Analytics, EU – Baltic States, Financial Services, Investments, Legislation

EU member states’ governments and citizens are of a general agreement about the perspectives of the Capital Markets Union, CMU. They want the Commission to make quick progress in such spheres as, e.g. creating a new market for simple, transparent and standardised securitisation products, and by reviewing the Prospectus Directive. The EU intentions for creating a single market in capital dates back nearly 60 years. Now, the replies to consultation show that there is the opportunity, the support and the will to make that happen; this opportunity the Commission intends to seize.

Jonathan Hill, the EU Commissioner for Financial Services, Financial Stability and Capital Markets Union, underlined that there is also a shared analysis of the benefits of a stronger single market in capital to help support more cross-border risk-sharing, create deeper and more liquid markets, and diversify the sources of funding to the economy.

The CMU has the following advantages: it will deepen financial integration and help increase growth and competitiveness over the medium term. In other words, it will better link savings with growth. It will provide more options and better returns for savers and investors. It will offer businesses more choices of funding at different stages of their development. It will channel investment to where it can be used most productively, increasing the opportunities for Europe's companies and infrastructure projects.

It will also help to ensure that the financial system supports growth and jobs and helps with the demographic challenges that Europe faces. The CMU should create the conditions for capital to cross borders, to flow to entrepreneurs with high growth potential, no matter where they are located.

And it can strengthen the stability of our financial system; presently the EU’s system is heavily dependent on bank financing, so if there is a contraction in banking, then lending in the whole economy dries up. So, the EU’s idea is to encourage equity investment, in place of debt; in this way the member states could make their economies more resistant to shocks.

Commission’s formal consultations and results

The Commission received more than 700 responses on the consultation on the Capital Market Union, CMU and the linked subjects of securitisation and the prospectus directive. The aim of the Green Paper was, first, to make sure that the Commission had identified the right areas for action. Second, to get ideas and suggestions as to where the barriers and obstacles to a single market in capital are, and how to overcome them. And third, to check how people supported the step-by-step approach combining long-term ambition with immediate practical steps.

Alongside the formal consultation, the DG has been travelling across Europe to talk to politicians, consumers, business start-ups, regulators, the financial services industry and investors. This has become a classic single market project for all EU 28 member states.

CMU’s three most important issues

The Commission has identified three most important CMU’s themes: how the CMU can increase funding options for business; how it can create more opportunities for investors; and how it can encourage cross border investment.

Theme 1: increasing access to finance. In general, the first theme (which has emerged as a top priority from the consultations) is about the ways to improve Europe’s ‘funding escalator’, i.e. how to build a financial system that is better able to meet the businesses’ financing needs –from the smallest micro-firm to the largest listed companies, at different stages in their development.

Bank lending remains central both to the European economy and, in particular, to the sources of funding for SMEs. Among major steps in the “funding escalator”, which are missing in Europe, are that alongside more innovative new businesses with higher returns, also higher risks emerge, which make it hard for SMEs to get investment from banks. There are, as well, other gaps where SMEs find it difficult to attract capital as they seek to expand.

Although overall, the financial system in the EU provides some two trillion euros to SMEs, non-bank finance is less than half of that in the US. A large majority of respondents have argued that key links in the chain are missing or not yet delivering on their potential: angel investing, venture capital and innovative forms of finance such as equity crowd-funding.

There are a range of factors that cause this, including cultural, historic and regulatory. Thus, the Commission will review EU venture capital regulation (so-called EUVECA) to support the growth of this market further: both in terms of allowing a wider range of funds to participate, and a wider range of possible investments.

The Commission wishes to investigate how to eliminate “passporting barriers” to funds raising capital across Europe. It is known that the factors holding back an equity culture in the EU are broad and deep but strengthening EU’s venture capital ecosystem must be a key priority.

Another issue in this team is the non-bank lending channels to play the role of “peer-to-peer lending”, e.g. a kind of alternative investment funds, as present long-term funds (ELTIFs) play in the financial system. But then, the availability of funding will increase while maintaining investor protection and financial stability. It is worth remembering, argued Jonathan Hill, EU Commissioner for Financial Services, just how much work has been done in recent years through MIFID II, EMIR and AIFMD to strengthen the regulation of non-bank finance.  

For larger firms in the member states it shall be easier to raise capital by issuing debt or equity on public markets. There is probably more could be done to build on the success of private placements in Germany and France for companies wishing to place large amounts of debt with institutional or qualified investors. Most respondents to the EU consultation said that more time should be give to recent market-led initiatives by the industry to allow them to bear fruit rather than regulating.

Some respondents, particularly investors, have pointed out that there are some ambiguities in the regulatory treatment of private placements. They have asked the Commission to look at aspects of Solvency II in order to support insurance companies to invest through private placements. And they have identified the issue of national divergences in the treatment of withholding tax as a potential obstacle to the development of a deeper cross-border market for private placements.

One of the strongest messages to have emerged from the consultation supported Commission’s view that getting the Prospectus Directive right will be an important early priority. As the gateway to capital markets, the EU need to make sure that prospectuses fulfil their original purpose: giving investors information they can understand before making an investment decision.

The consultation confirmed how valuable prospectuses are, and the role national authorities’ prior approval of prospectuses plays in giving legal certainty and supporting investor protection.

But many respondents said the EU should lighten the burden on issuers who are already listed on a regulated market when they want to make a secondary issuance. They want the prospectus regime to have a more joined-up approach to information that is already published under other rules. They also argued that the lighter disclosure regime for smaller companies has had virtually no take-up. Therefore, the Commission needs to take a radical look at how the prospectus directive is working, particularly for smaller companies and smaller countries in Europe.

The Commission will bring forward proposals to review the Prospectus Directive in the autumn, added Jonathan Hill, the EU Commissioner.

Promoting simple and transparent securitisations. Alongside the consultation on the CMU, the Commission has held a specific consultation on securitisation (more than 120 replies were given), with very broad support for the plans. Respondents clearly shared Commission’s view that all securitisation should no longer be tarred with the same brush. The EU plans to build on the work of the ECB, Bank of England, IOSCO, and the ESAs to put forward a framework for securitisation products that are simple and transparent.

With this new legislative proposal, the Commission aims to rebuild trust and make it easier for investors to assess the risks of securitisations. Issuers will have to maintain ‘skin in the game’ so that their incentives are aligned with those of their investors. The products will have to be transparent, so investors will know what they will be buying. The system should work with all the appropriate checks and balances, without being too complex.

This will enable the Commission to put in place more appropriate capital and solvency requirements for investors (so that simple securitisation products do not end up being penalised); it will also allow to improve the way existing due diligence and disclosure rules currently work.

Theme 2: making CMU work (creating opportunities for investors)

The second main issue is creating opportunities for retail and institutional investors, who are background of the whole CMU’s idea.

Life insurance companies and pension funds are the natural long-term investors in European equity, venture capital and infrastructure. They have the deep balance sheets and the long time-horizons to be able to manage significant exposure to equity investments.

Over recent years, however, these institutional investors have been retrenching, and holding more significant amounts of liquid debt at the expense of equity, argued Jonathan Hill, the EU Commissioner. There is a concern on the part of some EU states, the insurance industry and other observers that the regulatory framework may indeed be driving this tendency.

In October 2014, the Commission gave insurers a number of incentives for long-term investment in the detailed rules under Solvency 2; however, still more could be done to ensure that insurers can invest into Europe's infrastructure. The Commission intends soon to start the process of amending the Solvency II delegated acts to incorporate investments into ELTIF funds, together with the process of necessary changes to incorporate infrastructure as an asset class into Solvency II (after EIOPA reported on the issue later in June).   

Pension funds are one of the biggest potential sources of funding for equity and infrastructure investments. The IORP-2 proposal currently being discussed would give pension funds the freedom to invest in assets with a long-term economic profile on unregulated markets; the EU states have already agreed their position on IORP-2.

Personal pensions, too, offer the potential to inject more savings into the capital markets and channel additional financing to productive investments. The consultation suggested that many want the Commission to look at ways of encouraging and supporting people to save more for retirement. There is also the question, argued Commissioner Jonathan Hill, whether the EU should consider the feasibility of a standardised product, e.g. through an optional pan-European or '29^th ' regime. This could remove obstacles to cross-border access without forcing cross-border harmonisation on what is a very diverse market place with very different legal systems in place. Any changes would need to ensure consumer protection and not disrupt existing systems which are working well, arguing Commissioner J. Hill.

Retail investors need to be at the heart of the CMU; over the years, small investors have been reducing their investment in shares: the proportion of retail investors among all shareholders is less than half what it was in the 1970s.The reasons for this are varied, but particularly, because of a lack of trust. Retail investors will only invest in capital markets if they have confidence in those markets and the financial intermediaries operating in them, and if they believe that they will do better by investing than sticking their money under the mattress. More transparency is therefore a key in this issue. Significant progress in recent years has been made to increase transparency, improve and harmonise disclosure standards. A careful look has to done at whether this improves results for consumers and ensures standards are consistency across financial products. Retail investors should also be able to choose good products that meet their needs regardless of where it is being sold in the EU. Effective consumer and investor protection and dismantling the barriers to the single market for retail investors will therefore need to be at the heart of the CMU; the Commission will look at ways to take this forward (in particular, the DG will bring forward a green paper on retail financial services issues later in 2015).

Theme 3: dismantling horizontal obstacles to cross-border investment

Retail investors are not the only ones who come up against barriers to the single market: there are many long-standing and deep-rooted obstacles that stand in the way of cross border investment. The obstacles range from their origins in national law (e.g. insolvency, collateral and securities law), through obstacles in terms of infrastructure like a lack of access to credit data, particularly for SMEs, and through tax barriers.

On some of these issues, particularly those linked with taxation, the feedback suggests that the Commission should be pragmatic: i.e. it shouldn't risk making good progress in other areas by charging head long into some of the most intractable ones. But this is an area, in which the Commission need to see if another way can be found to address barriers in respect of withholding tax procedures, e.g. on problems of double taxation. Many respondents also said that the current bias in the tax system towards debt at the expense of equity is a barrier to the development to capital markets.

The same goes for barriers to cross-border investing caused by differences in insolvency proceedings. One way forward, argued Jonathan Hill, would be to identify existing best practices that could be exported and work to stimulate cooperation between national authorities, or targeted changes where they can be helpful.

Many responses also made the point that as the EU capital markets become more developed, there would be needs for the appropriate supervisory arrangements, both nationally and cross border.

Respondents also made the case, however, for further action by the ESAs, within their existing powers, to promote supervisory convergence so that the benefits of the single rule book and deeper capital markets can be shared by all. As markets develop, the Commission must be sure that macro prudential frameworks at national, the EU level and internationally are able to react appropriately to developments in the capital markets.

The Commissioner expressed his intentions to publish an Action Plan in September, drawing on the first findings from the present consultations with the first concrete proposals to follow.

Early actions will include a comprehensive package on securitisation with updated calibrations for Solvency II and CRR, the definition of infrastructure and revised calibrations for Solvency II, and the proposals to review the Prospectus Directive.

Reference: European Commission, Speech-15/5137 by J. Hill, Commissioner for financial services & capital market union, at a Conference “Next steps to build a Capital market Union”, Brussels, 8 June 2015, in:

http://europa.eu/rapid/press-release_SPEECH-15-5137_en.htm?locale=en