Industry and regulatory focus on the European Union’s Capital Markets Union ramped up several notches this month with the publication of Mario Draghi's highly anticipated report on Europe's competitiveness, as well as papers from FIA and FIA European Principal Traders Association, among others.
In a report that will influence the European Commission’s next five-year policy agenda, Draghi, the former European Central Bank President, said the EU must raise an additional €800 billion per year in investment – equivalent to 5% of the bloc’s GDP – if it wants to keep pace economically with the US and China and meet its key competition and climate targets.
Without extra investment, the EU will have to "scale back some, if not all, of its ambitions" and be left behind, Draghi warned.
The report offers a diagnosis of the ills afflicting Europe's economy – from high energy costs and fragmentation to over-regulation and inappropriate regulation.
At nearly 400 pages long it proposes a wide range of “horizontal” recommendations to create the right conditions to stimulate flows of private finance and close investment gaps, alongside actions to address sector-specific issues, including the energy sector.
At the heart of the report is a demand for massive private and public investment, the like of which has not been seen in Europe since the 1970s. Draghi, who is credited with bringing the eurozone back from the brink at the height of the Greek debt crisis in 2011, said there was no option but to push through dramatic reforms.
Key recommendations for financial markets
His report calls for building out the EU’s Capital Markets Union as a major source of funding for the EU’s political priorities and follows papers from several EU political figures this year, including former Italian prime minister Enrico Letta and ex-governor of the Banque de France Christian Noyer, which advocated for the Capital Markets Union to be a top priority for the next Commission.
On steps to help mobilise private finance, Draghi’s report recommends transitioning the European Securities and Markets Authority from a coordinator of national regulators into a single regulator for all EU securities markets – similar to the US Securities and Exchange Commission.
For this purpose, ESMA should be entrusted with exclusive supervision over nonbanks, including large multinational issuers, major regulated markets with trading platforms in various jurisdictions and CCPs.
Amendments to ESMA’s role and governance structure will be critical to achieving the objectives of the CMU, Draghi said, arguing that governance and decision-making processes should be removed as much as possible from the interests of EU member states in a similar model to that of the ECB Governing Council.
“Turning national security market regulators into subsidiaries of a single, EU-wide one will face fierce resistance, not only by the national bureaucracies that will feel directly displaced but also by trading platforms and market participants who draw sizeable rents from the status-quo fragmentation,” Draghi said.
The report also proposes that the EU should ultimately have a single clearinghouse and a single central securities depository for all securities trades. Consolidation of clearinghouses and CSDs should start with the largest players, with smaller ones joining afterward, the report says.
This is likely to prove unpopular and is not the first time the idea of a single clearinghouse has been floated. The Giovannini Group, a group of financial market experts that advised the European Commission on the EU's capital markets, published two reports on clearing and settlement in 2001 and 2003, recommending the Commission coordinate consolidation of the different post-trading infrastructure providers in the EU.
On banking, the report questions whether the EU will actually roll out global bank capital rules known as the Basel III package, referring to the “possible upcoming implementation” of the rules and calling for an EU rethink into whether current prudential rules are “adequate” to have a globally competitive banking system.
The EU has already delayed part of the rules after the US delayed its rollout, but a delay or cancellation for the full package would be a significant change.
The report pitches a “separate jurisdiction” commonly referred to as a “28th regime” for big, cross-border banks, which would have the same regulatory, supervisory and crisis management rules. It also recommends harmonising insolvency rules in the EU and removing tax-related obstacles to cross-border investing – two areas, which along with single supervision for nonbanks, are the most political elements of fostering the CMU.
Energy markets
Drilling down to the energy sector, the report argues for an overhaul of the markets, saying a significant gap exists between Europe’s energy price levels and those of its trade partners. Included in Draghi’s proposals are measures to limit “the possibility of speculative behaviour”.
In particular, Draghi pitches the creation of a coordination body between the EU Agency for Cooperation of Energy Regulators (ACER) and ESMA to supervise the energy and energy derivatives markets with both investigative and policy powers focused on anti-competitive conduct.
The report calls for a review of the ancillary activities exemption, which allows non-financial firms to trade commodity derivatives without needing to be authorised as an investment firm, to increase transparency, and a requirement for all market participants to report their trade and positions to EU regulators.
It also recommends giving EU authorities powers to set financial position limits and price limits for normal trading, and dynamic price caps during crises, particularly when the bloc’s prices diverge significantly from global prices.
Derivatives and the CMU
In its paper on the Capital Markets Union, published in early September, FIA strongly recommends against the use of controls to cap prices, saying that “if improperly implemented and calibrated, these tools can be damaging to the market and the wider financial system”.
A proportionate regime for commodity markets should be considered and maintained to preserve liquidity and diversity in the marketplace, the FIA paper says.
Published a few days before Draghi’s report, FIA’s paper outlines the association’s views on how to support the progress of the Capital Markets Union.
It says the keys to a successful implementation include the simplification of the EU regulatory framework from excessive red tape and overlapping requirements, the reduction of restrictions on access to clearing services across borders and the harmonisation of certain aspects of non-bank insolvency laws in the EU.
Ultimately, the FIA paper sets out the role that derivatives play in effective capital markets.
“As the EU advances on the CMU, it should work towards and promote an open, competitive, pragmatic, predictable, safe, well-regulated and fair marketplace for domestic and international financial institutions alike,” the paper says.
“Any measure by the EU that falls significantly out of step with other major relevant non-EU markets will risk causing a fragmentation of liquidity, which hampers the ability of end users to manage the risks associated with their exposures as part of their legitimate hedging strategies.
“Well-designed cross-border regulation will contribute to the success of the CMU, as will the participation of international institutions.”
Unlocking liquidity
Another paper published at the same time by FIA EPTA makes several policy recommendations while prioritising strong liquidity provision as the basis of competitive European capital markets.
The association, which represents Europe's largest principal trading firms, makes recommendations that call for the strengthening of the EU single market for capital through enhanced supervisory convergence and more centralised supervision.
It also proposes measures to enhance the attractiveness and global competitiveness of EU markets by establishing clear objectives centred on competitiveness supported by a framework of simplified regulation and the unlocking of EU capital market liquidity by implementing targeted regulatory reforms.
The reforms should focus on increasing market transparency and introducing more proportionate prudential rules to create a balanced regulatory environment, the association said.
Other papers published this month include the European Parliament’s briefing on One Money, One Financial Market – The Capital Markets Union.
“Bringing all European financial markets under one roof, the Capital Markets Union stands to provide European savers and borrowers with better opportunities. This, in turn, is expected to boost long-term growth and to improve the functioning of the Economic and Monetary Union. Yet, powerful private and public interest groups have been able so far to stand in the way of this transformation,” the report says.
These powerful groups include market participants who have developed longstanding relationships with their national authorities, the national authorities themselves, who would lose their powers in the CMU, and foreign financial markets, which attract the businesses of European savers and borrowers, the European Parliament’s report says.
“Most governments are torn between the benefits from the CMU and the pressure of these interest groups,” the report continues.
“In the end, the creation of the CMU rests on ending a vicious circle where private interests block public actions and the preservation of public administration interests mute decisions likely to shape private interests.”
Reports
Mario Draghi’s report on Europe’s competitiveness can be found here.
A shorter version of the Draghi report can be found here and a digest version here.
FIA’s paper on supporting the progress of the Capital Markets Union is here.
FIA EPTA’s paper on enhancing liquidity provision is here.
The European Parliament's CMU briefing is here.
