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2015FEBRUARY

Unblocking the EU’s capital markets: The European Commission’s Green Paper on the Capital Markets Union

A Cicero Group analysis

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Although integrating Europe’s capital markets is an ongoing policy objective, the importance of doing so was brought into sharp relief by the slow pace at which Europe has recovered from the financial crisis. As ECB Executive Board Member, Yves Mersch put it, “The euro area economy is like a plane flying on only one engine: bank financing.

To increase the speed and stability of the plane, it would be good to add a second engine: capital market financing”. The Capital Markets Union can therefore be seen as an effort to diversify and stimulate Europe’s financing environment by improving the efficiency and functioning of its capital markets.

The reliance on bank financing draws inevitable comparisons with the US, which has a more diverse financing environment and has recovered from the crisis far more quickly. Mid-size companies in the US receive approximately five times more funding from capital markets than their equivalents and European companies are currently going to the US to access private placement markets rather than stay in the EU.

Rates of saving are twice as high in the EU as the US, suggesting that EU markets are less effective at channelling the vast sums of savings into productive forms of investment.

Given that European savings accounts for 20 per cent of Europe’s GDP this is a significant sum that can be put to use. European officials are quick to point out that the EU is not the US but it is clear that one of the primary objectives of the Capital Markets Union is to move the EU model in that direction.

The moniker of “Capital Markets Union” is also slightly misleading for its similarity to the Banking Union. In contrast to Banking Union, the Capital Markets Union will apply to all 28 Member States and doesn’t automatically assume a push towards central supervision of capital markets. This hasn’t prevented suggestions from figures such as Jeroen Dijsselbloem, President of the Eurogroup and Roberto Gualtieri, Chair of the ECON Committee that ESMA should take on a greater supervisory role – although for now such a move seems unlikely.

In contrast to the clear policy objective and actions contained in the Banking Union, today’s Green Paper suggests a policy response as broad and complex as capital markets themselves. A set of short term actions gives way to a wide ranging mix of discussion, suggestions and questions.

The ambition of the Capital Markets Union is evident throughout the paper and responses are sought on issues that have been frustrating the industry and policymakers for years. The Commission asks for examples of best practice on how to develop risk capital markets or how to encourage institutional investors to invest in a wider range of assets.There are questions on how create a more successful private equity and venture capital regime after the lack of interest in the specific EU venture capital and social entrepreneurship funds.

A review of the prudential regime for insurers is also promised to encourage investment in complex and long term infrastructure investments.

Cicero analysis - New phrase but old idea

The phrase “Capital Markets Union”, may be new but the idea is not. As our timeline shows, better integration of Europe’s capital markets is a policy objective intertwined with the creation of the Single Market, an objective rooted in the 1957 Treaty of Rome.

A mere 58 years later, Jonathan Hill has taken office with great expectations that in the short and medium term (the next five years), critical barriers to more integrated capital markets will be removed and a more strategic plan to remove longer term barriers will be developed. Unlike other Commissioners then, Lord Hill will have a quantifiable key performance indicator – the establishment of a Capital Markets Union by 2019.

Treaty of Rome (1957)Founding treaty establishing Free Movement of Capital

Single European Act (1987)Provides impetus towards integration of capital markets

Treaty of Maastricht (1992)Free movement of capital becomes a Treaty right

Giovannini Report (2003)Identified 15 barriers to integrated financial markets

Single Market Act I/II (2011/12)Renewal of EU Single Market to boost growth

Contents

• Capital Markets - EU vs US 4

• Europe’s capital markets 5

• Next steps 6

• The Green Paper dissected 7

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There is a real sense from the Commission that if a good idea can be presented to them then they will rigorously explore whether it can be made to work.

However, the success of the Capital Markets Union project could be limited by the fact that it is in reality, new momentum for tackling old problems. European policymakers have been trying to diversify funding and integrate capital markets for many years. Increasing the range of assets in which institutional investors can safely invest for example is not something that can be achieved through a simple legislative proposal.

Barriers to capital market integration are also complex and often impinge on national competences. National insolvency laws, differing tax regimes and pension provision all impede the ability of funds to be accumulated and channelled cross-border. These are all complicated areas which for many different reasons, have remained divided along national lines despite years of integration in other sectors.

Consequently the Green Paper represents a process that needs to be both ambitious and realistic. There is a clear demand for ideas from the Commission and a sense of willingness to tackle difficult issues. A valuable role could be played by the newly established unit for the Capital Markets Union to coordinate its actions and proposals across multiple teams and directorates – energy infrastructure investment being an obvious example.

Jonathan Hill has until the autumn to present his blueprint and until 2019 to create his Capital Markets Union. Much progress can be made but few expect it to be complete by then.

Cicero analysis - New phrase but old idea

James HughesAccount Director

Helena WalshExecutive Director

Alexander KneepkensSenior Account Executive

Sebastian Damberg-OttAccount Executive

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Capital Markets - EU vs US

284%90%

EU 300% of GDP vs US 70% of GDPSource: EBF, 2014, International Comparison of Banking Sectors

VS

Banking system assets

$33.1bn$7.4bnEU $7.4bn (15% of global market) vs US $33.1bn (68% of global market)

Source: EY, 2014, Adapting and evolving

VS

Venture capital market

70% 70%

30% 30%

EU 70% Bank loans & 30% Market financing vs US 30% Bank loans & 70% Market financingSource: EBF, 2014, Capital Markets Union: what is at stake?

VS

Bank vs Market based financing

EU 10.56% vs US 4.90%Source: Trading Economics, 2015, European Union Personal Savings

VS

Personal savings rates

10.56% 4.90%

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Europe’s capital markets

Supply of funding Access to finance

Real economySMEs | Mid-Cap | Large

Companies

Improving the investment chain

Mobilising pensions and

savings

Expanding range of assets for institutional

investors

Stimulating non-bank

finance fora

Promoting cross-

border retail investment

Simplifying investments in

SMEs

Facilitating infrastructure

financing

Promoting new forms of finance, e.g. securitisation, covered

bonds, crowdfunding

Harmonised trading

environment including liquidity

Improving company mobility

Common approach to insolvency

Better reporting of market data

Easing collateral flow

Promoting supervisory convergence Sound financial infrastructures

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Next steps

2016

Q4

Q2

Q3

Q1

Publication of the Green Paper 18 February

2017

2018 2019

2015

Publication of the consultations on the Prospectus Directive and

Securitisation 18 February

EP plenary vote on ELTIFs March

EC Conference on CMU Summer

Publication CMU Action

Plan H2

Evaluation of Insolvency Framework

H2

Legislative proposal on

Resolution of CCPs

H2

Delegated Acts on SME Growth

Markets (MiFID II)H2

Consultation on EU Covered Bond

FrameworkH2

Launch of Target 2 Securities

H2

Solvency II takes effect2016

EC Work Programme December

Introduction of MiFID II / MiFIR

2017

Capital Markets Union in place

2019

CMU consultation

deadline 13 May

EIOPA advice on single market for personal pension

productsFebruary

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The Green Paper dissected

Priorities for early action

Area Initiative Status

Review the Prospectus Directive Consultation published

Set up a framework to enable a comprehensive approach to securitisation in the EU Consultation published

Set up a framework for common minimum and comparable information for SMEs to improve SME credit information EC will hold workshops

Set up a framework for private placements to take away barriers including insolvency laws and lack of standardisation in processes, documentation and information

Evaluating market-led approach

Expand the take up of ELTIFs Potential policy opportunity

Access to finance

Increase issuance of quoted shares for large companies Potential policy opportunity

Incentivise long term investments and infrastructure investments in addition to the existing EFSI initiative Potential policy opportunity

Develop simplified, common and high quality accounting standards tailored to companies listed on MTFs Potential policy opportunity

Set up a central EU-level website for infrastructure projects Policy action identified

Set up framework for covered bond market by adopting best practices Consultation coming in 2015

Consider setting up framework for standardisation in corporate bond market, either being market led or by regulatory intervention Potential policy opportunity

Monitor industry framework to Green bonds Potential policy opportunity

Review possibilities for a cross-border approach to crowdfunding Potential policy opportunity

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The Green Paper dissected

Supply of funding

Area Initiative Status

Identify policy measures to incentivise institutional investors to invest in a broader range of assets Potential policy opportunity

Institutional investors – Review prudential rules for lower risk debt and equity investments Policy action identified

Institutional investors – Examine a standardised product (29th regime) to create single market for personal pension provision Policy action identified

Institutional investors – Explore how to widen range of market participants in EuVECA and EuSEF and potentially remove the EUR 500 million cap on size of investors Potential policy opportunity

Examine what measures can be taken to create a better environment for business angels, venture capital and initial public offerings Potential policy opportunity

Explore the barriers to entry for new and innovative financing vehicles such as peer to peer lending Potential policy opportunity

Retail investors – Incentivise standardised or simple financial products to restore consumer confidence in financial markets Potential policy opportunity

Retail investors – Enhance cross-border competition in retail financial services, especially in electronic and mobile financial services Potential policy opportunity

Retail investors – Preparatory work on how a single market for retail financial services can deliver more benefits to consumers Policy action identified

International investors – Increase the attractiveness of EU markets to international investors Potential policy opportunity

Institutional investors - Amend prudential requirements for pension provision through the IORP II Directive

Legislative proposal in progress

International investors - Facilitate direct marketing of EU investment funds and other investment instruments in third countries Potential policy opportunity

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The Green Paper dissected

Area Initiative Status

Enforcing the single rulebook and avoiding gold-plating to prevent divergent implementation of EU law Policy action identified

Explore a single framework to govern the treatment of cross-border investment Potential policy opportunity

Act on the possible improvements on the ESAs set out in the EC’s report on the func-tioning of the ESAs Policy action identified

Use the ESAs to prevent national supervisory regimes from creating differing investor protection standards and barriers to cross-border investments Potential policy opportunity

Consider appointing commercial entity to run consolidated tape if market-led efforts fail Policy action identified

Review if more work is needed to improve trade data and reporting Policy action identified

Set up common IT approaches for certain reporting requirements under EU legislation involving national authorities and ESAs Policy action identified

Proposal for recovery and resolution of systemically relevant financial institutions such as CCPs

Legislative proposal to be published

Potentially remove barriers to facilitate flow of collateral throughout the EU Potential policy opportunity

Assess need for changes to the securities ownership rules Potential policy opportunity

Examine potential improvements to market liquidity Potential policy opportunity

Examine legal certainty in cross-border transfer of claims Report planned in 2015

Review company law on cross-border establishment, operation of companies and company mobility Policy action identified

Improving the investment chain

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The Green Paper dissected

Area Initiative Status

Review conflict-of-law rules on the internal functioning of companies and consequences for third parties of transfers of claims Policy action identified

Evaluate the EC Recommendation on a new approach to business failure and insolvency to prevent further divergence of national insolvency frameworks Evaluation planned in 2015

Examine the tax treatment of cross-border investments by life insurance companies and by pension funds in real estate Policy action identified

Will take action if discriminatory tax rules are found on cross-border investments by life insurance companies and by pensions funds in real estate at a later stage Policy action identified

Simplify withholding tax relief procedures related to post-trading and link in to OECD TRACE project Policy action identified

Examine the treatment of debt and equity and consider harmonised definition Potential policy opportunity

Consider targeting tax incentives for R&D expenditure at young innovative companies Potential policy opportunity

Consider measures to increase the use of modern technologies and integrate the benefits of digitalisation Potential policy opportunity

Improving the investment chain

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