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EU's capital markets union gathers steam, but direction may be wrong

While the EU's plans for a capital markets union have been gathering steam since Brexit, observers say the project does not go to the heart of what it is supposed to achieve: creating a unified market that will lessen the EU's dependence on bank lending and encourage participation of retail investors in the bloc's financing.

The EU unveiled several initiatives in 2015 to implement a capital markets union, or CMU, by 2019, and in June 2017 published a revised, harder-hitting version. According to EU officials, Brexit has made completing the union all the more important because the EU will lose the liquidity provided by London, which represents the largest capital market within the current 28-member bloc.

Although the plan goes in the right direction by integrating Europe's market further, it does not go far enough in opening up the equity markets to entice European retail investors to participate in the capital markets, according to observers.

"The objective is very good, but when we look at what has been done for the development of the stock markets in Europe and, notably, to foster retail investment in capital markets, it's very disappointing," said Guillaume Prache, managing director of Better Finance, the European Federation of Investors and Financial Services Users.

He added that the union favors investment in fixed-income and life-insurance products instead of encouraging investments in higher-performing products such as small- and medium-sized companies. Parts of the plan — such as a pan-European personal pension plan face "an uphill battle," he said, because member states would need to agree to a favorable tax regime.

Securitization concerns

There is also the question of debt securitization, that is, the process whereby a lender converts loans or assets into bonds and sells them on to investors. The European Parliament, the European Council and the European Commission reached an agreement on debt securitization May 30, which could unlock some €150 billion of additional funding for Europe's real economy, according to the EU. Observers say this is key to opening up Europe's capital markets.

"Securitization is one of the most important mechanisms nowadays on the capital markets — it needs to be working fast, it needs to be working without many costs, and it should be very transparent," said Grigory Vilkov, a professor of finance at Frankfurt School of Finance and Management.

The concept has been a thorny issue, largely because the securitization market helped spark the financial crisis. In addition, some observers said the plan would be limited in what it could achieve for the CMU.

"The securitization market in the U.S. of small- and medium-sized enterprises does not exist, so I don't see why it is going to exist in Europe," Prache said. "It's going to be like usual — mortgages, credit cards, car loans. It is going to alleviate bank balances for lending, but it's not ... going to switch funding to the capital markets."

ESMA's role

One of the elements of the revamped plan is to increase the supervisory powers of the Paris-based European Securities and Markets Authority, which was established in the wake of the financial crisis. Under the new proposals, ESMA would be responsible for approving some non-EU prospectuses and increase its supervision of benchmarks and data-service reporting. In addition, it would have more oversight of some investment funds.

While France is pushing for greater powers, it would have to convince its European partners that this is a good idea, said Pierre-Henri Conac, professor of commercial law at the University of Luxembourg.

"There is no valid argument to justify this, and it could be counterproductive in terms of efficiency," he said. "It is an ideological project that has little chance of coming to pass."

Prache said the idea of strengthening ESMA does not take into account investor protection. ESMA has had a more prudential role up until now, but the proposed reform does not involve a "twin peaks" approach to market supervision like in the U.S. or the U.K. where prudential supervision is separated from that of business and customer protection.

The original CMU proposals were beset by differences over issues such as securitization, and observers say there is still much to do to meet the 2019 deadlines.

The EU has already met 20 of its original 33 objectives and added nine more in its revamped version of the plan. In early 2018, it will put forward a draft law on a more integrated covered bonds market, which Conac said would help create a more liquid market and cross-border investment. Yet given the challenges in harmonizing laws between member states, the related work will likely not be finished until 2019 "at the best," he added.