Europe takes on Wall Street

The Capital Markets Union is the EU’s most ambitious financial initiative since the launch of the euro in 1999.

The European Commission on Wednesday unveiled what is arguably its most ambitious financial project since the birth of the euro: a plan to create a single capital market across 28 states to boost growth and challenge the U.S. as a center for investment.

The proposal to create a Capital Markets Union by 2019 aims to give European companies access to funding from sources other than their own national banks or money markets — making them more like their American competitors who draw on vast equity and bond markets for capital.

The global financial crisis and its repercussions in the EU have made financial institutions more cautious about lending, stifling economic growth. The Capital Markets Union — the flagship financial project of Jean-Claude Juncker’s Commission — is designed to make Europe more resilient to financial shocks and bank failures. It follows months of consultations with the financial industry.

The Capital Markets Union will be “a central part of the Commission’s overall effort to encourage jobs and growth,” said the EU financial services chief Jonathan Hill, presenting the plan in Brussels at midday Wednesday.

At the moment, although the European economy is roughly the same size as America’s, U.S. capital markets dwarf their EU peers. The U.S. venture capital market is five times larger than Europe’s and U.S. equity markets are approximately twice the size of their EU peers in terms of capitalization.

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“We have 28 member states and legislations — and few more languages, if you want to compare us with the American situation — but it doesn’t mean that you cannot create a European market for venture capital financing,” the Commission vice-president in charge of jobs and growth, Jyrki Katainen, told POLITICO in a joint interview with Hill following the launch Wednesday.

“If you create a harmonized market someone will start using it, and the others will get jealous and start to follow, and it will change the culture,” said the Finn.

Hill, a former leader of the House of Lords for Britain’s ruling Conservatives, called for the U.K. to take an active role in shaping EU regulation around “financial services, which is such a strong part of the British economy and its biggest export.”

The City — London’s financial center — is shaping up as critical voice in support of staying “In” the EU ahead of the referendum on British membership in the bloc that Prime Minister David Cameron has promised to hold by 2017.

Freeing up trillions

Unifying its capital markets is the next step in integrating the EU’s economies at a time when disintegration seems to have the upper hand — visible, as in recent days, in the sharp differences between Western and Central Europe over how to deal with the refugee crisis, in Catalonia’s bid for independence from Spain and in the Brexit debate.

The complex and highly technical plan, prepared largely behind-the-scenes by one of the lowest-profile commissioners in Brussels, could be the most sweeping change to the way Europeans do business since the introduction of the euro in 1999.

The hope is to free up funds for investment in companies and infrastructure. The Commission estimates, for example, that of the more than €9 trillion that insurance companies have invested in Europe, less than 0.25 percent is currently placed in infrastructure projects such as telecoms networks or roads.

The goal is to make cross-border investment and services like life insurance and retirement savings easier and cheaper, to provide  incentives to venture capital funds, and to review financial regulation to ensure investment is not unfairly burdened.

“When a lot of this system was put in place … the thing at the forefront of people’s minds was the financial crisis,” Hill told POLITICO. “Now I think the thing at the forefront of people’s minds, certainly at the forefront of mine, is how to we create jobs and growth because 23 million people are out of work. A low-growth environment is not just a threat to financial stability, it’s a broader threat.”

Some elements of the plan, such as new collateral requirements for insurers to invest in infrastructure, could be in place as soon as the end of this year if there are no objections from national leaders or the European Parliament.

Other proposals, like harmonizing European insolvency rules in to reduce anxiety levels for cross-border investors, will take years.

“Anonymous investors”

“Building a capital markets union will require a sustained effort year in, year out,” Hill said. “But we are starting fast to build momentum … to work through the biggest barriers one by one.”

“It’s exactly this type of policy action that we need in Europe,” said Wim Mijs, the chief executive of the European Banking Federation. “I hope the Commission can maintain its resolve to make it work so that these plans can deliver a single European capital market without obstacles…. At our end, banks are ready to play their part.”

More skeptical observers such as some financial watchdogs and center-left politicians worry that regulations introduced after the global financial crisis to rein in banks could now be rolled back. They also say there is too much emphasis in the plan on promoting riskier investments such as venture capital.

“The German craftsman, the Spanish agricultural company or the Greek tourism firm need well-capitalized local banks that will provide long-term financing by their side — something an anonymous, financial quarter-oriented investor cannot provide,” said Gerhard Schick, financial expert for the Greens in the German parliament.

Other groups have raised concerns that the Capital Markets Union’s embrace of securitization — the bundling and onward sale of illiquid assets, such as mortgages — will benefit the big banks, which use this process to free up capital on their balance sheets.

A statement signed by more than 20 civil society organizations, including the non-profit group Finance Watch and the World Future Council in Germany, portrayed the plan as counterproductive in terms of financial stability.

“The CMU revives pre-crisis trends without adequately integrating the lessons from the crisis,” they said.