The EU Single Market came into being in 1993. The introduction of the Euro followed six years later, bringing tangible financial integration of Euro area member states. The development of a truly single capital market in Europe should have followed. But it hasn’t.
In fact, there has been little change in the development of the EU’s capital markets over the past decades. The global share of market capitalisation of listed shares in the EU has declined from 18% in 2000 to 13% in 2023; whilst the US has consolidated its position as the undisputed leader accounting for 50% of the world’s equity market cap in mid-2023. China has rapidly expanded, accounting for 0.3% of the world’s total market capitalisation in 2000 to 13% in 2023. The evolution of market capitalisation also has repercussions on the depth of regional liquidity pools. Market data suggests US and China are more liquid centres than Europe with turnover ratio (trading volume relative to market capitalisation) standing at 3.5x in the US, 2.6x in China versus 1.5x in Europe.
These numbers indicate that there is increasing urgency to transform the EU’s existing capital markets into a globally competitive, well-functioning and scaled-up single capital market. Without this, the region’s future growth and competitiveness are at stake.
Last month, EU finance ministers recognised this need in a Eurogroup statement setting out recommendations for both Member States and the next Commission to consider.
While this is a positive development, more transformative and bold measures are needed to scale the EU’s capital market to bring it into line with the size of its economy, its future investment needs and the role it wants to play on the global stage. To succeed, decision-makers cannot shy away from addressing some structural, and often political, issues. Four key areas need to be addressed in order to secure Europe’s long-term economic prosperity and competitiveness.
Firstly, bringing retail savings to the EU market, whether directly or indirectly, is a priority. This requires a pan-European approach to pensions, which will only occur under the clear leadership of heads of state committed to resolving on a pan-European basis.
Secondly, the EU needs to enhance its rule-making agility in wholesale capital markets. This can be a powerful way to increase the attractiveness and competitiveness of the EU marketplace. To achieve this, greater discipline needs to be exercised so that co-legislators set out principles in legislation but refrain from hardcoding details therein. Instead, regulatory authorities should be given responsibility to determine the technical substance of rules. The European Supervisory Authorities (ESMA in this case) should be charged with making policy assessments and detailed rules based on robust market data and should be held accountable to the co-legislators on the basis of this observable data. This will allow the framework to adjust more rapidly to changing market conditions in a manner which is more comparable to rule-making for markets in other jurisdictions. This will imply giving greater resources to those authorities and changing their governance with European single market objectives in mind. Going a step further, the EU should recognise that not all circumstances can be foreseen in regulation. Supervisory authorities should be further empowered to intervene, again on the basis of robust market data, when it is necessary for instance to preserve market functioning or price formation. Supervisory assessments and intervention should be strongly coordinated across the EU, and where necessary and more effective, could be centralised.
Thirdly, greater emphasis should be placed on improving market liquidity. At present, there is no common understanding amongst EU policy makers of what kind of liquidity is truly available within the EU’s equity markets, and where this liquidity is. As a result, and in fear of further losing market depth, EU law has imposed restrictions on certain types of trading. This has perversely resulted in less rather than better investor choice and fails to make EU markets attractive to capital, domestically and internationally. Understanding our liquidity landscape and overcoming constraints would produce greater liquidity, thereby attracting more savings, investments and listings of firms with better valuations. Moreover, for a genuinely single EU capital market, the EU needs to break down barriers to incentivise the creation of pan European exchanges and post-trading infrastructures fit for the digital era. EU-wide bond market liquidity also needs to be carefully monitored and deepened, particularly in the government bond markets. Introducing regulatory and supervisory agility can go a long way to facilitate this.
Finally, adjusting the regulatory framework for securitisation is vitally important. This does not mean a return to the pre-Global Financial Crisis era of regulation, but rather targeted changes which will allow securitisation to make a useful economic contribution in an economy where bank lending will continue to play an important role. Indeed, securitisation is the only financial technique which enables indirect market-based financing of SMEs and allows banks to recycle capital into financing additional lending.
Member States need to help grow the EU’s capital markets, and at pace. The recognition by EU leaders that a more advanced Capital Markets Union is needed to achieve the new competitiveness deal set out during the 17-18 April Special European Council meeting is positive. Sustained focus from leaders will be necessary to realise the broader benefits of a truly EU integrated capital market.