Capital Markets Union: Commission's Mid-Term Review and Plans for the Future

One of the flagship initiatives of the Juncker Commission, the Capital Markets Union (CMU) was launched in 2015 as an ambitious, overarching initiative that aims to create new funding opportunities for European companies, thereby strengthening the European economy while promoting innovation and growth. In the Mid-Term Review published last week, the Commission evaluated the progress made in the last two years and identified new areas for action in order to ensure the continued effectiveness of the initiative. The Communication announces nine legislative and non-legislative priority actions, confirms three future legislative proposals, and sets out a broad range of additional initiatives, with the aim of completing the CMU by 2019.

Background

In the Political Guidelines written for his candidacy to become head of the Commission, President Juncker emphasised that the CMU “would cut the cost of raising capital, notably for SMEs, and help reduce our very high dependence on bank funding”, adding that it would also “increase the attractiveness of Europe as a place to invest”. Strengthening the capital markets in the EU has therefore been established as one of the key priorities of the Juncker Commission, which launched the initiative in September 2015.

The goal of the Mid-Term Review was to establish which goals have been achieved, identify the key areas for improvement and propose further actions if deemed necessary. It was partially based on a stakeholder consultation conducted between January and March 2017, and sets out future measures with the aim of completing the CMU by 2019.

Well on course with room for more

Although it has been established that, in twenty months, two-thirds of the original commitments have been completed with a few others within sight, the Commission felt that further actions were necessary in order to keep the programme “fit for purpose” with regards to the latest developments, particularly Brexit. With the United Kingdom leaving, the EU is about to lose its largest financial centre, and this could upend the very foundation of financial services within Europe. More generally, the Commission hopes that accelerating the removal of the remaining obstacles to the free flow of capital in the EU will lead to more investment and therefore more jobs and, overall, a more resilient European economy.

The proposals contained in the Review aim to strengthen the financial system in Europe and to give more opportunities for both investors and consumers by providing a strong and dependable new source of financing. It is especially hoped that through a stronger CMU SMEs would be able to find more opportunities for growth, while principles such as sustainability and green financing were also firmly emphasised.

This briefing will follow the structure of the Commission Communication, presenting the main proposals and actions as well as their justification and expected effects.

State of play and remaining challenges

The Commission notes that, in the last 18 months, 20 of the 33 measures (60%) announced in the CMU Action Plan have been delivered, highlighting among others the progress made on venture capital, the agreements on modernised prospectus regulation and on Simple, Transparent and Standardised (STS) Securitisation, the Action Plan on Consumer Financial Services, and the Report on the removal of national barriers to the free movement of capital in the EU. Nevertheless, the Commission warns that most of the challenges set out in the Action Plan are still relevant:

  1. Start-ups and scale-up firms still find it hard sometimes to acquire risk finance, which hampers their ability to invest in innovation and growth.
  2. The EU’s public equity and debt markets are still largely inferior in size when compared to other developed economies, which leads to difficulties in some Member States to access public markets, especially for SMEs.
  3. Due to the financial crisis, there has been a contraction in new loans to EU businesses by banks trying to reduce their exposure to risk.
  4. There is not enough investment by insurance companies and pension funds in risk capital, equity and infrastructure.
  5. Most of European household savings are held in bank accounts with short maturities, because there is a low level of engagement by retail investors with capital markets, hampering their access to attractive investment propositions.
  6. Cross-border investment is still hindered by many long-standing and deep-rooted obstacles.

At the same time, Brexit makes these challenges even more complicated to resolve, and the Commission argues that it will require an even stronger action for enhanced financial integration. It therefore calls on the Parliament, the Member States and market participants to support the development of the CMU, the cooperation of whom they regard as key in the building process.

Legislative proposals and additional measures

The 2015 Action Plan announced that the Commission is preparing a handful of proposals seen as crucial for the creation of CMU. The Mid-Term Review revealed that one of these proposals is already in the pipeline, with two others expected to be launched at the end of 2017 and the beginning of 2018, respectively.

First of all, the Commission will propose a legislation on a Pan-European Personal Pension Product (PEPP) by the end of June 2017. The aim of PEPP would be to encourage more savings into personal pensions to secure adequate revenues for retirement by fostering a safer, more cost-effective and transparent market in pension savings.

Secondly, in the last three months of 2017, the Commission expects to introduce a proposal to specify conflict of laws rules for third-party effects of transactions in securities and claims. Uncertainty about the specificities of applicable law in different Member States is a serious obstacle for cross-border transactions, which is why the Commission is aiming to provide clarity on which law applies to the third-party effects in cases of transactions in security and in claims. 

Lastly, by the end of March 2018, the Commission will propose legislative action for an EU framework for covered bonds, which would aim to further integrate the covered bond market, thus boosting an important channel for the long-term financing of the real economy. The Commission clarifies that it will strive to ensure the quality of existing covered bonds is not undermined.

In addition, the Commission is in the process of preparing a number of measures which it deems necessary for the smooth implementation of the commitments of the 2015 Action Plan. The Commission highlighted five specific measures:

  1. Amendments foreseen in 2018 to Delegated Regulation (EU) 2015/35 (known as the ‘Solvency II Delegated Regulation’), in order to review the prudential treatment of private equity and privately placed debt, where justified, from a risk-based supervisory perspective – in the broader framework of the review of the Solvency II Delegated Regulation.
  2. A Recommendation on private placements, in order to broaden the availability of finance for unlisted medium-sized companies, by the end of 2017.
  3. A Communication, to be published by the end of this year, on a roadmap for removing barriers to post-trade market infrastructure. Post-trade market infrastructure is crucial for the securities markets, by ensuring that transfer of ownership, payment and exercise of rights flowing from securities is conducted in an orderly manner.
  4. A Communication, also foreseen to be presented by the end of 2017, on corporate bond markets, which represent an important funding channel for larger companies. The Communication will build on the recommendations of the Expert Group on Corporate Bond Market Liquidity, which consists of individual experts from EU Member States and the US, as well as NGO and EU institutions representatives as observers.
  5. A Code of Conduct to simplify withholding tax procedures (with a focus on refunds), also by the end of 2017. The Commission hopes that this will lead towards more efficient operational solutions for recovering withheld taxes, and is consulting national tax experts in order to learn best practices and agree on a code.

The need for a strong CMU

The Commission brings up several points, arguing that the EU needs CMU more than ever. First of all, the Review argues that stronger supervision of the financial markets is necessary due to its ever-increasing interconnectedness. It lists the ongoing review of the operations of the European Supervisory Authorities (ESAs), as well as the expected amendments to the ESAs’ founding regulations. Secondly, it warns that Brexit has led to a situation where there is a pressing need to strengthen and integrate the EU’s CMU framework, for example on central counterparties (CCPs) as well as investment firms and markets for initial public offerings (IPOs).

In addition, as we emphasised in a previous briefing, the emerging financial technology (FinTech) is a potentially transformative development which may change the whole landscape by bringing in new market players, more efficient solutions, increased competition and lower costs. Capital Markets could also experience significant efficiency gains thanks to FinTech, for example with regards to equity issuance, corporate governance, asset management, and so on.

The Commission also wants to put more emphasis on sustainability with regards to the financial system, for example integrating the goals and commitments laid down in the UN 2030 Agenda for Sustainable Development and the Paris agreement. To achieve sustainability economically, socially and environmentally, the Commission established a High-Level Expert Group to advise it on how to integrate sustainability aspects into new regulations and practices. The Communication highlights that capital markets have the potential to help the EU meet its social responsibilities by channelling capital into investments with positive externalities.

Lastly, the text warns that in order for all Member States to be able to reap the benefits of more integrated capital markets, there is a need to broaden the reach of capital markets to more remote regions, in order to provide funding in a local context.

Nine priority initiatives

Taking into consideration the aforementioned trends and circumstances, the Commission identified seven key areas in which progress is needed, with a total of nine priority actions. These actions would aim to establish the CMU by 2019, according to the original timeline.

1. Strengthen the effectiveness of supervision to accelerate market integration

The Commission argues that consistent and effective supervision is pivotal to build CMU, as it eliminates barriers and reduces compliance costs resulting from the differences in implementation for firms that operate across borders. The Commission will therefore propose amendments to the functioning of the European Securities and Markets Authority (ESMA) and other ESAs in the next few months, trying to promote more effective and consistent supervision both across the EU and beyond (Action 1).

2. Enhance the proportionality of rules to support initial public offerings and investment firms

Due to shortfalls in the current regulatory environment as well as the negative effects of the financial crisis, public listings of SMEs are fairly low in the EU, and they often find it hard to raise capital on public markets. After working with representatives of public markets ecosystems to assess how the public markets for SMEs are functioning, and to identify potential solutions for barriers to SME listing, the Review found that these issues could be alleviated by reviewing these regulatory barriers.

In this context, the Commission will conduct an impact assessment by the middle of 2018 on whether targeted amendments to relevant EU legislation could help to deliver a more optimal environment to support SMEs listing on public markets (Action 2). In addition, a legislative proposal to review the prudential treatment of investment firms will also be presented by the end of the year, which the Commission believes could restore the level playing field, boost competition and improve investors’ access to new opportunities (Action 3).

3. Harnessing the potential of FinTech

Innovative financial services have an enormous potential to deepen and broaden the EU capital markets through digitising business models in asset management, investment intermediation and product distribution. At the same time, the Commission fears that innovative businesses not following the habitual practices of more traditional firms may suffer from disproportionate or inconsistent practices with regards to regulatory requirements.

The public consultation on FinTech closed on 15 June 2017, and its findings will help the Commission to identify to what extent FinTech businesses tend to suffer due to the nature of their endeavours and whether new licensing arrangements are needed in areas such as investment-based and lending-based crowdfunding. The Commission also wishes to support FinTech firms to do cross-border business without requiring further authorisation in each EU country (so-called “passporting”). Subsequently, the Commission proposes to assess the licensing and passporting framework for FinTech activities by the end of 2017 (Action 4).

4. Using capital markets to strengthen bank lending and stability

The issue of non-performing loans (NPLs) is still a heavy burden on national banking systems, hampering both the banks’ profitability and their ability to lend. The Commission believes that secondary markets for non-performing loans need to be improved, especially in terms of predictability and transparency, so that banks are able to sell their NPLs to a larger pool of investors at better prices.

The Commission will shortly launch a public consultation to establish in what areas the EU could take action; it is in the process of carrying out a benchmarking exercise (to be completed by the end of the year) in order to shed light on the features of enforcement and insolvency systems which contribute to either better or worse outcomes. It will also present measures to develop the secondary markets for NPLs during the first few months of 2018 and will launch an impact assessment with a view to proposing a legislative initiative to strengthen the ability of secured creditors, and to recover value from secured loans to corporates and entrepreneurs (Action 5). Any initiative would be consistent with the 2016 Commission proposal on insolvency and restructuring.

5. Strengthen the EU's leadership on sustainable investment

In line with the spirit of the UN 2030 Agenda for Sustainable Development and the Paris agreement, the Commission seeks to advance the principle of sustainability to become an integral part of the financial system as well, by integrating previously neglected negative externalities (especially with regards to the environment) into considerations regarding long-term investments. The Commission previously established a High-Level Expert Group on Sustainable Finance, and according to its upcoming recommendations – to be published by December 2017 – the Commission will decide on the nature of concrete action to be taken (Action 6).

6. Cross-border investment

The Commission warns that investment funds in the EU are still relatively small, costly and geographically limited in distribution, which – according to a public consultation – stems from the fact that there is a lack of regulatory and supervisory convergence. Greater innovation as well as more efficient capital allocation at better value could be achieved through greater cross-border (digital) distribution. The Commission therefore intends to start considering a possible legislative proposal to facilitate the cross-border distribution and supervision of Undertakings for Collective Investment in Transferable Securities (UCITS) and Alternative Investment Funds (AIFs), with an impact assessment foreseen to be launched at the beginning of 2018 (Action 7).

In addition, greater clarity on existing substantive EU standards is also deemed important by the Commission, arguing that a stable investment environment could encourage more investment, as well as greater transparency on the effective protection of EU investor rights. Subsequently, in the first quarter of 2018, the Commission will adopt an interpretative Communication with the aim of providing guidance on the existing EU rules for the treatment of cross-border EU investments. In addition, an impact assessment will be launched with a view to setting out an adequate framework for the amicable resolution of investment disputes (Action 8).

7. Support the development of local capital market ecosystems

The Communication highlights that there are necessary prerequisites for market-based finance to be a viable and sustainable alternative to bank lending, such as financial circuits, market conventions, and technical and legal infrastructure, which enable market participants to operate on any level from local to pan-European. A report will be released by the Vienna Initiative’s CMU Working Group by the end of 2017 to identify the most important areas in need of improvement and to propose practical solutions.

Based on this report, and taking into account the experience gained through the growing delivery of on-demand technical support under the Structural Reform Support Programme, the Commission will propose a comprehensive EU strategy on steps that can be taken to support local and regional capital market development across the EU (Action 9). It is understood this strategy will be published in the second quarter of 2018.

Conclusion

A more efficient Capital Markets Union could potentially have a significant positive effect on the European economy, and stakeholders such as Better Finance, AFME, EFAMA and Eurosif all welcomed the Mid-Term Review and a large majority of its new initiatives. With the departure of the UK – the largest financial centre in Europe – CMU has become a particularly sensitive project which, at the same time, can help to mitigate the negative effects of Brexit and provide EU businesses and investors with access to strong and dynamic capital markets. Whether the Review will be able to ensure that all building blocks of the CMU are concluded by 2019 remains to be seen, as substantial commitment from stakeholders, Member States and EU institutions will be necessary to achieve effective implementation.

Next Steps

The Communication has been sent to the European Parliament and the Council for consideration, both of which can now decide whether to formally respond.