More than fifty years ago, the Treaty of Rome enshrined the “four freedoms”: that goods, people, services and capital could move freely across the internal borders of what was then the European Economic Community and is now the EU.
Of those freedoms, the one that has been the most difficult to put into practice has been the freedom of movement of capital. So, 57 years after its founding treaty, the EU last week launched an effort finally to create its “Capital Markets Union” (the CMU). The principal aim of the CMU is, in the words of the European Commission, “to create deeper and more integrated capital markets in the 28 Member States”.
Why a Capital Markets Union?
Historically, companies in most EU Member States have had a much greater reliance on bank funding than companies in the US and other parts of the world. The financial crisis demonstrated the structural risks of this reliance: as banks sought to conserve capital after 2008, bank lending to corporates – especially to small and medium-sized companies – fell. This in turn deprived companies of both working capital and investment funds, with a concomitant effect on the rest of the economy.
The financial crisis demonstrated what was already well known: that the EU should attempt to strengthen its capital markets (i.e. non-banking financing) in order:
- on the demand side, to diversify the sources of capital available to companies; and
- on the supply side, to increase the opportunities for providers of capital to put that capital to work.
As the Commission asks:
“Why is this worth doing? A few examples illustrate the potential benefits. Compared with the US, medium-sized companies, the engines of growth in many countries, receive five times more funding from capital markets than they do in the EU. If our venture capital markets were as deep, as much as €90 billion of funds would have been available to finance companies between 2008 and 2013. If SME securitisations could be returned – safely – even to half the levels they were in 2007 compared with today, this could be equivalent to some €20bn of additional funding.”
So what are the European Commission’s plans?
The Commission acknowledges that the creation of a true capital markets union will be a very long haul – or, in its words, “a long-term project”.
It took the first steps in this renewed initiative (and there have been a few since 1957) last week with the publication of its Green Paper, “Building a Capital Markets Union”, and with two consultations on aspects of the CMU:
• one reviewing the Prospectus Directive, “with a view to make it easier for companies (including SMEs) to raise capital throughout the EU”; and
• one on specific measures to create a “sustainable, high quality” securitisation market in the EU.
There is already, to some extent, a single capital markets rulebook in the EU, through legislation on markets in financial instruments, market abuse, alternative investment fund managers, market infrastructure and central securities depositories. The Commission’s aim is to build on those measures to achieve these broad objectives:
• improve access to financing for all businesses across Europe (in particular SMEs) and for infrastructure projects;
• increase and diversify the sources of funding from the EU and wider investment community; and
• make markets work “more effectively and efficiently, linking investors to those who need funding at lower cost, both within Member States and cross-border”.
The consultation on the Green Paper runs until 13 May 2015. After that, the Commission will consider the actions needed to put in place “by 2019 the building blocks for an integrated, well-regulated, transparent and liquid Capital Markets Union for all 28 Member States”.
Ambitious. Does the Commission have any priorities for early action?
Yes. The Green Paper sets out various priorities:
Reviewing the Prospectus Directive
The Commission’s review of the PD will look at when a prospectus is required, at streamlining the prospectus approval process and at simplifying the information needed in prospectuses. The overriding purpose of the review: to make it easier for SMEs to raise capital throughout the EU.
Building sustainable securitisation
Of course, the securitisation markets did not cover themselves in glory in the run up to and during the financial crisis. Nevertheless, the Commission recognises that securitisation can provide a “powerful mechanism” for transferring risk and increasing bank lending capacity. So, again concurrently with the Green Paper, the Commission has started a consultation on specific measures to “ensure high standards, legal certainty and comparability across securitisation instruments”. That consultation also closes on 13 May 2015.
Developing European private placement markets
Here, the Commission is referring to the private placement of corporate debt. Since the financial crisis, private placements have increased in some Member States – but barriers remain in the form of differences in national insolvency laws, lack of standardised processes and information on the credit worthiness of issuers. The Commission observes approvingly that as a first step towards developing European private placement markets, the Pan-European Private Placement Working Group, led by ICMA, recently published a guide to corporate private placements, setting out standards, best practice and recommended documentation.
The wide range of other areas at which the Commission is looking
As well as these priority areas, the Green Paper contains a panoply of questions as to how the EU’s capital markets could be improved. In no particular order, these include:
• SMEs on MTFs: is there value in developing a common EU-level accounting standard for SMEs listed on multi-lateral trading facilities?;
• Crowdfunding: how can barriers to developing crowdfunding or peer-to-peer platforms on a cross-border basis be addressed?;
• Fund managers: what steps could be taken to reducing the costs to fund managers of setting up and marketing funds across the EU?;
• PE and VC: how can the EU further develop private equity and venture capital as an alternative source of finance?;
• UCITS: how can cross-border retail participation in UCITS be increased?;
• Law I: what aspects of insolvency laws need to be harmonised in the EU?; and
• Law II: what are the main obstacles to integrated capital markets arising from company law and corporate governance?
All told, the Green Paper asks 32 questions about the EU capital markets for respondents to consider.
Osborne Clarke comment
Nearly six decades since Rome, the EU seems focused on creating a true capital markets union. It is a central plank of President Juncker’s platform. And it is an area in which the UK is heavily invested, both because of the importance of these markets to the UK’s economy, and because it is Jonathan Hill, the British commissioner, who is leading the capital markets charge in Brussels.
But the reasons for the current fragmentation of the EU capital markets are complex and deep; legal, historical, structural and cultural. The Commission is accordingly realistic in its acknowledgement that this is a multi-year, difficult task. The overall aim is a good one and the first priorities, particularly a review of the Prospectus Directive and promoting private placements of debt, are well chosen.