Despite progress made since the European Union’s first Capital Markets Union (CMU) action plan in 2015, and second action plan in 2019, Europe’s capital markets remain fragmented and underdeveloped compared with other geographies, in particular the United States.
Aggregate market equity capitalisation equates to 81% of GDP in the European Union compared with 227% in the United States. And bond markets in the euro area are still three times smaller than in the United States, while EU venture capital lags significantly behind the United States, at just one-fifth of the size, all according to the ECB.
Jeanne Aing, Head of Regulatory Anticipation at BNP Paribas CIB, notes: “The next legislative cycle starting this year will offer an opportunity to galvanise all stakeholders around the Capital Markets Union, including banks, which will have a key role to play in funding the green and digital transitions, to support the real economy and help companies compete on the world stage.”
In a recent speech in November 2023, Christine Lagarde reiterated the need for all European citizens and firms to have access to funding, together with the pressure to improve the efficiency and risk-sharing opportunities of the financial system in general, putting the CMU along with the EU’s competitiveness among the top priorities on the Eurozone’s agenda.
“I have argued that there is a compelling collective interest in taking a more ambitious European approach to establishing a capital markets union. In the changing circumstances we face today, where the challenges of deglobalisation, demographics and decarbonisation are looming larger, integrated capital markets are integral to our success… Faced with such an immense financing challenge, the moment for action is now. So I encourage all of us to be bold and not to let this moment pass.” [extract from Christine Lagarde’s speech, November 2023]
❝ The next legislative cycle starting this year will offer an opportunity to galvanise all stakeholders around the Capital Markets Union, including banks, which will have a key role to play in funding the green and digital transitions, to support the real economy and help companies compete on the world stage. ❞
Supporting the transition to a more sustainable and digital economy
The European Commission has estimated that the green transition will require additional investment of EUR620 billion per year, while the digital transition will require a further EUR125 billion per year: the finance sector will be crucial in financing this twofold transformation. In this context, a fully-fledged Capital Markets Union is key, not only to support the region’s transition towards a digital and sustainable economy, but also to achieve a strategically-open autonomy in today’s increasingly complex global economic context.
Valdis Dombrovskis, Executive Vice-President for an Economy that Works for People, says: “The coronavirus crisis has injected real urgency into our work to create a Capital Markets Union. The strength of our economic recovery will depend crucially on how well our capital markets function and whether people and businesses can access the investment opportunities and market financing they need. We need to generate massive investments to make the EU economy more sustainable, digital, inclusive and resilient. Today’s Action Plan aims to tackle head-on some of the remaining barriers to a single market for capital.”
Supporting the growth and competitiveness of the EU economy
The CMU has three key objectives, with the first one consisting of making financing more accessible to all European companies. This implies making companies more visible to cross-border investors to stimulate cross-border and foreign investment, establishing a European single access point (ESAP) to provide for seamless, EU-wide access to all relevant public information disclosed by EU companies, including financial and sustainability-related information.
It also means supporting access to public markets in particular for small and medium-sized enterprises, both in regulated markets and multilateral trading facilities. European companies rely a lot more on bank financing than their US counterparts to meet their funding (70% compared with 20% in the United States), potentially hampering in some instances the speed of the economic recovery after a crisis such as the Covid 19 pandemic.
It is also about encouraging more long-term and equity financing from institutional investors, ensuring that banks and insurance companies are not unduly constrained in their long-term investments by local prudential rules; and helping banks to lend more to the real economy with the ongoing review of the EU regulatory framework for securitisation that aims to balance its various objectives, including investor protection, financial stability and access to finance.
The next two other objectives are to make the EU an even safer place for individuals to save and invest long-term and to integrate national capital markets into a genuine single market. This implies among other things alleviating the tax-associated burden in cross-border investment, and making the outcome of cross-border investment more predictable as regards insolvency proceedings, while facilitating shareholder engagement, developing cross-border settlement services, and creating a consolidated tape provider (CTP) for all Member States providing a single stream of information for all securities, accessible for everyone.
Once completed, this CMU will benefit domestic investors, making it more attractive to foreign investors. This serves not only large firms that are already active on global markets, it also presents significant opportunities for smaller EU companies with promising and innovative business models. These smaller companies will be in a position to better attract investors globally to receive the necessary capital to scale, build brand recognition, and become recognised global players in their field. Overall, the CMU will contribute to making Europe’s economy more innovative and competitive globally.
According to William de Vijlder, BNP Paribas Chief Economist: “Breaking down the walls separating markets would broaden the investor base and increase the risk bearing capacity due to diversification effects. As a consequence, financing costs would be lower.”
❝ Breaking down the walls separating markets would broaden the investor base and increase the risk bearing capacity due to diversification effects. As a consequence, financing costs would be lower. ❞
A pivotal role of banks in connecting corporate issuers with investors
Acting as a bridge between investors and corporates, banks are already instrumental in connecting the funding needs of issuers with the investment needs of investors worldwide. This role is set to grow as progress on the banking union takes place, with a further expansion of investment banking services in Europe, particular directed to SMEs.
William de Vijlder adds: “International diversification allows an increase of the exposure to risky assets, thereby increasing long-term portfolio returns. […] this increase benefits both the domestic and foreign firms and ventures that are raising money through capital markets and lowers their financing costs.”
A fully-fledged banking union combined with a more effective and deeper securitisation market will also allow banks to further support economies across the bloc. In the United States, banks locally have access to a securitisation market that is three time the size of Europe’s allowing banks to more easily transfer some risk to investors, release capital and provide additional lending to support the economy.
The role of banks in providing financial advice is also of fundamental importance. The relatively low level of financial literacy in Europe presents a challenge. Financial education is a long-term objective and savers cannot be expected to become investors without banks’ support. Banks are also useful in providing direct long-term equity financing, which is increasingly relevant as companies’ capacity to absorb debt is reaching its peak.
“The CMU project will clearly benefit from an enhanced role of EU banks in the financial services industry and, in turn, integrated capital markets will provide greater space for banks’ business. Importantly, financial integration, via CMU and banking union, offers risk-sharing mechanisms that can mitigate the impact of global or country-specific shocks and, therefore, contribute to macroeconomic stability,” states Rolf Strauch, Chief Economist, European Stability Mechanism.
Looking ahead to the next steps
Despite some “CMU fatigue” among public authorities and industry stakeholders, there is real momentum to consider ambitious and effective actions. “CMU should be at the top of the agenda of the new European Commission to achieve a diversified, competitive and self-sufficient European market,” adds Jeanne Aing.
With France recently launching a taskforce led by Christian Noyer to perform an in-depth assessment of the Capital Markets Union for the next term of the European Commission, the Council is working on new proposals on various aspects of deepening the Capital Markets Union.
EU finance ministers have committed to considering the longer-term future of European capital and financial markets, and work by the Eurogroup is under way to negotiate political priorities and draft the political agreement for presentation at this year’s Euro Summit later this month. The new political cycle ahead with elections to the European Parliament in the second quarter of this year and the new Commission will be an opportunity to share new priorities. Public authorities are also looking for proposals from the financial industry, which can unlock clear opportunities for the Capital Markets Union and a stronger single market to become true drivers.
Ahead of this summit, the ECB has published a statement on advancing the Capital Markets Union, noting: “While many of these initiatives will take time and the Capital Markets Union remains a long-term project, urgent and decisive action is now needed to make real progress in the integration and development of EU capital markets… the EU must now address the most important and structural challenges.”
Commenting on the pressing need to close the EU capital markets gap, finance ministers for France and Germany respectively, Bruno Le Maire and Christian Lindner, recently highlighted the need for a new dynamic to build a genuine CMU for our citizens and businesses. Despite Europe’s substantial progress, they noted that this is only the groundwork and the region must intensify its efforts. With this in mind, leaders have recognised the need to put the under-developed CMU top of the agenda. Under the impetus of the President of the Eurogroup, Europe’s finance ministers will regularly discuss the priorities to be addressed in the next legislative cycle. A Franco-German road map has also set out joint ideas on a way forward, calling for a new CMU agenda.