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02 October 2017

ECMI - Capital Markets, Debt Finance and the EU Capital Markets Union: A law and finance critique

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Contrary to conventional wisdom, this paper contends that the excessive development of capital market finance has been one of the catalysts behind the crises and scandals that have unfolded over the past 15 years.

In particular, innovative debt transactions have proven instrumental to the creation of excessive levels of risk-taking and leverage, which have had catastrophic consequences, both at the firm and systemic level.

While much regulation has been enacted in response to these crises, the way in which debt transactions in capital markets are designed and entered into remains largely unregulated. Moreover, regulators have so far neglected the role that leverage and debt creation play in the economy and their consequences for the wider social context. Moreover, the recent policy design in the EU is promoting a renewed implementation of an old design, the Capital Markets Union (CMU). This revolves around disintermediated, market-based forms of financing, which should represent an alternative to the traditionally predominant (in Europe) bank-based financing channel. This paper finds that the European policy design fails to appreciate the dangers associated with capital markets finance and its ensuing debt-creating effects. It argues that, despite some regulatory efforts, a suitable architecture for the regulation of disintermediated capital markets is still missing.

This paper proposes a different perspective on the EU policy aimed at further integrating European capital markets through the CMU. At the heart of this critique is the realisation that through the CMU the Commission is seeking to resuscitate a number of practices and credit channels that were prevalent in the pre-crisis years. In particular, a careful reading of the Commission Green Paper shows that debt transactions, and in particular securitisation, are central to the envisaged functioning of EU capital markets. This is also confirmed by the implementation stage of different segments of the CMU, where an agreement has recently been reached to revive securitisation through the STS Regulation, while more socially-oriented channels of finance, such as equity crowdfunding for instance, have not been pursued with the same eagerness.

In a recent speech on sustainable finance at the European Parliament, Vice-President Dombrovskis highlighted the commitment to focus on long-term goals and those serving the interest of the real economy. He emphasised the importance of embedding sustainable goals into financial regulation and stressed that efficient capital markets can contribute to sustainable societies. Dombrovskis added one important caveat: the essential need for a financial stability dimension to ensure that capital markets can adequately internalise risks and make the financial system more resilient. For this to happen, he called for a deeper re-engineering of the financial system. In light of the critique, this paper contends that the necessary re-engineering of the financial system is not likely to occur under the EU Capital Markets Union.

Full paper


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