The EU has a problem. It’s falling behind. Growth has been largely stagnant across the continent for the last two decades, with a wide number of metrics pointing to an ever-increasing investment and growth gap with the US.
The recently-published EU competitiveness report, penned by former prime minister of Italy Mario Draghi, is the latest in a long line of research projects that has shone a spotlight on the EU capital markets, reaching a similar conclusion to those gone before it: things need to change. If the EU wishes to be a competitive force on the global stage, there has to be a fundamental rethink of how the bloc operates.
At the heart of the problem is the fact that the EU is not a favourable location for a company to scale and compete effectively with their US (and now Chinese) counterparts. The Draghi report points out that only four of the world’s top 50 tech companies are European, while there isn’t a single EU company with a market capitalisation over ¤100 billion that has been established in the last 50 years.
Consequentially and simultaneously, the landscape for investors in the region is equally tricky. A key problem, for organisations and investors alike, is the muddled patchwork of rules and regulations across the continent, forged independently over centuries, which they must manoeuvre through to operate effectively.
So, the question now for the EU decision-makers is: how do you make the EU competitive again? The current plan is the Capital Markets Union (CMU): a flagship initiative designed to boost investment, enhance access to finance, enable cross-border investment, and reduce the fragmentation of Europe’s financial markets.
Sounds great, right? The problem though, is that the CMU has struggled to gain traction throughout the member states since its ideation in 2014. The lumbering, 27-pronged consortium is burdened with a deep-rooted inertia as consensus on policy and legislation can often be so hard to come by. Combine this with a rising nationalistic sentiment sweeping through the region, driving a further wedge between the EU and its harmonisation goals, and it is becomes abundantly clear that change won’t be easy.
But 10 years on, the political impetus surrounding the CMU seems to be reinvigorated. The string of damning reports appears to have awoken the beast, with government ministers and institutions across the continent coming forward with plans to kickstart Europe’s new age.
“The race is on and I want Europe to switch gear,” said Ursula von der Leyen, upon successfully securing a second mandate as European Commission President in July.
A more hospitable environment
To unlock those opportunities for growth and to boost investor power in the region, there needs to be a simplification of the disparate systems that exist within the EU.
“If you have 25 to 30 smaller places that operate independent of one another – this can be in Europe or anywhere else – the liquidity and interoperability associated between jurisdictions becomes limited,” explained Okan Pekin, head of securities services at Citi, at a recent AFME conference. “As a result, even if the investors want to bring in hundreds of billions of dollars of capital, getting in and out will become problematic because of frictional costs. So, by virtue of your market structures, you are impeding investor attractiveness.”
Take withholding tax, for example. Each country within the bloc has their own approach to the reliefs and refunds process, which are often complex, burdensome procedures that can actually serve as a deterrent for cross-border investment – particularly for individual and small investors. In some cases, the process takes years.
Another pertinent example is the provision of depositary services, where there is currently no passporting service available to asset servicers in the EU. “[This is] close to our heart as a provider of depositary services,” says Ben Pott, international head of public policy and government affairs at BNY. “You cannot provide cross-border depositary services under UCITS or AIFMD – which, when you talk about a unified Capital Markets Union, is a big miss.”
Insolvency laws, pension schemes, corporate actions, shareholder rights, securities laws – the list goes on. For Europe to become an attractive place for investors and issuers, the EU must tackle these regulatory divergences head on.
“It is not that Europe does not have the cash and investment potential,” says Sam Riley, CEO of Clearstream. “It is about market attractiveness for local and international investors.”
Harmonised post-trade as the bedrock for growth
The disparate frameworks also have a detrimental impact on the post-trade landscape, which faces its own fragmentation problems. To unlock those opportunities for growth and to boost investor power in the region, a harmonised post-trade landscape must form the bedrock on which other initiatives can sit. Without a smooth and efficient post-trade environment, the CMU risks stagnation as fragmented systems will continue to stifle market access and growth.
“We have said for a long time that when you look at some of the post-trade processes, there is still a significant amount of scope for harmonisation, for allowing much more effective cross-border provision for Europe to move closer together,” says Pott. “Historically when you look at the integration of investment services, there is a lot that has happened on the execution side, and not as much on the post-trade side.”
The Draghi report calls for a centralisation of clearing and settlement systems, with a single central counterparty platform (CCP) and a single central securities depositary (CSD) – but the acquisition and integration of 27 CSDs and 14 CCPs is an unrealistic, expensive and time-consuming task. Instead, a focus on strategic partnerships and interoperability would likely yield faster results.
As Riley, points out, over 90% of settlement activity within the EU is processed at three institutions. “That’s the reality,” he says. “We and the two other main CSDs in Europe have already progressed in providing consistency and harmonisation across platforms and processes. That naturally leads to consolidation.
“The challenge is determining what the top priorities for capital markets harmonisation are. What can we realistically achieve? Competition is good; it is healthy. It drives service quality, innovation and efficiency. Eliminating competition would not be a good idea, as it would limit investor choice.”
While progress has undoubtedly been slow-moving, there is a clear desire to bolster harmonisation across the post-trade landscape. Connectivity upgrades to the T2S are due to be rolled out next year, while the CSDR refit will enable the possibility of closer collaboration between CSDs.
Another notable success has been the integration of Euroclear Bank as the domestic CSD in Ireland. Following Brexit, the Irish market agreed that the asset protection framework on domestic securities would be governed by Belgian law, with Euroclear Bank now serving as the CSD for Irish securities. As pointed out in Euroclear’s Unlocking scale and competitiveness in Europe’s market report, the example shows that full CSD consolidation is possible and could serve as the basis for similar efforts in other countries, but it “requires the support of market participants and national authorities”.
The problem is that initiatives often encounter the same national barriers impacting regulatory alignment, as Pablo Portgual, senior director, public affairs at Euroclear, described at the AFME conference: “Some countries, for national security reasons, have a big problem with outsourcing, and that effectively prevents the creation of synergies between infrastructures.”
Next steps
With the political motivations seemingly in the right place, and the key areas identified to boost harmonisation, the next step is to put the plan into action – which may be easier said than done.
The rising tide of nationalism in Europe is placing increased pressures on domestic governments to take more inward-looking approaches when it comes to policy. The age of globalisation is grinding to a halt, with the European collective set to suffer as a result.
“People want to have their cake and eat it,” explained Pekin. “They want interoperability, they want union, they want integration – but also, nobody wants to give up anything from their national sovereignty agendas. So how do you square that circle? If you want a Capital Markets Union, you want no barriers, you want the single CSD – you may never get there in our lifetime. So, the next question becomes: what can you do in the meantime? You can start with interoperability; you can start with data – it’s a critical point.”
Therein lies the challenge for the EU. Policy makers and country leaders need to try and get those wheels turning again, and instil within these local governments a belief that a more consolidated Europe would bear fruit to all participants.
“Convincing is the word, and that is our daily business,” said Marcel Haag, director of horizontal policies at the European Commission, at the AFME event. “We are engaging with member states and we hear them out and we exchange arguments. A lot of member states will say, ‘our priority is to grow our national market’ or ‘we are on the periphery, we have an underdeveloped capital market’. We have to engage, assess the pros and the cons, and let’s see how we can accommodate their concerns.”
While some are eager to ensure an aligned approach across the 27 countries, others are not so patient. Talk of a breakaway coalition within the EU has picked up pace in recent months, with Spain’s minister for the economy, Carlos Cuerpo, outlining proposals to the Financial Times in October for a new mechanism that would allow three or more countries to proceed on joint initiatives without the inclusion of other member states.
On such a project, Haag said: “EU law allows for this under certain conditions. Of course, the Commission’s role is not to divide and create different leagues, but to unite and create a united Europe. Solutions that would allow a smaller group of member states to go forward faster, that for us is always the second best option.”
A ‘28th regime’
A separate proposal – set out in the Draghi report – recommends the establishment of a “28th regime”, whereby a special legal framework is created outside of the 27 different legal frameworks with a view to shortening the length of national procedures and integrating them into a single process.
“It’s a really interesting piece, which is gaining traction,” says Pott. “Rather than saying to member states, you have to all conform to a single system and we’re going to do away with the existing 27, you say to businesses that want to adopt the 28th regime that they can move in that direction.
“It might work better in some areas than others,” he continues. “For taxation, it won’t work so well because business is still bound by its local taxation rules. But when you think about insolvency rules, for example, which was one of those intractable areas where it’s very difficult to move beyond the national insolvency provisions that exist, having a 28th regime that firms could opt into, would be a helpful alternative and maybe overcome some of those national sensitivities of giving up or doing away with national systems.”
How ever the bloc plans to move forward, it’s important to get the ball rolling as soon as possible. The gap between Europe and the US is only widening – a 2023 report from the European Centre for International Political Economy found that the gap between US GDP per capita and EU GDP per capita rose from 47% in 2010 to 82% in 2021.
Harmonised tax and investment frameworks, and a unified post-trade environment are not just a technical necessity; they are the foundation upon which a successful Capital Markets Union can be built, enabling Europe’s capital markets to thrive on the global stage.
“I hope the political momentum and spotlight that we have in Europe at the moment can help us provide the right context to drive change,” said Portugal. “A lot depends on the market and on FMIs collaborating with their clients and with the ecosystem to deliver that call for more integration, more efficiency and cost reduction.”
Yes, the project is vast and the road will be long, but the EU and the financial services industry has the opportunity to spearhead something great in Europe. It’s time to make it happen.
Can the Capital Markets Union save Europe from mediocrity?
A disparate and fragmented European Union is thwarting the continent’s ability to compete effectively with the largest markets in the world. But a new political impetus has reinvigorated the consolidation agenda, with a view to challenging national frameworks and bringing growth back to the region, writes Chris Lemmon.
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