, 29-30 April 2002.
Santos and Tsatsaronis, The cost of barriers to entry: evidence from the market for corporate euro bond underwriting, BIS Working Papers No. 134, September 2003.
Schueler and Heinemann, How Integrated are the European Retail Financial Markets? A Cointegration Analysis.Center for Economic Research.
Prepared by Francois Haas (ICM).
See Appendix IV.A for illustrations.
TARGET (Trans-European Automated Real-time Gross settlement Express Transfer system), is run by the ECB and National Central Banks. EURO1, a net settlement system, is run by the Euro Banking Association.
The percentage of cross-border interbank transactions has declined slightly in the last 3 to 4 years, possibly reflecting the redistribution role performed by large banks to the benefit of smaller banks within countries and, within large banking groups, the concentration of treasury activities at the home country level.
A repurchase agreement (or repo) is an agreement between two parties whereby one party sells to the other a security at a specified price with a commitment to buy the security back at a usually pre-agreed later date, for a specified price. According to the European Repo Council, the gross size of repo transactions in euro amounted to euro 3.2 trillion in mid-2004, more than twice the estimated size in June 2001.
The CCBM is designed to allow Eurosystem counterparties to use eligible collateral issued (i.e. registered or deposited) in other euro area countries, by transferring collateral to an account maintained by the national central banks (NCBs) in the “issuing” Securities Settlement System (SSS). The local NCB will act as a correspondent central bank (CCB). In triparty repo transactions, the collateral and the cash are delivered by the trading counterparts to an independent custodian bank or clearing house which is responsible for ensuring the maintenance of adequate collateral value.
The STEP task force has been set up by the ACI-Euribor. Its recommendations for the establishment of a European market for short-term securities include, in particular, the use of a single set of market conventions and standardized information memorandum by issuers. While the ECB is supporting the launch of a “STEP label” it has not had the same catalytic role as for the EONIA initiative in 1998–99.
While there is no formal coordination of issuance policy between the debt agencies and treasuries, different venues, such as the EFC Sub-Committee on EU Government Bills and Bonds Markets allow for technical discussions and exchanges of information.
Constant maturity bonds, inflation-indexed bonds and, more recently, ultra-long maturity bonds. With a rapidly aging European population and in the context of a reform of public pension systems, ultra-long fixed income securities are expected to meet a growing demand from institutional investors with long term liabilities, such as pension funds and life insurers, and ultimately provide the necessary anchor for the development of new investment products.
The MTS system organizes quoted prices so that the best bid and offer prices are displayed, but layered behind these are a “depth of book” (i.e., other market makers’ prices that will be used when larger trades come through). This approach has many advantages: market makers can quote prices that are, in effect, conditional on the strength of demand; and traders can rapidly execute large complex trades, confident that they are getting the best price for each trade.
Madhavan and Porter (2001) find that on the Toronto Stock Exchange, the increase in pre-trade transparency (public dissemination of the limit order book) had detrimental effects on liquidity (volatility and execution costs), and on the depth of the market.
Average gross fees in the euro denominated corporate bond market halved in 1999 (from 1.7 to 0.8 percent), and have remained around 0.6 percent since then, a level similar to the United States.
In 2004, new issuance of Asset Backed Securities (ABS) and Mortgage Backed Securities (MBS) grew by 15 percent and 10 percent, respectively, in Europe, to euro 105.1 and 138.5 billion, respectively. New issuance grew by 53.2 percent (to euro 896.6 billion) and 12.4 percent (to US dollar 387.4 billion) in the US. The latter figure refers to private-label MBS. When taking into account Agency MBS and Collateralized Mortgage Obligations (CMO) issuance, overall new issuance in the US declined by 42.6 percent (to US dollar 1.76 trillion).
In 2004, the “True Sale Initiative” became operational, and should facilitate the development of a securitization market in Germany.
Daily average transactions in over-the-counter interest rate derivatives denominated in euro represent, according to the 2004 BIS survey of derivatives markets, 45 percent of OTC interest rates derivatives (forwards, swaps and options), ahead of US dollar denominated contracts (33.9 percent).
Interest rate swaps indexed on the overnight euro reference rate are estimated to represent an daily average turnover of euro 40 billion.
See, for example, Adjaouté and Danthine (2004).
The Euronext group brings together the stock markets of Paris, Brussels, Amsterdam, and Lisbon, as well as the LIFFE derivatives exchange.
They can rely on local/correspondent banks, who are members of the foreign Central Securities Depositories (CSDs), operate through an International Central Securities Depositary (ICSD) or a global custodian, or use, when available, direct links between CSDs (such direct links do not exist between all CSDs and, furthermore, often offer only “free-of-payment” securities transfer facilities, meaning that the cash component of the transaction has to be processed independently, through another system).
Direct costs comparisons are difficult, due to differences in fee structures and services. Based on a bottom-up approach, Deutsche Boerse/Clearstream estimated that the average cost per transaction was between 29 percent (wholesale transactions) and 152 percent (retail transactions) higher in crossborder operations than in domestic operations. The 2001 Giovannini report also offers an indirect estimate of differences in costs for domestic and crossborder transactions, based on per-transaction income of CSDs and ICSDs, with the cost of the latter being up to 11 times higher than the cost of the former. Furthermore, according to a 2004 NERA/City of London study, direct clearing and settlement costs in Europe are significantly higher than in the United States, for domestic transactions (by a range of factors from 3 to 8, depending on the market) and even more for cross-border transactions (by a range of factors from 5 to more than 300, depending on the channel of settlement).
In December 2004, the Forum Group on Mortgage Credit released a report, and offered a series of 48 recommendations to the European Commission on how to better integrate mortgage markets across the EU, addressing issues such as consumer confidence (harmonization of early repayment fees, harmonization of the way the Annual Percentage Rate Charge is calculated), legal and collateral framework (need to avoid conflicts of law, facilitate cross-border mortgage contracting, flexibility of the link between mortgage debts and the collateral security), and distribution of mortgage products (equal treatment between local and foreign banks).
The FSAP was endorsed by the European Council in March 2000, with the deadline for the adoption of EU-level legislative measures set for 2005.
Significant differences remain, however, in domestic corporate laws, for instance regarding bankruptcy procedures, and may call for further harmonization.
Bond issues with a minimum denomination of € 50,000 are exempt from most of the directives’ requirements.
The Alternative Investment Market, a component of the London Stock Exchange, has relinquished its status as a Regulated Market to become an “Exchange Regulated Market.” Similarly, Euronext launched a new “organized” but unregulated market (Alternext), accessible to equity issuers with limited requirements, but still offering investors more guarantees than the so-called “free markets”. In the Eurobond market, similar initiatives have been launched in London, Luxembourg, Switzerland, and Norway.
Level 2 Committees are the European Securities Committee, the European Banking Committee, and the European Insurance and Operational Pensions Committee.
The Committee of European Securities Regulators (CSER), the Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS), and the Committee of European Banking Supervisors (CEBS).
See “Towards a Single European Market in Asset management,” May 2003, ZEW, and “FSAP: Progress and Prospects. Final report from the Asset Management Expert Group,” May 2004.
While there is little cross-border competition among banks in the retail sector, within national markets competition has increased in recent years.
