Article
Banner headlines in May announced a major milestone towards the creation of an EU Capital Markets Union – unfortunately it is little more than a statement of intent
The reality not being said about the Capital Markets Union is that development will take years to complete even the small steps outlined shows both how unsuited the processes of the European Union are to enable change, and how woeful has been the progress towards delivering on what was promised from the introduction of the euro.
Member states that joined the euro ceded the levers of monetary policy and financial independence to EU-level authorities (in this case the European Central Bank) in exchange for benefits that have not materialised.
The member states cannot ask for their money back, though, as it is impossible to leave the euro.
Message manipulation
Euronews’ version, available here, was typical of the way in which events were reported:
The press reports might make one conclude that the six biggest EU member states had agreed to merge their capital markets, and that this would trigger the unification into that market of the remaining 19 member states, and into a market in which market forces were given their head.
In fact all these six member states have done is to send a letter to the European Commission pressing the point that a Capital Markets Union is desirable.
Main action demanded
The main action the six member states proposed to bring about this union is a transfer of powers to the European Securities Markets Authority (ESMA) from national financial regulators. This mirrors the transfer of powers from a member state’s national central bank to the European Central Bank when it adopts the euro.
Indeed it is correct that the landscape of the monetary authorities in the EU consists of a mosaic of emerging EU-level bodies and pre-existing but emasculated member state-level bodies. The intention is to bring ESMA gradually towards having the same role and status as the US’ Securities and Exchange Commission (SEC).
Even bigger change required
Strangely the real quantum leap towards emulating the SEC is not mentioned. This is moving from a mindset whereby capital markets exist for the protection of borrowers, rather than of investors. The current overarching concern of EU authorities is to preserve the market for the issuance of debt by member states, EU-level supranationals, and other public bodies.
This concern for debt markets, and for public issuers, is why the public credit rating agencies have to be licensed, so that only they can issue public credit ratings (which apply to debt instruments and not to equity instruments) – and so that the ratings be correct in the EU’s view.
Ratings obscure the lack of a risk-free investment and of sovereign borrowers
The ratings obscure that there cannot be a risk-free investment in euro because there is no sovereign borrower in the Eurozone: an obligation of a nation state in its own currency of which it is the sole user, and over which it controls the main levers of monetary policy: foreign exchange rate, interest rate, and money supply.
Control of those levers has been surrendered to the European Central Bank by member states.
Several nations use the euro in parallel, without any one having the dominant voice.
EU supranationals are not sovereigns either, because they do not have the ‘full faith and credit’ backing of a constituency of individuals and businesses that are responsible for their debts. EU supranationals are backed, one way or another, by the member states – who are themselves not sovereigns.
The ratings of Eurozone public borrowers do not recognise these shortfalls, which means that Eurozone public borrowers are systemically over-rated making them less creditworthy than they appear.
Short-selling
The ban on short-selling is a key indicator that the EU financial market is tilted in favour of borrowers, to the detriment of investors. The aim is to protect the access of public borrowers to new money on terms acceptable to the borrowers, even if the borrowers’ creditworthiness does not merit those terms.
Taken together with the inflated public credit ratings, the ban on short-selling enables a gap to emerge between the terms commanded by borrowers in Eurozone capital markets, and the terms they intrinsically merit.
The letter to the European Commission comes from borrower countries who benefit from this anomaly so, naturally, it contains neither a recognition of the anomaly nor a requirement that it be eliminated in order to achieve a fully transparent capital market.
The importance of allowing full rein to market forces is not recognised as a key component of a capital market.
Product offering
It follows there is no recognition of how truncated a capital market in terms of one offering the euro is at present, compared to what was originally promised.
The promises of the euro in 1996-98 portended “a unified, deep, and liquid capital market with a choice for investors of risk/return options right along the maturity spectrum’”.
That would embrace any and all of the listable financial instruments that can appear on the liabilities side of a balance sheet: secured debt (backed by credit card receivables, mortgage loans, car loans etc), senior unsecured debt, equity, preference shares, convertible debt, subordinated debt, mezzanine debt, and any variations thereupon, and with fixed interest, floating interest, zero-coupon, step-up, step-down…
All that has been achieved is a market for fixed-interest, unsecured public sector debt: member states, state agencies, national-level public sector entities, the European Union itself for NextGenerationEU, bailout funds like the European Stability Mechanism (ESM), and the European Investment Bank (EIB). That is quite different from the promise.
Then you have the plastic ‘private sector’ borrowers under the InvestEU programme, where European Investment Bank (EIB)/European Investment Fund (EIF) are taking the highest risk, and unloading most of it back on the European Union.
Process – several years
The hyperbolic headlines mask that the news is simply that there is a letter from some member states asking that the Capital Markets Union be accelerated – by the European Commission. The European Commission is the EU government, which cannot be sacked by EU voters but only by the European Parliament.
The letter will translate – at best – into some prescriptive legislation passed in 2028 with a first live date of 2030 and an implementation/transition period of five years until full compliance…and compliance will only be steps towards what the US Securities and Exchange Commission already does.
No doubt what is proposed in the letter will need to be compromised upon and watered down in some way in order to get the proposals approved in the European Council, that being the ultimate decision-making body, composed of the member states.
Voting thresholds
The fact that the senders of the letter are the six largest EU member states does not mean that they are in a position to force the legislation through.
The vote for such legislation in the European Council is by a Qualified Majority Voting (QMV) system in which there are two thresholds for the amount of support that the legislation must receive.
Firstly it must be supported by member states representing 65 per cent of the population of the European Union. On this measure the six signatories of the letter should be enough.
However, the other measure is that 55 per cent of the 27 member states need to support it. Under that measure the six need to enlist the support of a further nine member states, to reach 15 out of 27. That is where the compromises and watering-down come in.
These are the thresholds in the ‘standard’ system of QMV. Anything radical invokes the ‘reinforced’ system of QMV: it then requires the support of 72 per cent of member states constituting 72 per cent of the EU’s population.
The QMV system facilitates the taking of only non-radical steps, even where the situation requires radical steps.
Conclusions
The announcements that a Capital Markets Union is now just around the corner are, therefore, well away from reality.
Increasing the powers of the regulator ESMA will do nothing to eliminate the main barriers towards a fully-transparent capital market. These barriers are (i) the prioritisation of the interests of borrowers over investors; (ii) the over-rating of Eurozone public borrowers which fails to reflect the transfer of control over the levers of monetary policy away from member states to the ECB; (iii) the lack of freedom permitted to public credit rating agencies to rate EU public borrowers in line with borrowers’ lack of sovereignty and/or lack of direct ‘full faith and credit’ backing; (iv) the ban on short-selling; and (v) the lack of priority given to equity and quasi-equity instruments compared to debt instruments.
Upending all of that would be a radical change, and ought to be in the letter if its signatories were interested in a transparent capital market within which market forces were given full sway.
But the EU’s Qualified Majority Voting is a barrier to any of that happening, and these member states probably would not want it happening anyway, because their own debts would become more expensive.
