Europe’s Capital Markets Union

 

The core idea of a capital markets union in Europe is to strengthen the financial system across the European Union (EU) by integrating regional capital markets to create robust and diverse financing options that more efficiently match supply of and demand for credit. Proponents hope to achieve this by removing barriers to cross-border investment to create a single market for capital for all 28 EU member states. They believe this should lower costs of funding within the EU.

A consultation process is underway, which is based on proposals unveiled in February by the European Commissioner for Financial Services Jonathan Hill. Lord Hill’s policy is designed to complement Europe’s banking union and enhance the strength and flexibility of the broader regional financial system. The consultation period closes on May 13, 2015, and an Action Plan reflecting the feedback is due to be published in the third quarter of 2015. It is important to note that these types of structural reforms take time. While it warrants discussion now, at the moment of its formal introduction to policymakers, this is not something that will be carried out overnight. We expect to see some initial progress in key areas in the short term, though we are cognizant that it will likely be years before a capital markets union could be fully implemented in the EU.

European policymakers realize that reforms are needed to improve access to credit in the eurozone, particularly for small- and medium-sized enterprises. Smaller businesses are overly reliant on banks for access to capital, which impedes credit growth and economic activity when banking systems retrench or deleverage, as they have in Europe over the last several years. Europe has also taken note of the US financial system’s relatively swift recovery from the brink of disaster and concluded that deeper, more liquid and diverse capital markets can act as a source of stability and support.

We believe the initiative should help improve liquidity and expand investment options. In Europe, banks provide about 70% of external financing for corporations, with the remainder coming from securities markets. In the United States, it’s the other way around: the bulk of corporate financing is market-based. As a result, financial markets are far more dynamic in the United States, providing companies access to more efficiently-priced credit and savers with more ways of investing their capital.

As investors in European banks, we do like the captured pool of credit that they control. However, thinking more holistically, we realize that Europe’s overreliance on banks is inhibitive to the growth and development of the corporate sector in the region. We are generally supportive of any “pro-European” measures that help improve systemic integration across the monetary union.