Europe’s capital markets are facing some of their toughest challenges since the global financial crisis. Brexit, global competition and political uncertainty risk fracturing the integration achieved so far in these markets. This unprecedented uncertainty could also threaten the future deepening and integration promised by the European Commission’s plans for an EU Capital Markets Union (CMU).
We are approaching a critical juncture, with Brexit and European Parliament elections in particular, which could disrupt the smooth functioning of Europe’s capital markets. Policymakers therefore need to ensure that avoiding market fragmentation and improving the capacity of Europe’s capital markets remain at the heart of a reviewed strategy around CMU.
The CMU’s original aim of developing a single European capital market remains as compelling as when the project was launched in 2015.
At the project’s outset, the European Commission set a deadline of October 2019 (the end of its legislative term) to put in place the building blocks of the CMU. With less than a year left until that deadline, the initiative is at a defining moment.
Several steps have been taken towards achieving the CMU’s objectives. These include the introduction of a new framework for simple, transparent and sustainable securitisation, reforms of the prospectus regulation and the promotion of SME growth markets to facilitate listings on public markets. But there is still much more to be done.
Valdis Dombrovskis, vice-president of the European Commission, spoke earlier this year of the “intensive work” still required to ensure those key building blocks would be in place by the deadline. It is clear that for CMU to be a success, 2019 cannot be viewed as the end of the story. Now is the time to reinvigorate the CMU with a renewed sense of purpose and a clear vision for the future.
Those who push the project forward will have the benefit of building on the strong foundations and progress that has already been made. For instance, recent research by AFME shows that there have been encouraging improvements in the availability of pools of capital for investment. In the past five years, the total amount of EU household savings invested in capital markets assets (such as life insurance and pension funds) has increased from 114% of GDP to 118% GDP. This robust pool of savings is fundamental to support job creation and economic growth in the EU.
At the same time, the amount of risk capital invested into SMEs in the form of venture capital, private equity, business angel investment and equity crowdfunding has more than doubled from €10.6bn in 2013 to €22.7bn in 2017, enabling them to scale-up and innovate.
But challenges still remain, with European businesses continuing to rely too heavily on bank finance. For example, in 2017, only 14% of new funding for EU businesses came from capital markets compared with 86% from bank lending. This results in capital markets funding for EU businesses being about half the level in the US, despite the US economy being a similar size.
There are several outstanding areas that CMU could target, which could significantly boost the effectiveness of Europe’s capital markets.
For example, as part of the aims of the CMU, and in view of the increasing retirement savings gap, member states need to encourage households to invest more savings in productive assets (in the form of equity, for instance, through private pension funds). Currently, EU households have high levels of savings, but they prefer to accumulate these in conservative cash products or bank deposits. As a result, the stock of EU household savings held in capital markets instruments is only 1.18 times GDP, compared with 2.9 times the annual GDP in the US.
The CMU could help EU households use their savings more productively. This would mean policymakers providing incentives for retail investors to save for retirement. Initiatives such as a Pan-European Personal Pension Product (PEPP) would help European integration in this area, and member states could encourage the take up of PEPPs through appropriate tax incentives and consistent application in line with other member states.
Corporate bond markets also play a key role in giving businesses alternatives sources of finance and investors more investment opportunities, and there is significant potential for them to upscale. At present, European corporate bond markets are about one third of the size of those in the US (10% of GDP in Europe in 2017 versus 31% GDP in the US). In November 2017, the European Commission’s Expert Group on Corporate Bonds published 22 recommendations to enhance the functioning of European corporate bond markets. Off the back of these recommendations, policymakers should now aim to propose concrete reforms and actions.
The UK’s decision to leave the EU has fundamentally shifted the context of the initial CMU launched in 2015. As we enter the CMU’s next phase, policymakers should take stock of this new environment, the work done so far and the scope for further progress. It will be vital to develop policy measures that balance market resiliency, market integrity and appropriate supervision while keeping Europe’s capital markets sufficiently open and competitive.
In addition, for CMU to remain relevant, it must also take into account the growing impact of developing areas of finance such as fintech and sustainable finance. Fintech is a fast-developing area, and if the EU is to truly unlock its potential, it must be global in its ambition, and coordinate with regulators across the world to create the right environment to support innovation. On sustainable finance, Europe has already made a promising start on becoming a global leader. The EU has a vital role in supporting the nascent sector to continue to grow. In particular, its plans to create a sustainable finance taxonomy is a vital first step to provide clarity on which activities can be considered ‘sustainable’ before kick-starting further developments.
These are just a few areas that could form part of the CMU agenda into the future but there are many more areas where reform and better collaborative working across the EU could boost the capacity of Europe’s capital markets. It is clear that the CMU agenda for post-2019 must be bold, ambitious and far-reaching. Tackling such complex issues will require long-term political commitment and momentum to drive through the scale of the change that is needed.
Whatever the political landscape next year, post-Brexit and following the European parliamentary elections, one thing is clear – CMU must continue to be a priority in order for companies, investors and savers to thrive across Europe.
Simon Lewis is chief executive of the Association for Financial Markets in Europe (AFME)