Anneliese Dodds MEP

The South East's Voice in Europe

Three tests for the capital markets union


I was elected as a new MEP in May this year. When I campaigned for that election, it was as part of a Labour Party calling for five things from the European financial system.

That financial system should be:

1 ) Competitive
2 ) Safe
3 ) Stable
4 ) Efficient
5 ) And effective.

We have all seen what happens when the financial system is not characterised by those virtues.

Tonight, however, we are looking forward, and much of the talk is about the subject of this event - so-called ´capital markets union´.

This is the interesting proposal, trailed by President Juncker when taking up his office, for greater integration of capital markets across the EU. This could, in theory, make the European financial system more competitive, efficient and effective. But in my opinion it also carries with it significant risk if it is not introduced properly.

While we wait for additional information on how exactly the proposed capital markets union would operate, I would like tonight to share with you the three tests that I will be applying to any proposal that comes forward, and that I would like to see my Parliamentary colleagues apply too.

First, capital markets union must contribute to growth and stability in the real economy.

It is true that Europe, in contrast with other parts of the world, may have been too reliant on the banking sector, with companies in Europe having relied on bank loans for roughly 80% of their debt funding over the last decade. We have seen the impact of that concentration, with bank lending to companies down by over a third since 2008.

Capital markets could present an alternative, but I think we must be wary of assuming that they can wave a magic wand which will immediately solve all issues with financing the real economy. First, building up capital markets takes time. Long-term pools of capital are required, which generally rely on micro-processes, like the take up of pensions, which are very lengthy. It took the UK three decades, for example, to move from a situation where pension assets were a fifth of GDP to one where they were four fifths of GDP. And once these capital funds are in place, we need to ensure that they are genuinely invested in the long-term (in businesses and in infrastructure) and not just incentivising more high-risk, short-term investments. The other Brits in the room will appreciate that these issues are close to my heart, given that I have a USS pension from my previous employer! With interest rates at historic lows, pressures to return high yields are if anything even more keenly felt at the moment.

So, we need to get the incentives right, both at an individual level (to take up pensions in the first place), and at an institutional level (to invest in the real economy, and not in high-risk, short term activity).

Second, capital markets union has to help small and medium-sized enterprises.

It is true that the promise of capital markets union for SMEs may have been over-egged; perhaps the greatest impact would be on opening up bank lending by providing alternative financing opportunities for larger companies. Nonetheless, the US comparison is interesting. Capital markets for SMEs in Europe are five times shallower than in the United States- which does at least suggest there is the potential for growth.

We should be thinking about how SMEs can make better use of peer to peer lending, plus flotation and other forms of equity finance. We can also consider sexier, if less well-evidenced, approaches like crowd funding and social investment bonds. Above all, however, the cost-benefit analysis for SMEs must be appropriate. Similar reporting structures across Europe may help cross-border investment, for example, but new opportunities will not be made use of by SMEs if they require a radical overhaul of their existing reporting systems. It should not be the case that only large companies with significant economies of scale can access the finance that they need. We need to make new sources of finance genuinely open to SMEs.

Thirdly, however, and most importantly, any capital markets union must be appropriately regulated.

Despite considerable talk about the volume of financial regulation that has been put into place within Europe over the last few years, a number of unresolved issues remain. Indeed, the experiences of the last six years have indicated that 'light touch' does not work, and that much remains still to be done.

Personally, I am not sure that the term 'shadow banking' is always helpful, since it suggests an activity that is always undesirable. The fact remains, however, that much non-bank lending is opaque to an extent that threatens both stability and efficiency at the same time. Regulation is required in this arena, just as has been put in place in banking, to ensure that lending benefits the real economy and does not result in high-risk, speculative activity which may have a significant, and systemic, impact if incorrectly controlled.

In summary, those are the three tests I propose to apply as we begin to understand more about what is meant by the proponents of capital markets union. Asking these questions will ensure that any such union contributes to:

1 ) Stimulating growth, and creating jobs
2 ) Helping SMEs to grow and prosper
3 ) And genuinely improving the lives of and opportunities for people across Europe, especially the five million unemployed young people in Europe - in a way that does not put their futures at risk.

This post is adapted from a speech given to the AFME Finance for Europe / ICMA Event on 'capital markets union' 30th September 2014.


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