Europe needs a better and more complete capital market set-up, according to the European Central Bank (ECB).
In its analysis ‘Europe needs to think bigger to build its capital markets union’, the bank says the key is the creation of an “integrated European capital market”. Fabio Panetta, a member of the ECB’s executive board, argues this capital market union (CMU) would both enhance Europe’s economic structure and benefit the continent in three ways.
“It would allow us to reap the benefits of euro area-wide capital markets and facilitate greater risk-sharing across member countries,” he said. “At present, barriers between national markets are deterring cross-border investment, leaving European firms and households largely reliant on national funding, as well as overly exposed to domestic economic shocks. By eliminating these barriers, the CMU would help investment flow across the euro area, which would diversify risk and mitigate the effects of local shocks.”
Panetta added: “There is also a pressing need for the CMU to complement traditional banking channels in financing the innovation vital for Europe’s future growth – notably in the energy and technology sectors. Equity funding and specialised forms of investment, such as venture capital, are typically more suitable than debt funding for the financing of innovation, since such projects often involve high levels of risk and uncertain returns, making it difficult to commit to regular debt repayments.
He also suggested a fully functioning CMU would be beneficial for the implementation of the ECB’s monetary policy, adding: “By fostering deep, liquid and integrated capital markets, the CMU would support the timely, smooth and even transmission of monetary policy to firms and households.”
Further harmonisation
Panetta, who has been a member of the ECB’s executive board since 2020, said the European Commission’s CMU action plan was launched in 2015, with some progress made, including the adoption of legislation to develop securitisation markets on the continent. He also pointed to further harmonisation of prudential rules for investment firms, and eased investment conditions for European venture capital to promote risk capital funding.
The results were still not satisfactory, however, he argued, noting: “Europe’s capital market remains fragmented across national borders, and ECB analysis shows that financial integration in Europe is still much lower than before the global financial crisis.
“Moreover, Europe’s capital markets are less developed than those of other advanced economies. In the euro area, bond markets as a percentage of GDP are three times smaller than in the US. And although equity represents firms’ main source of funding in both jurisdictions, in the euro area it is mainly unlisted, while in the US, most equity is listed, opening firms up to a greater pool of potential investors.”
Potential blindspots
Panetta, who also published his piece in Politico, argued that Europe still had a prominent role in sectors such as the green bond market, even if this advantage may fade as the market develops. He also warned of other blindspots, including the lack of a permanent European safe asset equivalent to the US’s federal bonds.
“A risk-free benchmark is necessary for critical financial activities,” he argued. “It would enable better pricing of risky financial products, such as corporate bonds or derivatives, encouraging the development of such products. It would provide a common form of collateral that would promote centralised clearing activity and cross-border collateralised trading in interbank markets. It would also help diversify bank and non-bank exposure. And it would support the euro’s international role, helping to attract foreign investors.
“Establishing such a permanent European safe asset would be a game-changer, but it hinges on Europe having a standing fiscal capacity with a borrowing function. Without that, building a deep and competitive CMU will prove much more difficult.”
Another blindspot Panetta identified was the lack of a complete banking union, which “restricts European banks to a limited number of markets”. He added: “Banks play a crucial role in the functioning of all major capital markets. They operate — and often have a leading role — in crucial segments like asset management, bond underwriting and trading, initial public offerings and financial advice.
“They are active traders in securities markets and often provide market-making services. Thus, it is difficult to envisage a genuine CMU without the key players being able to operate throughout the euro area. The global landscape is evolving rapidly and Europe must keep pace, if not lead, that change. To be successful, it needs a genuine – and complete – CMU.”
