The last few years have tried and tested EU corporates and SMEs. Through six years of extreme disruptions, starting with Brexit, stretching through the pandemic and the fallout from the war in Ukraine, businesses have faced continuous challenges. Now, the current energy crisis and soaring inflation mean EU businesses are once again in uncharted waters.
Especially, at times of crisis, it is all the more important that businesses can rely on strong capital markets that can provide necessary funding. However, it is well-known that European enterprises continue to heavily rely on bank lending to finance their investments. According to recent analyses by EY, Eurozone bank lending is predicted to fall next year for the first time since 2014.
The ECB estimates 75% of corporates in the Euro area still continue to seek bank loans over other types of market finance. An important aim of the Capital Markets Union (CMU) is to help reduce this dependence on bank funding and to cut the cost of raising capital, in particular for SMEs. This will only be achieved by building a financial system in which deeper and integrated capital markets will absorb more of citizens’ savings and play a greater role in business finance.
The case for a Europe-wide CMU is, therefore, greater than ever before. The CMU has been discussed in Europe as a long-term project for years, but progress has been slow to materialise.
Stumbling blocks – EU equity market gap
AFME’s research shows that a few key obstacles are preventing the CMU project from truly taking off. Chief among these are the EU’s equity finance gap, which continues to widen compared to global peers, and the subdued securitisation market, which remains a material loss to the EU’s financial system.
Overall EU equity markets are making slow progress. The EU is performing far below its potential, reflected in the declining proportion of global equity market capitalisation of listed shares. For example, EU domestic market capitalisation of listed shares has fallen from 18% in 2000 to just 10% of the world’s total today. This drastic fall is a result of a combination of factors – an ongoing trend of company delistings, fewer IPOs and most recently, lower company valuations linked to the uncertain economic outlook. As a result, the EU as a whole is becoming less and less attractive as a place for businesses to access deep pools of capital and go public.
To address this, public markets and the IPO environment need improvement. The EU Listing Act will be important in this respect, and it will boost cross-border competitiveness of the EU markets for listings, both for companies already listed at exchanges and new entrants. This initiative should aim to facilitate for a vibrant environment for listings, by cutting down on the costs for businesses of all sizes where possible, while ensuring that investors continue to benefit from legal certainty and strong reporting mechanisms. Features of the existing EU framework that are unclear, disproportionately burdensome on issuers and which fail to provide adequate reassurance to investors, should be addressed in this review.
Securitisation market remains subdued
The European securitisation market has also failed to take off and falls behind that of its global peers. For example, EU securitisation issuance levels decreased by 10.9% during 2020-2021, while US securitisation grew by 74.5% during the same period. In addition, during the pandemic, securitisation played a supporting role in freeing up capacity for bank lending outside Europe, but in the EU, average annual securitisation issuance has declined by 10.9% compared to pre-pandemic averages.
There is a wide view among market participants that regulatory impediments are holding back the growth of the European securitisation market. While changes to the securitisation framework were delivered at EU level with a new Simple, Transparent and Standardised (STS) framework, these have not had the desired effect on the recovery of the securitisation market.
The absence of a well-functioning securitisation market is a strategic loss to the European financial system. It is undermining the competitiveness of European financial institutions and limiting their ability to recycle capital to support new financing. It has also driven institutional investors towards other products that do not offer the same advantages in terms of protection, transparency and liquidity.
As a tool, securitisation is uniquely placed to support the European economy through its ability to transfer risk while enhancing banks’ capacity to manage their balance sheets efficiently to continue to lend to businesses and households. To overcome this, further work needs to be done to unlock the contribution of this important instrument for financing EU growth. Imbalances in the European securitisation framework need to be urgently addressed in order to encourage issuers and investors back to the market. There is no doubt that there have been some considerable policy achievements over the last five years, but EU legislators should now grasp the opportunities provided by the current legislative discussions on the CRR3/ CRD6 and Solvency 2 to include adjustments to securitisation-related calibrations in these legislations and concrete mandates for further revisions to be undertaken.
Positive steps forward on CMU
It becomes clear that the EU needs to continue working towards significantly expanding and deepening its capital markets capacity. This is even more important in view of the capital mobilisations demanded by the green and digital transitions. Capital markets have the innate ability to contribute the building blocks to this goal and in the last five years, the evolution of ESG markets has been particularly remarkable in this respect. The amount of EU ESG debt issuance increased from €61bn in 2017 to €360bn in 2021. EU green bond issuance continued to rise in 2022, albeit at a slower pace this year, with volumes up 8% year-on-year in the first half of 2022.
The EU continues to consolidate its global leadership in sustainable finance. EU and national authorities have encouraged this transition via strong strategies to combat climate change and ambitious decarbonisation targets. The development of the regulatory framework in this area – particularly the EU taxonomy for sustainable activities, the ESG reporting framework, and an EU green bond standard – are expected to further support the EU’s sustainability transition and global leadership. The European Commission launched an unprecedented bond issuance programme in the form of social, green, and conventional bonds accumulating more than €200bn in proceeds as of 2022 (and expected to surpass €750bn).
In the realm of digital finance, 2021 was an extraordinary investment year for FinTechs. 2022, on the other hand, has seen a decline in investment activity globally. AFME has found that investment has declined in all major regions from about USD 90bn in 2021 and expected to reach USD 80bn in 2022.
Nonetheless, the EU has progressed on the road towards greater digitalisation, as Member States have improved their local regulatory frameworks with new sandboxes and innovation hubs. The number of FinTech unicorns increased from 13 to 18, suggesting an overall improvement in the environment for financial technology.
These digital trends, have, however, brought about challenges for supervisors and regulators as unregulated financial activities (some via Decentralised Finance protocols, or DeFi) have grown exponentially over the last years.
A long road ahead
As the current EU legislative cycle enters its final year, it is more critical than ever for the EU to take further steps towards putting in place a strong and diversified financial system capable of effectively mobilising Europe’s deep pools of savings, supporting businesses of all sizes, promoting innovation and attracting leading global players.
The deteriorating economic outlook this year has further highlighted the strong case for progressing CMU, reinforced further by the combined challenges of the capital mobilisations demanded by the green and digital transitions.
Reflecting on the past five years, it is apparent that capital markets have remained resilient, but policy makers need to keep the momentum going on CMU. Without this, Europe’s position among leading global capital markets risks falling further and further behind.
Success ultimately depends on the quality of regulation and its effects in advancing the CMU objectives, and not the number of legislations adopted. Current initiatives under discussion as part of the second CMU Action Plan and upcoming Commission proposals have the potential to deliver significant progress. EU authorities should seek policy outcomes that focus on investor and corporate needs and which create the right conditions for building the EU’s wholesale markets capacity and potential to be at forefront of innovation in global financial markets.
The road to CMU remains a long one.