Fortress Europe or Open Door Europe? The External Impact of the EU’s Single Market in Financial Services

Andreas Dür

Accepted for publication in the Journal of European Public Policy (2011)

Abstract I argue that the intra-European integration of services trade, even if it threatens to impose costs on third countries in the short run, on average makes the European Union (EU) more open to foreign service providers. The reasoning is that third countries are likely to respond to discrimination in ways that ensure continued openness of the EU. This may be achieved by (a combination of) concessions that entice a change in the EU’s policies, unilateral policy changes, or threats that force EU policy adjustments. Regional integration in the service sector thus does not result in Fortress Europe but in Open Door Europe. I show the plausibility of this argument by analyzing the external consequences of three steps towards completing the Single Market in the area of financial services.

Key words: European Union, financial services, Single Market Programme, trade policy, transatlantic relations

Introduction Over the last two decades, as key part of the single market project, European Union (EU) member states have agreed to a stepwise integration of the EU’s financial services markets (for studies of these developments, see Mügge 2006; Quaglia 2007; Grossman and Leblond 2011).1 One of the first steps in this process was the Second Banking Directive of 1989, which introduced mutual recognition of banking laws and banking licenses. A decade later, the European Commission presented the Financial Services Action Plan (FSAP), which contained 42 measures aimed at facilitating the intraEuropean provision of financial services. A speedy implementation of the plan became possible once the Council of Ministers decided that several directives included in the FSAP would be adopted under a new decision-making procedure, known as the Lamfalussy process. In 2005, the Commission followed up with an additional set of proposals that led to an even further integration of the EU’s financial services market. Remarkably, as several indicators suggest, this internal liberalization has not made the EU more protectionist vis-à-vis foreign providers of financial services. First, EU financial service imports from third countries increased rapidly over the last two decades. Between 1996 and 2005, the EU-15’s financial services imports grew from €8.7 billion to €21.7 billion, an increase by nearly 150 percent (Eurostat 2006: 45 and 2007: 62).2 Financial services imports from the U.S., the EU’s most important trading partner in this sector, even went up from €2.8 billion to €7.4 billion over the same period, an increase by 164 percent (Eurostat 2006: 51 and 2007: 68). Second, the EU has been proactive in WTO negotiations to liberalize trade in financial services in parallel to the implementation of the single market project (Hoekman and Sauvé 1994; Dobson and 1

Jacquet 1998: 84). Finally, the EU’s high degree of openness in this sector is also confirmed by recent reports on foreign trade barriers by the United States Trade Representative, which do not list any trade barriers for United States (U.S.) exports of financial services to the EU (see, for example, United States Trade Representative 2009). My explanation of this outcome assumes that moves towards further integration of services markets in Europe often have the potential to impose costs on providers in third countries. These third-country providers react to the threat, and ask their government for help in maintaining existing competitive conditions. In response, the third country offers concessions to entice a change in EU policies, undertakes unilateral adjustments that reduce the costs for their services providers, or uses a threat to force the EU to take into account the interests of third-country providers. In any of the three scenarios, the expectation is that moves towards closer integration in Europe do not lead to the creation of Fortress Europe but may even make the EU more open to firms from third countries. The analysis of the external consequences of three moves towards European integration in the field of financial services – namely, the Second Banking Directive and two measures included in the FSAP – shows the plausibility of the argument. In making this argument, I take issue with a literature that views regional integration as stumbling block for further liberalization (for the stumbling block terminology, see Bhagwati 1991).3 Such a stumbling block scenario may result because internal market opening within a regional trade agreement imposes costs on importcompeting interests, making them lobby for more protection against competitors from third countries. Internal liberalization may also satisfy the demands of the more competitive parts of the economy for better foreign market access, causing them to stop

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their lobbying for external liberalization. Lastly, the decision-making rules in regional trade agreements may give countries with restrictive policies the possibility to block regulations that are open towards third countries. On the basis of these arguments, when witnessing the implementation of the Single Market Programme in the late 1980s, many observers raised the spectre of a “Fortress Europe”, which would combine internal free trade with a protectionist external trade policy (see, for example, Aho 1994; Wolf 1994). For the case of financial services, my paper contests this literature’s expectation that the preferential liberalization of trade nearly inevitably makes it more difficult for thirdcountry producers and providers to export to this market. Beyond establishing this point, the paper makes several contributions to broader scholarly debates. It adds to a growing literature on the external consequences of the Single Market project (see, for example, Hocking and Smith 1997; Young 2004; Posner 2009; Bach and Newman 2010). While many of the more recent studies in this field approach the topic from a politics-of-regulation perspective, this paper builds on the trade policy literature to address the question of the EU’s openness to third-country providers. The paper also provides a rare study of EU trade policy in the services sector. That there is so little research on this area of the EU’s external relations is astonishing given that services account for 77 percent of the EU’s economy (European Commission 2007), and that Europe is the largest importer and exporter of services in the world. The External Effects of a Preferential Liberalization of Services Trade The external economic consequences of the preferential liberalization of goods trade are fairly straightforward (Panagariya 2000). Already in 1950, Jacob Viner (1950) realized that the preferential reduction of tariffs may impose costs on third countries by way of 3

trade diversion. To the extent that market integration leads to an acceleration of economic growth in the member countries, preferential trade liberalization may also lead to an increased demand for some imports. This effect is unlikely to offset the costs imposed by trade diversion, however, as it will be felt in the longer term, and the benefits may not accrue to the same producers that suffer the costs. In sectors with economies of scale, trade diversion is likely to have more severe consequences than in other sectors, since producers suffering from trade diversion may lose cost advantages as their production decreases. Two particularities of services trade make an assessment of the external economic consequences of the regional integration of services markets more difficult (Mattoo and Sauvé 2007; Fink and Jansen 2009). First, since many services cannot be transported easily, the provision of services often necessitates physical proximity between the provider and the consumer of a service. In the terminology of the General Agreement on Trade in Services, these services require consumption abroad, commercial presence, or the presence of natural persons (World Trade Organization 1994). Services trade thus cannot be neatly separated from foreign direct investments (capital mobility) and the free movement of persons (labour mobility). In fact, according to World Trade Organization (2005: 8) estimates, commercial presence accounts for 50 percent of all services trade (as compared to 35 percent for cross-border supply). Second, services trade is affected by behind-the-border regulations rather than tariffs. Such behind-the-border regulations may be imposed to ensure policy objectives other than protecting domestic providers of services. Protectionist barriers hence may be incidental side-effects of policies that serve other primary objectives.

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Despite these particularities, the conclusion that the preferential liberalization of trade is likely to produce some (short-term) costs for third countries extends to services trade (Mattoo and Fink 2002; Mattoo and Sauvé 2007). In the words of Mattoo and Fink (2002: 10), “The exemption from a wasteful regulation implies reduced costs for a class of suppliers and hence a decline in prices in the importing country. This decline in prices hurts third country suppliers who suffer reduced sales and a decline in producers’ surplus.” The costs for third country providers arise independent of whether the member countries of a preferential services agreement pursue market integration by way of mutual recognition or harmonization. In the case of mutual recognition, third-country providers face the fixed costs of setting up in all participating countries, while providers from within the preferential trading area in which mutual recognition is applied face these costs only once (Mattoo and Fink 2002: 11-12). In the case of harmonization, trade diversion may be even more significant since decision rules and political economy reasons often induce member countries to agree on strict new rules (Young 2004), hence increasing the costs of compliance for third-country providers. Trade diversion in the services sector may also result from quantitative restrictions on the number of third-country service providers (as in air transport) or the amount of services they may provide (as in audiovisual services); restrictions on the movement of capital (branching rights) and labour (immigration rules); and discriminatory domestic regulations (qualification requirements). World trade rules impose relatively few restrictions on countries that consider including such discriminatory provisions in a preferential services agreement. Under the General Agreement on Tariffs and Trade (GATT), preferential trade agreements in goods

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have to cover “substantially all the trade between the constituent territories in products originating in such territories” (Article XXIV). By contrast, until 1994 the GATT did not deal with trade in services and thus there was no prohibition on discrimination in this sector. Under the General Agreement in Trade in Services (GATS) that has governed services trade among members of the World Trade Organization since 1994, bilateral or regional services agreements are only required to have “substantial sectoral coverage”, which makes it relatively easy to design agreements in ways that discriminate against third countries. The authors of a recent study on the subject hence refer to a “greater policy flexibility shown by WTO members towards preferential liberalization in services” than towards preferential liberalization in goods trade (Mattoo and Sauvé 2007: 261). The reliance on behind-the-border barriers, moreover, means that governments possess many subtle means to discriminate against foreign providers of services that are not available with respect to trade in goods. Finally, the potential for discrimination is higher with respect to services trade because multilateral liberalization commitments in that area still are very limited. The EU, for example, had multilateral liberalization commitments on less than 50 percent of its services trade prior to the Doha round of trade negotiations that has been ongoing since 2001 (Hoekman et al. 2007: 374). So far, the discussion has established two points: that there are many ways in which the regional integration of services markets can impose costs on third-country providers and that countries face few international restrictions to discrimination in services trade. My explanation for the external political effects of the preferential liberalization of services trade builds on these two points. It expects that many initiatives towards the regional integration of services markets initially include provisions that

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threaten to impose costs on providers in third countries. This is so because for electoral reasons, decision-makers in the member countries of a regional integration agreement often have an incentive to be more attentive to the concerns of domestic constituencies than those of foreign service providers.4 My reasoning is that when witnessing these discriminatory provisions, foreign service providers will mobilize with the aim of defending the existing competitive conditions. Facing losses, they will engage in lobbying to convince their government to resolve the issues they are worried about. As long as the interests concerned have enough political clout, the foreign government will respond to the lobbying effort with an initiative aimed at alleviating their situation. It will choose among one of three responses to the regional services agreement: threatening with retaliation to force the member countries to take into account third-country interests; offering concessions to entice the member countries to adjust their policies; or making unilateral policy changes that offset the policy choices of the members of the preferential agreement. Powerful countries (where power is a function of both structural characteristics – a country’s market size, trade dependence, and ability to divert exports and investments to third countries – and issue-specific factors such as the extent of the costs imposed on the third country) will respond to discrimination with a threat that forces the members of the preferential agreement to adjust their policies.5 A threat can even lead to the abortion of the attempt at creating or deepening a preferential services trade agreement. A less powerful country, by contrast, will either offer concessions to achieve a negotiated solution or make unilateral policy adjustments. The former strategy may entail opening up the third-country market to firms from the preferential agreement in exchange for an

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end to discrimination. The latter strategy may involve the unilateral adoption of standards and regulations that allow third-country firms to avoid discrimination. This strategy is akin to the “trading up” that has been observed in the fields of environmental and consumer regulation (Vogel 1995).6 As long as the response correctly reflects the distribution of bargaining power between the members of the preferential agreement and excluded countries, the former will accept a deal.7 The expectation hence is for preferential services trade liberalization that imposes short-term costs on third countries to be accompanied by a foreign reaction that aims at offsetting these costs. Services sectors that are liberalized within a preferential trade agreement will also be opened to imports from those third countries that react to the discrimination created in this process. For the case of the EU, the expectation is that even if European integration in the services sector potentially discriminates against providers from third countries, conflictive issues will be resolved in line with the political process set out above, ensuring that the creation of a Fortress Europe is avoided. I use three case studies on the external consequences of EU-internal market liberalization in the area of financial services to assess the plausibility of my argument. Focussing on financial services has the advantage that EU-internal liberalization in this area started early and has progressed quite far. Liberalization in many other services sectors has started only recently or has been limited, making it unlikely that there are major external consequences. The cases that I look at are the Second Banking Directive (1989), the Financial Conglomerates Directive (2002), and the International Accounting Standards Regulation (2002). The aim of these case studies is to show that the argument is plausible and empirically relevant, without claiming that the argument captures the

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only causal mechanism that links the preferential liberalization of services trade to external openness. Each of the three cases illustrates one of the three response strategies by third countries discussed above: a threat in the case of the Second Banking Directive; unilateral policy adjustments in the case of the Financial Conglomerates Directive; and concessions in the case of international accounting standards. In all three cases, I focus on the U.S. reaction to EU integration. The reason for doing so is that the transatlantic relationship dwarfs all other bilateral relationships in overall services trade and in financial services trade more particularly. With respect to overall services trade, the U.S. is by far the largest trading partner of the EU: 40 percent of all U.S. services exports go to the EU-25 and 35 percent of all EU services exports to the U.S. (Hoekman et al. 2007: 371, FN 6). In absolute numbers, U.S. exports of services to the EU accounted for $143.3 billion in 2006 (Cooper 2008). Many more services are directly provided by U.S. companies in Europe. In fact, U.S. foreign affiliates in Europe produced an output of $333 billion in 2000 (Quinlan 2003: 4); this was nearly 3 percent of European Gross Domestic Product. The numbers are equally impressive with respect to financial services: in 2004, the EU-15’s financial services trade with Switzerland and Japan (the second and third largest trading partners in this sector) only amounted to less than half and around one sixth of transatlantic trade in financial services respectively (Eurostat 2006). The empirical relevance of the argument thus can best be established with a study of the U.S. reaction to the single market project in the area of financial services.

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The Second Banking Directive European integration in the financial services sector started with the Second Banking Directive (1989), which created a single banking license – known as “single passport” – allowing banks to operate throughout the Union and to provide a wide range of financial services. The main principles underpinning this directive were mutual recognition and home country control. A bank that is authorized to provide certain financial services in one member country would be allowed to do so throughout the EU. The directive also stipulated that there should no longer be capital requirements at branch level, but only at bank level. This facilitated branching and thus enhanced banking competition across the EU. Of concern to foreign banks, the draft directive that the European Commission published in February 1988 included a clause that asked for reciprocity from third countries (Gruson and Nikowitz 1988; Golembe and Holland 1990; Smith and Vigneron 1990). Article 7 of the draft directive explicitly stated that banks from third countries would only be allowed to benefit from the single passport, if EU banks received reciprocal treatment in these third countries. The Commission would undertake the reciprocity examination for each bank applying to establish a subsidiary in the EU. While the directive was not very precise with regard to the meaning of reciprocity, initially the provision was interpreted as demanding mirror treatment and not only national treatment. For U.S. banks, this interpretation created the threat of discrimination, since mirror treatment was clearly not given in the U.S. Interstate regulations restricted access to the U.S. market for all banks, European as well as American. The Glass-Steagall Act (1933), moreover, limited the range of financial services that a bank could provide, and the

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International Banking Act of 1978 extended these restrictions to non-U.S. banks. Consequently, if the EU had insisted on mirror treatment, U.S. banks would have faced discrimination in the European market. U.S. banks had significant interest in the European market at that time. No fewer than 33 U.S. banks were active and 17 U.S. banks owned subsidiaries in the EU around that time (Story and Walter 1997: 279). As expected, in response to the Second Banking Directive, U.S. banks and other financial institutions with an interest in the European market such as the American Express Co. lobbied Congress and their government to take action that would help them avoid being disadvantaged in that market (Committee on Ways and Means, Subcommittee on Trade 1989a). The Bankers Association for Foreign Trade was in the forefront of this lobbying effort, complaining that the Second Banking Directive would discriminate against U.S. banks (Evans 1989). The Bank of America feared “subtle” discrimination that would force foreign banks to “compete as secondclass citizens at least for the next decade” (The Washington Post, 20 March 1989: 1). The American Bankers Association published a report in which it criticized the lack of a precise definition of reciprocity in the directive (International Banking Report, 1 March 1989). The U.S. administration responded to the banks’ lobbying effort with only thinlyveiled threats of retaliation. The Deputy Secretary of State, John C. Whitehead, for example referred to the U.S.’s “potent retaliation ability” (quoted in National Journal, 29 October 1988: 2729). In the presidential campaign between George Bush and Michael Dukakis, moreover, both candidates promised retaliation against discriminatory EEC measures (The Times, 27 September 1988). The passage in August 1988 of the Omnibus

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Trade and Competitiveness Act, which included strengthened retaliation provisions, provided a further credible signal that the U.S. would be willing to strike back against European discrimination. In spite of these threats, initially the EU took a tough stance. France even wanted to limit the rights of existing European subsidiaries of American banks if the U.S. did not grant identical treatment (New York Times, 10 February 1989: IV, 2). A partial explanation for this approach can be found in the weak position of French banks, which had substantially lower capital ratios than other banks (Story and Walter 1997: 286). In line with this position, the European Commissioner for External Relations, Willy de Clerq, stated: “We see no reason why the benefit of our internal liberalization should be extended unilaterally to third countries” (quoted in Story and Walter 1997: 286). The European Commission also insisted that access to the Single Market for new entrants would be free only to “firms from countries whose market is already open or which are prepared to open up their markets on their own volition or through bilateral or multilateral agreements” (Commission of the European Communities 1988). The first months of 1989 saw further U.S. threats with retaliatory action (Rockwell 1989). The mood in the U.S. is well illustrated by a quote from Representative Richard T. Schulze: “We will not tolerate a Fortress Europe … if that evolves, we are going to have to develop reciprocal legislation … we want to give [the administration] the arms, the ammunition, the ability … to make sure that we do not have that type of development in Europe ‘92” (Committee on Ways and Means, Subcommittee on Trade 1989b). The message was that the U.S. would impose restrictions on European banks operating in the U.S. equivalent to any restrictions imposed by Europe on American

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banks. These threats, which worried internationally competitive European banks and made them ask for a more cautious European approach (Mason 1997: 118), clearly contributed to the EU’s decision to give in. In the decisive version of the Second Banking Directive, which was adopted by the Council of Ministers on 15 December 1989, the EU did not ask for mirror legislation, but only included a national treatment test. The European side explained that, as EU banks received national treatment in the U.S., U.S. banks would receive national treatment in the EU. Moreover, the directive clearly stated that the reciprocity examination would not apply to third-country banks already established in the EU. As expected based on the argument outlined above, the Second Banking Directive thus did not make the EU more protectionist. In fact, on average third-country providers found it easier to access the European market after implementation of the directive. While before this step towards the integration of financial markets third-country banks faced costs in each EU member state in which they wanted to get established, in the wake of the Second Banking Directive they only had to incur these costs once and then could service the whole European market. Interestingly, this outcome came about in response to a threat rather than negotiations based on the reciprocity principle. The Financial Services Action Plan Although in the late 1980s and early 1990s progress was made in the integration of financial services markets across the EU, and although the launch of the Euro gave further impetus to this process, some barriers to intra-EU trade in financial services remained. In 1999, the European Commission presented the Financial Services Action Plan with the objective of eliminating those barriers (European Commission 1999). The 13

FSAP identified 42 measures that would allow for the creation of a single wholesale and a single retail financial market across the EU by the end of 2005. Some of the measures were also aimed at improving the supervision of financial services provision. With respect to the liberalizing features, the single market would allow market participants to buy and sell financial instruments freely across borders. Financial institutions would be allowed to provide services to EU consumers on the same terms and conditions as they do domestically. Financial products authorized in one country could also be offered in all other EU countries. The potential for discrimination against third-country providers from some measures that were considered as part of the FSAP was considerable. Even Fritz Bolkestein (2003), at that time the Commissioner for Internal Market and Taxation admitted that “it is impossible to contain all the effects of our measures to the EU.” Foreign financial service providers, especially in the U.S., reacted with concern. The U.S. Securities Industry Association even suggested a “U.S. Action Plan” to engage with European regulators about discriminatory effects of the FSAP (Thornburgh 2004). This reaction by U.S. financial services providers was a reflection of the size of their stakes in the European market: in 2003, Europe accounted for more than 50 percent of total U.S. foreign investments in banking and finance (HM Treasury et al. 2004: 35). Thirty-four U.S. banks were active in the EU, holding assets worth $747 billion (Bies 2004: 36). In the same year, U.S. investors held about $947 billion of equity, $405 billion of long-term debt and $152 billion in short-term debt in the EU (Almunia 2006). Gross transactions by U.S. investors in EU equities amounted to $1,937 billion in 2000 (Steil 2002: 19). Among the legislative acts decided in the framework of the FSAP that had the greatest potential

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for discrimination against third country providers were the Financial Conglomerates Directive and the International Accounting Standards Regulation. Below, I discuss how the U.S. reacted to these measures and how this reaction further opened the EU’s market to U.S. providers of financial services.8 The Financial Conglomerates Directive The Financial Conglomerates Directive, which was proposed in March 2001 and adopted in December 2002, determines that all parts of a financial conglomerate have to be subject to supervision from the same regulator. Financial conglomerates are defined as large financial services groups that are engaged in both banking or investment and insurance (for a precise analysis of which groups are covered by the directive, see Gortsos forthcoming). The directive also covers foreign financial conglomerates with subsidiaries in the EU, as long as they are mainly (that is, more than 40 percent of the balance sheet) active in the financial sector. These foreign conglomerates have to accept EU supervision in addition to their national supervision unless they can demonstrate that they are subject to consolidated supervision of their worldwide activities. Only if the EU – or more precisely the national authority competent in this case, mainly the British Financial Services Authority – deems their national supervision equivalent to the supervision foreseen in the Financial Conglomerates Directive, does the foreign firm avoid double supervision. This provision caused concern among U.S. financial service providers, because they considered it probable that (parts of) U.S. supervision would not be deemed equivalent under the directive (Viñualez 2006: 32-33). The U.S. had no consolidated supervision at that time, since parent companies of conglomerates were unregulated and

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supervision of conglomerates was shared by a large number of different functional supervisors. For large financial service providers from the U.S. this meant that potentially they would have to create a holding company with head-office in the EU and ring-fence their business activities in Europe from those conducted by the rest of the company (Meyers and Ballegeer 2003; Gruson 2004: 28; Viñualez 2006: 50). This would significantly add to these companies’ costs of doing business in Europe and thus put them at a competitive disadvantage vis-à-vis companies with head office in the EU. The considerable uncertainty that existed about exactly what the directive would mean for individual U.S. companies exacerbated the situation. U.S. companies started early with efforts to find a solution that would allow them to avoid discrimination (Financial Times, 27 October 2003: 22; Posner 2009: 687). The Securities Industry Association (SIA), a trade association representing some 600 U.S. securities firms, showed itself “troubled” by the need for an equivalence judgment (Securities Industry Association 2002). As a result, the association was highly active in lobbying U.S. decision-makers on this issue (see, for example, Thornburgh 2004). The Securities and Exchange Commission (SEC) summed up: “Several U.S. securities firms have communicated to the Commission [the SEC] that they have serious concerns with the Proposed Directive. […] They conclude that the Proposed Directive would not only increase their cost of doing business in Europe, but would also place them at a competitive disadvantage with European-based firms” (Nazareth 2002: 72). The first equivalence judgments were to be made in June 2004, but this deadline was not met by European regulators. The delay further aggravated the concerns of U.S. companies that feared that they would be judged as being not in compliance with the

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Financial Conglomerates Directive. The Senior Managing Director of Bear Stearns & Co., Michael J. Alix, thus stressed the need for an early equivalence determination in hearings in the U.S. House of Representatives (Alix 2004). Lehman Brothers considered “of critical importance” that SEC rules would be changed in a way that they “are deemed to be equivalent to the rules imposed by E.U. [sic] financial supervisors” (Polizzotto and DeMuro 2004). In line with the concerns voiced by societal actors, already in 2002 the SEC showed awareness of the potential problem (Nazareth 2002). Similarly, the chairman of the Committee on Financial Services of the House of Representatives, Michael Oxley, when referring to “some concerns” that existed in the U.S. with respect to the FSAP, highlighted the issue of supervision of financial conglomerates (Oxley 2002: 38). The U.S. then made unilateral policy adjustments to re-establish a playing field for U.S. financial services providers in the EU (Viñualez 2006: 34-41). Most importantly, the SEC decided to move towards consolidated supervision of financial conglomerates in proposals first circulated in October 2003. The final rules, which were published in July 2004, made important changes to the U.S. regulatory framework to make it equivalent with EU supervision for financial conglomerates. The main innovation was that large financial services companies were allowed to voluntarily opt into a new regulatory regime known as Consolidated Supervised Entities. Moreover, the SEC allowed for the creation of so-called supervised investment bank holding companies. Both types of companies would be supervised at group-level as demanded by EU legislation. In July 2004, the Banking Advisory and the European Financial Conglomerates Committees, in a report on the equivalence of supervision of financial conglomerates in

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the U.S., directly referred to these changes introduced by the SEC. They came to the conclusion that after implementation of these changes, “on balance, there is broad equivalence in the U.S. supervisory approaches” (Banking Advisory Committee and Financial Conglomerates Committee 2004: 3). This decision largely eliminated the threat to U.S. companies from the Financial Conglomerates Directive.9 Again, an EU measure aimed at facilitating financial market integration in Europe initially caused fears of discrimination among U.S. providers. The U.S. response (in this case, a unilateral change in U.S. policy), however, ensured that Fortress Europe could be avoided. In fact, the convergence of regulatory approaches made it easier for both EU and U.S. providers to access markets on both sides of the Atlantic. The International Accounting Standards Regulation The EU’s decision to adopt International Financial Reporting Standards (IFRS) for all publicly listed companies by 2005, which was first spelled out in the International Accounting Standards Regulation of July 2002, was also of relevance to a large group of financial services providers from third countries (Regulation (EC) No 1606/2002, 19 July 2002).10 In 2007, no fewer than 233 U.S. companies listed on European stock exchanges using U.S. Generally Accepted Accounting Principles (GAAP) (Committee of European Securities Regulators 2007: 21). For them, using IFRS standards in parallel to GAAP was expected to be costly. The Securities and Exchange Commission (2008: 140), for example, estimated the costs of maintaining two sets of accounts to about $900,000 per year for an average company. Clearly, carrying these costs would put U.S. financial service companies at a disadvantage in the European market and hinder transatlantic trade in financial services.11 18

The Bankers’ Association for Finance and Trade, consequently, voiced unease about the consequences of this EU decision for U.S. banks (BAFT Newsletter, June 2004: 1). The prospect of being able to continue using GAAP in the EU, but with major adjustments to achieve equivalence, as was set out in an April 2005 paper of the Committee of European Securities Regulators (2005), was not much more enticing. The Securities Industry Association feared that such a rule would ultimately force a U.S. firm “to keep two sets of books to ensure that it has identified all possible significant discrepancies between the two sets of accounting standards” (Lackritz 2005). To avoid such a situation, some parts of the American financial industry asked the SEC to accept IFRS in the U.S. in exchange for the EU accepting U.S. GAAP (Shadow Financial Regulatory Committee 2004). Responding to these complaints, already in 2002 the U.S. Financial Accounting Standards Board (FASB) reached an agreement with the International Accounting Standards Board (the so-called Norwalk agreement) that stated that the two sides would make IFRS and U.S. GAAP compatible with each other. When witnessing relatively little movement on this issue over the next few years, however, European Commissioner Charlie McCreevy felt compelled to make an implicit threat. He stated: “[I]t is only reasonable for European companies to expect that U.S. regulators will make similar efforts to judge the equivalence of our international standards with US GAAP and […] to release companies from the costly burdens of converting standards” (McCreevy 2004). One year later, U.S.-EU negotiations resulted in the announcement that EU companies listed in the U.S. would be able to use IFRS by no later than 2009 (The Guardian, 23

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April 2005: 26). The two sides would utilize the time until that date to achieve equivalence between the two sets of accounting standards. Despite direct talks between CESR and SEC, however, initially the two sides made little progress. When the deadline of December 2006 approached, at which U.S. companies would have been required to switch to IFRS, the European Commission decided to postpone the deadline by two years until the end of 2008. In November 2007, finally, the SEC announced that it would immediately remove the need for reconciliation for foreign companies listed on U.S. exchanges using IFRS (Financial Times, 16 November 2007: 22). This decision was expected to bring cost-savings for European companies in the region of €2.5 billion (European Parliamentary Financial Services Forum 2008: 2). In mid-2008, the SEC even went a step further in allowing U.S. companies to use IFRS. At the same time, the European Commission decided that U.S. companies could continue being listed in Europe under U.S. GAAP. Finally, in August 2008 the SEC decided that the U.S. would most likely substitute IFRS for GAAP over the next few years. Importantly, for the argument made here, these steps made the European side desist from insisting on the conversion of the accounts of U.S. companies that want to be listed in Europe. The EU’s move towards internal integration thus again did not lead to the creation of Fortress Europe. On the contrary, short-term discrimination caused the U.S. to make a significant concession, which produced a liberalization of transatlantic trade in financial services. This was an outcome that was thought highly implausible only ten years earlier (Financial Times, 13 March 1997: 32; Trachtman 2000).

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Conclusion The intra-EU liberalization of financial services trade as a result of the Single Market Programme has not led to the establishment of Fortress Europe. In fact, the EU’s move towards greater integration in the financial services sector over the last twenty years ended up making the EU more open to firms from third countries. I explained this outcome by arguing that the discrimination caused by deeper integration in Europe makes third countries react with policies that re-establish the previous competitive situation. The recent EU-U.S. debate about the negative effects of the EU’s Directive on Alternative Investment Fund Managers, which introduces supervision of alternative investment funds at the European level, provides a further illustration of the argument from within the financial services sector. Again, the U.S. responded to the threat of discrimination, with the U.S. Secretary of the Treasury Timothy Geithner complaining about the threat to U.S. financial service providers in a letter to the finance ministers of four EU member countries (Geithner 2010). Although the empirical analysis has been confined to the interaction between the EU and the U.S. in the field of financial services, careful generalizations to other actors and sectors seem possible. With respect to the geographic restriction, the EU’s interaction with third countries other than the U.S. seems to have followed a similar pattern as the one presented here. The EU, for example, used the Second Banking Directive to get better access for European banks to the Japanese market (Mason 1997). Japan also responded to the requirement for companies listed in the EU to use international accounting standards with efforts to reach convergence between Japanese and international rules. Switzerland reformed its arrangements for the supervision of financial

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conglomerates in response to the EU’s Financial Conglomerates Directive. Cautious generalizations beyond the case of financial services to other services sectors also seem possible. For sectors such as telecommunications and air transport, where companies are large enough to overcome collective action problems and to engage in lobbying, this paper’s expectation thus is for EU-internal services trade liberalization to be accompanied by greater openness vis-à-vis third country providers. In fact, in both of these sectors past intra-EU liberalization led to EU-U.S. negotiations that resolved conflicts between the two sides (for the case of telecommunications in the 1980s, see Dür 2010: 159-84). Returning to the title of this paper, my expectation is for the European integration of services markets to produce Open Door Europe rather than Fortress Europe.

Andreas Dür is Professor of International Politics at the University of Salzburg, Austria.

Address for correspondence: Andreas Dür Department of Political Science and Sociology University of Salzburg Rudolfskai 42 5020 Salzburg, Austria [email protected]

Acknowledgments:

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I would like to thank Manfred Elsig, David Howarth, Sophie Meunier, Tal Sadeh, Alasdair Young, and the anonymous reviewers for helpful comments on earlier versions of this article.

Notes 1

Unless otherwise noted, throughout the paper the term “financial services” is used to refer to banking,

financial trading and investment, and insurance services. 2

I provide the sum across financial and insurance services, which are listed separately in the source. The

trend is the same in both subsectors. 3

In the context of services trade, trade liberalization does not necessarily mean deregulation, that is, the

withdrawal of government intervention. “Liberalization” can also occur if two or more countries harmonize their regulations at a high level, as long as this step facilitates cross-border trade and/or commercial presence. 4

These concerns by domestic constituencies do not have to be predominantly defensive for the expectation

regarding discriminatory provisions to hold. Discrimination will also result, for example, when decisionmakers buy off a few firms voicing defensive demands or respond to offensive demands by prying open foreign markets. 5

This definition of power is similar to the one provided by Drezner (2007: 35).

6

In this paper, as my focus is on showing that regional services integration often acts as a stepping stone

for further liberalization, I do not provide a full explanation for the third country’s choice of response strategy. See Dür (2010) for a detailed discussion of this question. 7

An exception to this is the case of a third country that cannot offer concessions that are valuable enough

for the members of the preferential agreement to accept a deal. A small developing country will find it significantly more difficult to engage in negotiations with the EU than the U.S. did in the cases dealt with below.

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8

Posner (2009) also provides an analysis of these developments. The two treatments are different, however,

as Posner is interested in explaining the EU’s power relative to that of the U.S., while my explanandum is the EU’s openness to third-country providers of financial services. 9

Formally, the final decision on whether a company’s regulation is deemed equivalent is to be taken on a

case-by-case basis by the relevant national regulatory agency. The agencies’ decisions should take account of the Financial Conglomerates Committee’s judgment, however; the conclusion of “broad equivalence” is therefore likely to weigh heavily in these decisions. 10

The need for third-country companies to use either international or equivalent accounting standards was

actually spelled out in the Prospectus (2003/71/EC) and Transparency directives (2004/109/EC). 11

While the conversion did not only affect the financial service sector, U.S. companies in that sector were

particularly concerned because many of them did business in the EU, accounting standards are especially important for their sector, and they potentially faced indirect costs from the EU’s rules in that if U.S. manufacturing firms stopped listing in Europe this would go to the detriment of the U.S. financial service companies that provided services to them.

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