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FREEDOM OF ESTABLISHMENT AND FREEMOVEMENT OF SERVICES: AN OPPORTUNITY TO HARMONISE AND LIBERALISE THE CYPRUS SERVICE SECTOR

Elena Papageorgiou and Eleni Kouzoupi *

INTRODUCTION

“Freedom of Establishment and Free Movement of Services”[1] is simultaneously a complicated and wide-reaching subject area. Not least because, on the one hand, it touches on a variety of political issues regarding the extent of the national treatment on aliens and, on the other, it covers a wide spectrum of activities, mainly of financial nature, affecting almost all aspects of the economy.

This particular subject is considered of pivotal importance by the European Union (EU), reflected in the extensive reference to the subject in Articles 43 and 49 of the Treaty of European Community (EC)[2]. It may be stated that the harmonisation effort relating to this subject has “acquired a new eminence in the political agenda of the European Union and has been the subject of variousconsultation papers and Commission Communications”.[3] These were discussed and welcomed by both the European Parliament and the Council.[4]

Nowadays, with the implementation of the Euro expected to be completed by the end of the current year, the EU member states are concentrating their efforts on the liberalization of the service industry, so as to allow for the right of legal and natural persons to establish themselves in any member state, while only having to register with and comply with the home country’s regulatory authority. The attention of the EU naturally gravitates to the financial industry, much because of its pervasiveness and of the ease of establishment of financial service companies.

Freedom of establishment, covering Articles 43 to 48 EC, requires the removal of restrictions, legal as well as administrative, on the right of individuals and companies to maintain a permanent or settled place of business in a member state. Establishment has been defined as “the actual pursuit of an economic activity through a fixed establishment in another member state for an indefinite period”.[5] Establishment extends to the establishment through agencies, branches and subsidiary organizations. The right to establishment of self-employed individuals is acutely stressed. The abolishment of restrictions provides for freedom to acquire and use land and buildings as well as lifting indirect restrictions, wherever the latter might exist, in the differing treatment of European citizens and locals in obtaining state benefits.

The free movement of services, covered in Articles 49 to 55[6], requires the removal of restrictions on the provision of services between member states. In general, the services offered must be provided on payment and include industrial, commercial, manual and professional services.[7]

The basis of the provisions relating to both establishment and services, which are usually read in parallel, comprises the principle against discrimination on grounds of nationality, thus promoting market integration.

Apart from Article 43 EC on the freedom of establishment and Article 49 EC on the free movement of services, the acquis communautaire principally consists of directives which may be classified into those which generally concern the right of establishment and the freedom to provide services in specific fields, as well as directives which abolish restrictions and extend rights so that the citizens of the member states of the European Union can have equal treatment. Finally, there are also directives, which call for the alignment of the legislations, regulations and procedures applied by member states.

The acquis communautaire directives and articles pertaining to the subject of freedom of establishment and free movement of services include the following significant unities, each one of which to be presented and analysed separately in this chapter:

  • Financial services:

(i)Banking;

(ii)Insurance;

(iii)Investment Services and Securities Markets.

  • Non-financial services:

(i)Article 43 EC on the freedom of establishment and Article 49 EC on the freedom to provide services;

(ii)Directive 95/46/EC on the protection of personal data and the free movement of such data;

(iii)Directives on the freedom of establishment and the freedom to provide services for craftsmen, traders and farmers;

(iv)Directive 86/653/EC on self-employed commercial agents;

(v)Information Society Directive 98/47/EC on the provision of information in the field of technical standards and regulations and of rules and Directive 98/84/EC on the legal protection of services on conditional access.

The right of establishment and the freedom to provide services in many areas of the Cyprus economy is not necessarily regulated by specific legislation relating to each of these fields, but usually by legislation of a more general nature addressing the movement and residence of aliens in Cyprus generally, as well as the acquisition of immovable property by aliens and foreign exchange control applicable within the framework of government policy regarding the issuing of permits for foreign investments.

It appears to be that the subject “Freedom of Establishment and Free Movement of Services” impinges on a wide spectrum of services which cover almost all fields of the economy. It may be argued, therefore, that the pervasiveness of the service industry makes implementation of this subject rather challenging. The task of the Cypriot authorities is made even more cumbersome because they are obliged to adopt a vast number of directives which, in contrast to the regulations, by their very nature do not have direct effect[8]. Consequently Cyprus, by the time of accession to European Union[9], must adopt all necessary administrative and legal measures for their implementation[10]. The administrative measures usually aim at creating, introducing, and organising a competent authority to apply the legislation. The legal measures are in the form of primary or subsidiary legislation.

FINANCIAL SERVICES

BANKING SECTOR

The Cyprus banking sector is a dominant player in the local service industry. The banks’ clout is evident in their dominating presence in all fields of the financial services industry, with the inclusion of the insurance industry (for both general and life insurance products) and the securities and investment services industry.

The Cyprus domestic banking system can be broadly divided into three groups of credit institutions:

(i)commercial banks·

(ii)specialised credit institutions· and

(iii)co-operative credit institutions.

At the apex, is the Central Bank of Cyprus (CBC), the competent authority vested with the power and responsibility for the regulation and supervision of the banking sector.[11]

The CBC has always aimed at a high standard of regulation and supervision. The rules and policies applied hitherto with respect to banks have, in many ways, outstripped the recommendations of the Balse Committee on banking supervision and the European Union Banking Directives. The CBC has its prudential standards under constant review to incorporate new developments and changing circumstances.

Following the application of Cyprus for full membership of the European Union,[12] the Central Bank of Cyprus has embarked upon a program of harmonisation of the banking legislation to the acquis communautaire.

The most important harmonisation measure instigated so far, in the field of banking, has been the enactment of the Banking Law in June 1997[13], achieving “legislative approximation with the EU in the field of banking to a very large extent”[14].

The Law[15] regulates the banking system in Cyprus and aims to grant protection to depositors. It sets the legal framework within which banking business may be pursued and reflects, to a very large extent, the principles and rules of the EU banking legislation[16]. It should be stated that the legal framework and the methods of supervision apply to domestic banks and offshore banks alike. However, the co-operative credit institutions are not captured by the Banking Law and are thus not under the prudential supervision of the CBS[17].

In particular, the Banking Law defines the term “banking business” and provides that a banking license is required for the pursuit of banking business.

Furthermore, it lays down minimum authorization requirements and prudential rules, in conformity with the acquis, that must be satisfied so as to permit any entity to operate as a credit institution. The Law prescribes limits on large credit exposures and non-banking holdings, defines a bank’s capital base and requires the maintenance of a solvency ratio. Furthermore, the Law empowers the Central Bank of Cyprus to exchange information with overseas supervisory authorities, provides for contacts between the CBC and external auditors of supervised banks, and enables the CBC to prescribe the format and content of bank accounts. Moreover, the Law provides for consolidated supervision and provides for the setting up of a Deposit Protection Scheme. The Law also contains extensive enforcement powers and penalties that the CBC may impose on banks breaching the provisions therein.

The First and Second Banking Directives[18], the Own Funds[19] and Solvency Ratio Directives[20], the Large Exposures Directive[21], the Consolidated Supervision Directive[22], the Deposit Guarantee Scheme Directive[23] and the Annual Accounts and Consolidated Accounts of Banks Directive[24] are, to a large extent, in conformity with the provisions of the Banking Law.

In particular, the Banking Law covers the First and Second Banking Co-ordination Directives approximately to their entirety. Prior approval of the Central Bank of Cyprus is required for qualified holdings, branches of foreign banks are not required to maintain endowment capital, the Central Bank of Cyprus has the right to co-operate with foreign supervisory authorities and the principle of “home country control” is recognised and applied. There are also rules governing holdings in non-bank companies or in companies carrying on business not closely related to banking or which do not consist of business dealing with insurance. The Law provides for measures and penalties against non-compliance.

The Banking Law and the Regulations issued by the CBC thereunder, incorporate, to a very large extent, the provisions of the Solvency Ratio Directive, including the obligation to maintain a solvency ratio at a level not less than 10%[25], the methodology for its calculation and the requirement for solo and consolidated positions in the case where a bank is a member of a wider group. The Central Bank of Cyprus achieves the classification of countries into Zone A and Zone B through the exercise of discretionary power. Under the current methods of classification employed by the CBC, there is some deviation from the EU’s classification. The Regulations currently in force do not cover market risk as the risks taken by the banks are small and are well below the threshold laid down by the Directive. Full harmonisation will be achieved upon accession.

The definition and computation of the level of own funds is in full conformity with the requirements of the Own Funds Directive.

The Large Exposures Directive is covered by the Banking Law, which prohibits excessive concentration of exposures to any one client or group of connected clients. The various exposures must be measured in relation to the bank’s own funds and must not exceed the limits specified, which limits are equal to those specified in the Directive. Specific limitations also apply with regard to the exposures to a bank’s director. Monitoring is effected through regular reports and on-site examinations.

In addition, the CBC has issued to banks[26] an instruction concerning the application of the limits on large exposures as stipulated in the Banking Law, including some clarifications on the matter and monitoring procedures[27], in full compliance with the EU Directive on the Monitoring and Control of Large Exposures of Credit Institutions.[28]

The Consolidated Supervision Directive is fully transposed by the Banking Law, which empowers the Central Bank of Cyprus to exercise supervision on a consolidated basis covering the holding company and any of the subsidiaries of a bank. The principle concerning supervision on a consolidated basis is also incorporated in the instructions issued to banks on the solvency ratio and on large exposures.

Moreover, the Banking Law requires banks to prepare financial statements in accordance with international accounting standards and in addition it empowers the CBC to issue regulations as to the content of the public accounts in conformity with the Bank Accounting Directives. Banks are required to submit to the Central Bank of Cyprus and to publish their balance sheet and profit and loss accounts, the format and the content of which are very much in line with the Bank Accounting Directives. Accounts must be consolidated when the bank is a member of a wider group; branches of banks having their head office outside Cyprus are also required to publish their accounts. An instruction issued to banks at the end of 1999, incorporates in all detail the layout and content of the balance sheet and profit & loss account, as described in the Directives concerning annual accounts and consolidated accounts of banks.

In December 1998, the CBC issued to banks instructions concerning the definition and computation of the level of own funds and the method of computation of the required solvency ratio. These are in conformity with the requirements of the EU Directive on the Annual Accounts and Consolidated Accounts of Banks and other Financial Institutions.[29]

Whilst giving the CBC “wide–ranging powers”[30] including the power to issue general or specific instructions to banks,[31] the Banking Law explicitly defines the Central Bank of Cyprus’ s obligations with respect to the exercise of its discretionary powers, and prescribes that the CBC should take cognizance of international practices and the relevant EU Directives, and that the CBC issues adequately reasoned decisions.

Concerning the application of articles 43 and 49 of the EC Treaty[32] to banking, the authorisation criteria apply similarly to national and non-national applicants, and foreign establishments are accorded national treatment.

Following the enactment of the Banking Law, other harmonisation measures have also been instigated. These include the following:

  • The issue of Regulations pursuant to the powers granted to the CBC under section 34(2) of the Banking Law to issue regulations with the approval of the Council of Ministers, on 1.9.2000, for the operation of a Deposit Protection Scheme.[33] The Regulations incorporate all the requirements of the relevant EU Directive.[34] The purpose of the Regulations is to protect private individuals who deposit money with commercial banks registered in Cyprus by providing for damages to be paid to them out of the fund if the commercial bank is not in a position to repay the deposit due to its financial position, or a court order has been granted for the winding up of the bank. The minimum capital of the fund has been fixed at CY£2 million which amount may be increased in the future. The scheme initially covers only deposits in Cyprus pounds. The amount of damages granted to a private depositor may not exceed at any time the equivalent of Euro 20.000 in Cyprus pounds at the time. The intention, however, is to extend the scheme to other currencies in the future.
  • An amendment of the Banking Law, abolishing article 37 therein, has been effected.[35] As a result, the CBC may no longer be able to exempt offshore banks from the full application of all the provisions of the Banking Law.

The main areas in which Cyprus is not yet in conformity with respect to the EU Banking Directives are the following:

  • The application of the “economic need criterion” in relation to granting a license for carrying banking business. The Central Bank of Cyprus, in deciding whether to grant a license may take into account the economic need for the services of the applicant. It was thought expedient, as a matter of policy, for the CBC to retain this discretionary power because of the small size of the banking market, which, in its current state, is considered saturated. Nevertheless, it should be noted that this criterion is not enshrined in the Law and this particular discretionary power of the CBC may be eliminated. It is anticipated that the “economic need criterion” will be abandoned upon harmonisation with the single passport principle by the time of accession.
  • The implementation of the Capital Adequacy Directive[36] (CAD). It should be noted that the provisions of this Directive have not been implemented because of the small scale on which banks have hitherto been involved in trading instruments captured by the Directive. Banks in Cyprus have not been engaged, to a significant extent, in activities exposing them to market risk. Their trading book business is small, well below the threshold laid down by the Directive. Therefore, Cyprus is not in breach of its requirements and will implement the Directive upon accession. There are enabling provisions in the Banking Law[37] allowing CBC to take steps for the implementation of CAD as and when the commercial banks’ trading business grows to a point where application of CAD will be mandatory.
  • The implementation of the Directive on Contractual Netting[38] (amending the Solvency Ratio Directive) and Directive 33/98/EC amending both the Solvency Ratio Directive and CAD. The 2000 Progress Report on Cyprus, issued by the Commission on 8 November 2000,[39] states that “further alignment is needed in the field of the recognition of contractual netting agreements, consolidated accounts and capital adequacy for market risks”. However, according to the CBC, banks in Cyprus have not hitherto been involved in off-balance sheet items or derivatives, where contractual netting may apply. Thus, while Cyprus has yet to adopt these Directives, it is not at present in breach of their rules. These Directives will be implemented upon accession, as indicated in the harmonogram.[40]

In conclusion, it may be asserted that Cyprus is at an advanced stage of harmonisation in the field of banking regulation and supervision, with further legislative alignment scheduled for implementation upon accession. In this process, no serious problems are envisaged. By accession, full harmonisation of the banking sector will be in place.