At the beginning of 2015, the European Commission launched an ambitious initiative aimed at integrating the EU’s capital markets: the Capital Markets Union (CMU). Introduced in order to remove barriers to investment and boost growth and jobs in Europe, the CMU has been a flagship project of the EC’s Investment Plan for Europe.
The Capital Markets Union: Developing Europe’s Markets
Capital markets in Europe are relatively underdeveloped: stock market capitalisation in the EU amounted to 64.5% of GDP in 2013, compared to 138% in the US. They are fragmented along national borders, too, with investors rarely going outside their own countries.
European investment remains heavily reliant on the banking sector, and businesses struggle to access alternative sources of funding. While the share of bank financing in total corporation financing declined from 70% between 2002 and 2008 to 50% between 2002 and early 2016, this decrease was attributable to changes in the financial structure of large companies – small and medium enterprises, meanwhile, continue to rely on bank financing.
Debt financing was relevant to 85% of European SMEs in 2016, yet only 13% of them have used or considered using equity capital as a source of financing. In contrast, medium-sized businesses in the US obtain five times more funding from capital markets than EU-based companies.
Through the CMU, the Juncker Commission hopes to unlock capital around Europe and allow it to move freely across the single market, by harmonising regulatory frameworks and cutting down legal barriers to cross-border investments. Enhancing non-bank financing to European firms would not only promote investment but could also play an important role in the resilience of the corporate sector to shocks, by diversifying the sources of funding – thus reducing the risk and impact of problems in the banking sector being transmitted to the real economy and widening the distribution of risk.
Risks Beyond the Banking Sector
Despite the large potential for supporting investment afforded by the Capital Markets Union, especially for Europe’s 22 million small and medium enterprises, the safety of non-bank sources of financing is problematic. Banks need to adhere to certain regulatory and supervisory frameworks such as Basel III or the Europe’s banking union rules that are meant to improve banking sector’s risk management, governance, and transparency.
Capital markets are significantly less regulated and less secure. They also generate the risk of asset bubbles and rapid capital outflow in times of uncertainty, which could have a destabilising impact on national economies.
So far, the implementation of the project is not going smoothly. First and foremost, the EU’s biggest financial centre, London, will no longer be a member of the single market and will not join the CMU. Moreover, in the wake of Brexit, the CMU project lost its founding commissioner Jonathan Hill, who resigned in June 2016.
On the top of that, the initiative has encountered difficulties in the European Parliament. MEPs are sceptical of some of the EC’s proposals, such as measures to revive the securitisation market, which supposedly played a triggering role in the global financial crisis in 2008.
Nevertheless, Valdis Dombrovskis, the European commissioner in charge of financial services policy, has remained optimistic, declaring that Brexit makes the project of completing the CMU “even more urgent” and that the CMU is an opportunity to show the true value added by European integration.