Swedish holidaymakers are fond of Spain. Many Swedes even buy holiday homes there. However, for now, they are far less ready to put their money in Spanish shares.
The reason is not Spanish companies but Europe’s fragmented capital markets. The EU lacks efficient financial ecosystems. There are too few cross-border activities. This makes competition less intense, puts a brake on productivity and risks making us fat cats. Thus, the EU must create a more dynamic and single European capital market, to meet fierce competition from the USA and China.
Strong capital markets matter
The Single Market is incomplete. It is still patchy, in particular for services and for the financial sector. This is an urgent problem now that we need to move out of the pandemic and lay the foundation for a more efficient, greener and modern Europe.
To move in that direction investments are needed. In infrastructure, in technology, in more resilient value chains. For such investments we need capital and a functioning capital market that can allocate capital in an efficient way. But we don’t have that. On the contrary, the European Union’s capital markets are fragmented. There are too few cross-border activities. Thus, we suffer from lack of scale and from beneficial influences and positive externalities of capital investments across European borders.
Access to different forms of credit is a prerequisite for an economic recovery after a recession. The EU’s debt crisis a decade ago contributed to a shortage of credit. Banks and financial institutions started to retreat within their original national borders. This is one reason behind the euro area´s slow economic recovery compared to other regions. Europe was simply not equipped to cater for European companies’ investment needs.
To fuel the European post pandemic recovery, a well-functioning and stable supply of credits will be vital. This challenge cannot be met by the banking system alone but must be supplemented by strong and efficient capital markets. That means equity, both private and public. It means vibrant bond markets, and it means innovations in finance.
We all know that the existing capital markets unions in the US and China have benefitted them enormously. In the US, nation-wide stock markets and private equity have funded the rapid rise of a world-leading global industry. And in China, the huge pool of cheap capital has flowed into immense investments in a new digital infrastructure. For better or worse.
I see future risks in this state of play. European companies depend on bank lending much more than American businesses. But bank loans are not always available to everyone or everywhere. If businesses cannot tap large capital markets – larger than those in our respective small nations – it hampers their growth prospects. Capital is needed at all levels, from seed funding to IPOs. Even after an IPO, a company may need to tap the market, not least during crises like the current pandemic.
In an ideal world, companies should be able to seek and raise capital anywhere in the EU’s single market. Underdeveloped European capital markets handicap the financing of European companies and sometimes prompt innovative European growth companies to seek finance outside of Europe – and in the worst case leave the EU altogether. The risk is that conservative banks mainly benefit existing, old companies – and thus protects an economy of fat cats.
I draw the conclusion that the deficiencies in the European capital market are a lethal threat to the prosperity of Europeans. In particular in these times of great power rivalry, when ability to expand and upscale matters more than ever before, both America and China are weaponising their own capital markets.
The need for speed
The challenges in developing capital markets differ from one EU Member State to the next. In some cases, size is the problem, in some cases lack of competition, in other too much regulation or an old-fashioned national tax system. Consequently, we need to push for a more inclusive equity culture for retail investors in many countries, remedying weak financial ecosystems to support SME companies, divergent national legislation, complex taxes, debt bias in corporate taxation, as well as different non-bank insolvency laws.
The EU is starting to take action to address some of these areas, notably with the Capital Markets Union. However, the combined effects of the coronavirus pandemic, Brexit and the green transition have been that the CMU project has stalled. This is unfortunate. If anything, the crises mean that the capital markets union needs to happen faster, in order to strengthen the EU’s competitive position. The urgency of the situation is driving calls for increased stakeholder dialogue and collaboration across the financial ecosystem. That is good! We need to address the needs of companies seeking capital as well as investor expectations, market incentives and marketplace adaptations.
We need an environment where capital markets can finance the companies that build tomorrow’s economy. That is urgent. It is the pre-eminent task. Retail investment in listed companies has a role to play here. The EU needs to foster an equity culture, which connects retail investors with listed companies with growth potential. That way, the investors also get rewarded when investments are successful.
Unfortunately, this will not happen overnight. It will require actions on both EU and national level, such as investment tax breaks, a pension structure that encourages own allocation choice, the presence of online retail brokers and building a culture of greater financial literacy. As a starting point, employee shareholder schemes should be encouraged. Stock options have been quite effective in the US and could be utilised more – also in Europe.
Digitalisation will support the flow of information, thereby increasing cross-border investment and activity within the Single Market. Online banking and asset management, including pension capital management, are already adapting to the latest technology. Payment options such as Swish, iZettle and Klarna are now household services in my native country, Sweden. Other digitalised services are emerging, but uptake is still relatively slow in many EU countries. The single digital identity proposed by the European Commission this summer will be key to speed up the uptake of digitalised financial services.
Europe’s economic recovery will depend heavily on how well our capital markets function. It will depend on whether people and businesses can access investment opportunities and market financing. Massive investments will be needed to make the EU economy more sustainable, digital, inclusive and resilient. A truly common European capital market and much more of a pan-European infrastructure could make it happen – and even spur Swedes to invest in Spanish and other companies across the EU.
The European Union’s capital markets are fragmented. There are too few cross-border activities. Thus, we suffer from lack of scale and from beneficial influences and positive externalities of capital investments across European borders.
The deficiencies in the European capital market are a lethal threat to the prosperity of Europeans, particularly in these times of great power rivalry, when ability to expand and upscale matters more than ever before, both America and China are weaponising their own capital markets.
