Analytics, Banks, EU – Baltic States, Financial Services, Legislation, Markets and Companies

A Capital Markets Union, which will mean better cross-border risk sharing via capital markets, can help diversify funding sources for market participants across all EU countries and thereby enhance financial stability for the EU as a whole. CMU can play a pivotal role in boosting financial integration and in enhancing financial stability to the benefit of businesses, households and public finances across Europe.

New financial market structures

The European Commissioner for financial stability, financial services and capital markets union, Jonathan Hill, in his speech at the European Financial Integration and Stability Conference under the title “Reinforcing financial integration on growth and jobs” (Brussels, 27 April 2015) he underlined the important issues of the European financial stability.

The conference’s main speakers and participants is a living proof that the SSM and the Single Resolution Mechanism (SRM) are up and running, and a sign of progress has been made. Among participants were, e.g. Vitor Constâncio from the ECB, Danièle Nouy from the Single Supervisory Mechanism (SSM), and Elke König from the Single Resolution Board (SRB).

During spring 2014, the focus was on completing the Banking Union. It's easy to take for granted what has happened since then. The Single Supervisory Mechanism, SSM has got off the ground in record time and started its work as single supervisor for the Banking Union. The Single Resolution Board members are now all in place, doing the spade work so that they are ready when the Single Resolution Board, SRB becomes fully operational at the end of 2015.

And, in the wider EU single market, the European Banking Authority, EBA has helped build a culture of supervisory cooperation. Thus, the EU has got some strong institutions in place headed by the right people, with the right skills.

The new financial market structures created in 2014 have been put to a tough test: the so-called Comprehensive Assessment, made up of the stress test and the asset quality review. The aim of these tests was to identify and address any remaining weaknesses in the EU banking system and to dispel doubts about their health. The results show that the European banking sector is now more resilient and much better capitalised, i.e. by over €200 billion in 2014 alone. The median EU bank participating in the Banking Union has capital ratios above 12% to deal with unexpected losses. These are similar levels to large banks in the US; moreover, the majority of financial institutions have “further buffers” to withstand future shocks, which should help to reassure investors.

Commission’s prospective priorities

As a result of the new regulatory framework, the actions that supervisors have taken (and due to market pressure), European banks are becoming stronger. They are in a better position to get on with their primary business: lending to households and firms and financing the rest of the “real economy”.

Nevertheless, it is too early to conclude that the EU has completed the regulatory jigsaw. Therefore it is the Commission’s prospective priority to make sure that all EU member states transpose the Bank Recovery and Resolution Directive (BRRD) as an essential piece of European instruments to break the negative spiral between failing banks and national finances.

In the beginning of 2015, only five EU countries have transferred BRRD into their national legislation. By the end of June 2015, the respective number of states shall reach 15 states. There is an evident progress, though the pace is not enough. Therefore, the Commission will be keeping the pressure on the remaining EU states to give a clear commitment that they will press on with implementing the BRRD.

New approaches

Creating new institutions and finalising the rules for the banking union are not the only things that are different this year. Both the new European Parliament and the new European Commission, with a new structure where the Vice Presidents, intend to coordinate the Union’s work.

This is aimed at helping to make member states more focused on a smaller number of priorities, of which the biggest is jobs and growth. There is a new sense of urgency in the Commission in addressing these priorities; for example, the Commission has launched the Investment Plan only three weeks after the new Commission was inaugurated; it set its Commission Work Program for 2015 only 3 weeks after that.

The EU’s new push on the single market is connected to such vital for all states spheres as energy, digital affairs, free trade and capital markets, to name a few, as ingredients of EU efforts to create growth and jobs. 

Better regulation in financial services

The Commission takes a new approach to regulation too; under the leadership of First VP Frans Timmermans, the Commission is working to legislate less and do fewer things better. In 2015, the Commission will be bringing forward only one fifth of the total number of new legislative proposals that the last Commission proposed on average each year.

More than that, the Commission intends to review over two and a half times as much existing legislation as was usual in the past.

The same approach will be applied to legislation in the area of financial services: less new legislation in the future is expected and more focus would be on bedding-in the reforms of recent years. The main idea behind this approach is that businesses need stability and regulatory certainty.

There is a need to look at the cumulative effect of the legislation introduced in the past (this is what the European Parliament wanted for long). Over the last five years, the Commission was forced to legislate “at speed”, while the dangers of crisis were visible in the member states; however, the EU managed to make the financial system stronger.

At present, there is a growing consensus that it makes sense to contemplate whether everything was made right all the time. It’s not about “fundamentals in approaches”, but seeing whether the combined effect of EU’s financial legislation always achieved the correct balance between stability and growth.

If the evidence shows that some of the rules are not proportionate to the risks posed by different types of institutions, or that there have been unintended consequences, then the changes shall be made. The member states need financial stability because that is the basis for sustainable growth. Besides, the states also need to recognise that the greatest presently is threats to financial stability through the lack of jobs and growth.

Capital Markets Union

Commissioner Jonathan Hill’s obligations stretch above the financial stability; they include Capital Markets Union and financial services in general. The two last “competences’ elements” are closely interrelated: building a stronger single market in capital is a key part of the overall European efforts to boost jobs and growth. Capital markets, at its most simple pattern, are to provide more opportunities for savers and investors to be linked to providing growth. It is done by helping to increase investment, by making it easier for businesses to grow and by driving growth in the whole European economy.

As part of the Commission’s drive to strengthen the single market in capital, it intends to promote financial integration and, more specifically, to create large and liquid capital markets for European states.

Thus, by helping to create a more diversified and resilient European financial system, the Commission could reinforce financial stability. These two objectives are related and mutually supporting: both are needed in order to assist in delivering economic growth and jobs on a sound and sustainable basis.

Capital Markets Union and financial integration

Free movement of capital was one of the four fundamental principles on which the European Union was built. But more than half a century on from the Treaty of Rome, there isn’t a fully functioning single market for capital.

Things took a step forward in the mid-1980s when capital account restrictions were removed in more and more countries, and accelerated in the late 1990s, when the euro was introduced. This sparked a wave of cross-border financial activity and pressure from market participants to remove the remaining barriers to integration.

Many of those barriers were removed with the help of the Financial Services Action Plan; but some of the achievements in financial integration had been lost during the crisis.

Integration in capital markets means making it easier for capital to flow and, crucially, saving the risks to be transferred across borders. It means that investment being channeled to where it can be used most productively, while market operators can take advantage of economies of scale to provide financial products and services in the most cost-effective manner. It can boost competition across borders, whereas providers can become even more cost-effective and consumers can benefit from wider choice. Integration in capital markets means making member states’ economic resources expand and ensure that the financial system supports growth and jobs.

Capital Markets Union and financial stability

Capital Markets Union is not only about integrating markets; it has to safeguard financial stability too. Thus, firstly, it should help reverse the financial fragmentation that followed the recent crisis. In principle, integrated markets allow risks and benefits to be shared better across Europe.

For example, if a resident in a country A has financial assets from countries B and C as well as A, he/she will be more sheltered from possible shocks that can hit his domestic economy. A lack of international diversification often leads to a much deeper and longer crisis in individual countries, because there is a vicious feedback loop via the domestic holders of financial assets.

Looking back in the EU’s history, it becomes clear that there were problems with the nature of EU financial market integration that took place before the crisis. While there were massive cross-border flows between EU countries, little risk was actually transferred. Instead, risk was retained in those countries that were tapping external funding. This pattern was amplified by financial institutions that were ill-prepared to channel the pools of funds on such a scale and the EU’s governance frameworks were ill-suited to deal with them.

With the crisis, financial integration itself went into reverse. Risk was created and retained in some EU states to such an extent that foreign investors were discouraged from rolling over their funding or from continuing to invest. As a result, financial flows collapsed.

Today the situation is such that some EU member states have no shortage of funding, while others are stuck with failed projects and don't have the funding to initiate new ones. This uneven distribution in access to funding has created serious problems for many EU states, depressing economic growth and creating financial vulnerabilities.

European reforms of financial governance, including the Banking Union and European Semester, were necessary to restore confidence in financial markets and help repair banks' balance sheets so that they resume sustainable lending.

A Capital Markets Union, which will mean better cross-border risk sharing via capital markets, can help diversify funding sources for market participants across all EU countries and thereby enhance financial stability for the EU as a whole.

Secondly, a Capital Markets Union can strengthen the resilience of the EU financial system by giving companies access to more diverse funding sources. It is known that the Europe’s financial system is relatively bank-based, particularly when compared to other developed economies. This has left some parts of the EU economy less capable in generating growth and jobs, as a number of banks have been recovering slowly from the enormous damage inflicted by the crisis.

Bank-based and market-based financial systems

As to the Capital Markets Union, it is necessary to see that there is a dichotomy between bank-based and more market-based financial systems; the sound economy needs both. Bank-based funding has many strong sides (not least the close relationship that some banks have with their clients, including SMEs).

But the crisis has clearly demonstrated that there is a risk in having too many eggs in one basket. A more diversified financial system – with a better balance between direct and indirect funding channels – would be more resilient and strengthen the capacity of Europe’s economy to handle any future crises.

In creating a Capital Markets Union that achieves these dual goals of integration and stability, the member states need to ensure that people can have confidence that capital markets are governed by appropriate rules. It is not true, as some contend that while banks are subject to tight regulation, capital markets are a "wild west" free-for-all. There are some regulatory instruments in the EU, e.g. MiFID, EMIR, and rules governing different categories of investment fund. This is a highly regulated area, with a view to protecting investors by making them aware of risks and ensuring that there is proper governance and oversight.

Building Capital Markets Union step by step

It is not an easy task to create a sound single market for capital; it is a long-term project that will require sustained effort over many years. And it will need to be approached from many different angles: securities laws, investment restrictions, tax treatments, insolvency regimes, etc. These are all issues that have to be brought into consideration, and the member states’ economies need “single market for capital” urgently...

The approach to the capital market union (CMU) shall be through adequate economic analysis and with practical input from the financial services industry and member states in order to identify and understand barriers and obstacles. The European Financial Stability and Integration Review, which has been launched at the end of April 2015, will help with that analysis.

Informal ECOFIN in Riga (April 2015) generally supported both the CMU in general and the Commission steps to combine long term ambition with a great sense of urgency, while identifying a number of areas in making quick progress.

Getting the market for securitisation again into European financial sector could free up banks' balance sheets so they could get back to lending, which is their core business. Commission’s aim is to support a framework for securitisation, singling out a category of highly transparent, simple and standardised products. This is an approach strongly supported by the ECB, the Bank of England, Basel institutions, etc. Securitisation will not be the answer to all European challenges, and bank finance is not always the most appropriate source of funding, for instance for higher risk, higher growth companies. Therefore, the Commission wants to encourage different solutions like venture capital or IPOs that will support different types of business at different stages in their development.

Besides, the Commission also wants to revise the Prospectus Directive so that it becomes easier for SMEs to fulfill their listing obligations (consultations on this issue are going on…). The Commission is also looking at what could be done to make SME’s credit information more accessible to potential investors, without imposing unnecessary administrative burdens on them.

Private placements have the potential to offer investment opportunities to long-term investors, and could broaden the availability of finance for infrastructure projects. A group of industry bodies recently launched an initiative to encourage the development of the European private placement industry; the Commission supports this, in part because legislation is not always the best option.

Conclusion

The Capital Markets Union (CMU) aims to complete initial European efforts to the free movement of capital as a fundamental freedom in the Treaty of Rome. Namely, to take down barriers, remove obstacles and improve Europe's ecosystem for investors and for companies that need financing.

CMU can play a pivotal role in boosting financial integration and in enhancing financial stability to the benefit of businesses, households and public finances across Europe. CMU is supported by the European Parliament, by most member states and businesses, both those keen to invest and those keen to attract investment. No one is underestimating the scale or the complexity of the challenge. But there is a new opportunity and the need to make progress.

The Commission will during summer 2015 publish a plan that will set out EU’s longer term priorities as well as concrete proposals for immediate action.

Reference: Speech by the European Commissioner for financial stability, financial services and capital markets union, Jonathan Hill at the European Financial Integration and Stability Conference “Reinforcing financial integration on growth and jobs”, Brussels, 27 April 2015. In:

http://europa.eu/rapid/press-release_SPEECH-15-4861_en.htm?locale=en