EBF ARTICLE

Between Old and New Challenges: The Role of the Capital Markets Union in Achieving Inclusive and Sustainable Growth in Europe

Article by Jacopo Borgognone, EBF Policy Advisor – Financial Markets

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The European Commission’s relaunch of the Capital Markets Union (CMU) in2020 is bound to intersect with a fast-paced revolution in the economic landscape driven by technology as well as political and societal forces pushing for the twin transition. To discuss why completing Europe’s ambitious reforms remains essential to fostering sustainable and inclusive growth in Europe, experts from the public and private sectors gathered virtually at the event co-hosted by the EBF and the Markets4Europe Campaign on Monday 6 December 2021, entitled “Are Europe’s Capital Markets Ready for the Future?”. These are the main conclusions that emerged from the discussion.

September 24, 2021, marked the first anniversary of the ambitious new Action Plan of the European Commission aimed at relaunching the CMU.  Over this time, European economies – now fully embarked on the road to recovery and in search of sustainable growth – have continued to face major transformation such as an increased demand for action against climate change and the emergence of disruptive technologies. The rapid development and deployment of digital technologies and the entry of new, highly innovative FinTechs are changing the way the traditional financial ecosystem operates. Meanwhile, to achieve the goals set by the European Green Deal, the European Commission has pledged to mobilize at least €1 trillion in sustainable investments over the next decade, requiring an unprecedented shift in both public and private funds to finance the transition. Capital markets are a growing part of this process.

The following takeaways emerged from the discussion:

• There is a close, mutually reinforcing but also inter-dependent relationship between the CMU and the sustainable and digital transformations. The CMU will help both transformations (eg by financing sustainability or digital innovation that requires risk capital and by simply adding a new channel of financing and investment). In turn, the twin transition will also help the CMU (eg through sustainable finance bringing new investors to markets and digital tools helping attract more investors and reducing costs for issuance or trading). However, this also means that obstacles on any of the three paths could slow down the others. In particular, the EU’s global leadership in sustainability can only translate into global competitiveness with greater progress in entrepreneurship capacity through capital markets financing.
• The CMU needs progress on all three fronts. EU Financial Markets should be made more efficient by growing scale, widening the investor base, and increasing capital supply. Cross-border investments should be as easy and reliable as domestic investments by removing current structural barriers, harmonising different sets of rules and designing the right trading and post-trading infrastructure. The Capital Markets Union should enable digital and financial innovation by unlocking the potential of the data-driven economy, preparing the regulatory ground for the digital financial transformation and by promoting fair and transparent competition.
• The CMU requires attention to both the ‘CM’ and the ‘U’ parts. To create a deep and liquid CMU, one need to develop/deepen capital markets (‘CM’) and integrate (‘U’) them. While the Union dimension (integration of markets) is important to draw the full benefits of the EU’s potential investor base and innovative capacity, the development/deepening of markets is vital. Some participants even called for a sequencing of these two processes, with the development being more of a priority than the integration of the markets.
• The CMU project requires both legislative changes and a change in culture. In addition to the needed legislative reforms, investors and entrepreneurs need to develop new attitudes to demand and supply risk capital investments.
• National policies matter. While the EU’s ambition in confronting structural obstacles to the CMU is useful, many of the most important remaining cross-border obstacles, such as fragmented insolvency frameworks and double taxation, require national action. National best practices in facilitating investment and entrepreneurship are also instrumental in developing markets.

To watch the full discussion, please click here.

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More detailed summary

1. The Three Inter-Twined Challenges
2. The Green Capital Markets Challenge

The United Nations estimates that $5 trillion to $7 trillion in annual funding is required to meet the Sustainable Development Goals (SDGs). Similarly, to achieve the goals set by the European Green Deal, the European Commission has pledged to mobilize at least €1 trillion in sustainable investments over the next decade. This clearly indicates that both public and private funds are needed to leverage capital markets to achieve the financing goals of the transition.

Capital markets are a growing part of this process, driven by the increased demand for sustainable bonds observed during the pandemic (in 2021, global sustainable bond issuance exceeded $700 billion, compared to the 400 billion of 2020).

The European Union retains a clear leading role in scaling up sustainable finance not only in terms of market issuance (50% of the outstanding sustainable bonds are issued in the EU), but also by virtue of regulatory initiatives aimed at shifting investment flows towards ESG objectives to support the European Green Deal.

1. The Digital Capital Markets Challenge

The rapid development and deployment of digital technologies and the entry of new, highly innovative FinTechs are changing the way the traditional financial ecosystem operates.

In this context, discussants identified three key drivers of transformation :(a) the exponential uptake of Distributed Ledgers Technologies (DLT), such as Blockchain; (b) the diffusion of data-centric models, both inside and outside traditional value-chains; and (c) the growth of new trading platforms providing a direct access point to retail investors.

DLT, for instance, offers both new challenges and new solutions. At the same time, DLT’s current lack of interoperability and the risk of further fragmentation anticipate new challenges facing the financial landscape of tomorrow.

Neither sustainability nor digitalization can happen without the support of more liquid, efficient and integrated capital markets enabled by the CMU. This is due to three key reasons:

1. In the coming years, financing the green and digital transition will require increased levels of risk capital to complement bank-based financing to support innovation and in the presence of intangible assets.
2. The completion of the CMU plays a crucial role in leveraging capital markets and “crowding-in” investors to scale up and accelerate the green transition. These elements are mutually reinforcing, as the absence of more integrated markets can undo the successes achieved on other fronts.
3. Finally, completing the CMU remains essential also to enabling secure, trusted, and sustainable financial innovation in the digital space.

1. What do we need to do to get there?

To develop EU capital markets capable of meeting old and new challenges, discussants identified three those key reforms that – if completed- would enable a future-proof and fit-for-purpose CMU:

1. EU Financial Markets should be made more efficient. This can be achieved by:

• Growing scale – i.e., by supporting the high-growth SMEs’ access to public markets to tap risk capital, for example by simplifying listing rules and making companies more visible to investors.
• Widening the investor base – i.e., by encouraging retail participation in capital markets, fostering financial education and equity culture in Europe and ensuring that adequate long-term products such as ELTIFs are available to investors.
• Increasing capital supply – i.e., by encouraging Members States to channel long-term savings such as pensions into capital markets to finance entrepreneurship.

2. Cross-border investments should be as easy and reliable as domestic investments. This can be achieved by:

• Removing current structural barriers – including those identified by the first Giovannini report such as ovelycomplex Withholding Tax relief and refund procedures.
• Harmonising different sets of rules – i.e., by making the outcome of market participants’ insolvencies more predictable.
• Designing the right trading and post-trading infrastructure – to enable the development of primary and secondary markets for sustainable and innovative assets.

3. The Capital Markets Union should enable digital and financial innovation. This can be achieved by:

• Unlocking the potential of the data-driven economy – i.e., by making reliable data more accessible through the European Single Access Point.
• Preparing the regulatory ground for the digital financial transformation – i.e., by adapting existing financial regulations to new products and technologies before changing them, while promoting the “same activity, same risk, same rule” and “technological neutrality” principles.
• Promoting fair and transparent competition – between incumbent and new market participants.

To achieve these results, it takes a collective effort. Therefore, the Markets4Europe campaign, and the EBF as its initiator, remain committed to supporting national governments and European stakeholders in implementing the ambitious reforms needed to achieve a truly functioning CMU.