EU’s Disjointed National Laws May Undermine Capital Markets Push

The biggest barriers to the European Union’s drive to jump-start capital markets may be the borders that divide its 28 countries.

As EU financial-services chief Jonathan Hill prepares to publish a Capital Markets Union “action plan” at the end of the month, he’s confronted by a welter of different national tax laws, bankruptcy rules, accounting standards and incentives for issuing equity.

The European Commission, the EU’s executive arm in Brussels, sees more closely knit capital markets as a way to fuel growth, increase credit to smaller companies and boost financing for long-term infrastructure projects. If national rules aren’t brought into sync, the effort could exacerbate the weak spots in Europe’s financial framework, trade groups, think tanks and watchdog groups say.

“The cross-border part is very difficult due to the tax regimes and bankruptcy laws, so you need to deal with that,” Wim Mijs, chief executive officer of the European Banking Federation, said in an interview. “You can postpone it again, as they have been doing for years, or you can take it head on.”

More integrated financial markets are crucial to the EU’s plans to strengthen the single market and the 19-nation euro area. In a June report endorsed by EU President Donald Tusk and European Central Bank President Mario Draghi, commission President Jean-Claude Juncker said better connected financial markets will provide needed risk-sharing.

German Chancellor Angela Merkel called on Aug. 31 for progress on the “very important” plan to shore up the currency zone and improve economic governance.

‘Landmark Project’

Hill presented a proposal for the “landmark project” in February. The EU says its plan aims to complement banks as a source of funding, and it seeks to put equity financing on more equal footing with loans in terms of tax treatment.

While the importance of market integration is widely acknowledged, the commissioner has his work cut out, judging by the reaction to his draft plan.

“Europe is severely lacking in equity financing,” according to a study from the Policy Network, a London-based think tank, citing national barriers and tax hurdles. Efforts to boost venture capital haven’t succeeded, and nations haven’t done a good job of promoting “mutual learning” to spread the success of finance policies that work, according to the report.

Free movement of capital won’t be easily achieved because countries haven’t aligned their accounting rules and national tax laws get in the way, the Federation of European Accountants said in its response to the commission’s proposal. “The lack of stability, predictability, legal certainty and coherence of tax regimes are the main threats to investment,” especially for small and medium-sized enterprises, the group said.

Asset-Backed Debt

The federation also warned that any push to expand capital markets runs in the opposite direction of EU efforts to build an 11-nation financial-transactions tax.

Hill’s plan is right to note that preferential tax treatment for debt distorts markets and gives lenders an incentive to take on more leverage, according to Finance Watch, a Brussels-based independent research group whose members include consumer groups and trade unions. Yet reducing the EU’s reliance on banks isn’t a guaranteed road to prosperity, “given the markets’ well known manic depressive behavior.”

Along with the capital markets union action plan, Hill will unveil his overhaul of EU rules for asset-backed debt. The commission estimates that returning the securitization market to pre-crisis levels would provide 100 billion euros ($113 billion) to 150 billion euros in additional credit to households and businesses, a 1.6 percent increase.

Risk Appetite

Turning small-business loans into securities “will be too complex and too expensive to work without subsidies” because there will be too many intermediaries and too much pressure to provide attractive investor returns, Finance Watch said in its consultation response. It recommended giving priority to channels like “plain vanilla” bond markets, equity markets, covered bonds or venture capital, and said the commission should promote traditional banking alongside market improvements.

“A higher reliance on capital market financing would in turn make the economy more vulnerable to a tightening of capital markets’ risk appetite and liquidity,” the group said. “The crisis has shown that traditional relationship banking was more robust and more focused on lending to the real economy than the activities of large universal and investment banks.”

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