On 18 February 2015, the European Commission published a green paper on building a Capital Markets Union, alongside two complementary consultation papers on a revised EU framework for securitisation and a review of the Prospectus Directive. The proposals are part of an initiative to develop a more integrated single market for raising capital across the EU. The proposals in the green paper are in outline form because the ideas for creating the Capital Markets Union remain at an early stage of development. However, with an action plan due to be published later in 2015, they provide insight into the early ideas of the Commission. In this note, we explore the main changes proposed.
The green paper1 consults on the establishment of a Capital Markets Union (the "CMU"), the development of which is considered necessary by the Commission to lower the costs of funding within the EU and increase sources of funding for businesses by ensuring the capital markets fulfill a greater role in channeling finance to the economy. The paper identifies five priority areas for early action: (i) reducing barriers that prevent access to capital markets; (ii) widening the potential investor base for small and medium-sized enterprises; (iii) building a sustainable securitisation market; (iv) boosting long-term investment; and (v) developing a more harmonised European private placement market. The Commission is seeking to "create a single market for capital for all 28 member states by removing barriers to cross-border investment within the EU and fostering stronger connections with global capital markets."2
The Prospectus Directive3 consultation seeks views on making it easier for companies to raise capital throughout the EU, whilst maintaining effective investor protection, through simplified disclosure in prospectuses. The consultation on an EU framework for simple, transparent and standardised securitisations aims to develop a regime for high-quality securitisation, through greater standardisation, legal certainty and comparability across securitisations.
The CMU proposals in the green paper are part of the European Commission's commitment to "boosting jobs and growth in Europe."4 The growth objective will be furthered through the Investment Plan for Europe, announced at the end of 2014 (discussed further below).5 The Commission has committed to put in place the building blocks for a well-regulated and integrated CMU for all 28 member states by 2019. Given the various legal and political challenges involved, this is an ambitious timeframe.
Current Status of Capital Market Financing in the EU
Compared with some jurisdictions, capital market financing in Europe is relatively underdeveloped, with corporate finance being more concentrated in the banking sector. In the EU, businesses get approximately 80% of their financing from banks and 20% from debt securities, whereas in the US these ratios are broadly reversed.6 Funding can therefore become constrained when the banking sector is under pressure, as was seen during the recent financial crisis. Funding constraints, in turn, negatively impact growth. This is a particular issue for small and medium enterprises ("SMEs"), which are generally less able than larger corporates to obtain funding in the capital markets. By diversifying the range of available funding sources, particularly for SMEs, a CMU would seek to support sustainable growth across the EU.
Capital markets in the EU are also fragmented along national lines. Different rules, documentation and market practices for securitisations, private placements and crowdfunding7 apply in different member states. Cross-border transactions are hampered by a lack of harmonisation across legal requirements and tax treatments. Insolvency and company laws, for example, are harmonised to only a very limited extent. This fragmentation hinders the free movement of capital across the European single market, and the CMU is the first major cross-sectoral initiative to address this.
Despite rumours which circulated prior to the publication of the proposals, the green paper makes no reference to a new EU-level supervisory body, or "super-regulator," for the CMU. The current intention appears to be to adapt the existing European supervisory framework based around the European Supervisory Authorities ("ESAs").8
The Commission has stressed that it does not intend to produce large volumes of new legislation to facilitate the CMU, but instead will rely principally on adapting existing frameworks or on market-led solutions, where this is feasible. Neither will there be a "big bonfire of existing regulations in the name of growth."9
The CMU also has an international outlook. It is likely that a better functioning single European capital market would both help to attract additional international investment and enhance the global competitiveness of the EU.
In light of this, the CMU will seek to fulfil the following objectives:
- Improving access to financing for all businesses across Europe (in particular SMEs) and investment projects such as infrastructure;
- Increasing and diversifying the sources of funding for investors in the EU and all over the world; and
- Making markets work more effectively and efficiently, linking investors to those who need funding at lower cost, both within member states and cross-border.
Proposed New Initiatives – Short Term
The green paper identifies a number of priority areas for action in the short term.
Review of the Current Prospectus Directive Regime
The EU prospectus regime defines the gateways into the EU capital markets for firms seeking funding and is therefore of critical importance to the CMU. Although some harmonisation has been achieved in the EU under the Prospectus Directive, various barriers remain, including the complexity of the prospectus approvals process and differing implementation of requirements across member states. The Commission has launched a parallel consultation on a review of the current Prospectus Directive regime, with a view to making it easier for companies (including SMEs) to raise capital.10 One key aim is to narrow the circumstances where a prospectus is required, for example, by widening current exemptions for private placements, introducing new exemptions for secondary issuances and improving the "proportionate disclosure regime" (currently limited to rights issues) so that more use can be made of it. In addition, possible extensions are proposed to the scope of the employee share scheme prospectus exemption so that it might apply to employees of non-EU, non-listed companies. However, the Commission is also proposing extending the Prospectus Directive regime so that admissions of securities to trading on multilateral trading facilities (or MTFs) should also trigger the requirement for a prospectus, as is currently the case with admissions on exchanges, to create a level playing field and harmonise disclosure requirements. Another area of focus is streamlining the prospectus approval process. Unlike other EU passporting regimes, the Prospectus Directive does not provide for automatic passporting of a prospectus approved in one member state into other member states. Translations are required of the prospectus summary, which presents an additional cost that issuers prefer to avoid, and there are often concerns about bank or auditor liability for a broader retail distribution. Simplifying the information required in a prospectus to make it more accessible for investors, including by limiting the length of a prospectus, is also an identified priority. Other possible changes to the prospectus approval process include allowing issuers to carry out certain marketing activities which go beyond "advertising" (as currently permitted) while also requiring draft prospectuses submitted for approval to be made public.
Improving Credit Information on SMEs
SMEs in particular faced challenges in obtaining funding during the financial crisis. A limited amount of financial and other information on SMEs is publicly available, and as a result they have more difficulty in obtaining non-bank investment. The Commission proposes an improved SME credit information framework, with a common minimum set of standards for credit reporting and assessment, aimed at helping SMEs to attract funding without being too burdensome. This could also contribute to the development of SME securitisations or other methods of refinancing SME loans. More publicly available credit scoring is also put forward as a way to diversify lending sources for innovative and high growth start-ups.
Encouraging 'High-Quality' Securitisation
Securitisation can provide a mechanism for transferring risk and increasing capacity for banks to lend. However, the EU securitisation market has not fully recovered since the financial crisis. Regulation of securitisation was tightened post-crisis with the introduction of a "skin in the game" risk retention requirement for originators or sponsors of securitisations and stricter capital requirements for securitisation exposures of banks and insurers.
The Commission has issued a separate consultation paper on an EU framework for simple, transparent and standardised securitisations.11 The proposed EU securitisation framework will aim to:
- Restart markets on a more sustainable basis, so that simple, transparent and standardised securitisations can act as an effective funding channel to the economy;
- Allow for efficient and effective risk transfers to a broad set of institutional investors as well as banks;
- Allow securitisation to function as an effective funding mechanism for some non-banks as well as banks; and
- Protect investors and manage systemic risk by avoiding a resurgence of the flawed "originate to distribute" models.
Existing EU legislation has already introduced a notion of good quality securitisation which permits insurers to hold more risk-sensitive capital.12 Further reforms will build on this framework and on the work already begun by the EBA.13 A number of EU, UK and international bodies including BCBS/IOSCO are also currently working on proposals on this topic.14
Supporting Take Up of Long-Term Investment Funds
Growth in the EU is being hindered by low levels of investment, which have not recovered since the financial crisis. In Novmeber 2014, the Commission announced an EU Investment Plan to unlock public and private investments in the economy of at least €315 billion over the next three years, through the establishment of the European Fund for Strategic Investment and a range of other measures.
Political agreement was reached on 27 Novmeber 2014 on the proposed Regulation on European Long-term Investment Funds ("ELTIF"), although the final legislative text remains outstanding.15 An ELTIF is a new type of Alternative Investment Fund ("AIF") through which investors (including retail investors) can invest in companies and projects needing long-term capital. It is thought that these vehicles will appeal to insurance companies and pension funds which need steady income streams or long-term capital growth. Marketing of ELTIFs could possibly begin by mid-2015.
Views are requested in the green paper on what further role the Commission and member states could play in supporting the take-up of ELTIFs, including the possible extension to ELTIFs of advantages currently available under national regimes.
Developing European Private Placement Markets
The private placements targeted in the proposals are medium- to long-term senior debt obligations issued privately by companies to a small group of investors or to institutional investors only. In most EU countries, the private placement market is small. The exceptions are Germany and France, which between them accounted for approximately €15 billion of issuances in 2013.
The EU has few institutions which typically invest in private placement issuances and companies are therefore generally reluctant to undertake them. Instead, many EU companies access the US private placement market to raise capital.
The International Capital Market Association ("ICMA") set up a working group in mid-2014 to promote the EU private placement market.16 Various private-sector bodies, the UK Treasury and the Banque de France are involved. A market guide has been established setting out standardised structures, practices and documentation compatible with different legal regimes.17 The Commission welcomes this market-led approach, which it suggests could help facilitate the creation of a European private placement regime in the short term.
In addition, many countries have preferential tax treatment for listed securities which discourages private placements. In the UK, a new exemption from withholding tax for interest on private placements was included in HM Treasury's 2014 Autumn Statement.18
1. European Commission, Green Paper: Building a Capital Markets Union, 18 February 2015.
2. Green Paper, p.5.
3. Directive 2003/71/EC, as amended.
4. Jonathan Hill, "Unlocking Funding for Europe's Growth" (Speech) Brussels, 18 February 2015.
5. Communication from the Commission to the European Parliament, the Council, the European Central Bank, the European Economic and Social Committee, the Committee of the Regions and the European Investment Bank: An Investment Plan for Europe /* COM/2014/0903, 26 November 2014.
6. Jonathan Hill, Capital Markets Union – finance serving the economy (speech) Brussels, 6 Novmeber 2014.
7. The European Banking Authority published an opinion on 26 February 2015 proposing the harmonisation of practices across the EU for the supervision of crowdfunding in order to avoid regulatory arbitrage, create a level playing field, ensure that market participants have confidence in crowdfunding as a market innovation and contribute to the single European Market, see: https://www.eba.europa.eu/documents/10180/983359/EBA-Op-2015-03+(EBA+Opinion+on+lending+based+Crowdfunding).pdf.
8. Jonathan Hill, Capital Markets Union – finance serving the economy (speech) Brussels, 6 Novmeber 2014.
9. Jonathan Hill, Capital Markets Union – finance serving the economy (speech) Brussels, 6 Novmeber 2014.
10. Commission, Consultation Document, Review of the Prospectus Directive, 18 February 2015.
11. Commission, Consultation Document, An EU framework for simple, transparent and standardised securitisation, 18 February 2015.
12. On 10 October 2014, the Commission published delegated acts under Directive 2009/138/EC ("Solvency II") and Regulation 575/2013 ("CRR") on the Liquidity Coverage Ratio. Securitisation positions of banks and insurance firms will be eligible for a more proportionate and risk-sensitive prudential treatment, provided that they meet a set of eligibility criteria relating to the nature and underwriting process of underlying exposures, and structural and transparency features (http://europa.eu/rapid/press-release_IP-14-1119_en.htm?locale=en).
13. On 14 October 2014, the EBA published a discussion paper on "simple, standard and transparent securitisations" (EBA Discussion Paper on simple standard and transparent securitisations (EBA/DP/2014/02, 14 October 2014)). The EBA proposes: (i) a differing regulatory treatment for "structurally risky" securitisations and those that are "simple, standard and transparent" ("qualifying securitisations"); (ii) qualifying securitisations will be those meeting: (a) a set of criteria on simplicity, standardisation and transparency; and (b) a minimum credit quality of the underlying exposures; (iii) capital treatment of securitisations should be conservative but broadly consistent with the capital requirements for the underlying portfolio; and (iv) a systematic review of the regulatory framework for securitisation transactions should be carried out, comparing it to other frameworks such as for covered bonds.
14. Joint Bank of England and EBA Discussion Paper: The case for a better functioning securitisation market in the European Union, May 2014. The BCBS and IOSCO announced on 3 July 2014 that they are co-leading a task force that will undertake a wide-ranging survey of securitisation markets worldwide. On 11 December 2014, the BCBS published a revised securitisation framework (http://www.bis.org/bcbs/publ/d303.pdf).
16. ICMA Press Release: "Trade bodies join forces to promote EU Private Placement market", 12 June 2014.
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