The Capital Markets Union: Where it’s at and what is worrying

The European Commission (EC) is quickly moving forward with its plan to create a Capital Markets Union (CMU). The proposal to regulate for “simple, transparent and standardised” (STS) securitisation was given priority, but has met some opposition. Other regulations have also been introduced, aiming for more non-bank business financing. The proposals expose a serious bias in favour of the financial industry, which has requested more and more deregulation.

The European Commission (EC) continues to work apace on its ambitious project of creating an integrated and substantially larger capital market across all EU member states by 2019, the Capital Markets Union (CMU).

The Action Plan for the CMU(opens in new window) that was presented on 30 September 2015 lists over thirty separate work streams for legislative or non-legislative action to be taken. Not all of these are being worked on simultaneously. Some have been assigned priority status and were already at a highly advanced stage when the EC presented the action plan, especially the proposal for a regulatory framework for loan securitisation. Others are in the inception stage, and still others will only be tackled in the coming years. The following are the most important active and recently added work streams.

Proposal for ‘simple, transparent and standardised’ (STS) securitisation

 Loan securitisation is the bundling of large numbers of bank loans, e.g. to homeowners, SMEs, students or other types of borrowers, with the purpose of selling slices of these bundles to financial investors. Securitisations of “subprime” mortgage loans triggered the 2008 financial crisis and have since suffered from a bad reputation and lacklustre demand. Therefore the EC put forward a proposal for a regulation that would establish eligibility criteria(opens in new window) thereby making them more trust worthy. In addition, an amendment to the Capital Requirements Regulation(opens in new window) was proposed to lower the capital requirements for issuing and holding securitisations that qualify for the STS label. According to the Commission, this will boost securitisation markets and help channel more financing to the real economy.

Critics have questioned the economic usefulness of stimulating securitisation markets but were unable to halt these proposals and have therefore concentrated on mitigating the risks to financial stability from securitisations. They have demanded, for example, that so-called synthetic securitisations which provide protection against default should not be eligible for the STS label. However, the financial industry, which wants the fewest restrictions possible, has a sturdy friend in the EC, so those demands are not reflected in the legislative proposal. Nonetheless, sceptical MEPs on the ECON Committee have managed to slow down the process and delay a vote in the Committee until November 2016. It plans to publish an ECON working document on 12th May 2016, followed by a Committee discussion on 23-24 May, a hearing with stakeholders on 13-14 June, and the publication of an ECON draft report on 22 June 2016.

Proposal to amend the Prospectus Directive

This EC priority initiative is intended to make the production of prospectuses – frequently large documents that issuers of tradable financial instruments must publish to provide potential investors with the necessary information – less cumbersome for smaller issuances (between €1 and €10 million). The proposal(opens in new window) is currently in the European Parliament’s ECON Committee. Over 600 amendments have been tabled, which are to be discussed on 23-24 May 2016 and voted on by ECON on 13 June.

Critics fear that granting exemptions from the more onerous prospectus regime to smaller issuances could leave retail investors unprotected.

The “Call for evidence: EU regulatory framework for financial services”

In this public consultation(opens in new window) (now closed) the EC asked the public to provide empirical evidence about the impact that the regulation passed in the past six years has had on the financial sector. This consultation was biased in favour of deregulation(opens in new window) because it implicitly presented financial sector regulation as more of an undue burden on business and economic growth than a robust and beneficial framework serving the public interest. Moreover, its design ensured that it was little more than an invitation to the financial industry to let the Commission know what it wants changed. A hearing(opens in new window) organised by the EC in the same way will take place on 17 May 2016.

It confirms the general trend of the current Commission to conveniently forget(opens in new window) the lessons from the financial crisis, thereby sacrificing the goal of creating a more stable financial sector whose failures do not take down entire economies. This EC process deserves more attention from civil society to strategize how to influence the political process.

Insolvency framework

On 23 March 2016 another public consultation was launched by DG JUST(opens in new window) to gather views on the principles that should inform a harmonised EU framework for business insolvencies. Having such a framework in place would facilitate cross-border investment as investors would have more certainty about what to expect when a business they have invested in goes bankrupt. The consultation specifically focuses on measures to speed up frequently lengthy insolvency proceedings to give viable businesses a chance to restructure their debt and continue operating while quickly winding down non-viable businesses. The deadline for submissions is 14 June 2016. The Commission plans to present a legislative proposal, accompanied by an impact assessment by the end of 2016.

Loan origination by funds

Work has just begun on an initiative that looks set to give more fuel to the shadow banking industry: the common EU framework for loan origination by investment funds, i.e. direct lending by funds to businesses. This is already possible to some degree for alternative investment funds under the European Venture Capital Funds (EuVECA), the European Social Entrepreneurship Funds (EuSEF) and European Long Term Investment Funds (ELTIF) regulations. Several EU member states have already introduced their own regulatory frameworks for this kind of non-bank lending. The European Securities and Markets Authority (ESMA) has been consulted on the issue and, on 11 April 2016, released an opinion(opens in new window) which supports the EC’s view that the introduction of a common EU framework would boost this type of lending. This is in line with the Commission’s general argument for CMU: that the bank lending channel is broken and that non-bank channels for business finance need to be stimulated.

Direct lending by investment funds is shadow-banking pure and simple and carries substantial systemic risks, which, however, the ESMA opinion only mentions briefly at the very end. In principle, a pan-EU framework could be an opportunity to minimise these risks, given that national frameworks already exist. In practice, however, the EC’s business-friendly bias will probably ensure that the EU framework will lower restrictions, e.g. with regard to the type of borrower that loan-originating funds should be allowed to lend to (should they be able to make consumer loans?), or with regard to the type of investors that loan-originating funds can be marketed to (should retail investors be able to invest in them?). A public consultation is to take place later this year.

Overall, the direction in which CMU work is going under Commissioner Jonathan Hill confirms fears that the regulatory climate has shifted in favour of the financial industry and light-touch regulation. Opponents cannot count on finding a friendly ear at the Commission. While work on mitigating the worst excesses through direct engagement in the legislative process must continue, more creative ways of slowing down this agenda and exposing its risks should be found.