When the European Commission first started advocating a “capital markets union” in 2014, there was little doubt that the City of London was going to be the driving force behind the initiative.
It was telling that Jonathan Hill, the UK Commissioner, was selected to run the project. And it was easy to see how London, with its outsized focus on financial services, might end up operating as the hub in a hub-and-spokes model for European capital markets.
After the UK voted to leave the European Union in June 2016, this vision was torn apart. The state that is home to the largest capital market in the EU is set on a course towards becoming a third country, putting its close relationship with the remaining 27 member states in jeopardy.
Nicolas Véron, a senior fellow at Bruegel, a think-tank in Brussels, argues that the Brexit vote has completely undermined the usefulness of the term “capital markets union”.
“The capital markets union was launched as a slogan for what was really a UK feel-good project,” he explains. “That motivation is no longer there. The spin has now disappeared.”
The incoming commission, headed by Germany’s Ursula von der Leyen, will nonetheless be looking to give the moniker a new lease of life in the next legislative term.
In a speech following an informal session of the Economic and Financial Affairs Council (Ecofin) last month, Valdis Dombrovskis, the Latvian commissioner in charge of financial services, said that he was committed to making sure that the capital markets union can “go to the next level” in the next five years.
Brexit is certainly one of the most obvious obstacles in the way of achieving this objective.
Though market participants have often been frustrated by the difficulty in pinpointing what the EU means when it talks about developing a capital markets union, it is clear that some part of the project envisages deepening the pools of capital available to companies in Europe.
It is hard to see how this would be possible unless the EU is able to maintain very close ties with the UK, which has yet to decide on what it wants from its relationship with the EU after Brexit.
According to research from New Financial, the EU’s share of global capital markets activity will fall by nearly a third if it loses the UK as a member. The country dominates EU finance, taking an average share of 30.6% of capital market activity across 26 different sectors.
“The UK was the biggest EU capital market,” says Jonathan Faull, a former top official in the European Commission. “It was open to the rest of the world. It was outside the euro but inside the single market. The situation was already complicated. Now you add in Brexit — with no clear understanding of the direction that everybody will take afterwards — it makes the whole thing even more difficult.”
The highest hanging fruit
For now Dombrovskis is looking to home in on the things that are easier for him to influence directly.
Having taken stock of the Brexit vote on several occasions — including in a mid-term review of the capital markets union in June 2017 and in a progress report this March — the Commission determined that the UK’s departure from the bloc made it more important than ever for the EU to develop its capital markets infrastructure.
“It is not worth pretending that it has all been very easy to set up a capital markets union,” says Faull, who is now chair of European public affairs at Brunswick, an advisory firm based in Brussels. “All of the difficulties that don’t involve the UK are still there. How do you make progress? Who supervises what? Should there be a decentralised model or a centralised model?”
Jean-Claude Juncker will argue that he was able to lay down the “building blocks” of a single market for capital during his term as president of the European Commission, between 2014 and 2019.
The Juncker Commission adopted 11 of the 13 legislative files that it put forward for the project. But many of the proposals, including changes to the rules on prospectuses, covered bonds and securitizations, were largely uncontroversial in the context of EU politics.
“Thanks to significant progress in CMU since 2015, the so-called easy work has already been done,” says Mika Lintilä, minister of finance for Finland, which holds the presidency of the Council of the EU until January.
Lintilä explains that the EU will look to address more “complex” problems in the next legislative term, including looking at making tax and insolvency laws more consistent across the bloc.
These issues have already been discussed in the context of the capital markets union. But they have so far been met with a lot of pushback from member states, which have tended to resist any encroachment into their ability to make and enforce their own insolvency and tax regimes.
“Some differences in national laws, such as in insolvency, corporate, securities, and tax law, form a barrier to cross-border capital flows, but they also extend beyond the competence of the Ecofin,” says Lintilä.
“Thus, progress is only possible with a high level of ownership across the relevant Council formations.”
This is still an ambitious proposition by any stretch of the imagination, particularly with regards to harmonising tax frameworks. In this area, any amendments to national rules require a unanimous vote of the European Council, making conversation on the subject notoriously difficult to get going.
“It might be that there is significant progress on these issues,” says Bruegel’s Véron. “But I wouldn’t make it the metric for determining the effectiveness of the European Commission, because it depends so much on the member states.”
Véron argues that there are other outstanding issues that the Commission should concentrate on if it wants to make another push towards creating a single market for capital in Europe.
In particular he says that the EU should overhaul the governance and funding arrangements of the European Securities and Markets Authority (ESMA), with a view to expanding its role in capital markets.
At the moment, ESMA covers rating agencies, trade repositories and a number of other market participants within its supervisory remit.
But there is plenty of room for its authority to be extended over other parts of the market with pan-European significance, including central clearing counterparties (CCPs), trading platforms and settlement providers.
“I think anybody in the business would agree with the proposition that a fragmented supervisory framework has a lot to do with the proliferation of fragmented market structures,” Véron explains.
There is power in a union
The new European Commission will need to make a choice about where it wants to focus its efforts in the next phase of the capital markets union.
Alongside calls to strengthen the supervisory framework and proposals to harmonise certain features of insolvency and tax law, there have also been appeals for the EU to improve market transparency by revisiting MiFID II — the Markets in Financial Instruments Directive.
Some market participants believe in stricter prudential oversight of systemic institutions like CCPs and complex investment firms, and others feel strongly about the need to establish new frameworks for combatting money laundering and financial crime.
Given the potential breadth of the project, the new Commission needs to be able to give a definite sense of its overarching goals for capital markets union from the outset of its term.
“The next steps should be to take stock of the achievements and shortfalls in order to form a clear picture and to identify gaps and the need for further work,” says Lintilä.
Nobody is forgetting why Europe is so keen to strengthen and consolidate its capital markets, however.
Fragmentation along national borders is preventing companies from accessing a broad and more diverse pool of financial resources, forcing too many of them to rely too heavily on a banking system that is still in the middle of a long process of restructuring.
“From a capital markets perspective, Europe is significantly behind Asia and the US across all of the key proxies: daily equity trading volumes, number of IPOs, number of listed companies, amount of capital raised, as well as retail participation levels,” says Niels Brab, head of government relations at Deutsche Boerse in Brussels.
These problems have profound implications for growth in the EU. The IMF expects euro area countries to increase their economic output by 1.3% in 2019, compared with a 2.6% increase in the US and 6.2% of growth in emerging and developing markets in Asia.
A seemingly endless stream of monetary stimulus from the European Central Bank has done little to alter this outlook, and member states have so far been reluctant to chip in with any fiscal stimulus, even where they have sufficient headroom to do so.
But the incoming Commission remains convinced that there are significant gains to be made from public policy initiatives.
“It is critical to realise the importance of the reflections around the capital markets union and their ability to significantly boost the overall growth contribution capacity,” Brab says.
“With Brexit on the horizon, this reasoning is only going to be reinforced in the EU27.”