EU releases blueprint on capital markets union to unlock funding for growth

The EU has set out plans to create a capital markets union, to complement bank lending in generating capital for an economy struggling to rebound from six years of recession and sluggish growth.

Jonathan Hill, the Commissioner for Financial Stability, Financial Services and Capital Markets Union, outlined a set of initiatives with a central aim of reducing small business (SME) dependence on bank lending. Helping to pick up the slack will be stronger stock and bond markets and alternative financing, such as crowdfunding.

“Capital Markets Union is about unlocking liquidity that is abundant, but currently frozen, and putting it to work in support of Europe’s businesses, and particularly SMEs,” said Hill. “It’s about growing the overall pot so that everyone benefits: banks, capital markets and, most importantly, firms which find more sources of funding.”

Three quarters of all corporate fundraising in Europe flows from banks. With only a quarter raised on markets, the continent is exposed to ebbs and flows in the availability of credit, the Commission said. This was dramatically highlighted when credit dried up in the financial crisis of 2007-09.

"If we had had a more diversified financial system, the economic crisis may not have hit Europe as hard as it did,” said Cora Van Nieuwenhuizen, a Dutch member of the European Parliament with a seat on the assembly’s Economic Affairs Committee. “Certainly, the recovery would have been quicker and less painful, like in the US."

For innovative young firms, equity capital can be particularly important to fuel growth. But the task of finding it is not easy: EU capital markets come with a spaghetti bowl of fragmented national markets with separate rules, regulations and business practices. As a result, there are very limited flows of equity capital across national borders.

Approaching the vast thicket of laws is, “a bit like picking up War and Peace on page 730”, Hill said in a recent interview with the Financial Times.

The announcement of the capital markets union is an early blueprint. The Commission is inviting feedback from businesses and lawmakers before 13 May, before fleshing out the final action plan in the summer.

Possible reforms

The EU has set out several short-term initiatives for coming months, in three consultation documents.

The Commission feels that more can be done to make credit information on SMEs more readily available for investors to see. One of the documents examines the possibility of reforming the prospectus directive, EU legislation that stipulates what information companies must provide to investors when seeking to raise capital, with the aim of reducing the administrative burden on SMEs.

Longer-term measures would include reviving bond markets, changing rules for asset management or pension funds, and measures to incentivise people to invest in capital markets, instead of holding their money in savings accounts.

The EU would ultimately like to move towards the kind of balance seen in the US, where markets supply the bulk of funds for companies.

The aim is to be welcomed, said Jan Famfule, deputy director of Prague-based think tank European Values. “Today, banks provide for about 75 per cent of the financing of the European economy while in the US, 80 per cent of all financing comes from the markets – a company simply gets money by issuing its shares or bonds,” he said.

“While getting an 8 - 10 year loan from a bank can be a problem for an SME, the stock market is capable of offering a long-term financing to the company,” Famfule said.

But such a fundamental shift is unlikely in the lifetime of the currrent Commission, with one official calling the idea “too ambitious.”

The word union in the capital markets plan might turn out to be a misnomer: there is an apparent appetite for quick, easy wins over a barrage of more difficult law-making for tax and insolvency rule changes across the EU.

It is also highly likely that the UK would veto any attempt to transfer more powers to Brussels.

Snags in Europe’s money flow

Equity markets come in all different sizes in Europe. London’s stock market value is Europe’s biggest, worth the equivalent of 121 per cent of the UK’s gross domestic product (GDP), while countries including Lithuania and Cyprus host stocks worth a tiny fraction of their own GDP.

Companies based in one member state struggle to raise money in another. When investors sit down and look at investment opportunities, there is a strong home bias: only 40 per cent of equity financing transfers between states.