Brexit and the Capital Markets Union

Brexit and the Capital Markets Union

Valentina Romei

 | Mar 24 14:48 | Comment | Share

If the UK were to leave the European Union, it will mean that it will also be outside the Capital Markets Union (CMU), when completed. The CMU is a set of measures designed to clear obstacles between companies and potential investors. The idea – in the words of the European Commission that created it – is “to mobilise capital and channel it to all companies, including SMEs, and infrastructure projects that need it to expand and create jobs”.

The EU economy is slightly bigger than that of the US, but its capital market is very different. Its equity market is about half the size of that of the US and its securitisation market is less than a quarter of the US.

Private finance is 70 per cent higher in the US despite the EU catching up in recent years.

At the moment the UK is an important part of the EU’s capital and financial markets. According to data from the Association for Financial Markets in Europe (AFME), The UK is home to 27 per cent of EU listed companies by market value, 40 per cent of the EU’s listed SME’s are listed on UK exchanges and 46 per cent of the EU’s equity capital is raised through UK capital markets.

But such interconnectivity might not continue if the UK were to be outside the common regulatory framework of the CMU.

Paul McGhee, Director of Strategy at AFME, in an interview with the FT suggests that “a Brexit would call into question the ability of investment banks to offer their services throughout Europe. This would certainly limit the ability of the UK market to act as a hub for raising capital”.

Jean-Pierre Mustier, partner at Tikehau Capital Advisor, stated that “the benefits of the initiatives under the Capital Market Union might only apply to EU countries, which will no doubt launch “charm” offensives to convince firms to relocate.”

While Umberto Marengo, Associate Fellow at the Institute of International Affairs, in a paper published on EUROPP, affirms that “as the undisputed financial centre in Europe, the UK is set to gain disproportionally from deeper capital market integration – if it remains in the EU”.

With a less developed capital market, EU firms have fewer opportunities to access finance and they end up relying on lending from banks. According to S&P Global Market Intelligence only about 10 per cent of US non-financial corporate lending was via banks last year, the proportion is over three times higher in Europe.

European households also rely on the banking sector more heavily then they do in the US. According to data from the Bank of International Settlements more than 50 per cent of the credit to household and non financial companies last year were from banks, compared to about half of that amount in the US. The proportion remained largely stable despite some decline recently.

One of the problem with an large exposure to bank-lending is that it might tighten in times of crisis, as in 2009 when many firms, particularly SMEs, had difficulty accessing finance.
Last year, about one in ten of SMEs in the Eurozone reported access to finance as the most pressing problem they faced, down from about 15 per cent in 2009. The proportion was about double for the micro firms than the large companies and was higher in some countries, including Spain where 27 per cent of SMEs suffered from poor access to finance in 2009.

Moreover, 44 per cent of EU SMEs did not get the full amount they needed and seven per cent had their application refused altogether. The proportion of refusal was much higher in France (13 per cent), Ireland, the Netherlands and Greece, where over 20 per cent of the applications were not fully met in 2015.

Increased investment would be good news for Europe, where the level of fixed capital formation – including buildings, infrastructure and equipment – collapsed after the crisis and are not yet showing signs of recovery, while in the US investment levels are already above pre-crisis levels.

The European Commission estimates that € 1.5-2tn of infrastructure investment will be needed by 2020. Of this, the energy sector is the largest component, with around €400bn on distribution networks and smart grids, another €200bn on transmission networks and storage and €500bn to upgrade and build new generation capacity. But the EC estimates do not cover the whole range of infrastructure. Water & sewage, waste management are not included, nor is social infrastructure or power generation.

Increased and diversified funding resources are expected to revamp economic growth in Europe. While the US has enjoyed a sustained recovery since the Great Recession, economic growth in Europe is weak, with slow productivity growth and pockets of very high unemployment rates.

Smaller countries and countries with less developed capital markets are likely to benefit more from the Capital Markets Union, according to Mr. McGhee , but UK companies will face huge uncertainties if they are out of it.