It is over 50 years since the Treaty of Rome enshrined the free movement of capital across what was then the European Economic Community and is now the EU but the capital markets union (CMU) initiative has been revived with the publication of an EU Commission Green Paper in February on building a CMU.

You would be forgiven for thinking that the revival of the CMU initiative seems at odds with the preoccupation with consumer protection and tidal wave of financial services regulation that have characterised the years that followed the economic crisis of 2008. Let us not also forget the fact that the financial transaction tax has won the backing of the European Commission.

Despite these mixed signals, it is clear that the new European Commission’s priorities for the financial system have changed. Its predecessor’s focus was on creating stability but now that our financial system is now widely believed to be more stable the focus has shifted to the current threat posed by the 24 million unemployed Europeans and the lack of growth afflicting the EU.

Lord Hill, the EU Commissioner for Financial Stability, Services and the Capital Markets Union, speaking at a conference in London in late May 2015 acknowledged that these issues have created a very pressing need to make progress towards a CMU. He also indicated that a new more developed approach to regulation was needed and said that we would see less legislation in the financial services market.

What is a CMU?

The free movement of capital across the EU. According to the European Commission, the principle goal of the CMU is “to create deeper and more integrated capital markets in the 28 Member States”. Capital markets are of course the markets for non-bank financing.

Why do we need a CMU?

In the UK and across the EU, companies are heavily reliant on bank finance. Figures suggest that around 70-80% of companies in the EU use bank finance and 20-30% use equity finance. In the US, the inverse is true.

The financial crisis of 2008 highlighted the risk of such reliance and the need to strengthen its capital markets as the years that followed the crisis saw the amount of bank finance made available, especially to SMEs, severely reduced with pretty serious consequences for many businesses (which were lacking working capital and investment) and the effects of this were felt across the rest of the economy. The level of private funding to venture capital in the EU is lower now than it was pre-crisis.

Broadly, the EU needs to strengthen its capital markets by diversifying the sources of capital available to companies on the demand side and creating greater opportunities for the providers of capital to put that capital to work on the supply side.

What does the CMU mean for fund managers?

For EIS fund managers, the renewal of the CMU initiative, if successful, should introduce a single and simplified regime, which will enable venture capital funds to raise capital across the EU to invest in European SMEs and infrastructure more easily.

Following the success of UCITs, which prove that it is possible to create successful and competitive retail products while also providing the appropriate level of consumer protection, the ELTIFs and EUVECA regimes introduce alternatives to the relatively draconian AIFMD regime and provide for marketing and management passports for private equity managers, which allow for the marketing of these products to retail investors.

Challenges

How a CMU will be achieved is still being worked out but it is clear that a CMU will not be brought about simply or quickly. In fact it is likely to take many years.

One of the key challenges we face is the fragmentation across Europe. With 28 Members States, 23 languages and 28 different regulatory regimes, it was never going to be easy to achieve an ambitious goal like the CMU. However, all Member States seem to be committed to the CMU, which is a good start.

Another issue is the attitudes of European households. As a general rule, European households are relatively cautious investors, especially compared to their American counterparts, and largely invest in insurance, pension funds and deposits. The willingness of European investors to invest in equity appears to be lacking so there is a need to change attitudes and educate European investors about other financial products but it is also up to the industry to deliver better products.

Next steps

The Commission has identified the following priorities:

1. reviewing the Prospectus Directive;
2. reviving securitisation (which acquired a nasty reputation during the financial crisis but is an incredibly useful financial practice if practiced the right way);
3. developing the private placement market;
4. supporting the new long-term investment funds to encourage investment into infrastructure and other long-term projects; and
5. improving the availability of credit information on SMEs so that investors can invest in SMEs more easily.

We are expecting Lord Hill to publish an action plan for the CMU in September but of course a lot can happen between now and then. In particular, a ‘Grexit’ would likely be calamitous for the CMU initiative.