Why should creation of an integrated market in Europe matter to U.S. banks or investment firms, given the immense problems many of them face at home?

Because U.S. institutions could lose opportunities for cost savings -- and face substantial unexpected costs -- if European Community regulatory and market developments are not evaluated fully and promptly.

Many U.S. banks seem to have lost interest in doing business in the community. To a significant extent, they have been content to leave these highly competitive and potentially costly markets to their European counterparts.

Understandably, many have decided not to compete in Europe's extremely tough retail banking environment.

The Single European License

But in perhaps too many cases, a result has been failure to appreciate the need to maintain or develop an effective presence in wholesale banking markets.

U.S. institutions currently operating in Europe will have opportunities to cut costs through restructuring. The "single European license," due to come into effect at the end of this year, will enable U.S. institutions to operate within the community via a single subsidiary.

Once established in one country in the community, an institution from outside will be treated just like a European institution. Cross-border branching without further authorization from the host country will be possible, and branches will not require endowment capital.

Moreover, institutions with one European subsidiary will be free to provide in all 12 community countries those services permitted in their European home country. No host-country authorization will be needed.

Non-European institutions that now have more than one community subsidiary could rationalize their structures by converting any "surplus" subsidiaries into branches, thus cutting capital costs.

Alternatively they could decide that a physical presence in all countries in uncessary and simply provide services crossborder out of a single entity domiciled somewhere in the community.

As a result of such a rationalization, scope may exist for benefiting from remaining regulatory differences. The community approach is based on minimum standards; in some cases, national requirements over and above the mandatory stipulations will continue.

'Regulatory Arbitrage'

For instance, though minimum capital ratios are set at 8% in most community countries, the minimums can vary from that level to about 15%.

A bank might choose to maintain its subsidiary in the most cost-effective country from the regulatory point of view. Of course, other issues -- such as availability and cost of local expertise, property costs, and how site selection blends with overall strategy -- must also be considered.

The idea that "regulatory arbitrage" can be exploited in a major way through moving subsidiaries to a less-demanding regime is probably misguided. Unless a convincing business case can be made, European supervisors are unlikely to look kindly on banks wishing to move in order to escape a more onerous regulatory regime.

Regulatory-arbitrage opportunities are more likely to arise when establishing a subsidiary in the community for the first time, deciding to reduce the number of European subsidiaries, or assessing where an asset should be booked.

Other Savings

Opportunities may also arise for cost savings by, for example, rationalizing European trasury management and back-office functions.

Tax is another key dimension. Potential exists for tax savings as a result of community legislation abolishing withholding tax on dividends transferred between a parent and subsidiary in the community.

This could enhance the role of European holding companies. Where to locate them in order to benefit from the least stringent conditions will become a key issue in routing funds.

Restructuring, whether due to tax or regulatory considerations, should also be facilitated by the community's Mergers Directive.

This directive will provide deferral of tax in respect of capital gains arising from the transfer of assets and the exchange or cancellation of shares in any of six specified merger, de-merger, or share-exchange transactions.

In terms of location, tax incentives offered by certain centers such as Dublin must also be considered.

Risk Capital Rules

The advent of the single European market may also introduce a completely new layer of costs for U.S. institutions operating in Europe.

The community is working alongside the Basel Committee and the International Organization of Securities Commissions in developing capital-adequacy requirements to cover the market risks of banking and investment firms. The timetable for the introduction of new capital requirements is unclear; a discussion paper from the Basel Committee and the securities regulation group is expected in the summer.

Because of the political pressures of the single-market timetable, the community may introduce market-risk requirements before these other bodies -- despite an awareness of the dangers.

Banks, on their trading books, and investment firms might thus face additional capital costs on European operations as early as the end of next year.

If so, community subsidiaries of U.S. investment firms might also face European capital-adequacy requirements covering credit risk on their nontrading books and the deduction from capital of their illiquid assets.

Whatever the outcome, the new regulations will necessitate expensive systems changes in order to meet new reporting requirements and to monitor on a daily basis the capital position according to the new rules.

The latest indications are that the community will wait for Basel and the securities regulators to move forward, and that a lengthy consultation period will be allowed.

Still, developments need to be watched closely. Progress in negotiations on a single European license in investment services -- which would require minimum capital standards in the community -- could suddenly place the community under considerable pressure to implement quickly the market-risk requirements.

Deposit Protection

As the regulatory changes extend beyond capital adequacy and authorization issues, sizeable costs may also be incurred in other areas.

The single-license regulatory umbrella covers minimum rules on large exposures. It also introduces new requirements governing deposit protection, the presentation of accounts, insider trading, and money laundering.

In the area of deposit protection, the branches of non-European banks might be obliged in some member states to join a deposit gurantee scheme to cover their deposits in all currencies. This could increase the costs of deposit protection for U.S. banks.

U.S. operations in the community will find national regulations changeing as the implementation process moves ahead. Operational costs could rise as each change takes effect.

Establishing a Presence

A more immediate, strategic consideration, carrying considerable costs, affects non-European institutions as a result of the reciprocity clause of the single-market legislation.

A non-European institution that has no community subsidiaries but might wish to eventually establish a presence in Europe should set up a subsidiary this year to avoid the risk of reciprocity problems later.

U.S. banks with an authorized European subsidiary will be able to take full advantage of the single market. But a nominal, brass-plate subsidiary may be insufficient, as some member states may require that a significant amount of business be actively conducted out of the subsidiary for it to be deemed "established" in the community

Those applying for authorization from 1993 onward will be subject to reciprocity requirements based on national treament. That is, the community must be satisfied that European banks operating in the American markets face regulation equivalent to what is imposed on U.S. banks.

Although the potential impact is not yet clear and will inevitably be subject to political considerations, U.S. institutions should be taking this into account, especially in the light of the treatment of non-U.S. banks under the recent changes of U.S. banking legislation.

New Strategies Needed

The regulatory and tax implications of the single market are the most tangible. Although careful examination of national legislation as the European directives are implemented is necessary, the ensuing capital costs or capital and tax savings are generally quantifiable.

Potential increases in regulatory costs can be estimated as the detailed legislation unfolds. But the less tangible strategic and business implications, though difficult to quantify, must not be overlooked.

The European environment is now significantly different from the one in which many U.S. banks made strategic decisions to retreat from Europe several years ago. Strategic plans must be reviewed taking cognizance of the rapidly unfolding developments.

Here Comes the Ecu

European monetary union and a single community currency are planned by 1999 at the latest. This will have a significant influence on U.S. banks' foreign-exchange operations.

The Ecu is likely to develop into one of the world's three leading currencies. In the long term, this compound currency could threaten the predominance of the dollar; foreign-exchange risk will be substantially reduced, and important opportunities for Ecu products will appear.

U.S. banks will have to become fully versed in Ecu dealing, the Ecu capital markets, and new Ecu financial instruments or risk losing market share. U.S. corporate foreign exchange transactions will be significantly affected.

American banks will need to examine their ability to service their customers on a global basis under a triangular dollar-Ecu-yen currency regime.

Global Customers

As economic integration intensifies, further openings are developing for cross-border servicing of clients.

U.S. banks may not wish to risk incurring heavy costs attempting to compete in Europe, but their choice may be limited if they are to retain the loyalty of multinational customers who will increasingly look to be serviced on a global basis.

In the ongoing realignment of the European financial services industry, opportunities are opening up for the exploitation or reinforcement of markets through acquisition of weaker European institutions or participations in some of them.

Furthermore, intracommunity linkups between banks, and between banks and insurance companies, could place U.S. institutions at a significant competitive disadvantage at home as well as in Europe.

Concentrating on U.S. markets may make strategic logic in the short term, but failure to evaluate the vast shifts in the contours of European finance could be fatal.

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