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

Great effect is expected from the newly created EU’s banking union, which will help break negative feedback loops between national finances and banks. However, additional financial regulations are needed to respond to the threats to financial stability posed by the financial crisis. Notable, presently there is a new threat to financial stability: the lack of jobs and growth. It is time to see the overall impact of regulation, in particular the legislation of the last five years, and look at it through the prism of jobs and growth, so-called “reality check” making the right balance between reducing risk and fostering growth.

Reality checks

With the worst of the crisis behind, the issue is to find out whether the rules adopted have achieved what they set out to do. If the rules are in practice impeding the capacity of the financial industry to lend and invest, then such rules shall be revised. Alongside, the EU shall take into account the diversity of Europe's financial landscape. That means to differentiate the rulemaking and see that rules are proportionate to the risks posed, as well as ensure that they take into account different business models, e.g. in the bank sector.

The Commission has already done this in the Capital Requirements Regulation where the rules were adjusted to recognise that savings and cooperative networks are different (more recently with the liquidity coverage ratios).

First, the proportionality will be Commission’s key principle in decision-making in tackling future challenges. In perspective, the Commission will provide a greater degree of regulatory stability as businesses need certainty to be able to plan ahead; therefore the Commission does not anticipate a volume of new legislation.

Second, reality check goes to the need to check new sources of risk. That is why the Commission wants to review various legislative files (still in negotiation) to find a solution on such issues as Money Market Funds, benchmarks and bank structural reform. Already in Autumn 2015, the Commission will bring forward new proposals for an effective resolution regime for non-bank financial institutions, and for clearing houses, or CCPs, in particular.

There are other potential risks, e.g. the threat to the financial sector posed by cyber criminals or the lack of preparedness for an ageing population. For example, there are today around four workers to support each pensioner in Germany, but that by 2050 there will be only two…

Thirdly, there is a need for reality check on how the member states’ economies are doing. The forecasts are improving, with the latest ECB numbers suggesting 1.5% GDP growth for the euro area this year, increasing to 1.9% in 2016 and 2.1% in 2017. This is regarded as a positive signal, though the situation is far from making a healthy level of growth, as the number of unemployed is dramatic – about 24 million people are out of work across Europe. 

That is why restoring growth is the new Commission's top priority and the idea behind a €315 billion Investment Plan to support investment in long-term infrastructure projects. In the beginning of March, the EU finance ministers approved the legislation to set up the European Fund for Strategic Investments. Germany has pledged €8 billion to the fund, a sum matched by France and Italy. The Commission hopes to have the fund in operation by summer 2015.

The Investment Plan will give a welcome shot in the arm to investment in Europe. But if we want it to be more than a one-off, if we want to have a durable impact on economic conditions in Europe, then we need more structural change. We need to remove obstacles currently standing between companies or projects and the financing they need.

And the Capital Markets Union will assist in increasing the range of options available to investors so that Europe's savings, pension contributions and investment premiums can be put to more productive use.

Capital Markets Union

Free movement of capital has been one of the four fundamental principles on which the European Union was built. But fifty years on from the Treaty of Rome, Europe still doesn't have a fully functioning single market for capital. The market remains fragmented, largely along national lines.

Making progress on building that single market provides for considerable growth. For example, if European’s venture capital markets were as deep as the US, as much as €90 billion more in funds would have been available to companies between 2008 and 2013. This is a missed opportunity...

The EU’s goal with the Capital Markets Union is to make Europe more attractive to inward investment while creating more financing opportunities for SMEs and infrastructure projects, and spreading risk more effectively to those who can bear it, and opening up new opportunities for business across borders with increasing competition.

However the Commissioner rejected the idea of emulating the US model at the expense of well-functioning bank financing small businesses. This is not to attack on Germany's three-pillar banking system, neither to encourage smaller investors to take more risks than is sensible.

The EU’s Capital Markets Union is about complementing the role of banks, not about displacing them. It is about developing European solutions, not aping American ones.

Europe's banking system will obviously continue to play a pivotal role in Europe's economy; it is very important to local communities, and it is at the heart of capital markets themselves. Many EU companies will continue to get the bulk of their finance through bank lending.

In Germany, bank financing works much better than in many other parts of Europe where SMEs and start-ups simply can't get the finance they need from banks to grow. But even in Germany, developing more funding sources could help; high-potential technology companies from Germany move to the US in order to have access to a more suitable range of funding options for their needs. There's even a German school in Silicon Valley to cater for the families of all these entrepreneurs…

Missed opportunities and perspective ideas

Even in Germany, where bank funding has proved highly resilient throughout the crisis, there are opportunities being missed. Behind the label of Capital Markets Union are a number of pragmatic, incremental steps to get funding to where it needed most: in long-term investment projects; in infrastructure and in our SMEs.

The Commissioner mentioned some perspective ideas, e.g. re-establishing the market for securitisation in Europe, which will make a real difference to long term investment by broadening the investor base to include more long term investors such as insurers and asset managers. The EU wants to achieve a differentiation of high quality securitisation products across all financial sectors, indeed to set up a framework for the development of an EU market that singles out a category of highly transparent, simple and standardised products. This is not entirely new ground – the detailed rules for Solvency II and CRR Liquidity Coverage Ratio establish a differentiated approach for securitisation instruments.

The EU is also supporting institutional investors to invest in long-term projects; much has been written about the need for institutional investor behaviour to take a longer term approach. Governments and EU institutions shall support such developments, e.g. to give insurance companies a number of incentives to invest for the long term in the detailed rules introduced for Solvency II in October 2014.

There is a need to create a single market for personal pensions which would help mobilise more personal pension savings for long-term financing.

As far as banks are concerned, many of the detailed rules implementing the capital requirements take account of long-term finance needs: the Commission will produce a report under the review of the Capital Requirements Regulation to assess how appropriate the existing rules are in relation to long-term financing.

Finally, 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.

Investments into infrastructure projects

The Capital Markets Union, CMU provides a framework for investments into infrastructure projects: the roads, the bridges, and the broadband networks. This can be done by providing incentives to institutional investors to put their money in infrastructure.

The Commissioner provides two examples:

First, the European Long Term Investment Funds or ELTIFs is an ideal vehicle for such type of incentive, both for the new European Fund for Strategic Investment and for insurers (the European Parliament has agreed already to ELTIF). Second, the work of the task force on the investment plan to help increase the transparency of infrastructure projects, which should make it easier for investors to identify strong projects in which to invest.

Commission’s intention is to make amendments to the detailed rules on Solvency II in both these areas, i.e. to make provision for ELTIFs, and to give insurers more ways of getting involved in infrastructure projects.

CMU can also help SMEs to get access to finance. This is not a new goal, member states have been active in a number of areas; some have taken initiatives to try to channel funding more effectively to SMEs. The Commission has supported bank lending to SMEs by setting lower bank capital requirements, relative to Basel rules, for lending to certain SMEs. It will also focus on SME lending in the forthcoming assessment of the impact of capital requirements.

In the context of international standards, particular attention should be paid to the appropriate calibration of SME lending capital requirements. EU banks could help in one area, i.e. in giving better feedback to SMEs and pointing small businesses towards alternative types of financing when they consider a loan is not right for them.

Some SMEs may want to have other options, like listing on a growth market or attracting venture capital. The EU has to help raise SMEs' awareness of alternative financing opportunities. And companies that decide to take the plunge and offer securities on a market should not be deterred from doing so simply because of the paperwork involved.

Therefore the Commission wants to revise the Prospectus directive so that it becomes easier for SMEs to fulfill their listing obligations, but in such a way that investors are still well informed about what they are buying.

Although there is good basic information on companies’ activities, potential investors can't easily assess the credit risk that they might present. So the new steps are towards increasing standardised data for credit assessment without putting all SMEs in a new tangle of red tape.

Finally, the Commission is considering how to boost the "ecosystem" in Europe for venture capital. This might include adapting the rules for European Venture Capital funds and European Social Entrepreneurship Funds to expand the categories of fund managers able to offer these funds.

Bottom-line is, that the Capital Markets Union “project” offers certain opportunities: for banks as important intermediaries of market-based funding, for investors to increase their options for investment, for the member states to widen access to new channels of funding for SMEs and infrastructure projects, and to finance growth, in general.

Concluding remark on “reality check”

Last reality check deals with the jobs and growth concept: neither politicians, regulators nor supervisors would create growth in Europe; it will be done by businesses and companies who innovate, who take risks, expand into new markets and create jobs.

Since the financial crisis the Commission has made numerous efforts to ensure a safe and stable EU’s financial system being robust enough to cope with challenging times. The bulk of EU’s legislation includes better supervision, greater transparency, stronger financial institutions and means to deal with urgent problems.

The EU intends to assist the member states in providing conditions for growth by offering stability and regulatory certainty. When regulating, it is important to rely on proportionate principle, and take into account the effect of the rules on the marketplace. The reality check should apply in creating jobs and growth in Europe.  

Reference: European Commission, Speech “How to restart growth” by J. Hill, Commissioner responsible for financial services and capital markets union, 17 March 2015, Germany. In:  

http://europa.eu/rapid/press-release_SPEECH-15-4616_en.htm?locale=en