Thought Piece

Putting the C for Capital at the heart of the Capital Markets Union

Posted: 17 May 2022

Resource Type: Thought Piece

Capital markets in the EU are relatively undeveloped despite many years of pushing for a Capital Markets Union (CMU). The EU economy still is heavily dependent on traditional bank financing, which of course in many cases has served it well.

But citizens need to diversify their savings away from bank deposits into long term assets like shares and into products like private pensions and become investors. This change in behaviour needs to happen at Member State level, not top-down from Brussels. 

The need for capital markets

Financial markets play a vital role in allocating capital to the economy. Banks in particular play a crucial role in transforming our individual savings in short term cash deposits into long term loans to industry. Capital markets such as bond markets and equity markets arguably play an even more important role in providing long term stable borrowing by corporates - and indeed by governments. It is widely held that economies with a mix of bank and capital market financing provide more diversified and cost-effective financing than those with just bank finance. The comparison with the US is often deployed - the US has a 26/74 mix of bank vs capital market financing whereas the EU is the reverse at 75/25 and the UK in the middle at 53/47 (New Financial). But I would argue the difference with the US and even within different EU economies is more deep-rooted than that and goes to the heart of how citizens save.

The US has a 26/74 mix of bank vs capital market financing whereas the EU is the reverse at 75/25 and the UK in the middle at 53/47.

In the EU, most citizens depend on the state for their pension and tend to save in bank deposits, even at the current low, sometimes negative, interest rates. One-third of EU household savings are held as bank deposits on average. In the US the share is just over one-tenth. EU savings rates are high but invested in products which will not provide a hedge against rising inflation. In the US, citizens save in individual savings accounts which are largely invested in a range of real assets. Some EU member states like Sweden or the Netherlands which have large pools of private or funded pension schemes tend to have deeper capital markets. The difference becomes more important as we handle ageing populations and the challenge of financing sustainable infrastructure which requires long term investment. 

One-third of EU household savings are held as bank deposits on average. In the US the share is just over one-tenth.

Is the CMU project progressing? 

Yes, but very slowly. The calls for the EU to develop capital markets go back a long way. I remember a Commission paper from around 1996 calling for the EU to develop “risk capital markets” - and make the EU economy look a little more like the US, which even then was successfully using public and private capital markets to grow technology "unicorns". The Commission subsequently launched the first financial services action plan under the 1998 U.K. Presidency which was designed to create deeper, more integrated EU capital markets. Commissioner Hill launched a dedicated CMU action plan in 2014.

But despite the Commission's efforts, and a number of significant legislative proposals being agreed, the EU's capital markets continue to lag behind. Brexit of course makes things worse since the EU has lost one of the more successful capital markets in Europe. Indeed, having a large international capital market inside the EU arguably distorted its relative weakness. The trend is pretty stark. The EU’s share of global capital markets activity has fallen from 22% before Brexit to just 14% and in the longer term, the EU’s share will shrink to around 10% (New Financial).

The EU’s share of global capital markets activity has fallen from 22% before Brexit to just 14% and in the longer term, the EU’s share will shrink to around 10%.

More fundamentally, the blockage is really at Member State level. Governments seem reluctant to tackle the core issue of ageing populations and low levels of pension savings. Europe is making little progress in financing new unicorns, with many start-ups continuing to look for risk capital in the US. Some Member States admittedly have strong regional equity markets and pension savings, but the overall picture remains one of underfunded retirement savings.

‘A new vision for EU capital markets’ - our recent event on CMU

We recently discussed some of these issues in a webinar on CMU. William Wright from New Financial, a think tank dedicated to promoting capital markets, gave an assessment both of the state of play in the EU and of the impact of losing London's capital markets. He is a strong believer in focusing on growing the supply of capital in the EU, for example in the form of pensions. Sweden, as described by Urban Funered from the Swedish Financial Markets Association, had developed a successful ecosystem at national and regional levels. During the event, all the speakers noted that better investor education at national level will help encourage citizens to invest in real assets for retirement. I see this theme has rightly now been picked up by the EU Commissioner Mrs McGuinness.

Every year 4,800 companies could list in the EU raising over Euro 500bn.

The recent New Financial report is commendably positive about the potential for growth in the EU. It predicts that every year 4,800 companies could list in the EU raising over Euro 500bn. But it does seem as if the political impetus in Brussels that Lord Hill brought to the table has faded somewhat. The current Commission proposals under discussion seek to include ESAP and consolidated market data feeds to create a more integrated capital market but it does not seem to move the needle on creating capital in the first place.     

Focus on savings

In conclusion, it is absolutely right that the EU should redouble its efforts at Union and Member State level to develop and encourage citizens to save for the long term in assets like pensions. The attempt to create a European pensions product was a good idea but seems to be failing in practice. It is also right that investors should be protected and that retail savings products like mutual funds, insurance policies and pensions should be properly regulated. But investors also need better education on the risks of not investing in such products, particularly when cash deposits are going to be seriously eroded by inflation. We in the City continue to support these moves, even outside the EU. Capital markets are not a zero-sum game. 

 

About the author

Nick Collier joined the City of London Corporation as Managing Director of the Brussels office in March 2019. He was previously Global Head of Government Relations at Refinitiv (Thomson Reuters). Before that he worked at a range of organisations in the financial services sector, including Morgan Stanley and the Bank of England and, until recently, served as Chair of TheCityUK’s Public Affairs Group as well as Deputy Chair of the International Regulatory Strategy Group. Nick is chair of diplomatic engagement at the International Business and Diplomatic Exchange. He holds a MSC in Economics and Finance from the London School of Economics and a BA from Oxford.

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