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Part 4

Parochial euro vs. global euro

An essential dimension in assessing the quality of preparation and the implications of the proposed Directive has to do with its impact on European capital markets. This is clearly where the controversy is raging at the present moment.

In a nutshell, the case being made by IPMA, ISMA and other major international associations of market practitioners is that the proposed Directive will drive a very significant part of euromarket activity out of Europe toward New York (wholesale activities) and Switzerland (retail and custodial activities).

Part of the protests voiced by these important and respected associations could be expected as it is in their mission to lobby for the best possible business environment for their members. Yet two observations of a more general nature come to mind. They have to do, first, with the worrisome lack of communication between euromarket professionals and the Commission and, second, with the lag in "cultural perceptions" on the part of European policy makers who are still focused, quite understandably, on the "euro-for-Europe agenda" just a few weeks before the euro turns global.

In short, the dangers to which this report would like to draw attention in this fourth part are benign neglect (section 4.1.) and euro-parochialism (section 4.2.).

4.1. EU policy makers and market practitioners: the risks of mutual benign neglect

First, the unusually abrupt tone used in some of the documents prepared by the euromarket community¹⁴ does suggest that an important task of communication has not been carried out, neither by the Commission as originator of the proposed Directive nor by these professional associations in an earlier period as part of their ongoing role in representing their members, at least not at the level that the present debate would have warranted.

It was striking to see that a well attended conference in Brussels around notably the Commissioner in charge of the proposal had brought together many prominent members of the financial community for a full day of panels, but that none of these distinguished invitees came from the capital market associations most directly involved.

This, in itself, should be a source of concern and of remedial action by both parties. At the risk of making enemies on both sides, we shall venture the following:

• The Commission should become aware not just of the amazingly low level of consultation that has accompanied such an important project but also of the fact that this failure to consult was grounded in the low priority given to capital market considerations in its euro-related work.
  
• For its part, an association like IPMA may want to reflect upon one candid finding that it shares with the public in its 10th anniversary document: the surprising discovery that the dialogue in which it had engaged the Commission a couple of years ago regarding the Prospectus Directive was both very unusual on its part and very useful. The time is no longer when "euromarkets" could be treated by market practitioners as something so global and flying so high above ground that time spent with 'generalist' policy makers, beyond a small circle of Treasury officials, would be time lost. Time spent by euromarket experts sharing views with non-specialists and with the public should be seen as time well spent.

These two communities of dedicated and knowledgeable professionals should be warmly encouraged to overcome the bitterness in their present relationship to establish and keep alive a thorough, in-depth communication process: the benign neglect in which they have been holding one another is in nobody's interest.

The volatility of the markets exacerbates the potential cost of belated or incomplete communication: while a currency like the euro does not rise or fall like Alcatel shares (minus 40% in one day!), the EU and market practitioners active in the EU would certainly benefit from more professional communication and from the capacity to listen to one another before, rather than after problems develop.

4.2. From 'the European euro' to 'the global euro'

Beyond these communication failures, another cultural revolution is still waiting to happen. For almost one decade now, national and European officials have devoted tremendous energy and skills to the creation of the euro as the flagship project for European integration. This was, by nature, an inward-looking process with an agenda of intergovernmental Conferences (the two IGCs of the early 1990s), of national debate over the ratification of Maastricht and of efforts to meet the demanding convergence criteria. In all these instances, the Union was its own, ambitious self-reference.

The long march toward the euro has been a very successful endeavour, which makes it even more difficult for Europeans to realise that their common currency must now succeed and prove its worth again, as a new-born major currency for the global economy. In this sense, the proposed Directive clearly suffers from looking at the task ahead as one of merely completing what has been achieved. The reality is more likely to resemble a new beginning and a new challenge.

The absence of the UK from the group of core euro countries reinforces this tendency by continental countries to look at the post-euro agenda in a slightly parochial or, at least, defensive, perspective. In all fairness, from the standpoint of British interests, one could also observe that this is clearly one concrete example of the costs for the UK waiting until new steps toward European integration no longer stand a reasonable chance to fail before embracing them.

An essential although often invisible aspect of international politics lies in the capacity to set the agenda: from this perspective, the proposed Directive reflects what we called in another work the "KernEuropa scenario" and its tendency to inward-lookingness on the continent and on the other side of the Channel. This clearly departs from the Pan-European Monetary Union scenario and its combination of deeper integration and open global competition that our previous report found far more positive for Europe.

Preparing for massive flows of portfolio diversification Like any convertible currency, the euro will be open to a whole range of forces, including potentially destabilising ones that will often take Europeans by surprise.

The first set of forces that will express themselves in the markets at unprecedented levels are those of portfolio diversification. The pent-up demand for non-USD assets is enormous as a large numbers of non-European investors saw little real alternative until now to the depth and liquidity of USD markets.

According to Fred Bergsten, who uses notably the results of analysis by J.P. Morgan, diversification out of the USD into euros can range between 400 USD and 1,000 billion USD. Part of this will be accounted by Central Banks who will look for a more balanced distribution of their reserves (to the tune of something like 100/300 billion USD diversification) but the major part will be accounted by asset managers world-wide who will further accelerate the diversification of the trillions of USD holdings under their management. There is a strong risk that this tide of portfolio diversification will trigger, at first, euro overvaluation. And there is also a strong risk that changes in the macroeconomic environment, business cycles and return prospects could then lead, in a second phase, to abrupt and excessive devaluation of the euro.

Watching today's financial markets makes such a scenario easy to imagine: it should not take a long speech to alert policy makers to the huge risks implied by the tendency of markets to overshoot in one direction and, a few months later, in the other direction. Guarding against such risks should clearly be a central preoccupation today.

Preserving the pool of good-will essential to the global co-ordination process now called for mastering risks of such magnitude will call for in-depth, trustful co-operation with US monetary authorities, notably in the G7 context and capital market practitioners, through informal channels that the EU should hasten to strengthen.

In times of crisis, it takes little to create misunderstandings, even if under other names. A number of recent US editorials regarding what 'the Commission' might do with the euro and the risk of turning the G7 into a 'managed finance' bureaucracy are a reminder that the pool of good-will is not infinite. The recent political changes in Germany make it even more important to preserve the overall framework for trustful co-operation as policies on both sides of the Atlantic may become more divergent.

In this context, the level of suspicion and misunderstanding between EU officials and market practitioners illustrated by the IPMA/ISMA papers should be taken as a serious warning that the EU may be beginning to draw upon its pool of good-will before even having to use it! Since 1993, markets have been supportive of the creation of the euro. They have not done so out of altruism.

A capacity by market practitioners to understand what policy makers are trying to achieve and to relate to it positively is a significant ingredient in creating and maintaining the most valuable assets of all, the real currency of last resort: trust.

Having the euromarket financial community up in arms, talking of leaving Europe would not be the most auspicious beginning for the euro. The proposed Directive needs, at the very least, to be well explained to the markets. But the surest way to diffuse anxiety and 'procès d'intention' would be for the EU to shift from its present 'tax collector mood' to a 'monetary and financial architect mood'.

Altogether, the search for a level-playing-field inside the EU cannot be separated from the search for a global level playing field and from the permanent search by markets themselves for the most efficient modes of operation. One may recall indeed that the 'Common Market' of 1968 was in good synergy with the search for higher levels of trade openness in the context of the Kennedy Round. Similarly, it was no coincidence that the European 'internal market' of 1992 and the global negotiations of the Uruguay Round also went hand in hand. In a field more closely related to the euro, the success of the EMS facilitated - and benefited from - whatever progress could be made in the G7 context (Plaza and Le Louvre agreements as well as day-to-day pragmatic co-operation among Central Banks). It is good to remember that Europe either succeeds internally and externally or fails on both accounts.

¹⁴ In its position paper of 4 September 1998, ISMA states that in spite of the obvious importance of the proposed Directive for capital markets "not a single relevant organisation appears to have been consulted ... the Commission's method of consultation seems to have been to read some reports published during the previous twelve months about a completely different set of high-level proposals ... without taking the basic precaution of consulting the people who will be involved in making (the Directive) work on a day-to-day basis". (ISMA, op.cit. p. 3)

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