Executive Director, Cicero Group
One of the European Commission’s headline initiatives is the creation of a Capital Markets Union (CMU) by 2019. The broad objective of the CMU is to steer the European economy away from its reliance on bank lending – which was sharply exposed during the financial crisis – to create a ‘second engine’ in the form of a more vibrant capital market.
Since it was first announced in the summer of 2014 by the then President-elect of the European Commission, Jean Claude Juncker, there has been a flurry of activity to put together a set of proposals on a broad and complicated subject. Many aspects of Europe’s capital markets are ingrained in national law and practice, meaning that they have not been part of the broader integration of much of the Single Market.
On 30 September 2015 , the Commission finally published its “Action Plan” containing a diverse set of proposals, from stimulating the securitisation market through to pushing for a more harmonised insolvency framework across the EU, that are designed to broaden the mixture of finance available to European businesses.
The trading environment is an important element of capital markets. An active trading environment allows for bonds issued by European businesses to be easily transferred between investors. The depth and vibrancy of this secondary market – and the subsequent willingness of investors to hold certain bonds - can impact on the initial cost of funding in the primary market. The availability of trading data, particularly post trade can provide investors with better sight of the market, which could serve to increase willingness to invest. Cross-border securities ownership rules are also important for giving investors legal certainty when trading with a counterparty located in a different Member State under a different legal regime.
The Action Plan acknowledges many of these issues. It highlights the importance of a liquid secondary market, saying “limited liquidity could translate into higher illiquidity premiums and higher borrowing costs”. Improving liquidity is one of the objectives of a review of the corporate bond market that the Commission will conduct by the end of 2017, which will assess the impact of market reforms. This initiative will be very welcome although it could be premature since the effects of the most relevant reform, MiFID II, will either be difficult to assess or unknown by then, depending on the duration and scope of the proposed delay.
In a sense, MiFID II is the elephant in the room of this element of the CMU since it will have a significant impact on secondary market liquidity for corporate bonds. The draft Regulatory Technical Standards (RTS) published by European Securities Market Authority (ESMA) on 28 September 2015, while an improvement, continue to use the class of financial instrument approach (COFIA) for the initial assessment of a bond’s liquidity. This means that under the proposed thresholds, a sizeable portion of bonds will continue to be falsely classified as either liquid or illiquid. This could cause investors’ to lose confidence in their ability to assess the true liquidity of certain bonds. The consequences will be most noticeable for bonds issued by smaller companies, whose liquidity will be harder to asses. This puts the proposals at odds with the overall objective of the CMU to make it easier to invest in European businesses.
At the time of writing, European legislators are considering a suggestion from ESMA to delay MiFID II and it is hoped that any extra time to finalise the standards will be used to ensure that they protect sensitive trades at the same time as achieving their objective of increasing transparency in the market.
The CMU Action Plan explores a number of other measures to support the trading environment including efforts to standardise offer documentation in corporate bond issuances. The initiative aims to address the concern that the huge variety in bonds could be a deterrent to investors. The challenge will be to arrive at a solution that simplifies the documentation accompanying bond issuances while retaining the flexibility that firms need to meet their specific funding requirements.
In the area of post-trade, the Action Plan states that they will undertake a review by 2017 to assess the progress of removing the Giovannini barriers to cross-border clearing and settlement. Many of the barriers will be addressed once the CSDR and MiFID II come into effect but it is anticipated that some will still remain.
The CMU is a welcome initiative and the Commission has produced a solid and realistic set of proposals in a complicated area. The initiative retains an admirable focus on its overall objective of promoting funding for business. For the CMU to be a success, this outlook needs to be reflected in all of the Commission’s work. The CMU has to work within a framework created by other pieces of legislation. So it is just as important to get these right too.
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