In this piece published today by Bloomberg View, I make the case that Jean-Claude Juncker's project of a European Capital Markets Union (CMU) may be revived by the UK decision to leave the EU. This is because requires CMU stronger EU-wide enforcement institutions, something that couldn't be envisaged in the pre-referendum period.
Update (September 10, 2016): Bloomberg kindly gave its authorization for reposting the text of the article, shown below.
A Post-Brexit Opportunity Europe Shouldn’t Miss
If there is a silver lining for the world of finance from the Brexit vote it is this: that the departure of Britain offers the European Union a chance to complete much-needed reforms to the Continent's lagging capital markets. If it can do that, the EU might just be able to demonstrate its ability to serve a purpose and enhance growth across the EU.
Two years ago, European Commission President Jean-Claude Juncker made strengthening Europe's capital markets one of his key priorities. Europe lagged America across the board: in public and private equity financing, bond issuance by medium-sized companies, securitization, corporate transparency, and the ability to work out debt in a downturn. Bank loans represent more than three-quarters of external credit to non-financial companies in the EU, against less than a third in the US. Europe’s small- and mid-sized firms, especially those with a high growth potential, needed better access to financing options.
With Britain's EU referendum looming, Juncker also saw the EU's Capital Markets Union (CMU) as a way of showing that EU policies could be aligned with U.K. interests, since the City of London had a massive comparative advantage in capital markets services. U.K. Commissioner Jonathan Hill was put in charge of the ponderously titled “Financial Stability, Financial Services and Capital Markets Union” portfolio. But it turned out to be a bit more complicated.
Strong EU capital markets require strong EU institutions to oversee them and enforce existing regulations. As the British Commissioner – and therefore the official primarily tasked with helping the case for the U.K. to remain in the Union – Hill had to rule out any changes in institutional arrangements that might be seen in the heat of the referendum campaign as a “Brussels power-grab.”
Thus, in the past two years the CMU agenda has remained long on rhetoric, and short on policy. Hill made the case for CMU as a way of providing adequate financing to high-growth firms and thus to stimulate growth and job creation on a long-term basis with no fiscal or financial stability downside. But there have been few concrete proposals for reform, the main one being a securitization bill that is currently bogged down in the EU legislative process.
Now that Britain has voted to leave the European Union, a window is opening for a vigorous CMU relaunch. A serious agenda would include things like consistent processes for listing and fund approvals across EU member states, an integrated framework for auditor oversight and public enforcement of accounting standards, consolidated EU-wide supervision of important market infrastructure firms, moves towards insolvency law harmonization, and possibly also some convergence in the taxation of financial investments. All these require pooling of sovereignty. The existing European Securities and Markets Authority could be built upon, as outlined in an EU report last year.
Inevitably, not everyone in Europe is a fan. Opposition against CMU broadly crystallizes along three dimensions. First, pooling sovereignty is always difficult, even outside the U.K. Second, anti-market ideology remains strong in many European countries, as illustrated by the pursuit of the Financial Transaction Tax. Third, a range of special interests seek to defend the status quo. These include protected financial infrastructure firms, such as national stock exchanges which are still (mistakenly) viewed as vital national attributes in a number of European capitals, and other financial institutions whose business model may be challenged by a successful CMU, such as the politically influential German local banks.
But none of these political obstacles is as intractable as the U.K.-specific constraints that hamstrung Commissioner Hill. There are powerful forces on the pro-CMU side as well. Aside from the U.K., member states with strong capital markets already include France, Belgium, the Netherlands and Sweden. The European Central Bank has come strongly in favour of CMU, which it rightly sees as a way to diminish the euro area’s bank bias, increase its shock-absorption capacity, and thus enhance financial stability. So has the President of the Eurogroup, Jeroen Dijsselbloem, with similar arguments. And, in the 19-nation euro area, the steps already taken to build a much-needed banking union have profoundly undermined the case for keeping financial services policy at the national level. Following Commissioner Hill’s resignation, the financial services portfolios will be taken over by the Latvian Vice President of the Commission, Valdis Dombrovskis.
That, ironically, offers a key opportunity. In the wake of Britain's calamitous referendum, few measures would do more to strengthen Europe’s growth, and perhaps rebuild bridges to its now off-shore financial hub in London, than pressing ahead with reform to create more integrated and vibrant continent-wide capital markets.