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

The overall aim of the capital markets union, CMU is to link savings with growth and give companies greater choice in getting financing sources. European businesses remain heavily reliant on banks, which makes the economy vulnerable to a tightening of bank lending. Making it easier for companies to get funding from markets, while not replacing banks as a source of financing, should make Europe more attractive to inward investment and spread risk more effectively than in the past.

The CMU’s ideas

The Commission's top priority for the coming years is to strengthen Europe's economy and stimulate investment to create jobs. The € 315 billion investment plan, adopted by the Commission soon after it took office, intends to assist financially in starting-up that process.

A clear thing: strengthening investment for the long term needs stronger capital markets. Thus, CMU would provide new funding sources for business, help increase options for savers and make the economy more resilient. In this way, CMU becomes an additional tool to implement EU key priorities for growth and jobs.

Besides, the free movement of capital has been the EU’s long-standing objective as the essential fundamental freedom of the single/internal market. However, Europe’s capital markets remain fragmented along national lines and European economies remain heavily reliant on the banking sector for their funding needs. This makes them more vulnerable should bank lending tighten, as happened during the financial crisis.

The Action Plan sets out the priority actions needed to put in place the building CMU blocks by 2019, removing barriers to cross-border investment and lowering the costs of funding. As part of the third pillar of the Investment Plan for Europe, the CMU should help businesses tap into more diverse sources of capital from anywhere within the EU, make markets work more efficiently and offer investors and savers additional opportunities to put their money to working order to enhance growth and create jobs. 

The Action Plan sets out the actions that will be taken over the next years so that the building blocks of the CMU are in place by 2019.

Thus, the CMU’s main objectives are: improving access to finance for all businesses and infrastructure projects across Europe; helping SMEs raise finance as easily as that for large companies; creating a single market for capital by removing barrier to cross-border investments, and diversifying the funding of the economy and reduce the cost of raising capital.

CMU’s economic analyses see on:

http://ec.europa.eu/finance/capital-markets-union/docs/building-cmu-economic-analysis_en.pdf.

Commission’s proposals and further steps

The Commission has committed to three legislative proposals in the short term; others may be needed in the medium term. In line with the Commission's Better Regulation principles (IP/15/4988), legislation will only be used where needed, and where it is the best tool for the CMU.

For some CMU’s areas, legislation might not always be the appropriate policy response, and the onus in many cases will be on the market to deliver solutions. Non-legislative steps and the effective enforcement of competition and single market laws might offer the best way forward in other areas.

The Commission will support market-driven solutions when they are likely to be effective and regulatory changes only where they are necessary.

According the Commission’s action plan, it will also put forward the following two immediate steps: one on high-quality securitisation and another on allowing more funding to flow to infrastructure projects.

It is also launching three additional consultations – one on venture capital funds, another one on covered bonds, and a call for evidence on the cumulative impact of financial legislation.

Presently, the Commission has published:

·                     Legislative proposals to establish a framework for simple, transparent and standardised securitisation and to set out new prudential calibrations for banks in the Capital Requirements Regulation (CRR);

·                     An adjustment to the "Solvency II" legislation to make it easier for insurers to invest in infrastructure and European Long Term Investment Funds (ELTIFs);

·                     A consultation on how to build a pan-European covered bond framework;

·                     A call for evidence on the cumulative impact of financial services reforms, with the objective of assessing the interactions between rules and cumulative impact of the reforms adopted in the recent years;

·                     A consultation on venture capital to assess whether targeted changes to the regulations could boost the take-up of these investment funds.

By the end of the year the Commission will review the Prospectus Directive to reduce barriers to smaller firms listing on markets, and publish a Green Paper on retail financial services to boost consumer choice and competition in cross border retail financial services and insurance.

Commission’s longer term actions

From 2016 and in subsequent years, the Commission will support access to finance through:

·                     Support venture capital and equity financing,

·                     Overcoming information barriers to SME investment,

·                     Promoting innovative forms of corporate financing,

·                     Strengthening access to public markets,

·                     Supporting equity financing, and supporting infrastructure investment

= By increasing investment through: increase choice and competition for retail consumers, support saving for retirement, and expanding opportunities for asset managers

= By removing barriers to cross border investment through:

·                     Removing national barriers to cross-border investment,

·                     Improving market infrastructure for cross-border investing,

·                     Fostering convergence of insolvency proceedings,

·                     Removing cross-border tax barriers,

·                     Strengthening supervisory convergence,

·                     Enhancing capacity to preserve financial stability.

More precise details and timetable are set out in the Action Plan.

1. New rules on securitisation

Securitisation refers to a transaction that enables a lender – often a bank – to refinance a set of loans/assets (e.g. mortgages, auto leases, consumer loans, credit cards, trade finance) by converting them into securities.

The lender pools a portfolio of its loans into a set of securities tailored to different investor risk/reward characteristics. End investors are then repaid by the cash-flows generated by the underlying loans.

If soundly structured, securitisation can be an important channel for diversifying funding sources and enabling a broader distribution of risk by allowing banks to transfer the risk of some exposures to external agents (for example to non-bank financial agents such as insurance companies and asset managers). The proposal presented by the Commission provides for criteria which should help better differentiate simple, transparent and standardised (STS) products to support investor confidence and make it easier to carry out due diligence. Building on advice from the European Banking Authority (EBA), the Commission also proposes more appropriate prudential requirements for banks' investments in STS products. This should allow banks to clean up their balances sheets by freeing the part of their capital that had previously been set aside to cover for the risk, and therefore allow banks to lend more to the real economy, notably to SMEs. Also see Memo/15/5733.

2. Making it easier for insurers to invest for the long term (Solvency II)

Investment in infrastructure projects is essential for supporting economic activity and growth in Europe. Such projects require large, long-term sources of financing.

The insurance industry is equipped to provide long-term finance by investing in equity shares as well as loans of infrastructure projects, and the Commission aims to incentivise the insurance sector to play a full role in European infrastructure projects. It asked for the advice of the European Insurance and Occupational Pensions Authority (EIOPA) on the creation of a distinct infrastructure asset category under Solvency II, the EU’s insurance prudential framework.

The proposed legislation which modifies the Solvency II Delegated Regulation creates the right incentives for insurers to invest in infrastructure projects, in particular by reducing the amount of capital which insurers must hold against debt and equity of qualifying infrastructure projects. Also see Memo/15/5734.

3. Public consultation on venture capital

Small and medium-sized unlisted companies often find it hard to get mainstream financing via bank loans and they do not have access to capital via stock markets. The European Venture Capital (EuVECA) and European Social Entrepreneurship Funds (EuSEF) regulations set up two new types of collective investment funds to make it easier and more attractive for private savers to invest in unlisted SMEs.

The new funds can be marketed to investors able to commit at least € 100,000, regardless of where they are based. The consultation will ask whether targeted changes to the regulations could boost the take-up of these investment funds.

The consultation will look in particular at more technical issues such as the restrictions on who is able to manage the funds, the level of minimum investment of € 100,000 for investors and whether non-EU managers should be able to offer EuVECA or EuSEF funds. It runs until 6 January 2016.

4. Public consultation on covered bonds

Covered bonds are a cornerstone of long-term finance for many EU Member States as a key instrument to channel cheap finance to the property market and public sector entities. Covered bonds are debt obligations issued by credit institutions which offer a so-called "double-recourse" protection to bondholders: if the issuer fails, the bondholder has a direct and preferential claim against certain earmarked assets and an ordinary claim against the issuer's remaining assets. Covered bond outstanding volume in the EU reached €2.5 trillion in 2014, making European credit institutions global leaders in these markets.

Although overall issuance remained resilient during the crisis, covered bond markets in the EU remain largely fragmented along national lines and performance varied greatly between EU states.

The consultation is running until 6 January 2016 and it will look at the ways to develop an integrated European framework for covered bonds, building on national regimes that work well without disrupting them and based on high-quality standards and best market practices.

5. Cumulative impact of financial legislation

The Commission is launching a 'call for evidence' to gather feedback from consumers, the EU member states, the financial industry and all interested parties to gauge the cumulative impact and interaction of current financial rules.

With this consultation, the Commission hopes to identify inconsistencies, incoherence and gaps in financial rules, as well as unnecessary regulatory burdens and factors negatively affecting long-term investment and growth. Also see Memo/15/5735.

There are close links between CMU and the Commission investment plan in the way that CMU supports and complements the Investment Plan for Europe. Some of the measures, such as promoting infrastructure investment by insurers through Solvency II, a package of measures to promote venture capital and lowering barriers through the prospectus directive will reinforce the Investment Plan.

The CMU Green Paper and the Action Plan

There was a large and positive response to the consultations on building a Capital Markets Union, and to the separate ones on the prospectus regime and the proposed EU framework on simple, transparent and standardised securitisation.

The Commission received over 700 responses from businesses, regulators, investors, supervisory bodies, governments, banks, funds, insurers and European citizens.

Feedback has been overall supportive of the importance of building a CMU as well as for the pragmatic, step-by-step approach proposed by the Commission in the Green Paper.

The consultation responses also confirmed that the issues identified in the Green Paper were the right ones. The European Parliament and the Council have also expressed support for the CMU.

The first priority identified by respondents to the consultation on CMU is how to fix Europe’s ‘funding escalator’. How can we build a financial system that is better able to meet the financing needs of all our businesses — from the smallest micro-firm to the largest listed companies — at the different stages in their development?

The second priority is creating opportunities for investors. Retail and institutional investors – such as pension funds and insurance companies – are the fuel in the tank of CMU. EU capital markets need to deliver attractive returns and good performance for these investors.

Third, the consultation highlighted some long-standing barriers to cross-border investment, which range from tax, insolvency, through collateral management and securities law to post-trade market infrastructure that prevent a better allocation of capital across borders.

Access to finance continues to be a major constraint on business development and a drag on growth across all EU member states. A recent study by Ernst and Young reveals that – with the exception of the UK which scores strongly- the largest EU states are among the worst performers in the G20 in terms of access to finance. CMU is perceived as a key part of the solution, particularly in those EU states where the banking system is still under repair.

See: http://www.ey.com/Publication/vwLUAssets/EY_G20_-_Funding_the_future:/$FILE/EY-g20-Funding-the-future.pdf.

Reviewing Prospectus Directive

Prospectuses are legal documents that must be used by companies if they want to issue securities or be admitted on a regulated market.

The Prospectus Directive provides for an EU-wide regime for prospectuses so that there is an equivalent level of investor protection across the EU and to make it possible for investors across the EU to compare investment options.

But prospectuses are also costly and administratively burdensome for companies to produce, often requiring hundreds of pages of detailed information. And for investors, it can be complex to wade through excessively detailed information.

Experience has shown that certain requirements may constitute unnecessary administrative burdens on companies that draw up a prospectus (especially SMEs), despite efforts to establish proportionate disclosure regimes when the Prospectus Directive was reviewed in 2010. The amount of administrative, human and financial resources needed to draw up prospectuses make it very difficult for SMEs and start-ups to put together the large package necessary to attract the investment they need to grow.

Given the need to enhance access to financing on capital markets for companies (in particular SMEs) at a time of bank deleveraging, a review of this directive is important.

The review will look at when a prospectus is required, and look at ways to streamline the approval process and simplify the information included in prospectuses.

The Commission will make a proposal to modernise the Directive by the end of the year.

CMU and banks

In their role as intermediaries between investors and businesses, banks should benefit from better functioning markets and a deeper integration of the single market for capital as this will mean fewer barriers to cross-border investments and an increase in the number and the volume of transactions, both domestically and across the EU.

Key actions targeting bank lending include:

·                     Establishing a framework for simple, transparent and standardised securitisation, together with new prudential calibrations for banks in the CRR to help banks to transfer risk safely off their balance sheets to other, longer term investors. (see Memo/15/5733)

·                     Consulting on the establishment of a pan-European framework for covered bonds, building on national regimes that work well without disrupting them and based on high-quality standards and best market practices; and

·                     Exploring the possibility for all Member States to authorise credit unions operating outside the scope of capital requirements rules for banks.

CMU’s role in the member states developing smaller capital markets

For Member States with developing capital markets, CMU should provide:

·                     a wider range of finance opportunities to companies with high-growth potential and strong commercial prospects, regardless of where they are located. Entrepreneurs whose companies have strong commercial prospects should benefit, for example, from more business angel investment, venture capital funds, and loan originating funds;

·                     increased capacity to attract investment through the removal of barriers which prevent a better allocation of capital across borders (reduction in tax deterrents, more efficient insolvency procedures, and more efficient clearing and settlement processes); and

·                     greater choice and higher potential returns for investors through efforts to enhance the range of retail investment products on offer, and increased efficiency and service quality in the intermediation chain; and

·                     a possibility to benefit from tailored assistance from the Commission to develop local capital markets capacity building on the features of the national market.

CMU is about connecting growing and innovative companies with sources of finance – no matter where they are located.

CMU in cross-border investment

Key actions that aim to facilitate cross-border investment include:

·                     removing the remaining barriers in the post-trade environment (clearing and settlement);

·                     enhancing the efficiency of national insolvency regimes and the ability of investors to assess risks related to cross-border investments. For this purpose the Commission will propose, by the end of 2016, legislation on business insolvency and early restructuring, building on the experience with the Recommendation issued by the Commission in 2014 on a new approach to business failure and insolvency;

·                     increasing legal certainty on the effects of assignment of claims on third parties (where the original creditor transfers the claim to someone else); and

·                     improving the quality of supervision through convergence of supervisory outcomes.

Non-bank finances and possible risks to financial stability

By promoting more diverse funding channels and reducing Europe’s dependency on banks, CMU should increase the resilience of the financial system.

Nevertheless the member states need to be alert to financial stability risks that may emerge as a result of efforts to further develop Europe’s capital markets. Recent reforms, such as the European Market Infrastructure Regulation (EMIR), the Alternative Investment Funds Managers Directive (AIFMD), the Markets in Financial Instruments Directive (MIFID) and the Securities Financing Transactions Regulation (SFTR) have put in place a range of reforms to make capital markets more transparent, well regulated and robust.

The European Securities and Markets Authority will continue to play an important role in ensuring consistent implementation and application of these laws.

As financial markets develop it will be important to ensure that risks are monitored and mitigated. Work is under way within the EU and internationally to better understand and monitor systemic risks. The Commission will propose changes to the macro-prudential framework in the context of the review of the ESRB in mid-2016 if it appears necessary to allow for effective intervention to contain and mitigate risks arising from market-based finance.

For more details on the issues:

-MEMO on securitisation in:

http://europa.eu/rapid/press-release_MEMO-15-5733_en.htm

-MEMO on Solvency II Delegated Regulation in:

http://europa.eu/rapid/press-release_MEMO-15-5734_en.htm

-MEMO on cumulative impact of financial services legislation in:

http://europa.eu/rapid/press-release_MEMO-15-5735_en.htm

Reference: European Commission, Fact sheet, Memo-15-5732 “Questions and Answers on the Action Plan on building a Capital Markets Union”, Brussels, 30 September 2015, in:

http://europa.eu/rapid/press-release_MEMO-15-5732_en.htm?locale=en