Europe is good at having money. It’s bad at moving that money across its 28 member states to companies that need capital to grow.
Enter the Capital Markets Union, a gallant but complex European Commission initiative aimed at increasing and improving investment channels in the EU.
If the heart of the Commission’s agenda under President Jean-Claude Juncker is jobs and growth — boosted by a €315 billion investment package — the Capital Markets Union is a makeover of the EU’s capital channels aimed at ensuring that money can flow swiftly and completely across the economy, especially to small- and medium-sized firms, the EU’s bread and butter.
Under-the-radar commissioner Jonathan Hill — a British Conservative appointee — is shepherding the project and will reveal his action plan in September, just as Brussels is coming back from summer holiday. To help you prepare for it, POLITICO explains what’s in Mr. Hill’s file.
So, what is it?
In the simplest terms, according to Hill, the CMU is about “linking savings to growth in Europe.”
As a matter of European culture, bank lending is the most popular form of financing. Bank lending works well except when the banking sector contracts, as it has in recent years since the financial crisis, and lending in the whole economy dries up.
The alternative to bank lending is non-bank lending (critics have branded it “shadow banking”), which enables venture capitalists, private equity firms, angel investors or crowd funding to inject cash into companies.
The former is a Skoda, the latter is a Ferrari: Bank financing is reliable and safe, non-bank financing is sexier and potentially riskier but can maneuver faster.
The Capital Markets Union is aimed at making sure the EU has both cars at its disposal. The two types of finance are there to complement each other, according to the project’s architects.
Then there’s the issue of turning Europe into a single market for capital by lowering the national boundaries that keep investment money from flowing from, say, Germany through the U.K. to Bulgaria. Hill likes to remind audiences that the free movement of capital is — along with goods, service and people — one of the four main freedoms at the heart of the EU economy.
“Everybody loves it (the CMU) because nobody knows what it is” — Wim Mijs, European Banking Federation
The timeline
In September, Hill will introduce his action plan. He’s said that the first efforts will be aimed at “low-hanging fruits” or quick fixes to help the project gain momentum. The first actions of the Capital Markets Union will be to:
1) Simplify the documents that companies are required to produce to raise capital. These prospectuses can comprise hundreds of pages and cost up to €100,000 to prepare.
2) Revise the laws around securitization — or how banks bundle assets to sell onward and free up space on their balance sheets — to make it simpler and more transparent.
3) Lower the capital requirements for long-term investors, like insurance companies and pensions funds, who want to invest in infrastructure projects.
Beyond those first steps, the CMU will have to evolve until at least 2019 with targets each year.
Two ears, one mouth
So far, Hill has been proudly taking a step-by-step, consensus-building approach, listening more and talking less to help the CMU take shape. In the process, he’s become the sixth most-lobbied person at the Commission, according to Integrity Watch.
Hill opened a four-month consultation period in February. Everyone from Goldman Sachs to German Finance Minister Wolfgang Schäuble wrote to him and completed his online survey, while the European Parliament passed a non-binding resolution in support of the project.
The consultation ended in the Commission’s Charlemagne building in June with a public hearing, where for seven hours venture capitalists, investment bankers, savings banks, European Central Bank emissaries, bank lobbyists and their ilk aired their concerns and sketched out their dreams. That is to say, there’s huge interest in this project.
Given the enormity of the CMU and the limitless opinions about what the free movement of capital could entail, the project is also a surface on the which all branches of the financial services industry can project their hopes and anxieties.
“Everybody loves it (the CMU) because nobody knows what it is,” said Wim Mijs, chief executive of the European Banking Federation, at his group’s summer party.
Hills to climb
In the EU, there are 28 sets of tax law, company law and insolvency law that transnational investments have to navigate. There are many examples of how this trips up capital as it tries to flow across Europe.
A simple example from company law: In some countries, investors have different voting rights connected to their shares if they’re a resident of the country of where the company is registered or not.
A bigger issue is…
Bankruptcy law
Discrepancies between national insolvency practices in Europe are the most tangible hurdle for the CMU. If an investor in the U.K. has money in a firm in Germany that goes bankrupt, what happens?
After calling the capital markets union “very important” and “extraordinary” at his press conference at European Central Bank headquarters in Frankfurt this month, ECB President Mario Draghi acknowledged how difficult it would be to implement.
The CMU is “actually a very ambitious and complex, and very likely long, undertaking, because it entails changes in legislation in several parts of the area,” Draghi said, singling out “legislation that’s been with national countries for ages, like bankruptcy legislation.”
Jay Westbrook, emeritus director of the International Insolvency Institute and a pioneer of comparative studies of national bankruptcy law, explained in an interview how far apart mindsets are across the EU:
“The Brits have always had a more sympathetic idea to saving a debtor in trouble,” Westbrook said. “The Germans have had a much stricter view: There remains a big bias in favor of the idea that ‘the management of this company screwed up, they’re losers, they probably did something fraudulent, the company should be bankrupt and pay the creditors as best they can, and the management should go join a monastery,’ so to speak. And then you have French law, which is somewhere in between but has much more emphasis on protecting employees and protecting jobs.”
Securities law
The prospect of European-wide securities runs into another obstacle: harmonization. In a speech at the University of Frankfurt in March, Mijs spelled out the difficulties around, for example, securitizing home mortgages at the European level.
“How will it … be possible to reconcile home repossession laws in Italy with those in Sweden?” Mijs asked. “In Italy it can take five years, while in Sweden a home can repossessed in merely six months. Differences such as these will not make it easy to securitize mortgages at a European level.”
Banks typically bundle securities together into homogenous groups — such as Italian mortgages — but the example shows the degree of interrelated sensitivities that can affect the project of building a single market for capital.
Shoes, tech or cement?
There’s an issue with the definition of what sort of small- and medium-sized enterprises Europe wants to cultivate. Is it a group of designers in Portugal launching their own line of shoes? Two tech visionaries in Greece launching a startup with global ambitions? Or a new company producing cement in Germany?
They’re all SMEs and they all have different financing requirements, different risks and different likelihood of getting a loan from a bank, the kind of capital investment which Europe favors immeasurably.
As far as some of the parties affected by the Capital Markets Union are concerned, there’s no lack of financing in Europe. That view hinges, however, on the type of small- and medium-sized companies they envision in the EU. Tech startups, for example, do better with capital market-based financing, rather than bank loans.
Competing interests, careful whispers
National interests are also playing a major role in shaping the Capital Markets Union. The finance ministers of Germany and France, Wolfgang Schäuble and Michel Sapin, sent a joint letter to Hill in July saying that basically they don’t want to copy the economic model of the United States.
“Since different economic conditions, legal frameworks and cultural roots constitute Europe’s current financial landscape, we will have to find a specifically European solution and should refrain from bluntly reproducing the U.S. financial system,” the two most powerful finance ministers in the euro zone wrote.
Meanwhile, Hill has been warming up to bankers in the City of London, the beating heart of the Capital Markets Union.
“From here investment flows out across the continent: U.K. banks lend more than $2 trillion into other European countries,” Hill told bankers in a speech on July 15 in London. “More than a third of U.K. private equity funds’ investments go to companies elsewhere in the EU. So the success of the City is tied to a successful Europe.”
Hill is talented at making everyone feeling like the Capital Markets Union is being designed for them. It’s a huge challenge.
- Venture capitalists and private equity firms:
Non-bank lenders would like to see their sector grow, eyeing America where it is more than twice as robust as it is in the EU.
- Savings and Retail banks:
Bank lending has a dominant position in Europe, and the Capital Markets Union puts banks on the defensive.
“Capital markets funding is in the limelight in the moment but bank lending should not be simply harmed because of some financial requirements,” says Caroline Gourisse of the European Savings and Retail Banking Group, which met with Hill in June.
The top political priority for savings and retail banks, Gourisse said, is a loosening of the conditions that were imposed on banks after the crisis, like reducing leverage ratio requirements.
Hill has promised to remain open and sensitive to revising bank regulations that were passed in response to the crisis if they prove to hamper bank lending.
“Over the last five years or so, we had to legislate at speed while the fires of a crisis were burning all around,” Hill said in his London speech. “…But if you have to legislate at speed you cannot expect to get every bit of regulation completely right. And the economic context in which you regulate changes too. I am taking the same approach in my portfolio as the Commission is taking as a whole: less new legislation, more reviews of existing legislation.”
- Large investment banks:
Large investment banks do well when the economy is humming with loose capital. They’re some of the biggest cheerleaders of the project.
“Europe is the largest economy in the world and one of the richest. It is the world’s biggest trading block; it ranks first in both inbound and outbound international investments and enjoys significant pools of savings,” Goldman Sachs Group Vice Chairman Michael Sherwood wrote to Hill in May. “So there is no shortage of capital.”
- Think tanks:
Groups like the Center for European Policy Studies (CEPS) are pushing the Capital Markets Union as an opportunity to extend investment options for average Europeans. Keeping money in the bank is not an effective way to save — inflation and low interest rates consume cash over time — but only the wealthy can afford access to financial advice and specialized investment products.
CEPS would like see improvements in the long-term savings and investment options of Europeans as they prepare for retirement.
“The vast majority of Europeans — i.e. those with little financial resources and literacy — would benefit immensely from the idea,” according to a paper published by the think tank.
- Skeptics:
Some independent lobbyists see inconsistencies between Hill’s objectives and the proposed measures: the measures do more to promote market-based banking rather than bond or equity markets, they argue.
“The idea that Europe is over-reliant on banking — I’m not sure where that comes from,” says Frédéric Hache, the head of policy analysis at Finance Watch, a think tank in Brussels that watches the financial industry. “More importantly, being heavily reliant is not the same thing as being overly reliant. It’s not a reason to change the model.”
Encouraging European companies to seek investments from so-called shadow banks is fine but requires parallel regulation. Non-bank lending can be more pro-cyclical and unstable in times of crisis. “What we need is not more funding in general, but funding that does not withdraw quickly in times of stress,” says Hache.
Tear down the wall
Hill, whose full title is commissioner for financial stability, financial services and capital markets union, declined a request for an interview about his flagship project. He is, however, considered a master of frictionless political communication.
Educated at Cambridge, Hill was leader of the House of Lords and education minister in the U.K., but he remains largely unknown at home and abroad. His team occupies the former offices of Neelie Kroes, a flashy Dutch digital single market commissioner under the presidency of José Manuel Barroso.
Hill had walls erected where Kroes experimented with an open plan. It will take a few years to show if the commissioner can do the opposite for the EU’s capital markets.