How Europe Began Flexing Financial-Regulation Muscle

The European Union’s financial regulations are shaping up to be a big deal for companies based in the U.S. and elsewhere — even beyond their European operations. For the most part, the new rules won’t kick in until 2011 or later, and as the U.S. hammers out its own regulatory revisions, policy-makers on both sides will probably iron out their differences.

Still, history suggests Europe’s regulatory boldness won’t end with this financial crisis and global recession. Indeed, research by Elliot Posner, a Case Western Reserve University political-scientist, suggest it was already stirring before the crash, and is likely to linger.

What's happening is a kind of role reversal. For years, even decades, the United States has blithely told foreign companies how to operate within its borders -- and, to some degree, beyond. Europe's efforts to get its accounting standards recognized in the U.S. met with indifference for years, while European regulators accommodated U.S. Generally Accepted Accounting Principles, Posner notes. European stock exchanges likewise ran into obstacles when they wanted to even display their stock prices in the U.S. without having to follow intricate stock-exchange rules set by the Securities and Exchange Commission.

That began to change early this decade, when the EU adopted its Financial Conglomerates Directive, requiring consolidated supervision -- ie, a regulator overseeing holding companies from the top, across subsidiaries -- for financial firms operating in Europe. U.S. investment banks had nothing of the kind -- and, with a good chunk of their revenue coming from Europe, they scrambled to get such a system in place. In 2002, they won the Consolidated Supervised Entity regime from the SEC, now much criticized as having allowed investment banks to ratchet up their leverage to dangerous levels.

More examples followed: After the post-Enron reforms of Sarbanes-Oxley required foreign auditors to register if they audited U.S.-listed foreign firms, the U.S. extended its deadline twice and made modifications to accommodate conflicting law in other jurisdictions -- prompted at least in part by fear of EU retaliation. American rules about board and audit-committee independence, which threatened to run afoul of German corporate structures in particular, were quickly interpreted broadly enough to cause less trouble for European firms.

Posner traces the EU's newfound clout at least in part to the founding, and the development, of the Euro zone, which gave European countries the leverage they needed: size, scale, and an outlet for coordinating negotiations with the U.S. It also gave them considerable experience coordinating their financial-market efforts generally.

None of which is to say that Europe can expect to get everything it wants, of course. But "it's much more of an even game now," Posner told BusinessWeek. "They're both such large markets that both of them can play the same game."