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UNCLAS SECTION 01 OF 04 FRANKFURT 008629 
 
SIPDIS 
 
STATE FOR EUR PDAS RIES, EB, EUR/AGS, AND EUR/ERA 
STATE PASS FEDERAL RESERVE BOARD 
STATE PASS NSC 
TREASURY FOR DAS SOBEL 
TREASURY ALSO FOR ICN COX, STUART 
PARIS ALSO FOR OECD 
TREASURY FOR OCC RUTLEDGE, MCMAHON 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EUN
SUBJECT: Expert report on best practices for financial 
analysts in the EU 
 
 
T-IA-F-03-0054 
 
This cable is sensitive but unclassified.  Not/not for 
Internet distribution. 
 
  ¶1.   (SBU) Summary: In September a group of European experts 
     issued a report to the European Commission with 31 
     recommendations on best practices for financial analysts. 
     This work coincides with work underway in the US, UK and the 
     International Organization of Securities Commissions 
     (IOSCO). In September IOSCO issued a statement of principles 
     to guide regulators regarding potential conflicts of 
     interest financial analysts may encounter.  The Commission 
     has called for comments on the expert report and will issue 
     a Communication of its policy approach next year.  Since 
     financial analysts issue products for use globally, they 
     have to adhere to the strictest rules.  A European approach 
     that is in line with IOSCO principles may help to avoid 
     potential conflicts with other national laws in the future - 
     assuming IOSCO members implement the principles themselves. 
     End Summary. 
 
  Ministers Ask for a Report 
  -------------------------- 
  ¶2.   (SBU) In April 2002, against the background of market 
     abuses that have shaken investor confidence, the European 
     Commission and the EU Economics and Finance Ministers, at 
     their informal meeting at Oviedo, Spain, invited the 
     Commission to assess the role of financial analysts and 
     possible measures to improve their participation in the 
     market.  In November 2002, the Commission asked a group of 
     experts to research and evaluate current regulatory and 
     market practice issues concerning financial analysis, 
     notably those pertaining to the assessment of securities 
     traded on debt and equity markets, with a view to 
     recommending optimal regulatory and best practice options 
     within an integrated European capital market.  The group 
     consisted of 21 European experts, mostly from private banks 
     and investment firms and their associations, but also from 
     national regulators, as well as consultants and one 
     academic. 
 
Report on Financial Analysts 
----------------------------- 
  ¶3.   (SBU) The report of the group, which was released at 
     the beginning of September 2003, is meant to be a first step 
     in a process which should develop over time through 
     "continued and thorough consultation involving national 
     regulators, professional bodies and market practitioners." 
     The report particularly covers conflicts of interest 
     resulting from analyst involvement in new issues and other 
     corporate finance work, best practices for issuers, 
     analysts' remuneration and own account dealing in 
     securities. 
¶4.   (SBU) The group notes that while its recommendations 
should respect and reflect the nature, structure and 
practices of European financial markets, Europe is part of a 
global marketplace and cannot be treated in isolation.  For 
instance, the recent comprehensive regulatory reforms in the 
US will have a global impact because the firms they affect 
are globally active and may thus decide to adhere to US 
rules in other jurisdictions. 
¶5.   (SBU) The experts agreed that the European approach to 
problems perceived in the investment research industry world- 
wide should be principles-based, emphasizing transparency 
and self-governance, rather than rules-based.  Their 
recommendations deliberately concentrate on actions, 
behaviors and outcomes, rather than the legal means of 
delivery.  The recommendations have been framed so that they 
could be implemented on a pan-European basis - either 
through EU legislation or by cooperation among national 
regulators and supervisors, assisted by professional bodies 
and market practitioners. 
¶6.   (SBU) The Forum Group produced a list of five core 
principles which it believes should be applied by those 
producing and disseminating investment research: 
          Clarity: research should be fair, clear and not 
          misleading 
          Competence, conduct and personal integrity: 
          research should be produced by competent analysts 
          with skill, care, diligence and integrity; and it 
          should reflect the opinion of its author(s) 
          Suitability and market integrity: research should 
          be distributed taking into account the different 
          categories of its intended recipients and the need 
          to maintain market integrity 
          Conflict avoidance, prevention and management: 
          analysts' firms should have in place systems and 
          controls to identify and avoid, prevent or manage 
          personal and corporate conflicts of interest 
  ¶7.   (SBU) Disclosure: conflicts of interest, whether 
     corporate or personal, should be prominently disclosed. 
¶8.   (SBU) The report makes 31 recommendations which relate 
to these principles. These focus in particular on conflicts 
of interest resulting from analyst involvement in securities 
offerings and other corporate finance work; best practice 
for companies issuing securities; remuneration of analysts; 
securities dealing by analysts; qualifications; and the 
distribution of investment research to the retail market. 
More generally, the experts recommend that investment 
research produced and disseminated in the EU should comply 
with the principles and standards advocated in their report 
, regardless of the location of the subject companies 
covered in the research. 
¶9.   (SBU) With regard to research from third countries, the 
group argues that it should be permitted for use in the EU 
if it was produced under equivalent rules.  Where the 
dissemination of research from third countries that is not 
produced to equivalent standards is permitted, this should 
be prominently disclosed.  Moreover, the experts recommend 
that the EU should seek acceptance of its standards in other 
jurisdictions relating to the production and dissemination 
of research. 
¶10.  (SBU) The group also notes that some of the issues 
discussed are already covered by the EU Market Abuse 
Directive or the Investment Services Directive. 
¶11.  (SBU) Overall, the principles and recommendations 
appear to be rather general and self-evident.  For instance, 
"research analysts should adhere to the highest ethical 
standards."  According to a Commission official the expert 
group did not always agree, so that their report reflects a 
rather low common denominator. 
¶12.  (SBU) The Commission announced that in assessing the 
Group's report and any necessity for follow-up action at the 
EU-level, it will seek to strike a balance between ensuring 
investor protection, allowing investors to benefit from an 
open and competitive market for financial research and 
investment advice, and avoiding undue restrictions on the 
services investment banks can offer, thus ensuring that 
listed companies have access to the corporate finance 
services they need.  The Commission has asked for comments 
from interested parties by November 30th 2003. 
 
Commission expert View 
---------------------- 
  ¶13.  (SBU) A Commission expert working on the report 
     explained that the trickiest issue was whether banks could 
     manage the potential conflict between its financial analysts 
     and investment banking department.  He also admitted that 
     the report was rather broad and hoped that the comments the 
     Commission will receive will give them "more orientation" on 
     how to address the issue.  He personally doubted that new 
     legislation was needed, particularly given that the Market 
     Abuse Directive and Investment Services Directive address 
     some of the potential conflict of interest issues.  He 
     thought that next year the Commission would issue a 
     "Communication" that would present its views on how to 
     proceed. 
¶14.  (SBU) On the provisions regarding financial analysts 
from third countries, this expert reported that the topic 
had been subject to very little discussion.  The group also 
did not have a real discussion of the US Securities and 
Exchange Commission's approved changes to the NASD and NYSE 
rules to address conflicts of interest raised when research 
analysts recommend securities in public communications.  He 
thought that investment banks had not reacted to these rules 
as negatively as auditing firms had reacted to the new US 
registration requirements. 
 
A View From the Market 
----------------------- 
  ¶15.  (SBU) We talked to a contact at Deutsche Bank who had 
     been listed as member of the expert group.  He told us that 
     he only participated in the very first meeting and would 
     have considered it a "waste of time" to come back.  He 
     criticized that most other members of the expert group, even 
     from banks, were not practicing analysts, i.e. often came 
     from other departments and did not know much about the 
     practical side.  He felt that his views were not 
     sufficiently taken into account. 
¶16.  (SBU) Our contact argued that the approach of the group 
was wrong, as it focused on bank analysts.  In his opinion 
journalists and tip letters should be regulated as well.  He 
stressed that while analysts only speak with professional 
investors, the other two groups give their advise to retail 
investors, are not regulated as banks are, and have a very 
small reputational risk.  Moreover, our contact argued that 
the issuer's prospectus is the most important source of 
information in an IPO and that regulation should thus focus 
on its accuracy.  He pointed out that as a consequence of 
regulation, independent research houses are being opened, 
which are not regulated and make investment recommendations 
that could just be as harmful to investors as those of 
banks.  (Note: The expert group recommended that analysts in 
independent houses should be required to respect the 
principle of the report.)  With regard to EU regulation, the 
Deutsche Bank analyst stated that banks doing business on a 
global scale will always adhere to the strictest rules world- 
wide anyway.  It makes no sense to differentiate between 
markets. 
 
Other Developments 
-------------------- 
  ¶17.  (SBU) At the beginning of September, the British 
     Financial Services Authority (FSA) announced that it will 
     not enact specific rules for analysts regarding their 
     independence as well as conflicts of interest.  Instead it 
     will publish general principles, which will be in line with 
     those formulated by IOSCO as well as with EU policies in the 
     framework of the market abuse directive.  FSA chairman 
     Howard Davies stressed that his organization starts from the 
     assumption that it is the obligation of each bank's top 
     management to eliminate obvious conflicts of interest. 
     Thus, the FSA continues to rely on the self-regulation 
     approach it has been following so far. 
¶18.  (SBU) In May the SEC approved proposed changes of rules 
by NASD and NYSE to address conflicts of interest that are 
raised when research analysts recommend securities in public 
communications.  The EU expert group's report and the Market 
Abuse Directive overlaps with several of these, such as 
limitations on relationships and communications between 
investment banking departments and analysts, linking an 
analysts compensation to specific investment banking 
transactions, compensation by firms for investment banking 
services, restrictions on trading by analysts and 
disclosures of financial interests. However, the SEC 
approved rules, generally, tend to be more prescriptive and 
not general principles. 
¶19.  (SBU) At the end of September, the International 
Organization of Securities Commissions (IOSCO) issued a 
Statement of Principles to guide regulators and other in 
addressing the conflicts of interest that analysts may face. 
The principles, inspired by the SEC approved rules cited 
above, stipulate that mechanisms should exist so that 
analysts' work is not prejudiced by their or their 
employers' financial or business relationship interests, and 
that reporting lines should be structured to eliminate or 
severely limit actual or potential conflicts of interest. 
Moreover, firms should establish written internal procedures 
to identify, eliminate, manage or disclose actual or 
potential conflicts of interest.  There should be no undue 
influence of issuers, institutional investors or other 
outside parties on analysts.  Disclosure of actual or 
potential conflicts of interest should be complete, timely, 
clear, concise, specific and prominent.  Analysts should be 
held to high integrity standards.  Investor education should 
play an important role in managing analyst conflicts of 
interest. 
¶20.  (SBU) These principles are combined with a set of "core 
measures" that are considered necessary to properly address 
potential conflicts of interests.  These "core measures" 
contain clear prohibitions, e.g. of analysts or their 
employers trading securities ahead of publishing research on 
the issuer, of analysts reporting to the investment banking 
function or participating in investment banking sales 
pitches.  The German Financial Supervisory Authority (BaFin) 
announced that it is in favor of making these principles 
binding in Germany.  The British FSA stated that it will 
largely adopt the IOSCO principles.  Experts believe that 
they will also considerably influence the EU directives on 
market abuse and investment services. 
 
Comment 
------- 
  ¶21.  (SBU) The issue of investment banks and analysts has 
     been an issue raised in Germany while the "Neuer Market" was 
     melting down.  Efforts by the Economics Ministry to forge a 
     voluntary code of conduct could not secure sufficient 
     agreement among all interested parties.  Investors' groups, 
     however, still see a need. 
¶22.  (SBU) EU legislation is already covering part of these 
issues, such as the Market Abuse Directive and its 
implementing measures on the fair presentation of investment 
recommendations and the disclosure of conflicts of interest. 
However, even in those rules developed by the Committee of 
European Securities Regulators, the approach is more towards 
disclosure than prescriptive rules.  As the Deutsche Bank 
analyst observed, global investment banks have to comply 
with the strictest rules.  If those are in the US, then, in 
his view, the US rules rule. 
¶23.  (SBU) Since the EU has yet to propose any standards on 
financial analysts it would stand to reason that whatever 
they propose should be in line with those adopted by IOSCO. 
The fact that IOSCO standards reflect US standards is 
partially a function that securities market regulators have 
similar views on the topic rather than bowing to US 
influence.  Having similar rules in the US and EU could help 
avoid potential problems and conflicts in the future. 
  ¶24.  (U) This cable was coordinated with Embassy Berlin and 
     USEU. 
 
  ¶25.  (U) POC: Claudia Ohly, Treasury Representative, e-mail 
     ohlyc@state.gov; tel. 49-(69)-7535-2367, fax 49-(69)-7535- 
     ¶2238. 
 
BODDE