In the wake of the financial crisis, the EU announced the Capital Markets Union (CMU) initiative, with the objective of reinstalling financial and economic stability. Following its mid-term review in June 2017 and the introduction of new initiatives, will this drive any progress towards this goal? What does the future hold for the CMU? In this article, Tanja Schrum of the Market Advocacy team explore where things currently stand
In the wake of the global financial crisis, European Union (EU) regulators turned their focus to reinstalling financial and economic stability. This was done in several ways, not least through the creation of the banking union and the introduction of the single supervisory mechanism and recovery mechanisms for failing banks. These measures however, came at the cost of Europe’s economic growth, which was sluggish in comparison to that of the United States.
In an effort to stimulate the economy and further integrate Europe’s capital markets, the EU announced the Capital Markets Union (CMU) initiative in 2015 – with the objective of providing new sources of funding for small and medium-sized enterprises (SMEs), and to reduce the cost of raising capital, at a time when banks were deleveraging. The over-arching strategy for achieving this, inter alia, is by reviewing EU corporate bond markets – focusing on improving market liquidity – producing initiatives that serve to strengthen public markets, supporting equity financing and revaluating the regulatory barriers to SME admission on public markets and SME growth markets.
Hence, the CMU initiative is important to the financial industry and its clients because market participants like investors and issuers will have a broader horizon of opportunities. However, the success of the CMU’s activities thus far remains uncertain – its effect on Europe’s capital markets will not be seen for many years.
The state of play
Certainly, progress has been evidenced in some areas of CMU’s original action plan. Legislation aiming at reviving the market for high-quality securitisations, the simplification of prospectuses (documents which provide details about an investment offering for sale to the public) making it easier for small companies to access capital markets, and regulation creating a new regime for European venture capital funds and European social entrepreneurship have been adopted by EU regulators. Nevertheless, adoption does not necessarily mean implementation. Banks and other market participants will now have to incorporate the new rules into their business. As such, it is too early to judge how the new regulations will work in practice.
In the interest of continuously improving its work, the CMU underwent a mid-term review (see box-out for developments) in 2017. The result of this review was the production of a number of new initiatives which sought to broaden the CMU’s remit and augment its efforts to safeguard Europe’s investors and foster the market’s integrity.
Lessons learned and the way forward
Perhaps the most significant of all these developments is the regulation which looks to amend the role of the European Securities and Markets Authority (ESMA), as well as the other European Supervisory Authorities (ESAs). It is important because, only by promoting effectiveness and consistency of supervision across the EU can the creation of a true capital markets union become possible. A lesson learned from the past is that even harmonised legislation can still lead to diverging national outcomes when enforcement and supervision lie in the hands of national competent authorities (NCAs).
While 2017’s mid-term review represented some positive steps toward the CMU’s original objective, there remain some roadblocks to overcome. In fact, certain trade barriers identified by the European Post Trade Forum (EPTF) – established in 2016, delivering its final report in 2017 – have not yet been addressed by CMU regulation. Other legislations proposed by the CMU – such as a directive on business insolvency and early restructuring and the Common Consolidated Corporate Tax Base (CCCTB) – were delayed. As such, the work on the completion of CMU is as important as ever: capital markets continue to play a rather small role in Europe (compared to bank lending) and there is still a strong home bias in EU member states (according to articles such as “Making a reality of Europe’s Capital Markets Union” by Sapir, Veron, and Wolff published in April 2018).
Evolution of the CMU
The 2017 mid-term review introduced a number of important initiatives to the CMU agenda:
1. A directive on non-performing loans (NPLs) was introduced that is designed to reduce stocks of NPLs and prevent their future accumulation. The legacy stock of troubled assets and distressed loans accumulated by European banks is still one of the major impediments to a full economic recovery and increase of credit supply in some EU Member States. It is also hindering the ongoing political negotiations on the establishment of a European Deposit Insurance Scheme (EDIS), which is the missing pillar of the European Banking Union.
2. A legislative proposal on cross-border distribution of investment funds was issued, with the aim of mitigating current barriers asset managers are facing, such as diverse tax regimes across jurisdictions and national barriers on clearing-settlement and custody services.
3. A legislative proposal on covered bonds, harmonising criteria for covered bonds across member states and strengthening investor protection.
4. A regulation on crowdfunding introducing a minimum standard of safeguards for consumers and establishing enhanced transparency to navigate the associated risks of crowdfunding – which broaden access to finance for innovative companies, SMEs, start-ups and other unlisted firms.
5. A regulation on the law applicable to the third-party effects of cross-border assignments of claims. When a securities issuer and the corresponding investor are located in different EU countries – or even when claims are used as cross-border collateral – there can be legal uncertainty surrounding the cross-border securities’ rights.
6. A regulation introducing more proportionate and risk-sensitive rules for investment firms.
7. A regulation which looks to amend the role of the European Securities and Markets Authority (ESMA), as well as the other ESAs.
8. A regulation on pan-European personal pension products, which hopes to boost personal investments into the capital market.
9. Although formally outside the CMU, proposals such as the Re-Fit proposal on European Market Infrastructure Regulation (EMIR), the new framework for the recovery and resolution of central counterparties (CCPs) and a proposal on CCP supervision serve as a complementary action plan.
10. Increased focus on sustainability, resulting in a 2018 publication of a first set of legislative proposals, looking to create a respective taxonomy and channel investments into renewables and energy efficient areas.
What does the future hold for the CMU?
A full and proper implementation of the CMU agenda would require an upheaval in national laws and, ultimately, a transferal of authority over capital markets regulation to a pan-European body.
Undoubtedly, this level of upheaval was not part of the CMU’s vision when it launched in 2015. However, its agenda has since broadened to include a commitment to galvanizing the powers of ESMA and of the other ESAs. In principle, agreement among the EU 27 should be achievable in many areas, as unlike prudential supervision, the implementation of capital markets rules does not predominantly imply fiscal responsibilities.
In other domains it will be more challenging to achieve full harmonisation. For example – due to the fact that countries have different regimes – how to handle withholding tax is considered one of the biggest barriers. A joint approach of all EU member states will not be possible without further legal changes, as well as a shift in national determination.
A most important task
Despite these difficulties encountered along the way, the most important task for the CMU remains the same as it was in 2015 – to remove the regulatory and legal barriers that are discouraging cross-border investments and slowing the growth of Europe’s capital markets. This particularly includes those legislative areas that frame the operations of capital markets, and where a lack of convergence can still be observed.
Certainly, a significant step towards this goal will be to abolish the remaining road-blocks identified by the Giovannini Group in 2001’s report, as well as to address the barriers identified by the European Post Trade Forum (EPTF) group. These barriers include those that relate to national differences in technical requirements/market practice, national differences in tax procedures and finally, barriers that relate to issues of legal certainty. Eight of the twelve remaining barriers need EU Commission or EU Member State engagement to be dismantled.
While the CMU faces the challenge of abolishing the barriers to economic growth, it must also ensure that its own regulatory agenda goes far enough. In the past, this has not always been the case. For example, an EU wide Initial Public Offering (IPO) still needs to be approved by the supervisory authorities of each member state. In addition, an issuer who wants to be listed on another market still needs the approval by its home supervisor.
How is the prospective Brexit changing the environment?
The CMU might have been perceived as an incentive for the UK to remain in the EU – given the UK’s dominance in the European Capital Markets. However, Brexit could now be viewed as an even greater justification for the EU to pursue the goals of the CMU, in order to establish strong centers in the continent that can compete with London.
While the Brexit decision was a setback to some CMU initiatives, the UK has been a consistent and powerful voice against supervisory integration. As such, it is likely that agreement on certain measures will now become easier among the remaining EU member states. And, if UK-based firms lose their EU passporting rights, it is possible that capital market activity could migrate from London to EU 27 locations. Indeed, there is a strong case for the CMU project to continue after the UK leaves the EU.
The building blocks that CMU has laid down are due to be in place by 2019, with full and proper implementation part of a longer-term plan. To achieve complete implementation of the various CMU initiatives, it will be required that the new EU Commission will pursue the topic after the European Parliament elections in May 2019. The future of the European capital markets is being reinvigorated now.
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European Commission (2015a), “Green Paper: Building a Capital Markets Union”, COM (2015) 63, 18 February
European Commission (2015b), “Action Plan on Building a Capital Markets Union”, COM (2015) 468, 30 September
European Commission (2017a), “Communication from the Commission on the Mid-Term Review of the Capital Markets Union Action Plan”, COM (2017) 292, 8 June
European Commission (2018a), “Sustainable Finance Commission’s Action Plan for a greener and cleaner economy”, press release, 8 March.
Xafa, M (2018), “Where we stand on European Capital Markets Union”, CEPR Policy Portal, 17 April
Guide to Going Public in Europe: http://www.europeanissuers.eu/_lib/presentation/Online_Guide_To_Going_Public_2015.pdf
Andre Sapir, Nicolas Veron, Guntram B. Wolff (2018), “Making a reality of Europe’s Capital Markets Union”, April 2018
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