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21 Mar 2023

Eurex Exchange

Capital Markets in Europe – The need to act is now

Ahead of the Eurex Derivatives Forum, Eurex caught up with Fabrizio Campelli, Member of the Management Board at Deutsche Bank responsible for the Corporate Bank and Investment Bank, to discuss the need for deeper capital markets in Europe and what needs to be done to achieve this.  

What progress has Europe made in developing its capital markets and how important is this work for the continent?

Europe has not made a lot of progress in developing its capital markets. Yes, there have been, and still are, many regulatory initiatives in development. But these have not delivered deeper European capital markets.

Increasing economic and geopolitical tensions mean that Europe needs new impulses to accelerate work on establishing deeper and more liquid capital markets. This is absolutely crucial for Europe given the combination of challenges it faces such as harnessing the benefits of digitization and the transition to a sustainable economy.

This and other requirements including diversifying global chains and defence spending creates massive funding demands which cannot be met by conventional methods of bank or public financing.

Despite years of attempts to make progress on a capital markets union, 70% of all corporate funding in Europe is still provided by banks. Bank lending capacity is determined by capital requirements, which constrains their capacity to fund the necessary investments. Likewise, European governments are also constrained in their ability to spend for fiscal sustainability reasons.

What can be done to accelerate progress and how urgent is the need to act?

The window of opportunity to act is clearly now. We must introduce targeted changes ahead of the European Elections in May 2024. Three areas will be especially important to get right:

First, more support for the European Securitisation market. Securitisation is an indispensable tool for diversifying funding sources and financing the green transition. Compared to the US, the European market for securitisation is very small. Securitised assets represent only 8% of eurozone GDP but 47% of GDP in the US.

Second, proposed measures for strategic autonomy, such as the review of the EU clearing framework could penalise European banks and drive business to non-EU markets and players. As such, careful consideration should be given in the legislative process to determine how to protect EU liquidity providers competing internationally.

And third, the retail investment strategy should empower retail investors to participate in capital markets. The potential introduction of an inducements ban in the sale of investment products will drive retail investors to more risky asset classes or away from capital markets. Instead, disclosures should be made clearer and knowledgeable investors should be able to choose from a broad range of products. A full ban on inducements should be avoided.

In the longer term, EU policymakers and Member States should consider the broader challenges facing Europe. This includes a regulatory framework for European firms which does not undermine their competitiveness and access to global liquidity pools.

What shape might the right regulatory framework take?

It might involve trade-offs for Member States, given the differences in maturity of capital markets within the EU. The five biggest members represent 70% of capital markets activity, which means there are different needs and interests in enhancing the single market for capital, however, the opportunity costs for the Union are immeasurable.

The regulatory framework in which European firms operate must not undermine their competitiveness and access to global liquidity pools. There are a number of areas to address but as above I will choose three of particular importance:

The lack of flexibility in the current EU regulatory framework creates competitive disadvantages. At the same time extraterritorial application impacts EU bank competitiveness. So, the first requirement is an adjustment to international standards and more flexible equivalence assessments. The European framework cannot react to changing market environments. We need more agility in decision-making to future-proof it, as the UK and US are able to.

Equivalence is especially needed when it comes to clearing and access to non-EU CCPs to service international clients. Here, EU banks fully support the objective of the European Commission to increase the share of clearing activities in the EU. At the same time, as these markets are global, EU banks also need to continue to be able to clear via UK CCPs. Restricting this clearing will make EU banks less competitive via-a-vis global clients but ultimately also when servicing EU clients. Therefore, permanent equivalence should be granted or EU banks should receive a targeted exemption from clearing via non-EU branches or for market making activities via the current review of EMIR.

Second, there is a need for more harmonisation outside the direct financial services framework. The EU capital markets framework is still deeply rooted in national provisions, which have developed over decades and hamper cross-border provisioning of capital and services.

And finally, we need more consolidation of EU market infrastructure. European capital markets are still heavily fragmented, leading to inefficiencies in the application of the regulatory framework and supervision. EU equity capital markets are only 25% of the size of the US. However, the EU has three times as many exchange groups, 18 central counterparties (CCPs) and 22 central securities depositories (CSDs), as opposed to 1 each in the US.

Furthermore, consolidation creates deeper liquidity pools. This makes it more attractive for investors to stay and invest in Europe instead of switching to the US (and in the future possibly the UK).