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Comparative studies on the financial holding company laws and practices in the U.S. and Taiwan Lee, Hsiang - Hui Emily 2007

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COMPARATIVE STUDIES ON THE FINANCIAL HOLDING COMPANY LAWS AND PRACTICES IN THE U.S. AND TAIWAN by HSIANG-HUI EMILY LEE LL.B. National Taiwan University, 1993 LL.M. The University of British Columbia, 1998 A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF DOCTOR OF PHILOSOPHY in THE FACULTY OF GRADUATE STUDIES (Law) THE UNIVERSITY OF BRITISH COLUMBIA December 2007 © Hsiang-Hui Emily Lee, 2007 Abstract Using the U.S. Gramm-Leach-Bliley Financial Modernization Act ("GLBA") as a model, I argue that this act of financial reform, promulgated in November 1999, is a result of "Re-regulation", rather than "Deregulation" as suggested by most scholars. I emphasize the linear development of the GLBA, from 'regulation' to 'deregulation' and then further to 're-regulation'. This linear direction denotes sequential regulatory development that concerns the gradual relaxation of permissible banking activities, which is correspondingly marked by the Glass-Steagall Act of 1933, the Bank Holding Company Act of 1956, and the GLBA of 1999. The GLBA enabled the U.S. financial services industry to begin offering all round financial services under the single roof of the Financial Holding Company ("FHC"). The GLBA's mandate is to provide the U.S. financial services industry with a level playing field and allow them to compete with their strongest rivals from the European Union. European Union banks already operate under a liberal regime, following the success of the Second Banking Directive of 1989 that embraces financial liberalization. Taiwan's Financial Holding Company Act ("FHCA"), promulgated in July 2001, owes much of its content to its U.S. counterpart, the GLBA. Taiwan's FHCA is basically modeled after the U.S. GLBA but selectively adopts parts of the E.U. model. The U.S. model is represented by the GLBA while the E.U. model is represented by the Second Banking Directive. Through cross-selling and cross-marketing, financial holding companies in the U.S. model and universal banks in the E.U. model, both can achieve economies of scale and scope. This dissertation is otherwise devoted to providing a comparative analysis on certain key elements of the U.S. GLBA and Taiwan's FHCA, although I sometimes refer to the E.U.'s Second Banking Directive. I conclude that while Taiwan's FHCs lack the economic scale of U.S. FHCs, the adoption of the U.S. model in the FHCA offers Taiwan's FHCs better fire wall protection than the E.U. model would. More generally speaking, there are pros and cons to Taiwan's adoption of the GLBA. The GLBA and by extension the FHCA require its domestically established FHCs be pure holding companies, as opposed to the E. U. model which requires the parent companies (universal banks) to also be operating holding companies. ii Table of Contents Abstract^ ii Table of Contents^ iii List of Tables viii Preface^ ix Acknowledgements^ xii Introduction  1 I. Research Purpose^  1 II. The Context of Historical and Theoretical Frameworks^ 4 1. What is a Financial Holding Company? (Definitions in both the U.S. GLBA and Taiwan's FHCA)^ 9 2. What are the Advantages and Disadvantages for Becoming a Financial Holding Company? 13 3. What is the supplementary legislation to the GLBA/FHCA as Major Governing Law(s)? (Relevant Laws Accompany the U.S. GLBA and Taiwan's FHCA)^ 20 4. Recent Studies on Major Taiwanese Banks' Operational Efficiency^ 23 (4.1) Research Subject: FHC Banks and Non-FHC Banks in Taiwan 24 Table 1. Operational Efficiency for Banks in Taiwan^ 25 (4.2) Research Period: Pre-FHCA and Post-FHCA 26 (4.3) What Do the Research Results Tell Us?^ 27 5. ESSP (Environment, Strategy, Structure, Performance) Module and Theory ^ 29 (5.1) In the Pre-FHCA Era^ 30 (5.2) In Post-FHCA Era 31 6. Sub-conclusion^ 34 (6.1) Taiwan and the U.S. Both Adopt a "Two-Pronged" Approach (FHC + Subsidiary Reinvestment)^ 34 (6.2) Debate about FHCs vis-a-vis Universal Banks^ 36 (6.3) Tax Benefits for FHCs in Taiwan—Causing "Unfair Competition"? ^ 39 III. Theoretical Perspectives^ 43 1. Deregulation^ 43 (1.1) Deregulation in the Banking Industry^ 46 (1.2) How did the U.S. GLBA Inspire Taiwan's FHCA? A Canadian Perspective ^ 49 (1.3) Lessons for the Banking Industry to Learn^ 50 (1.4) Almost-Equal Treatment of Subsidiaries and Affiliates by Sections 23A & 23B of the Federal Reserve Act^ 54 2. Functional Regulation^ 57 (2.1) Deregulation vis-à-vis Separation of Power: Is there a "Turf Battle" between the Fed and the Treasury? 57 (2.2) "Operating Subsidiary" and "Holding Company Affiliate" Are Both in Practice Now^ 61 (2.3) Is the Issue of a "Subsidiary" a False Issue?^ 62 iii (2.4) Freedom to Choose Which Type of Corporate Structure- the E.U. Model Compared^ 65 (2.5) Functional Regulation in Practice^ 67 3. Game Theory 69 4. The Principal-Agent Theory/Agency Problem and Conflicts of Interest^ 72 5. Deposit Insurance and Moral Hazard^ 74 6. Externalities^ 77 7. Institutions and Institutional Power 80 8. Globalization 82 9. Corporate Governance^ 83 IV. Methodology^ 84 Chapter One 89 A Brief Banking History of Taiwan^ 89 I. Introduction^ 89 II. Taiwan's Banking History/System 95 1. Vestiges of Japanese Colonial Power in Taiwan's Banking System: "Fringe Banking Industry"^ 97 (1.1) Credit Cooperatives^ 99 (1.2) Credit Departments of Farmers' Association (Farmers' Co-ops)^ 100 (1.3) Credit Departments of Fishermen's Association (Fishermen's Co-ops) ^ 100 (1.4) Postal Offices^ 102 (1.5) Mutual Loans and Savings Companies^ 102 (1.6) Fringe and Satellite Financial Institutions Turned into Commercial/Private Banks (in Recent Banking Development) 104 2. Four Major Types of Banks in Taiwan^ 105 (2.1) Banks Established under Japanese Colonial Power from 1895 to 1945 ^ 106 (2.2) Banks Taken Over by the Chinese Government and Then Reorganized in Taiwan from 1945-1959^ 108 (2.3) Banks Founded in Mainland China and Subsequently Re-established in Taiwan^ 110 (2.4) Fifteen New Private Commercial Banks Chartered in June 1991 and the Sixteenth in May 1992^ 116 3. Two Other Types of Banks in Taiwan: "Banks for a Special Business Purpose" and "Trust and Investment Companies"^  120 4. Over-Banking in Taiwan^ 121 (4.1) Overbanking Problem in Taiwan (Internationally)^ 122 (4.2) Overbanking in Taiwan (Nationally): Zhong Xing Bank Scandal ^ 124 III. Conclusion^  128 Chapter Two 134 Financial Holding Companies in Taiwan^ 134 I. Introduction^  134 II. FHCs in Taiwan 138 1. An Overview  138 iv 2. Recent Scandals Involving 'Further Synergy'- Attempts by China Trust FHC to Take Over Mega FHC^ 142 (2.1) Letting the Cat out of the Bag—How did the Scandal Start?^ 142 (2.2) An Update on this Scandal^ 145 3. A Closer Look^ 147 4. Recent Interview with Fubon Financial Holding Company^ 148 5. The Role of the Taiwan Ratings Corporation with respect to FHCs in Taiwan ^ 151 (5.1) TRC's Partnership with Standard & Poor's Boosts Taiwan FHCs' Corporate Governance  151 (5.2) Pragmatism Prevails—Finding and Developing Meaningful and Measurable Good Corporate Governance Standards is Key^ 153 6. Deregulation amid Streamlining of Taiwan's Financial Regulatory System ^ 156 III. New Developments and Challenges Facing Taiwan's FHCs^ 159 IV. Conclusion^  168 Chapter Three 171 Regulation, Deregulation, Reregulation: Pre-GLBA (Gramm-Leach-Bliley Act) Era Regulatory Restraints ^  171 I. Introduction  171 II. Regulation, Deregulation, and Re-regulation: Evolutionary Historical Development ^  178 1. Regulation^  178 (1.1) Regulation for Securities Dealing—the Glass-Steagall Act 1933^ 178 (1.2) Regulation of the Insurance Business—Bank Holding Company Act 1956 et seq.^  188 (1.3) Regulation Y^ 190 (1.4) Bank Holding Company Act Bans Banks from Crossing over into Insurance Business^  196 2. Deregulation  198 3. Re-regulation 201 III. Case Study: Citigroup Merger^(Example of "Deregulation + Re-regulation") ^ 205 1. Background Introduction for Citigroup Merger^ 205 2. Important Features of the Citigroup Merger 207 (2.1) 'Grey' Distinctions^ 207 (2.2) Regulatory Rulings 208 3. The Citigroup Merger: a Journey from Regulation, to Deregulation, and Further to Re-regulation^ 208 (3.1) The Essence of "Regulation-Deregulation-Re-regulation" (Linear Direction Development) 208 (3.2) Citigroup's Recent Loss from Securitization Settlements Call for Further "Re-regulation"^ 212 4. Strategic Transformation of the Citigroup Merger: Its Past, Present, and Future ^ 215 (4.1) The Billion Dollar Deal ^ 216 (4.2) Strategic Transformation 217 v (4.3) Mega-Merger Plan Hinges on Congress^ 219 (4.4) Market Forces have Power to Displace Outdated Regulations^ 223 (4.5) Government Focus Shifted from Competition Policy to Economic Analysis ^ 227 IV. Conclusion^ 228 Chapter Four 233 Re-regulation and De-segmentation: Post-GLBA Era Financial Liberalization^ 233 I. Introduction^ 233 II. "Re-regulation" and "De-segmentation" As a Result of GLBA^ 242 1. "Financial in Nature" and "Incidental" Financial Activities 247 (1.1) Statutory Definition/Examples for "Financial in Nature"^ 247 (1.2) The GLBA Authorizes the Fed to Determine, in Consultation with the Treasury, What is "Financial in Nature" or "Incidental" thereto^ 248 (1.3) Factors to be Considered^ 249 (1.4) Regulation Y^ 250 2. What is "Complementary" to Financial Activities? ^ 251 III. GLBA-Authorized Expanded "Permissible Financial Activities", Subject to Statutory Restrictions and Bank Regulators' Interpretations 252 1. Merchant Banking^ 252 (1.1) GLBA Grants FHCs Merchant Banking Authority (Subject to Five Conditions) 254 (1.2) 'Interim Rule' and 'Final Rule' for Merchant Banking^ 257 (1.3) New Development for Merchant Banking's Cross-Marketing: Section 501 of the Financial Services Regulatory Relief Act of 2003 263 2. Derivatives^ 265 (2.1) Derivatives (Definition, Market Value, Controversy etc.)^ 265 (2.2) Derivatives and 'Regulation W'^ 269 (2.3) With Limited Exceptions, Derivatives Are Generally Regarded as a "Non- Permissible" Activity by the GLBA 274 3. Securitization^ 279 (3.1) A Brief Definition for Securitization (& How Securitization Works) ^ 279 (3.2) Congress' Debate on Securitization^ 282 (3.3) Securitization—Soon To Be Considered as "Incidental" to a Financial Activity by the GLBA?^ 285 IV. Conclusion^ 290 Chapter Five (Conclusion)^ 296 A Comparison of Taiwan's Financial Holding Company Act and the U.S. Model ^ 296 I. Introduction^ 296 II. Comparing Taiwan's Financial Holding Company Act ("FHCA") with the U.S. Gramm-Leach-Bliley Act ("GLBA")^ 299 1. Minimum Capital Requirement 299 2. Umbrella Regulator^ 301 3. Functional Regulator 303 vi (3.1) The Interrelationship between the Umbrella Regulator and Functional Regulator(s)^ 303 (3.2) The Umbrella Regulator Must Defer to Its Subordinated Functional Regulator(s) 304 (3.3) Functional Regulation Promotes Interagency Consultations^ 306 (3.4) The Structure of Umbrella Regulator vis-à-vis Functional Regulator(s) ^ 308 4. Well-Capitalized and Well-Managed Requirements^ 310 5. Competition Policy (Usually referred to as 'Anti-trust' in the U.S.)^ 312 6. Exempting Financial Holding Companies (Smaller Capital)^ 312 7. Exempting Foreign FHCs from Additional Local Establishment 314 8. Management or Employment Interlock between FHC and Affiliates/Subsidiaries (Permitted by U.S. GLBA, but still Prohibited by Taiwan's FHCA)^ 316 III. Citigroup's Post-GLBA Development^ 318 1. The Recent Break-Up of Citigroup 318 2. Revenue Enhancement & Ultimately Great Profits Back Up Merger Decisions322 3. Is Citigroup Too Big To Be Broken Up?^ 322 IV. Comparing the 'Evolutionary' U.S. Model with the 'Revolutionary' E.U. Model ^ 325 1. Statistical Information in 1999^ 327 2. Cross-Border Banking Mergers in the E. U. Countries (The Economist Report in 2005)^ 328 V. Conclusion 333 Bibliography^ 348 I. Statutes and Regulations (U.S )^ 348 II. Regulatory Rules/Notices/Reports Published in the Federal Register (U.S.) ^ 348 III. U.S. Congressional Records 349 IV. U.S. Legislation Interpretive Notes^ 349 V. U.S. Court Cases^ 350 VI. Legislation & Ministerial Orders (Taiwan)^ 351 VII. Legislation in the European Union 351 VIII. Books^ 351 IX. Journal Articles (& Conference/Research Papers)^ 353 X. Legal News & (Financial) Magazine Articles 357 XI. Websites (On-line Information)^ 362 Appendix One^ 368 vii List of Tables Table 1. "Operational Efficiency for Banks in Taiwan"^  .25 viii Preface This is a comparative study on the legal implications of the U.S. Gramm-Leach- Bliley Financial Modernization Act of 1999 (hereafter "the GLBA") and Taiwan's Financial Holding Company Act of 2001 (hereafter "the FHCA"), the governing laws for the financial holding companies ("FHCs") in their respective jurisdictions. Most scholars view the GLBA as a result of 'deregulation'. Even though this perspective is not fundamentally false, I contend that the GLBA is instead a form of 're-regulation'. That is to say, the word 'deregulation' is somewhat misleading; the GLBA does not mean total liberalization but rather that the scope of permissible financial activities for FHCs has been expanded. On a theoretical level, I compare and contrast the old and new banking law regimes in the U.S. that address the role and permissible banking activities for banks and their related FHCs. The linear direction of the GLBA (from 'regulation', to `deregulation', and further to 're-regulation'), as I argue, denotes sequential regulatory development that concerns the gradual relaxation of permissible banking activities, which is correspondingly marked by the Glass-Steagall Act of 1933, the Bank Holding Company Act of 1956, and the GLBA of 1999. Taiwan's FHCA is basically modeled after the U.S. GLBA (the U.S. model) but selectively adopts parts of the Second Banking Directive of 1989 in the European Union (the E. U. model). In light of this, the latter part of this dissertation is also devoted to examining the essence of the E. U. model and discussing why Taiwan adopts such a two- pronged approach. In conclusion, I argue that while Taiwan's FHCs lack the economic scale of those FHCs in the U.S., for better firewall protection, Taiwan seems to have embarked on the right path in following the U.S. model, which requires its domestically established FHCs be pure holding companies only, as opposed to the E.U. model where the parent companies (universal banks) are also operating holding companies. Banks in America, Asia, and Europe have provided much of the capital that has fuelled the massive economic growth of the 20 th century. Many view banks as one of the ix drivers of economic progress. The financial and legal structures within which they operate is of key importance to a strong economy. These structures are not static. They are ever-changing and are obliged to evolve with a variety of new circumstances to meet the needs of today and tomorrow's economy. Only very recently has the world seen a push towards liberalization in all financial sectors including banking. When we examine the banking sector we observe this liberalization movement in addition to a corresponding drive to relax formerly restrictive legislative regimes. The question remains which legislative framework best serves an increasingly liberal and democratic banking environment. I use the word `democratic' to refer to democratic principles of accountability and transparency, in addition to recognizing the interests of various stakeholders, including corporate and retail consumers and bank shareholders. In America and Europe there have been dramatic changes within the banking sector over the last several decades. Developing countries such as Taiwan have the opportunity to learn from the U.S. experience and the European experience. In any event, legislative reactions to historical, cultural and financial events and developments, while varied, provide an opportunity to see exactly what drives legal reform itself and what impels the process of regulation, deregulation and re-regulation. In Europe, banks operate under a universal banking system whereby the parent company operates and manages the banking business on a daily basis. In the U.S., banks are trending to operate under a financial holding company structure; and management and operations are divided between parents and subsidiaries respectively. Financial holding companies are embodied by the U.S. GLBA. After the GLBA came into effect, the financial holding company structure has been used by Taiwan and the U.S. to both rein in and at once liberalize their respective banking sectors, while at the same time trying to maintain a globally competitive presence. I have traced back the enactment process of the GLBA, and simultaneously followed through the passing of the FHCA in Taiwan (also known as 'The Republic of China'). Taiwan's FHCA owes much of its content to its U.S. counterpart, the GLBA, especially in regards to the establishment and monitoring of the FHCs. It is against such a backdrop that my comparative examination of the U.S., E.U., and Taiwan banking law regimes and their recent developments, has been conducted. My aim is to provide an international perspective on the study of banking evolution in major jurisdictions. xi Acknowledgements I would like to thank my supervisory committee, Professors Pitman Potter, Robert Heinkel, Janis Sarra, and Ian Townsend-Gault, for their inspiration, attentive supervision and immeasurable assistance. Their limitless patience, guidance, and encouragement have made my graduate study possible and enjoyable. I would like to extend additional thanks to my primary supervisor Professor Pitman Potter for his insightful comments and steadfast support. His invaluable suggestions enhance the text. His wealth of knowledge and experience in Chinese and Taiwan laws has tremendous influence on both my theoretical framework and comparative examination. He is truly my mentor. I am very grateful for Professor Robert Heinkel for his generous help and tremendous support. I especially want to thank him for educating me on various economic theories and for addressing to my attention many important issues relating to commercial vehicles, which greatly help shape the research direction of this dissertation. I am enlightened by Professor Janis Sarra's critical comments, which improved my dissertation considerably. Her academic precision and devotion to scholarly work in business law has motivated my study in this field. Professor Ian Townsend-Gault has inspired me with both his teaching and research. The leadership role he took in guiding me through the last stage for completing my Ph.D. is greatly appreciated by me. I would like to thank my grandmother, my parents and god parents for their constant support in my pursuit of legal education. I am indebted to my siblings for their caring and unconditional love and support. I especially want to thank my brother Dennis Lee, for continuing assistance and for being a constant source of inspiration. Finally, I would like to thank my friends and colleagues, in particular Michael Molson, Yi-Shu Lin, Chih-Poung Liou, Dah-In Yeh, Tai-Yi Chih, Helena Chen, and law librarian Mary Mitchell, without whose help in my study and research, completion of this thesis would have been a much more difficult task. I also want to thank my friends, Professor Tae-Ung Baik, Anna Holeton, graduate program advisor Joanne Chung, and law secretaries Veronica Uy and Lillian Koh at UBC, for their continual friendship throughout my tenure as a Ph.D. student and candidate. Special thanks go to Michael Molson for lending me his banking experience and for reviewing my dissertation and providing very constructive comments. In spite of all the assistance I have received, the sole responsibility for any errors or omissions in my dissertation is mine alone. xii Introduction I. Research Purpose Taiwan has influence beyond its geographic size and borders by virtue of its importance to the world economy. In the last half century Taiwan has transformed itself from an underdeveloped, agricultural island to an economic power that is a leading producer of high-technology goods. According to the Global Competitiveness Report l , published by the World Economic Forum, Taiwan was ranked the number five most competitive country in the world during 2003-2004. One year later (2004-2005), Taiwan's ranking increased to the number four position. Even though its latest report (2007-2008) indicates that Taiwan's global competitiveness ranking has dropped to 14 th place (out of 131 (countries') economies that collectively account for more than 98% of the world's GDP according to the World Economic Forum's assessment), it is safe to say that Taiwan is still among the most globally competitive countries. Taiwan is also often seen as the quintessential post-modern economy as defined by its significant lack of natural resources. Consequently, it is seen by many developing countries as a successful model of growth and development. Its economic success in the face of its natural parameters has already provided much journalistic and academic grist for the mill. However, Taiwan's legal and business infrastructure has sometimes lagged behind its economic ambitions. To proceed to the next level of economic progress it has to undergo restructuring in some of its key sectors, including the banking sector. This mirrors the situation in many countries which have likewise been the beneficiaries of the global economic boom and yet have been ultimately faced with painful restructuring in a given industry in order to for the global business community reap such rewards. Nations like Taiwan have had to correct and align their business and legal systems with I See the 'Introduction' on the World Economic Forum's website at [http://www.gcr.weforum.org/]. 1 progressive economies. In the field of banking, progressive economies such as in North America and Europe are marked by a higher degree of integration along product lines and an ability to leverage across the securities and commercial banking sectors and departments. North America and Europe are continuing to progress towards banking sectors which are marked by fewer large banks providing integrated cost-efficient services to its customers. This is not to say that there do not exist smaller banks in these countries which coexist for niche markets, it is simply to say that at the top level of banking financial institutions, they are able to provide more sophisticated products at better prices to their corporate clients. In contrast, corporate clients in developing economies are not often able to be served in their country of origin after these companies have reached a certain period of growth and sophistication. Therefore, developing the financial institutions of countries like Taiwan not only benefits the host country but also the global economy by forcing yet further innovation on the world's leading banks. The challenge that faces Taiwan is therefore also a challenge that faces the global economy and presumably other nations in the same paradoxical situation — i.e. nations which have leapfrogged ahead in terms of raw wealth and yet remain bound to financial systems which are in many cases simply archaic. The laws underpinning the financial systems in Taiwan are, of course, much to blame. While some argue the laws in Taiwan are merely a reflection of its institutional history, legislative reform in other countries has been proactive, responsive and ultimately effective in meeting the needs of their business communities. I am interested in researching the history of banking legislative reform in the European Union (E.U.) and North America because their experience has much to pass on to Taiwan despite these regions' historical and cultural differences. The interests of capitalism can transcend these differences. This suggests that some of the lessons of legislative banking reform can be transposed among these regions and countries. In the course of my research I hoped to learn and share with my readers and fellow academics how Taiwan has chosen to reform its banking system, and to what extent it has chosen to adopt the E.U. model or the U.S. model. In turn, this analysis may serve as both the basis 2 for further research into the impending financial law reform happening in other countries and ongoing research and analysis into the continuing effectiveness of banking law reform to transform Taiwan's economy and banking sector in general. I am interested in researching Taiwan's FHCA also because of its potential application to China. The FHCA may provide some inspiration for China. China has no financial holding company law but the first de facto financial holding company, the CITIC Group (China International Trust and Investment Corporation) (4 A 1 TAAX , in Chinese) has been established and officially launched its business on December 5 2002. According to People's Daily News, on December 6 2002 "China's first state- owned financial holding company, China International Trust and Investment Corporation (CITIC) Holdings, was established Thursday (December 5 2002) in Beijing." 2 In light of this, if China were to enact a financial holding company law, we should consider what model would cater to China's particular circumstances - the U.S. model, the E.U. model, or the Taiwan model. The Taiwan model adopts a two-pronged approach by selecting parts of both the U.S. and E.U. models. Given that any systematic failure of China's financial holding company (FHC) would inevitably affect numerous shareholders and stakeholders both within and outside China, it is my view that research of the much anticipated Chinese financial holding company law is imminent and hence Taiwan's experience may be a lesson that China can learn from. Taiwan's implementation of the FHCA has been examined to various degrees in this dissertation, from both theoretical and practical perspectives. This paper is therefore a comparative overview between the Taiwan banking system, its U.S. counterparts and to some degree its European counterparts. It will look at the major theoretical underpinnings of the respective U.S. and Taiwan's financial systems (and at times referring to that in the E.U.,) and the corresponding legal foundations thereof. A fuller assessment of Taiwan's adoption of the U.S. model, as 2 "China's 1 s' State-owned Financial Holding Company Born", see People's Daily On-line [http://english.peopledaily.com.cn/] (This news was posted on December 6 2002.) 3 embodied by the Taiwan Financial Holding Company Act (FHCA), including the assessment of performance, is beyond the scope of this dissertation. I do not intend to discuss at any significant length the implementation of the FHCA and the effectiveness of the regulation thereof. II. The Context of Historical and Theoretical Frameworks This introductory chapter is intended to provide an analytical `roadmap' for readers to better appreciate the more descriptive chapters to follow. By pointing readers to the relevant sections in each chapter, my goal is to give details on the rather evolutionary nature of deregulation, following the promulgation of the Gramm-Leach- Bliley Financial Modernization Act of 1999 (hereafter the GLBA) 3 in the United States and the Financial Holding Company Act of 2001 (hereafter the FHCA) in Taiwan. Deregulation is the central theme of the dissertation, which examines the legal implications for the establishment of financial holding companies (FHCs). Many believe that both pieces of legislation have inexorably changed the financial landscape in their respective jurisdictions. Taiwan's FHCA owes much of its content to the U.S. GLBA. With a view to making a comparative analysis at the end (Chapter Five of this dissertation), I started by providing readers a brief banking history of Taiwan (Chapter One), which is ensued by an account of the establishment and operation of the FHCs in Taiwan (Chapter Two). I then look into the Pre-GLBA legislations pertaining to bank holding companies (Chapter Three) and subsequently the Post-GLBA legislations that focus on bank-led financial holding companies (Chapter Four). Concluded in Chapter Five is a reflection of certain key features existing in both the U.S. GLBA and Taiwan's FHCA, as enumerated on a comparative basis. By comparing the regulatory situations in both the U.S. Pre-GLBA and Post- GLBA eras, it is fair to conclude that financial deregulation, epitomized by the GLBA of 3 Gramm-Leach-Bliley Financial Modernization Act, Pub. L. No. 106-102, 113 Stat. 1338 (1999). 4 1999, is evolutionary, rather than revolutionary. 4 Revolutionary changes are represented by the European Union's (E.U.) Second Banking Directive of 1989 5 . In a nutshell, the Glass-Steagall Act of 1933 6 ("GSA") in the U.S. marked the beginning of strict separation of commercial banking from investment banking. Although the Glass- Steagall Act created a firewall between commercial and investment banking, this wall is not impenetrable. By attempting to circumvent the law (GSA), banks at that time either set up or affiliated with holding companies, and through the holding company, commercial banks began to engage in non-banking activities. This is a loophole, as the GSA restriction only applies to banks, not bank holding companies. Subsequently, before the loophole was finally closed by the Bank Holding Company Act of 1956 7 ("BHCA"), banks continued to conduct securities business through the guise of its holding company. Given that these new entities (bank holding companies) were not banks, they were not implicated or limited by the GSA's proscriptions. Consequently, bank holding companies freely purchased both commercial and investment banks and ultimately served to circumvent the mandates of the GSA 8 . To close the loophole, the BHCA of 1956 was enacted, requiring bank holding companies to divest themselves of non-banking interests 9 . While the general rule of the BHCA is that a bank holding company is prohibited from acquiring direct or indirect control of a company that is not a bank, the general rule is nonetheless subject to a few exceptions. The most important exception to the general rule of the BHCA is set forth in Section (4)(c)(8), which states that the Federal Reserve Board ("FRB") may permit a bank holding company to acquire or control a non-banking company if its activities are "so closely related to banking or managing or controlling banks as to be a proper incident thereto". The second exception is Regulation Y, from where the FRB lists a number of "permissible non-banking J. M. Jeannot, "An International Perspective on Domestic Banking Reform: Could the European Union's Second Banking Directive Revolutionize the Way the United States Regulates its Own Financial Services Industry?", (1999) 14 Am. U. Int'l L. Rev. 1715 at 1747. 5 Directives EC, Second Council Directive 89/646 of Dec. 15, 1989 on the Coordination of Laws, Regulations and Administrative Provisions Relating to the Taking Up and Pursuit of the Business of Credit Institutions and Amending Directive 77/780/EEC, [1989] 0. J. L 386. [hereinafter the Second Banking Directive]. 6 The Glass-Steagall Act refers to only four sections (Sections 16, 20, 21, 32) of the Banking Act of 1933. The Banking Act of 1933, 48 Stat. 162. The Bank Holding Company Act of 1956, 12 U.S.C.S. §§ 1841 et seq. 8 Jeannot, supra, note 4 at 1727. 9 Ibid. 5 activities" for bank holding companies. Thirdly, outside the bank holding company framework, the securities activities of commercial banks also expanded due to liberal interpretations of the Glass-Steagall Act by the Office of the Comptroller of the Currency ("OCC"). The OCC permits commercial banks to engage in an expansive array of securities and securities-related activities, such as the underwriting of government bonds (the United States government, state, and municipal obligations)1 o . In retrospect, the BHCA of 1956 actually started the process of the gradual relaxation of the GSA restraints. That also means strict separation of commercial from investment banking started to break down following the promulgation of the BHCA of 1956. Specifically, for commercial banks that intended to engage in non-banking activities (such as securities dealing or underwriting), the governance required them to form bank holding companies, under language in Section 20 of the Glass-Steagall Act (known as "Section 20 Subsidiaries"). That also means, before the GLBA, commercial banks had to rely on their subsidiaries to conduct securities business that banks wanted but could not be pursued by banks themselves. Furthermore, before the enactment of the GLBA in 1999, the FRB required any Section 20 Subsidiary be limited to 5% of revenues from securities activities. A few years later, 5% increased to 10% and just two years before the GLBA (that is, in 1997), 10% again is increased to 25%. Deregulation had been moving so fast that the GSA restriction (a product of 1933) was not left with much content anymore. Suggested by one commentator, it seems at that time that "the only two significant banking activities that national commercial banks appear to be proscribed from engaging in are the general underwriting of securities that are not their own, and the purchasing of equity and other bank-ineligible securities for their own accounts". The GSA restriction is stretched so thin that it could explain why Citicorp and Travelers were gambling with Congress's agenda with the draft GLBA and came to merge into Citigroup. Interestingly, the Citigroup merger was precipitated one year before the GLBA came into place to legitimize it. Details of this discussion can be found in Chapter Three of this dissertation. l° Ibid at 1727-1729. 11 Ibid at 1729. 6 Deregulation is also progressive and ongoing. Subsequent to existing legal reform awaits another wave of development that intends to inject the market with more aggressive doses of financial liberalism. Based on such regulatory review, I further argue that the deregulation of the financial industry in the U.S. (manifested in the GLBA of 1999) is evolutionary, as opposed to the more revolutionary deregulation in the European Union (E. U.), following the Second Banking Directive of 1989. Consequently, I argue that "deregulation", as is used by many scholars in describing the historical development of GLBA, is somewhat misleading and should be replaced by a more appropriate term of "re-regulation". Hence, the evolution from "regulation" to "deregulation" and further to "re-regulation" (Regulation—Deregulation—Re-regulation) that concerns the gradual relaxation of permissible banking activities is correspondingly marked by the Glass-Steagall Act of 1933, the Bank Holding Company Act of 1956, and the GLBA of 1999. I intend to use the framework below to feature certain characteristics in the financial holding company law regime. (1) What is a financial holding company? (2) What are the advantages and disadvantages of setting up a financial holding company? (3) Does regulation as reflected in the GLBA increase the possibility of creating monopoly or oligopoly financial institution(s)? (4) Why is there a "turf battle" between the Federal Reserve (Fed) and the Department of Treasury (Treasury) in connection with the "Subsidiary vis-à- vis Affiliation" choice?" (5) What is functional regulation? The first two questions (1-2) will be examined in the first part of this chapter (prologue) in order to pave the groundwork for tackling more technical issues (3-6) that are to follow. In the second part of this chapter (theoretical perspectives), answers to the 7 remaining questions (3-6) will be explored under the subheads of "deregulation" and "functional regulation. I have highlighted a review of the legislative infrastructures (as in both GLBA and FHCA) with real life case studies and looked first into the corporate structure of Citigroup, the world's largest FHC, and then Cathay FHC, the largest FHC in Taiwan. Through both case studies 12 , I conclude that a financial holding company is a relatively new kind of bank holding company which currently can draw on two types of regulatory models. The U.S. model is represented by the GLBA of 1999 while the E.U. model is represented by the Second Banking Directive of 1989. Taiwan's financial holding company law (FHCA) is basically modeled after the US model but selectively adopts parts of the EU model" . Financial holding companies (FHCs) can provide customers with one-stop shopping financial services; and at the same time enhance revenues and be cost efficient. An FHC is a financial conglomerate and parent company. In the U.S. model, the FHC is a "pure holding company" while in the E.U. model, it is an "operating holding company". Through cross-selling and cross-marketing, financial conglomerates of either model (FHCs in the U.S. model and universal banks in the E.U. model) can achieve economies of scale and scope. Secondly, I argue that while the banking industry faces potential problems of monopoly and oligopoly, it is less susceptible to monopoly or oligopoly than other industries. On one hand, the maturity of competition law and banks' risk-based capital assets would prevent any single bank from monopolizing the financial industry, as it would not be able to absorb all risks linking to its over-expansion. On the other hand, bank products and services are more comprehensive, complex, and diversified than those provided by other industries. Furthermore, bank products and services are more "customer-tailored". 12 For details of the case study of Citigroup can be found in Chapter Three, while Cathay FHC, Chapter Two. 13 This is especially true in the regard of minimum capital requirement. 8 Lastly, I looked into the U.S. Congressional Report in order to better appreciate the "turf-battle" between the Fed (the Federal Reserve) and the Treasury (the Department of Treasury) in determining whether the GLBA-granted financial activities are better carried out by a financial holding company's "subsidiary" or "affiliate". The Fed is "pro- affiliate", while the Treasury is "pro-subsidiary". Both the Fed and the Treasury argue that their views are based on the "safety and soundness" principle to protect the integrity of the federal reserve fund. This begs the question, given the equal treatment of "subsidiary" and "affiliate" by the Federal Reserve Act, from a legal perspective, it really does not matter whether the GLBA-granted financial activities are engaged by the subsidiary of affiliate (of a financial holding company). This probably explains why in the E.U. model, the financial institution was granted the freedom to choose between a subsidiary and an affiliate to engage in similar financial activities. More details are to follow in the second part of this chapter (Theoretical Perspectives) under the subheading of "functional regulation". 1. What is a Financial Holding Company? (Definitions in both the U.S. GLBA and Taiwan's FHCA) In the U.S., the term "financial holding company" (FHC) was first introduced by and encoded in the GLBA to refer to a relatively new kind of bank holding company. FHC is a concept adapted from "bank holding company", which was initially defined in Section 2(a) of the Bank Holding Company Act of 1956 (BHCA) as any company that either (i) directly or indirectly owns or controls at least 25 per centum or more of the voting shares of each of two or more banks or of a bank holding company by virtue of the BHCA; or (ii) controls in any manner the election of a majority of the directors of each of two or more banks. The definition for "bank holding company" has otherwise been slightly changed following the promulgation of the GLBA on November 12, 1999. Currently, the BHCA Amendment of 2006 defines a "bank holding company" as "any company which has control over any bank or over any company that is or becomes a 9 bank holding company by virtue of the Act (i.e. BHCA)". 14 To this end, a bank holding company can have ownership or controlling interest over either a bank or another bank holding company, so long as it (1) "directly or indirectly or acting through one or more other persons owns, controls, or has power to vote 25 per centum or more of any class of voting securities of the bank or (another bank holding company); or (2) controls in any manner the election of a majority of the directors or trustees of the bank or company" 15 . As well, a bank can "hold" another company by virtue of owning or controlling at least 25 per cent of its voting shares or by controlling the election of a majority of the directors or trustees of another company. In this case, the "bank" is deemed a "bank holding company" at the same time. Emphasis needs to be made that even though both the BHCA of 1956 and its latest amendment of 2006 generally defines a bank holding company as the latter, a company will NOT be deemed as a bank holding company if its ownership or control of shares of a bank is held in a fiduciary capacity, unless by trustees for the benefit of a company or the shareholders, members, employees of a company 16 . On the other hand, according to the post-GLBA regulations 17 , the FHC means a bank holding company that meets certain requirements. First, all of the depository institution subsidiaries of the bank holding company must be "well-capitalized" and "well-managed". Secondly, the bank holding company must file with the Board of Governors of the Federal Reserve System ("the Board") a declaration that the bank holding company elects to be a financial holding company to engage in activities or acquire and retain shares of a company that were not permissible for a bank holding company to engage in or acquire before the enactment of the GLBA. Thirdly, the FHC must (at the time of its election) attain at least a "satisfactory" or better CRA rating (as prescribed in the Community Reinvestment Act) and must at all times maintain this level, after being approved as an FHC by the Board. Unless these conditions are met, a bank holding company that wishes to become an FHC may not engage in "expanded financial 14 P.L. 109-351, 12 U.S.C.S. § 1841 (a)(2). As of writing, the latest amendment to the BHCA was made on October 13, 2006. 15 Ibid. 16 P.L. 109-351, 12 U.S.C.S. § 1841 (a)(5). See also P.L. 109-351, 12 U.S.C.S. § 1841 (g)(2)&(3). "P.L. 110-6, 12 U.S.C.S. § 1841 (p), 12 U.S.C.S. § 1843(1)(1). Both are amendments to the Bank Holding Company Act of 1956, made on the same day (November 12, 1999) when the GLBA was promulgated. 10 activities" I8 prescribed under the GLBA but rather only those "closely related to banking activities", under Subsection 4(c)(8) of the BHCA, deemed as permissible for any bank holding company. In a legal sense, for any bank holding company that elects not to, or if it is not eligible to become an FHC, its applicable governing law is the BHCA (despite being amended), not the GLBA. In practice, the GLBA removes the artificial barrier that traditionally separates commercial banking from investment banking, due to regulatory restraints previously set by the Glass-Steagall Act of 1933 and the BHCA (of 1956 and its later amendments prior to 1999). Deregulation of the old regulatory regime allows for an FHC (typically headed by a bank) to expand its subsidiary bank's commercial banking activities, through mergers or consolidations with affiliated securities firms and insurance companies. This is done within the framework of the GLBA, in name of "re-regulation". Worth noting, the U.S. GLBA provides banks with the alternative of using a "financial subsidiary" of the bank (both national and state) rather than an FHC as the vehicle for conducting new financial activities. The most important difference between the FHC and the bank's financial subsidiary is that the latter is prohibited from engaging in certain financial activities as "principal". The non-permissible activities include: insurance underwriting, real estate development or investment, merchant banking, and "complementary (i.e. non-financial) activities" 19 . The same regulatory conditions apply for establishing a financial subsidiary as for establishing an FHC 20 . Adapted from Section 121 of the GLBA, it is fair to conclude that if the consolidated assets of the national bank's financial subsidiaries are less than US$ 50 billion, the national bank could opt NOT to become a financial holding company, even though it would still be allowed to conduct some of the new financial activities under the GLBA. 18 Such "expanded activities" are defined in Section 103 of the Gramm-Leach-Bliley Act as any activity the Board determines, by regulation or order, to be either (i) financial in nature or incidental to such financial activity, or (ii) is complementary to a financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. 19 Covington & Burling, Financial Modernization: The Gramm-Leach-Bliley Act Summary, American Bankers Association, 1999 (Hereafter the "Executive Summary", at 10. 20 Ibid. According to the Executive Summary, the GLBA allows the bank to conduct new financial activities by amending the National Bank Act to authorize a national bank to own or invest in a new type of subsidiary called a "financial subsidiary". The Summary further points out that a state bank is equally permitted to establish such a financial subsidiary. See also Section 121 of the U.S. Gramm-Leach-Bliley Act, under the subtitle "Sec. 5136A. Financial Subsidiaries of National Banks". 11 In Taiwan, the FHC is defined in Article 6 of the Financial Holding Company Act (FHCA) as the same person or the same affiliated person who has a controlling interest in a Bank, Insurance Company, and/or Securities House that exceeds a "certain amount". To this end, the actual amount has been determined as NT$ 300 billion (equivalent to approximately US$ 9.2 billion), through an order 21 issued by the Ministry of Finance, effective as of November 1 st 2001. That goes on to say, as long as the same person or the same affiliated person that holds a controlling interest of NT$300 billion or more, it shall apply to the Financial Supervisory Commission (FSC) for approval for the establishment of an FHC. Conversely, if the same person or same affiliated person does NOT CONCURRENTLY hold shares or capital of a company from any two of the banking, insurance and securities industry, or the aggregate amount of assets of the Bank, Insurance Company or Securities House in which such same person or same affiliated person has a controlling interest does NOT exceed NT$300 billion; then, such same person or same affiliated person need NOT establish an FHC. Worth noting, FHCs in Taiwan do not have to concurrently hold shares or capital from all three financial industries (banks, securities firms, and insurance companies), but only any two of these three. As far as the percentage holding (i.e. "controlling interest") is concerned, Taiwan also adopts the U.S. model (GLBA) by requiring a company (which could or could not be a bank) to own at least 25% of the outstanding voting shares or capital stock of another company to qualify as a holding company. To qualify as a bank holding company, at least one of the companies that are being held by the former company has to be a bank. Accordingly, if a bank holding company meets certain requirements as set out in Taiwan's FHCA (such as meeting the minimum capital requirement of NT. 20 billion), and if it opts to become a financial holding company, then it could apply to seek for government approval to actually become one (an FHC). Article 4 (Paragraph 1) of Taiwan's FHCA clearly stipulates that "controlling interest" shall mean "holding voting- 21 See Order of the Ministry of Justice (no. 0901000118), entitled "The Aggregate Amount of Assets Referred to in Paragraph 2 of Article 6 of the Financial Holding Company Act". 12 right-shares or capital stock of a Bank, Insurance Company, or Securities House of more than 25% or otherwise having the direct or indirect ability to designate the majority of the directors of a Bank, Insurance Company, or Securities House." To pare with this one, Article 4 (Paragraph 2) further defines "financial holding company" to mean "a company established in accordance with this Act (i.e. FHCA) and having a 'controlling interest' (as just mentioned earlier) in a Bank, Insurance Company, and/or Securities House." 2. What are the Advantages and Disadvantages for Becoming a Financial Holding Company? There are both advantages and disadvantages for a bank or bank holding company in opting to become a financial holding company (FHC). Advantages, as summarized by many commentators, include the followings 22 : (1) FHC establishment is attributable to conveniently provide clients with "one-stop shopping financial services", and through cross-selling and cross-marketing, economies of scale and scope can be achieved. (2) The FHC, as a parent company, can effectively manage to maximize investment returns from utilizing the accumulated assets from each of its subsidiary. As both the U.S. GLBA and Taiwan's FHCA restrict their FHCs to be pure holding companies only, a parent FHC's only job is to ensure that the assets of all its subsidiaries should be well protected and well managed at all time. (3) When it comes to variances in regional business productivity or revenue, cross-selling and cross-marketing can help redress the inadequacies experienced by one region, by the well-being of another. Likewise, as a result of mergers or acquisitions an FHC can utilize the variances in economic strength of one sector to help bring up the efficiency or profit level for the entire FHC. For example, in the U.S., after the merger 22 J in-Lung Peng, Financial Hong Company Regulation and Strategy (Taipei: Best Wise, 2004) at 18-19. (In Chinese) 13 between Citibank and Travelers' Insurance, Travelers' reputable services and good will in the insurance sector boosted consumer confidence in using the banking services provided by Citibank, and vice versa. Similarly, in Taiwan, Cathay United Bank (Guo Tai Shi Hua Yin Hang, in Chinese) is unquestionably benefiting from its predecessor Cathay Insurance Company's good will in the insurance sector. Before the merger in becoming the Cathay FHC, Cathay Insurance Company boasted having the largest capital assets in Taiwan's entire insurance sector. (4) Cost saving is attainable as a result of lowered operational cost (e.g.: lay offs, department mergers) and management resources being fully utilized. (5) FHC establishment can provide necessary transparency and accountability for both investors and shareholders, as all FHCs are subject to government supervision. (6) Legally speaking, each subsidiary of the same FHC is a legal person enjoying rights in its own right and bearing responsibilities. This "fire wall" design works as a cushionable protection, separating one subsidiary from bankruptcy or any management failure caused by others. (7) Generally speaking, an FHC would not interfere with the business operation of its subsidiary (subsidiaries). This factor, coupled with the fire walls erected to protect one subsidiary from being inflicted by another subsidiary's failure, works as the fundamental basis for lowering the risk of insider trading or conflict of interests. There are also disadvantages, "myths", as I will call them, linked to the FHC establishment, as pointed out by some commentators 23 . To name a few, •^Myth 1 Despite the fire walls in place, the closeness within the same company (e.g. all three financial sectors working within the same FHC) makes people skeptical about the efficiency and soundness of fire wall 23 Ibid. 14 protections. Besides that, there exists a problem of lack of transparency arising from the complexity in FHC-conducted transactions. My view is that although FHC structure cannot guarantee that insider trading will not happen; the truth is that such a problematic practice is not peculiar to FHC establishments. Prevention of insider trading relies on good corporate governance, combined with a strong regulatory enforcement structure, and not on absolute dismissal or disapproval of the FHC establishment. For the same reason, despite some commentators' attribution of the FHC establishment to a lack of transparency in that many transactions executed by the FHC are deemed extremely complicated, such a view or concern simply cannot justify a total dismissal of FHCs. To address the issue, FHC supervisory authorities in both countries, namely, the FRB (Federal Reserve Board) in the U.S. and the FSC (Financial Supervisory Commission) in Taiwan, have respectively issued necessary measures that require FHCs to disclose information with substantial importance to the general public. •^Myth 2 As a result of cross-selling and cross-marketing, information sharing is both permissible and prevalent among all financial subsidiaries within the same FHC. Within this legal parameter set by the GLBA, there are allegedly three negative implications for customers. (i) Customers are concerned that information sharing may affect adversely his/her interest and that could constitute a violation of the GLBA's protection of private information. Specifically, some argue that information sharing among FHC subsidiaries means that firewalls have been broken, which is in itself a form of conflict of interests. For example, a customer would allege that his/her interest be adversely affected if the FHC's insurance subsidy provides the FHC bank (another subsidiary) with the customer's "financial information", and based on which the FHC bank turned down the customer's loan application with a view to preventing non-performing loans. 15 (ii) Equally alarming to the customer is that in some incidents FHC employees (often part-time workers, suggested by a commentator 24) sold non-affiliated third parties customers' private information that they obtained through their jobs. (iii) Conflict of interests could also arise from inappropriate joint marketing arrangements (i.e. "tying") where the FHC bank would not agree to make loans to its customer unless he or she agrees to purchase the securities underwritten by the FHC's securities subsidiary. This is a typical case of conflict of interest. In my view, First, conflict of interests can be properly redressed or prevented by granting customers sufficient rights protections. Case in point, Title V of the U.S. GLBA sets out the privacy provisions that must be observed by FHCs in disclosure of non-public personal information. Specifically, this section summarizes the GLBA's four new requirements that will apply equally to all financial institutions 25 , regarding the sharing of customer information with others. To comply with this law, each financial institution must (i) establish and annually disclose a privacy policy26 , (ii) provide customers with the right to "opt-out" of having their non-public information shared with non-affiliated third parties (subject to many significant exceptions 27), (iii) not share customer account 24 Wen-Yu Wang, "Comments and Analysis on the Financial Holding Company Law" (Jin Rong Kong Gu Gong Si Fa Zhi Ping Xi, in Chinese) (2001) 77 Yue Dan Legal Journal (Yue Dan Fa Xue Za Zhi, in Chinese) 194 at 196. (In Chinese) 25 The GLBA's privacy provisions apply to (i) Banks, thrifts, and credit unions; (ii) U.S. branches and agencies of foreign banks; (iii) Mortgage companies; (iv) Insurance companies and agents; (v) Securities brokers and underwriters; (vi) Investment advisors and mutual funds; and (vii) Certain other institutions engaged in "financial" activities or "incidental" activities as defined under GLBA. See "An Executive's Guide to U.S. Financial Modernization", published by PricewaterhouseCoopers, in January 2000. 26 In this regard, a financial institution must provide a "clear and conspicuous" notice concerning its privacy policies and practices to a new customer at the "establishment of a customer relationship" and annually after. Ibid. 27 Customers may not opt out of any of the following disclosures where a financial institution may disclose non-public personal information (i) As permitted or required by the Right to Financial Privacy Act or Fair Credit Reporting Act; (ii) At the customer's direction or consent; (iii) To comply with Federal, State, or local laws and to comply with properly authorized civil, criminal, or regulatory investigations, subpoenas, or summons; (iv) To insurance rate advisory organizations, guaranty funds or agencies, applicable rating agencies, persons assessing the institution's compliance with industry standards, attorneys, accountants, 16 numbers with non-affiliated third parties, and (iv) comply with regulatory standards to protect the security and integrity of customer information 28 . Secondly, according to a report by PricewaterhouseCoopers on the U.S. GLBA, "a financial institution and its affiliates may share nonpublic information without restriction (emphasis added) as long as they disclose to the customer that they will share the information. The customer cannot bar that information sharing among affiliates— although some firms voluntarily may permit a customer to 'opt out' of disclosure to affiliates."29 "Non-public personal information" is defined by Section 509 of GLBA to mean personally identifiable financial information provided by a customer to a financial institution or resulting from any transaction with the customer or service performed for the customer, or as a catchall, information otherwise obtained by the financial institution30 . Worth noting, the term "non-public personal information" applies to information that describes an individual's financial condition obtained from one of three sources set forth in the statutory definition, and by example would include experiences with the account established in the initial transaction or other private financial information31 . In this regard, it seems apparent that the protection of "non-public and auditors; (v) In connection with the servicing or processing a financial product or service requested by the consumer; (vi) In connection with maintaining or servicing the consumer's account with the financial institution, or with another entity as part of a private label credit card program or other credit extension; (vii) In connection with a proposed or actual securitization, secondary market sale or similar transaction related to a transaction of the consumer; (viii) To protect the confidentiality or security of the financial institution's records; (ix) To protect against or prevent actual or potential fraud, unauthorized transactions, claims or other liability; (x) For required institutional risk control; (xi) For resolving customer disputes or inquiries; (xii) To persons holding a legal or beneficial interest relating to the consumer; (xiii) To persons acting in a fiduciary capacity on behalf of the customer; and (xiv) In connection with a proposed or actual sale, merger, transfer, or exchange of a business or operating unit. Ibid. [It is my view that the exceptions have grown so many that they would dramatically diminish the regulatory (GLBA's) intention for sound privacy protection. While GLBA is proclaimed to be the first comprehensive Federal law governing financial firms' use of customer information, it might be due to these substantial exceptions that the Clinton Administration criticized GLBA's privacy protections as being too weak and vowed to submit stronger privacy legislation to Congress in the year of 2000. There is no doubt that privacy protection is becoming a larger and larger public policy issue.] 28 Covington & Burling, Financial Modernization: The Gramm-Leach-Bliley Act Summary, American Bankers Association, 1999 (See Executive Summary at p. 2). Covington & Burling is a Washington law firm, which is credited, by Hjalma E. Johnson, then President of American Bankers Association, to have one of the foremost banking practices in the U.S. 29 PricewaterhouseCoopers, supra, note 25, at 32. 30 K. R. Benson, K. M. Bianco & J. Hamilton, Financial Services Modernization Gramm-Leach-Bliley Act of 1999 Law and Explanation (Chicago: CCH Incorporated, 1999) at 100. 31 Ibid at 101. 17 personal information" focuses only on any 'financial" information pertaining to a customer. A continuation of Section 509 is Section 502 of the GLBA, where its title is quoted as "(financial institutions') obligations with respect to disclosures of personal information", along with its actual context, "unless as otherwise provided in this subtitle, a financial institution may not, directly or through any affiliate, disclose to non-affiliated third party any non-public personal information..." Given the subject matter of Section 502 is "non-public information" (statutorily defined to include individual's financial condition), and information sharing is otherwise permissible by GLBA as long as the disclosure is made among affiliates, it is most likely in our example that the customer has no legal basis to allege the FHC insurance company violated the privacy protection clause under the GLBA on account of his or her loan application being denied. If anything, Section 502 is to give customers the right to opt-out (with substantial exceptions) of information sharing with a nonaffiliated third party—it is the right to say no to the sharing or selling of non-public personal information. In actual banking practice: (a) There is usually an overriding obligation on banks to comply with court orders and statutory investigative powers conferred on federal and state authorities. In these cases, privacy agreements may sometimes be overridden. (b) There may also be written provisions in loan agreements or otherwise (such as banking agreements) which provide, as between the two parties, under which circumstances the bank is permitted to disclose client information (non-public private information) to other divisions or departments (broadly defined, as commonly used to cover both the Universal Banking and Financial Holding Company systems). For example, there may be situations where information must be shared with the insurance department that is affiliated with the bank. 18 (c) As one can imply from the above discussion, there is a general duty of confidentiality between the bank and its customer subject to agreed-upon or statutory exceptions. (d) In conclusion, conflict of interest is unlikely to be a basis for complaint because the customer consents to a certain amount of disclosure. And in any event, loan agreements and banking agreements often contain broad exculpatory clauses. It is also difficult to prove conflict of interest has adversely affected a customer, because such agreements give banks a lot of discretion in accepting or rejecting a customer's application for any banking products (loan applications, in our example). (e) Informed banking practice and proper documentation will rebut many client complaints of conflict of interest. Consent to information sharing and the bank's ultimate discretion in dealing with loan or insurance products render such complaints without a legal basis. In the end, clients may exercise their free will to sometimes seek a banking product elsewhere in the free market, if they have been rejected at one institution. Lastly, "anti-tying" laws have been enacted as early as in 1972 (12 USCS § 197232), and in consideration of the BHCA 1956, exceptions were made in order to facilitate joint marketing arrangements between bank holding company affiliates. In the same vein, the GLBA currently permits a depository institution subsidiary (bank, for example) of a financial holding company (FHC) to engage in cross-marketing activities with non-financial companies held by an insurance underwriting affiliate through statement stuffers and interest websites. These activities must comply with "anti-tying" restrictions33 . Therefore, a tying violation is less likely to occur with the statutory protection in place. In fact, commentators have suggested that any possible problems relating to tying and concentration are adequately dealt with under present law 34 . 32 See 12 U.S.C.S. § 1972, P.L. 110-37, Title 12 Banks and Banking, Chapter 22 Tying Arrangements. 33 Jonathan B. Engel, "Developments in Banking and Financial Law: 2003 XV. Merchant Banking Developments" (2004) 23 Ann. Rev. Banking & Fin. L. 179 at 184. 34 (Author's Name Unknown) "The Demise of the Bank/Non-bank Distinction: An Argument for Deregulating the Activities of Bank Holding Companies" (1985) 98 Harv. L. Rev. 650 (original note 34). See also Robert Charles Clark, "The Regulation of Financial Holding Companies" (1979) 92 Harv. L. Rev. 19 • Myth 3 Approval of FHC establishment may as well be enabling the producing of gigantic financial monsters that will be "too big to fail". In order not to dismantle the FHC and cause systematic financial disorder, the Federal Reserve is likely to come to the failing FHC's rescue with the reserve fund. This will not only breach the integrity of the fund but also increase the risk of moral hazard. In my view, the U.S. GLBA, in Section108, mandates the use of "subordinated debt" to protect financial systems and deposit funds from becoming "too big to fail". The subordinated debt doctrine basically requires that all belongings of a financial subsidiary (say, a FHC bank) must be subtracted from the calculation of FHC's consolidated capital assets. Legally speaking and from a safety and soundness perspective, an FHC establishment would not be attributable to unsubstantial allegations that FHCs might just become too big to fail. 3. What is the supplementary legislation to the GLBA/FHCA as Major Governing Law(s)? (Relevant Laws Accompany the U.S. GLBA and Taiwan's FHCA) In the U.S., the colossal Gramm-Leach-Bliley Act ("GLBA") is a comprehensive and complicated piece of legislation. The enormity of the GLBA also means that financial holding companies established in the U.S. are not only governed by its major governing law (the GLBA) but also other relevant laws, including but not limited to: the Bank Holding Company Act of 1956 (and its subsequent Amendments), The Interstate Banking and Branching Efficiency Act of 1994, the Investment Company Act of 1940, the Investment Advisers Act of 1940, the Securities Act of 1933, the Securities Exchange Act of 1934, the Community Reinvestment Act of 1977, the International Banking Act of 1978, Right to Financial Privacy Act of 1978, Riegle Community Development and Regulatory Improvement Act of 1994, Riegle-Neal Interstate Banking and Branching Efficiency Act 787, 826-27, 835-36. 20 of 1994, the Federal Reserve Act, the Federal Deposit Insurance Act, the Federal Home Loan Bank Act, the National Bank Consolidation and Merger Act, Bank Service Company Act, Electric Fund Transfer Act, Fair Credit Reporting Act, and the Home Owners' Loan Act. 35 As with the U.S., Taiwan's FHCA also prompted the enactment or amendment of a wide array of laws/rules for governing FHCs in Taiwan. Of particular importance are The Banking Act, Securities and Exchange Law, Insurance Act, Company Act, Business Mergers and Acquisitions Law (2002), Fair Trade Law (Taiwan's Competition Policy), Financial Institutions Mergers Act (2000), Criteria Governing Preparation ofAffiliation Reports, Consolidated Business Reports and Consolidated Financial Statements of Affiliated Enterprises, Computer Processed Personal Data Protection Law, Criteria Governing Information to be Published in Annual Reports of Public Companies, Corporate Governance Best-Practice Principles for Financial Holding Companies (2003), Regulations Governing the Acquisition or Disposition of Assets by Public Companies, Regulations Governing the Preparation of Financial Reports by Financial Holding Companies, Taiwan Stock Exchange Corporation Regulations for the Review of Stock Exchange Listing Applications by Financial Holding Companies, Regulations for the Examination of Financial Holding Company Merger Cases (2001), Regulations Governing the Consolidated Capital Adequacy of Financial Holding Companies (2001), Regulations Governing the Implementation of Internal Control and Audit Systems by Financial Holding Companies (2001), Regulations Governing Qualification Requirements for Responsible Persons of a Financial Holding Company and their Holding of Concurrent Positions in Subsidiaries (2001), and Rules Concerning Cross- Selling by Financial Holding Company Subsidiaries (2002). It is worth noting that between 2000-2001, just two years prior to the promulgation of Taiwan's FHCA, several laws had been passed to pave the way for the ultimate promulgation of the FHCA in July 2001; a case in point the Financial Institutions Mergers Act (2000). Subsequently, Business Mergers and Acquisitions Law 35 See "Table of Statutes Added or Amended" in Benson, Bianco & Hamilton, supra, note 30, at 9-13. 21 (qi ye bing you fa, in Chinese, 2002) was issued later for better implementation of the FHCA, coupled with the amendment to the Fair Trade Law (amended 2002). This legislative stunt was taken against the backdrop of "over-banking", which as many believed to have caused by over-competition among banks in Taiwan that focus business mainly on personal/commercial lending (making loans). For details about over-banking in Taiwan, please refer to Chapter One of this dissertation. The overhaul of Taiwan's banking/financial market was launched through the government's provision of tax incentives to encourage the establishment of financial holding companies, a policy embraced by both banks and other financial institutions in Taiwan aiming to achieve "operational synergy". At this point, it seems clear that both the Taiwanese government and industry reached a consensus that a "financial holding company" could provide a viable solution for attaining optimal operational efficiency. Influenced by the more successful experience achieved by Citigroup in the U.S, the largest FHC in the world, both Taiwanese government and industry focused their initiative on FHC promotions, even though there were indeed other means to achieve operational synergy, such as (i) strategic alliance, (ii) reinvestment through subsidiaries, and (iii) comprehensive universal banking practice. Details for all these options will follow shortly. Right now there are over 600 FHCs in the U.S. while up until June 2005, the total number of FHCs in Taiwan reached to 14. To drive the reforms even further, Taiwanese government also issued several measures aimed to encourage further mergers (2nd and even 3rd waves of merger) among existing FHCs and to draw foreign investment into Taiwan. According to one commentator, the government policy involved measures to (i) stop issuing operating license (for financial institution "wannabe(s)"—including those apply to become FHCs); (ii) no longer allow banks to open new branches 36 . If it is Taiwanese government's intention to purposely reduce the current number of domestic FHCs in Taiwan from 14 to 7 (even 5) in order to enable "healthy oligopoly", 36 Yu-Chen Tu et al., "The Operating Synergies of Financial Holding Companies in In-Market and Cross- Market Mergers" (2007) Taiwan Banking & Finance Quarterly Vol. 8 No. 1, 1 at 1. (In Chinese) 22 which allegedly could sustain the surviving FHCs' competence for global competition, it begs the question, would such "oligopoly" really help enhance domestic FHCs' revenues? To correctly tackle these issues, it seems necessary for both government and industry to examine whether the existing 14 FHCs and other commercial banks have been able to attain a state of "complete market competition" (wan quan jing zheng shi chang, in Chinese). In other words, failure to consider the hypothesis of INCOMPLETE market competition will over-estimate the degree of cost-saving efficiency 37 . 4. Recent Studies on Major Taiwanese Banks' Operational Efficiency As mentioned earlier, Taiwan's Financial Holding Company Act (hereinafter Taiwan's FHCA) was promulgated on July 9, 2001, marking the beginning of a milestone change that made operational synergy possible among all three previously- separated financial services: banking, securities and insurance. In this regard, researchers in Taiwan were interested in finding out whether there is improvement in operational efficiency for major banks in Taiwan, as of July 9, 2001. Two empirical pieces of research, both conducted recently to examine operational efficiency pertaining to Taiwan's major banks, prove that, generally speaking, there is improved operational efficiency in these institutions, especially those that are affiliated with a financial holding company (i.e. FHC banks; FHC bank subsidiaries). In order to correctly reflect the impact of Taiwan's FHCA, two pieces of empirical research have been selected that explain the operational efficiency gap between (i) two periods of time: referring to both the pre-FHCA and post-FHCA eras; and (ii) two research subjects: referring to both FHC banks (i.e. FHC bank subsidiaries) and non-FHC banks (i.e. individual banks that are not affiliated with or run by a parent FHC). Both pieces of research are considered as having "representative" value, as the first research involves the operational efficiency analysis for each and every 12 FHC banks, out of 14 37 Yung-Chi Chen, "The Impact of Financial Holding Companies on the Banking Market Structure" (2007) Taiwan Banking & Finance Quarterly, Vol. 8, No. 1, 29 at 30. (In Chinese) 23 FHCs currently existing in Taiwan (that accounts for more than 85% of the effective samples; 12÷14=85.7%) 38 . Likewise, in the second research paper, of the 30 sample banks selected by researchers as "research subjects", their aggregated capital assets account for 71% of the total assets of all banks in Taiwan 39 . (4.1) Research Subject: FHC Banks and Non-FHC Banks in Taiwan The first empirical research40 , aimed at examining the overall operational efficiency pertaining to both FHC banks and non-FHC banks, also suggests that the former (FHC banks) surpassed the latter (non-FHC banks) in overall operational efficiency. This research, conducted within a research period from December 2001 (that is, five months after Taiwan's FHCA was promulgated) to June 2004, has pointed to a few important empirical results: (i)^Firstly, by turning individual commercial banks into FHC banks, it helps raise the level of operational efficiency. Statistics (see Table 1, inserted below) indicate that from 2002 to 2003, the FHC banks' average operational efficiency is lower than that recorded in December 2001 (only six months following Taiwan's FHCA promulgation in July 2001). But in 2004, that is two and a half years following Taiwan's FHCA, the FHC banks' operational efficiency index rose to 0.991, even slightly higher than its original level kept in 2001 (0.990). This tells us that even though the FHC banks' operational efficiency had been adversely affected at the initial stage, due to structural changes, nonetheless, after FHC banks successfully integrated their financial subsidiary's resources (either "networking" or "financial and human 38 Jwu-Rong Lin, Huey-Ling Shiao & Jun-Mauo Chiu, "Evaluation of Performance Difference for Financial Holding Companies in Taiwan" (2006) Zhong Yuan Business Administration Review (Zhong Yuan Qi Guan Ping Lun, in Chinese) Vol. 4 No. 1, 43-68. (In Chinese) 39 Guo-Geng Gao & Jing-Kai Xiao, "Comparative Analysis of Operational Efficiency for Financial Holding and Non-Financial Holding Banks in Taiwan" (2006) Financial Law Review (Cai fin Lun Wen Cong Kan, in Chinese) Vol. 5, 42-57. (In Chinese) ao Gao & Xiao, supra, note 39, at 42-57. 24 capital") their operational efficiency level rose to surpass the original levels prior to Taiwan's FHCA. On the theory that cross-selling and cross-marketing are more likely to be achieved within the FHC structure, this gives another incentive for the establishment of FHCs, as it brings forth a positive prospect in elevating operational efficiency leve1.41 (ii)^Table 1. Operational Efficiency for Banks in Taiwan (adapted from original source42) Table 1. Operational Efficiency for Banks in Taiwan Types of Banks 12/2001 06/2002 12/2002 06/2003 12/2003 06/2004 (1) FHC Banks 0.990 0.985 0.984 0.985 0.980 0.991 (2) Non-FHC Banks 0.948 0.947 0.968 0.978 0.970 0.966 (3) All Banks 0.964 0.962 0.974 0.981 0.974 0.976 (iii) Secondly, as shown in Table 1, the FHC banks' average operational efficiency is not that much higher than that of non-FHC banks. Pointed out by researchers, this indicates that there is a certain amount of resource waste. Once the problem has been properly identified and solved, it can be reasonably predicted that FHC banks' operational efficiency can increase significantly. (iv) Thirdly, despite FHC banks have in general surpassed non-FHC banks in operational efficiency; this does not mean there are no exceptions. Certain non-FHC banks have actually outperformed other FHC banks. This might have to do with the increase in initial costs for FHC banks, following its merger or acquisition to become an FHC. Researchers suggest that increased operational costs are due for FHC bank subsidiaries as many of them were bound to work out differences in either corporate culture or management team style. On top of that, increased costs may be due to IT (information technology) 41 Ibid at 42. 42 Ibid at 50. 25 improvements. However, once the FHC banks have overcome various challenges, operational synergy can work as a leverage for improving operational efficiency and attaining revenue enhancement 43 . (v)^Lastly, despite the fact that there are 14 FHCs currently in Taiwan, what remains unchanged (either prior to or following the FHC establishment) is that banks in Taiwan still make their earnings mainly through bank loans. This heavy reliance on loans makes Taiwanese banks extremely sensitive to interest rate changes (in either domestic or global market). Highly homogenous lending practice also intensifies price competition. This is attributable to Taiwan's over-banking problem, stemming from initial banking liberalization in the early 1990s. (For details about Taiwan's over-banking problem, please refer to Chapter One of this dissertation.) In light of this, researchers suggest that Taiwanese banks should model themselves after the U.S. FHCs by focusing their earnings on "service fee charges". That is to say, FHCs should rely more on developing new financial products that cater to different customers' needs, in order to maintain their sustainability and ensure their overall development44 . (4.2) Research Period: Pre-FHCA and Post-FHCA The second empirical research45 that was conducted involves a research period from the first quarter of 2000 to the fourth quarter of 2004, totaling 12 commercial banks (all of them have repositioned themselves as FHC bank subsidiaries in 11 different FHCs) and 240 pieces of balance panel data. Its underlying purpose was to examine the changes reflected in each of these banks' operational efficiency, following the promulgation of Taiwan's FHCA. The research result suggests that operational efficiency changes were positive as a result of the FHC establishment. Certain factors have a tremendous impact 43 Ibid. 44 Ibid. 45 Lin, Shiao & Chiu, supra, note 38, at 43-68. 26 on operational efficiency, including the scale of the bank, number of branches, and whether merging activities have been taken place. Researchers suggest that "both the profit and liquidity indices were 'obviously better' after than before the FHC establishment. The greater a bank's scale is, the higher its profitability grows; this in turn helps improve the bank's liquidity than ever before" 46 . Empirical results suggest that each commercial bank enjoyed business growth after they became an FHC as a direct result of its transformation. The "profit indices" assembled by researchers further indicate that among all 12 FHCs ("the research subjects"), the average growth rate increased 12 percent (from 38.3501% to 50.385%) 47 . Researchers suggest that FHC banks have now possessed a better profitability level than they had before. Emphasis needs to be made that for most commercial banks, prior to their turning into FHC bank subsidiaries, their respective profit indexes were all below the average rate of 45.160%, except for a very few such as Fubon Bank (47.178%), Cathay United Bank (58.213%), Jiao Tong Bank (55.264%), Jian Hua (also known as Bank Sinopac, 47.262%), and China Trust (56.169%) 48 . On the other hand, what is very exciting is that, after the FHC establishment, most commercial banks reported a profit level higher than the sampled average of 45.160%. Worth mentioning, the First Bank has recorded the highest growth—before it repositioned itself as an FHC bank, its profit index was as low as -8.603%, but after becoming an FHC, its profit index rose to 56.566%—which makes up for a growth rate at 65.169% (56.566% + 8.603%=65.169%) 49 . In conclusion, the study suggests that with only limited exceptions, FHC banks in general have outperformed their pre-FHC selves. (4.3) What Do the Research Results Tell Us? With respect to the two pieces of empirical research mentioned above, it should be noted that the first empirical research's focus was on the overall 'operational efficiency' 46 Ibid at 67. 47 Ibid at 54. 48 Ibid. 49 Ibid. 27 of the FHCs being examined, while the second empirical research's focus was on their `profitability' . Given the results as noted above, we can therefore conclude that: (1) 'Profitability' is not as useful an indicator of financial system reform as data on `competitiveness' or 'financial intermediation'. (2) While 'profitability' is not as good an indicator of the effectiveness of financial system reform as 'competitiveness' and 'financial intermediation', data retrieved concerning operational efficiency in the first empirical research does provide a partial picture of the effectiveness of financial system reform. (3) 'Performance' (of the FHCs in Taiwan) may serve as the third indicator to show how implementation of Taiwan's FHCA might be assessed. However, as both research periods are relatively short-term50 , a full assessment of the performance of Taiwan's FHCA is not only impossible but beyond the scope of the dissertation. As it stands now, both the FHC banks and non-FHC banks, if properly managed, can achieve satisfactory operational efficiency. In fact, in addition to FHC's cross- industry operation, there are three other means to achieving corporate synergy: (i) strategic alliance (e.g. "joint venture" or "strong-tied cooperation"), (ii) reinvestment (through subsidiaries, Zhuan Tou Zi, in Chinese), and (iii) universal banking (German model). This coupled with a policy concern that there are certain tradeoffs for opting to become an FHC; it is advisable for bank's management to decide whether it is worthwhile turning their bank into an FHC, after weighing all the pros and cons. The larger a financial institution gets, the more expensive it is to keep running. How to strike a balance is the key, as there is, with no doubt, lots of overhead to cover, among other costs. That being said, the overall operational expenses may otherwise be reduced due to the savings in both employment and IT development costs, as a result of operational synergy. The commentator has correctly pointed out that in the initial stage of synergy, operational costs tend to be higher than those already incurred prior to the establishment 50 More specifically, in the first empirical research I reviewed, the research period spanned 4 years in total and only 2.5 years following the promulgation of Taiwan's FHCA. The 2 nd empirical research spanned 2.5 years and only a half year after the FHCA. 28 of an FHC 51 . Synergy of all-round financial services institutions (including all three or at least two of them: banking, securities, and insurance) for transformation into an FHC involves not only the consolidation of capital assets but also the adaptation to different corporate cultures and management philosophies. Different corporate cultures can reflect on different management styles, too. For instance, banking business is short-term by its nature as opposed to the insurance business that is more long-term; consequently, bank management teams tend to take a more risky approach than their counterparts on insurance management teams, in assisting their parent companies to make investment decisions for the entire FHC. 5. ESSP (Environment, Strategy, Structure, Performance) Module and Theory There are numerous reasons that attribute to financial services companies' cross- industry selling and marketing. Market competition is one major driving force, on top of the overall external financial environment change, said one commentator 52 . He proclaimed that although optimal Performance is the ultimate goal for operational synergy, from a strategic management perspective, however, the key in creating optimal operational efficiency is to "fit in" all other determinants, including Environment, Strategy, and Structure, to a satisfactory degree. In this light, the acronym ESSP stands for "Environment", "Strategy", "Structure", and "Performance" and ESSP also symbolizes their integration. In the ESSP module, a successful business must rely on a set of correct strategies that needs to be correspondent to external environmental change at all times. Once a strategy goes beyond the realm of the external environment, such a strategy might hardly achieve any projected performance target. That goes on to say, if the external environment changes, other variables (such as strategy and structure) should also be changed accordingly for the sake of adaptation. That means, once business strategies fail to respond to an external environment, the success of business operations are not attainable. In parallel, once the strategies have been devised, they would still need to seek for the most adaptive measures to apply and fit into the corporate structure. 51 Ibid. 52 Peng, supra, note 22, at 5. 29 Only when the environment, strategy, and structure (all three factors) can adapt to each other and work together to the extent of total satisfaction then optimal operational efficiency can be achieved53 . To apply the ESSP module to the development of financial holdin