[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]



 
                     THE EUROPEAN UNION'S FINANCIAL


                      SERVICES ACTION PLAN AND ITS

                     IMPLICATIONS FOR THE AMERICAN


                      FINANCIAL SERVICES INDUSTRY
=======================================================================

                                HEARING

                               BEFORE THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                               __________

                              MAY 22, 2002

                               __________

       Printed for the use of the Committee on Financial Services

                             Serial No. 107-70







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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 JOHN J. LaFALCE, New York
MARGE ROUKEMA, New Jersey, Vice      BARNEY FRANK, Massachusetts
    Chair                            PAUL E. KANJORSKI, Pennsylvania
DOUG BEREUTER, Nebraska              MAXINE WATERS, California
RICHARD H. BAKER, Louisiana          CAROLYN B. MALONEY, New York
SPENCER BACHUS, Alabama              LUIS V. GUTIERREZ, Illinois
MICHAEL N. CASTLE, Delaware          NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York              MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California          GARY L. ACKERMAN, New York
FRANK D. LUCAS, Oklahoma             KEN BENTSEN, Texas
ROBERT W. NEY, Ohio                  JAMES H. MALONEY, Connecticut
BOB BARR, Georgia                    DARLENE HOOLEY, Oregon
SUE W. KELLY, New York               JULIA CARSON, Indiana
RON PAUL, Texas                      BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio                MAX SANDLIN, Texas
CHRISTOPHER COX, California          GREGORY W. MEEKS, New York
DAVE WELDON, Florida                 BARBARA LEE, California
JIM RYUN, Kansas                     FRANK MASCARA, Pennsylvania
BOB RILEY, Alabama                   JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio           JANICE D. SCHAKOWSKY, Illinois
DONALD A. MANZULLO, Illinois         DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina      CHARLES A. GONZALEZ, Texas
DOUG OSE, California                 STEPHANIE TUBBS JONES, Ohio
JUDY BIGGERT, Illinois               MICHAEL E. CAPUANO, Massachusetts
MARK GREEN, Wisconsin                HAROLD E. FORD Jr., Tennessee
PATRICK J. TOOMEY, Pennsylvania      RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut       KEN LUCAS, Kentucky
JOHN B. SHADEGG, Arizona             RONNIE SHOWS, Mississippi
VITO FOSSELLA, New York              JOSEPH CROWLEY, New York
GARY G. MILLER, California           WILLIAM LACY CLAY, Missouri
ERIC CANTOR, Virginia                STEVE ISRAEL, New York
FELIX J. GRUCCI, Jr., New York       MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania         
SHELLEY MOORE CAPITO, West Virginia  BERNARD SANDERS, Vermont
MIKE FERGUSON, New Jersey
MIKE ROGERS, Michigan
PATRICK J. TIBERI, Ohio

             Terry Haines, Chief Counsel and Staff Director






                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    May 22, 2002.................................................     1
Appendix:
    May 22, 2002.................................................    37

                               WITNESSES
                        Wednesday, May 22, 2002

Dinan, Desmond, Jean Monnet Professor of Public Policy, George 
  Mason University...............................................    16
Lackritz, Marc E., President, Securities Industry Association....    18
Nazareth, Annette, Director, Division of Market Regulation, U.S. 
  Securities and Exchange Commission.............................     9
Olson, Hon. Mark W., Governor, Federal Reserve Board.............     5
Petrou, Karen Shaw, Managing Partner, Federal Financial Analytics    20
Quarles, Hon. Randy K., Assistant Secretary for International 
  Affairs, U.S. Treasury Department..............................     7

                                APPENDIX

Prepared statements:
    Oxley, Hon. Michael G........................................    38
    Gillmor, Hon. Paul E.........................................    40
    Jones, Hon. Stephanie T......................................    41
    Royce, Hon. Ed...............................................    43
    Sherman, Hon. Brad...........................................    44
    Dinan, Desmond...............................................    82
    Lackritz, Mark E.............................................    92
    Nazareth, Annette............................................    69
    Olson, Hon. Mark W...........................................    53
    Petrou, Karen Shaw...........................................   109
    Quarles, Hon. Randy K........................................    64

              Additional Material Submitted for the Record

LaFalce, Hon. John J.:
    Financial Accounting Standards Board letter, April 29, 2002..    45
Sherman, Hon. Brad:
    WorldBank, Over U.S. Objections, Plans More Loans to Iran, 
      Dow Jones International News, May 17, 2002.................    50


                     THE EUROPEAN UNION'S FINANCIAL



                      SERVICES ACTION PLAN AND ITS



                     IMPLICATIONS FOR THE AMERICAN



                      FINANCIAL SERVICES INDUSTRY

                              ----------                              


                        Wednesday, May 22, 2002

             U.S. House of Representatives,
                   Committee on Financial Services,
                                                   Washington, D.C.
    The committee met, pursuant to call, at 10:12 a.m., in Room 
2128, Rayburn House Office Building, Hon. Michael Oxley 
[chairman of the committee] presiding.
    Present: Representatives Roukema, Royce, Kelly, Gillmor, 
Weldon, Manzullo, Shays, Shadegg, Miller, Cantor, Hart, Capito, 
Tiberi, Lafalce, Waters, Mrs. Maloney of New York, Watt, 
Bentsen, Mr. Maloney of Connecticut, Sherman, Inslee, Mrs. 
Jones of Ohio, and Lucas.
    Chairman Oxley. The meeting will come to order. The 
Committee on Financial Services meets today to examine an issue 
that will have major implications for this committee and for 
America's financial services industry, the total overhaul of 
Europe's financial services sector.
    Since 1999, the European Union has been working to 
implement an ambitious agenda known as the Financial Services 
Action Plan. Targeted for completion by the year 2005, this 
plan includes major changes for EU regulators, financial 
service providers and investors.
    In late March of this year, I led a congressional 
delegation to Brussels, London and Berlin to meet with 
political and business leaders about developments in the 
European financial services sector. Ranking member LaFalce 
accompanied me on the trip, as did our colleague from North 
Carolina, Mel Watt. At each meeting we attended, the primary 
topic of discussion concerned major changes being undertaken as 
part of the Financial Services Action Plan.
    While Europe's move toward integration has been widely 
praised in the U.S. for the measures it takes to streamline the 
European financial marketplace, some concerns still exist. 
These concerns include new rules for the supervision of 
financial conglomerates, international accounting standards and 
corporate prospectuses. Unfortunately, the plan includes the 
divisive issue of expensing for stock options. I simply don't 
understand why the EU would choose this forum, which after all 
is supposed to be dedicated to harmonizing accounting 
standards, to raise this contentious issue.
    In addition, the action plan is at the heart of the EU's 
stated goal of making the European Union "the most dynamic and 
competitive knowledge-based economy in the world" by 2010. This 
committee must do everything possible to give American 
businesses the tools they need to compete in the global 
economy, and we must continue to anticipate challenges to 
American competitiveness.
    The global economy will benefit greatly if our friends 
across the Atlantic are able to streamline their markets and 
regulatory authorities, but it must not come at the expense of 
transparency and free trade. The U.S. financial services 
industry is the most innovative, competitive and transparent in 
the world. Coupled with the fact that Europe is both our most 
active trading partner and our most powerful ally, we are well 
served by staying ahead of the curve with respect to the coming 
changes in Europe.
    The Treasury Department, the SEC and Federal Reserve are 
closely following the changing financial services landscape in 
the EU. I would like to welcome representatives from each 
organization today, Governor Mark Olson, Assistant Secretary 
Randy Quarles and Ms. Annette Nazareth, who will be testifying 
about their impressions of the Financial Services Action Plan, 
and about their continuing dialogue with European counterparts.
    I would also like to thank representatives from the private 
sector, and from academia, who will go into further detail on 
implementation of the plan, how it will effect U.S. interests.
    Before the witnesses testify, I will now turn to the 
distinguished gentleman from New York, the ranking member of 
the committee, Mr. LaFalce, for any comments that he may have.
    [The prepared statement of Hon. Michael G. Oxley can be 
found on page XX in the appendix.]
    Mr. LaFalce. And you have forgotten, your favorite 
traveling companion. Okay.
    I really want to thank Chairman Oxley for holding this 
hearing on the European Union's Financial Services Action Plan. 
I think this hearing can serve a very important purpose by 
informing our members of the significant developments in the 
integration of the financial services sector taking place in 
the European Union. The EU's Financial Services Action Plan has 
the potential to transform the European market for financial 
services.
    Integration of the EU financial services sector can have 
profound implications, not only for financial services firms 
but, more generally, for the strength and competitiveness of 
the EU's economy and businesses. I would like to emphasize, and 
I think our witnesses are going to agree, that an integrated 
market in Europe is ultimately of benefit to U.S. firms 
operating in the EU.
    The efficiencies gained from a larger, integrated market 
will far outweigh the costs associated with the changeover. In 
fact, one estimate suggests that economic gains resulting from 
financial services integration could be an additional 43 
billion euros, or about $40 billion for the EU economy 
annually. The United States, and the rest of the global 
economy, will benefit from the successful economic integration, 
and I hope we will do all in our power to support the Europeans 
in their endeavor.
    And clearly the EU is up to the task of integrating complex 
regulatory schemes, not only in financial services, but across 
economic and social sectors. The introduction of the euro 
currency, first as an accounting entity, and now as circulating 
currency has gone remarkably well, and has silenced many 
critics of integration as a result.
    It is important to keep the big picture in mind as we look 
at their plan. The members of the EU are in the midst of a 
grand political, social and economic experiment. It is not 
unlike the one our founding fathers embarked on 226 years ago. 
The introduction of the euro alone has been a significant step 
toward unifying their economies, just as the introduction of 
Federal Reserve notes did for our country early in the last 
century.
    It may be inevitable that such a major revamping of the 
financial services regulatory structure in the EU will 
highlight differences in approach between our two regulatory 
systems. And we should be diligent in assuring that U.S. 
financial services providers operating in the EU are not 
disadvantaged by standards that may discriminate 
inappropriately against foreign financial service providers.
    At the same time, we should be mindful that EU legislators 
must make the same judgments that Congress has had to make with 
respect to competition, fairness and consumer protection for 
our own financial services.
    That is my prepared statement. Let me just take a few 
minutes now to make a couple of additional points.
    First of all, we have a lot to learn from the EU. The 
adoption of the euro is tremendous, it is significant, it is 
profound. But when we negotiate trade agreements, we negotiate 
everything but something dealing with the currency of our 
respective countries.
    And one of my chief concerns, when we negotiated the 
Canadian-American free trade agreement, was the relative value 
of our currencies. And when we negotiated it, was about 90 
cents on the dollar, and today it is closer to 60 cents on the 
dollar. That is profound. You look at the trade balances, and 
they will parallel that change almost to the dotted i and 
crossed t. If you look at the impact, especially on border 
communities, it is profound, intuitively.
    When I would go to a shopping market in Niagara Falls, New 
York, 25 percent of the people I greet couldn't vote for me, 
because they were Canadian. Today, they all could vote for me, 
but they just don't want to.
    [Laughter.]
    But there are no Canadians. I could met an awful lot of my 
constituents by going to Niagara Falls, Ontario. We have to 
take that into consideration.
    I was the chief proponent of the Canadian-American, but I 
also have problems with the NAFTA, and my chief concern with 
the NAFTA, as chairman of the Small Business Committee, I had a 
hearing on the imminent devaluation of the Mexican peso. And 
within a short period of time, less than a year, I mean we had 
a precipitous devaluation, which was not uncommon with the 
Mexican peso, but it was profound. And it had an enormous, 
enormous impact on the standard of living on the people in 
those countries, et cetera. So my point is, we can't negotiate 
trade without considering currency and trying to bring them 
into stability.
    Something else too. I will be finished in a second, Mike. 
There are so many things that if we want to engage an 
integrated global economy, we have to make sure that our 
standards are similar to theirs, you know, accounting and et 
cetera. But we can't try to get the Europeans to go for our 
standards if our standards are lower as political inconvenient. 
We should use the higher European standards as something to 
emulate and, when it is appropriate, vice-versa. And that is 
extremely important, and I thank the chair for his indulgence.
    Chairman Oxley The gentleman's time has expired. Any 
further opening statements the--
    Mr. Sherman. Mr. Chairman--
    Chairman Oxley. The gentlemen from California, Mr. Sherman?
    Mr. Sherman. Thank you, Mr. Chairman. I would like to use 
this opening statement to address what I think is the most 
important international financial issue facing this committee 
and perhaps this Congress, within the jurisdiction of this 
committee and the Assistant Secretary of the Treasury that 
comes before us.
    This country's leadership is engaged in two parallel 
tracks. One is to tell the American people that we are in a war 
on terrorism, and that we are trying to protect their safety. 
The other is to go along and to get along with European 
financial bureaucrats at tea parties regardless of whether that 
poses a threat to American safety.
    The State Department yesterday announced that Iran was the 
number one sponsor of state terrorism. The State Department was 
not fooled by the allegedly moderate, but powerless, front man 
who serves as president of Iran. The State Department 
understands that power in Iran is really held by unelected 
extremists. These unelected extremists have arranged their 
government to spend the minimum necessary on domestic 
expenditures which they need to do to hold onto power. Every 
additional dollar is then available for their nuclear weapons 
program and to sponsor terrorism.
    Today, the World Bank is going to provide and is planning 
to provide hundreds of millions of dollars of the money needed 
for those domestic expenditures, freeing up an equal amount for 
Tehran's nuclear weapons development program, a program bent 
upon not only developing those weapons, but smuggling them into 
the United States. But the tea parties with European financial 
bureaucrats continue.
    With the last administration, the World Bank decided to 
loan, I believe it was, $232 million. What did we do? We voted 
no, and when we got outvoted, we went to tea.
    Okay, that was before September 11, and perhaps we didn't 
have to view the war on terrorism as being all that important.
    Now, in a recent article by Dow Jones, it is revealed that 
the World Bank is planning to loan an additional $755 million. 
And unless Congress acts, we will do the same thing. We will 
vote no. We will vote no in a loud voice. We will get outvoted, 
because we cast only 16 percent of the votes. And as this 
article, which I would like to make part of the record of this 
hearing, reveals the European diplomats have already indicated 
that they are guaranteed to outvote us. And then we will go to 
tea with the European bureaucrats who understand that as long 
as Europe supports the government in Iran, that when that 
government develops nuclear weapons, they will be smuggled into 
American cities, not European cities.
    Chairman Oxley. The gentleman's time has expired.
    [The following information was subsequently furnished by 
Hon. Brad Sherman for the hearing record.]
    Mr. Sherman. I would just like to bring to the attention of 
the committee the intention to provide over $800 million to the 
World Bank at a time when the World Bank is planning to loan 
$755 million to the government of Iran.
    I yield back.
    Chairman Oxley. The gentleman yields back.
    Are there further opening statements? Noting none, then we 
return to our--I am sorry, Judge Jones?
    Mrs. Jones of Ohio. Thank you, Mr. Chairman.
    I just want to welcome each of those witnesses to our 
hearing this morning, and particularly, Mr. Chairman, I would 
like to welcome Mr. Mark Olson, governor of the United States 
Federal Reserve Board.
    On Friday of last week he was in my congressional district. 
The Federal Reserve sponsored a small business workshop for the 
small businesses in my congressional district. And this is a 
part of the hearing I want to thank him personally for coming 
and sponsoring that event on behalf of the small businesses in 
my congressional district.
    And I look forward to the testimony of each and every one 
of the witnesses that is going to be testifying. And, of 
course, you can look forward to probing questions from each of 
my colleagues.
    Thanks, Mr. Chairman.
    The Chairman. Thank you.
    We will begin with the hardworking Mr. Olson, particularly 
as this committee is concerned.
    And we appreciate your being here with us, and you may 
begin.

 STATEMENT OF HON. MARK OLSON, GOVERNOR, FEDERAL RESERVE BOARD

    Mr. Olson. Thank you, Mr. Chairman. I have a statement that 
I will submit for the record, but I would like to just pull a 
few comments from it for an opening statement.
    First of all, it is appropriate to thank you for the 
hearing and for the timing of the hearing. You mentioned in 
your opening statements that we are looking at a 2005 deadline 
for implementation of the plan. And the question might arise 
is, is it too early to look at this issue?
    But as we know, international negotiations are an iterative 
process, and so it is never too early for us to start taking a 
look. So the hearing is very timely.
    The Federal Reserve supports the efforts of the European 
Union to try to achieve greater efficiency and transparency in 
its financial markets. And the Financial Services Action Plan 
is an important step in doing that. Encouraging international 
participation in these markets to promote an efficient and an 
innovative marketplace will benefit all of us.
    Both you, Mr. Chairman, and Congressman LaFalce brought up 
the subject of assuring that U.S. financial institutions will 
have the opportunity to compete in a changing environment. We 
have noted that one of the important benchmarks that we have 
used to try to assure a level playing field is the concept of 
national treatment. National treatment became part of U.S. law 
in 1978, with the International Banking Act, and I think it is 
important to note that both the European Union and the U.S. 
have continued to follow that principle.
    The results up to this point speak for themselves. From the 
European Union nations, there are currently 66 banks 
functioning in this country, with a total of $1.7 trillion in 
assets under management--banking and non-bank assets. So there 
is a very substantial participation of EU banks functioning in 
this country.
    And at the same time, from the U.S. in the EU nations, 
there are 27 banks, with a total of $650 billion in total 
assets. So it is very clear that we have very good 
international cooperation with respect to international 
banking.
    In achieving national treatment, there are a number of 
things that the Federal Reserve does and has done. As directed 
by the fiducial legislation, we assess the supervisory 
capability of the home country of the banks that do business in 
this country.
    Importantly, we also have a very transparent rule-making 
process. When we propose rules that will affect foreign banks, 
the proposed rules are out for comment, we invite comment and 
often receive comment, both from the foreign banks and from 
foreign bank regulators, that help us assure that we are 
achieving national treatment.
    We do provide flexibility in considering how the structural 
differences in jurisdiction can be accommodated, and there are 
a number of examples of where that has been done. Finally, in 
this country we have a wide variety of charters that would 
accommodate different levels of banking participation in this 
country by foreign banks.
    There are three specific issues, with respect to the 
directives, that we would like to comment on.
    The first is the financial conglomerate directive, which is 
aimed at the concern that the regulation or supervision focused 
on the individual entities may leave some gaps if not analyzed 
on a conglomerate, or consolidated, basis. We at the Fed are 
very comfortable that the consolidated supervision under our 
jurisdiction, with respect to bank holding companies and 
financial services companies, is fully consistent with that 
directive.
    With respect to capital adequacy, we would like to point 
out, and I know that this committee is well aware, that the 
European Union's efforts with respect to capital adequacy are 
going at the same time that the Basel II negotiations are under 
way, and the timetables are relatively concurrent, so that we 
expect the differences or concerns with respects to differences 
in capital treatment will be addressed and recognized.
    Finally, with respect to the international accounting 
standards, we would point out that while the financial 
reporting is under the jurisdiction of the SEC within the U.S., 
that there are significant efforts under way to assure, with 
the SEC's participation--the Fed is also involved--that we see 
a greater amount, and a continuing amount, of overlap in 
international standards and U.S. GAAP. And we will be 
participating in that process as we move forward.
    Finally, Mr. Chairman, we would just point out that we at 
the Fed and the other regulators have excellent relationships 
with the European supervisors and other supervisors around the 
world. And I think it is that continuing ability to dialogue 
that has helped assure that there is consistency in the 
regulation.
    And I would like to just end by saying that I very much 
enjoyed being with Congresswoman Jones on Friday, it was an 
excellent seminar. And I am happy to be here today.
    [The prepared statement of Hon. Mark W. Olson can be found 
on page XX in the appendix.]
    Chairman Oxley. Thank you, Mr. Olson.
    Mr. Quarles?

     STATEMENT OF RANDY K.QUARLES, ASSISTANT SECRETARY FOR 
        INTERNATIONAL AFFAIRS, U.S. TREASURY DEPARTMENT

    Mr. Quarles. Thank you, Mr. Chairman, Ranking Member 
LaFalce, and members of the committee. It is a pleasure to be 
here testifying today. I agree with Governor Olson that this is 
a very timely hearing.
    I have prepared remarks for the record. I will not subject 
you to the tedium of reading them, but I just want to make a 
few comments.
    The first is that the Financial Services Action Plan that 
Europe is in the process of implementing, in our view, offers a 
clear win-win of opportunity for both Europe and the United 
States, if it is well managed. The experience of the U.S. 
teaches us that efficient capital markets are among the most 
critical structural reforms for promoting robust growth. There 
are European estimates that suggest that financial market 
integration could boost European growth by at least half a 
percent annually, which is a significant addition.
    It has been a strong theme of the Treasury and Secretary 
O'Neil that the U.S. cannot be the only engine of global 
growth, as we have witnessed in the last global slowdown. And a 
successful Financial Services Action Plan could help Europe 
become a welcome second engine of a growing global economy.
    Another point I would make is that U.S. financial firms are 
among the most competitive and efficient globally. They are 
leading worldwide players. So U.S. firms can help Europe 
achieve its aspirations in the Financial Services Action Plan.
    Clearly, for the reasons that you and others have outlined, 
the U.S. will need to continue monitoring the FSAP very 
closely, in light of a few principles, from our point of view.
    The FSAP should be consistent with the reality of an open 
and global financial system; so it shouldn't tilt the playing 
field. It should reward the most efficient firms that are 
operating in the European market, regardless of the firms' 
country of origin.
    And given that the financial services industry is usually a 
step ahead of its supervisors, the FSAP itself underscores the 
need for supervisors to consult closely with financial firms. 
So this process should take place in an open and transparent 
manner, the process of developing the regulations under the 
FSAP that will govern the operation of financial firms in 
Europe. And in our view, recently EU officials have undertaken 
some welcome steps to meet that challenge.
    Next, in implementing the FSAP, the decisions that European 
policy makers will take will reflect the diverse interests and 
financial traditions of Europe, as well as the need to promote 
the safety and soundness of financial markets. But, in our 
view, the decision should be taken in a manner that rewards 
innovation and competitiveness, and recognizes the reality of 
how global firms operate.
    These points relate to a number of specific FSAP directives 
that are on the table. First, U.S. investment banks often net 
out purchases and sales of securities. In other parts of the 
world, such transactions are put through exchanges. This issue 
is raised by an investment services directive. And in our view, 
this directive ought to be flexible enough to take account 
again of the reality of how firms operate, and that there are 
different ways to operate in a safe and sound manner.
    Another: What is adequate capital for an investment bank 
will differ from what is adequate capital for a commercial 
bank, given the different nature of their businesses. This is 
an issue that arrives within the financial conglomerates 
directive, where one shouldn't attempt to shoehorn a capital 
regime designed for commercial banks under the operation of 
investment banks, simply because of the universal nature of 
European banks, because not all of our firms operate that way.
    Next, firms may wish to list securities in a given country, 
even if their home base of operation is elsewhere. Authorities 
in the firm's home country, and they prefer that the listing 
take place there. That is an issue that will need to be 
addressed in the directive on prospectuses.
    Now, inevitably, in all of these areas and more, there will 
be differences in the way U.S. and European authorities and 
financial institutions approach these issues of common 
interest.
    So these issues need to be well managed. It wouldn't be 
appropriate, for example, for European officials to attempt to 
impose European regulatory standards on the rest of the world 
or to expect U.S. financial institutions to be identical in 
structure to European firms and to deny our institutions the 
benefits of the leading-edge technology.
    Naturally, we would be concerned by any proposals that 
might discriminate against the European operations of U.S. 
financial institutions and suggest that U.S. supervision was 
not appropriate simply because it wasn't identical to Europe's 
way to doing business.
    Rather, in our view, we need to put aside any formal 
differences, recognize that we share a common set of 
objectives, that the goal of increased European financial 
integration is beneficial to both Europe and the United States 
and to firms in both Europe and the United States, and to 
ensure that these objectives are being achieved in substance. 
It won't be easy, but we are working together to achieve that.
    We are in close contact with our European counterparts. 
Last November, the senior EC official responsible at the day-
to-day level for the FSAP visited Washington, met with John 
Taylor, the Undersecretary of the Treasury. In March, a team of 
Treasury, Federal Reserve and SEC officials visited Brussels. 
At the end of this month, the EC commissioner for the internal 
market, Frits Bolkestein, will be visiting Washington. His 
chief lieutenants will then follow up in mid-June for further 
discussions.
    So this is a process that we are very involved in and 
monitoring very closely and, in fact, are seeing progress in 
these discussions on a number of these issues of concern to us 
and to U.S. financial firms.
    It is important to note that this isn't just a one-way 
dialogue. Just as the U.S. is greatly interested in how 
European financial markets are developing, European officials 
are interested in how U.S. financial markets develop. And 
recognizing this, the two-sided nature of this and the win-win 
nature of this, President Bush and President Prodi, at the May 
2 summit in Washington, put this financial market dialogue at 
the top of the U.S.-EU positive economic agenda.
    So let me just conclude by underscoring that the U.S. 
welcomed Europe's efforts to integrate its financial markets 
and that we at the Treasury, in conjunction with our colleagues 
at the SEC and the Fed, intend to remain closely engaged with 
Europe to help ensure that the FSAP contributes to a strong and 
more robust international financial system.
    Thank you.
    [The prepared statement of Randy K. Quarles can be found on 
page XX in the appendix.]
    Chairman Oxley. Thank you.
    Ms. Nazareth?

  STATEMENT OF ANNETTE NAZARETH, DIRECTOR, DIVISION OF MARKET 
      REGULATION, U.S. SECURITIES AND EXCHANGE COMMISSION

    Ms. Nazareth. Chairman Oxley, Ranking Member LaFalce and 
members of the committee, thank you for the opportunity to 
testify before you today on behalf of the Securities and 
Exchange Commission on certain pending proposals of the 
European Commission. My testimony today will focus on the EC's 
proposal for a directive on consolidated supervision of 
financial conglomerates. I have also included in my written 
testimony a brief discussion on the adoption of international 
accounting standards, the proposed prospectus directive and the 
capital adequacy directive.
    European capital markets have been undergoing a major 
transformation. One aspect of this transformation is the EC's 
commitment to integrate financial markets in the European 
Union.
    The EC has stated that a single financial market will be a 
key factor in promoting the competitiveness of the European 
economy. An integrated market is being facilitated in part by 
the EC's development of the Financial Services Action Plan, 
which is a series of legislative proposals that would subject 
all financial services firms active in the EU to consistent 
standards of regulations.
    One of the primary legislative proposals by the EC under 
the action plan is the proposal for a directive on the 
consolidated supervision of financial conglomerates. This 
proposal, which I will refer to as the proposed directive, 
would impose a series of quantitative and qualitative 
requirements at the holding company level of a financial 
conglomerate or a mixed financial holding company, which would 
be applied by an EU member state's home regulator, which will 
be designated as the coordinator.
    If a financial conglomerate or a mixed financial holding 
company operating within the EU does not have its head office 
within the EU, the proposed directive provides for the 
verification by EU authorities that the firm is subject to 
supervision that is equivalent to the EC's proposed directive. 
If an equivalence determination is not made, then under the 
EC's proposal EU authorities could adopt other methods, such as 
imposing additional requirements on the firm to achieve the 
objectives of the proposed directive.
    Several U.S. securities firms have communicated to the 
commission that they have serious concerns with the proposed 
directive. They fear that the EU authority that will make the 
equivalence determination will take the position that the 
commission's supervision of securities firms at the holding 
company level is not equivalent to the EC standards. 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.
    The commission shares many of the EC's concerns about how 
to contain and supervise risks posed by financial conglomerates 
and believes that our approach to the supervision of securities 
firms is as effective as that in the proposed directive.
    The commission's mandate includes ensuring that our 
securities firms have the highest level of financial integrity 
and that they operate in a manner that promotes the protection 
of investors. Our regulatory regime has operated with 
remarkable success since the commission's financial 
responsibility regime was implemented in 1975. Very few large 
securities firms have failed, and in no instance has a failure 
had any significant impact on markets or required federal 
funding to liquidate a firm.
    The commission's financial responsibility program is an 
important component of its supervision of securities firms. 
This program requires that broker-dealers maintain prescribed 
amounts of liquid net worth, safeguard customer funds and 
securities, keep and maintain accurate books and record and 
regularly file detailed financial information with the 
commission and with the self-regulatory organizations.
    In addition to the regulation of securities firms, 
Congress, in 1990, amended the Securities Exchange Act to 
provide the commission with specific authority to obtain 
information regarding the financial activities of affiliates of 
securities firms.
    Under these rules, often referred to as our risk assessment 
rules, securities firms that are part of a holding company 
structure are required to provide the commission with 
comprehensive financial and operational information on a 
periodic basis.
    This information allows the commission staff to evaluate 
the material risks to securities firms posed by their 
affiliates. The information reported to the commission under 
the risk assessment rules is supplemented on a voluntary basis 
by risk information provided by the Derivatives Policy Group.
    DPG members now file with the commission on a monthly basis 
certain internal financial and risk management reports at 
holding company level. These reports generally contain 
extensive information regarding the firm's financial condition 
and risk exposures, including granular detail with respect to 
their value at risk computations and credit risk exposures.
    Finally, the commission may use its authority, granted 
under the Gramm-Leach-Bliley Act, to create a new type of 
voluntary holding company called a supervised investment bank 
holding company. Such a supervised investment bank holding 
company is generally defined as an entity that owns or controls 
one or more registered securities firms but is not affiliated 
with an insured bank, a savings association or a foreign bank. 
The staff plans to recommend that the commission implement this 
voluntary regime in the near future.
    The commission believes that its regulation of U.S.-
registered securities firms, and their affiliates, satisfy the 
proposed directives by providing equivalent group-wide 
supervision. Commission staff meet on a regular basis with 
foreign regulatory authorities to discuss regulatory issues and 
concern relating to global securities firms.
    The commission's staff, as Randy Quarles mentioned, has had 
extensive discussions on these issues of equivalence with EC 
representatives and foreign regulators, and the commission is 
committed to continuing these discussions in order assist them 
in arriving at a favorable equivalency determination under the 
proposed directive.
    Thank you for this opportunity to testify.
    [The prepared statement of Annette Nazareth can be found on 
page XX in the appendix.]
    Chairman Oxley. Thank you, Ms. Nazareth.
    And thank you all.
    Let me begin by asking Mr. Olson about the issue that I had 
addressed in my opening remarks, and that is expensing stock 
options, a very non-controversial issue--we thought we would 
start you off with any easy one.
    As you know, the International Accounting Standards Board, 
in conjunction with the action plan in Europe, is promoting the 
concept. What do you make of that? How does that jibe with how 
our system currently works? And ultimately, is there a 
competitive issue here lurking beneath an attempt to change the 
way that we look at how we expense these options?
    Mr. Olson. Mr. Chairman, our chairman has responded to 
questions regarding the accounting treatment for stock options. 
But that is not an issue that the full Fed board has taken a 
position on, in part because accounting issues come primarily 
under the jurisdiction of the SEC.
    So whereas Chairman Greenspan is occasionally asked for his 
input on broader issues beyond the Fed, we have not taken a 
position on that issue. So I would defer on that one to the 
SEC.
    The Chairman. Ms. Nazareth is avoiding my gaze, here.
    [Laughter.]
    Since you raise the issue, let me ask Ms. Nazareth for her 
viewpoint, and coming from the SEC.
    Ms. Nazareth. Well, I am not the commission's expert on the 
accounting issues. I think certainly the commission's position 
on all of these accounting issues is what we really should be 
working on is convergence of accounting standards, and it is 
unfortunate that, you know, one of the first issues that the 
IASB has chosen to consider is this very contentious issue, and 
in fact is taking a position that is contrary to what is 
currently the standard in the U.S.
    So I think our goal, obviously--as with all of these 
issues, and certainly Ranking Member LaFalce said--you know, in 
all of these regimes we should be seeking whatever is the best 
approach and not taking the position that whatever is the most 
expedient, politically or otherwise. And this is obviously a 
very important but contentious issue, but I think it would be 
incumbent on all of the standard-setters to try to arrive at 
some common ground, in terms of how to report stock options.
    The Chairman. Let me ask Mr. Quarles: The European Union, 
according to their statement, wants to become the most dynamic, 
competitive knowledge-based economy in the world in the next 
eight years. How realistic is that goal and does that present 
some competitive issues for our country?
    Mr. Quarles. Well, as for whether the goal is realistic or 
not, I think that we--obviously Europe is a very strong 
economy, and has the potential to be much stronger with 
appropriate structural reforms.
    What I would stress, I guess, is that the United States 
doesn't really have anything to fear from competition. And, in 
fact, just as we believe that competition is good within our 
own economy, we are strengthened by having strong competitive 
economies abroad. Those are markets for our goods and services. 
And they keep us on our toes as well.
    So I don't view that as a threat, so much as an opportunity 
for U.S. firms, and indeed a welcome goal of the Europeans, to 
seek to become the--and you have to discount the puffery in 
being the "most dynamic economy"--but to increase the dynamism 
of their economy, and to increase the amount of innovation in 
their economy is, in fact, something that I think we should 
encourage, because, in fact, that will benefit U.S. firms that 
operate in Europe as much as it benefits European firms.
    The Chairman. Thank you.
    Ms. Nazareth, how does the SEC coordinate, if you do, with 
Treasury and the Fed in responding to the Financial Services 
Action Plan? Is there a working group, or do you all work 
separately?
    Ms. Nazareth. Well, I think it has been somewhat informal. 
But I think it has been very effective in the recent past. As 
Mr. Quarles said, a group representing both the SEC, Treasury 
and the Fed, you know, went to Europe and met with EC officials 
and with the regulators at the federal level, to discuss issues 
relating to the financial services directive and other elements 
of this. And I think it has been very, very productive. But I 
don't think there is necessarily a formal mechanism, but it has 
been very constructive informally.
    The Chairman. Is USTR involved in this process as well?
    Ms. Nazareth. No.
    The Chairman. No. I am out of time.
    The gentleman from New York.
    Mr. LaFalce. I thank the chairman.
    The chairman brought up the issue of the expensing of stock 
options. I have tried, I believe successfully, in my 28 years 
in Congress, never to take issue with FASB, believing that the 
intricacies of accounting are so complex and great that it is 
always best to defer to them, even when, for example, the 
chairman of the Federal Reserve Board might differ, as he did 
on occasion, or when the chairman of the SEC might differ, 
which he did on occasion; to just stay out of that.
    And recently, I had dinner with Ed Jenkins, the Chairman of 
FASB. He will be leaving shortly, I think. And I asked him to 
give me a letter treating the history of FASB's 
recommendations, when they did recommend that stock options be 
expensed, and the opposition that they received from various 
individuals and groups. And he did send me a detailed letter 
explaining why he thought it was necessary then to expense 
them, and the difficulties he had in effectuating that. And I 
ask unanimous consent that Mr. Jenkins' letter be made a part 
of the record.
    [The following information was subsequently furnished by 
Hon. John J. LaFalce for the hearing record.]
    The Chairman. Without objection.
    Mr. LaFalce. Good. And we should have copies of that for 
anybody who might be interested shortly. I think it will make 
interesting reading.
    One of the questions that I asked Mr. Jenkins was, Well, 
people are saying it is so difficult, evaluating stock options, 
extremely difficult. And he says, basically, nonsense. It is 
done all the time. It can be done. There is a specific 
methodology to do it.
    I note that individuals such as Chairman Greenspan agree 
with him on that issue. Individuals such as Warren Buffett 
agree with him. We ought to get on with it. I think it is 
something the securities Industry Association should work with 
FASB on, in trying to come up with something. I think the 
capital markets would be much better. And now, if the European 
Union is taking that approach.
    Is that correct, European agreement is going to be taking 
that approach calling for the expensing of options? Anybody 
want to comment?
    Mr. Olson. I am not sure if it is the European Union or if 
it is the International Accounting Standard Board.
    Mr. LaFalce. Oh, yes, the International Accounting Board. 
Have they adopted that, or are they in the process of adopting 
that?
    Mr. Olson. My understanding is that it is being debated 
now.
    Mr. LaFalce. Being debated? I think I got from Ms. 
Nazareth's testimony that she thinks it is likely to be 
adopted.
    Is that correct, Ms. Nazareth?
    Ms. Nazareth. I don't think it is likely, but it is 
certainly being actively debated at this time.
    Mr. LaFalce. Well, I do think it is something that we 
should pursue. And I leave it up to you to pursue. I am not 
sure that the Congress is aggressively going to pursue that, 
but it ought to be pursued.
    Now let's pursue another issue, though, too, and that is 
the issue of privacy. And I knew where the previous 
administration, Mr. Quarles, stood on the issue of privacy. 
Because I worked with them on the privacy bill. And we passed 
the best privacy bill that we could pass. But it was a good 
first step. It was not adequate. And therefore we specifically 
said the states could go further. Now, the industry at large 
would love to see federal pre-emption. And I am open to that, 
if we can take the additional steps necessary.
    Working with the previous secretary of the Treasury, Mr. 
Summers, I introduced legislation, and he and Gene Sperling, et 
cetera, were at my side at a press conference, to take that 
next step. Now some are arguing to the European community, 
"Well, you ought to hold us harmless. Whatever we have done so 
far should be adequate. I say, no, not at all; that was the 
first step.
    What is the position of the Bush administration with 
respect to the adequacy of the privacy standards that were 
enacted as part of the Financial Services Modernization Act of 
1999?
    Mr. Quarles. You are referring simply to the position on 
the privacy standards domestically, or in our--
    Mr. LaFalce. Domestically, yes, domestically.
    Mr. Quarles. --discussions with the EU?
    Mr. LaFalce. No, first domestically. Has the Bush 
administration taken a position?
    Mr. Quarles. I guess I should say that, without wanting to 
pass the buck to someone who is not here, the responsibility 
for that in the Treasury Department rests with the Assistant 
Secretary for Financial Institutions. And so I would be loathe 
to speak for her today.
    Mr. LaFalce. Well, I would think that in negotiating with 
Europe that it would be helpful to know what our position is 
domestically.
    Mr. Quarles. You are absolutely right.
    And I am not aware that there has been any modification of 
the position on the adequacy of privacy standards.
    Mr. LaFalce. Modification? What do you mean modification? 
Modifications of a position suggest there is a position, that 
is one thing. Now, if you mean there is no position, that is 
something else.
    Mr. Quarles. I believe that the Treasury--we are at least 
engaging with the Europeans on the basis of ensuring that the 
Europeans view our standards as adequate.
    Mr. LaFalce. I was under the impression that Secretary 
O'Neill, at least personally, is a hawk on privacy, similar to 
Senator Shelby. And someone like Senator Shelby, who is the 
ranking Republican to be or the chairman to be, depending on 
the outcome of the elections, believes that the existing 
standards are grossly inadequate. And it is my understanding 
that Paul O'Neill personally shares his sentiments.
    The Chairman. The gentleman's time has expired.
    Mr. LaFalce. Thank you.
    [Laughter.]
    The Chairman. It may be safe to say that the administration 
supports the Oxley language that was added to the Gramm-Leach-
Bliley Act that became the final product. I would appreciate if 
you would check on that, but I suspect that is probably where 
the administration stands.
    Mr. LaFalce. Well, the Clinton administration supported it 
at that time. I thought it was the LaFalce language rather than 
the Oxley language to tell you the truth, Mr. Chairman, because 
I was involved in the conference deliberations, you know, 100 
percent.
    Mr. Quarles. If both of you claim that language, I am sure 
we must support it.
    Mr. LaFalce. Oh, you supported it, but we also thought it 
should go a lot further. Okay, thanks.
    The Chairman. The gentleman's time has expired.
    The chair would note that we have two votes on the floor. 
We have about eight minutes left. Does someone on this side of 
the aisle wish to say about three minutes of questions? What 
order did they come in?
    Mr. Watt, I will recognize you for three minutes, if that 
is okay, then we will break for the vote.
    Mr. Watt. That is fine, Mr. Chairman. I appreciate it.
    I just wanted to, first of all, express my gratitude to you 
for the privilege of traveling to Europe on this most recent 
break that we had to discuss some of these issues. And I feel 
like I at least understand what the witnesses are saying, with 
that as a backdrop. And that was very helpful.
    I did want to ask a question about this equivalence 
determination the conglomerates directive and play the devil's 
advocate a little bit.
    From the European discussions that we had on this recent 
trip, it seemed to me that what they were advocating for was a 
single point of corporate accountability and a single point of 
regulatory or supervisory accountability, neither of which 
seems to be an outrageous position. So let me just, kind of, be 
the devil's advocate here.
    It seems to me on the corporate accountability single 
point, we have found some lessons in the Enron situation that 
perhaps there needs to be a corporate accountability at the 
top. And we do have, kind of, a diffuse regulatory 
accountability between the Fed, the Treasury and the SEC, and 
it seemed to me that what they were saying was that there needs 
to be somebody where the buck stops on these issues. And that 
is particularly the case if you have an international European 
group that is wanting to deal with one point of contact or one 
final authority in the United States. It is even more 
imperative once you get outside of the United States to have, 
kind of, a single point of contact.
    That didn't seem especially outrageous, and I would welcome 
your reaction to that. Maybe I am oversimplifying it, 
misstating it. What seems to be the negative side of what they 
seem to be saying on those two fronts?
    I guess Ms. Nazareth seemed to address this more directly. 
It seemed to me that Mr. Olson and Mr. Quarles were talking 
more about the capital standards part of the conglomerate 
directorate.
    But Ms. Nazareth, and if either of the others have comments 
on it, that would be helpful.
    Ms. Nazareth. We certainly don't take issue at all with the 
goals of what the Financial Services Action Plan is seeking to 
achieve, especially with respect to financial conglomerates. We 
share concerns over the ability to effectively monitor, you 
know, large complex institutions. We obviously are concerned 
about financial stability and the like.
    I think, though, that there is a long history in this 
country of having, you know, more than one regulator for 
financial entities based on the businesses that they conduct. 
And there is a long and very proud history of coordination 
between the agencies. I think we need only look most recently 
to September 11 to see how successfully those financial 
regulators worked together in getting our markets, back up and 
running.
    You know, there is often a sense when there is a change 
that is, sort of, an innovation in a new place that you get 
people who are very convinced of the rightness of their new 
approach. Certainly in Europe in some of the jurisdictions, you 
now have a single, one-stop shopping with respect to financial 
regulation: The regulation of the banks and the insurance 
companies and the securities firms lie in one entity.
    Whether or not that model is superior to the more 
specialized, functional model that we have remains to be seen. 
It is a relatively new model in Europe. And, in fact, all of 
the countries within Europe don't have that model; it is just 
some.
    Chairman Oxley. The gentleman's time has expired.
    I thank our panel. And we will dismiss this panel with our 
sincere thanks for your effort. And the committee stands in 
recess for 15 minutes.
    [Recess.]
    The Chairman. The committee will come to order.
    We would like to call up the distinguished second panel. 
They are Professor Desmond Dinan, Jean Monnet Professor of 
Public Policy, George Mason University; Mr. Marc Lackritz, 
President of the Securities Industry Association; Ms. Karen 
Shaw Petrou, Managing Partner of Federal Financial Analytics 
Incorporated.
    All of you, thank you for your participation. And, 
Professor, we will begin with you.

STATEMENTS OF PROFESSOR DESMOND DINAN, JEAN MONNET PROFESSOR OF 
             PUBLIC POLICY, GEORGE MASON UNIVERSITY

    Mr. Dinan. Thank you, Mr. Chairman, members of the 
committee. I am honored to be here this morning to testify on 
procedural, political and institutional aspects of the 
Financial Services Action Plan. Thanks for having invited me 
and thanks to the staff for having organized this event.
    The commission adopted the Financial Services Action Plan 
in May 1999. It is, of course, part of the much larger goal of 
integrating the European Union economy, which is the main 
objective of the European Union. The committee's strategy was 
simple: to generate the political and institutional momentum 
with a package of approximately 40 measures and a deadline to 
achieve those by 2005.
    You may remember, Mr. Chairman, the famous single market 
program of the late 1980s, early 1990s. That set out a number 
of measures, approximately 300, to achieve a single market and 
a deadline of 1992. The Financial Services Action Plan 
replicates the single market program in its approach, although 
it is much narrower in its focus.
    The European Council, the Heads of State and Government 
endorsed the Financial Services Action Plan in June of 1999, 
which meant that they gave it added political momentum. And the 
incorporated the Financial Services Action Plan into the Lisbon 
strategy, which, as you mentioned this morning, Mr. Chairman, 
seeks for the European Union to become the most competitive and 
dynamic knowledge-based economy in the world by 2010.
    Now I won't go into the legislative process in the European 
Union. You can find a description of that in my written 
testimony. Let me just say that it is extremely complicated and 
arcane. It takes me an entire semester to teach at the 
university. And I won't attempt to describe it to you in five 
minutes.
    Let me just say that the European Union was concerned that 
the momentum behind the Financial Services Action Plan was 
waning and that some measures were not being enacted rapidly 
enough and that the quality of those measures was poor. And for 
that reason, the commission and some member states asked a 
committee of wise men, chaired by Alexandre Lamfalussy, a very 
eminent European banker, to produce a report on progress in 
implementing the financial services action plan.
    The Lamfalussy report was critical of implementation on two 
grounds. Lamfalussy called, first of all, for a much greater 
consultation in the legislative process between the legislative 
actors, the commission, the European parliament, and the 
council, with industry, with interest groups and consumer 
groups.
    And the Lamfalussy report also called for speedier 
enactment of legislation. Not just the primary legislation, 
that is, the directives which are necessary to provide general 
guidance and framework for implementation of the plan, but more 
importantly perhaps for the so-called secondary legislation; 
that is the legislation needed to provide the detailed 
implementation of the financial services measures.
    The Lamfalussy proposal resulted in the establishment of 
two important committees with respect to the Financial Services 
Action Plan: the European Securities Committee, consisting of 
senior representatives of the commission of member states; and 
the European Securities Regulators committee, consisting of 
national regulators.
    Will the plan be enacted? And will the plan be enacted on 
time? Well, there is a huge difference between rhetoric and 
reality in the European Union when it comes to any policy area. 
Even with the best will in the world, proposals are not always 
drafted on time, deadlines slip and inter-institutional strains 
emerge.
    Already there was a huge institutional battle between the 
European parliament and the commission on procedural aspects of 
the Lamfalussy plan, which delayed adoption of the Lamfalussy 
plan by the European parliament for an entire year. The 
European parliament only adopted the plan in February of this 
year.
    The main problem now, according to Lamfalussy, is lack of 
staff, a problem that I am sure is familiar to you here in 
Congress. In a recent article in the Financial Times, he 
expressed optimism generally about the procedures in place. But 
he said the main problem is a lack of qualified staff in the 
commission and in the relevant committee of the European 
parliament to get the work done.
    Thank you.
    [The prepared statement of Desmond Dinan can be found on 
page XX in the appendix.]
    Mr. Shays. [Presiding.] Thank you.
    Mr. Lackritz?

   STATEMENT OF MARC LACKRITZ PRESIDENT, SECURITIES INDUSTRY 
                          ASSOCIATION

    Mr. Lackritz. Thank you very much, Mr. Chairman, members of 
the committee. I appreciate the opportunity to testify today 
about the implementation of the EU's Financial Services Action 
Plan. And I thank you and commend you for your timely review.
    As the professor said, the EU adopted this plan two and a 
half years ago. And I think it is increasingly important that 
the Congress, the administration and the U.S. financial 
services regulators become engaged participants in this 
critical European development.
    The objective of the FSAP is to develop a single integrated 
EU capital market by 2005. Let me just say, we strongly support 
the implementation of this plan and would agree with the other 
witnesses that talked earlier this is actually a win-win for 
Europe. But more importantly, it is also a win for the United 
States.
    U.S. securities firms have long participated in Europe's 
capital markets. We have participated directly in the gains 
that have been made. And we and our customers expect to be the 
primary beneficiaries of a more integrated, efficient EU 
capital market.
    Our very largest members engaging in global business 
receive about 20 percent of their net revenues from Europe. And 
I might add that that is about two times more than the net 
revenues that we receive from Asia. And we employ about 35,000 
Europeans in the business.
    Let me review briefly some specific measures in this plan 
that are of potential concern to U.S. securities firms and our 
clients.
    First, to get back to the issue that was raised by Treasury 
and also by the SEC in the earlier panel, the proposed 
financial conglomerates directive introduces group-wide 
supervision of financial conglomerates. We agree with the 
overall objective of promoting financial stability, but we have 
very strong reservations about some of the directive's 
provisions.
    We are specifically troubled by the proposal's requirements 
that EU supervisors of regulated EU entity owned by a firm 
outside the EU must determine whether the group is subject to 
consolidated supervision that is equivalent to EU regulation. 
Rather than using the equivalence approach taken by the draft 
directive, we believe the concerns addressed by the proposal 
should be met through regular dialogue among global regulators.
    U.S. and EU regulators have had an initial exchange of 
views on the supervisory issues raised by this directive, and 
we believe that continued dialogue will result in a more smooth 
transition to the new EU supervisory regime.
    In addition, a new review of the investment services 
directive provides an historic opportunity for Europe's markets 
to create an environment for innovative, efficient, fair and 
internationally competitive markets, and we welcome this 
revision. The directive helps establish a passport which 
permits securities investment and trading services to be 
provided cross-border within the EU.
    The latest round of consultations has focused on changing 
market structures, such as alternative trading systems, and 
specifically concentrates on issues of, first, trade 
transparency in market conditions where transactions occur 
other than on traditional exchanges, and, second, appropriate 
regulation for order flow that is internalized by investment 
firms.
    We hope that the commission will produce a proposal for the 
new investment services directive that is targeted only at 
addressing existing gaps in an efficient single market and does 
not go out of its way to impose undue new regulatory burdens on 
Europe's capital markets and on participants like us.
    Third, the EU prospectus directive is designed to address 
the currently uncoordinated regulatory framework for approval 
of prospectuses where securities are to be sold in more than 
one EU member state. The most significant outstanding issue 
with respect to the directive relates to whether or not an 
issuer is able to choose in which member state its prospectus 
documentation is reviewed and vetted.
    Under the proposal, the current approach of requiring 
issuers to deal with only one member state where the securities 
are to be offered or traded would be replaced by an approach 
requiring the issuers always to deal with the member state in 
which they are organized, as well as where the securities would 
be offered. So they have a double-stop, basically, or redundant 
stops.
    The European parliament has accepted the need to preserve 
choice, however the council continues to prefer home 
jurisdiction. We hope the commission's revision, which is 
expected this summer, will preserve the choice issue.
    Fourth, the market abuse directive is intended to restate 
the current insider dealing directive and create a new offense 
of market manipulation.
    Our concerns have focused on, first, the absence of an 
element of intent in the definition of the offenses, creating 
strict liability and raising the possibility of prohibition of 
current practices; second, proposed safe harbors which were not 
sufficiently extensive; third, failure to acknowledge that 
effective information barriers, such as we have in the United 
States, should constitute a defense to the principle of deemed 
knowledge; and fourth, the broad scope, which creates competing 
EU regulatory jurisdictions.
    We are particularly concerned that the lack of an intent 
standard will reduce the flow of information to investors in 
the market. Significant, albeit insufficient, amendments were 
made in the European parliament and the council where broad 
agreement on the proposal has been reached.
    Finally, though not part of the plan, the financial 
services industry has sought an adequacy determination from the 
EU so that flows of data between the U.S. and the EU are not 
subject to potential data stoppages. We commend you, Mr. 
Chairman, and your colleagues on the committee for sending a 
letter last year that supported a determination of adequacy for 
the U.S. financial services industry for purposes of the EU 
data protection directive.
    We are also quite pleased that the Bush administration has 
begun a discussion with EU officials and will be seeking an 
adequacy determination in the course of that dialogue.
    The U.S. privacy regime reflects a careful balancing of the 
needs and interests of consumers, financial institutions, 
government, and the specific economic and security interests of 
the United States. The export of European privacy standards to 
the threat of transatlantic data stoppages creates a very 
dangerous precedent and one that should be strongly resisted.
    The U.S. securities industry plays an important role in EU 
capital markets and we are fully committed to the integration 
of the EU's capital markets. We look forward to working with 
the U.S. and the EU on a positive economic agenda to ensure 
that European capital market liberalization is achieved in a 
nondiscriminatory manner that is transparent, efficient and 
protects against risk.
    Again, we very much appreciate the committee's serious 
interest in the deepening relationship between the U.S. capital 
markets and those of our closest trading partner, the European 
Union.
    Thank you very much.
    [The prepared statement of Mark E. Lackritz can be found on 
page XX in the appendix.]
    Mr. Shays. Excuse me, is it Ms. Petrou?
    Ms. Petrou. It is.
    Mr. Shays. Thank you.
    Ms. Petrou. I have been married seven years, but it is 
taking a while.
    Mr. Shays. So let's figure out, that name Karen Shaw is?
    Ms. Petrou. Earlier.
    Mr. Shays. Okay. Very good. We will take it off.
    Thank you. You have the floor.
    Ms. Petrou. Thank you so much.
    Mr. Shays. It is nice to have you here.

   STATEMENT OF KAREN SHAW PETROU, MANAGING PARTNER, FEDERAL 
                      FINANCIAL ANALYTICS

    Ms. Petrou. Thank you.
    I am Karen Shaw Petrou, Managing Partner of Federal 
Financial Analytics. As a firm, we advise financial services 
firms, and indeed several governments, as to policy issues 
affecting the financial services industry. We do not represent 
any companies or clients before the United States Congress or 
the European Union.
    I, too, would like very much to thank you and Ranking 
Member LaFalce for holding this hearing today. It is so unusual 
for the Congress to be looking in 2002 at an issue that may not 
really demonstrate its full competitive impact until 2010. The 
hearing is an important step not only in ensuring that U.S. 
policy interests are understood, but also helping the industry 
take this emerging Financial Services Action Plan seriously.
    Companies tend to think quarter by quarter, and 2010 seems 
a long way out, but these issues are very significant, and 
preserving the fair competitive position of the United States 
in this critical industry sector is an important national 
priority.
    The Financial Service Action Plan is a very important and 
quite worthwhile effort in the European Union to eliminate 
idiosyncratic and anachronistic rules that have impeded the 
ability of the financial services industry in the EU to serve 
consumers and corporations. Many of the reforms under review, 
particularly those in the pension area, for example, could 
result in significant improvements that benefit the EU and 
therefore also the United States.
    However, I would like to summarize a number of issues that 
pose some significant competitive problems, and I believe these 
problems arise in part because our financial services industry 
is very significantly different than that of the EU.
    My written testimony includes some statistics bearing this 
out, but I would like particularly to point to the fact that in 
the European Union banks are by far the dominant providers of 
financial intermediary services. In other words, they take 
money from savers and depositors and they turn it into the 
resources that support economic development. In the EU, in 
several countries, banks' assets are more than 3 times the 
national GDP.
    In the United States, banking assets average about 70 
percent of our GDP. We have a much more balanced structure 
between banks, securities firms, insurance companies and 
pension funds in our business of taking funds from all of us 
and turning them into the assets that promote all of our 
interest, and we have a very different regulatory structure as 
a result.
    Attempting to force the European banking structure into an 
international financial regulatory one will create some 
significant problems for the United States. Chief among these, 
I believe, are pending in the capital rules and in the 
conglomerate regulation already discussed by several witnesses.
    The capital rules are under development by the Basel 
Committee on Banking Supervision, and this is a panel on which 
U.S. regulators sit. But negotiations are proceeding in a way 
that could put the competitiveness and, indeed, the safety and 
soundness interests of the U.S. financial system at risk.
    One key concern is a proposed new capital requirement on 
operational risk. This is the risk of systems failures or even 
man-made attacks, such as the one on September 11. The proposed 
operational risk-based capital framework in the EU will apply 
to banks and non-banks alike because the EU has the legal 
authority to do that. In the United States, it will apply only 
to banks, even though non-bank asset managers, and payment 
processors are very major participants. This could create some 
significant market distortions and even some safety and 
soundness issues, so I think this needs to be carefully 
considered.
    Pending rules on asset securitization are also problematic. 
European banks are far less competitive in this emerging and 
important market where loans are turned into securities, 
thereby creating new funds for lenders to make more mortgages, 
more car loans and more funding available to borrowers across 
the United States.
    Our technological innovation has spurred this market, and 
the European institutions have generally been slower to follow 
it. They are therefore proposing much higher capital charges on 
asset-backed securities than on the whole loans that comprise 
them, and this poses a significant competitive risk.
    Mr. Lackritz and the first panel have discussed the 
conglomerate rule, so I won't go into that, except to echo the 
concern that this is a bank-like structure. Congress 
established the financial holding company structure in the 
Gramm-Leach-Bliley Act, and it was intended to form a framework 
in which banks, securities firms and insurance companies could 
combine in a single company.
    Since Congress passed that law in 1999, only four non-
banking companies have become financial holding companies, and 
the reason for that is the fact that the financial holding 
company structure superimposes bank capital rules and a bank 
regulatory framework on the securities and insurance industry 
in ways that are often inappropriate. Allowing the EU 
conglomerate regulation to reach across the Atlantic and do 
that raises some very significant issues and warrants careful 
attention.
    Finally, I would like to mention the importance of how the 
United States is represented in these negotiations. Congress 
modernized its consideration of the financial services industry 
under your leadership, Mr. Chairman, by creating a Financial 
Services Committee in this Congress.
    However, trade and financial services is still split among 
many different agencies in the United States government, and no 
one is really responsible for it. This makes it very hard for 
the industry to find a keen advocate with the necessary degree 
of technical knowledge in these highly specialized industries 
to present a unified position in these highly complex 
negotiations.
    [The prepared statement of Karen Shaw Petrou can be found 
on page XX in the appendix.]
    Mr. Shays. Ms. Petrou, let me interrupt you here. Thank 
you.
    I just want to get a sense. We have one vote, that is the 
bottom line. I don't think we can go through all the questions.
    Do you have questions, Mr. Shadegg, that you want to ask?
    So I think what we will do is do you want to just go 
through yours? Are you going to come back?
    Mr. LaFalce. I think it is going to be difficult.
    Mr. Shays. Okay, here is what I am going to do. I am going 
to stay while the ranking member can ask some questions, 
unless--excuse me, I was next in line. I will just go with the 
ranking member. You can ask your question, and then I will 
stay, and then we are going to have you come back.
    So we are going to come back afterwards, if anybody wants 
to come back and ask a question.
    Mr. LaFalce. I thank the chair for his generosity. I will 
defer my questions. I can speak with the representatives 
personally over the phone. I thank the chair.
    Mr. Shays. I am willing to wait.
    Mr. LaFalce. No, I want to let you go ahead.
    Mr. Shays. Does someone want to ask a question now before 
we go and not come back?
    Mrs. Maloney of New York. I will.
    Mr. Shays. Okay, Ms. Maloney.
    Mrs. Maloney of New York. I am very concerned about 
protecting American interests, American business, American 
financial institutions. And in your testimony, you have pointed 
out how our capital markets are so much larger than our 
European sisters' and brothers', and I would venture to say it 
is because they are well managed and that people trust them and 
they want to invest in them.
    And I, for one, find it problematic that Europe is going to 
come over and preach to us on our accounting standards. We have 
had strong accounting standards, and the fact that there is one 
company that has been mismanaged does not speak to the overall 
strength of the American markets. And I really want to know 
what we are doing, steps we are taking, to make sure that in 
all these international agreements that our financial 
institutions and the businesses in America are not put at a 
disadvantage.
    I found Ms. Petrou Shaw's testimony troubling when she 
spoke about the fact that in the so-called Basel accords the 
capital requirements will be putting our banks at a 
disadvantage, or our financial institutions at a disadvantage, 
their capital requirements are lower.
    And then the comments of Mr. Lackritz, when you were 
mentioning how in the privacy situation the fact that our 
European sisters and brothers, with their standards, are 
creating ``a dangerous precedent in data stoppages.'' So I am 
concerned that some of these international standards that they 
are putting out there may have the effect of putting our very 
strong, high-performing capital markets at a disadvantage.
    And I guess this is a question I probably should be asking 
the Fed or the Comptroller, what steps are we taking in our 
overview to make sure that our businesses are not put at a 
disadvantage, and our financial institutions?
    But Ms. Shaw, you mentioned several areas where these so-
called accords would put us at a disadvantage.
    Ms. Petrou. I think that is a concern. And part of it is 
the lack of unity in the United States' position with the EU 
where they have one negotiating team and we have many.
    Mrs. Maloney of New York. But if their capital standards 
are lower than our capital standards, and we in this country 
want a higher capital standard, then our financial institutions 
are at a disadvantage.
    Ms. Petrou. Yes, that is correct.
    Mrs. Maloney of New York. So, I am concerned that as we 
move to globalization--we are at globalization. But quite 
frankly, I was stunned at the statement at how much larger our 
capital markets are than the entire European capital markets. 
We are, double the size, and I never realized that before.
    So I would say they should be coming over here and learning 
a little bit from us, not coming over and trying to make us 
change all our standards to theirs.
    Ms. Petrou. Yes.
    Mr. Lackritz. Can I respond, Congresswoman?
    Mrs. Maloney of New York. Sure.
    Mr. Lackritz. First of all, I thank you very much for that 
kind of support. I think that is the kind of support that we 
would welcome in these negotiations.
    I think that some of these directives--for example, like 
the financial conglomerates directive that I spoke of, and that 
the members of the earlier panel spoke of, and the privacy 
directive, and the directives that Ms. Petrou discussed, are 
good examples.
    And I think what we need here is we don't need regulatory 
imperialism coming at us from Europe. What we need is a 
dialogue to ensure that we have a race to the top, to ensure 
that our firms are allowed to compete fairly, openly and on a 
nondiscriminatory basis. And that is what we are trying to do 
in course--and I think in these kinds of hearings, we are able 
to present the kind of information that hopefully you, as the 
oversight committee, and the administration will be able to 
take into the negotiations and strengthen our negotiating 
position with respect to the Europeans. Because I think you are 
absolutely right.
    Mrs. Maloney of New York. Well, we have to run vote. But I 
would like to see what steps our government, or our not-for-
profits, our institutions, are taking to make sure that our 
firms, our industries are not put at a competitive 
disadvantage. You know, they may present, you know, "Here is 
our standard." Then you find out that their standard basically 
creates a data stoppage for any processing in our country. Now, 
is that really a better standard, or is that an effort to give 
them a competitive advantage?
    So I think that we have to really look at these things. You 
know, the new war is really an economic war in many ways.
    Mr. Shays. Let me just let Mr. Dinan just make a response. 
Then I really want to close up.
    Mr. Dinan. Well, my response would be that I appreciate 
your concerns, Congresswoman. I think they may be exaggerated, 
however, because Europeans are trying to learn from the United 
States. The whole point of the Financial Services Action Plan 
is to make the European Union more like the United States.
    If you look at the strategic objective of the European 
Union, the European Union seeks to become, by 2010, the most 
competitive and dynamic knowledge-based economy in the world. 
In other words, with whom do they wish to compete? The United 
States. Whom do they wish to emulate? The United States. Europe 
is becoming more like the United States in economic terms.
    As I said, I appreciate your concerns, and on specific 
issues they may be warranted. But overall, I think they are 
exaggerated.
    Mrs. Maloney of New York. Well, again, I would request in 
writing from the panelists what steps are being taken that you 
know of, or what steps would you suggest that our negotiators 
look at to make sure we are not being put at a competitive 
disadvantage.
    Mr. Shays. We need to vote here. I am sorry to have you 
come back, and I am sorry for the ins and outs and all the 
votes and all that. You all have been patient. You are aware of 
what goes on here. But we do have some questions we all want to 
ask you. So we are going to ask you. The first member who gets 
back, I am just going to empower them to start the meeting.
    Recess until a member gets back. So it will be less than 
10.
    [Recess.]
    Mr. Shays. The committee is called to order. Thank you for 
your patience and waiting.
    Unfortunately, in this committee, I have to expose my 
ignorance. I haven't been a member very long. But out of my 
ignorance, I learn a lot.
    And my simple mind tells me that the Europeans basically 
want to know what the United States does. As we the United 
States united our states, they are uniting their countries to 
have one basic system. And just as I wouldn't want them to tell 
us what to do, they probably don't want us to tell them what to 
do.
    But, in fact, my first question is in this new environment 
of world competition, the fact is that--and I would ask each of 
you--in order for us to work together, we have to tell each 
other what we want and what we don't want. And I want to know 
if that is true. And then the next is, I want to know what 
leverage we have. And I want to know why they would care what 
we think. I realize we are an economic force but ultimately why 
won't they do whatever the heck they want to do?
    Mr. Shays. Mr. Dinan, when you speak you have such an 
accent I kept thinking you were speaking for Europe, but--
    [Laughter.]
    --but in this concept if all three of you would share with 
me what you think.
    Mr. Dinan. Well, if I could begin, you are right. And this 
was the gist of my remarks to Congresswoman Maloney, that the 
European Union to a great extent wants to replicate the United 
States, certainly economically. The European Union realizes 
that in this global economy and global environment, countries 
the size of the European countries even countries as large, by 
European standards, as Germany, the United Kingdom and France 
can't act alone. In order to be competitive, in order to be 
successful, they have to integrate. And the greatest model of 
economic integration and political integration is the United 
States.
    And that is why they want to replicate the United States' 
tremendous economic achievement, especially recently in terms 
of increasing productivity and in terms of increasing jobs, 
because Europe is still plagued by relatively high unemployment 
and poor productivity.
    But the European Union does not want to do this at any 
cost, because the European Union also wants to maintain what it 
sees as an extremely important aspect of European integration, 
that is solidarity and social cohesion. The European Union 
wants to maintain a relatively high social security safety net, 
much higher than in the United States, for instance.
    So there are differences in the approaches and in the 
objectives.
    The European Union, I think, wants to learn from the United 
States. And I presume the United States wants to learn from the 
European Union, because each has so much to offer the other.
    And when we think of relations between the United States 
and the European Union, perhaps we think too much in 
traditional terms of intergovernmental relations. Because the 
relationship exists at all levels. There are networks, business 
networks, congressional networks, of course governmental 
networks, private sector networks, that are dense across the 
Atlantic and that are constantly exchanging information and 
exchanging knowledge.
    Finally, why would the European Union not like to go it 
alone? Mr. Chairman, I am sure you are very familiar with the 
criticism which the European Union makes at the moment of the 
United States, which is that the United States is, in the view 
of the European Union, too unilateral.
    Europeans don't like unilateralism. Europeans like 
multilateralism. They like institutions and organizations that 
are multilateral. They like to learn from each other.
    The whole process of integration, the whole process of 
bringing 15 countries, soon to be 25 or 27--
    Mr. Shays. Could I just interrupt you there?
    Mr. Dinan. Yes.
    Mr. Shays. The irony of that is I think of the European 
Union as one unit. So when they agree among themselves they 
think like they are multilateral, and I think they are 
unilateral in the sense that they then are this unilateral 
block that then wants to--so I mean, I guess I am just sharing 
a little bit of a bias. The French, they talk to the Germans 
and the Brits say they are multilateral. But if New York state 
talks to Connecticut and talks to California, that is not 
multilateral, obviously.
    Mr. Dinan. Right.
    Mr. Shays. So I am making the same comparison.
    Could close up in a second and let Mr. Lackritz respond as 
well? Could you finish your point?
    Mr. Dinan. Yes.
    Mr. Shays. Do you want to make another point?
    Mr. Dinan. No, I am going to leave it at that. Thank you 
very much.
    Mr. Shays. I appreciate the answer. It is very helpful.
    Mr. Lackritz?
    Mr. Lackritz. Yes, thank you very much Mr. Chairman.
    I think the question you raised is exactly the right 
question as we go into globalization discussions and 
negotiations. Because I think that we have to be very careful 
that there isn't a race to the bottom out of competitive 
concerns that weaken standards and lowers requirements. And at 
the same time, we have to take into account the political and 
cultural differences and the sensitivities of our trading 
partners and our potential partners around the globe.
    So I think the question you raise is exactly right. I think 
I would differ a bit with the professor's point, in that I 
think the Europeans do want to learn from our experience and 
are trying to emulate the experience we have had over here. 
However, in a couple of specific areas, whether it is because 
of political differences or cultural differences, they really 
are trying to impose on their trading partners, meaning us, the 
standards that they have evolved for their own internal reasons 
or for their own internal political reasons. They are very 
different from the standards that we have here and culturally 
are very different too, whether it is from the standpoint of 
pension system or from the standpoint of privacy or from the 
standpoint of consolidated supervision.
    In those circumstances, I think it is important for our 
negotiators to be strong on behalf of U.S. financial services 
providers and also talking to our partners about how it is a 
win-win situation. For them to cut off data, for example, as a 
result of pique at our privacy rules, really only hurts their 
own investors, their own companies and their own ability to 
attract capital since we have the largest pool of capital in 
the world.
    So I think we have to try and do an effective job of 
helping people understand what is in their own best interest 
and at the same time in our best interest in creating win-win 
situations.
    Mr. Shays. Just refresh me, one of you--and then Ms. Petrou 
we will go to you--what is the gross domestic product of that 
entire EU group versus the United States?
    Mr. Lackritz. My recollection is their GDP is in the order 
of $330 billion. And our is not significantly a little bit 
higher.
    Mr. Shays. You don't mean billion.
    Mr. Lackritz. Trillion, excuse me, I am sorry.
    Mr. Shays. You were giving me population, then, weren't 
you?
    Mr. Lackritz. I confused the population. Excuse me.
    Mr. Shays. Listen, I may be a new member to the committee, 
but I did see through that. You are just testing me.
    Mr. Lackritz. No, the GDP for the United States is $10.5 
trillion and for all the European countries it is a little bit 
less: $7 trillion plus.
    Mr. Shays. Right. But a larger population.
    Mr. Lackritz. Yes, a comparable population.
    Mr. Shays. Ms. Petrou, did you want to jump in?
    Ms. Petrou. No, but I think that, looking at the GDP 
numbers, which we tried to do as a way of just evaluating on a 
country-by-country or EU versus U.S. the different structure of 
the financial industries. The percentage that the banks control 
of assets in relation to European GDP, as I said, is much, much 
higher than the banks in the United States. And there are many 
fewer banks, very dominant providers of all financial services 
in the EU.
    We have, for better or worse, a very different system. We 
have 50 states regulating insurance. We have 9,000 banks. We 
have 16,000 institutions that have access to the Federal 
Reserve payment system.
    And the European Union, I think, views this as a very 
inefficient, troublesome system. And they are saying in some 
ways, "If you are coming to the EU, well, do business the way 
we understand it." But while we could improve certain aspects 
of our financial markets, as Mr. Lackritz was saying, to impose 
that across the Atlantic does raise concerns because 
fundamentally, our diverse, confusing, overlapping regulatory 
structure and chartering options have made the United States 
financial services industry the most competitive in the world.
    Mr. Shays. Let me ask you, does it also make it harder--I 
am sorry, and then I will get to Ms. Hart or Mr. Shadegg, 
whichever wants to go next--does it make it harder for foreign 
competition to compete in the U.S. market? Is it one way we are 
almost able to protect industries and discourage competition?
    Ms. Petrou. We have had a national treatment policy which, 
with occasional disputes, has been very effective.
    For example, the European Union and the European countries 
have long permitted their banks to be in a wide range of 
businesses, including owning significant amounts of commercial 
shares that are impermissible in the United States. We have 
always said to the European financial companies, "Come to the 
U.S., you just have to do business in the U.S. our way, i.e., 
observe our limits within the banking industry."
    Mr. Shays. Right. But I was asking something a little bit 
more than that. I was asking about the fact that many times 
U.S. businesses are having to adapt to state regulations, state 
rules, state process. Is that a further discouragement, or does 
that discourage foreign markets from entering? This doesn't 
need a long answer. If it doesn't, it doesn't. If it does, it 
does.
    Ms. Petrou. I don't think it does any more than it 
discourages U.S. issues. The question is not one of national--
in trade and financial services, it is a question of market 
efficiency.
    Mr. Shays. Mr. Lackritz, did you want to respond?
    Mr. Lackritz. Yes. I am not sure it has a deterrent effect 
on foreign investment in the United States. But we have a 
problem when we have 50 different state securities regulators, 
for example, going off in different directions.
    Mr. Shays. I know it is difficult for the U.S. businesses 
to deal with. I would think it would just make it a little 
harder for foreign businesses to deal with.
    Mr. Lackritz. It may. The data, as I recall, are that there 
are 67 European-centered banks that are doing business in the 
United States now. And there are 22 or 23 U.S. institutions 
doing business in Europe. So my sense is that that is probably 
not a big deterrent at this point.
    Mr. Shays. Okay.
    Mr. Shadegg, you were technically next in line, but you 
didn't get back first. So I have this problem of how to know to 
what to do. So I am going to give you 10 minutes.
    Mr. Shadegg. Ten minutes? I don't know if I will use 10 
minutes, but let me begin; I have a variety of questions. I 
want to begin with the capital adequacy directive and its 
implications for the United States and for U.S.-based 
companies. And you say in your testimony that they propose to 
impose a new capital charge for operational risk. I am very 
concerned about the effect of all of this on the U.S. markets 
and U.S. jobs and on our competitiveness in the world.
    But given the relative size of the two capital markets, I 
guess I am somewhat curious how they will impose this, the 
charge for operational risk, and how you see American 
companies, or U.S.-based companies responding to that.
    Ms. Petrou. The current proposal in the Basel Committee 
offers three different options for how the operational risk-
based capital charge would be imposed. And U.S. regulators have 
fought hard for one that relies on internal models of 
operational risk, where the EU is much more determined to 
impose what they call a basic indicator, which would mean that 
the operational risk-based capital charge would be a simple 
about 20 percent of gross income. And then through first the 
Basel Committee and then implemented through the EU capital 
adequacy directive, that would be the amount of capital the 
European banks and non-banks would have to hold against 
operational risk.
    Mr. Shadegg. That would, in fact, be damaging to U.S. 
interests, would it not? Or would it?
    Ms. Petrou. It very well could be because in the EU market, 
we would be bearing that charge as well as a supervisory 
burden, and there are some significant market entry issues that 
are raised by that.
    There are also profound issues in the United States where a 
U.S. bank in, say, the asset management business would have to 
hold a large amount of capital against operational risk, 
capital that would probably bear no real relation to the 
economic risk because it was set by the EU in this crude way. 
But all the non-bank competitors in the same line of business 
would be exempt from that capital charge.
    Mr. Shadegg. Are there things that the United States 
Congress should be looking at doing so that U.S. interests are 
not, in fact, hurt by such a charge?
    Ms. Petrou. I think we are all hopeful that the Federal 
Reserve and the other U.S. regulators will work out this 
agreement so that the competitive and safety and soundness 
issues are addressed. But if this is not possible, then I would 
hope that Congress would look into it.
    Mr. Shadegg. Mr. Lackritz, to that point, you have been 
working with the interests in Europe on these issues. I guess 
my question of you is how receptive are they, and is this 
something that we in the Congress need to be somewhat concerned 
about, deeply concerned about? Where would you put it?
    Mr. Lackritz. Well, first of all, I appreciate your 
question. And I think we would like you to be engaged and 
concerned, because this is a process that, sort of, ebbs and 
flows. And in some areas, we make progress and then in other 
areas we are less successful.
    What we need, I think, and the administration has provided 
a good start on this, is a continuing dialogue with the EU 
regulatory officials and governmental officials, and ability to 
stress how our own laws are adequate or equivalent as the case 
may be. And so as a result, we appreciate both your engagement, 
oversight and support to encourage our negotiators to adopt 
these kinds of positions.
    Mr. Shadegg. Have the Europeans been receptive at this 
point, or are they resentful of America's structure?
    Mr. Lackritz. I think the answer is yes.
    Mr. Shadegg. They have?
    Mr. Lackritz. No, it is both. I mean they have been 
receptive and I think there is some resentment.
    Mr. Shadegg. Do you see a potential for an effect on jobs 
or on our competitiveness in the world market rising out of 
this?
    Mr. Lackritz. I think there is an impact on jobs and 
financial services to the extent that we are restricted 
unnecessarily from competing in Europe. From the European 
standpoint, there is the impact of reduced economic growth 
because they are not going to be able to attract as much 
capital as they might want to attract.
    As Ms. Petrou said, they are very bank-centric in Europe. 
They have been very bank-centric historically. Our capital 
markets and our diverse financial services industry is very, 
very different from that and has produced a very different 
pattern of economic growth and development.
    And I think the professor's point that they are looking at 
us as a model for what they want to do means that they are 
trying to emulate some of the processes that we have done. But 
I think that we are in the process of, as we negotiate, trying 
to explain to them the benefits of openness, transparency, non-
discrimination and those kinds of things.
    Mr. Shadegg. I don't want to go over my time, but maybe 
either you or the professor could answer this question. It 
seems to me that it is in our interest to negotiate in an open 
and forthright way between now and then. But it also seems to 
me that if they remain arbitrary, and if they impose 
requirements which do damage, there will be American companies, 
or American-based companies that will simply say, "We, in fact, 
will pull out. We will not meet your demands."
    And it seems to me it is a little bit like the gamesmanship 
we sometimes play on the floor of put a rule out on the floor 
and you don't know if the rule is going to pass because you 
don't have 218 members that say ahead of time they are going to 
vote for it, but you, kind of, call their bluff. And at the end 
of the day they vote for it.
    And it seems to me that if requirements are imposed upon us 
that are arbitrary or would be damaging, the real pain will be 
inflicted on the European economy, as you point out, by us 
pulling out.
    Professor or either one of you, if you want to make a 
comment on that?
    Mr. Dinan. If I could comment, first, Congressman, in my 
testimony I mention that there is a reform procedure called the 
Lamfalussy program.
    Mr. Shadegg. Yes.
    Mr. Dinan. Mr. Lamfalussy is a very eminent European 
banker, a former head of the European Monetary institute, the 
precursor of the European Central Bank. And the commission and 
member states asked him to look at the Financial Services 
Action Plan. They felt that there were problems and Lamfalussy 
agreed that there were problems. There were procedural 
problems.
    But a main problem that he identified, and therefore the 
main recommendation that he made, was that there be more 
consultation. And in that recommendation, which has since been 
implemented, he did not distinguish between people within the 
EU and outside the EU who could or should be involved in this 
consultation procedure.
    And now there is much greater consultation in both primary 
legislation and also in secondary legislation. And I think and 
I presume U.S. interests are involved in that.
    Obviously, the U.S. does not have a seat at the decision-
making table. But the U.S. is a major player and U.S. interests 
are, I think, represented. And I know that the U.S. mission to 
the European Union is watching these issues very closely.
    Mr. Shadegg. Thank you all for your testimony.
    I yield back the balance of my time.
    Mr. Shays. I thank the gentleman.
    Ms. Hart?
    Ms. Hart. Thank you, Mr. Chairman.
    I only have one question that may actually have missed some 
of you and so if I repeat it, I apologize.
    As this continues, I don't see any reason for us the United 
States to feel threatened in any way. And I know some of the 
earlier testimony suggested that this is a great opportunity, 
obviously, for American financial institutions. But is there 
something that Congress should be doing--this is really a 
question, I guess, for all three panelists--to help the U.S. 
institutions be more prepared to compete in this new market 
place?
    Ms. Petrou. I think monitoring, as you have, the ongoing 
effort in the Congress to modernize and improve U.S. financial 
regulation and also to improve the structure of the industry to 
make us even more efficient and competitive. And to the degree 
the committee continues those initiatives, that will be the 
best way to promote U.S. interests in the EU.
    Mr. Lackritz. The committee last year sent a letter, I 
believe it was to the Treasury secretary. It was signed by a 
number of members of the committee, urging the Treasury in its 
negotiations with the EU to push for an adequacy determination 
of our privacy laws. And it is that kind of support and 
cooperation, I think, between the branches of the government 
and policy and, sort of, unified support of the policy that is 
very, very helpful to our negotiators. And therefore, to our 
U.S. interests over there.
    So in all these areas where there are problems that we see 
in this process, getting support from the committee to our 
negotiators, and therefore, showing the Europeans that we are 
very unified on this, is very helpful.
    Mr. Dinan. I would say a hearing such as this is very 
encouraging. And I hope it will be reported in Brussels and in 
the relevant newsletters. And that will get the attention of 
the Europeans, the fact that the United States is aware of this 
issue.
    I think the CODEL, which Congressman Oxley led, was very 
important. It is easy to bash CODELs, we know. I think that 
particular CODEL was so timely and so relevant. And similarly, 
the return visit of the officials of the commission. And the 
fact that there is an active negotiation and interchange taking 
place is very important.
    Ms. Hart. Thank you, Mr. Chairman.
    Mr. Shays. Thank you very much.
    Mr. Shadegg, do you have any other questions? I have a few 
more and then we will conclude.
    Mr. Lackritz, you talked about why the private sector is 
concerned about some aspects of this plan. But I would like to 
know how U.S. firms will be placed at a disadvantage if all 
firms operating in the EU are subject to the same rules. What 
would be some of the disadvantages?
    Mr. Lackritz. Well, the disadvantages that we referred to 
depends on the directive. If we take them directive by 
directive, for example, on the investment services directive 
where they are now in the process of reviewing that directive 
to determine how broad a passport to provide in providing 
investment services throughout the EU. They are beginning to 
look at how to control or regulate off-exchange transactions, 
what we would refer to in the United States as either 
internalization, alternative trading systems, electronic 
communications networks and the like.
    We are very sophisticated, in terms of developing those 
kinds of facilities. There are currently 12 or 13 electronic 
communications networks, for example, operating in the United 
States. There is a regulation of the FCC providing for 
alternative trading systems.
    To the extent that that directive veers off because of the 
interest of a European exchange, for example, to try and block 
competition from that European exchange, our firms who own 
these electronics communications networks would be severely 
disadvantaged.
    Similarly, with respect to the data protection directive, 
that is not a question of playing by the same rules, that is a 
question of trying to play by--with respect to data 
transmissions, that is imposing a set of privacy regulations 
and legislation on the United States that is very different 
than what the Congress, in the Gramm-Leach-Bliley Act, decided 
to impose on the United States firms.
    So we would again be disadvantaged. Our customers would be 
disadvantaged. And actually Europe would be disadvantaged 
because they would at least threaten to block data flows out of 
Europe to the United States. And that would end up hurting, I 
think, the Europeans far more than it would hurt us. But it 
would diminish our ability to compete.
    So, I think in each of these areas there are specific 
examples of how we might be disadvantaged depending on the 
direction that the directive would take.
    Mr. Shays. Okay. And then, actually, it just triggers this 
question, though. So is the onus on us to get them to try to 
work out an agreement, a compromise with us, or do we have to 
change what we do?
    Mr. Lackritz. Because I think there is broad agreement that 
our financial services industry and our markets and our capital 
markets are really the best in the world right now, we would 
hope that they would be able to, as the professor said, try and 
emulate us and move a little bit more in the direction of the 
openness, transparency and non-discrimination that we have been 
advocating.
    Mr. Shays. Just one last question to you: You had stated 
the SIA has worked closely with the European commission and the 
national regulators. And I am interested to know how receptive 
have the Europeans been to American advice and concerns?
    Mr. Lackritz. I think in some areas they have been 
receptive and there has been great progress made. And in the 
other ones, I think that we have outlined here, there is still 
some work to do. So I think it is obviously a work in progress.
    As I said, we are very supportive of their Financial 
Services Action Plan and we are very optimistic that the single 
integrated European capital market will be a win-win. It will 
be a win for Europe. It will be a win for the United States. 
But we will have a little work to do to get there.
    Mr. Shays. Okay.
    Ms. Petrou, according to your testimony the Financial 
Services Action Plan will generally make Europeans more 
efficient, in fact, far more efficient to use your word. Are 
there any elements of the action plan that the U.S. could use 
to make our system more efficient? It is, kind of, partly the 
question I asked Mr. Lackritz.
    Ms. Petrou. I think there are areas where a federal 
standards--and I know this is a significant issue for this 
committee in terms of federal preemption and consumer standards 
like predatory lending and privacy. Many changes in terms of 
making the financial market in this country more uniform would 
undoubtedly improve efficiency.
    But we have a national tradition of liking to preserve 
local jurisdictions, which is very different than the EU one. 
So I think we have a very different balance to maintain.
    Mr. Shays. Okay. I have this general sense that the 
Europeans clearly allow--I mean a very real sense, the 
Europeans allow their banks to do so much that we don't allow 
here. But I am also getting the sense that there is greater 
regulation on the banks overseas. Is that true as well?
    Ms. Petrou. That is true.
    Mr. Shays. Okay.
    Ms. Petrou. I am sorry, you said lighter regulation?
    Mr. Shays. Greater.
    Ms. Petrou. Oh, no, no. I am sorry, Mr. Chairman. It is 
generally lighter. It is quite different.
    Because there are far fewer banks of size in each one of 
the European countries, there is a much more collegial system 
of bank regulation. For example, there is no examination. 
Supervisors generally do not go into the banks. Instead, the 
banking executives and their outside auditors are called in and 
then asked to describe their operations. It is a quite 
different system.
    Mr. Shays. This is the question my staff wanted me to ask. 
And I am not quite sure I grasp it. I may ask them to jump in. 
But maybe you will grasp it and we can have the dialogue.
    In your testimony you discuss the dominant role of the 
banks in the EU and the long tradition of bank regulation. That 
is the phrase that confuses from the question and says "Do you 
foresee the emphasize changing with the Financial Services 
Action Plan? Will this need to be changed in order for the EU 
to become more competitive?"
    But based on your answer, there isn't a lot of regulation. 
So I am not sure there would have to be much change on their 
part. Is that the answer?
    Ms. Petrou. I think the goal of the FSAP is to harmonize 
the different traditions of bank regulation within the EU, but 
not in any way to make it comparable to our system where we 
depend, as I mentioned, extensively on supervision as well as 
capital, and in addition, on a tremendous amount of disclosure.
    Now there is an overall effort to harmonize bank regulation 
through the Basel Committee and the Joint Forum, which are 
groups of international regulators. But this is still 
proceeding in lots of fits and starts.
    Mr. Shays. Could you turn to your statement on page four 
where you have the graph?
    Ms. Petrou. Yes.
    Mr. Shays. Could you turn to that and just walk me through 
it?
    Ms. Petrou. I would, but I am mostly blind, Mr. Chairman.
    Mr. Shays. Oh, I am sorry.
    Ms. Petrou. So I will have to do it in my head because I 
can't see it.
    Mr. Shays. Okay, I didn't know that. And your testimony is 
very well delivered and very thoughtful. So I wanted to take 
advantage of your extraordinary expertise.
    You said, "As it is shown, relative difference in the role 
of banks can be seen by comparing bank held assets to a 
country's overall economy." And so you show insurance, you show 
pensions, you show investment funds and you show banks.
    Ms. Petrou. Yes.
    Mr. Shays. Is this within their own countries?
    It is a comparison with the EU, and Japan and so on.
    So what we had interpreted from that is they had more 
regulations rather than less. But is it possible that they have 
more regulations, but simply don't enforce them the same way?
    Ms. Petrou. I think perhaps the testimony is not well 
phrased. They have had for many years in the EU what they call 
universal banking. And so the very few dominant financial 
institutions, going back several hundred years in some cases, 
were the institutions that became investment houses, and that 
also owned significant portions of the industrial base of those 
countries.
    For example, Deustche Bank has had major industrial 
interests in German companies since the end of the Second World 
War.
    Mr. Shays. You know, this isn't really regulation as much 
as the percent of the gross domestic product. And so it is 
really just saying banks both in the EU and in EU 15 and EU 11 
are extraordinarily dominant in their economies compared to the 
U.S. and Japan. And so I understand the context of your 
question then.
    Thank you. Sorry to show my ignorance on that.
    Mr. Dinan, I would like to ask you three questions. You are 
clearly an expert on European government institutions. The 
committee would like to know, who has been the driving force 
behind the Financial Service Action Plan. And how successful do 
you think they will be in implementing this plan? So who has 
been the driving force in Europe?
    Mr. Dinan. I think the driving force has come from within 
the EU institutions themselves and outside it. Within the EU 
institutions, the main driving force is the directorate general 
for the internal market in the commission. And the commissioner 
with responsibility for that is Frits Bolkestein, who is a 
senior Dutch politician and an economic liberal. So he is 
ideologically very much in favor of market liberalization and 
is pushing through market liberalization within the commission.
    Mr. Shays. When you use the term "liberalization," just so 
I make sure I understand it, in other words, do they want to 
let the market forces work for themself?
    Mr. Dinan. Yes.
    Mr. Shays. They are not liberal in terms of more of a 
social--
    Mr. Dinan. No. Bolkestein comes within the Netherlands from 
the right wing of the political spectrum on economic issues. He 
is an economic liberal. Not on social issues, I am sure, but 
economically he wants deregulation and further liberalization.
    Mr. Shays. Got you. Is there any particular countries that 
have been the driving force behind--
    Mr. Dinan. Yes. Some of the countries have, especially some 
of the bigger countries. France, for instance, the U.K., 
although the U.K. has certain concerns, and Germany too.
    It is significant, for instance, at the moment the country 
in the presidency of the Council of Ministers is Spain and the 
Spanish prime minister is also an economic liberal. He wants 
deregulation. He wants market integration. And so there is an 
interesting conjunction right now of a strong commissioner 
pushing for this and a strong country and a large country in 
the presidency headed by a prime minister, Mr. Aznar, who is 
well respected, who is very experienced. And that is why I 
think that there is a considerable push right now for the 
implementation of the action plan.
    Mr. Shays. My stereotype of the French, frankly, is that 
they, kind of, want to go it alone. And yet you are saying they 
are trying to bring Europe together on this issue.
    Mr. Dinan. Yes. France has been a major player in European 
integration generally because France realizes that it cannot 
achieve its objectives alone. And it is trying to Europeanize 
France; to Europeanize and integrate the European Union along 
French lines that is consistent with French interests.
    Mr. Shays. Yes, I understand, well said.
    Mr. Dinan. But you are right in your perception because 
generally the French are protectionist. But on this particular 
issue, the French do not have very strong national interests to 
defend.
    Mr. Shays. Okay, let me ask you this: Is the Financial 
Service Action Plan one of the, say, the strongest initiatives 
that the EU has undertaken? How would you rank it in terms of 
other agreements that they have tried to--
    Mr. Dinan. Well, in my testimony, I mentioned the single 
market plan of the late 1980s, early 1990s. That is when the 
European community, as it then was, set itself a goal of 
achieving an integrated single market by 1992. Clearly, the 
European Union did not succeed in all of that otherwise there 
would not be a Financial Services Action Plan. The reason for 
this plan is that the European Union feels it didn't achieve 
that aspect on time. And also circumstances have changed and 
the technology is such that the European Union concept needs to 
legislate more.
    And so compared to the single market plan, this is not as 
significant, but it is important nonetheless.
    But the two big issues on the agenda of the European Union 
at the moment are enlargement, the enlargement of the European 
Union, and the possibility of a constitution for the European 
Union.
    Mr. Shays. Well, that relates to my last question to you. 
Will the enlargement of the European Union affect the 
implementation of this plan?
    Mr. Dinan. Yes, it will effect everything. The enlargement 
of the European Union is going to make the European Union much 
more difficult to run and to operate.
    Mr. Chairman, if you think of this room, if you compare 
this to a similar room in the European parliament, a committee 
room in the European parliament, just imagine that by doubling 
the size of the European Union, the size of this committee 
would double.
    But not only that. Here you operate in only one language. 
Currently, the European Union operates in 11 official 
languages. And with enlargement, even more. And that means that 
the sides of this room, or its equivalent in Brussels, is full 
of interpretation booths.
    So if you look at just that rather mundane level alone, 
making decisions in the European Union, which already is 
difficult, is going to become even more so.
    And that is why I mentioned earlier, one of the main agenda 
items for the European Union is to reform, not just the 
institutions, but the entire entity in order to be able to cope 
and to be able to manage on the one had efficient decision-
making, but on the other hand, democratic openness.
    Mr. Shays. Is there any question that you wished we had 
asked that you think should be part of the record? Or you could 
ask yourself the question and then answer it. That is one 
question.
    And the other question is, is there any comment that was 
made by one of your colleagues to a question that you wished we 
had asked you?
    Okay.
    Let me just say that you have been excellent witnesses. I 
appreciate the staff putting together such a very fine panel. 
Thank you very much.
    And this hearing is adjourned.
    [Whereupon, at 12:42 p.m., the committee was adjourned.]
                            A P P E N D I X



                              May 22, 2002
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