Capital Markets Union: a welcome start - European Union Committee Contents


CHAPTER 3: PITFALLS, OBSTACLES AND OPPORTUNITIES


71.  We also highlight some potential pitfalls and obstacles to a successful Capital Markets Union, as well as the opportunities it might present.

Supervision

72.  Several seminar participants expressed concern about any formal pan-EU supervisory mechanism. Hugo Dixon said that it was misleading to draw parallels with the Banking Union Single Supervisory Mechanism. He stressed the distinction between a single supervisor and a common rulebook, but conceded that there might be a case for supervision of some very technical areas.

73.  Sharon Bowles said that the issue of centralised supervision would inevitably raise its head during negotiations. Although supervision might be necessary in specific areas, she said that there was no ready-made body to take on a pan-EU supervisory function, as the ECB had done under Banking Union. She did not think that it would be possible for ESMA to take on this role.

74.  Charles Roxburgh said that the UK Government did not think that a pan-EU supervisory framework was necessary or desirable: the current Member State-based system worked, while trying to create a pan-EU framework could create a significant distraction. Phil Evans agreed that, from the Bank of England's point of view, pan-EU supervision was not necessary. Barnabas Reynolds did not think that new powers for ESMA were necessary. Nor was it in the interests of the ECB to become a pan-eurozone capital markets regulator, given its existing onerous responsibilities.

75.  Our recent report on The post-crisis EU financial regulatory framework made the case for strengthening the powers, role and resources of the three European Supervisory Authorities.[78] We also recognise the principled case for as much consistency across all 28 Member States as possible. There may well be a role for ESMA to play in overseeing specific aspects of Capital Markets Union. Yet a distinction must be drawn between consistent application of a common rulebook and direct supervision of capital markets at the EU level. Any attempt to establish a system of pan-EU supervision would not only be contentious, but could prove an unhelpful distraction from the necessary reforms that Capital Markets Union is seeking to bring about.

SMEs

76.  As we have seen, the Green Paper focuses in particular on the need to improve access to finance for SMEs. The Commission acknowledges that small and rapidly growing companies possess low levels of cash flow and depend on external finance to grow. It is also recognised that bank financing, leasing and factoring are often not available or sufficient for companies with significant intangible assets, which can be less easily used as collateral. The Commission notes that the EU lacks risk capital, citing the relatively undeveloped venture capital market for SMEs.[79]

77.  Many seminar participants highlighted the importance of SMEs to the European economy. David Doyle said that they generated 67% of GDP, over 70% of employment and constituted 99.8% of all enterprises. Yet Charles Roxburgh said that the US experience demonstrated that many small businesses did not and would not be able to access capital markets. He said that Capital Markets Union should therefore focus on medium-sized companies.

78.  Marte Borhaug, Senior Policy Adviser, Financial Services at the CBI, said that the focus should be not just on the size of SMEs, but on whether they wanted to grow. A capital market needed to focus on companies with the ambition to grow: companies themselves needed to take the initiative. Sharon Bowles agreed, and noted that SMEs in the UK and the EU as a whole were not good at growing from medium to large firms.

79.  As we have seen, Andrew Van der Lem said that there were limited data on SMEs, most of which were held by banks and not readily available to investors. According to Jonathan Faull, comparable credit information was needed, though there was a question as to how much detail was required. Ultimately the challenge was to keep investors interested without imposing excessive burdens on SMEs.

80.  The term 'SMEs' covers an extremely broad range of companies, varying not only in size but in their ambition and motivation to grow. Capital Markets Union is unlikely to benefit all such companies. Nevertheless, many will be well-placed to make use of the avenues for access to financial investment that Capital Markets Union could create. We urge the Commission to consider how those SMEs who want to take advantage of Capital Markets Union can be encouraged to do so. Yet ultimately, the onus lies on SMEs themselves to respond.

International consistency

81.  The Green Paper states:

    "European capital markets must be open and globally competitive, well regulated and integrated to attract foreign investment, which means maintaining high EU standards to ensure market integrity, financial stability and investor protection. Given the global nature of capital markets, it is important that the Capital Markets Union is developed taking into account the wider global context."[80]

82.  A number of seminar participants compared the EU and the US. David Doyle pointed out that the US had a flourishing enterprise culture and ready availability of capital market-based intermediation funding. He pointed out that in the US 80% of capital funding came from capital markets and 20% from banks, whereas the reverse was true in the EU. According to Phil Evans, part of the reason the US was recovering faster than the EU was because all the increase in financing for corporates in recent years had come from capital markets rather than banks, which were deleveraging.

83.  In light of these factors, Barnabas Reynolds said that it was vital to consider how Capital Markets Union would fit with the US model, in particular from the UK's point of view, given that London was the gateway to US financial markets. It was important to ensure that it was not too "European-centric". Andrew Van der Lem said that the EU could learn from the US model. Its Small Business Administration played a key role in diversifying the market, investing in debt funds and lending on to small business, thus creating a market and a track record which attracted institutional investors. He thought that the European Investment Bank and European Investment Fund could play a similar role.[81]

84.  Michael Dakin agreed that the Small Business Administration was a good model, partly because it took the first loss and spread risk. He also stressed the need for co-ordination across jurisdictions, not only between the EU and US, but also with Asia. Disclosure standards in the US, for instance, would have implications in the EU. Jonathan Faull agreed that the US had very detailed data requests and they stressed that EU requirements needed to dovetail with international standards.

85.  The EU has much to learn from the development of US capital markets as a source of funding. The Commission should look to US models such as the Small Business Administration, to see if similar programmes can be adopted, whether at EU or Member State level. The EU must also ensure that Capital Markets Union contributes to, rather than conflicts with, the development of consistent international standards. In that light, we stress the importance of international co-operation and co-ordination, not only with the US but with other, growing, global markets. A failure to include financial services regulatory matters in the Transatlantic Trade and Investment Partnership (TTIP) would be a missed opportunity.

The need for realism

86.  Several participants stressed the need for realism about the challenges that Capital Markets Union would face. Hugo Dixon said that capital markets were not fail-safe, and risk could only be reduced rather than eliminated entirely. Lord Hill said that "nil risk means nil growth, and I do not want the stability of the graveyard."[82]

87.  Participants also said that capital markets should complement, not displace, the banking sector. Phil Evans said that the EU's heavy reliance on banks would not change, though the balance between banks and capital markets could be shifted. Bernardita Jimenez said that the financial system should be treated as an integrated whole, not as a collection of silos. As we have seen, she argued that Capital Markets Union presented opportunities for banks. Sharon Bowles agreed that banks had a role to play in growing the markets.

88.  Graham Bishop cautioned that similar issues had been discussed before, in the context of the Financial Services Action Plan and the Giovannini process:[83] it was disturbing that barriers like securities law and tax mechanisms, which had been identified then, were still a problem.

89.  William Wright drew attention to the huge disparities between EU Member States. Whereas the UK stock market was 130% of the size of its GDP, many Member States had stock markets comprising only 10-20% of GDP, or even less. Standards, protocols and systems needed to be introduced for Member States with under-developed capital markets.

90.  Amid the positive reaction to Capital Markets Union, it is important to retain a sense of perspective. Significant obstacles remain. Capital markets cannot, and should not, replace the banking sector, but rather should complement it as an alternative source of funding for economic growth. It is important that the financial sector is treated as an integrated whole, rather than as a set of silos. The state of development of capital markets varies considerably between Member States, and the needs, cultures and priorities for Member States without developed markets will differ significantly from those such as the UK, where capital markets are relatively well developed.

91.  We welcome the short-term initiatives that the Commission has identified. We also recognise that there are longer-term, more contentious issues that will need to be tackled if a true Capital Markets Union is to be created. Yet the sheer quantity of proposals that the Commission has set out in its Green Paper creates a danger that Capital Markets Union could lack focus. A good starting point would be to identify those measures that are most necessary to support the EU's jobs and growth agenda.

An opportunity for the UK

92.  Notwithstanding these caveats, there was widespread recognition that Capital Markets Union presented a significant opportunity for the UK. Sharon Bowles said that President Juncker had acknowledged that Capital Markets Union could not be achieved without the UK and London. Hugo Dixon said that more than half of all capital markets activity in the EU came through the UK. Boosting capital markets would therefore be a fillip to the UK economy and to the City of London in particular.

93.  David Doyle stressed that the UK should act as a constructive participant encouraging best practice. Charles Roxburgh said that the UK also needed more effective capital markets, and could learn from others. Capital Markets Union would help expand financial centres across the EU, not just the City of London. The aim was to make the cake bigger for everyone.

94.  Capital Markets Union presents a significant opportunity for the UK positively to promote the importance of capital markets, benefiting not just the UK economy, but the EU as a whole. We encourage the Government and the UK financial sector to do all they can to share best practice with other Member States, while recognising that the UK can itself learn from others. The UK must ensure that it is at the forefront of the debate as the Capital Markets Union agenda takes shape in the coming months.

95.  It will not suffice simply to react to others' proposals: the City and the Government should be active in responding to the Commission's initiative.

Overview and key conclusions

96.  We welcome the Commission's proposals for Capital Markets Union, as a vital means of unlocking investment and providing finance for SMEs, with the potential to boost economic growth in the EU as a whole. At the same time, we make the following observations:

·  As it takes its proposals forward, the Commission must balance the need, on the one hand, to ensure that companies have sufficient access to capital and investment opportunities, and are not overburdened by onerous requirements with, on the other, adequate protection for consumers and investors.

·  The Commission must also ensure that Capital Markets Union remains focused on jobs and growth.

·  The Commission is right to propose a balance of short-, medium- and long-term measures, and legislative and non-legislative proposals, but must take care that Capital Markets Union does not lose focus through the sheer number of ideas on offer.

·  The Commission must also ensure that all its proposals are subject to a rigorous Impact Assessment and cost-benefit analysis.

·  A differentiated approach must be taken, reflecting the specific characteristics of each element of the EU's capital markets. At the same time, capital markets should not be treated in isolation, but rather as an integral set of transactions and relationships within the wider financial system.

97.  Capital Markets Union presents an opportunity to break down obstacles to the creation of a properly-functioning Single Market in capital. We will scrutinise the Commission's proposals closely as they take shape in the coming months. Our initial assessment of this timely initiative is positive.


78   The post-crisis EU financial regulatory framework: do the pieces fit? Back

79   COM (2015) 63 FINAL Back

80   Ibid. Back

81   Mr Van der Lem also stressed the work undertaken by the British Business Bank in the UK in relation to crowdfunding and venture capital. See Appendix 3. Back

82    Q4 Back

83   The Giovannini Group was a group of financial market experts, formed in 1996 to advise the European Commission on financial market issues. In particular, the work of the Giovannini group focused on identifying inefficiencies in EU financial markets and proposing practical solutions to improve market integration. See https://www.ecb.europa.eu/paym/t2s/about/html/giovannini.en.html. [accessed 5 March 2015]  Back


 
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