BusinessOpinion

Without a functioning capital market, Europe’s decline will continue

The EU must regain global competitiveness through developing large and liquid capital markets so companies can grow and flourish

A share trader in Frankfurt. The EU's stock market capitalisation is less than half that of the United States

Brian Hayes
Mon Jun 3 2024 - 06:00

Earlier this week, French president Emmanuel Macron and German chancellor Olaf Scholz penned a joint op-ed in the Financial Times calling for a renewed focus on “competitiveness” over the next five-year EU mandate.

For the leaders, the answer is clear: the EU must regain global competitiveness through removing single-market barriers and developing deep and liquid capital markets so that European companies can grow and flourish.

Over recent decades the EU has been losing out to other regions of the world. Its share of global GDP is now lower than it was in 2003, while its stock market capitalisation is less than half that of the US, in percentage of GDP, and also lower than that of Japan, China and the UK. The same trend is also seen in the venture capital and private equity segments, where the lack of a sizeable pool of capital available for early-stage investments means that Europe cannot support and scale up its financing of innovative growth companies.

The EU’s capital markets are less developed and integrated than those of other advanced economies or even the EU’s single market for goods, labour and services.

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To put this into perspective, in the EU, bank loans account for 75 per cent of corporate borrowing and bond markets for 25 per cent. The inverse is true in the US. This means that there is a heavy reliance on bank-based financing to support economic growth, which can become constrained due to strict regulatory requirements.

The coming decades are likely to see increasing competition between economies for innovative, high-tech industries. If the EU cannot compete in the innovation race, it will fall behind economically and risks not being a relevant player in the longer term. The opportunity costs of not having large and liquid EU capital markets are stark.

EU economies will also require significant investment if they are to become carbon neutral and meet their 2050 climate targets. The same is true if the EU wants to meet its ambitious objective of moving towards a more digital economy. Combined, it is estimated that this twin transition will require additional investment of more than €700 billion annually. To achieve this, huge sums of public and private sector investment will be needed. Without a well-developed capital markets union these goals cannot be met.

For the past decade we have spoken about a capital markets union (CMU), but progress has been extremely slow. Within a proper functioning capital market, Ireland is ideally placed to be a leading financial centre.

European Central Bank (ECB) analysis shows that financial integration in Europe is much lower than before the global financial crisis; large investors, especially from outside the EU, are deterred by European market structures, which are often less liquid, less attractive and fragmented across 27 member states.

[ Europe ‘lagging’ rivals due to slow capital market reforms, says McGuinness ]

In the short term, the new European Commission, supported by the Irish Government, must look to revive the capital markets union initiative and specifically move towards further supervisory and regulatory convergence within the EU. At present, not all rules are harmonised at EU level, and national requirements are still widespread. The consequence is widely different application of rules, which is a direct cause for market fragmentation.

One of the key reasons behind the depth of US capital markets is the active range of participants investing and trading in securities. Having highly liquid markets helps to keep prices and costs for investors down, supporting further activity.

Traditionally, European markets have been dominated by universal banks, who operated across both debt and equity segments. However, in other jurisdictions, as in the US, they are complemented to a larger extent by nonbank marketmakers. These firms are often the largest traders across most asset classes and are crucial to the functioning of markets.

Ireland is already home to a large and diverse number of these firms engaged in various activities, ranging from the provision of liquidity across all EU exchanges to supporting the underwriting and syndication of the next generation of EU bonds. In fact, Ireland has become a significant hub in the EU for leading global marketmakers providing liquidity across all asset classes.

However, for this sector to continue to grow in Ireland, it is important to have a proportionate regulatory framework that reflects the nature, size and complexity of these entities. With it, Ireland can become the go-to location for investment firms growing or establishing their EU business, placing us in a unique position to build a deeper and more sophisticated financial services industry.

[ Plenty of disagreement as capital market reforms return to EU agenda ]

The EU also needs to revive the securitisation market to support further lending to European economies. One reason why the US banking sector has been such a powerful engine for the US economy is that it is able to recycle risk and financial resources, rather than relying on warehousing traditional credit products on balance sheet, as in the EU.

At present, the level of securitisation issuance in the EU is low compared to the US (€200 billion versus €3 trillion). For Ireland, having a well-functioning securitisation market is particularly important in the mortgage market.

Having well-functioning capital markets and a banking union are fundamental drivers that will allow a significant increase of financial resilience in the EU and cross-border financing. A new EU Commission and European Parliament mandate gives a chance to reset priorities. We need to turn the political speeches over the past decade about a CMU into concrete action. Without a functioning capital market Europe’s decline will continue.

– Brian Hayes is chief executive of the Banking & Payments Federation Ireland

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