The European Commission has fired the starting gun on the Capital Markets Union (CMU), the flagship agenda to deliver a single market for capital, by publishing its widely trailed first green paper (GP). In December we set the scene for the rapidly evolving CMU agenda and, although the GP is wide ranging, it contains little new information.
The principles adopted for the CMU coincide with those of the Juncker Commission’s growth agenda: maximising economic growth, increasing financial stability, removing barriers to cross-border investment, ensuring consumer protection, and enhancing competition. They apply to all 28 Member States.
The Commission’s Approach
The Commission intends to take a “bottom-up” approach which will be “based on an assessment of the outstanding priorities, both in terms of likely impact and feasibility, underpinned by thorough economic analysis, impact assessment, and consultation.” Further, the Commission makes the case that legislative and regulatory change will only be undertaken where necessary, with emphasis given to “market driven solutions”. This approach aligns with signals sent by the Commission to date, that it will be pragmatic, tackling each issue or barrier at a time rather than developing a legislative agenda on the scale of the Financial Services Action Plan or the post-crisis reforms under Commissioner Barnier. Competing interests in the CMU agenda could make it difficult for the Commission to stay this course.
The Commission has identified five areas “where there is potential to make early progress”. All five are existing areas of work by the Commission, the market or other public bodies, that have been subsumed into the CMU agenda.
- Review of the Prospectus Regime – The Commission has launched a parallel consultation reviewing the prospectus regime, focusing on the triggers for when a prospectus is required, requirements for prospectus approval, streamlining the process, and simplifying the content, with the aim of reducing the administrative burden of issuing securities.
Despite a number of recent and ongoing revisions to the prospectus regime, this latest review will revisit the amendments as well as fully assess the current impact of the regime and whether it disproportionately inhibits the issuance of equity and debt. The consultation highlights shortcomings in the current regime such as the costs, complexity, the length of prospectuses, and differences in application between Member States.
The review includes: the calibration of existing exemption thresholds; the creation of an exemption for secondary issuances; extension of the regime for issuance on MTFs (although under the ‘proportionate disclosure regime’, which will itself be revised); a bespoke regime for admission to ‘SME Growth Markets’ (under MiFID); extension of the base prospectus facility; and harmonisation of the sanctions and liability requirements across Member States.
If the Commission can introduce sufficient flexibility with proportionate requirements tailored to different participants, the reformed prospectus regime could extend access to the capital markets to a much large number of corporates while also reducing their costs.
- High Quality Securitisation - Building on separate consultations by the ECB/Bank of England and BCBS/IOSCO the Commission published a consultation seeking to develop simple, transparent and standardised (STS) securitisations. The aim is to revive the securitisation market, allow efficient and effective transfer of risk, enable securitisation to act as an effective funding mechanism for a broader range of market participants, and manage systemic risk.
The capital framework for banks, insurers and investment firms will differentiate the treatment of STS from other securitisation to reflect different risk profiles. This could address market concerns about the calibration of risk weights. The method for identifying qualifying STS securitisation is broadly based on that used for the liquidity coverage ratio and the criteria developed by BCBS/IOSCO.
Qualifying STS would likely have to comply with disclosure and transparency requirements, be limited to simple structures with homogenous pools of assets with a ‘true sale’ rather than a synthetic structure, ensure the creditworthiness of the borrowers is compliant with mortgage and consumer credit protections, and be listed on a trading venue. Derivatives would be limited to hedging purposes only and re-securitisation would be excluded. As qualifying STS would potentially benefit from more favourable capital treatment, this could lead to a split in the securitisation market between qualifying STS and non-qualifying STS.
Further aspects of the consultation include: identification criteria for short-term securitisations; streamlining risk retention requirements for investors; a standardised structure for securitisation (legal form of the SPV, forms of transfer, and the rights and subordination of shareholders); monitoring and verification mechanisms for compliance with the STS criteria; and securitisation for SMEs.
- Pan-European Private Placements (PEPP) – The private placement market differs to other areas of the CMU as there is known to be existing market demand. European companies have been accessing the US PP market for some time; more recently Germany has developed the Schuldschein market and France a PP market through the development of Euro PP.
The next phase of development is already underway - led by the market a PEPP guide and standard documentation have been created, which “evolved” out of Euro PP. Despite this recent push to standardise and reduce costs, barriers to a PEPP still exist such as fragmented withholding tax regimes, insolvency and company law, which - if not tackled - will limit the growth of this market.
- Improving SME Credit Information – Overcoming SME information asymmetries can be split into three subtopics, (i) standardised and common credit information, (ii) harmonised financial reporting, and (iii) a central database where market participants can access data.
The GP seeks to achieve (ii) through harmonising accounting standards. The EU mandates IFRS for consolidated financial statements of companies with securities admitted to trading on an EEA regulated market. Below this level some harmonisation is provided through the EU Accounting Directive. However, financial reporting remains fragmented on national levels. One potential solution is to adopt an approach similar to that taken by the UK through FRS 101 and 102. FRS 101 enables most subsidiaries, in their individual financial statements, to use recognition and measurement bases of IFRSs but with less disclosure. FRS 102 is an accounting standard based on the IFRS for SMEs but amended to make it more suitable for UK companies. Achieving harmonised accounting standards is achievable in principle, but recent experience shows how difficult this might be in practice, for example the failure to get the IFRS for SMEs endorsed for use across Europe.
Initiatives are already underway with a view to achieving (i) and (iii). The ECB is working towards a Central Credit Register for the Eurozone by 2017. HM Treasury and the Bank of England have also consulted on the mandatory sharing of SME credit data between lenders through Credit Referencing Agencies, and potentially reviving the UK Comprehensive Business Register. Overcoming the information problems would be a significant step forward to increase bank finance but also to enable non-bank financing.
- Encouraging the uptake of European Long Term Investment Funds (ELTIF) – The proposed ELTIF regulation is aimed at aligning long-term investment strategies with returns and providing an EU vehicle for, inter alia, infrastructure finance. ESMA is expected to commence its work on the technical standards during 2015.
Areas 1 - 4 of the Commission’s early priorities for the CMU are focused on SMEs, but alongside SMEs in the Commission’s ‘investment plan for Europe’ sits infrastructure investment. The Commission seeks to encourage the uptake of the ELTIF vehicle. However, it is still too early to see what effect ELTIFs will have on long-term finance.
Medium to Long-Term Initiatives
Looking beyond these five ‘quick wins’, the Commission will seek to focus on a broad range of potential areas to secure cross-border finance, develop a deeper capital pool and overcome information problems. These initiatives are likely to include bonds (covered, green and mini bonds), a review of the EU venture capital directive, insolvency law, tax, company law, FinTech (including crowdfunding), pension provision and products, private equity, leverage loans, corporate governance and market infrastructure.
The GP sets out the intention to revisit decisions made in the middle of the crisis to ensure the right balance between financial stability and growth has been struck. While review of the market and regulation may identify legitimate cases where the regulatory standards are disproportionate when applied in practice and that inhibit growth, determining the level that balances growth and stability is likely to be a point of political sensitivity. Although the GP does identify aspects of, e.g., Solvency II and the Prospectus Directive that could be revisited in order to develop the CMU, there is – unsurprisingly – a notable absence of ambition to re-open Directives and Regulations that have recently been agreed. This may leave some in the industry disappointed.
The barriers to the development of the CMU identified in the GP are not new and have been widely reported; these include inter alia a historical bias to certain sources of finance, different characteristics of pension provision, and heterogeneous equity cultures.
Moreover, the GP does not give sufficient weight to other barriers such as tax and insolvency which will limit how far the CMU, and even the early initiatives, can progress. The Commission’s approach turns on quick wins to kick start the single market in capital and pushes these bigger barriers into the long grass, at least for now. While this approach is politically pragmatic given the difficulties and sensitivities involved in obtaining even small reforms in these areas, e.g. tax requires unanimity in the Council, the CMU agenda is unlikely to be achieved unless these issues are tackled.
Some stakeholders have concerns that the CMU could lead to a single supervisor for EU capital markets. The paper has very little to say on this beyond: “there may be a further role for the European Supervisory Authorities to play in increasing convergence”.
Timetable & Next Steps
The Commission’s focus on market-based solutions over legislative ones is very welcome, as is its emphasis on the need for analysis of the barriers facing CMU before jumping to solutions. The ‘quick wins’ are important, but the changes which could really drive the CMU forward – insolvency and tax reform – remain distant and difficult. The road to CMU looks to be long and winding.
Responses to the GP are due by 13 May 2015. The Commission will host a conference in Q3 2015 and a roadmap is expected to be delivered in Q4 2015. The Commission aims to put in place the building blocks of CMU by the end of its mandate in 2019.
Market participants, trade associations, corporates and investors across the EU should all be actively engaging with the GP and the Commission. The breadth of the CMU requires those on the supply and demand side as well as intermediaries to participate with the CMU if its aims are to be achieved.
To find out more about the outlook for financial regulation and the Capital Markets Union see our regulatory top 10 predictions for 2015.