Capital Markets Union – a regulator’s perspective

It is clear that Capital Markets Union is going to be a central theme of the European Commission’s programme for the next five years (and possibly beyond). 

But we are still at the formative stage – defining the ambition, setting the goals, gathering ideas on the possible ways forward.

You’ve heard from Steven Maijoor at the start of today providing his thoughts – ESMA will clearly be an important and active player in the discussion about Capital Markets Union, and the FCA will play a full role as an ESMA member. 

You’ve also heard from eminent speakers on today’s panels, including Professor Alberto Giovannini, Philippe de Backer and prominent industry representatives. They’ve set out their thinking about the timing, approach to and priorities of CMU.

As a regulator, I am obviously particularly interested in those parts of CMU where regulation will be an important element. But I hope that my perspective will be drawn reasonably widely. 

Markets that work well are an essential foundation for successful, growing economies

The FCA’s statutory objective, after all, is to make markets work well. Markets that work well are an essential foundation for successful, growing economies. And the desire to support growth is obviously one of the main motivations for the Commission in promulgating the CMU initiative.

Deepening capital markets, enhancing investor choice, and diversifying financing opportunities for companies beyond bank finance, are all valuable aims that I am sure have widespread support. 

Although EU capital markets have developed over recent decades, fragmentation persists with a strong national bias and a smaller pool of funding available for investment in the EU than in the US. 

In addition, many EU domestic capital markets lack scale or competitiveness compared to the US. Further breaking down barriers to cross-border capital flows will help diversify risk, create larger economies of scale and thereby enable more efficient allocation of capital.

How do we do that? Everyone will have their own ideas of specific measures that are needed, or could be considered. 

And I will lay out a few of the FCA’s thoughts shortly. But, at this stage of the debate, I actually think it is more important to step back. 

Not to get too immersed too soon in detailed action plans. But rather to think about some overarching perspectives which I believe are critical to enable the development of CMU to be as effective as possible.

Action needed through the investment chain

The first point I would make is ‘Don’t forget the macroeconomic perspective. A programme that simply shifts the flow of finance from banks to capital markets, without any change in the aggregate total, is unlikely to make a substantial difference to long-term growth outcomes. 

Of course, there may be some benefits through greater spreading of risks. But we also have to think about how to raise the supply of savings. 

That takes us into a whole range of policy thinking about ageing populations, indebted young people, the decline of defined-benefit pensions, tax incentives for long-term saving and so on. 

A much much bigger set of issues than we are looking at today. But my point is, CMU has to start from, and recognise, this broader context.

And, focusing down on CMU itself, it is crucially important to realise that a successful CMU will require action on three fronts:

a) to increase the supply of investor finance into capital markets

b) to ensure competitive, fair and effective intermediation at a proportionate cost

c) to facilitate increased use of capital market finance by corporates and others

These three elements are inextricably linked. The Commission’s aim can only be achieved by a programme that focuses on all three elements, and which understands how the elements will interact together.

More capital market finance needs investor protection

My second point is that getting a greater supply of investor finance into capital markets will require appropriate protection for those investors. 

Getting a greater supply of investor finance into capital markets will require appropriate protection for those investors

As has been widely remarked, European citizens overwhelmingly prefer to place their savings in bank deposits. Bank deposits are simple to understand, liquid and protected by deposit insurance. 

To increase investor financing of companies and enterprise for growth will require people to move their money, at least in terms of the relative share, from banks to capital market instruments and products. Instruments and products which are less simple, less liquid, and typically less protected, or least with more complex protection arrangements.

Investors will be more likely to invest if:

• the product is explained adequately
• they are confident that the product is appropriate to their needs and risk appetite, and
• they trust that the product has the necessary safeguards and is provided within a robust but proportionate regulatory framework

Measures that achieve this clarity, confidence and trust should help increase the supply of investor finance into capital markets.

There is no trade-off between measures to promote market access and investor protection; rather, they go hand in hand.

Focus on effective implementation of existing and already planned legislation

My third overarching point is that Europe has already done a huge amount to build a capital markets union. There is already a substantial body of legislation promoting a single capital market in Europe – from common rules on accounting standards, prospectuses, prudential capital, UCITs, through to regulation of key infrastructures such as CCPs and trading venues.

The main building blocks are already in place.

And there is a big chunk of unfinished business from the most recent round of legislation – MiFID 2, CSDR, MAR to name but three. Many of these measures are still in the process of being finalised and have yet to be fully implemented. The key remaining components, in many instances, are the level 2 standards.

Given the time and effort currently being expended by both national authorities and industry in developing and implementing these new rules, and the need to understand the impact of new measures, it is important to complete current projects before thinking about new ones.

It should be a priority of the Commission to bring the work of the past decade to fruition as stage 1 of the CMU. This achievement would be a substantial further step towards a successfully functioning capital markets union.

Consistent supervision

My fourth point follows directly on from this. Having already built a substantial capital markets framework in terms of rules, we need to make sure that we get the maximum out of it. More consistent supervision within the current framework could bring significant benefits. This is central to maximising the efficiency of supervision within the single market, and to ensuring that consumers and markets benefit from an equivalent level of protection.

The ESAs provide the mechanism and the forums to promote effective and consistent supervisory outcomes throughout the EU, working in close co-operation with national competent authorities. Part of the Commission’s plan must surely be to encourage the ESAs to use the full set of their existing convergence powers to ensure compliance with the agreed rule book and comparability of supervisory outcomes.

Legislate only where necessary

So reviewing and re-calibrating existing regulation should continue to be a priority, and – my fifth point – new legislation should be proposed only when it is necessary, and developed according to Better Regulation disciplines.

However, in line with the principles of subsidiarity and proportionality, the Commission will need to first consider whether aims can be achieved through market-led solutions or whether it might be more appropriate for national solutions to be found. 

In part, as I noted earlier, capital markets union will be about building greater scale, so as to deepen liquidity and reduce unit costs. 

But it may be that, for some aspects, the appropriate scale can be best built at the national or regional level, rather than EU-wide. Market-led solutions can sometimes move quicker and be more targeted than legislation, and find innovative answers that harness the power of competitive markets.

Promoting effective competition

The sixth perspective is around the importance of competition. Competition is at the heart of efficient, open, and resilient economies, and needs to be embedded in any approach to CMU. 

Competitive markets are characterised by features such as low barriers to entry for new firms entering the market and existing firms seeking to expand. 

Competitive markets establish the right incentives for firms, help deliver the best outcomes for consumers, and result in lower prices and higher levels of service and innovation. 

As you may know, the FCA is developing its use of market studies as an element of its own competition remit, to assess whether competition in identified sectors is working effectively.

European markets need to be embedded in a globally competitive landscape

And the final point to emphasise is that steps to attract capital should not be limited to the EU. 

The Commission will undoubtedly want to continue to ensure that the EU remains a globally attractive place to invest and for intermediaries to base themselves and operate. 

Alongside increasing the total amount of money invested within the EU, increasing the amount of foreign investment into the Union will be all important. Steps to achieve this will likely be a benefit for both foreign and EU investors, and borrowers alike.

A major step necessary, from a regulators’ perspective, is for EU legislation to be aligned with the relevant global standards and international agreements from the likes of IOSCO and the FSB.

Priorities for action

So I have talked a lot about guiding principles – things that I believe need to be borne in mind in framing the approach to CMU. Let me finish with a few thoughts on some specific actions that could, in our view, contribute to a successful CMU programme. 

The FCA has submitted a substantial response to the Commission’s Green Paper, which we will be publishing very shortly, and which has considerably more detail. Here is a flavour.

In terms of enhancing the supply of finance, participation by investors in scale will largely come through pooled investment vehicles. There is a place for direct retail participation in capital markets, but experience suggests that ordinary retail investors will need significant protections, which will limit the scale of their participation in these channels (for example, crowdfunding).  

Measures that could help here include ensuring consistent implementation of key dossiers such as MiFID 2, PRIIPS, IMD, PSD and funds rules. The MiFID 2 product governance requirements could be applied to a wider range of products, including insurance, lending and credit products.

To support confident investing, the Commission should consider progressing its earlier ideas to create an EU Insurance Guarantee Scheme framework and consider reintroducing an updated Investor Compensation Scheme Directive.

In terms of promoting competitive, fair and effective intermediation, steps should be taken to ensure that appropriate pooled investment funds are available for a variety of different investors. 

Existing EU legislation should be reviewed to encourage more participants and greater competition in the funds sector. For example, larger EU fund managers could be allowed to run EuVECA and EuSEF funds, and believe this would be beneficial to the uptake of these funds. 

Investing via a EuVECA could also be made more attractive by widening what qualifies as an eligible investment.

New technology is playing an increasing role in our markets and bringing efficiency to the way investors and borrowers find each other and services are provided. One idea the Commission should examine is whether the current EU legislative framework adequately accommodates digital channels used by providers and consumers. 

For example, do we need to encourage a movement away from the predominant model of paper-based disclosure regimes that have underpinned the development of many European disclosure requirements (eg, the provision of KIDs in PRIIPs and KIIDs in UCITS). 

Communication and disclosure models should accommodate a range of channels and formats to match consumer preferences.

In terms of the demand for capital, an early priority should be reviewing the Prospectus Directive. 

The Prospectus Directive could be radically re-worked to focus on a single purpose: the admission of securities to the stock market

The Prospectus Directive could be radically re-worked to focus on a single purpose: the admission of securities to the stock market. The Prospectus Directive’s other function, the regulation of public offerings of unquoted securities, could be dealt with in other EU regulation more suited and adapted to that different purpose. 

Under this model, issuers could offer their securities into the entire single market at once, without having to conduct ‘due diligence’ on all jurisdictions.

Conclusion

So to conclude.

CMU represents a potentially massively important initiative for Europe. The programme needs to recognise the macroeconomic context, and the work that is already in place or impending to embed a single capital market. 

Measures need to lock together the supply of finance, efficient, transparent and competitive intermediation, and ease of access by corporates and other users. Investor protection will be key to underpinning a greater supply of finance. And competition will be key to transparent and cost-effective intermediation.

CMU is geared to realise our markets’ full potential. It will be a long-term project. The FCA stands ready to help the EU authorities with this important work.