The European Union (EU) is at a critical juncture, facing a decline in its competitiveness on the global stage. With European elections in sight and a new European Commission (EC) set to take up its post later this year, now is the time to define a fresh policy agenda for the next five years that can ensure the EU’s vibrancy and competitiveness. The EU’s policy approach to capital markets will play a key role.
Take the evolution of initial public offerings (IPOs) by European corporates. Before the creation of the European Single Market, corporates from the EU-27 Member States accounted for 5 percent of global IPOs. Following the first few years of the Single Market in the 1990s, this figure soared to 20 percent. Yet, over the past three years, this statistic has plummeted to levels of around 7 percent. Many Member States are understandably concerned about the EU’s lack of public listings, creating a litmus test of the EU’s ability to scale up the businesses it needs to maintain competitiveness. Yet companies are more likely to be attracted by the greater depth, liquidity and resulting higher valuations offered by markets outside the EU.
Further key figures underscore the challenge: The EU’s share of global gross domestic product (GDP) is around 17 percent, but its share of the world’s total market capitalisation currently stands at only 13 percent. Capital markets’ funding of EU corporates remains on average at around 10 percent—a similar level to that recorded by the Association for Financial Markets in Europe (AFME) in 2018. Meanwhile, market-based financing in the United Kingdom and the United States averages 26 percent. The EU remains a predominantly bank-funded economy.
Notably, the EU faces additional challenges, including demographic pressures on public budgets and state pension systems. Finding ways to keep pensions financially sustainable in the long term against the background of an ageing population is creating an urgent need for citizens to seek suitable alternative solutions for retirement. The sustainable transition will further strain financial resources, with an estimated EUR 700 billion annual requirement for ambitious environmental targets.
While European leaders are aware of these challenges, there appears to be no straightforward path to addressing them. Despite their ambitious goals, the Capital Markets Union’s (CMU’s) action plans of past years have not given rise to fundamental changes. As the EU gears up for the upcoming European elections, the policy agenda for the next five years needs to be designed with the goal of securing a more transformational impact.
Achieving scale through coordinated efforts
Scaling capital markets will require an approach incorporating both EU-wide and domestic-level initiatives. The challenge lies in ensuring that domestic approaches align within a structured and coordinated EU-wide framework. If the focus rests on bottom-up initiatives, with Member States focussed solely on their domestic markets and competing only with their EU neighbours for market share in their respective areas of specialism, then the scale necessary to attract capital and finance economic needs within the EU as a whole will fall short. Global competitiveness trends will not be reversed. Explaining and promoting the tangible benefits of integrated markets within Member States, and importantly for Member States, is imperative.
Tackling the pensions challenge is a good candidate for this approach, starting with a robust exchange of best practices derived from national experiences among Member States. A more ambitious strategy would be to build on this and previous lessons learned, for instance, from the Pan-European Personal Pension Product (PEPP) experience. Ultimately, creating a European pension product with cross-border investments, portability and harmonised tax incentives wherever possible would be a transformative step.
Another strategic move would be to ensure that the development of liquidity in the EU equities market is at the forefront of the Union’s policy objectives. Beyond its role in attracting capital and boosting valuations, robust secondary-market liquidity is integral to fostering growth within the EU. Taking a proactive stance on this front will not only improve market dynamics but also encourage EU listings and bolster the market’s overall resilience.
Implementing certain Capital Markets Union (CMU) Action Plan measures remains pivotal, particularly enacting those agreed by co-legislators in the present mandate, such as the European Single Access Point (ESAP) and the so-called consolidated tapes for shares and bonds. These initiatives hold the potential to overcome the existing geographical fragmentation of EU markets by providing centralised data access to investors—the first concerning information on EU corporates’ financial and non-financial performances and the second regarding information on securities’ trading prices. Both types of information will be visible to all investors, whether in the EU or globally, irrespective of the country of incorporation of the business or where a trade takes place, which is not the case today.
There are two caveats to this. More must be done to change attitudes that associate corporate champions with the need to list on a specific domestic exchange. Instead, the objective should be to foster the growth of EU corporates by ensuring those wishing to go public choose an EU listing venue, regardless of the specific country. For a consolidated tape to provide meaningful information on share prices, the current design of the tape will need some adjustments, specifically going into greater levels of the order book than what is presently envisaged for pre-trade information. This can be done relatively quickly if Member States look beyond incumbent commercial interests.
To further remove impediments to capital-market growth, addressing longstanding barriers will also be paramount. Here, withholding taxes and corporate-insolvency harmonisation require specific efforts from Member States to agree, at pace, on the proposals currently being negotiated. A new area to consider in the coming years could be the harmonisation of civil liability regarding prospectuses, particularly concerning forward-looking information, as this could enhance transparency for investors while providing greater clarity to issuers and their advisors on their potential liability risks.
Finally, leveraging emerging technologies will be central to fostering competitiveness and efficiency. The adoption of distributed ledger technology (DLT) holds the promise of streamlined trading and post-trade processes, translating into reduced operational costs and improved liquidity.
Beyond the above, recognising that direct market-based financing may not be a solution for all types of companies in all situations is important. In this regard, securitisation can be a tool for bridging the gap between traditional banking and market funding mechanisms. It can transfer risk from banks’ balance sheets, freeing up capital they can allocate towards additional lending. It is now well documented that the EU is lagging in this respect. As of June 2022, annual securitisation issuance in the EU and UK represented just 1.2 percent of total outstanding bank loans, whereas in the US, in the same period, annual securitisation issuance was equal to 12.6 percent of outstanding bank loans. To overcome this, recalibrating bank and insurer prudential treatments, reviewing disclosure frameworks for investors and supporting the nascent ESG (environmental, social and governance) securitisation market are essential. In all of these areas, EU policymakers can make a difference.
Paving the path to competitiveness
Europe is at a turning point, necessitating a fresh approach to its policies on capital markets. The EU’s dwindling number of IPOs and relatively low global market capitalisation highlight the urgent need for change. As the EU enters a new phase with its upcoming elections, a comprehensive and ambitious policy agenda is crucial.
The journey towards a more competitive and resilient European economy necessitates a joint effort. Coordinating EU and domestic-level initiatives is not simply a matter of practicality; it is imperative to achieving the scale and integration of capital markets required to position Europe competitively on the global stage. If this path is navigated successfully by a collective commitment to structured coordination and strategic action, it will pave the way for a resilient, vibrant and globally competitive European economy.
Originally published in the International Banker: https://internationalbanker.com/finance/a-turning-point-for-europes-capital-markets/