Disunity: The Divides Waylaying Europe’s ‘Capital Markets Union’

Many commentators we follow often refer to the 27-nation European Union (EU) as the single market.^[i] Yet in financial services, we find it is anything but. Attempts to unify its banking system (e.g., putting member countries’ national deposit insurance under one umbrella) have failed thus far.^[ii] And its capital markets are also fragmented.^[iii] For years, there has been a push to change that, which returned to headlines last week.^[iv] There are potential plusses and minuses to this approach, in our view, but above all, we remain sceptical an EU Capital Markets Union (CMU) will come to fruition.

The idea behind the CMU is to unify Europe’s financial markets—harmonising things like listing requirements and underwriting rules to broaden and deepen them.^[v] This, in theory, would allow businesses to access funding more easily across the EU, potentially boosting business investment and market liquidity.^[vi] Many commentators we follow also project it will foster innovation—and greater growth—as it entices more firms, who may be looking elsewhere, to put (arguably underutilised) capital to work on the Continent.

At the moment, the EU has 27 capital markets split along national lines, each with different securities laws, taxes and accounting, which impedes cross-border financing.^[vii] Imagine if the US had 50 stock exchanges—and securities regulators—one for each state, dividing liquidity amongst them whilst raising paperwork for all. It probably wouldn’t be ideal, in our view. This is partly why 70% of business financing in Europe is through bank loans and only 30% comes from securities issuance.^[viii] In America, it is basically the reverse.^[ix] And many European companies have chosen to list or issue securities in America in order to court its larger, unified market.^[x] According to former Italian Prime Minister Enrico Letta, who is leading CMU efforts, the EU has €33 trillion (£28 trillion) in private savings—mostly in bank accounts—that could be steered more profitably to corporations’ capital use.^[xi] But it is cut up into many small chunks by the current regulatory structure.

For a decade, the EU has been proposing to fix this.^[xii] Yet past efforts fell by the wayside. Now Letta and others are pushing them anew. There are two main parts to the proposed reforms: 1) European Commission (the EU’s cabinet, advising its executive decisions) studies aimed at bolstering securities market development and 2) EU government legislation to enact it. Under that broad rubric, the Commission would look to cut red tape by simplifying and reducing compliance costs, harmonise national accounting rules and improve pan-European pension products to harness retirement savings more effectively.^[xiii] To that end, EU governments are charged with harmonising insolvency laws and listing requirements, streamlining information access and developing attractive cross-border retail investment and savings vehicles so they are cost effective and easy to use.^[xiv]

Additionally, EU governments are tasked with creating tax incentives to increase the supply of—and demand for—securities.^[xv] Currently, bank financing carries more favourable tax treatment. Under EU corporate income tax systems, interest is tax deductible, but equity financing isn’t, which reduces the relative appeal.^[xvi] Meanwhile, governments will also focus on adjusting the tax treatment of capital gains and losses to generate more retail investor interest, alongside educational campaigns to promote stock investing, which is far less common than in America.^[xvii]

All this may sound promising, but to us, here is the thing: A lot of member states aren’t on board. Whilst the European Commission can help set the policy agenda, it doesn’t usurp national governments’ interests. Most big EU countries seem in favour—France, Italy, Spain, the Netherlands and Poland.^[xviii] Germany is divided on the issue, with Chancellor Olaf Scholz supportive but coalition partner and Finance Minister Christian Lindner opposed.^[xix] However, smaller members appear reluctant to cede tax and oversight authority to Brussels.^[xx] Tellingly, a reference to harmonising corporate tax law never made it out of committee, as some see it as a competitive advantage they are unwilling to part with.^[xxi] The same goes with joint supervision and securities regulation.^[xxii]

This is a matter worth watching, in our view, both for potential positive developments for investment banks and markets generally, but also for unintended consequences. We find harmonising rules is bureaucratic language for changing them, which can create winners and losers or inject uncertainty. And you never know what will find its way into legislation until it is in ink, in our experience. But we think this will go nowhere fast, much like the EU’s Banking Union, which remains incomplete after being widely touted as necessary for financial stability a decade ago.^[xxiii] If anything comes of the CMU, it will likely take a long time, in our view, giving investors ample opportunity to size up the changes.