European Union Reveals Plan to Build Capital Markets Union

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EU Commission invites public feedback on private lending consolidation plan.

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The European Union recently launched an initiative to strengthen its financial system by proposing the consolidation of private lending across all 28 of its member countries into one single “Capital Markets Union.” The move represents the Commission’s intent to accelerate Europe’s economic recovery as it shifts lending in the EU from a bank-driven system to one driven largely by private lending in capital markets.

The Commission issued a three-month consultation round, known as a green paper, in which public input will help shape a plan for developing the Capital Markets Union. The green paper highlighted the Commission’s priorities for the near future, which include plans to:

  • Unlock access to investments for companies of all sizes and for infrastructure projects
  • Bring to Europe greater investment from markets around the globe
  • Open up a wider range of funding sources to EU institutions

The Capital Markets Union would empower investors to raise money from a wide range of sources throughout the EU regardless of location. The Commission believes this would free up capital that currently sits unused due to investors’ fear of high administrative costs associated with cross-border lending. It could allow lenders to connect with investors more easily, helping to pull the EU out of the lingering wake of the 2008 crisis as it develops the individual markets of the participating member states.

There are many roadblocks to cross-border transactions within the EU. For example, current lending markets are fragmented, with diverse currencies, tax codes, and established lending practices making capital market financing very complex. Smaller regional markets face stiff competition from the U.S. and other markets. There is also wide variation in capital market development across the EU countries, with some member states being still very underdeveloped. And, as the Commission argues, “insolvency, corporate, taxation and securities laws” each also add roadblocks to cross-border lending.

Furthermore, the relatively high proportion of bank lending to capital market lending in the EU has contributed to the region’s weaker ability to absorb shock when bank lending tightens, as often happens early on in economic downturns. Currently, European firms rely on banks for 70% of their lending and get only 30% from private capital markets.

In the U.S., this balance is reversed. Some analysts believe the EU is attempting to move in the direction of the U.S., which was better able to handle the aftermath of the 2008 crisis due to its greater reliance on its more flexible private capital markets.

The green paper highlights other challenges to integrated markets in the EU. For example, private equity markets remain much smaller in the EU than in competitors’ markets. Additionally, risks and rewards are not always spread appropriately among members that currently engage in multi-state projects. The decision to form the Union suggests the EU intends to encourage cooperation among its member states by making further participation in the EU more attractive to all countries, including Britain, for example, which has so far held out from deeper participation in the euro zone in some important ways, such as the adoption of the Euro.

One of the Commission’s primary goals is to develop the individual economies of the EU member countries in addition to building the Capital Markets Union. In order to do so, the Commission plans to take measures to make financing more accessible to small and medium-sized companies, as well as start-ups. Most European markets contain many small and medium-sized companies that have more difficulty accessing capital markets than larger foreign companies do, which perpetuates the region’s reliance on banks. The Capital Markets Union is designed to remedy this shortcoming by widening the investor base for companies of this size and making it easier for institutional investors to access credit information about them.

In the near term, the Commission plans to develop new proposals for high quality securitization development, improving public access to information about small and mid-sized companies, opening investment channels into infrastructure investment, and more.

The Commission invited comments from “parliamentarians, member states, those who work in capital markets, and from all groups concerned about jobs, growth and the interests of European citizens” as it formulates its initiative. The consultation ends on May 13, 2015. The Capital Markets Union plan comes on the heels of a broader EU investment plan announced in November 2014, and the Commission intends to have a fully functioning Capital Markets Union in place by 2019.