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14 September 2015

Open Markets: Europe's search for capital

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The goal of the CMU is to expand capital access for businesses across Europe; attract more financing in the EU and beyond; and help create a more stable financial system overall. Seven months on, has this long-term project gotten off to a good start? Graham Bishop shares his vision.

Half of European Union employees work at companies employing less than 50 people. That compares to just 28 percent in the U.S.  Small and medium size business enterprises are a critical growth engine for the EU economy, yet these enterprises are often squeezed out of access to a capital markets system and cannot issue shares directly on publicly-traded securities markets, which leaves them reliant on bank lending.

The International Monetary Fund (IMF) forecasts gross domestic product growth at 1.8 percent in 2015 and 1.9 percent in 2017 for the eurozone.  While the European economy is growing, policymakers would like to see even stronger growth in Europe, and the proposed CMU is seen as a way to inject new capital investment, drive growth and spur job creation.

“Europe desperately needs to break the vicious circle of low growth, low investment and its over-reliance on funding from banks that have been paralyzed by the financial crisis,” says William Wright, founder and managing director at New Financial, a London-based think tank. [...]

U.S. and European Capital Markets

Some economists say the reliance on bank lending in Europe is holding back its growth prospects. In the Euro area, banks provide 70 percent of external financial to non-financial corporations, according to the European Central Bank. [...]

“The big issue for Europe’s capital markets is the lack of a Eurozone wide sovereign bond,” says William O’Grady, executive vice president at Confluence Investment Management.  “One of the key factors that makes the U.S. capital markets work is the existence of Treasuries, which act as the base rate for nearly all credit transactions,” he says. [...]

Creating a capital markets system across 28 nations is different than the capital markets system in the United States.  But a Capital Markets Union is not about copying the U.S. model, says Wright. “There are plenty of structural and cultural reasons why capital markets in Europe are significantly less developed than in the U.S.,” he says. “A CMU needs to be ‘made in Europe’ and needs to reflect the fact that markets in Europe will never be as integrated or as harmonized as in the U.S.”

Next Steps

To that end, the European Commission, led by Jonathan Hill, EU Commissioner for Financial Services, embarked on a public consultation in February 2015 to get input from individuals and organizations about what building blocks for a CMU should include.  The commission received over 700 responses.

“People want us to be ambitious for the Capital Markets Union, but they also want us to make quick progress where we can,” Hill told an audience in June. “For instance by creating a new market for simple, transparent and standardised securitisation products.” [...]

Wright highlights two key ways in which a CMU could boost the SME sector.

The first is greater access to venture capital, where EU activity is about one eighth the size of the U.S. market relative to GDP. That could free up significant investment in small high growth companies.  Wright points out that if venture capital in Europe had been just half as developed as in the U.S. over the past five years, there would have been an extra $100 billion of investment in European companies. The second key point is that by simplifying access to public equity markets, a CMU could boost the small-cap and high growth IPO market, Wright says.

Gaining Access

There are a variety of challenges to the creation of this ambitious project. One issue that may be overlooked is the demand side.

According to a bi-annual survey conducted by the ECB, access to finance was named as the most pressing problem by Euro Area SMEs over the last few years.  However, in the latest report that was replaced by the problem of finding customers. [...]

Another obstacle lies in cultural bias of the European investor. “Another issue is risk aversion and home bias of European savers,” says Neugebauer. “Compared to their American counterparts, they are much more likely to prefer low and safe returns from a bank, rather than the much higher but riskier ones from capital markets.”

Graham Bishop, an independent consultant who has served on several EU Commission finance advisory committees, o, hones in on the intricacies of creating deeper integration between the member states. “In the end, it comes back to the politics of an `ever closer union.’ Are the member states really willing to pool sovereignty over vital parts of their national economic life – such as harmonizing enough of company law, insolvency law, relevant parts of taxation and securities law – together with empowering a Union-level body to enforce it?,” says Bishop.

A Slow Start

[...] This project, while still in its early stages, could have a significant and lasting impact on the Eurozone economy. Economists believe the creation of more unified capital markets could help Europe avoid another crisis in the future.

“Yes, it could help,” Wright says.  “Financial crises are part and parcel of capitalism and are nothing new. What made the crisis in Europe so devastating – with a deeper and longer impact on the real economy than in the US – was that the over-extended banking system and transformed a financial crisis into an economic crisis.”

Hill, the EU commissioner, has stated that an action plan for implementing the CMU will be published in September, reflecting the consultation on the green paper with all interested parties across the EU, and with specific proposals to follow shortly thereafter.  In his speech following the consultation in June, he acknowledged there will be a long road ahead.

“Ladies and gentlemen, we will be making a quick start, but we are going to have to keep the effort up, year-in, year-out.”

Full article on Open Markets

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