Committee Reports::Report No. 11 - Free Movement of Capital::19 April, 1989::Report




(19 March 1993)



Community Measures

1.The Joint Committee has considered, with particular reference to its implementation in Ireland, Council Directive 88/361/EEC of 24th June, 1988 for the implementation of Article 67 of the EEC Treaty requiring, subject to certain transitional arrangements applicable to Ireland, Greece, Spain and Portugal, Member States to “abolish restriction on movements of capital between persons resident in Member States”. In examining the Directive the Committee has also had regard to Council Regulation (EEC) No. 1969/88 which was also adopted by the Council on 24th June, 1988 and which establishes a single facility providing medium-term financial assistance for Member States’ balances of payments.

Examination by Sub-Committee

2.A detailed examination of the Council measures was carried out for the Joint Committee by a Sub-Committee under the Chairmanship of Deputy M.J. Nolan. The Joint Committee wishes to record its indebtedness to Deputy Nolan and his colleagues and to express its sincere thanks to them for the considerable amount of work which they carried out on its behalf.


3.In its examination of these measures the Joint Committee obtained much assistance from a detailed memorandum prepared for it by the Department of Finance as well as from the written observations submitted by the Irish Bankers Federation. It wishes to express its sincere thanks for this assistance. Moreover it owes a special word of thanks to Mr. Nick Murphy and Ms. Mary Morrissey of the Department, Mr. Jim Bardon and Mr. Stewart McKinnan of the Federation and Mr. Garrett Maher and Mr. Paul Turpin of the Irish Life Assurance Company Ltd., all of whom attended a meeting of Deputy Nolan’s Sub-Committee and gave the Sub-Committee the benefit of their invaluable expertise.


4.Of the so called four freedoms of the Common Market, namely, the free movement of goods, persons, capital and services the free movement of capital has hitherto been the least developed. There are a number of reasons for this.

Firstly the Council was unable to agree on a number of proposals put forward by the Commission over the years. Before last year the First Directive, which was adopted on 11th May, 1960 and has only since been amended in minor respects, was the only substantial measure on which the Council could agree. The partial liberalisation of capital provided for by the First Directive will remain the requirement of Community law until 1st July, 1990 when it will be repealed by Council Directive 88/361/EEC. Secondly Article 67 of the Treaty which deals with the free movement of capital, unlike Articles 30 and 34 (quantitative restrictions on imports and exports), 48 (free movement of workers), 52 (right of establishment) and, to some extent, 59 (freedom to provide services) does not produce direct effect and so is not a source of rights which individuals can directly enforce. The Court of Justice so held in Case 203/80, Casati [1981] ECR 2595 pointing out that the obligation of Article 67 is to liberalise capital movements “to the extent necessary to ensure the proper functioning of the common market”, a matter for assessment by the Council from time to time.

5.While there is an obvious link between the free movement of capital and the other three freedoms of the EEC Treaty the close relationship between capital movements and economic and monetary policy would have even greater significance for Member States and probably accounts for the failure to achieve greater liberalisation of capital movements before the concept of the Single Market was accepted. The regulation of capital movements is an important instrument for implementing economic policy and Articles 104 to 109 of the Treaty which deal with economic policy leaves the ultimate decisions in this area to the Member States albeit imposing certain obligations on them.

6.In these circumstances the adoption of Council Directive 88/361/EEC within a year of the Single European Act coming into force represents a remarkable achievement. It must be seen as reflecting a resolute determination by the Member States to achieve the objective of the Single Market by 1992. To put the matter in perspective it is proposed in the first instance to outline the main provisions of the existing Community measures which are to continue in force until 1st July, 1990 when they will be replaced by Council Directive 88/361/EEC.


Capital Movements and Current Payments

7.Capital movements are not defined in the Treaty but it is clear that they are to be distinguished from current payments, which are dealt with in Articles 67(2) and 106. In Article 106(1) Member States undertook to “authorise, in the currency of the Member State in which the creditor or beneficiary resides, any payments connected with the movement of goods, services or capital, and any transfers of capital and earnings, to the extent that the movement of goods, services, capital and persons between Member States has been liberalised pursuant to the Treaty”. In Article 106(3) the Member States undertook “not to introduce between themselves any new restrictions connected with invisible transactions listed in Annex 111 to this Treaty”. Some guidance as to the distinction between capital movements and current payments is afforded by decisions of the Court of Justice notably that in Joined Cases 286/82 and 26/83, Luisi and Carbone [1984] ECR 377 where the Court stated “that current payments are transfers of foreign exchange which constitute the consideration within the context of an underlying transaction, whilst movements of capital are financial operations essentially concerned with investment of the funds in question rather than remuneration for a service [and] for that reason movements of capital may themselves give rise to current payments, as is implied by Articles 67(2) and 106(1)”.

Directive of 1960, as amended

8.The First Council Directive of 11th May, 1960 which was amended in minor respects in 1962, 1985 and 1986 was modelled on the OEEC (later OECD) Code of Liberalisation of Capital Movements in force at the time. It provides for different degrees of liberalisation for four categories of capital movements, designated as Lists A, B, C and D, as follows:-

List A comprises direct investments as well as capital movements closely connected with the free movement of persons, goods or services eg investments in real estate, debt settlements by immigrants, transfers of emigrants’ capital, granting and repayment of short and medium term credits and insurance premiums and payments and also some items with no apparent connection with the exercise of the other freedoms eg gifts, endowments, dowries and inheritances. In respect of this category Member States are obliged to grant all necessary foreign exchange authorisations;

List B comprises the acquisition by non-residents of domestic securities and the acquisition by residents of foreign securities other than unit trusts. Member States are obliged to grant general exchange authorisation for these transactions. However upon non-fulfilment of this obligation the Commission is empowered merely to issue recommendations which do not have legal effect.

List C comprises the issue and placing of securities of a domestic undertaking on a foreign market or of a foreign undertaking on a domestic capital market and the acquisition of certain securities not covered by List B such as units in a unit trust. In relation to this category Member States are required to grant all foreign exchange authorisations but where the movements of capital might form an obstacle to the achievement of the economic policy objectives of a Member State that State may maintain or reintroduce exchange restrictions which were in operation when the First Directive came into force or at the date of accession as the case may be;

List D comprises in particular short-term movements of capital as well as the physical importation and exportation of means of payment of every kind and gold. There has been no obligation for liberalisation of this category.

Protective Measures

9.Article 108 of the EEC Treaty deals with the situation “where a Member State is in difficulties or is seriously threatened with difficulties as regards its balance of payments”. Under Article 108(3) the Commission has authority in certain circumstances to authorise a Member State which is in such difficulties to take protective measures subject to “the conditions and details of which the Commission shall determine”. Over the years this power has been used on a number of occasions in the case of Ireland. Commission Decision 88/12/EEC of 16 December, 1987 which expired on 16 December, 1988 is the latest instance. Under this Decision Ireland was authorised to prohibit or subject to authorisation acquisition by Irish residents of foreign securities or of domestic securities issued on a foreign market except where the acquisition is financed from the proceeds of the sale of foreign securities or from borrowing abroad or where the securities were issued by the Communities or the European Investment Bank. However from 1 January, 1988 this restriction was not to apply and has not been applied to the acquisition by (a) residents of foreign securities or domestic bonds issued on a foreign market subject to a limit of £IR5,000 per investor and an overall limit of IR£30mn, (b) resident insurance companies, pension funds and unit trusts of foreign securities or of domestic bonds issued on a foreign market up to a limit of 12.5% of their net Irish pound cash flow in the previous year and (c) residents of domestic securities (other than bonds) issued on a foreign market and of American Depositary Receipts of resident companies.

10.In a joint statement issued by the Taoiseach and the President of the Commission on 23 October, 1988 it was announced that Ireland, being committed to the complete removal of exchange controls by the end of 1992, would from the end 1988 remove all restrictions on the purchase of medium and long term foreign securities by Irish residents and would not be seeking any further derogation from the Commission in this area. This decision was explained by the then Minister for Finance in an address to the Institute of Bankers on 11 November, 1988. He revealed that the investments allowed since 1 January, 1988 had come nowhere near the limits prescribed by the Commission and that in the first nine months of 1988 there had been a big inflow of funds from non-residents to the Irish gilt market. He pointed out that it was no longer possible to plead balance of payments difficulties to justify retaining any restrictions on investments in medium and long term securities. However he pointed out that there was no obligation to liberalise short term capital movements nor any intention to do so. Resident investors would not therefore be free to purchase short term foreign securities or to convert from medium term and long term into short term foreign securities. The only exception that would be allowed would be that for institutional investors who would continue to be allowed to purchase short term foreign securities with Irish currency within 12.5% of their cash flow.

Council Directive 72/156/EEC

11.Far from promoting the free movement of capital Council Directive 72/156/EEC, which is being repealed by Council Directive 88/361/EEC with effect from 1 July, 1990, was a step in the opposite direction. It was adopted at a time of exceptionally large capital movements of a speculative nature and its object was joint action by the Member States towards “regulating international capital flows and neutralising their undesirable effects on domestic liquidity”. Its legal basis is Articles 70 (exchange policies of Member States) and 103 (conjunctural policies of Member States). This Directive requires Member States to have available certain instruments which can be and are put into operation without delay where necessary for (a) effective regulation of international capital flows and (b) neutralisation of those effects produced by international capital flows which are considered undesirable.


Abolition of Restrictions

12.The basic requirement of Council Directive 88/361/EEC is the abolition by the Member States of restrictions on movements of capital taking place between residents in the Member States. There is no definition of residence but the Explanatory Notes indicate that the applicable definition is that “laid down in the exchange control regulations in force in each Member State”. For the purposes of the Directive capital movements are classified in accordance with the Nomenclature set out in Annex 1 thereto.

13.Member States will retain the power to prevent infringement of their national laws particularly those relating to taxation and supervision of financial institutions and are also permitted to lay down procedures for the declaration of capital movements for administrative or statistical purposes. However the use of this power must not have the effect of impeding lawful capital movements.

Third Countries

14.Member States have undertaken to attain the same degree of liberalisation as will apply among themselves to capital movements to or from third countries. This undertaking is not to prejudice the application to third countries of national or Community law, particularly any reciprocal conditions concerning operations involving establishment, the provision of financial services and admission of securities to capital markets.

Protective Measures

15.A Member State may be authorised by the Commission to take protective measures in respect of capital movements listed in Annex 11 of the Directive when short term capital movements of exceptional magnitude impose severe restraints on the foreign exchange markets and leads to serious disturbance in the conduct of the Member State’s monetary and exchange rate policy. In cases of urgency such measures (to apply for no longer than six months) may be taken by the Member State itself. The Commission may decide if such measures are to continue or are to be amended or abolished and such Commission decisions may be revoked or amended by the Council acting by a qualified majority. Annex 11 lists operations in securities, current and deposit accounts and unit trusts, short term loans and credits and physical importation and exportation of financial assets.

16.Where large scale short term capital movements to or from third countries causes difficulties for a Member State or a number of them or for exchange rate relations within the Community or between the Community and third countries the Member States are to consult among themselves as to the measures necessary to deal with the situation.

Taxation of Savings

17.The Commission was obliged to submit by the end of 1988 proposals aimed at eliminating or reducing risks of distortion, tax evasion and tax avoidance linked to the diversity of national systems for the taxation of savings and for controlling the application of those systems. The proposals were submitted in February, 1989 and suggest a minimum 15 per cent witholding tax in savings throughout the Community. They also suggest measures to improve cooperation between tax administrations. Any tax provision of a Community nature must be adopted by the Council acting unanimously.

Transitional Arrangements

18.The Directive provides for certain derogations which are to apply for limited periods in the case of Ireland, Greece, Spain and Portugal. Ireland is permitted until the end of 1992 to continue to apply or reintroduce restrictions on operations in securities dealt with on a capital market, operations in unit trusts of an undertaking not subject to Directive 85/611/EEC and medium-term and long-term financial loans and credit (List 111 of Annex IV). Ireland may also defer until the end of 1992 the liberalisation of operations in securities normally dealt with on the money market, current and deposit accounts, units of unit trusts, short-term loans and credits, personal loans and physical importation and exportation of financial asssets (List IV of Annex IV).

Medium-Term Financial Assistance

19.Council Regulation (EEC) No. 1969/88 established a single facility providing medium-term financial assistance for Member States’ balance of payments. It repeals and replaces Council Decision 71/143/EEC, as amended, providing for medium-term financial assistance financed by the Member States and Council Regulation (EEC) No. 682/81, as amended, providing a Community loan mechanism, financed by Community borrowing. Under the new single facility loans may be granted to a Member State experiencing or seriously threatened with difficulties in its balance of current payments or capital movements. Decisions to grant such loans will be taken by the Council on a qualified majority and loans will normally be payable in instalments and will be subject to economic policy conditions. The total amount of loans is limited to 16,000 mn ECU (IR£12,477mn approx.) and the Commission may borrow up to 14,000 mn ECU (£IR10,917 mn approx). If borrowing under this ceiling is insufficient or if borrowing conditions are unsatisfactory loans to Member States may be financed in whole or in part by other Member States whose contributions would be limited to 13,925 mn ECU (IR£10,859 mn approx.). In the latter case Ireland’s contribution would be limited to 158 mn ECU (IR£123 mn approx.).


Irish Legislation

20.The Joint Committee is satisfied that exchange control legislation will continue to be necessary after 1992. While Council Directive 88/361/EEC envisages that Member States will endeavour to attain the same degree of liberalisation in respect of capital movements to and from third countries as will apply within the Community it imposes no legal obligation on them to achieve this objective. Moreover the Directive will allow a Member State to reimpose exchange control when the situation warrants it either with the authorisation of the Commission or, in an emergency, on its own initiative. Legislation providing the machinery for imposing exchange control will therefore have to be in place.

21.The present legislation governing exchange control is contained in the Exchange Control Acts, 1954 to 1986 and Regulations made thereunder. Most of the Acts in this code are continuance measures which have at present the effect of continuing the Act of 1954, as amended, until the end of 1990. The Joint Committee is of opinion that this legislation ought to be allowed to lapse at end of 1990. It is structured on the basis that certain activities are prohibited unless the permission of the Minister for Finance (or his delegate, the Central Bank) is obtained. In the Joint Committee’s view new legislation to comply with the Directive should provide that capital movements would be unrestricted unless the Minister intervened in circumstances permitted by law. Moreover the Joint Committee believes that it would be wholly inappropriate for the new legislation to be embodied in a statutory instrument made under the European Communities Act, 1972. It is pleased to be able to report that in their discussions with Deputy Nolan’s Sub-Committee the representatives of the Department of Finance appeared to share these views. It can, therefore, be expected that proposals for legislation will come before the Houses of the Oireachtas before the end of 1990 which will provide Members with the opportunity of considering the consequences of the free movement of capital within the Community. In this report the Joint Committee proposes to concentrate on a few points which it suggests ought to receive attention when the debates take place in the Houses.

Constraints on National Policy

22.The Joint Committee considers that it will have to be accepted that free movement of capital must constitute a constraint on national policy in the management of the public finances. It has been told by the Department of Finance “that Ireland should be able, without undue difficulty, progressively to remove the remaining exchange controls over the period to end-1992”. The experience gleaned from recent relaxations in exchange control restrictions supports this opinion but the Department’s optimistic view is founded in the longer term on the progress made in rectifying the public finances, improving the balance of payments and reducing inflation. In the Joint Committee’s opinion the maintenance of confidence nationally and internationally in the Irish economy must command a high priority in formulating and implementing national financial and economic policy under the new regime even at the expense of foregoing desirable projects which might imperil that objective.

Interest Rates

23.Complete freedom of capital movements should in theory lead to an approximation of real interest rates throughout the Community and such a development would be in line with the concept of the Single Market. This presupposes that interest rates will be regulated only by free market forces. The Department of Finance expects that “when all exchange controls are abolished, the potential for movements of capital into and out of the country will grow both in amount and volatility”. It sees interest rates as playing a major role in defending the exchange rate and in regulating inward and outward flows of capital involving perhaps the adjustment of interest rates by “margins significantly higher than we have been accustomed to”. It seems to the Joint Committee that great care will be required in having recourse to the interest rate mechanism as an instrument of monetary policy to avoid placing Irish products at a competitive disadvantage in the open economy of the single market.


24.The existence of exchange control and other restrictive legislation may have facilitated the introduction of a range of new taxes on financial services eg bank levies, deposit interest retention tax (DIRT) and insurance levies. The Department of Finance accepts that there is a risk of a loss of revenue from DIRT under the new regime. This risk may to some extent be mitigated if the Commission’s proposals for a tax on savings is accepted but already opposition to these proposals has been expressed, notably, by Luxembourg and the United Kingdom. Moreover the liberalisation of capital movements in no way depends on the acceptance of these proposals.

25.Strong representations have been made to the Joint Committee by commercial interests for the removal of taxes on financial services and of the advantages enjoyed by Government securities in this respect on the grounds of their effect on the competitiveness of Irish undertakings. In the present circumstances the Joint Committee believes that national fiscal requirements must be the predominant consideration in matters of taxation but it recommends that the Houses consider the advisability of continuing taxation of this kind after 1992 in the conditions of the single market.

Securities Markets

26.It has been suggested that exchange control has facilitated Government borrowing on the gilt market and that the removal of exchange control may increase the cost of Government’s borrowing. Any such tendency could of course be offset by other factors including the level of the Government’s borrowing requirements. The Joint Committee suggests that this topic be pursued when the proposals for legislation come before the Houses.

27.The Joint Committee has been informed by the Department of Finance that it is not thought that the removal of exchange control will represent a serious threat to markets in Irish equities and gilts. While acknowledging the difficulty of making an accurate forecast the Department points to the following factors as supporting its opinion:-

“(i)the improved annual Irish pound allowance (£5,000 to a private investor; 12 ½% of annual cash flow to an institutional investor) made available from 1 January 1988 to Irish residents to purchase foreign securities have not been fully taken up, a development which suggests that there is no pent-up demand for this type of investment;

(ii)further to the conclusion in (i), it is to be noted that resident investors have been completely free to purchase unlimited amounts of foreign securities through borrowing foreign currency. Given the stability of the exchange rate, resident investors could have satisfied their demands for foreign securities in this way at little or no perceived exchange risk. With continuing exchange rate stability, it is unlikely that these investments would be substituted by ones bought from Irish pounds;

(iii)the international investor’s perception of the Irish economy has improved markedly as a result of positive developments in the real economy and in economic policy. This has been reflected in significant foreign investment in the Irish gilt market so far this year.

(iv)prudential requirements will always limit the freedom of institutional investors to invest abroad.”.