Nick Collier / Jul 2023
Deepening and integrating European capital markets has been an EU priority for a long time. The core economic challenges have changed little over the last couple of decades, but progress has been mixed.
Banking versus capital markets
There are two main issues. The first is the dominance in the EU of banking finance. Europeans save a lot, but they tend to save in deposits rather than real assets such as equities or infrastructure, and they tend not to have large, funded pensions. This means that financing for corporates and particularly small and medium-sized enterprises (SMEs) or start-ups tends to come more from banks rather than from venture capital, private equity, or long-term investors like pension funds.
There is of course nothing wrong with bank lending, but the system would be more stable with a more diversified mix of bank and capital market funding, as in countries like the US (or indeed some EU member states like Sweden and The Netherlands). The comparison between banking and capital market finance in the US and EU is striking, European corporates are roughly twice as dependent on bank financing as their US counterparts.
The second issue is the lack of scale. Where Europe does have equity markets or even start-up specialist markets, they are national and lack the scale of US markets. Europe has dozens of stock exchanges and hundreds of trading platforms. Liquidity is very fragmented. Many commentators note that start-ups, therefore, tend to go to the US market for financing and ultimately for IPOs.
The capital markets union (CMU) project
The Capital Markets Union project promoted by then UK Commissioner Hill in 2014 was a renewed attempt to push the capital market agenda forward. But as the think tank New Financial has reported, EU and indeed UK capital markets have continued to shrink compared to other global markets. The current Commission has recognised that progress was slow and that “Brexit and the Covid crisis have injected a new sense of urgency into the CMU project” and launched a fresh initiative in 2020.
This initiative is now drawing to a close under this Commission and Parliament. Some progress has certainly been made - the co-legislators have agreed to changes to listing rules, to market structure (MIFID/MIFIR), and to set up a new EU reporting repository (ESAP - European Single Access Point) for corporate data. But proposals to encourage EU-wide personal pensions have not delivered much. Reforms to harmonise national insolvency laws and withholding tax are finally underway but are likely to take a long time to agree and implement. Commissioner McGuinness recently blamed member states for not doing more.
Building EU capital markets from the bottom up
Perhaps we need to take a longer-term perspective. Europe needs time to build the C in CMU. At the City of London Corporation, we discussed CMU in a recent panel event in Brussels, where the New Financial presented their recent excellent report calling for bottom-up reforms, particularly to develop private pensions. Some countries do this well and provide a model for others. Encouraging young people to save in long-term assets, perhaps via Auto-enrolment in pensions is the key.
The outcome might initially be rather decentralised or polycentric capital markets across Europe. This is not necessarily a bad thing - and arguably better than infighting between EU centres over who replaces London. But it does raise the thorny question of balancing local market dynamics with harmonised and convergent EU standards. Many larger industry participants would like to see, for example, centralised supervision in ESMA of at least the bigger parts of EU market infrastructure. ESMA is widely thought to have done a good job of ironing out differences in supervision. But many national entities such as exchanges and smaller firms, often supported by member states, view this move to centralised supervision with suspicion.
The next phase: CMU 3.0?
So where do things stand now? Well, there does seem to be momentum for a third CMU push. The Euro Summit in March called for “stepping up collective efforts, involving policymakers and market participants across the Union, to take forward the Capital Markets Union”. But details remain scarce. This looks like a topic for the next Commission. And maybe there needs to be some external nudge before we see progress.
One possible nudge might be the need to finance the green transition. There is considerable interest, for example, in green securitisation as a supplement to green bank loans. Another might be further consolidation in the industry and political support for European scalable capital market champions to compete with Asia and the US. And finally, there is always the possibility of a technological Great Leap Forward, with, for example decentralised forms of innovative finance bypassing traditional national markets. My money will be on a new push by the next Commission that presses all these buttons.