One year after its creation, the Baltic Capital Markets Union, or CMU, project is an "important step" toward the establishment of a pan-EU capital market, European Commission Vice-President Valdis Dombrovskis said.

Dombrovskis, former prime minister of Latvia, was speaking at the European Bank for Reconstruction and Development's Pan-Baltic Capital Market conference at the bank's London headquarters Oct. 18.

Finance ministers of Estonia, Latvia and Lithuania signed an agreement in November 2017 to establish a common market and introduce new instruments such as covered bonds and structured products. The project, backed by the EBRD, is an attempt to overcome some of the limitations that Baltic economies face in accessing finance and attracting inward investment due to their small size.

As a first step, the governments of the Baltic countries are in the process of drawing up a legal framework for a pan-Baltic covered bond, with support from the European Commission's Structural Reform Support Service and the EBRD.

Dombrovskis called the creation of the pan-Baltic CMU a "pioneering move" and said that he hoped that other EU member states would follow its example and work toward a common capital market.

The EC has long harbored ambitions of creating a CMU for the whole bloc, but progress has been slow, and at times, disjointed.

EC President Jean-Claude Juncker promised in his maiden speech in 2014 that he would create a pan-European CMU, but plans were dealt a blow by the U.K.'s vote in 2016 to leave the EU, which raised questions about how such a union would work without the involvement of the country with the largest capital market in Europe.

Deeper capital markets are important in both the Baltics and the EU because they help to diversify sources of funding, making businesses less dependent on the "frequently constrained" banking sector, Dombrovskis said. Building deeper capital markets will particularly help small and medium-sized enterprises, which account for the bulk of economic activity in the Baltic region, and who may struggle otherwise to find alternatives to bank lending, he said.

The Baltic project for covered bonds and securitizations is already "well underway," Dombrovskis said.

"This will contribute towards well-functioning and deeper capital markets in the region. And it will open up long-term funding options for banks, so they can free up their balance sheets to enable increased lending. I believe this cooperation and coordination sends a clear message to European and global investors that the Baltics are open for investment."

The Baltic CMU will bring welcome diversity to the financing mix in the region, which has often been "too dependent" on banks, Dana Reizniece-Ozola, finance minister of Latvia, said during a panel discussion at the event.

Migle Tuskiene, Lithuania's vice-minister of finance, agreed that the CMU would be a useful step to diversifying sources of funding for businesses in the region, and would help the local financial system to be less pro-cyclical.