Jean-Claude Juncker, the incoming President of the European Commission, has brought a ‘capital markets union’ one step closer by placing it on the agenda for his term as head of the EU executive. Much will have to happen to make that vision a reality but the commitment should aim to lead to more flexible and affordable financing for European companies.
There is no doubt that Europe is hungry for investment. The Commission itself has stated that EUR 1trn is required for critical infrastructure, such as transport, energy and telecoms networks, by 2020. Small and medium-sized enterprises (SMEs) need financial investment to grow after weathering the recent downturn. In Europe, banks have traditionally been the cornerstone of corporate finance but now they are under pressure to shrink their balance sheets. The result is a greater need for alternative forms of finance.
A ‘capital markets union’ would enable Europe to follow the example of the US where alternative sources of finance play a larger role than bank financing. Securitisations – loans made by banks and packaged and sold to investors – as well as bonds, peer-to-peer lending, direct infrastructure finance from pension funds and other investors and long-term equity finance such as private equity, would all be part of a diverse range of options open to growing companies.
This would be good news for Europe on many fronts. A wider range of options should make access to the most suitable forms of finance easier and lead to lower borrowing costs for companies. Moreover, it would make the European economy a lot more resilient. A financial system that offers various funding mechanisms and is less reliant on banks, is better able to absorb shocks and to continue to provide capital in times of crisis.
European institutions, as well as international bodies such as the International Monetary Fund (IMF) and Financial Stability Board (FSB), recognise this. The mood music emanating from Brussels has changed as Europe’s economic woes linger on. Debate about financial market risk is shifting to a consideration of how capital markets can and must facilitate growth.
There are still plenty of challenges ahead. Now the concept needs to be fleshed out with concrete proposals. All must be based on the principal commitment to free movement of capital across national borders under appropriate regulation – not just within Europe, but globally. Disparate regimes will need to be harmonised and EU law, such as the AIFM Directive, will need to be transposed consistently across the European Union to tap the full potential of the single market.
A Capital Market Union is also needed for Europe’s professional investors, such as pension funds and insurance companies, many of which struggle to generate sufficient returns to match their liabilities in a low interest rate environment. These institutional investors are therefore very interested in investment into long-term investment classes, such as private equity and infrastructure, which have a proven ability to generate high returns and provide essential funding for businesses and infrastructure investments. New financial market regulation that would impact such investments needs to be carefully assessed.
Building an integrated European capital markets system will take time. But it is a welcome step that it is on the agenda. Europe needs an improved financial system that will be good for companies, as well as for lenders and investors. Ultimately, that will be good for the system too.