The European Union is founded on four freedoms: the free movement of people, goods, services and capital. While some meaningful barriers remain to each of these freedoms, capital is the most constrained.

How Europe can proceed towards a viable capital markets union was the subject of a roundtable hosted by OMFIF for the launch of Can Europe Survive?, a new book by David Marsh. While most participants agreed on the desirability of the CMU, they identified trust among European Union member states as the most serious constraint on its advancement.

The promise of integration

The CMU promises lower costs of borrowing for governments and businesses alike, higher rates of return on capital, enhanced risk-sharing resulting in a more resilient banking system, greater productivity and a richer, more prosperous and innovative society. Such far-reaching benefits entail multifarious policy initiatives, with components including financial market infrastructure, corporate reporting, banking supervision and the creation of a true euro-denominated reserve asset, all with a view to developing deep and liquid capital markets in the EU.

While progress has advanced slowly, there have been some notable successes over the past decade. The EU now leads the world in the synthetic securitisation market, where assets remain on the balance sheet of the originator but credit risk is synthetically transferred through a contingent derivative (such as a credit-linked note), deepening European capital markets.

The Next Generation EU fund established an EU-level yield curve, paving the way towards the creation of a homogeneous and liquid pool of euro-denominated safe assets. NGEU created a framework for up to €750bn in long-term debt issued at the European level, to finance loans and grants to support recovery from the Covid-19 pandemic. The Single Supervisory Mechanism, under which the European Central Bank supervises 114 ‘significant’ banking institutions in the Union, lays the groundwork for the banking union that would undergird the CMU.

Looking ahead, the forthcoming European Single Access Point database will centralise corporate financial and sustainability information, enhancing intra-union corporate transparency. The announcement of increased consolidation of supervision of ‘data and information service providers’, such as exchanges, by the European Securities and Markets Authority is also a step forward.

Challenges persist

Despite these modest successes, the CMU remains mired in disputes that pit national capitals against one another. A project with such sweeping domestic and international policy implications is inevitably contentious. Key components of the project, such as taxation rules, most aspects of insolvency legislation and the licencing of financial institutions remain national competencies, meaning that progress necessitates consensus among 27 member states.

For the most part, the successes to date of the CMU are those that require the least intraunion trust. The ESAP project does not pit the interests of member states against each other. It merely consolidates corporate financial and sustainability reporting information at the EU level. It is an easy win for proponents of the CMU. Citizens, researchers and businesses all benefit from this increased transparency, no additional reporting obligations are imposed and almost no new processes or costs are created. Critically, no country has an interest group with financial incentives to oppose ESAP and none needs to make major legislative changes. Trust is not a factor.

Advancements in the securitisation market require similarly little intraunion trust. In 2021, a regulatory change facilitated a boom in the European synthetic securitisation market, and Europe now accounts for almost half of synthetic securitisation globally. However, financial regulation was already a European competency. While member states must trust European regulators to competently assess and manage risk, national capitals did not need to trust each other to achieve this step towards CMU.

The rise of the SSM and the current proposals to increase the consolidation of supervisory powers over ‘data and information service providers’ with ESMA are more fraught. There are clear benefits to consolidating banking supervision within one trans-union expert agency, in both efficiency and the convergence of standards and consistent application of rules. Despite this, the creation of the SSM raised concerns over the erosion of sovereignty given the connection between fiscal sustainability and banking stability. Member states with strong national banking authorities, such as Germany and Austria, were particularly averse to transferring control to the European level. Yet, this reform still did not require member states to trust each other. Rather, they put their faith in an independent European bureaucracy, with strong institutional credibility. The CMU proceeded, slowly.

EU must achieve lasting progress

The NGEU fund is different. For the first time, European nations agreed to issue common debt to finance collective expenditure. This step created shared fiscal exposure at the European level. While changes to securitisation regulation and the creation of the SSM required vertical trust in EU agencies, the NGEU package entails horizontal trust between member states. Member states showed faith in each other, but it took a global crisis to bring this about.

Unfortunately, the CMU cannot proceed on the back of successive crises. Lasting progress can be achieved only through the gruelling work of legislative compromise. Since 2015,  CMU related policies have generated more than 55 regulatory proposals and 50 non-legislative initiatives at the European level. Despite broad agreement on the need to harmonise insolvency, taxation, and licensing rules, progress on these structurally difficult problems typically stalls endlessly in the European legislative process or advances only in the form of nonbinding commitments.

At the OMFIF event, a former central banker, referring to a perceived absence of concrete actions advancing the CMU, noted that: ‘we build trust by doing, by translating policy into action’. Sadly, trust may be both the prerequisite and the missing ingredient for meaningful advancements of the CMU.

Conor Perry is an Economist at OMFIF.

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