Low investment, low infrastructure spending and low bank lending to corporates have caused structural concerns for European growth. Action has been taken, culminating in the so-called Juncker Plan, a EUR 315 billion programme for infrastructure spending, and a draft proposal for a Capital Market Union. The effort towards the creation of a European Capital Market Union echoes the post- crisis process that delivered the European Banking Union. Policymakers are defining cross country initiatives to achieve improved access to financing for all businesses across Europe as well as investment projects, for start-ups, SMEs and long-term projects. They are also aiming to increase and diversify sources of funding from investors in the EU and worldwide. Results that may be achieved by making the markets work more effectively overall. Colin Mayer, Peter Moores Professor of Management Studies at the Saïd Business School at the University of Oxford, outlines the priorities and challenges for such a capital market union in a conversation with Euromoneys Giada Vercelli.
Euromoney Conferences: Are these concerns valid? If so, what should be done to address them?
Colin Mayer: These are valid concerns we have addressed in our research on Restarting European Long-Term Investment Finance (available here http://reltif.cepr.org/sites/default/files/RELTIF_Green%20Paper.pdf). The way they should be addressed is threefold, tackling three key components of the financial system: regulation, information and governance.
Euromoney Conferences: Lets address regulation first...
Colin Mayer: The issue here is how regulation operates consistently across markets. Firstly, it needs to be recognised that there are different interpretations across countries. Secondly, we need to reach an agreement on achieving consistency and better coordination across countries. Thirdly, we need the political acceptance of a single overarching regulatory body, similarly to the Security and Exchange Commission in the US. For instance, through the creation of European-wide bodies and committees that have the authority to ensure rules are adopted consistently.
EC: Are we close to this approach?
CM: It has been discussed. Before the financial crisis, there was serious consideration of whether this was the right direction. The financial crisis led to a greater degree of fragmentation of policy in this area, so while in the longer term this may be necessary, the ease with which such an approach can be adopted in the near future is questionable.
EC: Looking at systemic risk, how does the Capital Market Union relate to sovereign risk?
CM: It is important to distinguish between different types of risks. When talking about systemic risk, the need for harmonisation between different countries is very clear cut. The importance of having an approach that ensures proper protection is critically important and requires a high level of coordination, if not the existence of an overarching body like the European Central Bank to ensure that level of protection of the EU financial system. When one has that type of systemic issues, it is when one really does need to have a much more serious consideration of a coordinated approach.
EC: Where else do you see risk emerging?
CM: At the other end of the spectrum are elements of the capital markets that are very much a reflection of particular countries structures and institutional arrangements, for example corporate governance factors. In that case it is quite beneficial to have diversity of approaches across countries. In the US, there is an oversight of the banking system that comes from the Fed and its regional banks, there is an oversight of protection in the financial markets that comes from SEC and other regulatory bodies. Yet in corporate governance matters, regulation is done at individual state level. This encourages competition.
EC: Where would you like to see the emphasis on harmonisation and the creation of single regulatory bodies and where should policymakers encourage the competition between different systems?
CM: The different parts of the financial system and the corporate system demand different degrees of integration. In terms of systemic protection of equity markets and banking, the coordination of systemic protection is critically important. In terms of corporate governance rules, the greater the degree of choice that exists and the easier it is for companies to choose to incorporate in Germany as against Sweden or the UK, depending how they want to match corporate governance with their activity, the better it is. The real battle will be achieving functioning European capital markets as against having harmonisation in terms of imposition of one type of governance standard across Europe. This is one of the main issues that needs to be considered.
EC: What type of policy in accounting standards would be best suited to create a desirable outcome?
CM: In relation to accounting standards and information provision, the higher the degree of coordination and standardisation, the easier it is for investors to compare and the easier it would be for financial capital to flow between markets.
EC: Looking retrospectively at the process that resulted in the European Banking Union, what lessons can be learnt to achieve overarching policies over the European capital markets?
CM: There is nothing more effective than a crisis to stimulate action. The Banking Union progressed rapidly when it became evident that the protection of the European banking system, in particular within the context of the European Monetary Union, depended on the creation of a Banking Union. In terms of the development of a greater degree of harmonisation elsewhere in relation to equity markets and other parts of the financial markets, the most likely stimulus to real action will come with the realisation that it is critical to the continuing functioning of the European capital markets.
EC: Low investment, low bank lending to corporates, and SMEs access to the capital markets virtually precluded. It should be more than enough to take action...
CM: Although there is a problem with European investment financing, the provision of adequate equity financing and the development of a sufficiently large bond market in Europe, it is not perceived to be an overwhelming crisis and so it would take quite a lot of pressurising from relevant bodies to push this high up the agenda. There is a sense that there is a serious problem, as shown by the response of the ECB in trying to promote greater bank lending. The trouble is that they dont know what to do about it. In the case of the Banking Union there was a quite clear notion of what in principle was required. There was a crisis demanding action and the response on what to do was clear cut, whereas here the appropriate response is much more opaque. That is why the nature of the response is doubtful.
EC: What should be done to abate costs for SMEs to access the bond markets?
CM: There has been a much more extensive bond market for SMEs in the US, so it is not entirely unfeasible. One important aspect in the US market is the role of credit ratings. Having provision of credit ratings information for smaller companies would be an important component of developing such a market. In general, around the world, bank finance ends up being the key form of finance for SMEs. In Europe we have been observing the emergence of alternative sources of market finance such as peer-to-peer lending and crowd-funding. They fund SMEs to a certain extent, but it is very limited scale funding. They are also very vulnerable forms of lending.
EC: Hence, knocking at the banks doors for credit?
CM: In relation to banking, we see a very different performance of bank financing to the corporate sector across European countries. In the case of Germany, bank finance continued to be available, the terms have been favourable, it was less cyclical than in other countries, and there has been less evidence of credit constraints. One of the arguments is that the nature of the relationship that exists between banks and companies in Germany facilitates the provision of bank finance. One of the elements of the success of bank lending in Europe is the extent to which there are close relationships between banks and borrowers. Other countries will either need to replicate the relationships that have been built in Germany or create more of a market in bank lending as well as in securities.
EC: Increasingly non-European companies are looking at Europe as a market of issuance? Why?
CM: The level of IPOs has been low in Europe, but the level of secondary public offerings by already listed companies has been growing in terms of the amount of money raised. The same has been the case in the corporate bond market. In terms of already established companies, issuing either equity or bonds in Europe has become a more feasible exercise than in the past. That is good news at least for large companies, but at the small end, we see companies that are not able to get bank finance or raise IPOs either. They are not raising external equity, nor do they have access to bond markets. In relation to larger companies, the European market is providing reasonably deep and liquid market corporate bonds.
EC: Lack of liquidity in the bond markets is again one of the deepest fears amongst investors. Can the Capital Market Union address and solve this issue?
CM: This is precisely the sort of issue the CMU needs to be able to address. One of the problems that fragmented markets present is the extent to which truly liquid markets are undermined. Having transparent markets as an alternative to OTC is a significant way to develop a more liquid market. However, in the equity market, you still observe OTC trades taking place alongside the more formal market, because different type of trades need different trade mechanisms. Therefore, it is not that one is a substitute for the other, but having several platforms available is an important component of creating greater liquidity.
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