The new European Commission bounded into office last year with Capital Markets Union. Jean-Claude Juncker, the first president of the Commission ever to be elected by the European Parliament, made it a major plank of his new approach, and in a way, it is the perfect European project.
It talks the language of Europe — the lineage from the Common Market to Economic and Monetary Union to Banking Union to Capital Markets Union is clear – it features vast potential expenditures of public money, and it offers a fix for every ill that ails the European economy.
Those fixes aren’t going to come fast. The timetable for building Capital Markets Union (still an embarrassingly nebulous term) is to get it done in the lifetime of the Commission, by 2019. SMEs that need finance now will be bust by the time the Commission has finished tweaking accounting rules, listing rules, creating new classes of bond and equity and overhauling insolvency.
But that doesn’t mean it is pointless. On the coat tails of the project could come a sincere, and politically palatable, attempt to fix much of the poorly designed regulation which has dogged Europe’s markets from the financial crisis to the present.
Many of the worst regulatory projects had their genesis before the crisis — Solvency II and MiFID II are both scheduled updates of existing European rules.
The new Commission has already committed to looking at improving the design of European regulation — Frans Timmermans has been appointed as Commissioner for Better Regulation, and pledged to consider withdrawing regulation. This is likely to include the bank structural measures proposed by the Liikanen Report.
But Capital Markets Union can push this project much further, because it comes with a positive goal of improving market access.
Rolling back
The Commission is due to put out a Green Paper setting out its work programme on February 18, but a draft seen by GlobalCapital has several ideas for rolling back onerous regulation.
It will review the Prospectus Directive, aiming to “alleviate unnecessary administrative burdens for companies raising capital across the EU, looking at when a prospectus is required, whether all prospectuses need to be approved and streamlining the approval process, and simplifying the information included in prospectuses.”
The first Eurobonds featured prospectuses of five or six pages; now, a base prospectus over 150 pages is not at all unusual.
Measures on private placements and securitization could also see a review of regulation in these areas. For mid-caps, the Commission notes that “IPOs and debt underwriting are characterised by substantial fixed costs generated by due diligence and regulatory requirements, which may present a disproportionate burden for smaller firms. This includes the costs of disclosing information required by investors or regulators and meeting other corporate governance requirements.”
The Alternative Investment Fund Managers Directive (AIFMD), has been heavily criticised. The UK’s House of Lords noted in an investigation of the EU regulatory framework, that “AIFMD is one of the most contested and controversial of the EU’s crisis-era reforms…it, came in for criticism for imposing disproportionate costs on the asset management sector, with HM Treasury noting the costs it had generated... concerns have arisen that it fails to reflect appropriately the different levels of risk posed by different asset managers.”
Thankfully, CMU might come to the rescue.
The Commission suggests that “reducing costs for setting up funds, and cross border marketing more generally, would lower barriers to entry and create more competition.”
In insurance, Solvency II has similarly been panned, especially by the securitization practitioners, for imposing higher capital charges on senior tranches than on whole loan portfolios. The Commission claims in the green paper that “the standard formula to calculate insurers’ capital requirements does not impose obstacles to long-term investment”. But it also points the way to a “possible review of prudential rules and the creation of infrastructure sub-classes.”
The EC could even be pushed to work on bond market liquidity — a fragile issue, under even greater threat by the European MiFID rules. It says in the green paper: “The Commission is interested in views on how to achieve better priced and robust liquidity conditions, notably whether measures could be taken to support liquidity in vulnerable segments and whether there are barriers to entry for new market participants.”
Cynicism
All of the above needs to be taken with a pinch of salt. First, this is only a draft green paper. The Commission is years away from introducing measures to achieve these goals, and may never do so. Announcing an intention is not equivalent to passing legislation, and the European regulatory process of the past six years shows the difficulty of passing any complicated financial legislation, let alone reversing existing policy.
Second, if the Commission does make progress in any of these areas, it means years of new regulatory uncertainty. Banks and financial markets have swallowed an extraordinary volume of new regulation since the crisis, and adapted their business models to the new world order. Pushing back the regulatory perimeter means a return to the uncertainty which has dogged financial markets since the crisis, and is only now starting to abate.
But none of this means Capital Markets Union should not be welcomed. Market participants should see it not just as a mirage, but as an opportunity. It’s optimistic to think it can fix Europe’s regulatory woes, but it’s not impossible.