EU Unveils Ambitious Plan to Unite Capital Markets by 2019 as Antidote to Europe’s Sluggish Economy (10/1)     Print Email

Single Market Would Promote NonBank Financing, Remove Investment Obstacles, Encourage Financial Innovations

By James D. Spellman, Strategic Communications LLC

The European Union set out an ambitious plan to remove barriers to cross-border investment, a move that could make it easier for a business in one country to obtain capital in any member-state. The resulting expansion of financing options could lower funding costs and provide more diversity in the financial products and services available in Europe to meet a company’s complex financing needs.[i]

“It’s about creating the right conditions for more funding to flow from Europe’s savers to Europe’s businesses,” said EU Commissioner Jonathan Hill, who is responsible for Financial Stability, Financial Services, and Capital Markets Union (CMU). "I want the CMU to help European businesses, and our small and medium-sized enterprises (SMEs) in particular, have a wider range of funding sources. I want it to give SMEs more options for investing their money. I want to knock down barriers to make it easier for capital to flow freely across all 28 Member States."[ii]

The EU already outlined the general contours of CMU in February. The September 30 announcement set out the action plan and unveiled 20 regulatory initiatives aimed at addressing critical problems that EU officials and others say are reasons why the region’s economy refuses to grow strongly.

Hill used the launch, too, to signal a major change in the EU’s approach to financial regulation after six years of initiatives to address the perceived causes of the 2008 financial crisis. He said he sought evidence of “unnecessary regulatory burdens” and “other unintended consequences” of the new banking and markets laws, in announcing that one key plank of CMU will include cutting red tape.

Elaborating on this point in an interview with the Financial Times, Hill said: “It is to say that when you’ve done 40 major pieces of legislation in five years...common sense tells you that you are unlikely to have been able to work out all the consequences and interconnections. It is sensible to look at it.”[iii] The commission is seeking input until January 6, 2015.

Bank lending has plummeted since the financial crisis as the gap between the supply of financing available and demand stays wide.[iv] Businesses rely on banks for roughly 80 percent of their needs while 20 percent comes from capital markets; in the United States, the reverse happens. Further, the range of financial products available in Europe is narrow.

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Source: Bank of England, “A European Capital Markets Union: Implications for Growth and Stability.” Financial Stability Paper No. 33. February 2015. http://www.bankofengland.co.uk .

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Source: Financial Times,

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Source: Florencio Lopez de Silanes, Joseph McCahery, Dirk Schoenmaker, and Dragana Stanišić, “Estimating the financing gap of small and medium-sized enterprises.” August 21, 2015. http://www.voxeu.org/article/estimating-financing-gap-small-and-medium-sized-enterprises .

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Source: Bank of England, “A European Capital Markets Union: Implications for Growth and Stability.” Financial Stability Paper No. 33. February 2015. http://www.bankofengland.co.uk .

The key one proposes to overhaul the securitized debt market, which enabled the growth in mortgages and other consumer debt before the global financial crisis. Such instruments (for example, asset-backed securities) package many individual loans into a tradable, interest-bearing “security,” which is then bought by investors, who in turn could resell it. This process allows lenders to move the risks off their balance sheets once they sold these securities. Doing so enables the lenders to extend more loans without having to bear default risks, which would otherwise limit lending activity.

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Source:   Andreas Jobst, “What Is Securitization?” International Monetary Fund. http://www.imf.org/external/pubs/ft/fandd/2008/09/basics.htm

Under the EU overhaul of this securitized debt market, a new class of “simple, transparent, and standardized” products would be created, which would be eligible for preferential regulatory treatment. To increase these products’ appeal to investors, the capital charges (the cost of capital times the amount invested) on holders of these new instruments would be lowered. These incentives would encourage banks and other financial institutions to lend to more businesses. The originator, sponsor or original lender of a securitization would be require to retain at least five percent of the debt.

Since 2010, the asset-backed securities market in Europe has fallen nearly 50 percent. “Even at its peak, the market was significantly smaller than in the United States, with just over $3 trillion outstanding in Europe compared to more than $12 trillion in the United States,” according to a Bank of England study.[v] The commission says its proposal would provide an “additional amount of credit to the private sector ranging between 100 billion euros and 150 billion euros.”

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Source: Financial Times.

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Source: Bank of England, “A European Capital Markets Union: Implications for Growth and Stability.” Financial Stability Paper No. 33. February 2015.

CMU will also aim to develop corporate bond markets, create incentives for infrastructure investment, and facilitate alternative financing, such as crowdfunding. A review, too, of the investor-prospectus rules is underway and the commission is exploring how to build am EU-wide framework for “covered bonds.”

As summarized by Reuters, the program’s steps are:[vi]

EARLY PRIORITIES_______________________________________________________________

* Legislation to make it cheaper and simpler for a company to issue stocks and bonds by reforming EU prospectus rules.

* Legislation to help kick-start the market for pooled debt or securitization by lowering the amount of capital banks must hold when they originate the debt in case of default.

* Cutting capital charges on insurers who want to invest in infrastructure projects.

* Review of whether EU regulation introduced since the financial crisis is affecting the ability of banks and markets to raise funds for the economy.

* Consultation on how to increase safeguards and make it easier for consumers to shop for financial products like pensions in another EU country.

* Consultation on whether targeted changes could boost take-up of venture capital funds.

* Consultation on a pan-EU framework for covered bonds.

MEDIUM TERM______________________________________________________________________

* Assess the case for pan-EU financial products like pensions.

* Review of how to make corporate bond markets work better.

* Legislation to make a stock market listing as attractive tax-wise as issuing company bonds.

* Legislation on clarifying legal ownership of shares in cross-border transactions and disputes.

* Legislation on business insolvency and early restructuring.

* Studies on removing cross-border tax barriers to investment.

* Consider a lighter set of accounting rules for companies listing on "growth" stock markets.

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[i] All documents related to CMU: http://ec.europa.eu/finance/capital-markets-union/index_en.htm#action-plan .

[ii] Press Release: http://europa.eu/rapid/press-release_IP-15-5731_en.htm?locale=EN .

[iii] Jim Brunsden, “EU Commission changes tone over financial regulation.” Financial Times, September 30, 2015. www.ft.com .

[iv] Florencio Lopez de Silanes, Joseph McCahery, Dirk Schoenmaker, and Dragana Stanišić, “Estimating the financing gap of small and medium-sized enterprises.” August 21, 2015. http://www.voxeu.org/article/estimating-financing-gap-small-and-medium-sized-enterprises . Also, see: A. Giovannini, C. Mayer, S. Micossi, C. Di Noia, M. Onado, M. Pagano, and A. Polo, “Restarting European Long-Term Investment Finance: A Green Paper Discussion Document.” January 30, 2015. http://www.voxeu.org/article/green-paper-restarting-european-long-term-investment-finance .

[v] Bank of England, “A European Capital Markets Union: Implications for Growth and Stability.” Financial Stability Paper No. 33. February 2015. http://www.bankofengland.co.uk .

[vi] Huw Jones, “Fact Box: EU begins building a capital markets union.” Reuters, September 30, 2015.

http://www.reuters.com/article/2015/09/30/us-eu-markets-regulations-factbox-idUSKCN0RU16S20150930?mod=related&channelName=ousivMolt .