Capital Markets Union vs. US Financial Markets: Can Europe Compete?

The Capital Markets Union (CMU) is an initiative by the European Union to create a single market for capital across the 27 member states. The goal is to get money flowing across borders more efficiently and boost economic growth in the EU.

But how does Europe’s ambition to build a Capital Markets Union compare to the depth and liquidity of US financial markets? Can the CMU eventually compete with Wall Street?

Understanding the Financial System

The EU financial system has traditionally been very bank-based, with banks providing most of the credit to businesses and households.

Capital markets, where companies can raise money by issuing stocks and bonds, are much smaller compared to the US. Total stock market capitalization in the EU is about €14 trillion, less than half of the US market valuation of over €30 trillion.

There are several reasons why capital markets are less developed in Europe:

• Fragmentation into 27 separate markets with different rules and supervisory regimes makes cross-border investment difficult. Harmonizing regulations has been slow and politically challenging.
• Culture and investor preferences lean more towards conservative bank financing rather than equity risk-taking. Access to bank loans has been easier.
• Companies in Europe tend to be smaller and medium-sized businesses rely more on bank lending as their primary funding source. The number of listed companies has been declining.
• Varied insolvency and tax regimes across EU members create barriers and uncertainty for investors looking at opportunities across borders.

Offering Easy Access to the Capital Market

A true single market for capital would provide European companies with easier access to a wider base of investors. This would lower funding costs and help channel investment into innovative business sectors. The Capital Markets Union aims to achieve this through several key initiatives:

1. Harmonizing regulations and financial reporting standards between countries to facilitate cross-border flows.
2. Developing EU-wide infrastructures and facilities for capital markets – such as payment and settlement systems, repositories for securities lending, and harmonized withholding tax procedures across borders.
3. Promoting retail investment into capital markets through vehicles like European Long-Term Investment Funds (ELTIFs).
4. Making it easier for smaller and medium companies to access public markets through targeted listing rules and platforms like SME Growth Markets.
5. Expanding alternative sources of finance such as crowdfunding, venture capital funds and private equity.

The US capital markets provide the deepest pools of investment capital globally. Can the European Union eventually emulate this liquidity?

Achieving the scale of American markets will be difficult due to structural challenges like the number of currencies across EU members. However, the regional market can meaningfully improve financing conditions for European companies.

The Role of Financial Technology

Financial technology (fintech) could provide a crucial boost to the Capital Markets Union’s development. Tech innovation is transforming major components of the investing process – from customer interface and distribution to securities trading systems.

New robo-advisory platforms and mobile trading apps are dramatically lowering the barriers to investing in securities and expanding retail participation in capital markets. Payment services like Adyen are allowing easier cross-border e-commerce flows. Crowdfunding models are providing households a way to fund small businesses and startups directly.

The European Commission is hoping fintech could spur more SMEs to tap into pan-EU investor populations. Expanding things like initial coin offerings (ICOs), blockchain-based securities issuance, and alternative data can facilitate capital raising and risk transfer. Crypto-assets and decentralized finance networks may enhance future market infrastructure connectivity across borders one day.

However, the rapid growth of fintech brings risks if appropriate regulatory frameworks don’t keep pace. As digital finance transforms market microstructure, updating legislation on areas like cybersecurity safeguards, customer diligence procedures, and transparency standards is crucial. The EU will have to balance carefully how innovation can expand market access while still preserving financial stability.

If European regulators and supervisors effectively collaborate with the fintech industry on emerging technologies, it would place EU financial markets in a strong position to benefit economically. This will be an evolving process requiring close public-private sector coordination in the years ahead.

CMU as a Geopolitical Necessity

There may also be a geopolitical incentive underlying CMU ambitions to strengthen European financial autonomy. Trade tensions around the globe are rising. Europe continues grappling with the consequences of Brexit. Relations between Western countries and China/Russia bring periodic strains.

In this climate, the EU remaining overly dependent on foreign financial institutions to fund large parts of its economy poses risks. European companies relying on overseas banks or capital markets for financing needs are more exposed to external legal or regulatory actions potentially motivated for extraterritorial political purposes.

Take the example of Trump introducing secondary sanctions restricting Iran’s access to US dollars funding during 2017-2019. This cut off European corporates still permitted to do business with Iran under international agreements. Firms like Total, Siemens, and Volkswagen faced the threat of being locked out of American markets if they transacted with Iranian counterparties in US dollars.

Reducing structural dependence on foreign financing channels or currencies may be a strategic priority for Europe looking out longer term. Deeper, more liquid domestic capital markets could provide an alternative source of funding for EU companies and governments. And an integrated CMU with harmonized supervisory standards could enable quicker deployment of financing tools if an emergency response is ever needed.

Final Words

Although progress has been slower than anticipated, the European Commission continues to push key CMU initiatives focused on:

• Increasing harmonization of insolvency laws that deter cross-border investment.
• Updating rules and supervisory convergence in areas like securities lending or derivative margining requirements.
• Expanding the investor base accessing EU capital markets by developing a standardized European personal pension (PEPP) product.

The sheer size and maturity of the US financial system will be hard to match. But the Capital Markets Union can fuel more dynamic EU capital markets, helping channel investment and savings more efficiently to strengthen European companies and economies over the long run. If successful, the CMU has the potential to be a “game changer” for EU financial market competition globally.