Covid-19 has lent a new-found urgency to the Capital Markets Union. The increasing recapitalisation of companies, a financial landscape that requires significant government support, both from a state and EU level, as well as increased corporate debt, could create a fairly significant drag on the recovery. SMEs will struggle with high levels of debt over extended periods, which could lead to increased restructurings across Europe, or recapitalisations that may require significant equity or debt write-offs.
To Michael Cole-Fontayn, Chair of the Association for Financial Markets in Europe, this precipitates the need for new mechanisms and thinking at an EU level. “The combination of the Commission’s agenda focused on green finance and digitalisation, Brexit, and the pandemic all come together to make the CMU even more important and urgent.” To Cole-Fontayn, the sourcing of this finance from market-based sources, alongside the more traditional bank finance in Europe, is critical to the recovery of European economies and corporates.
The combination of the Commission’s agenda focused on green finance and digitalisation, Brexit, and the pandemic all come together to make the CMU even more important and urgent.
While a number of initiatives and mechanisms have already been put in place, such as pan-European investment funds and growth funds, a shift in thinking is also needed. Rick Watson, Head of the Association for Financial Markets in Europe’s Capital Markets Group, highlights that even though many corporates across Europe are aware that equity is key, they are reluctant to give up control of the business.
Julie Becker, Chair of the Luxembourg Capital Markets Association, emphasises that financial literacy is key for this shift in mindsets to be effective, not only for retail investors as is often spoken of but also for SME owners to be able to understand the various financing options available.
Beyond the shift in mindsets that is necessary, Brexit is likely to lead to some inevitable restructuring and recalibrating of Europe’s capital markets prior to the completion of the CMU. Notably, the revised CMU action plan highlights the need for the EU to further develop critical market infrastructure and services for financial organisations that are developing within the EU.
Tapping the traditional equity markets, even though it sounds like the right solution, is frequently a non-starter with many who would rather take drastic measures such as shrinking parts of the business or other restructuring alternatives.
To Becker, the “CMU should ensure that an EU equivalence regime preserves market stability, as well as open and competitive global markets.” Cole-Fontayn says that while capital market participants have been hoping for the best, they have also been preparing for the worst. The need for substance within the EU has, for many, caused “a fragmentation of capital liquidity technology budgets, as well as the movement of roles and responsibilities from being significantly based in London to being increasingly based in the EU.” This movement of budget and roles can create a significant opportunity for the EU at a time when it is most needed.
Watson, however, provides a word of warning; pointing out that while some aspects could be a boon, a challenge that is set to arrive is the size of the pot in the EU minus the UK. Private pension money, a significant source of investable capital, is lacking in the EU. Overall, private pension savings in the EU28 (calculated before the EU left the UK) amounted to approximately $4 trillion, the majority of which, roughly 85%, is held in Scandinavia, the Netherlands and the UK. “Remove those and the pot of private pension investable capital sitting in the EU 27 falls to less than a trillion. It’s just far smaller than what is needed to support a vibrant capital markets ecosystem” states Watson. Therefore, while growing capital market infrastructure is critical, growing volume within the EU boundaries is also needed to sustain the recovery. To Cole-Fontayn, this lack of investable pools of capital is a clear issue that can only be truly solved by “improving the efficiency, connectivity and competitiveness of the securities market.”
In line with the EU’s New Green Deal, any recovery should be sustainable and aligned with the “Build Back Better” campaign. Long-term sustainable growth ambitions are a core aspect of the CMU action plan and in line with this a number of new regulations such as the Taxonomy and Non-Financial Reporting Directives, among others have been put in place. Additionally, the Recovery and Resilience Facility and EU SURE instruments are at the heart of the EU’s planned recovery.
The facility, which will provide €672.5 billion in loans and grants, is guided by four dimensions – environmental sustainability, productivity, fairness and macroeconomic stability. The first and third EU-SURE issuances were 13 times oversubscribed, while the second was 11.5 times oversubscribed. Becker notes that “strong EU capital markets, through the CMU, will help maintain Europe’s leading position in sustainable finance.” Cole-Fontayn adds that “the proposal to set up an EU wide platform as the European Single Access Point to provide investors with access to not only financial, but sustainability and green related information, should certainly steer more investments towards sustainable objectives.”
While many note that the CMU is critical to achieving true pan-European recovery, there are still harmful regulatory and structural issues that undermine the overall development of a pan-EU capital market. These include, structural inefficiencies embedded within MiFID II, the relative immaturity of the STS securitisation framework, the lack of investable pools of capital, challenges surrounding Solvency II and insurers being discouraged from investing in riskier assets, and significant material differences across EU member states individual capital markets.
Confident that Europe’s capital markets will be best served if policymakers continue to identify areas where further harmonisation can remove unnecessary barriers to cross-border investments.
Cole-Fontayn addresses the issue succinctly, noting that “we have strong French Capital Markets, Italian domestic capital markets, Spanish domestic capital markets, and strong Luxembourgish capital markets, but when you put it all together, you say ‘how does this all add up to an EU capital market?’”
While individual member states across the EU are committed to the CMU, competing national measures, such as details of insolvency law and withholding tax legislation, also hamper the uptake. For Becker, the clear challenge that comes to mind is “to establish a more market-oriented regulatory framework that enables the political objectives to deliver on the economy.” Becker notes that she is “confident that Europe’s capital markets will be best served if policymakers continue to identify areas where further harmonisation can remove unnecessary barriers to cross-border investments.”
The fundamental anchors that underlie the success of the CMU, and ultimately the recovery of Europe, include a number of factors such as, the ability to transfer loans cross-border, growing the proportion of the economy invested into market instruments and the percentage of household savings into instruments across Europe. Fostering the growth of the FinTech community will be critical to increasing market efficiency and job creation.
We have strong French Capital Markets, Italian domestic Capital Markets, Spanish domestic Capital Markets, and strong Luxembourgish Capital Markets, but when you put it all together, you say ‘how does this all add up to an EU Capital Market?’
Finally, engendering a culture of risk capital across Europe cannot be understated. Small businesses must be encouraged not only to go public, but to search for growth across markets. Here, according to Watson, while “public markets are an important part of the puzzle, there’s certainly a lot of room for private capital and financing.”
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