Capital Markets Union: a Fresh Start for EU Financial Policy

The UK conservative politician Lord Hill, who became the European Union’s (EU) new commissioner for financial services last October, has identified the capital markets union (CMU) as one of his flagship deliveries for the EU 2020 Agenda. The consultation period for
the green paper
, which runs to May 13, has the objective of identifying potential measures – regulatory or non-regulatory – which would help create a CMU.

The free movement of capital across the EU is one of the three key freedoms enshrined in the Treaty of Rome. However, with obstacles to domestic and cross-border capital movements as well as underdeveloped capital markets leading to lower levels of diversified funding for the economy, there is a need for action.

What are the Drivers of the CMU?

The European financial market is heavily characterised by bank-led lending – a phenomenon that is in stark contrast to the US, where businesses’ reliance on capital market financing is common practice. The paper therefore describes the current state of European capital markets, which has expanded over recent decades. Total EU stock market capitalisation stood at around €8.4 trillion at the end of 2013, or 65% of the region’s gross domestic product (GDP), compared with only €1.3 trillion in 1992.

On the debt securities side, the total value of outstanding debt exceeded €22.3 trillion (171% of GDP) in 2013, against €4.7 trillion in 1992. However, both the public and private equity markets in the US are double the size of Europe’s when measured as a percentage of respective GDP, while the private placement markets for bonds is around three times larger in the US.

Moreover, access to capital markets in Europe is unequal and varies significantly across member states, where equity markets have a strong home bias.

What is the CMU Trying to Achieve?

Three main areas form part of the CMU vision. Firstly, the difficult access to finance – especially for small and medium-sized enterprises (SMEs) – needs to be improved. Secondly, the CMU will look to enhance the financial flows of institutional and retail investors into capital markets. As a result, a more competitive and attractive European capital market could also attract more foreign direct investment (FDI). Thirdly, there is a particular focus on improving the effectiveness of markets, where barriers and fragmentation will have to give way to deeper and more integrated capital markets, improving stability, capital allocation, business growth and innovation.

Examples of Near Term Deliverables

The Commission identifies five areas where early action can be considered. The EU’s Prospectus Directive could be reviewed in order to make it easier for companies to raise capital across the single market. For SMEs a common set of minimum information for credit reporting and assessment, as well as standardised credit quality information, could be pursued. Securitisation, which has significantly dropped from its 2007 peak level of €594bn to €216bn in 2014, could be supported with the help of transparent and standardised instruments.

Next to the European long-term investment funds (ELTIFs) regulatory framework, the question is which additional role the Commission or member states could play in further support of ELTIFs. The private placement market is another area, where an industry-led market guide on common practices and principles is to be developed.

Overarching Measures to Develop the CMU

In the area of access to finance existing challenges – such as cost and complexity for SMEs, information challenges due to a lack of simple accounting standards and the need to enhance investor awareness of member state infrastructure projects – are mentioned. Developing a more integrated European covered bond market, as well as the promotion of crowd funding, are also considered.

Measures to boost cross-border pensions, private equity and venture capital retail and international investment should also be developed.

The effectiveness of the market could be enhanced with a single rulebook approach, enforcement and competition; supervisory convergence; data and reporting; market infrastructure and securities law; company law, corporate governance, insolvency and taxation; as well as technology.

What does this mean for Corporates in Europe?

Overall the CMU vision is a very positive one, which tries to provide more choice and better access to finance for businesses across Europe. This is particularly important in light of the continuing implementation of banking reforms, which is constraining the ability of Europe’s banks to lend to the economy.

In making Europe more attractive for both domestic and international investors, the CMU has the potential to enable positive change, driven by flexibility, transparency, choice and less red tape – which will ultimately benefit corporates, the financial industry and citizens.

However, it remains to be seen how other European legislative developments are potentially risking contradicting or hampering the unfolding of the CMU. A financial transaction tax for one (currently favoured by 10 member states), would constitute a clear barrier to the flourishing of capital markets activity as it would hurt investors and businesses. A broader perspective will therefore be necessary in order to enable the creation of the European CMU.

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