Eye on the Markets Summer 2016: The European Capital Markets Union

Regulation develops in cycles; regulation, deregulation, re-regulation... The cycles vary in length and depth but they will always occur.

Eight years on from the height of the financial crisis and policy-makers’ thoughts have turned in a new direction. Rather than focus on making markets and firms safer, regulators need to manage the next wave of regulatory change in a way to support economic growth and job creation.

It could seem contradictory to suggest that yet more regulation might be capable of facilitating innovation and supporting economic growth but that is what is being talked about in Europe. The European Commission’s next wave of regulation, a broad collection of 33 measures under the umbrella title of Capital Markets Union (CMU) specifically target ‘jobs and growth’ as the desired outcomes.

What’s Most Eye-catching in the CMU?

High on the list is probably the plan to revitalize the moribund securitization market. Securitization, in whatever form, has a bad reputation, having been at the heart of the financial crisis. However, increased capital requirements in recent years have reinforced securitization’s value in freeing up banks’ balance sheets to enable more lending to the real economy. In December 2015, the European Commission published a draft regulation on simple, transparent and standardized (STS) securitization. It acknowledges the importance of a well-functioning securitization market whilst noting that the problem caused by residential mortgage-backed securities (RMBS) during the crisis was largely a US rather than European one.

“For BBB-rated products US RMBS’ default rates peaked at 62% and 46% (subprime and prime, respectively) while EU products’ default rates peaked at 0.2%.”

Another interesting measure in the CMU is the proposed “review of EU corporate bond markets, focusing on how market liquidity can be improved”. This is inextricably linked to the forthcoming MiFID II rules which will bring full pre- and post-trade transparency to more liquid corporate bonds. A measure that some believe could damage the already fragile levels of liquidity in these instruments.

Finally, the European Commission has undertaken a call for evidence on the cumulative impact of financial reform.

This has attracted many responses, pointing out potential overlaps, underlaps and mismatches in EU financial services legislation, with many highlighting the current fragmented EU approach to regulatory reporting as ripe for reform. Some market participants would probably like the Commission to halt any new legislation whilst the implementation of the new rules is completed (most notably MiFID II), so that the cumulative impact of the legislation can be assessed properly. However, Lord Hill, European Commissioner for Financial Stability, Financial Services and Capital Markets Union, and his team will be pressing on with the Benchmark Regulation, the Securities Financing Transactions Regulation, the Prospectus Regulation and the rest. Can you really regulate for ‘jobs and growth’? Only time will tell.

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