financial integration in asean: lessons from...

Financial Integration in Financial Integration in ASEAN: Lessons from EUASEAN: Lessons from EU

Gloria O. Pasadilla, PhD

Philippine Institute for Development Studies

Macao University of Science and Technology

November 1, 2006

Presentation OutlinePresentation Outline

EU financial services liberalization–– Legal steps, salient features, current statusLegal steps, salient features, current status

Analysis of financial liberalization

–– Results of EU reforms : Results of EU reforms : Wholesale financial market, Wholesale financial market, CapitalCapital--market related banking activitiesmarket related banking activitiesRetailRetail

–– Remaining barriersRemaining barriers

Comparison with ASEAN and Lessons–– Where we are nowWhere we are now–– Impediments Impediments –– LessonsLessons

EU financial liberalization: legal stepsEU financial liberalization: legal steps

Major framework directives–– Banking Directives (1977, 1989)Banking Directives (1977, 1989)

11stst –– freedom of establishment, national treatment for EC freedom of establishment, national treatment for EC banksbanks22ndnd –– mutual recognition and single passportmutual recognition and single passport

–– Insurance Directives (1988, 1990, 1992)Insurance Directives (1988, 1990, 1992)Freedom of establishment, then freedom of supply (single Freedom of establishment, then freedom of supply (single passport)passport)

–– Investment Services Directive (1994)Investment Services Directive (1994)

Financial Sector Action Plan (FSAP, 1999)–– Timeline to 2005; address remaining barriersTimeline to 2005; address remaining barriers–– Harmonize rules and modernize prudential regulationsHarmonize rules and modernize prudential regulations

EU financial liberalization: featuresEU financial liberalization: features

Pillars of reform–– Minimum harmonizationMinimum harmonization–– Mutual recognitionMutual recognition–– Home country controlHome country control

Freedom of establishment + freedom of supply

• De-regulation + re-regulation

Existing conditions: sketchExisting conditions: sketchFor EU Member States

Non-EU GATS Commitments

Mode 1:Cross-border supply of services

No restrictions No restrictions but only for subsidiaries established in a MS

Mode 2:Consumption abroad

No broad EU legislation

National legislation applies

Mode 3:Commercial Presence

No restrictions; home country supervision; single passport

Subsidiaries established in a MS granted single passport while foreign branches no. Reciprocity condition

Establishment requirement to operate as unit trusts and investment companies, or as depositories of investment funds.

Mode 4:Movement of persons

Single Market Programme for free movement of labor applies

Unbound

Establishment requirement for specific financial services

EU financial liberalization: ResultsEU financial liberalization: Results

Wholesale (Price and quantity results)– Convergence of EU- area prices: both short: both short--

and longand long--term interest ratesterm interest rates

– Unsecured money market: cross: cross--border trade border trade increasedincreased

–– Steady Steady increase in cross-border interbankassets/ liabilitiesassets/ liabilities

–– Overall: positiveOverall: positive


Capital-market related banking activities– Gross fees in securities issues in euro area has issues in euro area has

declined (for big transactions); not much for declined (for big transactions); not much for equity issuance; equity issuance;

– Bonds: inroad of foreign (noninroad of foreign (non--EU) firms: from EU) firms: from almost zero presence in 1995 to 80% of almost zero presence in 1995 to 80% of transactions involving nontransactions involving non--European European intermediaries intermediaries –– for large transactions.for large transactions.


Equity: more localized than bond markets

Syndicated loans: non-euro area intermediaries increased presence in large transactions; asymmetry of information (costly for small transactions)

Asset management and trading –increasing diversification within euro area

Overall: Positive


Retail Banking

–– Least amount of liberalization seen Least amount of liberalization seen ––especially in mortgageespecially in mortgage

–– Relatively little crossRelatively little cross--border border transactions within EUtransactions within EU

Overview of integration in a selected number of Overview of integration in a selected number of retail productsretail products

Is Cross-border activity taking place?

Are pricesconverging?

What is the degree of integration?

Which are the main distribution channels?

Savings account

Yes some Yes Some signs of integration

Local establishment/

intermediaries; Phone; On line; ATM

Home Loans No Yes Rather fragmented Local establishment/

intermediaries

Investment in Securities (UCITS)

Yes Noevidence

Increasingly integrated (but scope for progress)

Distribution through local networks; on-line

Consumer Credit

Noevidence

No Very fragmented Local establishment/

intermediaries/retailers

Source: European Commission, Financial Integration Monitor, Commission Staff Working Document, 2005

Mergers and acquisitions in financial Mergers and acquisitions in financial services: trendsservices: trends

Mostly domestic M&As : 78%–– Of which: 60% within bankingOf which: 60% within banking–– Increasing domestic market concentrationIncreasing domestic market concentration

But spikes in cross-border M&As can be noted: –– 19991999--2000, cross2000, cross--border border M&AsM&As reached 42% of total value of reached 42% of total value of

M&A activity, also in 2004M&A activity, also in 2004–– Due to highDue to high--value M&A transactions e.g. B. value M&A transactions e.g. B. SantanderSantander

acquisition of Abbey National Bank (UK)acquisition of Abbey National Bank (UK)

There are more cross-border M&As in non-financial services sector –– => pan=> pan--European companies (in manufacturing and others)European companies (in manufacturing and others)

Regional clusters M&As: Benelux, Nordic/Baltic, and in Southern, Central and Eastern Europe

EU financial liberalization: EU financial liberalization: M&AsM&As lead to lead to decreasing credit institutions due to decreasing credit institutions due to

consolidationconsolidationNumber of Credit InstitutionsCountry/Area

2000 2002 2005

Germany 2742 2363 2089

Spain 368 359 348

France 1099 989 854

Italy 861 821 792

Netherlands 586 539 401

Austria 848 823 818

Great Britain

491 451 400

EU total 8368 7751 8616

Source: ECB and Eurostat, 2006.

EU financial liberalization: Domestic EU financial liberalization: Domestic and Regional clustering from and Regional clustering from M&AsM&As

As well as regionally clustered

Majority M&As are domestic: both target and acquirer are of same nationality

EU financial liberalization: Pension, EU financial liberalization: Pension, insurance, investment fundinsurance, investment fund

Insurance and pension fund– Increasingly organized cross-border as well as as well as

crosscross--sector, e.g. sector, e.g. BancassuranceBancassurance

– Accessed through establishment ; largely ; largely domestic servicedomestic service

– Direct cross-border selling has been limitedhas been limited

– Consolidation –– mostly within national borders mostly within national borders –– 85.5% of total activity => higher domestic 85.5% of total activity => higher domestic concentration levels.concentration levels.

EU financial liberalization: Pension, EU financial liberalization: Pension, insurance, investment fundinsurance, investment fund

Investment Fund (‘mutual funds’)– Level of cross-border consolidation (M&As)-

low; mostly domestically domiciled fundslow; mostly domestically domiciled funds

–– But fund sales suggest high level of crossBut fund sales suggest high level of cross--border distribution and sales. border distribution and sales.

– Demand side: different demand preference for different demand preference for foreign domiciled UCITS: Franceforeign domiciled UCITS: France-- low; low; Germany and Belgium Germany and Belgium -- highhigh

EU financial liberalization: SummaryEU financial liberalization: Summary

Banks, insurance, and conglomerates–– crosscross--border M&A deals lower than financial border M&A deals lower than financial

sector averagesector average–– More More minorityminority acquisitions and larger domestic acquisitions and larger domestic

dealsdeals

Securities activities –– More frequent crossMore frequent cross--border M&A transactionsborder M&A transactions–– Larger than domestic M&A transactionsLarger than domestic M&A transactions–– Often acquisition of Often acquisition of controllingcontrolling stakesstakes

EU financial liberalization: EU financial liberalization: Remaining barriersRemaining barriers

Fragmented infrastructure for cross-border clearing and settlement of securities transactions –> higher costs than in US

Differences in technical requirements and market practices -> no economies of scale–– Consumer protection, private law, differing Consumer protection, private law, differing

consumer habits/ preferences, taxation consumer habits/ preferences, taxation regimesregimes


Supervisory arrangements– Multiple reporting requirements -> difficult for

cross-border co’s to unify back office operations

Different taxation for dividends or exit taxes on capital gains –– hamper reorganization of head office functions hamper reorganization of head office functions

(across sectors)(across sectors)–– Tax liabilities calculated using different rules Tax liabilities calculated using different rules ––

transfer pricing and losses in one MS cannot transfer pricing and losses in one MS cannot be offset against profits in anotherbe offset against profits in another


Legal measures hampering acquisition –– EU law allows MS to block mergers on EU law allows MS to block mergers on

prudential grounds, legitimate interestsprudential grounds, legitimate interests–– Reporting requirementsReporting requirements

Direct and indirect political interference

Employees’ hostility and ‘poison pill’

ASEAN Financial Liberalization: where ASEAN Financial Liberalization: where are we now?are we now?

Individual countries made autonomous liberalization in foreign investment and capital account in 1980s

Signed ASEAN Framework Agreement in Services (AFAS) in 1994.

Chiang-Mai Initiative Swap Plan

Asian Bond Fund Initiative

ASEAN : where are we now?ASEAN : where are we now?

ASEAN Framework Agreement on Services–– Target: free flow of services by 2020Target: free flow of services by 2020–– Achieved 4 packages of schedule of Achieved 4 packages of schedule of

commitmentscommitments–– MRAsMRAs: Engineering*, Architecture, : Engineering*, Architecture,

Accountancy, Nursing, Surveying, Accountancy, Nursing, Surveying, TourismTourism

ASEAN financial liberalization: AFASASEAN financial liberalization: AFASMember Cross Border

SupplyConsumption Abroad Commercial Presence

Deposits Lending Deposits Lending # of Oper

$ of Trans

GATS Commitments(1997)

Indonesia N N N N LL LO1 LN

Malaysia U LC N LO1 U

Philippines U U N N DL LO2 LN LV

Singapore U U N N LO1 LN DL

Thailand U U U U LL LO1 LN

AFAS Commitments

LC

Indonesia LL LN

Thailand LL LO2

Philippines LC LC N N LL LO1, if locally

incorporated bankLO2

otherwise

LN

Legal Form

Equity

Malaysia

Singapore

N: None, U: Unbound, LC: Limited Commitments, LO1 limits on ownership < 50%, LO2: ownership limits>50%, LL: limits on legal forms, LN: Limits on number of operations, LV: limits on value of transactions or asses; DL: Discretionary Licensing or Economic Needs Test

Source: ASEAN website, 2005

Still very far from the freedom of establishment and freedom of supply conditions.

GATS-plus but so tiny-weeny plus

Summary of AFAS Commitments on Financial Summary of AFAS Commitments on Financial ServicesServices

In sum, commitments to liberalize financial services on AFAS built and added on already existing commitments in the GATS

The most common restrictions include:–– Limitations on the Limitations on the number of branches and their locations

Indonesia: 3 cities more than that committed in the GATSIndonesia: 3 cities more than that committed in the GATS

–– Limitations on the Limitations on the legal form of a company Thailand only allows share acquisition of a companyThailand only allows share acquisition of a company

–– Limitations on Limitations on ownershipThailand: up to 100%, but with limitation on operations and addeThailand: up to 100%, but with limitation on operations and added d stipulationsstipulations

–– Limitations on Limitations on amount of transactionsSingapore: offshore bank lending must not exceed S$ 300 Singapore: offshore bank lending must not exceed S$ 300 mnmn in in aggregateaggregate

Where are we? Existing conditions Where are we? Existing conditions in bonds and loan syndicatesin bonds and loan syndicates

Hub and spoke characteristic: (from Asian to Asian) –– Asian issuer chooses N.A or European firm as Asian issuer chooses N.A or European firm as

bookrunnerbookrunner (BR)(BR)--> BR assembles syndicate of > BR assembles syndicate of underwriters underwriters --> Underwriters sell about half of the paper > Underwriters sell about half of the paper to Asian accounts to Asian accounts

-- Asian holdingsAsian holdings range from 36% (Korea and range from 36% (Korea and Singapore issues) to 78%Singapore issues) to 78% (Indonesian issues) (Indonesian issues) ––based on distribution in the primary marketbased on distribution in the primary market

But most of the Asian holdings are also domestic i.e. But most of the Asian holdings are also domestic i.e. Korean bonds held by KoreansKorean bonds held by Koreans

Following discussion on financial integration is based on McCaulay, et.al (2002)

Where are we? Existing conditions Where are we? Existing conditions in bonds and loan syndicatesin bonds and loan syndicates

Syndicated loans – proxy for wholesale banking market integration. Data 1999-2002.

Banks with same nationality as borrowerprovided approximately 20% of nominal amount; East Asian banks provided another 20% of funds. Total approx 40%.–– Comparator: US banks to US issuers: 55%Comparator: US banks to US issuers: 55%–– EuroEuro--area banks to Euroarea banks to Euro--area: 64%area: 64%

But definition of Asia here is larger than just ASEAN;–– No data for crossNo data for cross--border loans within ASEANborder loans within ASEAN

ASEAN financial integrationASEAN financial integration

Percent share of total Asian issues by bookrunners/loan arrangers headquartered in:

(April 1999-August 2002)

North America Europe Asia

Bonds 54 29 17

Syndicated loans

12 23 63

Asian Participation in Asian Funding Needs

Source: McCauley, Fung and Gadanecz (2002)Increasing lead role of Asian banks in loan syndication of Asian issues

But Asian participation (i.e. purchase of Asian issues) are higher when: issues are smaller, ratings are lower, maturities are shorter

Location-wise, most of cross-border credit to borrowers in emerging Asia is provided by banks located in Singapore and HK (although maybe headquartered in N.A. or Europe)

Where are we now? SummaryWhere are we now? Summary

–– High High financial integration of region with global financial financial integration of region with global financial systemsystem: ratio of foreign liabilities to GDP is 60%: ratio of foreign liabilities to GDP is 60%

–– But regional integration is still at an early stage.But regional integration is still at an early stage.

–– BankingBanking: predominance of banks in financial system: predominance of banks in financial systemRegional crossRegional cross--border activity appears limited although, border activity appears limited although, perhaps, perhaps, more integrated than commonly perceived, if than commonly perceived, if indicator is Asian participation in syndicated loans indicator is Asian participation in syndicated loans (previous slide)(previous slide)but maybe not ASEAN; most business from Korea, China, but maybe not ASEAN; most business from Korea, China, TaiwanTaiwanHowever, there is growing interest in crossHowever, there is growing interest in cross--border bank border bank acquisitions, especially by Singapore banks. acquisitions, especially by Singapore banks.

Where are we now? SummaryWhere are we now? Summary

–– Equity markets: Equity markets: InIn Thailand, Korea, Japan, Thailand, Korea, Japan, almost 30% of turnover are by foreign almost 30% of turnover are by foreign shareholders, but few of these foreign shareholders, but few of these foreign shareholders are other Asians. shareholders are other Asians.

Limited crossLimited cross--listing from foreign companies in Asian listing from foreign companies in Asian exchanges.exchanges.

–– BondBond: foreign currency denominated bonds are : foreign currency denominated bonds are more globally integrated; mostly held by US more globally integrated; mostly held by US and EU, although there is evidence that Asian and EU, although there is evidence that Asian investors also hold large amountsinvestors also hold large amounts

Local currency denominated bonds Local currency denominated bonds –– little evidence of little evidence of cross holding; largely domestically held.cross holding; largely domestically held.

Legal and Fiscal ImpedimentsLegal and Fiscal ImpedimentsToo many national currencies, national rules and regulations, and different market standards

Restrictions include:

••Foreign firm participationForeign firm participation in local market (quota, share in local market (quota, share limits, ownership, type of operations)limits, ownership, type of operations)

••Exchange controls Exchange controls e.g.e.g. approval, limits in investments approval, limits in investments denominated in domestic currency, caps on amount of denominated in domestic currency, caps on amount of foreign borrowingsforeign borrowings

Legal and Fiscal Impediments: Legal and Fiscal Impediments: Restrictions and OmissionsRestrictions and Omissions

–– Differences in withholding Differences in withholding taxes,taxes, stamp duties stamp duties

–– Inadequacies in Inadequacies in bankruptcy lawsbankruptcy laws and and property property lawslaws that affect securitizationthat affect securitization

–– Problems on Problems on asset transfersasset transfers, especially to , especially to foreign asset holdersforeign asset holders

–– Problem in Problem in enforcement of court rightsenforcement of court rights, , including against stateincluding against state--owned enterprises and owned enterprises and sovereign governmentssovereign governments

Legal and Fiscal Impediments: Legal and Fiscal Impediments: Restrictions and OmissionsRestrictions and Omissions

–– Lack of clarity in Lack of clarity in settlement, custody, settlement, custody, nettingnetting and transfer arrangementsand transfer arrangements

–– Lack of clarity of master trading and Lack of clarity of master trading and repurchase agreementsrepurchase agreements

–– Differences in treatment: taxation, Differences in treatment: taxation, duties, refundsduties, refunds

Lessons from the EULessons from the EU

Experience of EU shows key role of European Commission, ECJ, and European Parliament –– MS agree to grand declarations but MS agree to grand declarations but national legislation and practice still show

protectionist bent, or conversely promote domestic advantage through , or conversely promote domestic advantage through regulatory laxity.regulatory laxity.

– Supranational institutions can take them to task to practice the spirit of the can take them to task to practice the spirit of the treaties, or force convergence of regulatory regime.treaties, or force convergence of regulatory regime.

– Commission is the most crucial integration factorintegration factor““ the existence of an institution to which the existence of an institution to which sovereignty can be delegated, even partially, is sovereignty can be delegated, even partially, is an essential precondition for deep integrationan essential precondition for deep integration””((WyploszWyplosz, C, 2006), C, 2006)

Yet, ASEAN desires an EU-like result but not EU-like institutionsPrefers interPrefers inter--governmental structure over supranationalgovernmental structure over supranational


EU – result of political vision and economic defensive motivation; –– ASEAN ASEAN –– economic: threat of economic: threat of

irrelevance due to China and India; but irrelevance due to China and India; but political vision?political vision?

Is it possible to achieve financial integration without supra-national institutions?


Steps to take: what legal steps would be worth copying and which do not require supranational institutions?–– Home country control, minimum harmonization and Home country control, minimum harmonization and

mutual recognitionmutual recognitionstrengthening prudential regulation and harmonizing strengthening prudential regulation and harmonizing

these rules with neighbors has universal validity. Pf: work these rules with neighbors has universal validity. Pf: work on globally acceptable guidelines for supervisionon globally acceptable guidelines for supervision

–– Inventory of national lawsInventory of national laws that can put obstacles to that can put obstacles to financial integration in the areas of: financial integration in the areas of: M&AsM&As, distance , distance marketing, transparency, accounting, bankruptcy laws, marketing, transparency, accounting, bankruptcy laws, collateral arrangements, collateral arrangements, competition policycompetition policy, etc., etc.

–– Start developing Start developing infrastructureinfrastructure: :

linkages between jurisdiction for linkages between jurisdiction for trading, trading, payment, clearing, settlement and custodian payment, clearing, settlement and custodian systems for money and financial systems for money and financial instrumentsinstruments to make crossto make cross--border border transaction more efficienttransaction more efficient

Existence of credible Existence of credible credit rating systemscredit rating systems



–– Importance of preserving financial Importance of preserving financial system resilience and stability during system resilience and stability during deregulationderegulation..

supervisory agencies should ensure supervisory agencies should ensure appropriate risk control measures are appropriate risk control measures are implemented in individual institutions; implemented in individual institutions; that capital adequately reflects the market, that capital adequately reflects the market, credit and operational risk exposurecredit and operational risk exposure


Credibility in the integrating plans (in EU case: the SMP) – helps influence wider, permanent bank expectation of greater competition.

Helps national financial sectorHelps national financial sector’’s s frame of referenceframe of referenceaway from protection and collusionaway from protection and collusion towards towards deregulation and greater competitionderegulation and greater competitionIntegrating plans in financial services Integrating plans in financial services -- not shown in not shown in AFASAFAS: major restrictions on operation, establishment, : major restrictions on operation, establishment, ownership, value of transactions, ownershipownership, value of transactions, ownershipASEAN has ASEAN has long way to golong way to go in freedom of in freedom of establishment. There are still many restrictions in establishment. There are still many restrictions in crosscross--border investmentsborder investments

Financial Integration in Financial Integration in ASEAN: Lessons from EUASEAN: Lessons from EU

Gloria O. PasadillaSenior Research Fellow

Philippine Institute for Development Studies

financial integration in asean: lessons from...

Documents