Will the European Union have a collective of competing financial centres or is it able to deliver a true Capital Markets Union (CMU) – a single capital market with the depth, breadth and liquidity to rival other global financial centres?
London emerged as a modern day pre-eminent international financial centre for a number of reasons, including language, legal system and time zone. UK regulation in the 1980s – and later EU regulation, particularly the 1999 Financial Services Action Plan (FSAP), which sought to create a single market for financial services – also contributed.
Regulatory changes in the 1980s – known as Big Bang – led to London become an early adopter of electronic trading, moving away from the physical trading pits. In addition, tax advantages, especially on fixed income instruments relative to the then dominant US market, saw the emergence of the London-based Eurobond market. Global firms increasingly traded derivative contracts, often between the US and Asia, and needed a convenient time zone and legal basis to underpin such financial contracts.
The UK market also benefitted significantly from the cornerstone piece of the EU FSAP, namely MiFID, the Markets in Financial Instruments Directive 2004, the precursor of MiFID II and MiFIR. Central to MiFID I was the abolition of the concentration rule, under which member states could require investment firms to route client orders through regulated markets – the Stock Exchanges. The plethora of new types of trading venues – Multilateral Trading Facilities (MTFs) and Systematic Internalisers (SIs) – although an EU-wide initiative - saw the majority base themselves in London, close to their largest customers and at the heart of international financial activity.
Data from before the UK left the EU shows that financial services activity in the EU27 was concentrated in France and Germany, followed by countries such as Italy, the Netherlands, Spain and Sweden. Derivative trading was dominated by France and secondary trading of equities by Germany, including IPOs.
Trading activity, particularly in the European equity markets, has shifted since the beginning of the year from London to new EU MTF entities based largely in Amsterdam, but some in Paris and Dublin too. Ironically, the share trading obligation (STO) in MiFID II has enabled this regulatory lever to be applied to a former EU Member State – not something I foresaw when we negotiated MiFID II in the European Parliament.
It will be interesting to see how much activity migrates to other EU financial centres over the course of the next few years. Many MTFs have chosen Amsterdam as their EU base. Another factor could be how much EU-wide, rather than national, regulators start to dictate where trading activity happens.
When first launched, the CMU project was intended to be complete by 2019 but was derailed somewhat by the 2016 referendum in the UK. The achievements to date, I would contend, are modest. They are not the ground-breaking changes that would genuinely see the EU move from a predominantly debt-based culture of bank lending to a more balanced capital markets funding model, in particular with more equity-based financing.
A 2019 International Monetary Fund (IMF) survey of investors and EU regulatory agencies on the CMU suggests some EU countries are more attractive destinations for global capital than others due to respondents’ perceptions of, for example, available data, the approach and expertise of the national regulator, audit regimes, tax rates and the difficult issues of withholding taxes and insolvency law.
The IMF asked the same respondents about the most important aspects of the CMU action plan. There was clear agreement on supporting harmonisation of insolvency laws, and that fintech will help to connect local markets. Roughly half agreed a single supervisor for capital markets is desirable, although surprisingly not everyone thought it should be ESMA.
EU Capital Markets Union Action Plan1
So where does this leave the current version of the CMU plan and what initiatives might deliver a true single EU capital market? The Green Deal and post-COVID recovery plan may well be the necessary stimuli for increasing cross-border activity and utilising more equity and other alternative funding options. The economic stress of the pandemic may have persuaded more Europeans not only to save but also to invest for the longer term.
However, the Commission has tried several times to harmonise the legislation surrounding securities. The latest iteration, during President Juncker’s term, called the Securities Law Legislation, never progressed beyond Commission proposals. The European Parliament never got a chance to persuade the Council that this was a much needed pillar of CMU. It was deemed too politically sensitive. MEPs had to make do with changes to securitisation and prospectus regulations but were not able to address the fundamentals of a single market; namely, the harmonisation of insolvency law as it pertains to securities, harmonising withholding taxes, addressing barriers to cross-border settlement and varying consumer protection rules that prevent capital from flowing easily across the Union.
Other measures that need to be addressed are the availability of a consolidated tape and the ability of EU authorities to oversee cross-border post-trade activities, especially in those organisations that manage risk like Central Counterparties (CCPs) and International Central Securities Depositories (ICSDs). International investors view the concept of a single regulator and supervisor in a positive way and do not appreciate the national sensitivities associated with capital markets needing to be locally overseen.
Other factors influencing capital markets development
Without ambitious implementation of CMU that embraces the challenges of securities law legislation, I suspect that traditional factors like labour laws, tax regimes etc. will continue to influence the capital markets development of individual member states. This will automatically foster a competitive environment amongst the EU27 rather than allowing a true CMU to emerge. Global investors will likely see the EU as a single destination of choice only once national competition for business becomes solely about where a firm interfaces with customers and counterparts, rather than the fundamentals of the marketplace. The barriers were identified decades ago and the EU now needs to be motivated to deliver. The prize of an international financial centre in the EU is worth pursuing.