[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]
THE US-EU REGULATORY DIALOGUE
AND ITS FUTURE
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED EIGHTH CONGRESS
SECOND SESSION
__________
MAY 13, 2004
__________
Printed for the use of the Committee on Financial Services
Serial No. 108-86
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HOUSE COMMITTEE ON FINANCIAL SERVICES
MICHAEL G. OXLEY, Ohio, Chairman
JAMES A. LEACH, Iowa BARNEY FRANK, Massachusetts
DOUG BEREUTER, Nebraska PAUL E. KANJORSKI, Pennsylvania
RICHARD H. BAKER, Louisiana MAXINE WATERS, California
SPENCER BACHUS, Alabama CAROLYN B. MALONEY, New York
MICHAEL N. CASTLE, Delaware LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York NYDIA M. VELAZQUEZ, New York
EDWARD R. ROYCE, California MELVIN L. WATT, North Carolina
FRANK D. LUCAS, Oklahoma GARY L. ACKERMAN, New York
ROBERT W. NEY, Ohio DARLENE HOOLEY, Oregon
SUE W. KELLY, New York, Vice Chair JULIA CARSON, Indiana
RON PAUL, Texas BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio GREGORY W. MEEKS, New York
JIM RYUN, Kansas BARBARA LEE, California
STEVEN C. LaTOURETTE, Ohio JAY INSLEE, Washington
DONALD A. MANZULLO, Illinois DENNIS MOORE, Kansas
WALTER B. JONES, Jr., North MICHAEL E. CAPUANO, Massachusetts
Carolina HAROLD E. FORD, Jr., Tennessee
DOUG OSE, California RUBEN HINOJOSA, Texas
JUDY BIGGERT, Illinois KEN LUCAS, Kentucky
MARK GREEN, Wisconsin JOSEPH CROWLEY, New York
PATRICK J. TOOMEY, Pennsylvania WM. LACY CLAY, Missouri
CHRISTOPHER SHAYS, Connecticut STEVE ISRAEL, New York
JOHN B. SHADEGG, Arizona MIKE ROSS, Arkansas
VITO FOSSELLA, New York CAROLYN McCARTHY, New York
GARY G. MILLER, California JOE BACA, California
MELISSA A. HART, Pennsylvania JIM MATHESON, Utah
SHELLEY MOORE CAPITO, West Virginia STEPHEN F. LYNCH, Massachusetts
PATRICK J. TIBERI, Ohio BRAD MILLER, North Carolina
MARK R. KENNEDY, Minnesota RAHM EMANUEL, Illinois
TOM FEENEY, Florida DAVID SCOTT, Georgia
JEB HENSARLING, Texas ARTUR DAVIS, Alabama
SCOTT GARRETT, New Jersey CHRIS BELL, Texas
TIM MURPHY, Pennsylvania
GINNY BROWN-WAITE, Florida BERNARD SANDERS, Vermont
J. GRESHAM BARRETT, South Carolina
KATHERINE HARRIS, Florida
RICK RENZI, Arizona
Robert U. Foster, III, Staff Director
C O N T E N T S
----------
Page
Hearing held on:
May 13, 2004................................................. 1
Appendix:
May 13, 2004................................................. 27
WITNESSES
Thursday, May 13, 2004
Bies, Hon. Susan, Governor, United States Federal Reserve Board.. 8
Quarles, Hon. Randal, Assistant Secretary for International
Affairs, United States Department of the Treasury.............. 6
Ross, Samantha, Chief of Staff, Public Company Accounting
Oversight Board................................................ 10
Schaub, Alexander, Director-General, Directorate General for the
Internal Market, European Commission........................... 20
Tafara, Ethiopis, Director, Office of International Affairs,
United States Securities and Exchange Commission............... 12
APPENDIX
Prepared statements:
Oxley, Hon. Michael G........................................ 28
Biggert, Hon. Judy........................................... 31
Gillmor, Hon. Paul E......................................... 33
Bies, Hon. Susan............................................. 34
Quarles, Hon. Randal......................................... 47
Ross, Samantha............................................... 52
Schaub, Alexander............................................ 68
Tafara, Ethiopis............................................. 82
Additional Material Submitted for the Record
Quarles, Hon. Randal:
Written response to questions from Hon. Joseph Crowley....... 101
THE US-EU REGULATORY DIALOGUE
AND ITS FUTURE
----------
Thursday, May 13, 2004
U.S. House of Representatives,
Committee on Financial Services,
Washington, D.C.
The committee met, pursuant to call, at 10:06 a.m., in Room
2128, Rayburn House Office Building, Hon. Michael Oxley
[chairman of the committee] presiding.
Present: Representatives Oxley, Biggert, Hart, Hensarling,
Garrett, Watt, Ackerman, Sherman, Inslee, Moore, Lucas of
Kentucky, Emanuel, and Bell.
The Chairman. [Presiding.] The committee will come to
order.
Two years ago, this committee convened a hearing to address
``The European Union's Financial Services Action Plan and its
Implications for America's Financial Services Industry.''
Today's hearing explores how the US-EU Dialogue has worked over
the last 2 years and how participants expect it to evolve in
the context of a united Europe consisting of 25 countries with
a wide range of economic strength and development.
We welcome back witnesses from the SEC, the Treasury, and
the Federal Reserve to discuss this issue. I look forward to
seeing whether their expectations 2 years ago were met and what
they think the future might hold. We welcome for the first time
on this topic our PCAOB witness who will provide a perspective
on how innovative and productive a variety of informal
processes can be in resolving difficult transatlantic
regulatory issues.
I am particularly pleased to welcome for the first time
before this committee the European Commission. It is not often
that a foreign authority testifies before Congress. I
understand that Director-General Alexander Schaub will use the
opportunity of this hearing to present significant new ideas on
how the US-EU regulatory relationship might evolve. We look
forward to this testimony.
Two years after our first hearing on this issue, many of
the same issues remain on the forefront of the transatlantic
regulatory debate: The supervision of financial conglomerates,
international accounting standards, convergence in accounting
standards, transparency in prospectuses, and making
consolidated supervision function on both sides of the
Atlantic.
And yet, much has changed. We convene today shortly after
the historic accession of 10 Eastern European countries into
the European Union. This fulfills the dreams of many, including
myself, that Europe after World War II could one day be united,
whole, and free. Much of the European financial services
agenda, especially after the fall of the Berlin Wall, has aimed
to create a financial services marketplace to serve a European
market nearly equivalent in size to ours.
The financial markets have also changed. The end of the
Cold War and a revolution in risk management and
telecommunications together have created opportunities and
enthusiasm for global capital markets to integrate across
borders. I believe that transatlantic trade in both goods and
services benefits consumers and businesses on both sides of the
Atlantic and helps create a vibrant job market here in the
U.S.. It generates competition in both markets and forces firms
to be more efficient, innovative and effective in serving
customers. These trends place pressure on financial regulators
to find better ways of working together.
Following our hearing 2 years ago, the US-EU Financial
Markets Dialogue was created. It fosters regulatory discussion
on emerging transatlantic issues and attempts to avoid
conflicts. I understand that the Dialogue has been extremely
successful. In fact, it has been so successful that some have
suggested it needs to grow and become more formalized. Others
have suggested that the Dialogue should seek to accelerate
financial market integration and foster convergence of
regulatory standards across the Atlantic. Our witnesses today
will provide insight into the innovative tools used today to
increase transatlantic mutual understanding and cooperation.
This is a very important initiative. Financial firms
operating in multiple states must comply with multiple,
sometimes conflicting, regulatory requirements. These
requirements reflect government efforts to protect consumers
and to foster financial system stability, safety, and
soundness. The Financial Services Committee seeks to strengthen
the U.S. regulatory framework, permitting it to adapt to a
world where significant changes in capital market behavior and
the world around us require new approaches to accounting,
auditor oversight, consolidated supervision and protection from
abuse from terrorists and money launderers.
This committee also seeks to reduce regulatory burdens.
Last fall, we enacted major banking regulation relief
legislation, and we are right now working on an insurance
regulatory package. I am committed to reducing inefficient
regulatory burdens for all financial institutions doing
business in the U.S. subject, of course, to security and
financial stability considerations.
Relieving regulatory burdens in the U.S., however, is only
part of the picture. America's largest financial institutions
are major players in the European capital markets. Major
European firms are a significant and growing presence in all
three sectors of the United States financial services market:
banking, securities and insurance. The choices one country
makes for how best to protect its investors and depositors may
not always coincide with the choices other countries make.
Different policies can be driven by differences in market
structure. Such differences are legitimate and do not easily
lend themselves to calls for convergence. I believe that
convergence and equivalence in regulatory structures can only
make sense where convergence is already underway in the markets
and where differences in regulation can have a detrimental
impact. To endorse convergence as a goal without considering
the needs and views of the voters that brought us to Washington
to represent their interests would be irresponsible.
I hope this hearing will help us understand which
differences in regulatory standards are needed to address
different market structures and which differences are
inefficient. I am skeptical that transatlantic regulatory
convergence will occur quickly in all areas. While the
financial markets continue integrating, national regulators
will need authority and a legislative mandate to protect
consumers and markets at home. I note that it took Europe
almost 40 years to achieve a legal framework based on mutual
recognition, and this framework is still under construction.
Some might question whether the mutual recognition concept
can operate outside the EU. In addition, the EU's new framework
has not yet been fully tested. The Financial Services Action
Plan will not be implemented until next year, and concerns have
already been expressed that full implementation may impose
unnecessary costs or create unnecessary conflicts. Questions
also exist concerning how the new regulatory structures in
Europe will interface with the rest of the world, putting
pressure on the execution of consolidated home country
supervision.
Here in the U.S., we have our own regulatory burdens to
consider and address. The specter of listed firms needing to
provide financial statements using two different accounting
standards and the prospect of having two different regulatory
capital frameworks for financial institutions are two examples
of areas where regulators on both sides of the Atlantic face
common challenges. I believe that practical working
relationships such as those created through the US-EU Dialogue
and other transatlantic discussions can help generate a process
for differences to be discussed and understood better.
We will not all agree today on the right solutions for any
of the issues before this transatlantic regulatory Dialogue. In
the future, we cannot expect disagreements will disappear
regarding how best to regulate the very fluid and innovative
financial sector. But I firmly believe that increased dialogue
can lower the temperature of our disagreements and can lower
the odds that serious misunderstandings can develop. The
capital markets will not stop integrating, and it is our
responsibility as policymakers to ensure that the rules
generated to protect consumers and enhance market discipline do
not generate excessive and inefficient compliance costs.
Are there other members seeking for an opening statement?
[The prepared statement of Hon. Michael G. Oxley can be
found on page 28 in the appendix.]
The gentleman from California, Mr. Sherman?
Mr. Sherman. Thank you, Mr. Chairman. No discussion of our
trade and international economic relationships can be complete
without a mention of the one-half trillion dollar trade deficit
of the United States. The world is building a house of cards.
It is a beautiful house of cards. They are happy living in the
house of cards. But every year we add another half trillion
dollars of debt of the United States to the rest of the world,
we build another story on the house of cards.
And in a perfect world we could hope that somehow that
trade flow would be not only--the negative would be slowed but
even reversed. We can dream of a world in which the second half
of this decade involves us sending a Cadillac to Europe for
every Mercedes they sent us in the first half of this decade. I
know of no one in the automotive industry planning for that as
an eventuality. The world is addicted to the United States as
importer and as borrower.
And so in perhaps a decade, individual actors in the
economic system, whether they be countries, banks or individual
investors, will probably and unfortunately in a very short
period of time suddenly lose faith in the dollar, wonder why
the world has lent so much to a country that has done so little
to repay.
Now, I would like to think that we can avoid this
catastrophe, but that would involve a weak dollar. Instead, our
Asian governmental friends and trading partners are
deliberately and I would say illegally or at least wrongfully
weakening their own currencies. That would involve a U.S.
budget surplus. I don't know of anyone who dreams of that at
any time in the near future.
So since we are unlikely to avoid the disaster, the
question is whether we are building our financial institutional
system to prepare for the disaster, to make sure that the panic
does not become a depression.
We have, I believe, in our stock markets circuit breakers
to deal with sudden drops. I hope that our witnesses today will
discuss with us here or supplement the record with a discussion
of what we can do to have equivalent circuit breakers for
sudden declines in the U.S. dollar, for sudden and multi-
trillion dollar outflows of capital from the United States, and
from all the things that you would expect will eventually
happen, and you can wonder whether it happens in 5 years or 15
years, but what eventually happens to a country that is almost
force-fed like a European goose, import after import,
consumption after consumption until suddenly it breaks.
I would hope that this international financial system is
not just the most efficient way to deal with how to live in a
house of cards, but also that we build in mechanisms to deal
for what happens when the house of cards falls over. I yield
back.
The Chairman. The gentleman's time has expired.
The gentlelady from Illinois seeks recognition.
Mrs. Biggert. Thank you, Mr. Chairman, and thank you for
calling this important hearing today. As you noted in your
opening statement, the financial services markets in the U.S.
and Europe are increasingly intertwined.
I think this hearing is well-timed, coming as it does just
2 weeks after the historic accession of 10 Eastern European
states to the Union. I would like to congratulate you for
organizing a hearing that includes our key partner in the
Dialogue--the Commission of the European Union. This is an
excellent opportunity for the Financial Services Committee to
hear both American and European perspectives on the key
transatlantic regulatory issues of our day.
The relationship between the American and European capital
markets is of keen importance to the U.S., generally, and of
particular importance to those of us who come from Chicago.
Last year, there was a great deal of controversy associated
with the proposal for a European options exchange to establish
itself as a competitor to the traditional options exchanges in
Chicago. The resolution was that the exchange submitted to the
jurisdiction of the CFTC and established a subsidiary. Along
the way, many people in my home state began to think in very
concrete terms about what it means to have such integrated
capital markets.
I am a firm believer in the adage that political
friendships follow the trade lanes. Free and fair trade fosters
competition and communication, benefiting workers and consumers
on both sides of the relationship. My impression from the
testimony submitted is that the regulatory Dialogue underway
right now between the U.S. and the EU contributes to these
goals.
While I support these goals and the accomplishments
achieved to date within the Dialogue, I think it is important
to sound a note of caution as well. We must be careful that in
our zeal to find new and better ways for our regulators to work
together internationally, we do not lose sight of our own very
important domestic policy goals.
In this country, we have over the last century built the
deepest, most transparent and most liquid capital market in the
world. This capital market and the economy that it supports are
the engines of global growth and innovation. One critically
important component of that market is the framework of laws and
regulations that protect investor access to information and
provide for rigorous oversight of financial institutions.
Financial innovation and economic growth in the U.S. have
thrived under this framework. Growth and innovation have been
slower in Europe, but are accelerating with a number of
reforms. On this side of the Atlantic, we must be sensitive to
the views of the financial markets and ensure that the EU
package of reforms does not stifle growth and innovation
through imposition of significant compliance costs.
I also believe that policymakers on both sides of the
Atlantic must consider more carefully the nuts and bolts of how
consolidated home country supervision will in fact work. This
is especially important for the highly complex financial
institutions that are at the heart of both the American and
European financial systems.
I agree that we can and must work more closely together. I
am just not so sure that agreeing up front to wholesale
harmonization of legislative frameworks or treating all
regulations as equal is wise. I think that a case-by-case
determination of where convergence might be necessary to
achieve increased market efficiency and stability is more
appropriate. It is for these reasons that I support the US-EU
Dialogue and look forward to hearing testimony about it today.
Thank you very much and yield back.
[The prepared statement of Hon. Judy Biggert can be found
on page 31 in the appendix.]
The Chairman. The gentlelady yields back. Are there further
opening statements?
The gentleman from Washington State.
Mr. Inslee. Thank you. I look forward to your discussion
about coordination in regulatory affairs, because I think we
have seen some good successes in coordination with the American
and EU regulators, but we have seen some different approaches,
temporarily at least, taken by the EU and American regulatory
structure, particularly an anti-trust issue that provokes my
concern from the 1st district of the State of Washington.
And we think there are problems that can happen when there
are obviously inconsistent approaches by the two regulatory
branches that can force American companies to undergo different
treatments, has wide implications in privacy issues and piracy
issues and the like.
So we obviously are very interested in anything we can do
to promote a true coordination, and I just hope that the panel
will address the prospects of working on the issues at the
upcoming US-EU Summit or the G7 meetings in the hopes that we
can really reach that happy day when we have got total
coordination between these two regulatory bodies. Thank you.
The Chairman. I Thank the gentleman.
We now turn to our distinguished panel. The Honorable
Randal Quarles, Assistant Secretary for International Affairs
at the United States Department of the Treasury; the Honorable
Susan Bies, Governor, United States Federal Reserve Board; Ms.
Samantha Ross, Chief of Staff of the Public Company Accounting
Oversight Board and Mr. Ethiopis Tafara, Director of the Office
of International Affairs, United States Securities And Exchange
Commission.
Welcome to all of you folks, particularly Ms. Ross who
makes her first appearance before our committee as a
representative of the PCAOB.
Mr. Quarles, we will begin with you.
STATEMENT OF HON. RANDAL QUARLES, ASSISTANT SECRETARY FOR
INTERNATIONAL AFFAIRS, UNITED STATES DEPARTMENT OF THE TREASURY
Mr. Quarles. Thank you, Mr. Chairman.
The Chairman. Get your mike on there, Mr. Quarles.
Mr. Quarles. Thank you, Mr. Chairman and members of the
committee. With your permission, Mr. Chairman, I would like to
submit my written remarks for inclusion in the record.
The Chairman. Without objection, all of the prepared
remarks will be made part of the record.
Mr. Quarles. Thank you, sir. And I want to begin by
thanking this committee for its support for the US-EU Financial
Markets Dialogue, which I, at least, think has been really
integral to the progress that we have been able to make over
the last couple of years, having that support.
As you mentioned at the outset, sir, the US-EU Dialogue
began in March of 2002, and since then we have had technical
meetings that have been led jointly by the Treasury and the
European Commission. That includes active participation of the
U.S. regulators, principally the Federal Reserve and the
Securities Exchange Commission. Those have taken place on
roughly a quarterly basis, and in addition to Dialogue it is
supplemented by substantial interaction of senior policy
officials.
The United States has a keen interest, a self-interest in
the success of Europe's Financial Services Action Plan, because
a central aim of our foreign economic policy is to promote a
strong and growing global economy. And we know that strong and
efficiency capital markets support robust growth.
Also, U.S. financial institutions are a vital and leading
part of the European financial landscape, and we want our firms
to be able to compete globally on fair terms that reward their
competitiveness. And so just as the United States is interested
in the evolution of European capital markets, so Europe is
interested in the evolution of U.S. capital markets and some of
the recent steps that we have taken here.
Both the U.S. and the EU recognize that our financial,
legal, historical and cultural traditional are different. The
challenge of the Dialogue is to see through these differences
and work to achieve our common objectives and substance and
manage the spillovers of these differences into each other
jurisdiction. If we are successful in this effort, then both
sides will win.
So against this background, the United States strongly
supports Europe's Financial Services Action Plan. And in fact
we commend Europe for the ambition and the progress that they
have made to date.
In my written remarks, I cover a broad range of issues, but
let me mention two of the many key issues that we are
discussing with Brussels. The Financial Conglomerates Directive
requires a foreign supervisor regime to be deemed equivalent by
Europe for firms from that country to operate within Europe
without making costly changes to their method of operation.
While there is always room for refinement and improvement, of
course, it goes without question that the U.S. supervisor
regime is a gold standard for the world's capital markets, and
all U.S. regulators have cooperated closely with Europe in
explaining their approaches to consolidated supervision. We are
confident that a positive equivalence finding will soon be
made.
Second, the Prospectus and Transparency Directives
initially suggested that U.S. firms that would be listing new
U.S. securities in Europe should prepare financial statements
on the basis of international accounting standards by 2005,
rather than US GAAP or they would have to cease issuing in
Europe.
Moreover, the draft directives didn't make any provision
for grandfathering previously listed issues. We discussed these
matters with Brussels for the last year, and the final text of
these directives provide for grandfathering of existing issues,
and we fully expect that U.S. firms that will be listing new
securities in Europe will be permitted to continue preparing
their statements in US GAAP.
In addition to these specific matters, we applied the
increased transparency of European rulemaking, growing
consultations of regulators with market participants. These
have improved European rulemaking in the same way that they
improve our own rulemaking here in the U.S.. They have created
a greater consensus and buy-in for proposed regulations, and
they have strengthened European financial markets.
I think it is inevitable that there will be compromises in
building an integrated capital market in light of different
European country practices. That will be part of the FSAP
process. But Brussels, the parliament, the member states and
the commission, in our view, are working to instill as liberal
a vision as possible for the European capital market.
The FSAP's implementation is a work in progress. It will
continue to evolve, but it represents an important step forward
and the extension of this vision at the European-wide level to
the so-called passport, and that will contribute to the growth
in global capital markets.
Following the selection of a new commission and European
parliament later this year, the Dialogue will need to tackle
new challenges in promoting a more vibrant transatlantic
capital market. Among these are promoting convergent accounting
standards, improving corporate governance, strengthening
investor protection and reducing the cost of clearance and
settlement in Europe.
In conclusion, the Dialogue has increased the transparency
of rulemaking and it is been part of the momentum to European
financial market reform. I think that it is rightly credited as
having helped diffuse transatlantic tensions in an important
area that is vital to the functioning of the world economy.
And, finally, if those of us on both sides of the Atlantic
can agree on financial regulatory standards, then others around
the globe will follow. I think the potential benefits of this
effort are enormous and that it is important that the Dialogue
succeeds, and I believe it will.
Thank you, sir, very much.
[The prepared statement of Hon. Randal Quarles can be found
on page 47 in the appendix.]
The Chairman. I thank you for your testimony, Mr. Quarles.
And, Ms. Bies--it is Bies, right? I am sorry, I had it
wrong, but we will correct the record.
STATEMENT OF HON. SUSAN BIES, GOVERNOR, UNITED STATES FEDERAL
RESERVE BOARD
Ms. Bies. My husband will appreciate that very much. Thank
you, Mr. Chairman. I appreciate the opportunity to speak today
on matters relating to the US-EU Financial Markets Regulatory
Dialogue. I am going to comment briefly on the Dialogue's role
in helping us to monitor European-wide regulatory developments
in financial services and understand the effects on U.S.
banking organizations operating in the EU.
At the time the Treasury Department initiated the Dialogue
in 2002, the European Union was continuing with efforts to
establish a single market in financial services by implementing
measures comprising the Financial Services Action Plan. U.S.
regulators were continuing to implement provisions of the
Gramm-Leach-Bliley Act, and Congress was considering reforms
that led to the adoption of Sarbanes-Oxley.
U.S. and EU financial services firms were and remain major
participants in each other's markets. These regulatory
developments will impact those firm's operations for years to
come. In the United States and internationally, it is generally
accepted that a foreign firm conducting business in a local
market should receive national treatment; that is, the foreign
firm should be treated no less favorably than a domestic firm
operating in like circumstances.
Implementing national treatment can be challenging, as
local rules must be adapted to foreign organizations that
operate under different legal and regulatory structures. It is
therefore critical that supervisors have timely and full
information in order to have a good understanding of the
supervisory and regulatory environments in which global firms
operate.
The Dialogue has served as a useful forum for information
sharing among regulatory experts who are responsible for
implementing rules embodying national treatment. It helps to
foster a better mutual understanding of U.S. and EU regulatory
approaches, developments and time tables and to identify
potential substantive conflicts in approach as early as
possible in the regulatory process.
Although the Federal Reserve has an established program of
working with foreign supervisors, both bilaterally and
multilaterally, the Dialogue is the only venue specifically
dedicated to US-EU regulatory issues. It complements the
Federal Reserve's ongoing relationships and discussions with EU
national regulators.
The Dialogue provides an efficient and effective forum for
discussion of issues across a spectrum of financial services.
As such, it has great utility for supervisors of large, complex
financial services organizations. We have been able through the
Dialogue to advance our views on the application of the EU's
Financial Conglomerates Directive to U.S. bank holding
companies.
Under EU rules, foreign financial firms must be subject to
supervision at the holding company level by competent home
country authority which is equivalent to the supervision
provided for by the provisions in the directive. In the absence
of an equivalence determination, U.S. financial firms with EU
operations could be subject to higher capital and risk control
requirements or be required to create an EU subholding company.
The Federal Reserve and the Comptroller of the Currency
have provided information regarding the supervision of U.S.
banking organizations. We anticipate that the commission will
keep us informed of member states' progress in this regard, and
we expect that U.S. banking organizations will be found to be
in compliance with the supervision standards of the directives.
I would like to comment briefly on the relationship between
the Dialogue and international developments in the areas of
capital, accounting, and auditing standards. As you know, the
Basel Committee on Banking Supervision is in the process of
revising the Basel Capital Accord. Dialogue participants have
discussed application, implementation, and timing concerns
regarding Basel II. It has not focused on technical issues that
have been under discussion within the Basel Committee.
Technical issues have been left for the experts to work
through.
The Dialogue has served as a useful venue for participants
to gain a better understanding of implementation procedures
that are anticipated. This discussion has helped both sides to
achieve a better sense of the implementation challenges we all
face and the commitment to see the process through.
The Federal Reserve and U.S. banking agencies are actively
involved in the efforts of the Basel Committee to promote
enhanced international accounting and disclosure standards and
practices for global banking organizations. For example, an
official of the Federal Reserve Board is a member of the
Standards Advisory Council that advises the IASB and its
trustees. Federal Reserve also has been active in supporting
the Basel Committee's project with the International Federation
of Accountants and other international regulatory
organizations, such as IOSCO.
Although we have been actively involved in addressing
international accounting and auditing issues primarily through
our involvement in the Basel Committee's projects, the
Securities and Exchange Commission has had the primary role in
discussing these matters with the EU representatives in the
Dialogue.
In summary, the Federal Reserve has found the Dialogue to
be a useful vehicle in monitoring the rapid regulatory
developments in the EU and exchanging information. At the
Federal Reserve, we have an obligation to keep apprised of
these developments on a timely basis in order to fulfill our
supervisory functions and ensure a level playing field for U.S.
banking organizations operating in the European Union. We are
confident that continuing the Dialogue in its present informal
form will facilitate these objectives. Thank you.
[The prepared statement of Hon. Susan Bies can be found on
page 34 in the appendix.]
The Chairman. Thank you, Ms. Bies.
Ms. Ross?
STATEMENT OF SAMANTHA ROSS, CHIEF OF STAFF, PUBLIC COMPANY
ACCOUNTING OVERSIGHT BOARD
Ms. Ross. Thank you, Chairman. Good morning. I am pleased
to appear before you today on behalf of the Public Company
Accounting Oversight Board to discuss the regulatory Dialogue
between the Board and the European Union.
While we are not part of the official Financial Markets
Regulatory Dialogue, under the leadership of our chairman, Bill
McDonough, we have established a very effective working
relationship with the EU related to oversight of the auditing
profession. Both we and Europe have learned from experience
that no borders can contain the losses and uncertainty that
occur with large corporate failures.
Beginning with the work of this committee, Congress took
steps to restore the public's confidence in our markets with
the Sarbanes-Oxley Act. The act created the Board to oversee
the auditors of public companies and gave it significant
powers.
Among these powers, the Board has the authority to register
public accounting firms that prepare audit reports for issuers
as well as to conduct inspections of those firms. The board
also has the authority to conduct investigations and
disciplinary proceedings concerning public company audit work.
Further, the Board has the authority to establish the standards
governing the preparation of audit reports.
One of the Board's first steps was to establish a
registration system for accounting firms that audit public
companies, including non-U.S. firms that issue audit reports
for companies that have registered securities in the U.S.. This
includes the auditors of U.S. multinational companies that have
significant operations abroad and the auditors of foreign
companies that have elected to access the U.S. capital markets.
Today, 840 accounting firms have been registered by the
Board, including 35 non-U.S. firms from countries such as the
United Kingdom, Germany and Hungary. More than 145 additional
non-U.S. firms have applied for registration, and we expect
that as many as 300 may register in the near future.
Registration is only the beginning of our oversight, however.
As we prepared for our oversight of non-U.S. firms, we
began exploring with international auditing regulators ways to
enhance the effectiveness of our oversight and minimize
duplicative regulations. Based in large part on these
discussions, the Board has developed a cooperative framework
that would allow it to gain insight from and rely on the
inspection by a firm's home country regulator.
This approach would permit varying degrees of reliance on
the home country system of inspections, depending on the
independence and rigor of that system. The board would place
the greatest reliance on those systems that maintain the
highest level of rigor and independence from the accounting
profession. Conversely, the Board would participate more
directly and rely less on those systems that are less
independent or rigorous.
The European Commission is facing the same issues relating
to audit quality that we face. The Parmalat scandal, which came
to light last December, galvanized investors in European
securities to demand more reliable financial reporting and
auditing. With the proposed 8th Company Law Directive, European
Commissioner Frits Bolkestein and Director-General Alexander
Schaub have taken important steps to restore confidence in
European markets.
Shortly after the 8th Directive was proposed this past
March, Commissioner Bolkestein and our Chairman held an
unprecedented roundtable discussion in Brussels with EU member
state representatives. Our primary discussion focused on the
key objectives of auditor oversight upon which we are all
building our new regulatory systems.
The oversight system required by the 8th Directive appears
to mesh quite well with the oversight system we are putting in
place here in the U.S.. The 8th Directive would require
external independent oversight of auditors in a manner that is
transparent, well-funded and free from undo influence by
auditors or audit firms. It would also provide for cooperation
with other regulators. These provisions should substantially
enhance our ability to coordinate with our European
counterparts.
While the assistance of non-U.S. regulators will help us
achieve our objectives under the Sarbanes-Oxley Act, true
collaboration is a two-way street. The board has previously
stated it is willing to assist non-U.S. regulators in their
oversight of accounting firms. Because the needs of every
regulator are different, we plan to work out the details of our
assistance through direct discussions.
In conclusion, we still have much work ahead of us to
establish lasting relationships and working protocols with
other regulators, and the Board is optimistic. Cooperation
among regulators requires good will and flexibility. Our
experience with the European Commission has demonstrated that
European regulators share this view. We are confident that with
the continuation of our open and constructive Dialogue with
both the EU and its member states, we will be able to work
together to fulfill our important missions to protect
investors. Thank you.
[The prepared statement of Samantha Ross can be found on
page 52 in the appendix.]
The Chairman. Thank you.
Mr. Tafara?
STATEMENT OF ETHIOPIS TAFARA, DIRECTOR, OFFICE OF INTERNATIONAL
AFFAIRS, UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Mr. Tafara. Thank you. Chairman Oxley and distinguished
members of the committee, I am delighted to have been invited
to testify about the US-EU Regulatory Dialogue on capital
markets. The Dialogue is the result of historic changes in the
way capital markets function and our likely to develop. Today,
almost all developed markets and even a considerable number of
developing markets have adopted forms of security regulation
similar to our own. At the same time, capital markets have
become global. The result is something unique--a truly global
capital market but operating in a world of expensive domestic
capital market regulation.
At this point, I should say that I firmly believe that the
U.S. securities laws and SEC market oversight are two of the
principal reasons why our markets are as efficient and
effective as they are at fueling the capital needs of our
economy. These laws focus on investor protection and have
created in investors a certain bedrock confidence in the
integrity of our securities markets that even sizable financial
scandals have not been able to diminish entirely.
In Europe, the union has promised to create an EU-wide
capital market and a rationalized coordinated European
securities regulatory structure. These initiatives will improve
the efficiency and liquidity of Europe's securities markets,
developments that will benefit both U.S. investors and issuers
in the long run by providing the former with greater investment
opportunities and benefiting issuers by possibly lowering their
cost of capital.
The U.S. and EU securities markets are too large to be
ignored, and potential conflicts between the regulatory
requirements of these markets can have an adverse impact on
cross-border flow of capital. Some of these conflicts may prove
difficult to avoid, stemming, as they may, from differences in
regulatory philosophy. Nonetheless, some duplicative or even
contradictory regulation in this cross-border environment may
offer little in the way of investor protection and merely place
an unnecessary burden on issuers, firms and investors. The SEC
is committed to avoiding such situations where possible.
The US-EU Dialogue was created as a form in which to
discuss such conflicts and other regulatory matters and fulfill
several functions. Most importantly, it has served to reinforce
our common ground. With respect to financial services
regulation, the U.S. and EU share the same fundamental goals:
Protecting investors, maintaining the stability of our markets
and allowing free and unfettered competition among all market
participants.
The Dialogue is also proving useful in resolving potential
problems by providing an opportunity for both sides to air
concerns about the possible impact of upcoming regulations and
to explore adjustments.
Finally, the Dialogue has afforded an opportunity to learn
from each other's experiences. The learning process allows us
to consider possible new avenues of regulation for our own
markets which ultimately enriches the regulatory rulemaking
process and helps us each to better carry out our regulatory
mandates.
We have made a connection with the Dialogue on a number of
occasions and on these occasions we have discussed a number of
key issues, including the implementation of the Sarbanes-Oxley
Act, EU Financial Conglomerates Directive and international
financial reporting standards. Although the US-EU Dialogue
began before the Sarbanes-Oxley Act was signed into law,
implementation of the act added new significance to the
Dialogue.
As the SEC began to implement the Sarbanes-Oxley Act, it
quickly became clear in some cases implementing the provisions
in certain ways could conflict directly with laws and
regulations in other jurisdictions. The SEC worked very hard to
resolve these conflicts in a manner consistent with the spirit
and intent of the act.
The Dialogue played a key role. Through our interactions
with representatives of the European Commission, the SEC
learned where potential conflicts lay, while the European
Commission came to understand the objectives of our proposed
rules. These discussions, in turn, led us to consider
modifications to our proposed rules and avoided putting foreign
market participants in the unenviable position of being asked
to comply with conflicting laws while still ensuring that the
objectives of the Sarbanes-Oxley Act were met.
The cross-border impact of securities regulation travels
both ways, as the SEC also had to respond to legislative
initiatives in the European Union. And one example we had to
respond to was the EU legislation called the Financial
Conglomerates Directive. This directive had cross-border
implications given that it requires non-EU holding companies or
financial firms operating in the EU to be subject to
consolidated supervision.
Again, the Dialogue played a key role. As the EU went
through the process of proposing, amending and finalizing the
directive, we discussed as part of the Dialogue the
implications of the directive for U.S. broker dealers with
operations in Europe. Indeed, the SEC provided detailed
explanations of the SEC's form of oversight to EU regulators
and policymakers and at this juncture expects that the European
Commission and EU member states will find our system of
consolidated supervision to be equivalent to the Financial
Conglomerates Directive.
Going forward, the SEC and the European Commission will be
examining many of the same regulatory issues partly in response
to very similar financial scandals in both our markets. The
Dialogue is proving to be fertile ground for exploring new
ideas and approaches, as both sides consider whether to
introduce new regulation or to strengthen existing regulation
to address regulatory concerns.
To complement our discussions with the European Commission,
I expect that we will in the near future also develop a
framework for cooperation between the SEC and the Committee of
European Securities Regulators, or CESR. The committee
comprises securities regulators from all EU member states and
is responsible for implementation of EU laws and day-to-day
oversight.
In conclusion, I would note that the US-EU Dialogue is a
key element in a web of connections between the U.S. and EU
policymaking community. It serves the important function of
providing a forum for developing greater understanding of each
other's approaches, for airing concerns about actions that
either the U.S. or EU has taken with respect to financial
services and ultimately will help us achieve more converged
regulations relating to financial services while ensuring the
highest level of investor protection.
I believe the Dialogue will lead to better securities
regulation in the U.S. and the European Union and in the long
run better protection and choices for investors. Thank you.
[The prepared statement of Ethiopis Tafara can be found on
page 82 in the appendix.]
The Chairman. Thank you, Mr. Tafara, and we now turn to our
panel, and I will begin with a series of questions.
I would first like to ask Mr. Quarles, since the Treasury
coordinates the views of the U.S. Federal regulators regarding
the issues before the Dialogue, one of the most striking
differences that I have noticed between the Federal regulators
until recently has been that the SEC did not regulate holding
companies and supervise holding companies. That appears to be
changing. It would seem to the outside observer that the SEC is
finally using the Gramm-Leach-Bliley authority in order to
converge with the EUs legal standard.
I understand the equivalence determination in Europe
regarding our state-based insurance regulators could be at
least as thorny as the determinations in the securities
industry. Having said that, what is the Treasury doing to help
facilitate the equivalency determinations for all sectors of
the U.S. financial services industry, and where do we go from
here?
Mr. Quarles. The question of equivalency has been one of
the central ones that we have been discussing in the Dialogue,
and we have--what the Treasury has been doing is attempting to
deal with all of the aspects of that as it arises in the
discussion. What the SEC is proposing has been helpful. We have
been encouraging direct conversations between the commission
and the regulators on the topic of equivalency and some of the
technical issues that arise.
And on the insurance side, there is a direct Dialogue as
well between the commission and the insurance regulators. It is
an insurance regulatory Dialogue that is led by the NAIC, the
National Association of Insurance Commissioners, which we are
monitoring, and occasionally representatives of the NAIC will
participate in our Dialogue on issues related to the Financial
Conglomerates Directive and equivalency determination. So we
have attempted to strengthen their separate Dialogue by
including them in ours.
The Chairman. Does our system of insurance regulation at
the State level complicate your efforts?
Mr. Quarles. I don't know that I would use the word,
``complicate.'' Obviously, because there isn't a Federal system
of regulation for insurance, we have to approach that in a
different way than we approach the regulation of other
financial institutions. But that said, I think that the
Dialogue that there has been between the State insurance
commissioners and the European Commission, which we have been
monitoring, has been helpful in addressing some of the concerns
about varying State regulations that the European institutions
face when they come into the United States.
The Chairman. When you get into Dialogue sessions, do you
have a coordinated approach going into those, and that is
directed by the Treasury, you are kind of the quarterback? Is
that how it works?
Mr. Quarles. Yes.
The Chairman. In areas of competency and regulatory
structure?
Mr. Quarles. Yes. Generally, the technical group when they
meet, for example, usually will meet in advance, not always,
but usually will meet in advance to go over the issues that
will be presented in the discussion, so that there is a unified
view.
The Chairman. Thank you. Let me ask all of our witnesses,
and I am kind of running short of time, so we will try to do
our best to get some answers. The exercise of consolidated home
country supervision in the world of modern finance is going to
involve a lot of sharing of information across borders--sharing
data, verifying models implemented properly, even on occasion
sharing enforcement and investigative authority.
Let me start with Mr. Tafara and we will work that way. Do
you believe that all of these things can be accomplished
through the informal networks that exist, such as the Dialogue,
or are we going to need at some point some more formal
arrangements to accomplish our goal?
Mr. Tafara. I am not sure that we need something more
formal. Indeed, today, I mean as we have put into practice our
risk assessment program, which involves gathering certain
information from broker dealers and assessing their exposure
and the capital that should be charged as a consequence of that
exposure, we do meet regularly with our counterparts in Europe
at the national level, particularly with respect to broker
dealer groups that have a presence in the major countries, in
Europe, Germany and the UK and indeed a country outside of the
EU, the Swiss.
We meet with them one to two times a year to share
information about what we see, concerns that we have identified
and to hear from them about the same thing. And that process
has worked extremely well over the course of the past several
years that we have been meeting with them. And I expect that
will continue going forward, that we would continue to meet on
a rather informal basis but yet share information relevant to
the risks and the risk exposure of these firms that we should
be taking into account.
The Chairman. Thank you.
Ms. Ross? Don't forget that mike.
Ms. Ross. Yes. We do plan on establishing working protocols
and procedures with the various auditor oversight bodies that
we hope to be able to gain assistance from and rely on in our
inspection work and our other oversight programs. That is one
of the things that we are beginning now to get working on. The
European Commission has been very helpful in establishing a
framework for that kind of work through the ACE Directive.
In addition, the European Commission is now helping us
establish relationships with the various member states which
will be forming these new auditor oversight bodies as we are
forming now so that we can work together.
The Chairman. Thank you.
Ms. Bies?
Ms. Bies. Mr. Chairman, the Federal Reserve already has
legal agreements that allow us to share information with all
the major banking regulators across the world, and where we
have specific cases of investigations, our experience has shown
we work very well together under the period where you are sort
of under stress and have a real problem situation.
So we are very comfortable we have the authorities that we
need day-to-day coordinate the activity between the home and
host regulators.
The Chairman. Mr. Quarles, specifically to you in terms of
terrorist financing and anti-money laundering, do we need to go
beyond the informal arrangements and look towards MOUs and
other forms of agreements? I know that based on the PATRIOT Act
that the Treasury has been quite busy and successful in many
cases in implementing that law. Could you give us some details?
Mr. Quarles. Sure. There obviously are a number of ways in
which we would want Europe to, again, refine and improve the
procedures it has in place for addressing anti-money laundering
and counterterrorist financing. I don't know--at this point, I
don't know that we would say that it requires something more
formal than what we have been doing.
We have a regular interaction with the Europeans on these
issues, and, for the most part, it is fruitful, and we have had
some significant successes, for example, in September of 2003
when Europe moved to designate the entire Hamas organization
rather than attempting to split it up from its charitable arm
and its political military arm.
But, for example, in that same vein, they still don't
designate all of Hezbollah, and that is something that we are
working with them to improve. We think they need to streamline
the clearinghouse process that they have for handling
information related to preparing designations and for moving
quickly to disseminate information about designations to banks
in their jurisdiction. We think they need to develop a more
flexible standard for designation. It is really more of an
actual criminal standard as opposed to an administrative
standard, and that isn't flexible enough to be able to act
quickly enough, and speed is of the essence in this effort.
So there are clearly issues like that--I think those are
the principal ones--there are issues like that we want them to
move on and are continuing to work with them to move on. But
the progress that we have had so far, while it is not complete,
I think would not say that we need a thorough overhaul of the
way that we are engaging with them.
The Chairman. My time has expired.
The gentleman from Washington?
Mr. Inslee. I was so enthralled with your questioning that
I was just momentarily rendered speechless, which doesn't
happen very often.
[Laughter.]
The Chairman. That is true. I won't start your time running
until you tell me when you want.
[Laughter.]
Mr. Inslee. Okay. Maybe it goes without saying that U.S.
businesses have a huge interest in having consistency between
American and EU regulatory structures. And where we have
consistency, we frequently have global kind of concurrence,
other nations follow. And where we don't, it can give
inconsistent results, not only in the EU but folks who feel
free to start new regulatory schemes around the world.
This was brought home to me. Obviously, frankly, with the
Microsoft case, it has two different at least potential, and
there are some good signs, actually, that we may find more
coordination in those policies, so that is--we have optimism
about that.
But I just wondered what you could tell us, particularly,
Mr. Quarles, about efforts at upcoming summits, EU-American
summit, G7 and the effort to really emphasize our need and
explore ways to improve our consistency across the pond knowing
how important it is to U.S. business.
Mr. Quarles. This Dialogue, for example, is something that
forms an important part of the discussion at the summit, at the
US-EU summit. And in the context of the G8 summit that will be
coming up, a central theme is the agenda for growth, which is
to say measures that all of the G8 economies need to take in
order to--we call them supply side measures that improve the
environment for economic growth in each of those economies. And
an important part of that is the regulatory environment and
ensuring that business climate is conducive to economic growth.
We have made that a constant and central theme of our
engagement with the developed countries at the summit level, at
the ministerial level and in various international forums, and
I think you can see that it is beginning to bear some fruit,
both from the support that the Dialogue has at the heads level
because it is always, as I say, a central topic of the US-EU
summit but also in some of the structural changes that European
countries are making in their economies that are pro-business
and pro-economic growth.
Mr. Inslee. Well, we encourage those efforts, we hope you
are successful, because this has enormous ramifications for
companies that need predictability, need consistency, need to
trust one judicial system instead of having to go through 100,
and we hope you will be successful. Thank you.
The Chairman. I thank the gentleman.
Let me ask Ms. Bies and Mr. Tafara, and I am going to be
asking a similar question to Dr. Schaub when he testifies. It
is a complicated issue and it is one that really has enormous
consequences going forward. Many U.S. institutions have been
listing in the Euro markets on the basis of US GAAP standards.
The euro markets are obviously huge. I understand that the
new EU directives imply that unless US GAAP is soon found
equivalent for the purposes of listing in Europe, these firms
may not be able to continue using the Euro markets. It would
seem to me that such a development would mean lower liquidity
and volume in the European capital markets, which would be
contrary to the basic purpose of the FSAP.
In the meantime, uncertainty in the markets could inhibit
issuances. Governor Bies and Mr. Tafara, there has been much
debate and concern in Europe regarding the IASB's proposed fair
value standard for derivatives. What is your impression of how
that debate is likely to turn out? Do you agree that it could
be a problem for the balance sheets in Europe and the United
States to have different standards for evaluating and valuing
derivatives?
Ms. Bies?
Ms. Bies. Mr. Chairman, the proposal that Europe is
debating at the moment would bring the international standard
closer to the U.S. Today, we have a very wide difference
between the two accountings. In the United States, several
years ago, the Financial Accounting Standards Board required
all corporations, not just financial institutions, to recognize
on their balance sheet financial derivatives of all types.
Europeans still don't do that.
So one of the things in terms of a level playing field and
transparency of these complex organizations, we think it is
important that they do move forward and provide that
transparency.
Now, the U.S. companies, to their advantage, had to adopt
all these changes one by one because these are in different
standards in the U.S. and so had more time to implement, and
that is one of the issues I think the Europeans are struggling
with to adopt all this at once. But the European firms who are
already preparing under US GAAP will find that much of the work
they are already doing will help them.
And, furthermore, some of the approaches that are in IASB
proposals 39 and 32 actually provide some interesting
alternatives to some of the areas in the US GAAP that we have
found problematic and might provide an alternative. So I am
hoping that we get to a closer consistency across the two
standards, and I think the Dialogue that is going on now
between the FASB and the IASB and our work with the other
banking regulators in Europe to talk about how to look at
financial standards in the two countries is very productive.
I would also add that even if we get comparable standards,
the issue is going to be whether they are implemented and
interpreted the same way, and that is going to require some
work. We think some of the new standards, for example, on loan
loss reserve accounting should move us closer than what we have
in practice today. And, obviously, the work of the PCAOB is
important because a lot of the issues that we struggle with
that we call accounting issues, even in this country, are not
accounting, they are audit failures.
The Chairman. Well, maybe we should ask Ms. Ross then to
comment on that since you brought her into the equation here.
[Laughter.]
Ms. Ross. Thank you, Chairman. Our board has not taken a
position on accounting standards, and I don't really expect it
to, because we really are in the audit area. But, of course,
once the accounting standards are established, we do play a
very big role in helping to ensure that these accounting
standards are applied in a consistent manner, just as Governor
Bies is saying.
So that will be critically important to us as we move
forward in our inspections of accounting firms work on public
companies, both those public companies that are the sort of
bread and butter companies we have here in the U.S. and then
also the foreign private issuers that are listed and registered
with the Securities and Exchange Commission. So this is
something we are very mindful of.
The Chairman. Thank you.
Mr. Tafara?
Mr. Tafara. Don't know that I have much to add to what
Governor Bies had to say about IS 32 and 39. We have tried to
stay outside of the debate that is raging in Europe with
respect to whether or not they should use IS 32 and 39, as they
have been currently proposed, other than to note that a
financial instrument standard is pretty important to add and to
note that the conceptual underpinnings to 32 and 39 are the
ones that are in FASB 133 and our institutions have been able
to adapt to use the standard.
With respect to convergence, I want to add on to what
Governor Bies had to say and say that we have been strong
supporters at the SEC, at least at the staff level, of the
convergence project that is taking place between the IASB and
the FASB, the exercise of identifying the principal differences
and trying to eliminate them over a period of time, and we
think that actually will increase the transparency and the
comparability of financial statements as investors look to the
choices they have for their capital.
But as Governor Bies pointed out, critical to the
acceptance of IAS on a cross-border basis will be a robust
infrastructure for consistent interpretation, application and
enforcement of the standards. Without that, what is supposed to
be one standard can quickly devolve into 15, 25, 30 different
standards, and that is something we are working with our
counterparts across the Atlantic on establishing.
The Chairman. I would assume that all of the witnesses
would share the same concerns expressed by Mr. Tafara in terms
of having numerous standards and trying to deal with all of
those. I see everybody shaking their heads. And, of course, one
of the purposes of the hearing was to get some of those issues
out there, and that is been enormously helpful, and your
testimony has been enormously helpful to the committee in
making a record as we move forward.
I think the encouraging thing is that we have made
significant progress already, and in many ways we are just
probably in the first inning of this process, but it is quite
encouraging, and for that we thank all of you and we are now--
you can go back to work, and thank you for your testimony.
The committee is now pleased to welcome Mr. Alexander
Schaub, Directorate General for the Internal Market of the
European Commission.
Mr. Schaub, it is great to have you here to share your
expertise. The committee is very familiar with your background
and your reputation in the European Union, and we most
appreciate your coming across the Atlantic to be with us this
morning and testify, and you may begin whenever you feel
comfortable.
STATEMENT OF ALEXANDER SCHAUB, DIRECTOR GENERAL, DIRECTORATE
GENERAL, INTERNAL MARKET, EUROPEAN COMMISSION
Mr. Schaub. Good morning, Chairman Oxley and members of the
committee. Thank you very much for inviting me to testify on
behalf of the European Commission and in addition for the first
time on the informal EU-US Financial Markets Regulatory
Dialogue.
Cooperation in this area is not an option, an extra. It is
an economic, political and regulatory necessity. We are
economically interdependent. In the global markets, our
regulations inevitably spill over on each other, not only in
this area, it was already talked about, competition policy
where you have exactly the same phenomenon.
The financial integration that we are undertaking in Europe
offers huge opportunities for the U.S.. And we can cooperate.
Within the EU, we have had to ensure that also in an enlarged
union investors in one country can feel secure about the offer
of service from intermediate in another. We have taken, and we
continue to take, stringent steps to ensure that high
regulatory standards prevail. Such cooperation, which we have
been training and practicing over 4 decades now within the
European Union, must also be possible with our friends in the
U.S.
We have taken a fresh start in our cooperation. That has
involved recognizing the need, not necessarily to take
identical approaches, but to agree on equivalent approaches.
That is, in our view, the only viable way forward, and it is
based on our practical experience over the last 40 years. We
have taken a fresh--excuse me.
The Financial Markets Regulatory Dialogue is key to this
exercise. There is no magic to the term, it just refers to the
fact that we are talking to each other frequently. It does not
matter whether that takes place face to face or by telephone.
What matters is that it does happen and in a constructive and
effective way which removes hurdles and prevents the creation
of new ones.
What makes it tick is its informality, meeting only as on
as an as and when basis and concentrating on solutions. We are
constantly looking at improvements by organizing our
discussions better, delegating work to experts, encouraging
parallel Dialogues, including that, by the way, between
yourselves and the European parliament, and we were always
pleased to see you in Brussels, and between industry, while
keeping all stakeholders informed of progress achieved.
One of the key issues will be, as already mentioned,
auditing. We welcome the excellent and extremely pleasant
cooperation with the PCAOB, and we hope this will continue.
On conglomerates, we recognize the need for certainty, and
we hope to be able to announce guidance shortly, European
guidance to be applied by the national supervisors. It is vital
that we work together on the reconciliation of international
accounting standards with US GAAP, and there are indeed
practical questions which have to be further clarified.
It is crucial that supervisors continue to work closely on
the implementation of a new capital accord, and I think we can
congratulate our negotiators from both sides of the Atlantic on
the outcome of the latest meeting in Basel. Banks must not find
the benefits of the new framework undermined by conflicting
approaches to implementation and interpretation.
There are benefits to cooperating on the regulation of
securities and exchanges and the possibilities of remote excess
to trading screens of exchanges based in the jurisdictions of
the other side. We also see benefits in the increased
cooperation on the collateralization of reinsurance, allowing
insurers on both sides to diversify risk.
Finally, there are issues such as credit rating agencies,
financial analysts, mutual funds and hedge funds which offer
real opportunities for more upstream convergence and practical
cooperation.
Mr. Chairman, I welcome the support that you have brought
to this process, and I ask this committee to support us as we
proceed. Our citizens, intermediaries and companies all stand
to benefit from it. Thank you for your attention.
[The prepared statement of Alexander Schaub can be found on
page 68 in the appendix.]
The Chairman. Thank you, Mr. Schaub, again for--Dr. Schaub
for appearing before us today and your very positive comments.
And, indeed, what you say is correct, that our constituents on
both sides of the Atlantic are depending on policymakers to
work together to make certain that the free flow of services
and their financial future is well in hand and that we do have
the benefits of regulation that provide the kind of safety and
protection for investors and for savers at the same time.
Let me begin. The EU's Financial Conglomerates Directive
states that the U.S. securities firms operating in Europe must
be subject to an equivalent consolidated global supervision
system which would be determined by the relevant Member State
regulator beginning in 2005, next year. As you know, the SEC
and others have been working closely with the European
Commission for over 2 years in order to ensure that the SEC's
regime is determined to be equivalent. As a matter of fact, we
had some discussions in Brussels about that, I guess, almost 2
years ago.
And I understand that the Commission will not issue its
guidance to start the equivalency determination process until
at least June of this year. This delay is causing some concern,
as you might guess, within the U.S. financial services
industry. Is there any reason for us to be concerned that the
SEC's new regime will not be found equivalent in time for
compliance?
Mr. Schaub. First of all, I should underline that this
equivalence requirement is not a way of torturing unnecessary
our friends and partners. It is a natural prerequisite before
you enter into cooperation in such sensitive, important matters
with important partners, and we find it perfectly natural that
in cases where the U.S. is supposed to cooperate--U.S.
supervisory structures are supposed to cooperate with us, that
they would naturally first have a look whether the partner,
their cooperation partner is at the equivalent quality level.
Now, on the concrete case, you will understand that I
cannot prejudge the outcome of this process, but personally I
am very much convinced that this exercise, which is a new
experience, which has taken more time also because American
companies needed more time to present the practical details, I
believe that at the end we will clearly come to a positive
outcome.
That is my firm, personal expectation, and I can tell you
that we in the commission, Mr. Bolkestein, in the first place,
are following closely this process. And if there should be any
problem in the further development, because, as it was said,
the final decision on equivalence is taken by the national
supervisors on the bias basis of community-wide guidance, on
the application of uniform rules at community level. But the
last word is delegated to the national supervisors, and we will
be in very close contact to make sure that unnecessary
accidents can be avoided.
The Chairman. Thank you. Do you think that the insurance
issues will perhaps create the thorniest problem? What is your
view just on the overall insurance issues within the scope of
your jurisdiction?
Mr. Schaub. Well, I think it is not a secret that the
insurance industry on both sides of the Atlantic is not in the
most brilliant state of its history and that market
participants rightly expect that this industry gets its act
together. That is what is happening on the European side, what
is happening certainly on the American side, and I believe that
we have an interest on both sides to make sure that this
process is closely followed and that it is pursued over time,
because the scandals have already created enough doubt and
hesitations in the marketplace, and it is vital for both sides
that confidence comes back, and confidence is created in the
first place by market players who visibly get their act
together.
The Chairman. And you heard the testimony from our panel.
Was there anything that the previous panel discussed that you
would like to comment on? Are there any glaring omissions or
differences that you may have noted during that testimony?
Mr. Schaub. I would say on the contrary, what is striking
for me and what is at the same time very encouraging is that we
are speaking more and more the same language and that your
concerns on the U.S. side are our concerns in Europe.
Let me just take one particularly crucial example, that is
the introduction of international accounting standards. We both
agree that this would be a major step forward, because what is
happening at present that big internationally active companies
have to present their annual results in four, five and
sometimes even more different techniques with the amazing
result that exactly the same company in some countries presents
losses of $2 billion and in other countries comes out with a
positive result of a billion. That is very amazing and puzzling
for the market participants, and it undermines, obviously, the
credibility of the whole system.
Therefore, there is deep conviction on both sides of the
Atlantic that this is certainly one point where we need to come
to single rules. We don't need single rules for everybody and
for everything, but this is a key element where do need, like
on capital requirements for companies, we need common single
rules. And I share the expectation and the strong wish of the
U.S. authorities and of Congress that this crucial step is done
soon.
As you know, these activities of the International
Accounting Standards Board is entering now in a dramatic final
phase. It seems to us clear if there is no agreement by mid-
June, it will practically be impossible to create the
conditions for companies to apply the new international
accounting standards as of January next year, which was
foreseen, which was the target date for a long time.
So we are working very intensely with Mr. Bolkestein,
personally involved with very intensive contacts with Paul
Volcker and with David Tweedie, the chair of the IS Board, on
how to solve the very few still open questions. And my
conviction is, and I was very pleased to see that this is also
Paul Volcker's conviction, that we can solve these one or two
open points until mid-June in a pragmatic way, which means that
we need not on every last detail come to solutions which would
be considered as solutions for the next decade.
If we come to solutions which are as a provisional
solution, acceptable on the condition that a credible process
is immediately now launched with a target date to further
improve the provisional results, which, as I see today, will,
in any case, imply very significant improvement if such a
pragmatic way could be followed, it should be possible to
terminate mid-June and to assure that as of January next year
companies will apply these new standards.
It would be an enormous breakthrough. It would give the
signal to the world that this target of credibility and of
reinsurance for the marketplace will be pursued and therefore
it is worthwhile that all forces are concentrated on this final
breakthrough.
If we would fail, we should have no illusions that this
would be a major shock for the marketplace, because it would
not just mean probably that the efforts to go forward are not
concluded, it would open a major risk that the process could be
brought backwards, because there are people in the marketplace
who would not be unhappy to work on more regional standards,
and the whole dynamic towards convergence risks to be
undermined and destabilized, and we could lose a decade if we
can't bring this now to a positive end. We really hope that it
will be possible, and I am personally confident that it will be
done.
The Chairman. And so we are really talking about a month.
We are already in the middle of May, so we are talking a matter
of 4 or 5 weeks; is that correct?
Mr. Schaub. That is exactly the case.
The Chairman. So as we would say over here, it is crunch
time.
Mr. Schaub. Yes.
The Chairman. Is the likelihood of fair valuation for
derivatives the key issue to be decided?
Mr. Schaub. This is certainly the most difficult remaining
issue, and I believe it is crucial that on this point real
significant progress is achieved, because I would understand
that it is not acceptable that on such a key point simply
nothing happens that would undermine the credibility.
From my point of view, what is absolutely essential is that
at least clear transparency is created, that investors in the
marketplace have a possibility to get an idea what this hedging
exercise, which is so complicated that only very few people
understand it and I don't belong to these people.
The Chairman. Nor do I.
Mr. Schaub. But I can understand that the simple human
being participating in the marketplace wants to know what does
this hedging exercise mean for my company in January, in June,
in December, and the minimum is that such transparency is
introduced as a compelling element of the future rules.
The Chairman. We have had some discussions with private
sector folks on this side of the Atlantic that they are
concerned about what appears to them to be lack of transparency
in the EU process. To what extent do you take into account
those views from private sector people that will be affected,
obviously, by the rulings?
Mr. Schaub. We are deeply convinced that high quality rules
cannot be produced without systematic implication of the
private sector on both sides of the Atlantic, because we are
talking about rules which should be applicable worldwide.
Now, it is not a surprise, certainly not for you, that
private does not appear spontaneously with a common view. So we
are systematically exposed to quite diverging views which are
reflecting often the diverging position of the companies or the
association of companies which appear. It is simply a fact that
there are--some of them are much more affected, and others are
much less or not at all affected. So they will not sing the
same song when they come, but our task is to make a sound
judgment what should be taken into account of their wishes and
what cannot be taken into account without endangering the
credibility of the new future rules.
The Chairman. Thank you. I think we have pretty well
covered the IASB issues, and, by the way, we have had testimony
from Mr. Volcker on a couple of occasions, and we could not be
better represented than someone with his stature and ability,
and we have certainly relied on him and leaned on him in many
cases to help the committee better understand this
transformation that is taking place across the Atlantic.
The home country supervision issue, the term, ``home
country,'' I just need to get this in my mind, home country
supervision, from our perspective, means, of course, U.S.
supervision. With the EU now, we are really talking about an
expanded breadth of home country supervision, correct? In other
words, the European Commission and European Union represent
that home country supervision. I am correct, right? In other
words, we are not talking about individual states here now, we
are talking about the entire European Union when we define home
country supervision.
Mr. Schaub. Well, in Europe, we do not have the same
structure than the one you have since very recently. We don't
have one single European supervisor. There is a lot of debate
about this. We have at present a decentralized European
supervisory system, and that means that there are common
European rules, there is a European body for security, CESR,
and corresponding bodies for banks and for insurances, which
are closely following the application--together with the
commission the application, the enforcement of the common
European rules by the national supervisors.
So it is a bit more complicated than your system today, but
the purpose is to assure, like on the U.S. side, convincing,
efficient, credible results. And we agree with the Bill
McDonough and your PCAOB that an intelligent work sharing
between the two sides is only possible if each side has
convinced itself that the system on the other side offers
comparable, equivalent guarantees.
Now, this is not done just because we like the Americans so
much or because you like the Europeans so much, it is largely a
question of efficiency, how are we from London or from
Frankfurt able to assure the supervision of a Japanese company
located in Kobi and having a Japanese auditor? That is very
difficult. So the same is true if you want to supervise an
Italian company located in Milan and Bill McDonough has
certainly highly qualified staff, but it is not sure that he
has enough Italian-speaking people who could really do the job
on the spot.
So the idea is that there is work sharing to the point that
it remains credible, that the guarantees of reliability of this
joint effort is the same. And we believe that this work sharing
is probably the only way to get out of the problem in an
increasingly global system.
The Chairman. Dr. Schaub, what is the--just having gone
through an enlargement now, what commitments do the new
countries that have joined the EU, what kind of commitments do
they make in terms of their regulatory structure and all of the
negotiations that are going on currently?
Mr. Schaub. Well, you know, the fundamental requirements,
preconditions for accession are for each of these 10 new
members that they introduce as of the 1st of May fully--they
introduce fully because there are no derogations accepted--the
implementation of the so-called community acquis that is the
totality of European Union rules on financial services. And it
is the task of the European Commission to make sure that the
community rules are effectively respected.
Now, it is not a secret that we have been working
frantically until the end of April with some of these countries
to make sure that they do the very few remaining elements of
homework which had not been delivered yet.
So we are now in a situation where they have introduced the
rules where they do have supervisory structures, and we will
now be in a much better position than in the past via the
multiple committees where the representatives of these
supervisory authorities from all 25 member states are regularly
meeting. It will be much easier to assure that all these 25
supervisors are effectively applying the same rules, that they
are making the same interpretation of these rules, and that
they deliver convincing results. That will be, of course, an
important responsibility for the commission and for these
Europe-wide committees, but it is an exercise which has been
applied in many other areas before.
So it is not something totally new, and it is something
which has successfully worked in other cases. Personally, I
remember particularly the positive experience after the last
accession exercise in the new member states at the time, and I
remember very well in the competition area the remarkable
efforts the 10 new member states have undertaken over the last
years to get their own competition authorities now, their own
financial supervisory authorities into the shape required to be
part of a convincing European system.
The Chairman. Very good. Again, we thank you profusely for
coming over and testifying before the committee. We know that
your trip was a brief one here, and for that we are most
appreciative that you did take the time to come over and visit
with us and impart some knowledge for the committee and make an
excellent record.
So, again, Dr. Schaub, thank you, and the committee stands
adjourned.
[Whereupon, at 11:40 a.m., the committee was adjourned.]
A P P E N D I X
May 13, 2004
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