Winston Churchill once said that “the Americans will always do the right thing, once they’ve exhausted all the possible alternatives”. The same is roughly true of Europe, and its attitude to financial markets, which is a showcase for the flaws, but also the strengths, of the European Union.
Europe’s financial markets and banks have a semi-permanent inferiority complex when compared to the United States. Whether the topic is bond transparency, depth of demand, retail investment, recapitalisation of banks, clearing of swaps, or the restart of the securitization market, the US got there first and most effectively. US investment banks now dominate the top of the European league table, as well as their domestic market. US bond markets can accept $50bn trades at a time, while the largest ever euro-denominated corporate deal, AB InBev’s acquisition financing, was nothing more than dessert after the dollar-denominated main course.
The firm hand of forced TARP recaps reconstructed the US major firms, while European banks were allowed to stagger onwards, held up by slugs of Qatari cash or encouraged by accommodating regulators. Only in European countries which set out on their own path, such as the UK, did the banks bounce back with relative vigour.
Large parts of this weakness are self-inflicted. State aid rules are bizarre and self-defeating, as illustrated by Italy’s recent experience. The jerry-rigged regulatory bodies, ESMA, EBA and EIOPA, are vastly under-resourced compared to their US counterparts, and only came into being in 2012, converting from mutual cooperation committees to overall regulators. Small wonder that ESMA has struggled to get through its work programme, playing a significant part in delaying MiFID II rules and dragging its feet on multiple other fronts.
The heavy workload and structural inefficiency of the European decision-making process also led to outcomes which are, frankly, wrong. Mandatory buy-in for failed trades, a provision in the Central Securities and Depositories Regulation, is agreed by the market and ESMA alike to be damaging and pointless, yet no mechanism exists to change the rule, short of restarting the whole legislative process. One can only assume it ended up on the statute book as the last European Parliament, which produced vast quantities of financial regulation before stepping down in 2014, lacked the time or the will to scrutinise it all properly.
Banking Union exists in some form — a common supervisor for large banks, gradually improving comparability between bank assets and reporting — but on other issues, such as the structure of loss-absorbing debt, the gulf between European countries is yawning ever wider.
Other parts of the European regulatory framework are somewhere between quixotic and vindictive. The bonus cap, tacked along with CRD IV, which was supposed to be a set of prudential capital rules, was almost entirely designed to affect bankers based in the UK — the only country which opposed the cap, repeatedly challenging it in the European court.
Securitization rules offer another example. Despite the strong performance of European securitizations, policymakers and politicians pushed forward a raft of new rules which have kept market volumes in the doldrums. Some tweaks, such as loan level data and 5% risk retention, are small and sensible. Others, such as Solvency II capital rules, are purposeless and damaging.
To fix the damage the last round of European policymaking did, a new round of political grandstanding, in the form of “Capital Markets Union”, has been necessary, as has the creation of a whole new regulatory apparatus around defining which securitizations are “simple transparent and standardised”. Yet even that has been derailed by MEP Paul Tang, who has offered alternative proposals for the re-regulation of securitization, some seven years after the key debates had already been hammered out.
So, at times, all of this can seem exhausting. The UK regulators, some of the best resourced and most experienced in Europe, might do a better job left to their own devices (if that were even possible).
But it’s only the shadow of the US which makes it seem so tawdry and dysfunctional.
The existence of the euro created a deep and liquid pan-European capital markets; the existence of the ECB backstopped those markets, while the Target 2 Securities system will, finally, create a level playing field for clearing those markets. Europe’s views count for plenty at international institutions, such as the Basel Committee or IOSCO; in some markets, such as interest rate derivatives, the market is defined by regulatory discussions between the US and Europe; other authorities have to essentially fall into line with their agreed approach.
And the European Union isn’t a country, let alone a federal superstate. If it fails to come to complete agreement on, for example, how to capitalise and supervise banks, how much more completely would 28 separate countries fail to agree? How much harder would it be to agree passporting rules on a bilateral basis?
It's also improving quickly. Capital Markets Union might not work as it should, and neither does Banking Union, but both are giant steps forward which deserve to be given a chance.
Financial markets have plenty of reasons to see the depth of Europe’s flaws, but while it isn’t perfect, it’s absolutely better than the alternative.