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11 May 2015

Progress on financial integration: the scoreboard on the way to CMU

The financial crisis struck a huge blow to the progress of financial integration in the euro area – a prime objective of monetary union and the Single Market. However, it is clear from bond yield spreads that integration has recovered substantially – and now CMU is getting underway.

The ECB’s financial integration index (FINTEC) gives an encouraging overview of the progress in restoring integration even before CMU becomes operational. Despite the recovery, there is still a mountain to climb in creating a single, borderless capital market – shown starkly in the index below that measures cross-border holdings.


What is FINTEC?The price-based Financial Integration index is constructed from a selection of price-based indicators that cover the four main market segments: money, bond, equity and banking markets. The quantity-based FINTEC uses intra-euro area cross-border holdings expressed as a percentage of euro area total holdings.Complete integration would be an index of 1.00

The ECB’s “Financial integration in Europe- 2015”[1] and the European Commission’s “European Financial Stability and Integration Review – 2015”[2] were  published recently – providing a treasure trove of data and analysis on these developments.

These reports are a useful cross-sectional analysis of progress in a wide variety of financial areas as it is all too easy to exist in a particular industry silo without seeing the linkages to all the other inter-connected fields. The central message of `the crisis’ was that the financial world is now highly inter-connected. Moreover, these statistical exercises also show where the gaps are in regulators’ understanding that may – in the heat of the crisis – open up the critical regulatory `underlaps’ that proved so destructive.

As the UK now contemplates an In/Out referendum on EU membership, City players should be fully aware of the precise policy goals that underpin the seemingly-disparate torrent of policy proposals. As the EU’s only genuine pan-European policy operator, the ECB’s views are particularly interesting in the light of the extensive powers given to it by banking union. We are well on the way to learning the true meaning of the concept of a single rule book for banking. The goal for Capital Markets Union is no less ambitious (see box below).

“In order to achieve these objectives, CMU needs to be pursued with a high level of ambition. In the ECB’s view, a genuine CMU would mean achieving full financial integration, which is achieved when all market participants with the same relevant characteristics face a single set of rules; have equal access to a set of financial instruments or services; and are treated equally when they are active in the market. The CMU therefore needs to be underpinned by a single and appropriate legal and regulatory framework that provides a level-playing field, and allows markets to develop. This would ultimately imply more steps towards greater harmonisation of insolvency law, company law and taxation of financial products. It is key that the definition of CMU should be included in the introduction of the upcoming proposal on CMU to clearly delineate the necessary level of ambition and to define the key steps leading to this final objective.”

The ECB’s report focusses more on historic, statistical analysis whereas the Commission’s counterpart can place more attention on the analysis that underpins Capital Markets Union proposals. So the Commission’s EFSIR includes comparative studies on SME credit registers; longevity risk and the private sector debt overhang.  Commentators focus on the level of public debt so it comes as a surprise that the average public debt/ GDP ratio of just under 100% turns out to be the minimum for private debt - with Luxembourg leading the rankings at 400%.

However, there is a weakness in such analyses: naturally, they focus on historic data about the past behaviour of markets rather than looking forward to the ending of the ECB’s non-standard monetary policy measures. The initial impact would most likely be manifested in a widening of yield spreads – thus apparently reducing financial integration, so there should be no complacency that the crisis is over. The European Council meets on June 25/26 to consider – amongst other topics – the Four Presidents’ Report on “Next Steps on Better Economic Governance in the Euro Area” and it is these steps that should encourage investors that the chances of a renewed crisis for the euro area as a whole are modest.

Is this the time for the euro area to look again at my proposal for a Temporary Eurobill Fund[3] (TEF) to provide a post-QE foundation for Capital Markets Union whilst underpinning financial stability in the event of a renewed financial crisis? My detailed plan for a TEF explicitly provides the “concrete mechanism for stronger economic policy coordination, convergence and solidarity” that is being sought by the Four Presidents. It can be initiated as a small step towards integration; be scaled up to become a de facto European Treasury and even provide a modest `fiscal capacity’; but it can be reversed easily – even to extinction within two years. The plan would contribute to answering most of the eleven questions posed in the European Council’s February Analytical Note.

© Graham Bishop

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