To date the market for bonds, stocks and derivatives remains highly fragmented along national borders. Barriers to a genuine European capital market range from the high administrative cost to access capital markets and national limitations to what assets pension funds can invest in, to the general lack of trust of retail investors in financial markets and intermediaries due to the crisis.
The EU is looking enviously across the Atlantic, where up to 70% of funding for the US economy comes from capital markets, and the rest from banks – almost the exact opposite of the situation in Europe. Less reliance on banks helped the US economy bounce back faster from the financial crisis, while banks in Europe have cut lending to focus on building up capital buffers.
There is an estimated shortfall of over an annual $1tn between what companies in Europe raise in the capital markets (by selling shares, bonds, or loans) and what they could raise if markets were as deep as in the US. As an example, the European venture capital industry would be roughly five times bigger if it were the same size relative to the economy as in the US. That means a lot of future potential European Googles, Facebooks and biotech companies are not getting the funding they need.
The anticipated Capital Markets Union (CMU) is a key tool aimed at boosting the EU’s sluggish economic recovery and encouraging much-needed investments, in particular for SMEs. The financial services industry hopes that the CMU will also have a significant impact on markets and open up new business opportunities.
The CMU is often called a “concept under construction”, but it will shape up rapidly over the coming months, with a roadmap expected in the autumn. The public consultation on the CMU is open until 13 May and provides a unique opportunity for business to help shape this agenda and the CMU vision.
The European Commission wants the CMU flagship initiative to serve two objectives: integrate capital markets across Europe to allow easier cross-border flows of investment, and expand the non-bank part of Europe’s financial system. Deeper and more integrated capital markets are seen as essential to reducing businesses’ dependence on bank lending and shield the EU economy from future credit crunches.
The CMU would give the UK another compelling reason to remain in the EU. However other Member States, including France and Germany, may be less supportive of an ambitious CMU agenda, whose banking industries may consider the CMU a threat to their role as financial intermediaries. The reform will become politicised when it comes to sensitive issues such as the allocation of pension assets for infrastructure investments.
Some ideas have already captured the political imagination. A notable example is the securitisation of SME loans, which allows banks to partly offload SME credit risks and transfer them from their balance sheets to the capital market. There also seems to be political consensus around the need to build dedicated stock exchanges for high-growth start-ups. Policymakers should however be wary of rushing these ideas through just to show that something is being done.
Other possible new initiatives range from further developing corporate bond markets (for SMEs) to enabling alternative financing, such as crowdfunding. However, building fully-integrated capital markets in the EU will take time, not least because the EU will have to address thorny issues such as taxation, and insolvency and securities law. The stated objective of achieving the CMU by 2019 may be too ambitious. But the launch of the consultation paper certainly marks is an important first step in this direction.
Roeland Van der Stappen is a Senior Director in FTI Consulting’s Financial Services practice