Capital Markets Union


The Capital Markets Union is an economic policy initiative launched by the former president of the European Commission, Jean-Claude Juncker in the initial exposition of his policy agenda on 15 July 2014. The main target was to create a single market for capital in the whole territory of the EU by the end of 2019. The reasoning behind the idea was to address the issue that corporate finance relies on debt and the fact that capital markets in Europe were not sufficiently integrated so as to protect the EU and especially the Eurozone from future crisis. The Five Presidents Report of June 2015 proposed the CMU in order to complement the Banking union of the European Union and eventually finish the Economic and Monetary Union project. The CMU is supposed to attract 2000 billion dollars more on the European capital markets, on the long-term.
The CMU was considered as the "New frontier of Europe's single market" by the Commission aiming at tackling the different problems surrounding capital markets in Europe such as: the reduction of market fragmentation, diversification of financial sources, cross-border capital flows with a special attention for Small and Medium-sized enterprises. The project was also seen as the final step for the completion of the Economic and Monetary Union as it was complementary to the Banking union of the European Union that had been the stage for intense legislative activity since its launching in 2012. The CMU project meant centralisation and delegation of powers at the supranational level with the field of macroeconomic governance and banking supervision being the most affected.
In order to address the goals and the objectives decided at the creation of the project, an Action Plan subject to a mid-term review was proposed consisting in several priority actions along with legislative proposals to harmonise rules and non-legislative proposals aiming at ensuring good practices between market operators and financial firms.
The new European Commission under the leadership of Ursula von der Leyen has committed to take ahead and finalise the project started by its predecessor by working on a new long-term strategy and to address the problems the project has had in recent times following the mid-term review and the UK's exit from the EU. This is also highlighted in her bid for the presidency of the European Commission during the process of election as the main economic motto of her campaign was "An economy that works for people".
Its successor is the Savings and Investments Union.

Context

History of the EU financial integration

Capital Markets Union is, by nature, a step in the history of the European Union financial integration, whose dynamic is to lead to freer movement of capital. The Treaty of Rome, establishing the European Economic Community in 1957, already expressed the necessity to instaure free movement of capital in between the member states. Then, the directive of 1988 implemented it by preventing any restriction on free capital flow. In 1999 was created the financial services action plan, first step in creating a single market for capital, and in 2011 the European Supervisory Authority, in order to insure the European financial markets stability. Only four years later, is the CMU project presented by Jean-Claude Juncker.

Characteristics of the EU financial system

EU economy remains bank-oriented, especially when compared to the United States. It means that corporations usually prefer to borrow money from the banking sector instead of financing their investments through financial markets. According to the OECD analysis, this is partly due to the fiscal bias: in most European countries, firms benefit from tax advantages if they have to reimburse a bank loan, but that is not the case if they emitted obligations on the capital markets. Therefore, there is a strong financial incentive for European companies to favour the banking sector. This high reliance on the banking system implies less stability for the European economy, hence the position of the European Commission, which advocates for a diversification of financing sources. SMEs, which have particular difficulties in integrating the financial markets but which represent a good share in the created value of the European firms, largely contribute to this tendency.
The second characteristic is part of the bank-based nature of the EU economy : it is the European saving patterns. Whereas the United States population choose to invest in long-maturity-assets through pension funds or life insurances, European savers prefer easily accessible financial instruments, such as deposits or short-maturity-assets. This economic behaviour generates a lack of financial profitability of the EU and accentuate the importance of banks as the main funding providers of the European economy.
The third characteristic of the European financial system is that capital invested stay usually in the national market : it is the home bias. Even if before 2011, there was a positive trend for cross-border investments, most of the capital flow was remaining within the national frontiers of the member states and European financial integration is still limited. This lack of cross-border investments prevent high-growth-potential companies from getting the financial resources they need to develop innovations and become more competitive. In fact, shareholders prefer buying shares from their national companies, creating an important hindrance to European financial integration, because they have to face regulation barriers if they want to invest in another country of the EU.

Financial and political shocks

Impact of the 2011 crisis

The 2008 financial crisis had two main consequences on the financial integration of the European Union:
  1. It showed the instability induced by an excessive reliance on banks' loans: When there is uncertainty, the offer of credit is reduced, impacting negatively all the economic activities depending on it. It is especially the case for Europe, whose SMEs mainly get financed by the banking system. Dealing with the aftermaths of the 2011 crisis, the dependency of the EU economy on banks made it harder to growth and employment, according to the former President of the European Commission.
  2. It increased the fragmentation of the European capital markets by increasing the domestic bias: There was a sensible reduction of cross-border investments after 2011. because the previous financial integration was led by banks investing on international financial markets. Once affected by the crisis, their withdrawal drove the European financial system to more fragmentation than before.

    Impact of Brexit

Most of the financial power of the European Union was located in the City of London prior to Brexit. Some British firms moved to continental Europe implying a loss of financial expertise in the EU. In spite of that, the European Commission asserted the consistency of the Capital Markets Union action plan, already launched at the time, and accelerated the efforts to implement it.

Objectives

Economic goals

The European Commission designed 3 different levels of objectives for the Capital Markets Union, from the global economic goals to the more concrete necessity for the construction of an integrated financial system. These economic objectives frame the six intervention areas encompassed by the action plan.

Overarching objectives

  • Facilitating the financing of both private and public sector on the financial markets
The Capital Markets Union aims to ease the access of firms and states to financing, which has become more difficult since the 2008 financial crisis. The creation of a single market for capital would send an incentive to private and institutional actors to invest the capital available, by creating new possibilities of cross-border attractive investments. This renewed possibility of financing may help the economic agents to come back to the level of growth they had before the crisis, impacting positively the employment rate. It is especially true for SMEs which might need more financing than what the banking system can offer them and therefore, would benefit from more accessible capital markets. CMU would also make the institutional investments in infrastructures way easier.
  • Ensuring the stability and the sustainability of the European financial system through integration
Economic stability depends on the diversification of the source of financing. When encountering a crisis hitting a particular source of financing, such as the banks in 2010, it is important to be able to get capital otherwise, both for the states and the companies. That is why giving and incentive to get financing through capital markets with the CMU would make the economy more shock-resistant, because it would depend less on the banking system. On the investors side, stability is ensured by the portfolio and the geographical diversification of the assets. It reduces the loss of value if a specific economic area is hit by a negative shock when you have invested in several types of activities and it reduces the loss if a specific country is touched when you have invested in several countries. Hence, the risk-sharing influence of the CMU may strengthen the European economic stability. Regarding sustainability, the increased access to capital is considered as a mean to finance environment-friendly economic projects and to encourage sustainable development.

Strategic objectives

  • Improving the competitiveness and the efficiency of the European capital markets, in order to fight against the "market fatigue"
By increasing the range of investments opportunities, a CMU objective is to improve the capital markets effectiveness. This means improving the allocation of capital, leading it to the most efficient economic actors among the European firms, because a single market for capital would have given the possibility to do so. The efficiency of capital markets deals with the competition between the European financial institution : making them gather in a common capital market would give the financial institution the incentive to become even more efficient. Competition would also lead to more diversification in terms of liabilities and assets. Market fatigue is the discredit from which asset and security exchanges suffered after the 2008 financial crisis. It reduces the capital flow on the capital markets and has a negative impact on the economic activity.
  • Pursuing a stable financial integration, in order to fight against the "integration fatigue"
The improved integration of the capital markets with the CMU is meant to increase cross-border risk-sharing and to reduce the home-bias of the investments. Currently, there are still some hindrances, as the differences in terms of regulation among the member-states persuade investors to invest in their home-country. Actually, the diversity of European rules regarding insolvency, restructuring or taxation represents a lack of legal security for investors. As the main point of a single market for capital is to remove the barriers of free capital flow in-between the member-states, the objective is to attract the savings of the richer countries towards the poorer ones. Removing the barriers preventing European exchanges, in order to act like a unified territory, is the very sense of integration. It counters the "integration fatigue" : the increasing difficulty for the European leaders to pursue the European integration. It is an incentive to invest abroad, therefore reducing the home-bias. Moreover, investing in another country leads to a geographical diversification of the assets possessed, which has a positive impact on the economic stability, as explained previously. Furthermore, investments in emerging economies can yield higher returns than advanced economies, as the idiosyncratic risk is higher.
  • Increasing cohesion within the European Union, in order to fight against the "eroding consensus"
The "eroding consensus" is the increasing difficulty to get the support of the European population for the European institutions' decisions. The erosion is illustrated by the negative response of France and Netherlands to the European referendum on the constitution of the EU. The Capital Markets Union's goal is to represent a part of the solution to this issue, by improving the cohesion in Europe. Firstly, it is a project encompassing different currencies, therefore encompassing countries outside the Eurozone area. Secondly, it involves few changes in the way European institutions work, preventing any opposition to a total overhaul. Finally, it does not require risk-sharing from the member-states, which could have made the population reluctant to the CMU. Its main contribution to the European cohesion is its goal : to equally provide financing on capital markets, across the European territory, and to provide this access on the basis of the economic actors' merit.