Why does the EU need a Capital Markets Union?It all boils down to growth and financial stability. Bank funding in Europe has not recovered since the financial crisis. In fact, it is currently down approximately 10% from the 2008 level, which has resulted in a funding gap for many European companies. With the banking sector under pressure to raise capital and shrink balance sheets, banks have not been able to spring back and fund new activity. Capital markets must fill that gap.
To some extent, this is already happening. Between 2008 and 2013, there was €600bn less of bank lending and €600bn more of corporate bond funding, which roughly cancelled each other out. However, in future, if we want stronger credit growth in Europe, we will have to look to the markets. Reducing Europe’s reliance on banking will also lessen its exposure to future financial crises, so a CMU should help to spread risk and offer more stability.
How could it change financing in the EU?The policy agenda for the CMU initiative is currently very broad, because it needs to reflect a range of different firms and funding needs. The conventional wisdom about Europe’s capital markets is that they are well-integrated for the funding of large corporates, but the smaller you go, the more reliant you are on the banking sector – and the more national and local markets there are. So, the EC really wants to focus on small and medium-sized businesses (SMEs). Within that there is a series of challenges regarding medium firms, small firms and micro firms, each of which have different funding needs. Private placement, for example, has been put forward as a solution for funding mid-cap corporates. At the smaller end of the spectrum, finance could come from venture capital or alternative funding streams, such as crowdfunding and Angel Investment.
About the expert
Paul McGhee is Director of Strategy at the AFME. He joined the organisation in August 2011 and is currently the lead on the Association’s response to the CMU. A former civil servant, McGhee began his career as a policy adviser on EU financial services for the UK's HM Treasury. He was later seconded to the EC as a national expert on financial regulation, working in the Directorate-General for Competition. Prior to joining the AFME, he worked for the Scottish Government as Head of Infrastructure Finance. What are the likely benefits for businesses and investors?It is primarily about choice, on both sides. Businesses are likely to profit from a broader range of funding options, and will hopefully benefit from cheaper funding as a result. The Commission is also looking to develop equity as a sustainable, long-term source of funding for companies, so that could be an important shift, as Europe’s equity markets are currently around half the size of the US equivalent.
For investors, it is likely that there will be a broader range of investible assets to choose from. Alongside the CMU, the Commission is looking at setting the right capital framework to encourage retail and institutional investment in long-term assets. Solvency II (which seeks to codify and harmonise EU insurance regulation), European Long Term Investment Funds (ELTIFs) and incentives to invest in infrastructure are just some of the ways that the Commission seeks to encourage such investment. More integrated markets should also lower execution and transaction costs.
Will traditional bank lending continue to play a role for some companies? Absolutely. Currently, more than three-quarters of all funding to Europe’s SMEs comes from banks and – particularly for small firms – bank lending is likely to remain the key source of funding. Securitisation and other types of structured bank finance could also bridge the gap between traditional lending and the wider investment base. It is certainly a case that we have been making, and one which policymakers are increasingly receptive to. Securitisation covers a whole range of bank assets, including SME loans and mortgages, which can enable investors to gain exposure to these pools of assets.
What challenges do you expect the implementation of a CMU to bring?There is not yet universal support for larger and more diverse capital markets in Europe, and confidence in the project needs to be built. Consumer confidence and investor protection are all-important aspects of the CMU, so the Commission will be very careful to emphasise the need to manage risk while enabling growth.
Another issue is the importance of tackling some of the big structural barriers the Commission has identified, such as quick wins, which include securitisation, data-protection reform, ELTIF, SME data and private placement. But there is also a list of long-term challenges, such as tax issues, insolvency reform and securities law. The Commission needs to make progress on these issues. We particularly support insolvency reform, because that’s currently a big barrier to cross-border investment. The practical option is not complete harmonisation, but a progressive, closer alignment of systems.
AFME believes that there needs to be much more retail and institutional investment in Europe’s markets. You can make it easier for firms to raise funding through new channels, but there also needs to be investor demand, and that means bringing new money to the markets. To tackle this, the AFME is encouraging the Commission to look at areas such as private pensions and the potential impact of initiatives such as auto enrolment.