COUNCIL OF THE EUROPEAN UNION. Brussels, 17 December /08 ECOFIN 629 MDC 2

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1 COUNCIL OF THE EUROPEAN UNION Brussels, 17 December /08 ECOFIN 629 MDC 2 COVER NOTE from: Mr Xavier MUSCA, President of the Economic and Financial Committee date of receipt: 15 December 2008 to: Mrs Christine LAGARDE, President of the Council of the European Union (ECOFIN) Subject: 2008 Annual EFC Report to the Commission and the Council on the Movement of Capital and the Freedom of Payments Dear Mr President, Under Article 114 (2) of the EC Treaty, the Economic and Financial Committee (EFC) is mandated, amongst other things, to: "examine, at least once a year, the situation regarding the movement of capital and the freedom of payments, as they result from the application of this Treaty and of measures adopted by the Council; the examination shall cover all measures relating to capital movements and payments; the Committee shall report to the Commission and to the Council on the outcome of this examination." 17363/08 TB/cd 1 DG G I EN

2 I hereby provide you with the annual EFC report for As in the past, the Report reviews the state of affairs with respect to the Commission's enforcement actions and new policy initiatives, the commitments undertaken by candidate countries and, action taken in the fight against terrorist financing and money laundering. This present Report also discusses key developments in global capital markets since It highlights the sharp reversal in the trends of capital movements caused by the present financial crisis, with a reduction of capital inflows and investment cross-border, and the less favourable economic conditions world-wide. In this context, the Report also signals some cases of jurisdictions worldwide that have already tightened measures, in a direction which is less favourable to cross-border investments. Against this background, the Report recalls the importance of maintaining open, competitive and sound capital markets both within the EU, through an efficient enforcement of the Treaty provisions and Internal Market rules, and globally, by promoting the EU approach where necessary. It also recalls the recent developments of a global approach in respect of Sovereign Wealth Funds, where the EU position also contributed to avoiding undue restrictions and safeguarding transparency and correct governance. Finally, the EFC has taken note of the concerns of the Commission in respect of arbitration risks and discriminatory treatment of investors in intra-eu Bilateral Investment Treaties. (Complimentary close.) Xavier MUSCA Encl.: 17363/08 TB/cd 2 DG G I EN

3 ANNEX ECONOMIC AND FINANCIAL COMMITTEE THE SECRETARIAT Brussels, 21 November 2008 ECFIN/CEFCPE(2008)REP/55806 Annual EFC Report to the Commission and the Council on the Movement of Capital and the Freedom of Payments 1. Under Article 114(2) of the EC Treaty, the Economic and Financial Committee (EFC) is called upon "to examine, at least once a year, the situation regarding the movement of capital and the freedom of payments, as they result from the application of this Treaty and of measures adopted by the Council; the examination shall cover all measures relating to capital movements and payments; the Committee shall report to the Commission and to the Council on the outcome of this examination." 2. In this tenth report, the EFC assesses developments with respect to capital movements and the freedom of payments, based on the Commission s examination. The Report covers a regular assessment of enforcement actions and new policy initiatives to enhance capital movements and discusses key developments in global capital markets since 2007, including the policy responses to deal with the surging importance of Sovereign Wealth Funds and the role of international dialogues in promoting cooperation and efficiency. I. General remarks clearly presented the turning point of the economic cycle for the global economy, with the beginning of the financial crisis that is still hitting very hard the financial sector, with contagious effects to the real economies. The crisis has had a strong effect on liquidity and on the proper functioning of credit markets, a general loss of confidence towards the financial sector and a pronounced slowdown in economic

4 activity. Therefore, the conditions for foreign investments and capital movements have markedly deteriorated since mid-2007 and the effects have deepened further in In respect of movements of capital, though aggregated data of 2007 still show a situation in line with the positive tendencies of previous years, preliminary figures for the first half of 2008 confirm a dramatic change in major trends. For instance, ECB data concerning the Euro zone already indicate a major contraction in foreign inward direct investments, which have fallen by 50% over the 12 months ending at mid Moreover, data on cross-border mergers and acquisitions show a drastic contraction, due to the reduced availability of credit, equity markets devaluations, the economic slowdown and a more cautionary approach to foreign investment. In fact, there are cases of jurisdictions world-wide that have already issued new measures and the tightening of existing measures, in a direction which is less favourable to crossborder investments. 6. This is of great concern, as it is well-known that a generalised trend towards protectionism could generate further negative effects and contribute to deepen the crisis world-wide and would be extremely costly for the EU economy. 7. The EFC stresses the importance to monitor the evolution of capital flows and recalls the importance of maintaining open and competitive capital markets both within the EU, through the efficient enforcement of the Treaty provisions and Internal Market rules, and globally, by developing and reviewing the EU approach where necessary. In particular, where Member States intend to adapt their investment legislation, the EFC underscores the need for transparent and proportionate legislation, which respects EU Treaty obligations and international commitments. 8. The EU position, for instance, has clearly contributed to a proportionate global approach in respect of Sovereign Wealth Funds, aiming at avoiding undue restrictions and safeguarding principles of transparency and correct governance. II. Capital movements and the freedom of payments within the EU 9. In 2007, Foreign Direct investment (FDI) reached a new global record high, but the rate of growth decelerated sharply and available data indicate that a world-wide decline can be expected for the whole of 2008 due to the financial crisis. 2

5 10. Foreign investment, within the EU and with third countries, was still at very high levels in 2007 and presented continued growth. A sharp increase in both EU outflows and inflows was registered in the year, an evolution which clearly reflects the EU present openness with respect to third countries. The increase of inflows into the EU was particularly strong (90% against 53% for the EU outflows). The 12 new Member States also registered a sharp increase in foreign direct investment inflows in 2007, but with differences between States. In fact, Hungary received the highest share of such total inflows and had the highest increase in the year, whereas Poland followed, in absolute value, but with a contraction of inflows during As a whole, also intra-eu FDI still remains very high (intra-eu flows still represent the major component of all flows) but the rate of increase was quite moderate in 2007 as compared to the above-mentioned external inflows and outflows. Inward investment (intra and extra EU) was and remains nonetheless far from uniform across Member States, with the United Kingdom still receiving the greatest absolute inflows, mostly from third countries, whereas a majority of other EU Member States mostly receives inward investment flows from other EU countries. In respect of stocks of investment, investment from EU Member States accounts for two-thirds, against one-third from third countries. 12. Cross-border mergers and acquisitions, as a crucial source of capital flows, in 2007, were still at the same level as in 2006 in terms of aggregate value and numbers of deals. Nonetheless, as anticipated, figures available for the first half of 2008 show a contraction in cross-border activity due to the ongoing financial crisis and the economic slowdown. This trend, which is due to persist, will contribute to the change in the overall volume of capital movements in 2008 in the EU. II.1. Infringement procedures 13. On infringement procedures since the 2007 report, five cases were closed or not pursued and nine new cases were opened, up from only five new cases last year. The five cases that were closed were related to restrictions on disposal of assets in an energy company, the right of direct appointment to the board of privatised companies, the renewal of motorway concessions, provisions in foreign exchange law and the requirement that certain credit institutions maintain liquidity reserves with a central 3

6 body. They were closed following a satisfactory clarification or amendment of the provisions of the Member States. 14. The EFC notes that a total of thirty-six cases are currently open, of which a majority relates to restrictions on investments in a company, for instance due to the powers of the regulator of that particular sector, to special rights governments maintain in some companies, such as the right to appoint board members. The EFC also notes that infringement cases have become more complex and their focus has changed from special rights of the States in companies or privatised companies to quite diversified restrictions, such as regulatory, company and real estate law restrictions. This is explained by the fact that infringement cases currently concern more specific sectors than has been the case in the past: twelve of the open cases concern the energy sector, whereas only one relates to the banking sector. Three of the open cases concern bilateral investment treaties. 15. As to Court Rulings, the ECJ delivered rulings in different areas. Firstly, on the issue of screening investment in the energy sector (cases with Spain). The ECJ established that a system of prior authorisation cannot guarantee to secure energy supplies and ruled that imposing specific obligations on energy companies can represent a more proportionate means of safeguarding energy supply than imposing restrictions of voting rights. Secondly, the ECJ ruled against the right of public authorities to nominate representatives on the board of privatised companies (case with Italy) by derogating from ordinary company law, i.e. against public authorities' participation beyond their status as normal shareholders. Thirdly, the ECJ also provided clarification on the distinction between free movement of capital and other Treaty freedoms, confirming that legislation exclusively targeted at intra-group relations primarily affects the right of establishment, i.e. Art. 43 EC. Furthermore, it explained that with regard to the movement of capital between Member and non-member States, Art. 56 EC applies irrespective of the category of capital movement, rebutting any counter-argument based on reciprocity. Finally, the ECJ also delivered judgements in the area of direct taxation, especially on the effects of Double Taxation Conventions, ruling that Member States enjoy a degree of autonomy and therefore the exercise in parallel by two States of fiscal sovereignty does not infringe the free movement of capital; at the same time, the ECJ highlighted the obligation to ensure non-discrimination. 4

7 II.2. Intra-EU bilateral Investment Treaties 16. The EFC report of 2007 mentioned the issue of the remaining bilateral investment treaties between Member States (BITs) and the concerns of the Commission, which invited Member States to review the need for such BITs agreements. Since the accession of Bulgaria and Romania, there have been and still are about 190 such agreements. The EFC took note that it remains the responsibility of Member States that have been informed of the Commission's concerns to address the issue through bilateral actions. 17. Most Member States did not share the Commission's concern in respect of arbitration risks and discriminatory treatment of investors and a clear majority of Member States preferred to maintain the existing agreements. 18. While dealing essentially with pre-accession BITs with third countries, three upcoming rulings from the Court of Justice could clarify some of the basic principles involved in this complex area, also with respect to intra-eu agreements. In the light of these rulings, the Commission will consider its options with respect to intra-eu agreements, which it has highlighted as a problem in past reports to the Committee and has requested Member States to terminate. III.External dimension of capital movements and the freedom of payments III.1. Candidate Countries 19. Membership negotiations with candidate countries generally demand full liberalisation of all capital movements by the date of accession at the latest. Candidate countries are at various stages on their road towards the EU. 20. The EFC notes that with Croatia enlargement negotiations are well advanced. Beyond the two chapters that have been closed and the negotiations that are open in ten further chapters, the opening of the chapter on freedom of capital movements has already been discussed at the Council and is expected to be opened in the autumn. As far as relations with Turkey are concerned, progress has been very slow. The Turkish government nevertheless has drafted an Action Plan to address the requirements of the opening benchmarks for the chapter on capital movements. 21. Since the granting of the statute of candidate country by the European Council of 2005 to the Former Yugoslav Republic of Macedonia (FYROM), the authorities 5

8 reiterated the commitment to liberalise capital movements, already started in 2002, with the new Foreign Exchange Law. Accession negotiations have not started yet, though the Commission may very soon recommend a date for the opening of the negotiations. III.2. Issues relating to other third countries Sovereign Wealth Funds and international policy initiatives 22. The recent rise in importance of Sovereign Wealth Funds (SWFs) in world capital markets is considered to be one of the consequences of the persistent international macroeconomic imbalances. Even though the EU reiterated its openness to investments from outside the EU, concerns have been raised in respect of SWFs, related to the lack of transparency, in particular on the size and composition of their assets and investment objectives. 23. In February 2008, the Commission adopted a Communication, as a policy response to the issue of SWFs. The Communication, presented to the EFC in February and to Ecofin at the beginning of March, was endorsed by the European Council in March. The European Council agreed on the need for a common European approach, taking into account national prerogatives, in line with five principles proposed by the Commission, namely: commitment to an open investment environment; support for ongoing work in the IMF and the OECD; use of national and EU instruments if necessary; respect for EC Treaty obligations and international commitments; proportionality and transparency. 24. Several international fora worked on SWFs and, in September 2008, an International Working Group (IWG) comprised of representatives from sovereign wealth funds, with technical support from the IMF and under its auspices, finalised a set of Generally Accepted Principles and Practices (GAPP) for SWFs, known as the Santiago Principles, which was endorsed by the International Monetary and Finance Committee (IMFC) in October. This document establishes a set of voluntary best practices for SWFs, focussing on governance and accountability, addressing also issues of transparency and aimed at easing the concerns of recipient countries, as well as supporting sound risk management by SWFs. In October, the IWG announced it has established a Formation Committee to explore the creation of a Standing Group of SWFs that could meet to review and explore the principles and consider other issues. 6

9 25. To complement the GAPP, the OECD developed a set of guidelines for recipient countries with the focus on recipient country investment policies relating to national security. The guidelines provide a very useful step towards promoting mutual trust and confidence for SWF investments and emphasize that national restrictions on foreign investments should be transparent, proportionate and non-discriminatory and should be kept to a minimum. A final report on the Freedom of Investment Programme is expected early next year. 26. The EFC welcomes the developments ongoing within international fora, which reflect the approach so far undertaken at EU level. International dialogues and restrictive measures on capital movements 27. As anticipated, there is some concern that the present financial crisis may give rise to protectionist measures world-wide and the Commission is currently assessing the situation. In July 2007, the United States passed the Foreign Investment and National Security Act, governing the screening of foreign investment affecting national security. It reinforced the powers of the Committee on Foreign Investment, which will conduct investigations whenever a transaction is foreign-government controlled or in cases it would result in control of any critical infrastructure. In April 2008, draft implementing regulations were published by the US Department of Treasury and have shown a tightening of the review process which gives rise to concerns. In this context, the EFC acknowledges that following the adoption of the Framework for Advancing Transatlantic Economic Integration between the USA and the EU at the EU-US Summit on 30 April 2007, the Transatlantic Economic Council (TEC) was established in view of the bilateral work programme and held meetings in November 2007 and April Discussions in the field of investments are being conducted in the context of the EU-US Investment Dialogue, through which a statement was endorsed, reiterating the shared commitment of the EU and US to preserve open investment policies and to address challenges given by rising protectionism in the world. The EFC welcomes this initiative and invites the Commission to report regularly and comprehensively both on topics and outcome, looking forward to a fruitful exchange with the US on issues of common interest. 7

10 28. In the context of the EU-US Financial Markets Regulatory Dialogue, an ongoing process with particular emphasis on financial sector issues, the EFC invites the Commission to maintain its efforts in pursuit of the best possible outcome out of this dialogue and to report back regularly to both the Financial Services Committee (FSC) and the EFC. 29. Negotiations with other third countries are ongoing: a dialogue has already been established with emerging countries such as China and India; negotiations with Ukraine have been initiated in the context of the European Neighborhood Policy; a new impulse has been given to the Euro-Mediterranean relations; a regular high-level economic dialogue with Brazil is expected to be launched at the upcoming EU-Brazil summit. 30. In the field of financial services regulation, the Commission in 2008 deepened its financial services regulation dialogues with the US, Japan, Russia, India as well as with China. 31. The EFC stresses the importance of these dialogues, particularly in the context of the present overhaul of the International Financial Architecture, and invites the Commission, together with the Member States and relevant Committees as appropriate, to continue its proactive approach in this respect and to report regularly on these discussions. 32. In particular, in a number of third countries (Russia, China, India, Australia and Japan), new restrictive measures have been adopted or are under scrutiny. Most of these cases, involving the imposition of new or additional checks to foreign investment, may give rise to further concerns about the freedom of capital movements. IV. Policy initiatives in the financial sector that may impact upon the movements of capital and freedom of payments 33. The EFC recalls that considering the close links between financial integration and capital movements, to ensure the free movement of capital, ultimately there should be no difference, within the Community, in ease of operation or cost between domestic and cross-border transactions. In this respect, remaining legal and institutional obstacles to financial integration should be abolished. In the context of the financial crisis, there is nonetheless a risk that particular pressures on national authorities may threaten the 8

11 upholding of these above- mentioned basic principles. Against this background, the following efforts in the area of financial services in the course of 2008 deserve to be mentioned: - First, within the field of retail financial services, o the Commission adopted in July a proposal for amendments to the UCITS Directive, which, inter alia, will help remove barriers to the crossborder distribution of funds, will create a framework for mergers and will improve cooperation between national supervisors. o the European banking industry issued in November Common Principles for Bank Account Switching, aiming at easing consumers' switch of their bank account within a Member State. o Finally, following the White Paper on the Integration of EU Mortgage Credit Markets of December 2007, the Commission has scheduled a Recommendation on mortgage credit at the latest by the beginning of 2009, covering property valuation, foreclosures and land registration. - Second, in the area of post-trading infrastructure, o further works have been conducted with a view to improving the efficiency and soundness of cross-border post-trading arrangements in Europe. So far, the Code of Conduct of 2006 has contributed to price transparency, and a decrease in fees resulting, amongst other things, from enhanced competition. In other areas progress has been slower, in particular in ensuring access and interoperability while in respect of service unbundling and accounting separation results have still to be tested; o in 2007, a FISCO group, composed of fiscal experts and set up to deal with the elimination of fiscal compliance barriers, presented proposals in this respect and the Legal Certainty Group has recently delivered an advice on the elimination of legal obstacles; 9

12 o the Euro-system continues its work to develop the common settlement platform called Target2-Securities (T2S); and, o on the common ESCB-CESR recommendations concerning central counterparties and central securities depositories, work has resumed with the aim of ensuring a coherent regulatory and oversight framework for European post-trade infrastructure, explicitly addressing also risks of OTC derivatives. o the Commission is working since October 2008 with the ECB, regulators and market participants to ensure the establishment of European-based CCP clearing service for OTC derivatives within the shortest time possible. - Third, in the field of cross-border payments, o the Single Euro Payments Area (SEPA) was officially launched in 2008, with the SEPA Credit Transfers. Work on the SEPA Direct Debit is still ongoing. The objective is to launch this new instrument once the Payment Services Directive has been transposed into national legislation (by November 2009). In addition, Card Schemes are progressively adapting to the framework that the banking industry has developed to make card payments within SEPA as efficient as at national level. The Commission and the ECB also published studies demonstrating the potential benefits of an integrated market for euro payments. o The Council is working on the proposal recently presented by the Commission for amendment of the Regulation on cross-border payments in euro of 2001, which already brought the cost of cross-border credit transfers in line with domestic payments. This new proposal aims inter alia at expanding the scope of the Regulation, for instance to include direct debits. Fourth, negotiations are still ongoing on the proposal, presented by the Commission in 2007, for a directive on the taking-up and pursuit of the business of insurance and reinsurance. The directive would remove some possible obstacles to investment 10

13 abroad. The adoption is foreseen soon and the system will be fully operational by end Fifth, in the field of company law, the Commission adopted a proposal for a Regulation establishing a European Private Company statute, which would facilitate cross-border business for smaller companies. 34. The EFC invites the FSC, within the framework of its mandate, to monitor progress in the above areas and to provide advice to Council and Commission, with a view to the completion of the mentioned proposals and initiatives. V Strengthening the fight against terrorist financing and money laundering 35. Building on the framework given by the EU Counter-Terrorism Strategy of 2005 and the EU Action Plan to combat terrorism, a revised strategy on terrorist financing was adopted by the Council in July The document underlined the importance of monitoring the transposition of legislations implementing the recommendations of the Financial Actions Task Force (FATF). In this context, since the Third Money Laundering Directive has not been implemented by all Member States as scheduled by December 2007, the Commission has started enforcement measures. On the possible abuse of the non-profit sector for the purpose of terrorist financing, the revised strategy acknowledges little progress since the Commission Communication of A report on the cooperation between Financial Intelligence Units (FIUs) of the Member States in exchanging information was published in December However, the development of the European network of FIUs, to exchange real-time information, is still incomplete. On this issue, two "good practices reports", aimed at facilitating cooperation between FIUs, were adopted by the existing informal platform of such FIUs. In international context, participation in the work of FATF has continued. 36. The EFC recalls the relevance of efforts addressing ways to prevent the financing of terrorism, money laundering and financial crime, encourages progress in the development of the European network of FIUs. The EFC also welcomes the Commissions' work and invites it to pursue its efforts in this area. VI Financial sanctions 11

14 37. Sanctions against several countries, persons or groups are continuously being reviewed. A Common Position was adopted in August 2008 to implement United Nation Resolution 1803, enhancing sanctions against Iran. 38. Besides that, financial sanctions concerning the freezing of funds and economic resources remain in force against a list of persons and entities. Anyway, as regards the EU assets freezing procedure, following Court rulings, improvements have been agreed regarding the listing and de-listing procedures for persons and entities and a new Working Party has been established and a fact sheet with regard to the listing procedure and all criteria was published in July The EFC welcomes the improvements introduced in the procedure for asset freezing in the EU. 12