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By Dr. Lúcio Vinhas de Souza, Chief Economist and Director of the Economics Department, BusinessEurope

 

 

 

 

The European Union (EU) and its Member States must invest at an unprecedented level to regain their lost competitive edge. As set out in the 2024 Draghi (Mario Draghi, former European Central Bank [ECB] president) and Letta (Enrico Letta, former prime minister of Italy) reports, access to finance in this context, specifically long-term debt financing, equity investment and risk capital, is a precondition for companies to thrive and make the investments necessary to drive growth, maintain competitiveness and provide jobs and prosperity to EU citizens.

The SIU’s primary objective should be to make the EU more attractive to both foreign and domestic investors, thereby enhancing growth.

For this to happen, the free flow of capital within the EU through various channels and on reasonable terms is crucial. We need to promote cross-border investment, as EU markets are currently still fragmented, with a strong home bias among investors. Developing a Savings and Investments Union (SIU)—which combines the 2015 Capital Markets Union and Banking Union initiatives, the completion of which had effectively stalled for several years but today continues with a greater focus on individual savers—should increase the availability of finance. However, the SIU’s primary objective should be to make the EU more attractive to both foreign and domestic investors, thereby enhancing growth.

The EU economy has stagnated at approximately 70 percent of the US GDP (gross domestic product) per capita for more than 30 years. This underperformance is primarily due to lower long-term competitiveness gains, which feed into persistent low growth and fragile public finances. In turn, EU competitiveness is disappointing not only because of the EU’s still fragmented real and financial markets but also because of high and growing regulatory burdens. It is crucial to also address these hindering factors.

Structural-reform implementations, including actions necessary for completing the EU’s Single Market, have stalled—and in some cases even reversed—in the past few years. Without meaningful improvements in this area, EU companies will be unable to escape the vicious cycle of low investment, low innovation and low growth; this is especially true for small and medium-sized enterprises (SMEs).

Currently, we observe that many startups and scale-ups, due to challenges related to the existing ecosystem and lack of concrete financing opportunities, too often seek growth opportunities outside the EU. As a result, investment as a share of GDP in the EU, after falling for years, is currently lower than that of its international competitors, even if its savings rate is higher than, for instance, that of the United States. Although we strongly support leveraging those private savings in support of the EU’s wider objectives, developing an SIU will not be enough to address the EU’s savings and investment mismatch. This situation can only be managed through parallel improvements in the business climate and regulatory burden.

It is also crucial to maintain an efficient and competitive banking system within a broader and deeper financial sector, one that is able to support the development of European companies of all sizes, as EU companies will continue to require bank debt financing. They will also need access to risk-mitigating financial instruments, such as derivatives, on reasonable terms, as these are of strategic importance for the risk management of non-financial companies, stabilising cash flows and enhancing creditworthiness. Financial entities are equally crucial in channelling savings into capital markets.

While finding investors is no longer a real problem for larger companies, SMEs continue to depend heavily on bank loans. Historically, banks’ share of credit intermediation has been approximately three times higher in the EU than in the US; given regulatory and balance-sheet pressures, bank lending will continue to be under pressure. It is, therefore, essential that the development of the Banking Union and the Capital Markets Union continues, now under the banner of the SIU, even if longstanding constraints are complicated to resolve (for example, a single rulebook for all aspects of trading, high variation in supervisory practices, unaligned tax and insolvency regimes, underdevelopment of pension funds, etc.).

BusinessEurope, the most influential business organisation on the European continent, has identified five key specific areas in which EU policymakers and Member States must take action.

To chart a path towards that goal, BusinessEurope, the most influential business organisation on the European continent, has identified five key specific areas in which EU policymakers and Member States must take action to implement the Banking Union and the Capital Markets Union under the SIU.

1. Improve information flows regarding growth prospects for small and medium-sized companies.

The availability of widespread and diverse research on small and medium-sized companies is essential to ensure greater funding diversification. This will improve access to capital markets for medium-sized firms that are most likely to benefit from easier access to finance, particularly longer-term, patient growth capital.

2. Ensure that prudential rules strike the right balance between increasing financial stability and supporting companies’ needs for investment capital.

BusinessEurope supports regulatory initiatives that address the failures that led to the Global Financial Crisis (GFC) and reduce the risk of new crises occurring. Companies are the first victims of financial-sector stresses, but reforms must strike the right cost-benefit balance and be mindful of their consequences for non-financial companies, which rely on financial companies’ services for their real-sector investments.

3. Restore confidence in securitisation.

Restoring confidence in securitisation, particularly for SME loans, is crucial in allowing banks to free up their balance sheets and extend lending.

4. Develop complementary sources of finance to bank lending. 

Historically, banks’ share of credit intermediation has been significantly higher in the EU than in the US; therefore, it is particularly important to support alternative financing routes, particularly for SMEs. These include:

  • Institutional investors: Pension funds and insurance companies normally pursue long-term investment strategies. These investors should be encouraged to invest in long-term risk capital to generate employment and economic growth.
  • Private placements: The EU should support market-led initiatives towards common standards, including by revisiting Solvency II calibrations to incentivise private placements.
  • Venture capital and private equity: This segment of the industry remains much smaller than in the US, even a decade after the Global Financial Crisis. The EU must support the industry’s development as an essential source of risk finance and expertise for innovative companies.
  • Capital markets for SMEs: These remain underdeveloped both for smaller bond issuances and equity listings, so initiatives should be undertaken to make both routes less costly for these companies.

5. Promote tax systems that support equity-financed investment.

Equity-financed investment decisions are hampered in some EU countries by corporate income-tax systems that are biased towards equity-financed investments. The practice of withholding taxes on dividends from cross-border portfolio investments also constitutes one of the primary obstacles to an integrated capital market in the EU. 

6. Channel household savings into capital markets.

BusinessEurope supports exploring options for EU Member States to mobilise household savings and develop true EU-wide savings and investment products. It is important that such products impose minimal administrative burdens, do not require locking in capital for excessively long periods and are liquid products that allow withdrawals without incurring costs. There should also be no undue restrictions on portfolio composition, forced allocation to EU assets or onerous requirements regarding the management of these funds. A regime with lighter requirements for small investments in simple, well-diversified and low-cost investment products can make investing less challenging for consumers, unlocking vast amounts of resources. The recent European Commission (EC) recommendation on Savings and Investment Accounts (SIAs) as part of the broader SIU agenda is a step in this direction.

Conclusion

Access to finance is vital for companies and for economic growth. Capital markets remain fragmented and regulated differently across the EU. Although European businesses, especially SMEs, will continue to be highly dependent on bank lending, financing sources need to be diversified and deepened, and cross-border capital flows must be strengthened. Deeper and more diverse financial systems are also more resilient to shocks such as the Global Financial Crisis.

Some concerns and recommended actions:

Many obstacles remain regarding different taxation rules, fragmented supervision and insolvency rules, which are still matters of national competence. While the European Commission (EC) has several proposals that target these obstacles, individual EU Member States ultimately hold the power in such matters, not the EU. Member States equally want to retain national stock exchanges, so any consolidation in this area is also difficult. Lastly, progress on the Banking Union is slow due to a fear of risk sharing, so capital remains ring-fenced in national jurisdictions. This, in turn, makes further bank consolidation—within and between EU Member States—difficult, as demonstrated by recent failed consolidation examples.

Any action to reinforce and implement the SIU should consider the need to strengthen EU companies’ access to capital. While harmonisation should be pursued to achieve these goals, it must not come at the expense of existing and well-functioning systems in the Member States. Harmonisation efforts must be carefully crafted, based on facts, including a review and understanding of existing costs and benefits, learning from what works well today and encouraging Member States to build on best practices.

We should concentrate on implementing the measures that have already been taken, not necessarily on the new ones. For example, the creation of a European consolidated tape (bringing together market data for the whole EU) and the establishment of the European Single Access Point (ESAP) (offering a common source for public financial and sustainability-related information about EU companies) should help to increase the availability of information regarding growth prospects for companies and encourage more cross-border investments. The implementation of the Listing Act package should make equity and bond financing in the EU more attractive, including for SMEs, and simplify national listing rules. The focus should be on promoting further simplification of listing requirements across European exchanges, encouraging companies to list on these exchanges and ensuring lower costs and reduced administrative burdens for companies.

Increasing capital-market financing and reviewing the regulatory framework to ensure that innovative, fast-growing companies and startups can finance their expansions is also a priority. Institutional investors, such as pension funds and insurance companies, which normally pursue long-term investment strategies, should be encouraged to invest long-term risk capital into generating employment and economic growth. Investing in the uptake of private placements should also be made more attractive, and the development of the venture capital (VC) and private-equity industries must be supported as an essential source of risk finance and expertise for innovative companies, as this sector remains much smaller in the EU than in the US.

More household savings funnelled into capital markets. It is essential that financial products have minimal administrative burdens and do not require locking in capital for extended periods, nor impose undue restrictions on portfolio composition or onerous requirements regarding the management of the funds. Ensuring this will make investing less challenging and more rewarding for European households.

With these actions, the SIU will finally deliver on the promise of its predecessors, the Capital Markets Union and the Banking Union, to support the future prosperity of the EU, its companies and its citizens.

 

ABOUT THE AUTHOR

Dr. Lúcio Vinhas de Souza has served as the Chief Economist and Director of the Economics Department of BusinessEurope—the joint voice of the EU private sector—in Brussels, Belgium, a position he assumed after graduating from Brandeis and Harvard universities in the United States. He is also the former Chief Economist of Moody’s and Head of the Economics Department of an internal advisory body to former European Commission President Jean-Claude Juncker, where he worked on the Capital Markets Union and Banking Union. He holds a Ph.D. in Economics from Erasmus University in the Netherlands.