Europe’s Emerging Capital Markets Union (Part 1)
In the first of a two-part article, Dr Dieter Pesendorfer examines a new wave of integration and deregulation and why it might be bad for the ‘real economy’.
The European Commission has recently held a public consultation on its Green Paper ‘Building a Capitals Markets Union’. The objective is to develop an action plan for the realisation of a ‘true’ Capital Markets Union (CMU) that would assure finance serves the ‘real economy’. More cross-border integration of financial markets and an increased share of capital markets in the funding mix for businesses should make Europe more competitive.
However, there is a serious risk that this initiative will not deliver the promised benefits to the wider economy, and to small and medium sized enterprises (SMEs) in particular, and that recent financial reforms will be undermined by a new wave of deregulation contributing to increasing financial instability.
Finance-led capitalism and incomplete financial market integration
Liberalisation and deregulation of global financial markets was a major trend from the 1970s until 2008. It led to the dominance of finance over other economic sectors – the ‘real economy’. Especially within the globalisation debates of the 1990s and 2000s, critics highlighted its negative effects on financial stability and ‘growth without production’. With the global financial meltdown of 2008, critical voices became much more prominent. Even key regulators now argue that finance has been transformed from an intermediary and serving role to the economy (shifting savings to investments in the real economy) to its master (speculating for themselves and even against their clients in a Casino-like market). As a result markets and states are driven into disaster, undermining democracy. More and more costly financial crises since the 1970s serve as proof of increased financial instability and rising inequality.
In Europe financial markets integration contributed to these trends and to particular features of the current financial and economic crises. Since the Single Market was created in the second half of the 1980s, financial and capital markets integration had become a key priority for the European Commission. This objective should have been achieved via a combination of regulatory and deregulatory measures. But foremost the powerful convergence drivers established with the Monetary Union should have led to deep integration.
Supporting global and regional market trends, the Commission’s policy actively contributed to the emergence of ever-larger European financial institutions and the use of increasingly complex, opaque financial products. While this was crucial for financial institutions in the EU including those in the City of London, to be able to compete, it came with a high price.
Financial markets in the member states remained fragmented and structural problems increased. Integration between financial markets suffered during the on-going financial and economic crises, and led to further fragmentation. This created significant challenges for cross-border activities and undermined the function of the Single Market.
Last year, the new EU Commission, led by its President Jean-Claude Juncker, launched new initiatives to revive investment in the real economy. Advertised as ‘unlocking funding for Europe’s growth’, it highlighted advantages for SMEs – a group that composes the majority of European firms and historically makes the biggest contribution to growth.
SMEs have struggled to access credit in recent years because they are traditionally reliant on banks who have been trying to improve their capital buffers in the event of future financial crises.
Major elements of the Commission’s strategy to boost economic recovery are an Investment Plan and a Capital Markets Union (CMU). For the latter, the Commission has recently run a consultation process.
High hopes and expectations
The idea of a CMU is not entirely new. Nevertheless, at the time of Juncker’s announcement to include it within one of the ten priorities of his Commission (priority 4: a deeper and fairer internal market), the idea was little more than an empty signifier for what became advocated as ‘the creation of a true single market for capital’. The Green Paper is now specifying the Commission’s approach.
The Commission tries to achieve what failed so far: deeper integration and more similarity to the U.S. financial markets should allow Europe to reduce the development gap between these economic powers.
It is worth remembering that Europe’s development gap to the U.S. was always justification for integration and that that the distance between the two jurisdictions did not change despite ambitious plans such as the failed Lisbon Strategy of 2000 famously aimed at making Europe ‘the most dynamic, fastest growing region’ in the world by 2010.
Now, expectations for relaunched integration are high. The Commission points towards the more developed, much larger ‘shadow banking’ sector in the U.S. Shadow bank is the name for all kind of financial institutions such as hedge funds, private equity, or money market funds that behave like a bank but are less strictly regulated. The financial industry is expecting new business opportunities and financial stability experts hope to link the changes to a better control of shadow banking. Firms, including SMEs might hope for better access to funding sources. Central bankers and legislators expect that integrated financial markets in the euro area would greatly facilitate the implementation of the ECB’s monetary policy. These interests will be difficult to balance in the action plan.
Part two of this article was published on 21 May 2015 and can be accessed here.
Dr Dieter Pesendorfer is a Senior Lecturer in Regulation in the School of Law at Queen’s University Belfast.