CMU is one of the cornerstones of the euro area’s financial architecture. But progress in developing it has been slow. Since the agreement on establishing CMU in 2015, many subprojects have been launched, and some completed, but European capital markets are still far from being fully integrated.
The capital markets union (CMU) is one of the cornerstones of the
euro area’s financial architecture. But progress in developing it has
been slow. Since the agreement on establishing CMU in 2015, many
subprojects have been launched, and some completed, but European capital
markets are still far from being fully integrated. Despite the fact
that the coronavirus (COVID-19) crisis has made CMU more important than
ever, progress has unfortunately slowed, notwithstanding the substantial
headway made on the fiscal side with the agreement on the European
recovery package (Next Generation EU).
Financing the post-crisis
recovery is one of the most pressing challenges Europe is facing today.
Capital markets will be crucial. The new bond issuance by the European
Commission, in the context of Next Generation EU, relies on
well-functioning capital markets.
But public funding cannot do the heavy lifting alone; it will have to
be complemented by substantial private financing. With the banking
sector under pressure due to the pandemic, private bond and equity
markets can play an important role in complementing bank financing.
In
order to recover from the pandemic and strengthen the euro area’s
growth potential, a new push is needed towards the long-term ambition of
creating a genuine single European capital market that is deeply
integrated and highly developed. This will not only mobilise the
resources needed to reboot the euro area economy after the global
contraction. It will also help meet the additional challenges posed by
external developments, such as Brexit and global trade tensions.
In addition, it will provide opportunities for accelerating the
transition to a low-carbon economy – thereby supporting the European
Union’s ambition to be a leader in green finance – and for funding the
transition towards the digital economy. A single capital market will
also strengthen our common currency’s role on the global stage. And last
but not least, a deeper and more integrated financial system is also
needed from a monetary policy perspective, as integrated capital markets
improve the transmission of our single monetary policy to all parts of
the euro area. In turn, this will help limit the risk of growing
asymmetries among member countries as our economies recover from the
COVID-19 shock at different speeds.
Our aim with this blog post is
to re-emphasise the importance of strengthening efforts to advance the
CMU project, in the light of the European Commission’s forthcoming new
Action Plan.
First, we explain why CMU is important, especially due to the COVID-19
crisis. Second, we describe the current state of play regarding capital
market development and integration in the EU, and identify the areas
where progress is needed most. And third, we set out a roadmap of policy
measures that would remove core barriers to further integration.
Following this roadmap would benefit the euro area, the EU and its
citizens. It would stabilise funding sources for households, companies
and governments, foster cross-country risk-sharing and consumption
smoothing, and stimulate growth and the post-COVID-19 recovery.
The
measures we propose are broad in nature and require strong commitments,
in line with the ECB’s long-standing view that the CMU project has to
be ambitious.
Accomplishing these reforms could trigger a virtuous cycle of better
economic outcomes and further reforms, strengthening the European
project. We recognise that developing and integrating European capital
markets will primarily be a market-led process, so the measures we
propose are designed to enable market forces.
Why is CMU even more important due to the COVID-19 crisis?
Even
before the pandemic, the ECB was a strong supporter of the CMU project.
CMU aims to deepen and further integrate capital markets in order to
establish a genuine single capital market within the EU, which would
allow investors, savers, firms and market infrastructures to access a
full range of services and products, regardless of where they are
located. Let us explain why CMU matters, and why it is particularly important due to the COVID-19 crisis.
First,
European firms would benefit from more diverse funding sources, which
would allow them to adapt more effectively to changing funding
conditions. Easier access to market-based financing instruments would
lessen firms’ reliance on bank financing when the banking sector has
been weakened by a shock, such as the COVID-19 crisis. This would also
support the smooth transmission of monetary policy.
Second,
progress towards CMU would increase private risk-sharing across
countries and actors, generating positive effects from a macroeconomic
stabilisation perspective and making economies more resilient to local
shocks. This is particularly important now, with the risk of diverging
economic development within the euro area due to the shock from the
pandemic. Within Europe, increasing cross-border ownership of stocks and
debt securities and cross-border business financing would be an
important way of sharing risks and thereby stabilising households’
consumption and firms’ investment over time.
Equity markets tend to have particularly strong risk-sharing
properties. Several studies also emphasise that equity funding is more
resilient to shocks than debt funding, and can be considered more stable
from a risk-sharing perspective.
Third,
boosting capital markets through policies aimed at increasing equity
financing would support growth and innovation. Research suggests that
firms with higher growth potential generally resort more to (public or
private) equity financing than debt financing and that capital markets
are better at financing innovation and new sources of growth.
This makes capital market funding particularly attractive with a view
to boosting Europe’s potential growth after the pandemic. A fully
fledged CMU would improve funding conditions for innovative firms, which
would mean brighter prospects for jobs and growth in a more sustainable
economy, thereby helping to successfully implement the structural
changes that will be unavoidable after the crisis.
Fourth,
advancing CMU would speed up the transition to a low-carbon economy.
Recent analysis suggests that an economy’s carbon footprint shrinks
faster when it receives a higher proportion of its funding from equity
investors than from banks or through corporate bonds.
Given equity investors’ propensity to fund intangible projects, equity
markets might be more successful in funding green innovation and
supporting the reallocation to green sectors.
Fifth, integrated
euro area capital markets would strengthen the international role of the
euro, as deep and liquid financial markets are fundamental to a
currency’s ability to attain international status.
By reducing transaction costs, deeper markets would make using the euro
more attractive for international financing and settlement. More liquid
markets also mitigate rollover risk and are thus perceived as safer by
investors. A stronger international role for the euro would benefit our
monetary policy, including through greater policy autonomy and improved
monetary policy transmission, with positive spillbacks and lower
external financing costs.
It would complement other measures supporting the international role of
the euro, such as the expansion of euro liquidity facilities during the
COVID-19 crisis.
Finally,
progress on CMU would dovetail with another key EU objective:
completing the banking union. Banks and capital markets complement each
other in financing the real economy, so the two projects are mutually
reinforcing.
On the one hand, more integrated capital markets support cross-border
banking activities, as banks exploit economies of scale and offer
similar capital market products across the EU. More cross-border
holdings would also allow banks to have more diversified collateral
pools for their securitised products and covered bonds. This could
ultimately make banks more resilient, as they would benefit from a wider
investor base for capital market-based funding instruments and a
broader market to which they could sell non-performing assets. On the
other hand, a more resilient and integrated banking system supports the
smooth functioning and further integration of capital markets. Just as
with CMU, the benefits of banking union become even more visible due to
the pandemic.
Where do European capital markets stand today and what has happened during the pandemic?
The
first CMU Action Plan of 2015 has generated some positive developments
in European capital markets. Among other things, it led to some progress
on harmonising and improving insolvency frameworks
and on establishing a new EU framework for covered bonds and simple,
transparent and standardised securitisations. But a significant “CMU
effect” has yet to be seen in the data – partly because these measures
have only been implemented recently and their full impact will take some
time to emerge.
European capital markets – and especially equity markets – remain
underdeveloped and insufficiently integrated at the European level.
While there was a strong positive trend in capital market integration
following the great financial and euro area crisis, as shown by the
price- and quantity-based indicators in Chart 1, the integration of
equity markets has stagnated since 2015 and has even declined since the
fourth quarter of 2017. Cross-border holdings of debt have increased,
but this is mainly true for shorter maturities, which are less stable
than longer-term debt. Another notable trend is that investment funds are playing an increasingly important role in cross-border integration.
However, overall risk-sharing is still low compared with the levels
typically observed across regions or states within a single country or
federation.
While
it is too early to fully assess the impact of the COVID-19 outbreak on
EU capital markets, some initial indicators show that the pandemic has
triggered a refragmentation within euro area financial markets, mainly
through bond and equity markets. At the height of the pandemic, this
meant that our private purchase programmes could not reach the
non-financial corporations (NFCs) of all euro area countries in the same
way.
Chart 1
Price and quantity-based indicators of financial integration
(quarterly data; Q1 1995 – Q2 2020)
Source: ECB (2020), Financial Integration and Structure in the Euro Area, March 2020.
Notes:
The indicators are bound between zero (full fragmentation) and one
(full integration). The result of the quantity-based composite indicator
for Q2 2020 is based on money market and equity market benchmark data
from Q2 2020; for the bond market, Q1 2020 benchmark data are used. For a
detailed description of the indicators and their input data, see the Statistical annex to the ECB report “Financial Integration and Structure in the Euro Area” (see source above) and Hoffmann et al. (2019).
Capital market development is also lagging behind.
While the US economy is financed through capital markets to a
significant degree, the euro area economy continues to be mainly
financed by banks and through unlisted shares. Nevertheless, the role of
capital markets in providing a stable source of funding to the European
economy is expanding, thereby moving the euro area’s financial
structure towards a more balanced composition.
NFCs have gradually diversified their funding structures and are
increasingly financing themselves in the market by issuing debt
securities. At the same time, however, corporate bond markets are very
uneven across euro area countries.
Even though the share of all
equity instruments in total financing in the euro area is comparable to
other countries, financing through equity traded on public markets
(listed shares) remains relatively uncommon, and well below the levels
seen in other major economies.
Conversely, loans and unlisted shares account for particularly large
proportions of financing in the euro area economy. Similarly, the EU is
lacking in early-stage private equity investment (see Chart 2). Data on
venture capital investment relative to GDP show that even in Finland and
Estonia, which are the most advanced EU countries in this area, the
ratio is less than one-fifth of that in the United States. Early-stage
financing is not the only ingredient missing for innovative firms to
flourish: the EU is also lagging behind the United States as regards an
ecosystem that promotes the next stages of growth when firms mature and
need to scale up their businesses.
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