A brief history of EU policies for financial integration

Financial integration in the European Union has been a long-term process, begun in 1957, which has involved a complex interaction of economic, social and political factors. Financial integration is the process through which different regions or countries become more financially interconnected, ultimately producing private risk sharing to withstand asymmetric shocks and a convergence of prices and returns for financial assets and services. An increase in cross-border asset holdings would be a proxy of private risk sharing.

The history of EU policies to promote financial integration can perhaps be summarised in three main waves, led by different political and economic events. The first wave was led by the post-world war reconstruction phase. The European stagnation following the two oil crises and the end of the Bretton Woods system led the second wave. The effects of the financial and sovereign crises of 2008 and 2010 currently lead the third wave.

It took on average about 20 years each to complete the first two waves of financial integration and most likely it will take a comparable amount of time to complete the last one. Table 1.1 summarises the key steps of this integration process. The following section will discuss in detail some of these steps to set the stage for the CMU action plan in the European financial integration process.

1.1 The first wave of financial integration

The history of European financial integration goes back to the founding Treaty of the European Communities in 1957. Article 67 established the free movement of capital, but only when necessary to the functioning of the single market. The subordination of capital liberalisation to what was needed for the single market did not allow direct application of this article, but it nonetheless helped to approve two Capital Directives in 1960 and 1963, which opened up the common market for capital around trade-related credits. It was a great advance, but it was still limited to some banking transactions and ignored capital markets in the broad sense (including securities). Capital markets integration was described not much later on as a pre-condition for the monetary union by the Segré Report (CEEC, 1966).

Taking stock of fragmented capital markets at that stage, the Segré Report reviewed the status quo and proposed a list of areas to which to direct more attention, such as regulation of the financial sector and market funding for public authorities. Most importantly, the report dwelled for the first time on the role of a more integrated securities market as a source of funding for firms and a way to better allocate savings and argued that:

"[...] there can be no monetary union in the Community without such a market" (CEEC, 1966, p. 15).

The report also stated that focusing only on primary markets is insufficient. The efficiency of secondary markets is as important for price discovery. Equity/debt tax bias (CEEC, 1966, p. 214), double taxation and discrimination against host service providers, fragmentation of the investment management industry (i.e. the absence of a pan-European pool of institutional investors) were crucial issues already at that time. Insufficient information flow was instead crucial for secondary markets, which were much smaller in the 1960s.

"Lack of information by which the comparative merits of different types of investment can be assessed, especially from the point of view of their yield and soundness, induces savers to stick to the simplest forms, like sight deposits and savings deposits, because they are not in a position to assess the advantages of other forms of investment, such as securities" (CEEC, 1966, p. 226, para. 5).

Ongoing mandatory corporate disclosure and other company information, which can promote more equity investments and cross-border listings, were missing at that time and their implementation under EU rules is still today a source of concern on a pan-European scale (see Chapter 4 for more details). The report also called for more cross- border trading in bonds for savers to reap the benefits of risk diversification.

The gradual collapse of the Bretton Woods system, between 1968 and 1973 (see, among others, Garber, 1993), raised concerns about the stability of the European internal market as currency volatility rose across Europe. To ensure the stability required for the a development of the internal market, in 1969, heads of state or government gave a mandate to a group of experts, chaired by Pierre Werner, to explore the idea of an economic and monetary union (EMU) in the European Community (Council and Commission of the European Communities, 1970). Due to unfavourable market conditions and political pressures, however, the report postponed a strict timetable and focused instead on cooperative systems to ensure irreversible convertibility of exchange rates. This work also led to a memorandum of the European Commission (CEC, 1970), calling for greater coordination of economic policies and putting a common capital market on the same level of the common market for goods. It also proposed the completion of the economic and monetary union by 1976-78, but this attempt also failed, as market conditions did not favour member states' political support to give up control over foreign exchange policies.

1.2 The second wave of financial integration

Despite the spectacular failure of the Werner Report and of the Commission memorandum, these reports sowed the seeds for the European Monetary System (EMS) in 1979, in a highly volatile post-Bretton Woods monetary system. The EMS was an exchange rate mechanism through which currencies were semi-pegged to the European Currency Unit (ECU), i.e. a basket of European currencies weighted by a pre-determined value that later became what we call today the euro currency. Not much more than that concretely happened in the field of financial integration since the second capital directive was approved in 1963. The Casati case in 1980 confirmed the non-direct applicability and subordination to the single market of the freedom of movement of capital enshrined in Article 67.1 of the Treaty of Rome (see Louis, 1982). Nonetheless, the instability of the global financial system and important political events, after the end of Bretton Woods, led to two major financial crises in 1973 and 1979 (also called the 'oil shocks' because they were triggered by a sudden and sharp rise in oil prices). The slow recovery from the shocks raised concerns that the gradual elimination of tariff barriers and the stabilisation of the exchange...