Brussels, 24 September 2020 – Finance Watch, the public interest association dedicated to making finance serve society, welcomes the European Commission’s intention to improve the functioning of European capital markets and acknowledges that it has the potential to do so on a number of important issues.
Beyond the headline subjects, Finance Watch calls on the European Commission to constantly keep in mind, when rolling out the different measures set out in the new Capital Markets Union Action Plan, that making sure that markets can bring capital to the economy is a pre-condition to making the EU sustainable finance agenda effective. This is particularly important in the context of the current health crisis and of the looming climate and environmental crises.
Finance Watch warns also that the Capital Markets Union can only achieve its objectives and contribute to a long-term recovery if existing safeguards for financial stability and consumer protection are maintained, and where necessary strengthened.
Amongst the measures proposed today in the new Capital Markets Union Action Plan, Finance Watch supports the European Commission’s intention to:
- Establish an EU-wide platform to provide investors with access to financial and sustainability related company information. Such a database has a potential to alleviate the challenge of insufficient availability of quality, comparable and reliable ESG data on companies, which is essential to make sustainable finance work in practice (Action 1);
- Propose a common, standardised, EU-wide system for withholding tax relief at source. Among others, the current dispersed system between EU Member States has been, at best, a cause of massive tax arbitrage by financial market players and, in many cases, sheer fraud that has cost Member States’ budgets dozens of billions of euros (Action 10);
- Harmonise Member States insolvency laws through better alignment of national regimes, based on best practice. Among others, it would increase cross-border investment within the EU and reduce the incidence of non-performing loans (Action 11);
- Create a consolidated, pan-European tape for reporting transactions in equities and similar instruments as a way to increase post-trade transparency across markets. To ensure consistency, data should be collected, the tape should be created and managed centrally by an EU agency (Action 14).
- Work towards an enhanced single rulebook for capital markets and improved supervision by assessing the need for further harmonisation of EU rules and monitoring progress towards supervisory convergence. Poor supervisory convergence is one of the biggest problems of EU capital markets and until it is addressed, the very notion of a Union of Capital Markets will not correspond to reality. This issue will be particularly acute when newly adopted EU sustainable finance regulations enter into force (Action 16).
However, Finance Watch cautions also against several actions proposed that bear financial stability risks with no gain for the financing of the real economy, or impact investor protection:
- Watering down the prudential rules for insurers (Solvency II) is not justified in all areas, and lowering banks’ capital requirements for proprietary investment and market-making activities will not improve the ability of capital markets to allocate capital to the economy and could harm financial stability (Action 4);
- Obliging banks to direct SMEs towards alternative providers of funding would only serve to channel activity to the less regulated ‘shadow banking’ sector, increase financial stability risks and possibly lead to massive conflicts of interest, predatory practices and market abuse (Action 5);
- Scaling-up the securitisation market, in particular synthetic securitisation, could accelerate and amplify future financial crises without bringing any benefit to the financing of the economy (Action 6);
- Increasing retail investor participation in capital markets to foster the Capital Markets Union brings potential risks to consumers, if not accompanied by robust and adequate investor protection measures such as appropriate disclosure rules and access to reliable and impartial professional advice (Action 8). Financial education, if good in principle in particular in relation to responsible investing, cannot replace strong investor protection rules (Action 7).
A more detailed analysis of the different action points can be found further below.
Thierry Philipponnat, Head of Research and Advocacy of Finance Watch, said:
“Sound and well-functioning capital markets are important to bring to the European economy the capital it needs. They are also a prerequisite for EU sustainable finance regulations to have an impact on the real world. In that context, the completion of the Capital Markets Union should not be an excuse for lowering prudential requirements and investor protection standards that were introduced for good reasons in the aftermath of the financial crisis, and it should not lead to the development of activities that will bring hypothetical or no benefit to the economy.”
Benoît Lallemand, Secretary General of Finance Watch, said:
“From past experience we know that financial markets need clear rules to allocate capital to productive use in a transparent manner. This point is only reinforced today by the importance of the sustainable finance agenda. For that objective to be reached, we need strong European supervisory authorities with the right rules of governance, strong mandates and proper funding.”
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NOTES FOR EDITORS
The Commission adopted the first CMU action plan in 2015. In her opening statement to the European Parliament, Commission President Ursula Von Der Leyen said: “Let’s finally complete the Capital Markets Union”.
On 24 September 2020, the European Commission presented a new action plan that sets out key measures to deliver on that commitment, including:
Action 1: “Making companies more visible to cross-border investors”
The creation of an EU-wide platform (European single access point) aims to improve the availability and access to financial and sustainability-related company information. Financial institutions need quality, comparable and reliable ESG data on investee companies to consider sustainability risks on financial returns and adverse impacts of their investments and to produce sustainability-related disclosures for retail investors. Public authorities, including supervisors, and civil society also have an interest in such information. Companies have a wide-ranging impact on the climate, environment and society at large and therefore should be accountable not only towards shareholders but towards stakeholders at large.
Such a database should centralise all financial and sustainability-related information currently or soon to be required to disclose under the EU law. This must include information on governance and social matters as well as environmental data under sectoral legislation. Companies not covered by the EU law should be allowed to include data on a voluntary basis.
The European single access point should be built using state-of-the-art and sustainable technology, with revenues coming from the fees paid by its members but data available free of charge and in an electronic and open source format.
Action 4: “Encouraging more long-term and equity financing from institutional investors”
Given that insurers are one of the largest institutional investors, there is merit in assessing whether Solvency II could be amended to further promote long-term investments by insurance companies to help the economic recovery and to finance the EU Green Deal objectives. For example, it would be important to assess the appropriateness of the eligibility criteria for the long-term equity asset class.
However, this should not be used to water down rules under Solvency II in areas where this is not warranted. Likewise, it should not be used as an excuse not to add new measures to the framework, where necessary. It is paramount that the upcoming Solvency II review does not jeopardise financial stability and policyholder protection.
Reviewing the prudential framework for banks in order to encourage them to re-enter the proprietary equity investment business brings more risks than opportunities. The need to separate proprietary and agency business is a lesson learnt, at great cost, from the financial crisis of 2008. Prudential safeguards against excessive risk-taking that were introduced in its aftermath should not be sacrificed, in particular given the lack of evidence about the potential benefit for the ability of capital markets to provide capital to the economy. Improving the return on equity of banks’ market making activities should not be an objective as such for financial regulation.
Action 5: “Directing SMEs to alternative providers of funding”
The suggestion that banks should be required to direct business they are not interested in taking on themselves towards other potential providers is extremely ill-conceived: at best, it channels business, such as lending, away from the regulated banking market and into the less regulated ‘shadow banking’ sector; at worst, it could lead to massive conflicts of interest, predatory practices and market abuse.
Action 6: “Helping banks to lend more to the real economy”
The revival of securitisation can have severe consequences: This technique was at the heart of the financial crisis, as it enabled banks to transform bad quality subprime loans into AAA rated securities.
The promotion of non-bank lending via the Capital Markets Union leads to an even more highly-leveraged, more collateral-intensive financial system, since the revival of securitisation will create more so-called ‘high quality liquid securities’ that can be used as collateral. This makes it all the more urgent to address the negative externalities and systemic concerns related to this practice.
In particular, only securitisations that do finance the real economy should be promoted, and synthetic securitisations should be excluded as they can only amplify market cycles by their complexity. Promoting an STS synthetic securitisation is a contradiction in terms (a synthetic securitisation is neither simple, transparent nor standardised), and it seems to have as its only motive to circumvent bank capital requirements rules such as Basel III.
Action 7: “Empowering citizens through financial literacy”
Financial literacy per se as a mechanism can help retail investors to make good financial decisions. However, this can only be a complementary measure to strengthening investor protection rules (e.g. appropriate disclosure rules and access to reliable and impartial professional advice).
Studies have clearly shown that financial literacy is not sufficient to ensure good outcomes for consumers due to factors such as retail investors’ cognitive biases and the complexity of capital markets.
Action 8: “Building retail investors’ trust in capital markets”
Fair and adequate advice as well as clear and comparable product information are crucial for retail investors. Adjustments to MiFID II and IDD frameworks need to ensure that end-investors are asked about their sustainability preferences at the distribution point. As referred to in the Commission’s consultation on the renewed strategy on sustainable finance, end-investors should always be offered at least one sustainable financial product.
The investor protection standards under MiFID II should be extended to the IDD. Disclosures to retail investors should be made more engaging and understandable for consumers and should include sustainability information in line with the regulation on sustainability‐related disclosures in the financial services sector.
Action 9: “Supporting people in their retirement”
It is important to create systems for monitoring pension adequacy in all Member States and to promote Pillar 2 occupational pension schemes as a complement to Pillar 1 statutory pensions. However, Pillar 2 and 3 pensions should not be viewed as a replacement for the provision of adequate Pillar 1 coverage by Member States.
Action 11: “Making the outcome of cross-border investment more predictable as regards insolvency proceedings”
A better alignment of national regimes, by harmonising member-state insolvency laws based on best practice, could not only lead to more accurate pricing of risk and increased cross-border investment within the EU but would also reduce the incidence of non-performing loans (NPLs), which tend to be concentrated in Member States with inefficient insolvency frameworks. Such an effort would also be highly desirable, and has been long overdue, in the banking sector where divergent national approaches to insolvency have emerged as a major hurdle for the effective implementation of bank recovery and resolution.
Action 12: “Facilitating shareholder engagement”
Shareholder engagement and stewardship can be a powerful tool to drive corporate change towards sustainability. Shareholders, including end-investors, should be able to seamlessly communicate with companies they are invested in, receive all relevant information and be able to table resolutions for AGMs, including on sustainability topics.
Therefore, the recently revised Shareholder Rights Directive has to be properly implemented across all Member States as a matter of priority, which is not the case yet. An evaluation of the implementation of this Directive should be carried out in the coming years. In this context, a harmonisation of the definition of “shareholder” should be indeed considered.
Action 14: “Consolidated tape”
The creation of a consolidated, pan-European tape for reporting transactions in equities and similar instruments is crucial to increase post-trade transparency across markets. To ensure a collection of consistent data, the tape should be created and managed centrally by an EU agency.
Action 16: “Supervision”
Poor supervisory convergence is one of the biggest problems of EU capital markets. Further harmonisation of EU rules and significant improvement of supervisory convergence are indispensable if the EU wants to have a true union of capital markets and to ensure a high level of consumer protection and financial stability across the Union. Within this exercise, the lessons of the Wirecard case should be used to assess which changes are needed to the EU regulatory and supervisory framework.
The review of the European System of Financial Supervision (ESFS) which was recently carried out, started with the right ambition but led to disappointing results without significant changes in the quality of capital markets supervision in the EU nor in the governance of European supervisory authorities. This new exercise should go further than the recent review and create strong European supervisory authorities with the right rules of governance, strong mandates and proper funding.