A focus on market outcomes: reforming EU financial regulation

Capital markets in the EU are only 2% bigger relative to GDP today than they were in 2014, the year before the EU’s capital markets union initiative was first launched.  This report measures the size, depth, and growth of EU capital markets over the last 10 years and explores the extent to which the EU’s regulatory framework for banking, finance, and capital markets may have contributed to the lack of development.

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A focus on market outcomes

A decade after the launch of capital markets union (CMU), EU capital markets are back where they started. The value of activity relative to GDP has shrunk in more than half of the sectors that we have been tracking over the past decade. The surge in political commitment over the past few years to building bigger and better capital markets across Europe has so far not translated into a significant shift in market outcomes.

There are many political, cultural, and structural reasons for this lack of progress. This report focuses on the role that the increasingly complex EU regulatory framework for banking, finance, and capital markets may have played in acting as a drag on growth, competition, and innovation. Since the financial crisis, the financial services industry has (with good reason) been subject to extensive regulatory reform. But the increased volume and complexity of regulation in the EU has reached a point at which the overall burden of regulation imposes significant direct costs and - more importantly - indirect costs on market activity and the wider economy.

Complexity is a feature not a bug of the EU framework, and it is added into the rulebook at every stage of the process by member states, EU authorities, and the industry. The result is a rulebook that runs to over 1,600 separate documents, more than 95,000 pages, and over 38 million words.

The starting point for this report is that capital markets can bring many benefits to the European economy and its citizens in terms of investment, jobs, and prosperity. At a time when the European economy needs all the help it can get, capital markets can play a vital role in supporting growth and have a direct impact on the EU’s competitiveness. Without more active and more dynamic capital markets, securing the EU’s competitiveness will be very difficult.

Here is a 10-point summary of the report

1. The benefits of capital markets: a more dynamic banking, finance, and capital markets industry is a vital ingredient in driving growth and competitiveness in the EU by enabling more in investment in jobs, innovation, and infrastructure and supporting the long-term prosperity of hundreds of millions of citizens.

   
   

2. Running out of steam: 10 years after the launch of CMU, EU capital markets are back where they started. On average across 25 sectors of activity, EU capital markets are just 2% bigger relative to GDP than they were in 2014. Activity has shrunk in more than half of these sectors, and progress has been propped up by an outsize growth in just a few select sectors (such as venture capital investment).

   
   

3. Rethinking the regulatory framework: the extensive regulatory reform of financial services since the financial crisis has made the system stronger and more resilient but has reached a point where the scale and complexity of the regulatory framework is acting as a drag on growth. There is a strong case for simplifying the framework without undermining the core tenets of financial stability, consumer protection, and market integrity. In some cases, there is a case for reforming some of the substance of regulation.

   
   

4. The next 10 years: if the EU is to avoid another lost decade in capital markets, member states and EU authorities will need to engage on what they are trying to achieve, focus on a small number of priorities, and embrace some of the trade-offs and difficult political decisions involved.

   
   

5. A reason for optimism? The good news is that the recent political focus on how capital markets can help support the European economy and drive its competitiveness as well as the European Commission’s new term can help inject more urgency into building bigger and better capital markets in the EU. The new savings and investments union (SIU) initiative is an opportunity to drive concrete change.

   
   

6. A standout sector: the flatlining in the depth of EU capital markets disguises the fact that some key sectors have seen significant growth. Venture capital investment in the EU has nearly quadrupled relative to GDP over the past decade, and there has been significant growth in asset management and investment funds in the EU.

   
   

7. A standout market: Sweden remains the standout market with capital markets that are more than twice as big relative to GDP as the EU average (and three times deeper than in Germany). Its deep pools of long-term capital, high retail participation, and vibrant venture capital and equity markets demonstrate what individual countries can achieve within the EU framework.

   
   

8. Going backwards: at the same time, activity across the EU in key areas such as equity markets, corporate bond markets, and securitisation has shrunk relative to GDP over the past decade. Two of the key aims of CMU were to diversify the financing options for companies in the EU and to encourage a shift from bank savings to investment - but this is happening too slowly or not happening at all.

   
   

9. The competitiveness of the EU: capital markets in the EU are not keeping up with other economies in financing and supporting their own economy. In almost all sectors of the capital markets, the EU’s market share of global activity has declined in recent years. There is not enough long-term capital to meet the investment needs of the EU, and EU capital markets are not really catching up with the US or UK.

   
   

10. A renewed commitment: this report does not outline a detailed policy agenda but instead paints a vision of how the EU and member states can work together to deliver concrete change in simplifying the regulatory framework and driving growth: from the top down, with the EU focusing on a small number of focused, high-impact, and achievable initiatives (while avoiding blind alleys). And from the bottom up, with more member states taking more responsibility for developing their own capital markets at a national level.