CMU mid-term review: "Priorities remain unchanged, despite concerns raised by CSOs"
CAPITAL MARKETS UNION MID-TERM REVIEW
"Priorities remain unchanged, despite concerns raised by CSOs"
23 January 2017, Brussels – The European Commission is launching today a public consultation on the planned Capital Markets Union (CMU) mid-term review. Finance Watch, the public interest advocacy group working to make finance serve society, notes that CMU retains a number of major flaws that still need addressing, but also some welcome initiatives, such as developing common definitions and standards on sustainable finance, and addressing the tax bias for debt over equity.
Frédéric Hache, head of policy analysis, said: "The current corporate tax regime allows debt interest to be deducted from taxable income but not dividends on equity. This incentivises financial institutions to borrow excessively, in turn making them more fragile and less able to absorb potential losses. We welcome steps to address this bias towards debt-funding.
“However, the review confirms that the priorities of CMU remain mostly unchanged, despite the concerns raised by civil society organisations."
The Capital Markets Union seeks to:
1. Better connect savings to investment. We understand this to refer to the push to shift retail savings away from bank deposits and to capital markets "to provide rewarding investment opportunities for savers and retirement provision." This raises many concerns: not only might this increase the risk of mis-selling but it might also give the erroneous perception that investing in capital markets will increase returns, all other things being equal. Yet there is no such thing as a "free lunch", or in other words investing in capital markets does not increase returns per se for the same amount of risk (See "A missed opportunity to revive boring finance" p23-24). This is particularly problematic if we understand this push to be linked to the expected development of second and third-pillar pension schemes.
2. Enhance private risk-sharing. We understand this to refer to the promotion of public private partnerships, despite their mixed track record, generally higher cost for the taxpayer and their assessment as "budgetary time bombs" (Ibid p 20-23).
3. Provide alternative sources of financing and break the EU's reliance on bank lending. Phrased differently, CMU is promoting non-bank lending (also called shadow banking) over traditional banking. This raises a number of concerns:
- Firstly, while the European economy does indeed rely significantly on bank lending, this is not the same as being over-reliant.
- Secondly, there is a wide academic consensus on the fact that whether an economy is financed by banks or capital markets has no meaningful impact on growth. It follows that there is no valid case for governments to promote one type of financing over the other.
- In addition, while being reliant on bank lending exposes companies to a reduction in bank lending, being reliant on capital market financing might arguably be far more dangerous, given the well-known manic-depressive behaviour of financial markets.
4. Remove obstacles to the free flow of capital across borders to strengthen the Economic and Monetary Union. While we support an integration of capital markets, pursuing the European integration via capital markets will likely never be a stable alternative to a fiscal union. The recent crisis has shown that the temporary convergence of borrowing rates for different Members States led to a brutal divergence when confidence disappeared.
5. Support the strengthening of banks. Yet it rather supports a very specific banking model, the universal and investment banking models that had to be bailed out during the crisis:
- Promoting STS securitisation will mostly benefit too-big-too-fail universal and investment banks, as they are the ones that will manufacture and use securitisation.
- At the same time promoting a shift in retail savings from bank deposits to capital markets will weaken traditional banks' ability finance the real economy. Retail deposits are a more important source of funding for traditional banks, whereas larger banks mostly borrow short term on financial markets.