By Adam Farkas, Chief Executive Officer, Association for Financial Markets in Europe (AFME)
Disappointingly, there has been little change in the development of the European Union’s (EU’s) capital markets, particularly in a global context, over the past decades. The global share of the market capitalisation of listed shares in the EU has declined from 18 percent in 2000 to 14 percent in the first half of 2024, whilst the United States has consolidated its position as the undisputed leader, accounting for 53 percent of the world’s equity-market cap in mid-2024. China has rapidly expanded, accounting for 0.3 percent of the world’s total market capitalisation in 2000 and growing to 10 percent in 2024. The evolution of market capitalisation also has repercussions on the depths of regional liquidity pools. Market data suggests the US and China are more liquid centres than Europe, with turnover ratios measured by trading volume relative to market capitalisation standing at 2.9 times in the US and 2.7 times in China versus 1.1 times in Europe.
These numbers stress the increasing urgency to transform the EU’s existing capital markets into a globally competitive, well-functioning and scaled-up single capital market. Without this, the region’s future growth and competitiveness are at stake.
This year has seen a significant sea change in the mood and support from policymakers who recognise the importance and urgency of developing the EU’s capital markets, not least because neither public funds nor bank financing will be sufficient to finance the circa one trillion euros of additional investment per year required to digitise and decarbonise the EU economy and to increase its defence capacity.
This support and recognition is needed and very welcome and goes, we hope, well beyond pure rhetoric. Thetime has come for policymakers to commit to concrete actions that will have real positive impacts. Quite simply, more transformative and bold measures are needed to scale the EU’s capital-market sector to bring it into line with the size of the union’s economy, its future investment needs and the role it wants to play on the global stage. To succeed, decision-makers cannot shy away from addressing some structural, and often political, issues.Four key areas need to be addressed in order to secure Europe’s long-term economic prosperity and competitiveness.
Firstly, bringing significantly more retail savings to the EU market, whether directly or indirectly, is a priority.The work of the Eurogroup to exchange best practices amongst member states in this area is therefore highlywelcomed. The mission entrusted by European Commission (EC) President Ursula von der Leyen to Maria Luís Albuquerque, the commissioner-designate for financial services and the Savings and Investments Union, clearly signals that this will be a priority for the next Commission when it takes office in the coming months.However, with most of the power to streamline access conditions and create financial incentives for savings and pension products being in the hands of member states, meaningful progress in this area is only likely to occurunder the clear leadership of heads of state committed to tackling the matter together.
Secondly, the EU needs to enhance its rule-making agility in wholesale capital markets. This can be a powerful way to increase the attractiveness and competitiveness of the EU marketplace. To achieve this, greater discipline needs to be exercised so that co-legislators set out principles in legislation but refrain from hardcoding details therein. Instead, regulatory authorities should be given the responsibility to determine the technical substance of rules. The European supervisory authorities (European Securities and Markets Authority, or ESMA, in this case) should be charged with making policy assessments and detailed rules based on robust market data and should be held accountable to co-legislators on the basis of this observable data. This will allow the framework to adjust more rapidly to changing market conditions in a manner that is more comparable to rule-making for markets in other jurisdictions. It will also imply giving greater resources to those authorities and changing their governance with European single-market objectives in mind.
Going a step further, the EU should also recognise that not all circumstances can be foreseen in regulation andthat attempting to do so can lead to an overly complicated and burdensome rulebook. Instead, supervisoryauthorities should be further empowered to intervene, again on the basis of robust market data, when it is necessary—for instance, to preserve market functioning, price formation or other critical objectives.Supervisory assessments and interventions should be strongly coordinated across the EU and, where necessary and more effective, centralised.
Thirdly, greater emphasis should be placed on improving market liquidity. As an example, at present there is no common understanding amongst EU policymakers of what kind of liquidity is truly available within the EU’s equity markets or where this liquidity is. As a result, and in fear of further loss of market depth, EU law has imposed restrictions on certain types of trading. This has perversely resulted in fewer rather than better choices for investors and has failed to make EU markets attractive to capital, domestically or internationally. Understanding our liquidity landscape and overcoming constraints would produce greater liquidity, thereby attracting more savings, investments and listings of firms with better valuations.
Moreover, for a genuinely single EU capital market, the EU needs to break down barriers to incentivise the creation of pan-European exchanges and post-trading infrastructures fit for the digital era. EU-wide bondmarket liquidity also needs to be carefully monitored and deepened, particularly in government-bond markets.Introducing the type of regulatory and supervisory agility described above can go a long way to facilitating this.
Finally, adjusting the regulatory framework for securitisation is vitally important. Recognition is growing within the EU that securitisation has a key and very legitimate role to play in financing the economy. The European Commission is currently consulting on the functioning of the EU securitisation framework, which is deeply encouraging. And let’s be clear: The reappearance of a vibrant securitisation market in the EU does notmean a return to the pre-Global Financial Crisis (GFC) era of regulation, but rather targeted changes that will allow securitisation to make a useful economic contribution in an economy in which bank lending will continueto play an important role. Indeed, securitisation is the only financial technique that enables indirect market-based financing of small and medium-sized enterprises (SMEs) and allows banks to recycle capital into financing additional lending.
In his September report, Mario Draghi’s (former prime minister of Italy and former president of the European Central Bank) recommendations relating to securitisation echoed those set out by AFME (Association for Financial Markets in Europe) in our paper “EU Securitisation back on track”, in which we outlined the five-point package of reforms we consider necessary. These changes can be made whilst maintaining the safeguards embedded within regulations that are there to prevent the proliferation of opaque products under the banner of securitisation, such as those that originated in the US in the run-up to the Global Financial Crisis.
Firstly, amendments to the banking prudential framework are needed. The current framework lacks risk sensitivity and needs to be brought more into line with the underlying risk levels of the transactions that actually occur in the market.
Secondly, a review of insurance prudential treatment is required in order to revive demand from the insurance sector. Pre-implementation of the Solvency II Directive, the insurance sector was a significant investor in thesecuritisation market, but the current miscalibration of the prudential framework for securitised products has resulted in substantially reduced demand, particularly for those tranches that meet insurers’ risk/return profiles.
Thirdly, an amendment to banks’ liquidity coverage ratios (LCRs) is necessary to enable banks to recognise securitisations in their liquid-asset buffers, in line with the proven liquidity performance of securitisation.
Currently, regulatory due-diligence requirements are a source of disproportionately high costs for institutional investors who would otherwise invest in securitisation. This has resulted in disincentivising investors frompurchasing AAA, AA and single-A tranches of securitisation compared to other asset classes with similar riskprofiles. Amendments to the EU Securitisation Regulation in this area could foster the return of institutional investors to investing in the securitisation market.
Finally, a more tailored approach to disclosure requirements that takes investor needs into account should beadopted. The current regime makes no distinction between private and public transactions, for instance, requiring template disclosures in addition to bespoke information exchanges to be put in place for private transactions.
It is in all our interests to see the return of a highly investible asset class that incentivises EU investors to finance EU economic growth.
Member states need to explore and pursue every possible avenue to secure the healthy growth of the EU’s capital markets at pace. The recognition by EU leaders that a more advanced Capital Markets Union (CMU) is needed to achieve the new competitiveness deal is positive and a welcome tailwind for the EU’s long-term economic prosperity. Sustained focus from leaders will be necessary to realise the broader benefits of a truly integrated EU capital market.