The second Capital Markets Union (CMU) Action Plan of the EU Commission lacks ambition. This at a time when the EU Commission wants to set an industrial policy for the EU to bolster competitiveness in key sectors. It also comes shortly before the UK’s departure from the EU. Yet a vision of what the EU wants to achieve, by when and how, is missing.
● CMU II action plan lacks a broad vision of what the EU wants to achieve
● It is full of details but does not cater for significant changes or boost Europe markets
● Proposed amendments to MiFID II and prospectus and securitisation regulations have been left out of the plan
Instead, the plan gets lost in details. As a result, it will not allow for significant change or help bring Europe’s markets up to speed. Several weeks before it was launched, the Commission proposed amendments to three key measures from the earlier wave – the Markets in Financial Instruments Directive (MiFID II), prospectus and securitisation regulations. Why these were not part of the final plan is unclear.
Competitiveness was already a key factor when the first CMU plan was announced in 2014 by the then President Jean-Claude Juncker. Six years later, it seems that it has become less rather than more attractive. On the equity market side, the US capital market, as measured by the MSCI equity market index, has advanced enormously over the past five years, while Europe has remained flat. Europe has clearly not achieved the goal set out in 2014 of becoming more market-driven. The attractiveness of the equity markets as a source of financing remains low, at about half the size of that in the US (figure 1).
On the debt-securities markets, in Europe the sector is about half the size of that in the US; in 2019 the amount outstanding of European debt securities was €19.5trn compared with €36.6trn in the US. Debt securities issued by governments and financial institutions have taken up the largest part of the financial system, with corporate debt securities representing only a small fraction. Other forms of market finance, such as crowdfunding, venture capital and private equity, are of limited use in Europe – especially for young, small and innovative companies. The issuance of equity and bonds is not the preferred option and rarely considered by SMEs.
Also on another metric, the availability of risk capital for European SMEs, the gap with the US is increasing. The average annual amount of risk capital in the US over the period 2015-18 was about €149bn, almost nine times the amount invested in the EU-27 (€17bn) (figure 2). Compared with the size of the respective economies, the US pre-initial public offering (IPO) risk capital represents 1.2% of GDP. In Europe it only represents 0.14%. It is clear that alarm bells should start ringing in the EU Commission but apparently they have not.
The CMU II Action Plan
The second CMU Action plan consists of 16 items, none of which is expected to require big changes. The overall themes are mainstream: adaptation to the green recovery and digitalisation; more disclosure; and better access to finance for SMEs. There is one exception – a proposed EU-wide system for withholding tax relief at source. This, if achieved, would be welcome, as the diversity of tax systems is a substantial barrier to cross-border holdings, certainly at the retail level. But it concerns tax harmonisation, which requires unanimity among the EU member states.
What should be the core elements? There was certainly no shortage of input from the private sector and member states. What is missing, as the Rebranding CMU task force report produced by the European Capital Markets Institute (ECMI) signalled, are a few areas that could bring substantial change – government bond markets, investment funds and long-term savings, and SME growth markets.
• Government bond markets: An important step was taken towards the euro safe asset, with the EU Commission market borrowing, on the basis of its AAA rating, for the EU recovery fund, NextGeneration EU (NextGenEU), proposed in July, and then agreed by the European Parliament.
Together with the borrowing by the other EU entities, the total borrowing of the EU under the top rating could reach €1.4trn, a big step towards a euro safe asset, and a benchmark yield curve in euros. But procedures for the issuance of government debt, and also other elements of the settlement systems for securities are not yet harmonised at EU level, which keeps markets fragmented. They have been long discussed but without much progress. The European Central Bank has, in the meantime, stepped in the void with the European Distribution of Debt Instruments (EDDI), an initiative that should have been taken by the EU Commission.
• Investment fund markets and long-term savings: Further initiatives are required to reduce the costs of fund investments by households on the basis of a few clear benchmarks, and to channel the savings of European households into long-term assets. An initiative to reduce the costs of funds, long highlighted by the European Securities and Markets Authority (ESMA), is however missing from CMU II. As ESMA noted in its most recent report: “costs remain a critical component in final investor benefits, with retail investors paying higher costs than institutional investors”.
• Start-ups, high-growth companies and SMEs: Much remains to be done to bring SMEs to the markets in Europe. The SME Growth Market label in the Markets in Financial Instruments Directive (MiFID) requires exclusive focus on SMEs with less complex requirements/costs than the regimes for ordinary regulated markets. Consistent definitions of SMEs across different pieces of legislation are necessary which, however, is far from easy, for tax and other reasons.
The impact of Brexit on Europe’s capital markets is not addressed either but it is important, certainly with almost half of the EU’s assets managed from the UK. The UK will try to react with unilateral market openness and greater flexibility in adapting rules. This could put the EU at a competitive disadvantage. The departure of the UK was already noted in the MiFID ‘quick fix’ amendments, which would not have been proposed otherwise. Under the pretext of supporting SME financing after Covid, the MiFID quick fix will do away with one of the building blocks in investor protection of MiFID II ‘unbundling’. The requirement to separate research from execution expenditure in asset management is designed to tackle inducements, and increase transparency for investors. In the countries that have applied unbundling for the longest time – the UK and the Netherlands – the cost of funds is the lowest in the EU.
“What the European Commission proposed last July – to not apply the unbundling below a market capitalisation of €1bn – is not only difficult to implement in practice, but it is also opening a Pandora’s box”
What the European Commission proposed last July – to not apply the unbundling below a market capitalisation of €1bn – is not only difficult to implement in practice, but it is also opening a Pandora’s box. Even further, some MEPs have proposed increasing the threshold to €10bn. This example clearly shows that industry wants to get rid of ‘unbundling’ as soon as possible, and undo one of the cornerstones of MiFID II. It also demonstrates where Europe’s financial markets are heading post-Brexit. That is, back to how it was before with universal banks, no open architecture, less competition, high costs for retail investors, and also less capital market financing.
The European Commission wants an industrial strategy for strategic autonomy but the pre-condition – the means of financing such investments – does not seem to exist. To make a difference, Europe will need more pronounced initiatives, affecting the supply of market finance, the rules for the public and small issuers in capital markets, and a further strengthening of ESMA. It will need to ensure that the massive amounts of household savings find their way to the markets, rather than languishing in bank accounts.
Karel Lannoo is the CEO and Apostolos Thomadakis a researcher at the CEPS think tank in Brussels. This article is based on a policy brief entitled ‘Europe’s capital markets puzzle’, forthcoming from CEPS and the European Capital Markets Institute (ECMI)
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Briefing: An unfortunate lack of ambition