Capital Markets Union

Background:

To overcome the financial and economic challenges facing the EU today, it is necessary to take further steps in ensuring the free movement of capital across the EU. This requiring breaking down of the cross-border investment barriers preventing business, especially SMEs, from getting access to finance. The current environment is tough for businesses that remain heavily reliant on banks. A more diversified financial system would contribute to financial stability in the EU by reducing the impact of banking crisis on the EU economy. Many EU countries remain much more dependent on bank loans relative to alternative sources of financing (securities and bond markets, direct placement, venture capital) that makes them vulnerable to shocks in the banking sector. Stock market values as a percentage of GDP differ widely across EU: in 2013, domestic stock market capitalization, which defines the aggregate market value of the issued share capital of all publicly-traded companies, exceeded 121% of GDP in the UK and 98% in the Netherlands, compared to around 30% in Greece, and below 10% in Slovakia and Cyprus, Latvia, Lithuania (Financial Times, 2014). Relative underdeveloped financial markets in the EU compared to other leading economies do not contribute to our common goal – EU competitiveness. US public stock markets are almost double in size (138% of GDP in the US vs. 64.5% in the EU in 2013; 74% of GDP in China compared to 64.5% in the EU in 2013) (European Commission, 2015). Indeed, many European companies in search of private placement money head to the US markets (Financial Times, 2014).

There are barriers in terms of access to finance, in particular for SMEs, start-ups and long-term infrastructure projects undertaken in areas such as transport and energy, but also social infrastructure (hospitals, schools and social housing). These barriers include the varying levels of information available to make investment decisions across the EU, the general lack of trust of retail investors in financial markets and intermediaries due to the crisis, the high costs of accessing capital markets, especially for SMEs, with many investors limiting themselves to their national markets. These problems are particularly severe in the countries that have been most affected by the crisis. In the eurozone, over a third of SMEs didn’t get the full financing they asked for from banks in 2013. In Greece, more than two thirds of such companies didn’t (Wall Street Journal, 2015).

Recommendations:

- To overcome these challenges, we recommend the Council to welcome the European Commission’s flagship initiative on Capital Markets Union reflected in the Green Paper (European Commission, 2015) aimed at unlocking financing and putting it to work in support of all the EU businesses, SMEs and start-ups and providing boost to growth and job creation in the EU.

- To maximize the actual impact of the CMU initiative, we recommend the Council to call on the Commission, upon the completion of the Commission’s consultation with stakeholders, to identify priorities for the medium term - three priority items out of suggested six items to develop a realistic

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CMU action plan for the next five years and the remaining three for a longer-term agenda based on step-by-step approach.

- We recommend the Council to call upon the Commission to focus on not just economic but also environmental and social responsibility criteria when developing CMU action plan to avoid widening of economic and social disparities across the EU, such as including appropriate measures to boost the green bond market, and measures to promote investment in social infrastructure (schools, hospitals).

- We recommend the Council to call upon the Commission to consider the following recommendations while drafting the CMU action plan:

Lowering barriers to accessing capital markets - a step focused on reviewing the rules for prospectuses to make it easier and cheaper for firms to go to the market, while still preserving proper investor protections1 – removing unnecessarily restrictive legislation in various member states such as dismantling national rules that require non-bank lenders to have banking license.

Widening the investor base for SMEs – an action focused on generating standardized credit information and credit score to make it easier for investor to compare lending opportunities across SMEs – to promote reliable public financial data for non-bank measures could include creation of common credit register – one stop shop for credit data.

Building sustainable securitization2 - an effort to revive securitization markets by defining a class of “high quality” securitizations that could be given more favorable regulatory treatment – amend Transparency Directive to facilitate medium-sized companies’ market access.

1 Prospectuses are legal documents used by companies to attract investment. They contain facts to help investors make informed investment decisions. But they 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. The Commission is launching its consultation on the Prospectus Directive with a view to making it easier for companies (including SMEs) to raise capital throughout the EU while ensuring effective investor protection. A key focus will be to reduce the administrative hoops through which companies have to jump. The consultation will, among other things, consider ways to simplify the information included in prospectuses, examine when a prospectus is necessary and when it is not and how to streamline the approval process.

2 High-quality securitization refers to the practice of bundling loans into securities and selling them as bonds. Poorly administered securitization was highly criticized during the financial crisis, when it was held responsible for encouraging reckless lending decisions by banks. The commission said it would seek to develop an EU securitization market that is “transparent, simple and standardized.” Banks could then be required to hold less capital against asset-backed securities fulfilling such criteria, freeing up their balance sheets to lend more to businesses and households.

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Boosting long-term investment funds – to ensure that a specific portion of long-term investment funds are geared towards social infrastructure, such as social housing, hospitals or municipal services.

Developing European private placement markets3 - an effort to develop a pan-European private placement regime to encourage direct investment into businesses – launch discussion on possible targeted measures to harmonize national insolvency, company and taxation laws (making information transparent and accessible); elaborating guidelines on rules affecting private placement, such as rules on exempt offerings (e.g. give exemption from registration to private companies that raise no more than specific amount through the sale of stock), modernizing private placement with electronic settlement that would give the EU competitive advantage (US still insists on paper settlement).

Question:

Could financial transactions tax in the EU undermine attempts to inject greater liquidity into capital markets

3 Private placement is a form of direct lending typically between institutional investors and mid-sized firms, or 'mid-caps'. It can take the form of loans or bonds with maturities between 3-15 years, with 5-10 years being more common. Investors involved in private placements are usually large banks, mutual funds, insurance companies and pension funds. Private placement is the opposite of a public issue, in which securities are made available for sale on the open market. Since a private placement is offered to a few, select individuals, the placement does not have to be registered with the Securities and Exchange Commission. In many cases, detailed financial information is not disclosed and the need for a prospectus is waived. The current EU regulatory framework allows private placements and some Member States – mainly Germany and France - have already developed these markets. However, there is room for improvement: the US private placement market is almost three times bigger than that in the EU, with an issuance volume of some €50 billion in 2013. Private placements have the potential to broaden the availability of finance for medium to large unlisted companies. They also have the potential of offering additional investment opportunities for long-term investors, such as the insurance sector and pension funds industry, which prefer longer maturities. The Commission has undertaken a mapping exercise of national private placement regimes and it notes that barriers to the development of a pan-European private placement market include the lack of standardized processes and documentation; information on the credit worthiness of issuers; as well as lack of liquidity in secondary markets.

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