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“A properly-designed Capital Market Union would deepen the single market in finance and simultaneously offset some of the pooling of sovereignty inherent in Banking Union. It would be an open union enabling the savers of Europe to make their own choice about where they put their money – a de-centralisation of power, both financial and political.
As a first step, the new Commission should start with a stock-taking exercise to confirm what still needs to be done to create the single financial market.”
Europe is now acutely aware of the mechanisms that led a loss of financial confidence to feed through into the real economy: rising spreads for `stressed’ governments followed by rising funding costs for banks thought to be guaranteed by them. The net result for the most vulnerable was (and still is) a lethal squeeze from a tight fiscal policy and a monetary policy impact in terms of interest rates paid/loans available which fails to transmit the ECB’s easy money policy.
Amidst the sound and fury about the appointment of Jean-Claude Juncker as President of the European Commission, it is easy to miss that he was actually elected on a programme of reform and that the Heads of Government – in placing his name before the European Parliament – wanted jobs, growth and competitiveness at the top of the agenda for the next five years.
The relevant European Council priorities included:
As co-legislator, the ECON Committee of the Seventh Parliament fully recognised that the package of financial regulation reforms and micro (in the sense of individual national) economic reforms would be insufficient to make robust the rapid and deep economic integration which was suddenly forced upon the euro area. The Committee examined various ideas – including Eurobonds and Eurobills – to provide a macro-economic policy framework for the euro area as an integrated entity.
President-elect Juncker set out his “Political Guidelines” to the European Parliament reflecting these Council priorities and was elected on that basis (see Appendix II for key extracts). His letters of appointment to each Commissioner incorporated these guidelines explicitly. So scrutiny by national Parliaments should be forward-looking and focus on the implications of this next phase of EU regulation.
The entire Eurozone banking system is now subject to the single supervisory mechanism (SSM) operated by the ECB. It will apply very detailed regulations drawn up by the European Banking Authority. These derive their legitimacy from legislation of the European Council and Parliament. When the process is fully operational, “Europe” will have rules that should ensure the nearly-absolute safety of customer euro deposits equal to about 150 per cent of Eurozone GDP. These deposits are part of the support for banking assets that are closer to 300 per cent of GDP. But 85 per cent of these assets are under the managerial control of the 120 `SSM’ banks – and 5 groups control around 45 per cent of them. That is a massive concentration of financial power and any major failure of these European rules will surely have grave consequences for European citizens. By any definition, that is a major centralisation of the political sovereignty used to protect those citizens.
What is Capital Market Union? It is the smooth flow of capital – at savers’ own risk - from them directly to users throughout the European Union, so both stakeholders in society benefit from cutting the cost of intermediaries. The credit standing of users will range from outstanding to just-acceptable, and the maturity of transactions will range from overnight to decades. The financial institutions that intermediate these flows will be regulated by the EU’s single rulebook for all participants in financial markets. As savers are taking the investment risk, they must be suitably educated/informed but protected against non-investment risks.
CMU would complete financial integration and bolster financial stability, as well as promoting the effective implementation of euro monetary policy in all parts of the eurozone economy. Crucially, it is profoundly de-centralising of economic, and thus political, power.
A properly-designed Capital Market Union would deepen the single market in finance and simultaneously offset some of the pooling of sovereignty inherent in Banking Union. It would be an open union enabling the savers of Europe to make their own choice about where they put their money – a de-centralisation of power, both financial and political.
Such de-centralisation is critical to avoid the vicious pro-cyclicality that is inherent in the fact that the great majority of EU financial intermediation is in the hands of financial institutions that are subject to strict rules on matching assets and liabilities. The requirement to maintain minimum capital buffers – even though they are large – forces sudden de-leveraging if there are major losses on assets. If the risk of a major loss due to currency shifts becomes apparent, then we have already seen how quickly the single market is forced to fracture as a natural consequence of these rules.
In contrast, if the bulk of financial intermediation is done via securities held by citizens, then citizens are not compelled by law to respond in such a leveraged manner. However, if a risk becomes obvious, there should be no doubt that they will still respond in what I call a `rolling referendum’ on the economic policies of the state concerned. That would be a powerful force for corrective action.
Capital market union is an explicit dimension of the single market and a clear requirement for the types of finance needed to pump-prime the economy. The citizen-savers who own €7tn of UCITS (or should it be €10 trillion in five years?) should be empowered to make their choices. They will not be hampered by the capital adequacy rules that could deter banks from lending or rules to match the term structure of their assets to that of their liabilities. Such savers who forsake the safety and low return of bank deposits may also be far bolder in locating their assets than highly-leveraged banks might be: they will be less driven by the fear of utter ruin, for example, if a currency mis-match appears. Undoubtedly, capital markets will continue to show some home-country bias but it would be interesting to compare the movements in UCITS allocations back to the `home state’ compared with the movement of bank assets.
This vision is much wider than the non-exclusive list in President-Elect Junker’s appointment letter to Commissioner-designate Hill requesting him to complete the Capital Market Union by 2019.
The foundations of CMU could include the Temporary Eurobill Fund (TEF): The last ECON Committee was instrumental in persuading the European Commission to set up an Expert Group to examine the pros and cons of proposals for a Debt Redemption Fund and for Eurobills. I had the honour of serving on this Group and gave evidence to ECON immediately after our Report was published. My proposal would create a genuine, single European yield curve for this market sector – with a TEF size of €0.8 trillion (nearly 10% of GDP) and perhaps twice that size. The participating states must finance all under two-year issuance through the TEF.
Participating governments would have the right to re-finance maturing issues by borrowing from the TEF – thus removing roll-over risk and enhancing financial stability. By common agreement, states could use any flexibility in the SGP to increase their borrowings from the TEF to stimulate public investment in the productive categories outlined in President Juncker’s Political Guidelines. This would give the euro area a modest, `targeted fiscal capacity’ as a modest public contribution to the €300 billion investment plan. As an example, the €20 billion funding of the required gas interconnectors would help Europe as a whole by enabling each state to play its own part.
Such a Fund is a natural foundation for Capital Market Union so that there is an unquestionable yield curve at the short end of the market for the highest-possible quality issuer and the greatest possible liquidity. That curve will provide the yield comparison for any short–term ABS etc, or floating rate bonds/mortgages – promoting the integration of these markets across the euro area. Non-bank suppliers of loans to say SMEs will be able to calibrate the yield increment needed to persuade citizens to fund directly, whilst providing a cheaper source of funds to companies for productive investment.
The TEF has the added advantage of providing powerful incentives for sound economic policies, and of being an insurance policy against possible future market misperceptions about the stability of public finances. (See Appendix I for more detail).
My plan for a TEF has been widely discussed with market participants and officials, as well as by the Commission’s Expert Group. I believe that no technical obstacles remain unsolved.
What is the Temporary Eurobill Fund? It would follow a similar legal structure to that of the ESM with pro rata callable capital - but with a crucial difference: only euro states in `good standing’ could join, thus excluding those in the ESM `sin bin’. The economic structure would be the plainest vanilla. The Fund would borrow from the markets - exactly matching quantities and maturities requested by borrower states – for maturities ranging up to two years. The key step is that participants would bind themselves to borrow all new funds in this maturity range only from the TEF. In short order, there would be a genuine, single European yield curve for this market sector – with a TEF size of €0.8 trillion (nearly 10% of GDP). Members would also have the right to re-finance maturing issues by borrowing from the TEF – thus removing roll-over risk and enhancing financial stability.
Political Governance: The decision-makers will be the Finance Ministers.
Can it be done? Yes – The Expert Group was clear that an ordinary Regulation of the European Union could set up the operational platform although a separate Inter-Governmental Agreement would be necessary to bind participants to decisions about the financial management of the fund: membership, size, maturity etc. The key is that there would be no need to change the main European Treaty.
Another key contrast with banking union is that there is not – and probably never can be – a single regulator with the power to delve into the micro-management of decisions about asset allocation. ESMA clearly has ambitions to operate a single rule-book and chairman Maijor did not mince his words in a speech to the International Capital Markets Association “What is needed now, is to complement the legislation issued in the past years, with the following two essential elements:
Many (probably the vast majority) of these legislative building blocks are already in place but each element needs to be re-scrutinised all the way along the transaction chain: from issuing and trading to final settlement in all its parts of central counterparty clearing, payments, custody and depositary. This author was part of the Commission Expert Group that advised then-Commissioner Monti on the creation of the Financial Services Action Plan in 1998, the first Giovannini report on the changeover of capital markets to the euro and then the reports that identified the 15 “Giovannini Barriers” to efficient settlement across Europe. A decade and a half later, that work is far from complete. Perhaps the new Commission should start with a stock-taking exercise to confirm what still needs to be done.
Some of the most recent legislative steps were analysed in an excellent ECB report in April, “Financial Integration in Europe”, but the special article on “initiatives to promote capital market integration” laid bare some of the missing essentials. Critically, a proposal on Securities Law Legislation has still not appeared from the Commission, despite consultations in 2009 and 2010. However, on the good news side of the balance sheet, the ECB’s T2S securities settlement system should be a major step forward when it comes into operation in less than a year. It will be a single, pan-European platform for securities settlement in central bank money, removing the differences between cross-border and domestic settlement and cutting costs.
The type of scrutiny that led to T2S needs to be applied all the way along the yield curve from the shortest money market instruments to the longest of bonds, and the perpetual liability of equity. The riskiness of the investment is also a key factor – from low-risk Treasury bills to junk bonds and the ultimate risk bearer – corporate equities. Success in creating an integrated euro capital market is widely accepted as a necessary condition for restoring sustainable growth – highlighted by the ECB’s drive to re-start `good’ securitisation. The plan put by this author for a Temporary Eurobill Fund (TEF)(see Appendix I) should be seen as part of such a drive.
First, major changes to MiFID and Solvency 2 should not be required as they have only just been completed. However, they are scheduled for a routine review in due course. CRD 5 is now on the horizon, which should mean that securitisation can be boosted by removing the reported absurdity that the same SME assets require eight times the capital if held as an ABS rather than directly. That will also provide an opportunity for a far more profound re-think about the zero-risk-weighting of government bonds (and thus the associated large exposure rules). UCITS 6 and Solvency 3 may be needed to make corresponding amendments on large exposures. The Money Market Funds proposal will need to be reviewed and the pressure for a new regime for private placements may need legislation. The benchmarks proposal will need to be finalised, though the TEF itself will provide a reliable short-term interest rate structure.
If my plan for a Temporary Eurobill Fund (see Appendix I for more details) is taken up, then it will require a Regulation for administrative aspects and – far more substantially – an inter-governmental Agreement amongst the participating states to limit their short term borrowing to only use the TEF. It would also provide the governance arrangements.
Any significant shift in financing the economy away from the banking sector into the securities markets would be transformational for all those involved in issuing, trading and managing securities. As the pre-eminent centre of such activities for the entire EU, the City should be well placed to benefit.