Home Contributors Supporting the EU’s Recovery Through Capital Markets

Supporting the EU’s Recovery Through Capital Markets

by Prashant

By Pablo Portugal, Managing Director of Advocacy, the Association for Financial Markets in Europe (AFME)

Following the hard-hitting impact of the coronavirus lockdown, the EU has entered the deepest economic recession in its history with severe socio-economic consequences. The European Commission (EC) has forecast that the euro area economy will shrink by 7.75 percent this year. The depth of the recession and the strength of the recovery will be uneven across the European Union (EU). During this difficult period, the effectiveness of the recovery will be shaped by how well the banking sector, capital markets and authorities can work together to support European businesses.

When EU countries emerge from the COVID-19 crisis, it is expected that they will have to shoulder higher levels of debt as a result of the support provided to entire sectors closing down and businesses furloughing staff under the lockdown restrictions. Although European banks have high levels of quality resources and the liquidity to fund companies, a robust and sustainable post-pandemic recovery cannot solely rely on bank funding. It is important to mobilise the range of options in the single market and the investment capacity available across Europe. Therefore, now more than ever, Europe needs to promote market-based finance.

Helping small businesses and households get back on their feet

In this respect, equity finance should be especially important in supporting the EU’s recovery. Funding via initial public offerings (IPOs), private equity and venture capital are going to be crucial vehicles for businesses to raise capital quickly. Corporates and SMEs (small and medium-sized enterprises), particularly those looking to invest in new technology or hire staff for rapid expansion or even re-finance existing loans post-pandemic, will require affordable funding to facilitate their future growth. Equity is well-suited to this as it can be raised from a diversity of investors even amid volatile market conditions. Businesses with high-growth potential will be the backbone of the future economy, and supporting them will be key to the post-pandemic recovery.

There is significant room for growing Europe’s equity markets. In 2019, European exchanges saw 106 companies go public, while over the same period, the United States saw 196 IPOs. Improving and converging essential regulatory requirements governing the IPO process could help to reduce the costs and execution risks of IPOs and widen the pool of interested investors across Europe. Another crucial aspect is providing appropriate incentives for investment in unlisted equity or SME growth markets. Well-designed investment vehicles and tax reliefs could, for example, be powerful tools to promote equity markets and channel capital to high-growth businesses.

Encouraging more retail-investor participation in EU capital markets is one of the keys to unlocking the true potential of the Capital Markets Union (CMU) and delivering direct value to citizens and the economy. A large part of the wealth of European households is placed in cash deposits with currently negative real returns. A stronger equity culture across Europe could significantly increase the pool of investible capital for businesses while delivering returns for private, individual investors.

Changes to retail-investment practices require work at the EU and national levels over a longer period, given the interaction with national pension systems, tax systems and other arrangements. The introduction of automatic enrolment in workplace pension schemes and the development of tax-efficient investment-savings accounts could be two initiatives with great potential for the development of capital markets in some countries.

Another way to support European businesses is to foster a well-functioning securitisation market. Bank loans will continue to be the primary funding tool for many businesses and households. Securitisation can help to support funding for companies in a tight-credit environment by enabling banks to free up capital needed to lend to SMEs, corporates and households. A sound framework for so-called “synthetic securitisation” will be especially helpful to the securitisation of large and midcap corporate, consumer and SME loans, which are capital intensive when held on balance sheets.

Yet, despite the adoption of a new European framework for simple, transparent and standardised securitisation, over the past year, growth in the market has been stagnant. This can be attributed in part to a regulatory treatment that remains excessively complex and conservative for issuers and investors, particularly when compared to other fixed income instruments. Reviewing this framework would help to expand the pool of investors and facilitate bank balance-sheet management.

Promoting efficient, competitive securities markets in a global landscape

The effectiveness of the securities market structure is vital to supporting liquid and cost-effective capital markets to service investors, businesses and households. It is important to encourage competition and choice in the provision of secondary-market services and to achieve a high degree of harmonisation in access requirements and market practices. Such harmonisation reduces complexity and maximises opportunities in the single market for all participants.

Key European legislations such as MiFID 2/R (Markets in Financial Instruments Directive 2/R) should be reviewed with a view to improving investor outcomes. This requires a focus on market-structure efficiency and well-calibrated transparency regimes that support liquidity and market confidence. Addressing inefficiencies in equities-trading regulations, such as the share-trading obligation and the double volume caps, and establishing a better differentiation in regimes relating to professional and retail investors would advance these objectives.

Promoting open, competitive and globally connected capital markets will be all the more critical in the context of the United Kingdom’s departure from the EU. Brexit reinforces the need to increase the size and capacity of EU capital markets while maintaining access to global capital pools and funding opportunities.

Looking towards a green recovery

In addition to ensuring that Europe remains economically competitive and resilient, we must also ensure its recovery is sustainable. There are growing calls for a “green” recovery—one that accelerates progress towards a sustainable and climate-neutral economy. The COVID-19 pandemic has shown what is possible globally with CO2 (carbon dioxide) levels already dramatically reduced. As businesses transition back to normalcy, it can be expected that there will be greater scrutiny on how organisations are being environmentally as well as socially responsible. The EU taxonomy for the classification of sustainable economic activities will be a central framework to help direct capital towards sustainable activities and prevent misleading claims on the environmental nature of an investment product.

Additionally, the pandemic has also demonstrated a need to focus more on the social aspects of sustainability, including better defining the parameters of an investment directed towards specific societal needs. This could mean, for example, investments supporting sectors with positive social externalities such as healthcare or education. Recent EU legislation already provides a foundation for setting criteria around socially oriented investments. The crisis represents an opportunity to accelerate work in this area.

As Europe navigates one of its greatest ever challenges, it cannot afford to neglect how vital capital markets will be in aiding its recovery and supporting sustainable long-term growth. Later this year the European Commission is expected to unveil its priorities for the next phase of the Capital Markets Union, a long-term project intended to unlock funding in Europe. The economic impact of COVID-19 has reinforced the urgency of this project in every area. A deeper and more integrated single market for capital could be a true engine to help Europe capitalise on its strengths and build a prosperous and more sustainable economy in years to come.

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