- Olivier Guersent – Director General, DG Financial Stability, Financial Services and Capital Markets Union, European Commission
- Yves Mersch – Member of the Executive Board, European Central Bank (ECB) and Chair, Euro Retail Payments Board (ERPB)
- Michael Cole-Fontayn – Chairman, EMEA, BNY Mellon
- Alex Wilmot-Sitwell – President Europe, the Middle East and Africa, Bank of America Merrill Lynch
- Steven Maijoor – Chair, European Securities and Markets Authority (ESMA)
- Edwin Schooling Latter – Head of Markets Policy, Financial Conduct Authority (FCA)
- Marc Antoine Autheman – Chairman, Euroclear
- Lorenzo Bini Smaghi – President, Société Générale
- Yann Le Pallec – Executive Managing Director, EMEA Ratings Services, Standard & Poor’s Ratings Services
- Karl-Peter Schackmann-Fallis – Executive Member of the Board, Deutscher Sparkassen- und Giroverband (DSGV)
- François Villeroy de Galhau – Responsable de mission, Ministry of Economy and Finance, France
The short term priorities of the Capital Markets Union have the potential to support growth and financial stability, provided some obstacles are lifted
The speakers on the panel generally supported the Capital Markets Union (CMU) project, considering that it has the potential to foster economic growth and job creation by better diversifying the funding of EU companies and enhancing financial stability by better allocating risks across the EU.
The short term priorities identified by the EU Commission in the CMU action plan were welcome, particularly the review of the Prospectus Directive, aimed at better taking into account the needs and characteristics of SMEs and the launching of an EU market for simple, transparent and standardised securitisation (STS). Some other areas of financial regulation in which reforms are already under way, such as investor protection and asset management, were also mentioned as potential contributions to the achievement of the CMU.
Some necessary conditions for the short term priorities of the CMU to be successful were however highlighted by the panellists. Ensuring that STS securitisation is attractive both for originators and investors is a key issue, which requires notably proportionate compliance rules and appropriate capital calibrations in the CRD IV and in Solvency II. The Financial Transaction Tax (FTT) was also cited as a potential obstacle to the further engagement of investors in the CMU. The lack or insufficiency of appropriate information and data on SMEs (i.e. regarding defaults) and of appropriate accounting standards is another matter of concern, as well as the reservations of many SME owners regarding the publication of confidential data about their company. The fact that credit information can be produced in different ways ranging from self-attestation to third party certification was however pointed out. Another area requiring attention concerns the MiFID II transparency requirements for non-equities for which the right details have to be achieved in order to maintain secondary market liquidity. Some of these issues are likely to be considered in the review of interactions between existing legislations that has been launched by the EU Commission with a call for evidence in parallel with the CMU action plan.
A panellist moreover suggested that a first step to be finalised by 2017 should be more clearly identified within the CMU action plan in order to show that short term progress is feasible, but a policymaker considered that it would not be possible to achieve other priorities than the development of securitisation in such a short timeframe.
The CMU should be considered as a complement and not as a substitute for bank financing
Some panellists stressed that capital markets cannot be considered as a substitute for bank financing, because many SMEs are too small to issue on the bond market in particular. Capital markets are a complement and a way to diversify the funding sources of SMEs. Moreover the close relationship that banks have with their clients is difficult to reproduce in a capital market environment. A policymaker confirmed that the objective of the CMU is to offer financing complementary to banks particularly in countries where bank financing does not cover all needs and for companies that are not appropriately financed by banks (e.g. fast developing start-ups). In addition banks that may not have the skills or technology to answer all the financing needs of their clients should be able to team up with institutions specialised in capital market solutions to complete the range of services they offer.
A rebranding of the CMU as a “Financing and Investment Union” was suggested by a panellist in order to better illustrate the complementarity between bank and capital markets financing and to ensure the support of countries where bank financing remains dominant. The combination of the CMU and the Banking Union would in effect lead to a “Financial Union” a policy maker pointed out, but there are major differences between the two initiatives since the CMU is a project for developing capital markets in all 28 member states whereas the Banking Union is an “institutional construction” for the Eurozone based on the banking single rulebook.
The longer term ambition of the CMU is to provide a level playing field and a single rulebook for EU capital markets
The overall longer-term benefits that can be expected from the CMU are a deepening and an increased efficiency of EU capital markets, a facilitated access to finance for EU companies and a diversification of funding sources. The CMU should also help to support the Banking Union at a time when there is a certain “entrenchment” of banks behind their domestic borders, an official remarked. It should also facilitate a better functioning of the Economic and Monetary Union by helping to diversify risk across borders and acting as a “shock absorber” in the event of a new financial crisis.
Three criteria were suggested for measuring the achievement of the longer term objectives of the CMU: investors across Europe should (i) all have the same costs when they invest in the same instruments; (ii) have equal access to finance, irrespective of where they are located; (iii) be able to operate according to a single rulebook.
The potential of the CMU could be huge when considering the additional investment that could be generated by more developed EU capital markets, some studies have estimated. A study by AFME suggests that achieving a market capitalisation of EU equity markets equal to 100% of EU GDP could generate an extra € 5 trillion of investment. A panellist believed that this was achievable and proposed that one of the objectives of the CMU should be for EU equity markets to reach such a level of capitalisation by 2020. Another study by the New Financial think tank has estimated that an increase in the size of smaller capital markets to the average EU level would generate an additional € 6 trillion of investment.
Several speakers moreover stressed that the growth in the past few years of European capital markets and particularly of bond markets, shows that the CMU “can work”. The CMU should help to preserve this strong basis and sufficient liquidity in the market. A higher amount of funding is coming from the capital markets at present in Europe than from the new bank loans that are currently being granted, a speaker noted. As a result, EU bond markets are progressively catching up with the US and now amount to about 80% of the US market. In addition the UCITS framework has been very successful in attracting EU and non-EU investors.
Focused regulatory evolutions are needed over time to establish a common set of rules and attract investors to the capital markets
Several potential obstacles to a stronger engagement of investors in the capital markets and to the creation of a critical mass of long term investors in Europe were emphasized. The FTT and the prudential requirements of Solvency II regarding loans, securitisation and infrastructure assets are essential issues that need to be addressed in the short term, some speakers suggested. The buy-in rules of the CSDR and asset segregation provisions of the AIFMD and UCITS V were also cited. Some other obstacles to the further engagement of retail investors in particular were also highlighted. First, there is a potential mismatch between the increasing risk of corporate investments, due to continuous innovation, and the growing risk averseness of retail investors, who are getting older and have a diminishing risk appetite following the financial crisis, a panellist remarked. Moreover retail investors are faced with an increasing diversity and complexity of domestic capital market rules, challenges in exercising the rights related to their investments, as well as potential barriers to accessing the capital markets (e.g. prospectus and asset segregation rules).
In order to solve these issues and generate additional investment for the EU economy, an ambitious long term roadmap is needed, with a combination of regulatory actions and market-led initiatives, several panellists proposed. Regulation should be very much focused on some specific areas likely to support the achievement of the long term objectives of the CMU, an official suggested: (i) improving accounting rules for SMEs to make financial information more comparable and facilitate data sharing; (ii) harmonising securities ownership rules in cross-border trading; (iii) harmonising insolvency laws with a focus on companies, credit institutions and financial market infrastructures; (iv) removing the tax bias in favour of debt that still exists all over Europe. Developing long term investment products that offer some capital protection together with restricted liquidity conditions was also suggested by a panellist building on the European Long Term Investment Fund (ELTIF) concept.
More integrated market infrastructures and further supervisory convergence are also essential for implementing the longer term ambition of the CMU
An appropriate market infrastructure is essential for implementing the CMU. Fostering synergies and evolutions in EU market infrastructures which remain very national is necessary, building on TARGET2 Securities (T2S), a panellist suggested. The design phase of a more effective EU post-trading infrastructure has been achieved with the adoption of the EMIR and CSDR regulations and CPMI-IOSCO standards, even if some issues remain to be fine-tuned. This new framework needs to be appropriately implemented, but the main challenge now is that of ensuring sufficient liquidity in upstream markets another panellist emphasized.
Achieving further supervisory convergence is also essential in order to maintain a consistent approach to the single rulebook and to make sure that rules are implemented and monitored in a consistent way in the key areas of the CMU, several speakers emphasized. This is high on ESMA’s agenda for the coming years but is a challenging task that requires resources and priorities to be identified. A panellist argued that supervisory coordination would not be sufficient for achieving the CMU and that a single supervisor might be required. This however seems very difficult to accomplish in the current “context” of the EU Council, where the views of member states are quite divergent and in the capital markets area, where the acceptance of an abandonment of sovereignty such as the one agreed for the Banking Union seems unlikely, a policymaker stated.
Some panellists emphasized that further consistency of rules and improved coordination among regulators are also essential at the global level and notably between the EU and the US in order to achieve the objectives of the CMU, due to the global dimension of many financial institutions and of their clients.
1. Short term priorities of the Capital Markets Union (CMU)
The short term priorities of the CMU can potentially have a significant positive impact on the EU economy
The speakers on the panel generally supported the CMU project and the short term priorities identified by the EU Commission.
An industry representative opened the discussion by stressing the importance of the CMU described as a "hugely positive opportunity". A successful implementation of the CMU should provide an adequate framework for expanding the availability of finance for businesses while being a genuine path towards the support of SME growth and job creation. The Commission’s Green Paper asked many of the right questions, particularly regarding short-term priorities. However, it is absolutely vital to get the details of these rules right, otherwise there is a risk of failing to reflect the real potential of this "bold initiative". "Obviously it is easier said than done", the speaker emphasized.
Some key short term issues to be addressed in the context of the CMU include the review of the Prospectus Directive, relaunching simple, transparent and standardised securitisation (STS) and achieving the right detail for non-equity transparency requirements in MiFID II.
A market observer stressed the need to fix a first short-term step in the implementation of the CMU to be achieved by 2017. 2019 is indeed "too far away". This relatively remote deadline raises scepticism about the project among many private investors and also raises questions as to why the deadline for the Juncker Plan, which is 2017, is closer than the CMU deadline i.e. 2019, the speaker argued. Having a two-step agenda is essential in order to show to European investors and corporates that real progress is possible in the relatively short term.
In this context, the panellist suggested that a first step, which should be delivered in the two years to come, would be to complete the financial toolbox offered to European businesses. The additions to the toolbox should focus on two axes: (i) debt and credit, and (ii) risk and equity. On the debt - credit axis securitisation should be a priority. This requires legislation from the EU Commission but it is clearly a short-term priority for 2016/17 in order to secure enough room in banks’ balance sheets for SMEs. With regard to the risk - equity axis, many issues remain open, including Solvency II requirements. A key short term priority, in connection with the Junker Plan, is the real fostering of a European Venture Capital market. Venture Capital (VC) markets are domestic at present and VC funds are too small, despite the growing desperate need to further develop cross-border venture capital in Europe.
A policymaker stated that the current intention of the EU Commission is to go forward with the adoption of the Simple, Transparent and Standardised Securitisation (STS) regulation alongside the Capital Market Union roadmap. This is a short-term priority that should be adopted before 2017, because there is a feeling of urgency in both the Council and the Parliament. Other issues will not be resolved until 2019 simply because there is "a great deal of work to be done".
The revision of the Prospectus Directive is an important step forward
A regulator stressed the importance of the Prospectus Directive. The Commission has taken a very worthwhile initiative in undertaking the revision of this directive which has to be viewed as "a real gateway" into European capital markets for many firms. The need to revise the directive can be illustrated by the high number (700) of responses received to the consultation led by the EU Commission and the steep rise in the average length of prospectuses, the regulator believed. The panellist took the example of the French market: the average length of a prospectus that was 11 pages in 1987 has increased to 347 pages in 2014 and there are other similar statistics across Europe.
The current prospectus regime might be the right model for large companies issuing securities on regulated markets, but it is clearly not appropriate for SMEs and smaller players. The time has now come to address this issue ambitiously by elaborating a more proportionate regime for smaller companies.
An industry representative agreed that the review of the Prospectus regime is a very worthwhile initiative, especially for improving the single market aspects of the current framework.
Launching a market for Simple, Transparent and Standardised securitisation (STS) is a key priority
One reason for creating a securitisation market in Europe, an industry representative emphasized, is that due to the high threshold for the issuance of corporate bonds - it costs around € 1 million to issue a Euro denominated bond - SMEs will not get access to the bond market. Creating an investor friendly and issuer friendly securitisation tool is essential for supporting the funding of SMEs in the EU.
An industry representative explained that there are a number of issues that need to be considered in order to achieve simple transparent and standardised securitisation. These new rules regarding securitisation will only succeed if (i) they work for originators, or there will be no supply; (ii) they are attractive for investors, otherwise there will be no demand. Indeed, these rules should not hamper market liquidity and should ensure both adequate investor protection and enhanced transparency.
With regard to the draft proposals issued by the EU Commission, the industry speaker emphasized firstly that regulatory capital calibrations must be appropriate and proportionate so that securitisations are attractive to end investors. Secondly, compliance burdens must not be so onerous that they make securitised assets unattractive for investors. Thirdly, enhanced clarity on the treatment of existing holdings will be necessary, as will be the development of a level playing field for similar instruments such as asset backed securities, covered bonds, etc. And fourthly, the retention requirements for originators must avoid making securitisation unattractive as a business line. In addition, the panellist deplored that the number of banks operating in the area of securitisation is still declining. If these different issues are not addressed, it will mean a "real struggle" to restart the European securitisation market. Issuers and investors should work with the EU institutions to deliver the very best possible outcomes in this important policy area, the speaker affirmed.
An industry representative however stressed that the plan to develop quality securitisation will not come without risk, since securitisation does not remove the risk from the underlying loans.
Information and data availability issues need to be solved with regard to SMEs
A market observer stressed that it is important to focus on small and mid-sized companies when considering economic growth and job creation objectives. These businesses represent about 30% of the European GDP. This is where the CMU should help to construct the right funding channels, in addition to or instead of traditional bank funding.
Moreover, beyond economic growth and jobs a key objective of diversifying the financing of EU enterprises is to enhance financial stability, in order to make the financial system funding the European economy more robust and resilient to a possible new crisis. A concern the market observer however underlined is that information, data and sometimes statistical series, especially regarding defaults and recoveries are only available for larger corporates. Therefore enhancing information availability for SMEs is one of the critical short term elements needed to achieve a successful CMU. This issue relates both to financial statements and market databases and is about keeping track of default recoveries across the Union in particular. This lack of information is a major hurdle to achieving a more resilient financial system. More resilience indeed requires a greater share of funding to be pooled and allocated at the level of the European Union and for this, standardised and consistent information is needed.
Another important issue is adapting the IFRS framework to SMEs. This involves developing a "slimmed down" and consistent version across the EU of some particular types of disclosures that are more appropriate to SME risk profiles and making them available to investors. The public authorities and private companies should also be able to provide much more information particularly with regard to the credit behaviour of SMEs.
With respect to credit information on SMEs, an industry representative added that non-financial companies have reservations about publishing confidential data, which limits transparency.
A policymaker however believed that there are various ways to operate a system for producing credit information, ranging from self-attestation by the originators to third party certification. While self-attestation is fine, there are a number of issues associated with third party certification but that supposes that the data is reliable, standardised and easily accessible.
Several on-going actions in the capital markets area should contribute to the objectives of the CMU
A regulator stressed that the post crisis regulatory reforms indeed already contain many elements which are relevant for the CMU.
Several speakers stressed that for instance, the calibration of pre and post-trade transparency requirements in MiFID II for bonds should be carefully considered, as the right balance needs to be found between improving transparency and preserving the liquidity of the EU bond market. This transparency regime is "incredibly important" for the secondary market liquidity of the bonds concerned, a regulator emphasized. Approaches which might unnecessarily "catch" illiquid instruments into that transparency regime making them difficult to sell should also be avoided.
Another area where rules and regulations from the past few years are very important for the CMU is investor protection, a regulator emphasized. The preparation for MiFID is "a really important step" to make the CMU work in this regard. Investor protection rules are essential building blocks to ensure that both retail investors and households participate more actively in the capital markets, therefore they need to be specified as accurately as possible.
Another sector that is important for the CMU but less frequently mentioned is asset management, the regulator pointed out. Europe has indeed been quite successful in developing a pan-European asset management sector, with the setting-up of a passporting system. Passports are however more on the fund or back office side. Markets and the offers made to investors are still very national. Improvements could be made in the asset management sector with more transparency, more European-wide competition and more technology, the regulator considered.
A policymaker confirmed that some parts of the CMU are a continuation of on-going actions. This is the case of MiFID but also of the "sanity check" that is planned to be launched around the same time as the CMU, with a call for evidence about the unintended interactions between the various legislations put in place following the crisis. This will help to "detect and cure" the issues and interactions that have "material unintended negative effects".
The CMU should be considered as a complement (and not a substitute) to bank financing
An industry representative was of the view that the CMU proposals do not necessarily correspond to a real need in the market and "might not really be helpful for SMEs". Secondly there is a mismatch between the proposals made in the CMU to develop more market financing for SMEs and the reality of market financing. For example, in Germany, the data shows that the average size of bond placements for mid-sized companies was around 50 million euros in 2011 and 37 million euros in 2013. Moreover a best practice guide of the German Stock Exchange suggests an annual turnover of at least € 100 million for a bond placement. This is far beyond the size of SMEs as defined by the European Commission i.e. a maximum balance sheet size of € 50 million. In comparison, the average amount of bank loans is about € 0.5 to 1 million. These figures show that the CMU proposal does not suit the requirements of the real economy and in particular of SMEs, the speaker claimed. Although one can be supportive of the objectives of the CMU, capital markets cannot be considered as an equal replacement for bank loans. Another issue is the relationship between banks and the companies they finance, which is difficult to reproduce in a capital markets environment.
A policymaker emphasized that the CMU is not a proposal that "runs against" bank financing. That is "neither the goal nor the reality". It is about offering complementary financing services to the industry particularly in two types of cases. Firstly, there are countries where bank financing does not cover all funding needs and where capital markets may supplement bank financing in some areas. Secondly, even in countries where there is no quantitative issue of credit availability, all types of financing needs may not be suitably addressed by bank loans. This is the case for example of capital injections in fast developing start-ups. The founding idea of a CMU is to propose complementary financing, not to replace traditional bank financing.
The CMU also offers opportunities for banks specialised in SMEs, which do not have the necessary skills or technology to satisfy all the needs of their clients related to capital markets, to team up with institutions able to offer such services, the policymaker suggested. Banks know their clients and have information about them but they do not systematically have all the competencies or technologies required to address their financing needs. Such partnerships should work to the benefit "of everybody", including the banks but first and foremost their clients.
An official added that even when the funding side of the European economy has been rebalanced, Europe will remain a predominantly bank funded economy, so the health of banks is an important element.
An industry representative agreed that banks "should not be afraid of the CMU". In the US, where there is a CMU, banks are still lending but they have the additional possibility to sell their securitised loans on the market. Therefore, to some extent capital markets may even support small banks.
A market observer agreed that the CMU is a very welcome project for corporates in Europe and that capital markets and banks provide complementary sources of financing. In this perspective, "the Financing and Investment Union" seems a better name than the Capital Markets Union. There are two reasons for this. The first is that capital markets are only one aspect among others of financing, which also includes banks in particular. Secondly a Capital Markets Union is unlikely to gain much support from politicians across Europe because of the explicit reference to capital or financial markets, but a "financing and investment union" would raise interest and support in the public opinion. Moreover the concept of a Capital Markets Union raises concerns, especially in Germany and Italy where bank financing is more important compared to other sources of financing than in other EU countries such as France and the UK. It is important not to push SMEs out of the banks’ balance sheets. All businesses in Europe should be able to diversify their sources of financing, but the objective is not a forced deleveraging within banks or dis-intermediation; there should be a demand-driven diversification of funding resources.
A policymaker explained that the initial name proposed by the EU Commission for the Banking Union was the Financial Union, because the Banking Union was considered as a first step towards a broader Financial Union. In the end, President Barroso decided that Banking Union was a more powerful term. In effect, a Financial Union is the combination of the Banking Union and the Capital Markets Union. There is some confusion about the name of the CMU because the very nature of the CMU is different from the Banking Union. The Banking Union is nothing but an institutional construction based on the banking single rule book. The CMU is of a fundamentally different nature. It is a project for the 28 member states. One of the reasons is that a successful CMU requires the City of London and its expertise and skills, but it is also a project that has a specific dimension for the Eurozone and one must be careful about the risks of fragmentation.
A regulator added that the CMU tries to bring together very different parts of the financial system therefore it is not as homogeneous as the Banking Union.
2. The longer term perspective and the ambition of the CMU
An official moved the discussion onto the longer-term goals and the ambition of the CMU.
The CMU addresses multiple issues. The overall benefits that can be expected from the CMU are a deepening of EU capital markets, an increase and a diversification in the access to funding sources and making markets more efficient. The CMU is also supporting the Banking Union at a time when there is a certain risk aversion and domestic entrenchment from banks. The CMU is also supportive of a better functioning of the Economic and Monetary Union because it should help to diversify risk across borders and therefore operate as a powerful shock absorber which will be supportive of monetary policy. The CMU is broadening the concept of financial stability beyond the banking sector to cover the whole financial industry. Moreover it attempts to address the specific needs of the European Union, such as infrastructure financing, and the specific structure of the European economies that have a disproportionate share of SMEs. With regard to the pensions area, new instruments would be necessary also to channel savings.
The official agreed with the concept of a funding and investment union suggested by another panellist. On the supply side, the CMU is a funding union; on the demand side, it is an investment union. In a genuine single market capital should be allowed to flow freely and should be allocated efficiently without cross-border barriers or frictions linked to the location either of the resources or of the actors. As this is not happening at the moment, regulatory action is required.
A market observer commented about the importance of the EMU (Economic and Monetary Union) dimension in the CMU. It was not in the first Green Book, but was in the Five Presidents’ Report of June. The CMU should be a 28 member states project, but for the 19 member states of the EMU it is a "must-have" project. A financial union is indeed necessary in order to have a safer monetary union.
An ambition to provide a level playing field and a single rulebook for EU capital markets with some key harmonisation priorities
Regulatory action to achieve the CMU should be based on a simple but appropriate legal and regulatory framework with the aim to provide a level playing field, an official stated. At the same time, markets should be allowed to both integrate and develop further in Europe. Three "factors" can help to measure the achievement of that aim: (i) ensuring that investors across Europe all have the same costs when they invest in the same instruments; (ii) having equal access to finance irrespective of where investors are located; (iii) investors should be able to operate according to a single rule book. Moreover it is important not to lose sight of the original ambition of the CMU and to set very clear milestones and deadlines for the short and longer term.
A combination of market-led and regulatory initiatives is needed to better promote capital markets, the speaker emphasized, and the regulatory agenda should be complementary to market led initiatives. Regulation should be very much focused and prioritised on some areas for the CMU action plan to be successful: (i) in the area of accounting law, the priority should be to improve the accounting rules for SMEs across borders to make them more comparable and to facilitate data sharing; (ii) in the area of securities law, the priority should be given to ownership rules in cross-border trading; (iii) in the area of insolvency law, the focus should be on the companies, credit institutions and financial market infrastructures which are the underpinning elements of the CMU; (iv) with regard to tax law, withholding tax is an important component, but the highest priority is to remove the debt-equity tax bias in favour of debt that still exists all over Europe.
It is possible to have functioning capital markets in the EU without necessarily harmonising insolvency laws and every part of the tax regime, a regulator believed, but that should not be a reason for not tackling inconsistencies in regulations or legal structures which may cause obstacles. The CMU should be about capital flowing freely so that it is allocated efficiently and about preserving a level playing field.
A market observer considered that further harmonising insolvency law is clearly a very difficult task but it would greatly help especially on the equity side.
Building on the current success of EU bond markets
Several speakers stressed that European capital markets and particularly bond markets have been successful in the past few years. This is a strong basis for developing EU markets further that should be preserved in the CMU project.
A regulator considered that it is reasonable to say that the CMU can work based on the current state of EU capital markets. Capital market flows at this stage are higher than banking flows in Europe and the new bank loans that are currently being granted correspond to a lower amount in total than the funding that is coming from the capital market. There are other positive elements. The UCITS framework has been very successful in attracting investments and investors, not only from Europe, but also from outside Europe. In the post-trading area, there is a move towards "an OTC derivatives union" with very consistent regulation and supervision.
A market infrastructure operator emphasized that there is a fast growing capital market in Europe. This has been partly concealed because of bond deleveraging which has basically capped the size of the bond market, but in the last ten years the EU corporate bond market has been catching up with the US. Before it corresponded to 50% of the US market but it is now close to 80%. Several factors are supporting the expansion of EU capital markets, the speaker stated: a strong increase of cross-border capital market reforms, a strong international demand and the fact that large corporates have turned to bond markets spontaneously. This is why some issues such as making sure that the liquidity remains strong in this market are of the utmost importance. Capital markets do not have to be created in Europe, they are going well and just have to be supported. The first consideration therefore, is "not to hurt" with the CMU what is going well, the speaker suggested.
Market infrastructures are essential for the success of the CMU and for increasing the efficiency of European capital markets
The CMU is not only about regulation, an official claimed. An appropriate market infrastructure is also essential for implementing the CMU. The existing capital markets infrastructure needs to be revisited to a certain extent as it is still partly national. Fostering synergies and evolutions across EU market infrastructures is necessary, building on TARGET2 Securities (T2S) in particular, in order to increase the efficiency of European capital markets.
A market infrastructure operator explained that the design phase of the EU post-trading infrastructure has been completed and the issue now is the implementation of the rules that have been defined. There is now a single regulatory regime for all Central Security Depositories (CSDs). A single detailed set of standards has been set up by CPMI and IOSCO and there will soon be a unified infrastructure in the Eurozone for the settlement of securities transactions with T2S. Some issues such as the settlement of conflicts of laws regarding securities laws still need to be resolved, but these are relatively secondary for the success of the CMU. What is essential is to make sure that there is growth in capital markets upstream. In the past, the bottleneck was downstream in the post-trading infrastructure. Now, there is a risk of a bottleneck developing upstream because liquidity in some markets is not sufficient and because the tax regimes in Europe are not "friendly" enough to equity investments.
Further supervisory convergence at the EU level is necessary for achieving the CMU
There is a need for more supervisory convergence in Europe, an official emphasized. There is some evidence of "backlash" in the banking area now that a single supervisor has been established. National level legislators have tried to claw back some of the competencies that they have lost through the SSM regulation (Single Supervisory Mechanism).
There was a very strong body of views in the responses to the CMU consultation that although the European Supervisory Authorities (ESAs) probably have the right set of powers in the regulatory area, supervision should be made more consistent. Much emphasis, many resources and thought are currently being put into improving supervisory convergence and conducting peer reviews within ESMA so that there is a consistent approach to the single rule book.
Supervisory convergence should be high on the list of ESMA priorities in the coming years, a regulator considered. The agenda has been very much focused on the single rule book in recent years, but what needs to be done when a rule has been agreed should not be underestimated. Once a rule is agreed at the EU level, it is then assumed that it will be implemented consistently across the various member states. However, on the basis of peer reviews, it can be seen that very similar rules are supervised very differently, with different intensity and different concepts. Therefore, supervisory convergence is due to become a bigger part of ESMA’s work in the coming years. That does not mean that convergence is needed in all areas, priorities need to be established. Bringing together supervisory practices will however take both resources and time and is to a certain extent more difficult than achieving common rules because rule making is much more visible and likely to lead to a tangible result.
An industry representative stressed that there are processes in place to develop common rules, but a consistent and fair implementation of these rules requires further progress and the action of ESMA must be enhanced in this area. It is right to say that the EU Commission should be ambitious with the CMU but the issue is being able to implement the CMU with some member states who might think that it is too ambitious. The idea that a CMU can be put in place just by having supervisors coordinating among themselves and without a single EU supervisor is like believing that there can be a monetary union with a simple cooperation of Central Banks. A European Central Bank was needed from the outset and the same position was adopted with the Banking Union. Eventually, this was accepted by EU politicians. Convergence and coordination are good but they can only foster progress up to a point, ultimately it is necessary to have a single rule book and a single regulator. Politicians will have to accept this because it is the only way to support growth in Europe, the speaker stated.
A policymaker agreed that in theory the ambition should be to unify everything in the EU, with a single supervisor, a single securities law, a single insolvency law and a single tax regime. This would be considered as "super ambitious". However, if this was the plan nothing would have happened in ten years’ time. The views in the EU Council are too divergent for things to be done this way. Some of the member states, including some that are part of the Banking Union and Eurozone, may stall the whole process. This is unlikely to be the ambition of the CMU action plan. The maturity of capital markets in Europe is not the same as that of banking markets and the link to sovereignty is not the same. Therefore, the feeling of urgency by political decision-makers is not the same in this area. The abandonment of sovereignty that was agreed for the Banking Union is very unlikely to be accepted for the Capital Markets Union. These are only some of the reasons why the CMU project is different and is not at such an advanced stage as the Banking Union. The idea of the EU Commission is that "it is necessary to walk before learning how to run". When capital markets start to be better integrated, the need, at least in the Eurozone, for a single supervisor may arise and decision-makers may agree that this is a necessity. This is likely to be a long term target, but should not be considered as a lack of ambition.
Coordination is also essential at the global level
An industry representative stressed that from a broader international perspective, a greater focus on the global coordination of regulation would be "extremely helpful" for achieving the objectives of the CMU. Policy makers in the EU and the US need to keep trying to act in a spirit of collaboration in order to remove both the inconsistencies and the overlaps existing in legislation. Divergences can already be seen not only in transaction reporting, clearing and margin rules and pre-trade transparency but also in securitisation and asset-backed finance rules. Achieving a greater harmonisation of the new rules as well as their consistent application across jurisdictions, e.g. through third-country equivalence approaches, would further support the overall success of a CMU.
Another industry representative agreed that regulatory coherence should be encouraged at the global level. Clients are global; clients from the US, Asia, Latin America are doing much business in Europe and European clients are also very active in doing business outside Europe. Ensuring that there are active relationships between US regulators and colleges of European regulators is "absolutely critical" in particular. Regulators should meet and talk to each other and understand that banks operate as global institutions. Getting banks to become simpler to regulate and simpler to resolve and recover is essential. However, helping international financial institutions to "deliver the power of a global franchise" both to global and local clients is also vital for the success of the CMU.
An industry representative agreed that the more regulators around the world can be encouraged to sit together and create a more harmonised and coordinated approach to the functioning of global markets, the better. Many markets and clients are global. Therefore, if there is insufficient coordination and harmonisation, a "huge opportunity" to create a more efficient market place for clients, investors and end users will be missed.
3. The investor perspective in the CMU
Increasing the attractiveness of EU capital markets for investors is needed in order to fully exploit the potential of the CMU
An industry representative outlined the key challenges of the CMU seen from an investor perspective. The CMU has enormous potential because deeper and more integrated capital markets will improve the range and diversity of financing options for investors and issuers of all sizes and complexities. Financing optionality creates the possibility for higher returns for investors and higher rates of investment in the European economy, as well as the potential for greater economic growth, stability, resilience, and sustainability of the economic system and of the players composing it. The CMU will benefit all European countries; those that have large and sophisticated markets for capital, but even more so the investors and issuers of smaller markets who should derive the greatest benefit from access to broader and deeper markets.
The potential figures are "very impressive", the industry speaker emphasized. The Association for Financial Markets in Europe (AFME) calculates that if European equity markets had a market capitalisation equal to 100% of European GDP, which is achievable, there could be an extra € 5 trillion of invested funds. Similarly, the New Financial think-tank calculates that if over the past five years European countries with smaller capital markets had increased the size of their capital markets to the current European average there would have been an extra € 6 trillion to invest.
A fundamental objective of the CMU is to increase the attractiveness of European capital markets for investors. This will create new and additional markets for capital coming into Europe.
The main challenge in Europe from an investor perspective is "some kind of mismatch" between corporate investment on the one hand and savings on the other, a market observer emphasized. It is not a quantitative mismatch because there are abundant savings in Europe, there is even a surplus of savings. But it is a "risk appetite" mismatch. Corporate investment tends to be more and more risky. With continuous innovation the investments of tomorrow will be less material, more creative and more risky. At the same time most savers are cautious in Europe. They are probably becoming even more cautious, because they are getting older and they have lived through the financial crisis, so their risk appetite is diminishing. The real mismatch in the market is qualitative and this is the challenge of addressing the caution of European savers. There are probably two ways of addressing this. The first one is capital protection and the second is liquidity. European savers "will not become Americans", the speaker stated, therefore capital protection should be a key element of the products that the financial industry offers in Europe. Regarding liquidity, the issue may be different, because the liabilities of savers, their expectations and needs are getting longer term. Retirement is probably the main purpose of European savings. It does not make much sense to continue selling a vast majority of liquid products to savers who have in reality long-term expectations. This is a key issue from an investor perspective. Offering some capital protection with longer-term products that may have less liquidity seems to be the best solution to this mismatch. Some proposals of the EU Commission such as the European Long Term Investment Fund (ELTIF) go in this direction.
Some key regulatory obstacles need to be lifted on the investor side to build the basis for a successful CMU
An industry player stated that defining an action plan for the CMU is a very complicated task because "starting a market is very complex by definition". Even if all the criteria and rules needed for starting a market seem to be in place, this may not be sufficient because of some regulatory obstacles. A "dialogue of the deaf" between regulators and the industry should be avoided. On the investor side, the main objective should be to develop a critical mass of long-term investors, which may require some specific measures. Otherwise there is a risk that those supposed to take part in the CMU eventually do not enter the market because of some obstacles that really need to be addressed. Some of these obstacles are linked to the post-crisis regulatory framework, such as the financial transaction tax which may "kill" the basis for creating a CMU. Moreover nothing seems to be done in Europe to promote a greater participation of intermediaries and broker dealers in capital markets. Some other issues such as transparency requirements, capital requirements and bank structure reforms can also be mentioned as potential obstacles to the CMU. A policy-maker however stressed that such criticisms did not emerge so strongly in the consultation on the CMU Green Paper.
An industry representative agreed that it is important not to forget the demand-side of the market in the discussions about the CMU. Customers have to be convinced of the advantage of investing in securitisation products for example. Risk is not removed by securitisation so it has to be made sufficiently transparent. In addition, the banks that will be distributing these products should not be hampered by MIFID requirements which have put a de facto ban on inducements.
A market observer noted that the CMU is largely about non-bank financing. With regard to non-bank investors, the "elephant in the room" is the insurance industry. Consistent and coherent treatment is required not only in bank regulation, but also in insurance regulation particularly in what Solvency II will devise in terms of capital calibration for loans, securitisation and infrastructure investment, both within the Union and also taking into account the consistency with other treatments. Capital requirements are for example much more penalising in Europe for insurance companies than in the US where insurers are already significant providers of funding to the economy, notably in the private placement market.
Considering the longer term the harmonisation of insolvency laws over time is something that would be difficult to do without, the market observer added. Certainly, investors at the European level will want to see that level of consistency, otherwise countries with less creditor-friendly regimes are going to be penalised.
Some key regulatory evolutions and simplifications are needed in EU capital markets in order to attract retail investors in particular
More generally, it is important to understand what dissuades investors from accessing European markets for capital and to tackle these problems in order to achieve the ambition of the CMU, an industry representative stated.
Five themes apply to all investors the industry speaker proposed, but they are particularly relevant for retail investors. (i) A first theme is complexity. European markets for capital are complex. Investors are faced with enormous diversity in processes and practices. The very different national laws and practices relating for example to securities, insolvency, corporate governance, and taxation play an important role in generating this complexity. (ii) A second theme is the exercise of rights linked to investment. Investors face multiple challenges; first, in knowing and understanding what their rights are and secondly in being able to exercise them. This presupposes that investors actually do have rights. National laws and practices may have the effect of deliberately limiting or conditioning the rights of investors located in other countries. The complexity of the environment and the uncertainties about the exercise of rights generate real risks for investors and for the intermediaries acting on behalf of investors. (iii) A third theme is about trust. Public trust in financial services and capital markets in particular must be restored. It is a necessary precondition for the success of a CMU. Creating and restoring trust by giving investors a greater certainty as to their rights and helping increase transparency about rights and how to exercise them, is critical. Two further themes are closely related: one is regulation and the other is access to services. (iv) Regulation is at the heart of the CMU project and affects all financial market participants - issuers, investors, intermediaries, and market infrastructures - in very different ways. Regulation becomes an issue if it creates obstacles for investors and for intermediaries acting on behalf of investors, in accessing the services and products that investors want or need. (v) There are numerous pieces of EU legislation that restrict the access of investors to services and to products. The rules concerning prospectuses and asset segregation provide "credible illustrations". These can have the effect of discriminating between different investors based on residency and asset segregation requirements up the custody chain and may restrict the access of investors to collateral management services.
Actions to lift such obstacles should be part of the CMU action plan, the industry representative emphasized. First, there must be an extension and improvement of the current single rule book. Without a common set of core rules it is not possible to have a CMU for the Eurozone or for the European economic area. There must be a particular focus on market infrastructure because this is the place where different market participants, buyers and sellers, issuers and investors meet each other. More specifically, at the level of core market infrastructure, there should be a very high degree of harmonisation in functionalities and service provision, as well as in market practices and regulatory requirements.
With respect to short term proposals, the EU Commission should take short-term steps to forestall some of the problems from in-flight legislation that may have a particular impact on investors. The most obvious example is the Financial Transaction Tax proposal. Other examples include the buy-in rules in the CSD regulation, some requirements in the money market fund regulation and possible variations and interpretation of the asset segregation provisions of AIFMD and UCITS V.
With regard to the longer term, the EU Commission should be very ambitious, the industry representative believed. The list of what can be done is long and contains some very difficult topics. But the difficulty in some cases is a measure of the benefits that can be achieved. This list should include work on instruments and tax treatment i.e. tax processes, insolvency and securities laws, as well as securities registration and shareholder identification processes. These are all areas to be addressed in order to achieve the objectives of the CMU. The Commission should also take steps to correct the anomalies in current legislation. The recent EMIR consultation has highlighted those parts of EMIR that have the effect of creating silos and segmenting markets by, for example, restricting the use of tri-party collateral management services. This is a critical component of some of the liquidity issues that exist in the market.
In conclusion, the Capital Market Union project has significant potential and it is a great opportunity both for the citizens of Europe and for powering economic growth, as well as for the financial sector. But it does need a clear vision and a clear direction of travel.
The industry speaker suggested three elements which might support that vision: (i) a goal of raising European equity market capitalisation to 100% of GDP by 2020: (ii) the CMU has to be inclusive in offering opportunities and benefits to investors and issuers across the 28 member states. Market infrastructures along with the capacity to innovate will be critical in this regard; (iii) the CMU has to both recognise and deal with the reality and the diversity of Europe and its economies.
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