Understanding European Capital Markets

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SME start-up and financing across Europe


Step-by-step plan to lift barriers to SME finance

In the last of the series, Phil Thornton looks at the EU’s initiative to achieve cross-border capital markets union.

Small and medium-sized enterprises (SMEs) are the backbone of Europe’s economy, providing 85 per cent of all new jobs. Since the global financial crisis, however, European businesses and especially SMEs have been caught in a cruel catch-22 trap.

Traditionally more reliant on bank loans than market-based finance compared with their American counterparts, many companies have struggled to access finance as the banks sought to restore their balance sheets to meet tighter regulations brought in following the financial crisis.

Brussels is now looking to bridge the gap with a series of initiatives designed to kickstart lending to SMEs. It’s Competitiveness of Enterprises and Small and Medium-sized Enterprises (COSME) initiative has a budget of over €1.3billion (£940 million) to fund these financial instruments that facilitate access to loans and equity finance for SMEs where market gaps have been identified.

Part of the COSME budget, which runs until 2020, will fund guarantees and counter-guarantees for financial intermediaries, such as banks and leasing companies, to help them provide more loan and lease finance to SMEs. Its most significant intervention was the unveiling of an action plan in September this year to help build a true capital markets union (CMU) across all 28 EU states. The key elements are:

• Legislation to establish a framework for simple, transparent and standardised securitisation

• Changes to the Solvency II rules to make it easier for insurers to invest in infrastructure and European Long Term Investment Funds

• Consultation on whether changes to the venture capital regulations could boost the take-up of these funds

• Review of the Prospectus Directive to reduce barriers to smaller firms listing on markets

• Green Paper on retail financial services to boost consumer choice and competition in cross border retail financial services and insurance

Lord (Jonathan) Hill, the EU Commissioner whose remit includes capital markets union, said in October that CMU was essential to deliver deeper capital markets to complement bank lending and support European growth. “We will look at how to remove barriers to small firms raising money from capital markets, and how we can better connect information on investment opportunities in SMEs to investors the world over,” he said.

Thanks to banking union, European banks have been able to invest cross border, but individuals and small businesses have found national legislation means it is hard to move money between different countries.

Christian Odendahl, chief economist at the Centre for European Reform, gives the example of an investor in London looking to put money in a Czech start-up finding issues such as the prospectus document, tax treatment and insolvency regime are all matters of national competence.

It is exactly these issues that have proved the hardest nuts to crack. Graham Bishop, a former City economist and consultant on EU integration, said: “Other commissioners have already picked the low hanging fruit, so Commissioner Hill has been left with the nettles to grasp.”

He welcomed the move to consult on the various insolvency and restructuring regimes across the EU and come forward with a legislative plan by 2016. “They have to do this because if they don’t, they’re not serious.”

Odendahl agreed. “Most of the steps they plan to take make a lot of sense, such as the modernisation of the prospectus directive to help smaller businesses take part in capital markets, or to revise the regulatory treatment of infrastructure investment,” he said.

Hill faced two choices. Once was to mimic the strategy with banking union when the Commission put the powerful institution of the European Central Bank in charge. However, that would have involved driving through harmonisation of national regulation at a time when member states were struggling to deal with the refugee crisis and negotiations ahead of the UK referendum on EU membership.

The alternative was to take a step-by-step approach to tackling the individual barriers. “There are a lot of constraints holding back a properly unified capital market,” Odendahl said.

“Hill has looked at what are the most binding constraints on cross-border capital flows, and where Europe can achieve the most bang for the buck, given that banking union-type full integration is not on the cards.

“The question is how much we can achieve with small steps in terms of convergence in how we treat capital market products and make sure investors in, say, London have enough confidence in a capital market of another country.”

If the process leads to simpler and better regulation, it could benefit supporters of a yes vote in the referendum. “People who understand capital markets will see that as a good thing,” Odendahl said. “Being successful on an issue like capital markets union is a positive for the ‘In’ campaign. It is certainly not something that the ‘out’ campaign will point to as a bad thing for Britain.”

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Comment & Analysis

Jim Esposito

Global Co-Head of Financing Group

Goldman Sachs

Free markets bring all-round benefits

Today’s institutional capital markets play a central role in allocating funds between investors who provide capital and companies who consume capital. The more efficient and free these markets, the greater the benefits to each side. Greater efficiency means cheaper capital for companies to grow and a broader more diversified array of assets for investors to deploy their capital.

Greater efficiency is driven by greater competition, and companies benefit hugely from being able to choose between accessing the bond and institutional loan markets or their traditional bank. Securitisation can boost traditional lending by enabling new challenger banks and speciality finance platforms, and by providing an additional source of funding and risk sharing to traditional banks.

Substantial reforms have been made to the financial services industry globally, with banks becoming more strongly capitalised. These reforms have impacted credit supply to European borrowers from traditional banks. Institutional capital markets are able to not only replace this source of credit, but they can often represent cheaper options, with fewer restrictions.

Given the recent maturation of the European debt capital markets, companies are increasingly confident that they can complement the traditional banking relationships by accessing the institutional capital markets.

Potentially the most important users of capital in Europe today are those companies that need to invest in growth. Their success can be enhanced by access to diversified sources of capital beyond the traditional commercial banks. Many of these companies, however, are rated below investment grade given their size. Changes in regulation could unlock incremental capital for these companies. Regulatory changes that provide greater freedom to investors, combined with changes to legal frameworks that deal with bankruptcy and insolvency, would help companies and investors alike.

Take infrastructure, a sector that provides benefits to towns, cities and national economies. The increased focus on levels of public debt across Europe meant that investment in infrastructure has suffered. This is often considered one reason for the reduced long term growth rate. Broader institutional investment can provide an effective solution by supplementing both public institutions and traditional commercial banking in this critical sector.

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