UK Response to the Commission Green Paper on Capital Markets Union BUILDING A STRONG CAPITAL MARKETS UNION

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1 UK Response to the Commission Green Paper on Capital Markets Union BUILDING A STRONG CAPITAL MARKETS UNION The UK welcomes the opportunity to respond to this consultation. Creating a Capital Markets Union is an exciting opportunity, to which the UK is fully committed and which we regard as being of critical importance to building a stronger and more competitive European economy. The views below represent the UK Government s response to the Green Paper. The Bank of England and the Financial Conduct Authority will be submitting separate responses. A fully functioning single market in capital would see more efficient allocation of capital without constraint due to location, diversification of sources of finance for businesses, provide confidence to investors accessing markets, and a decreased reliance on bank funding. In turn, risk would be shared beyond borders and national banking sectors, cushioning local shocks and contributing to sustainable economic growth. These are ambitions that will take time to achieve but they are of central importance to the future growth and competitiveness of the EU and its economies. We are not at the beginning of the journey towards a single market in capital. The last five years has seen an unprecedented level of reform to improve stability and raise standards of conduct in European financial markets. This reform, undertaken in response to crisis, has also represented a major contribution to the harmonisation of rules that is essential to achieving a single market. The creation of a Banking Union for supervision and resolution of the euro area s major banks was a core component of reform to stabilise and strengthen the single currency. In improving risk diversification and resilience to banking shocks, CMU is complementary to the Banking Union. But it is very distinct from it in terms of its direction, drivers and levers for change. Rather than the stabilisation of the currency area and the need to break the link between sovereigns and banks, CMU is directed at achieving integration of markets across all 28 member states in order directly to contribute to growth and competitiveness. And it is distinct from the other unions energy, customs and innovation unions for example because the legislative framework to support cross border capital flows is already broadly in place. That framework is built on more than fifty years of reforms and integration, establishing free movement of capital, one of the fundamental freedoms of the Treaty of Rome. Yet barriers to a single market for capital remain. Given the recent history of reform and harmonisation, it is unlikely that a legislative package or new harmonising measures alone would provide the right levers to address the remaining obstacles to building a single market in capital. In some cases further work will be needed to understand more deeply the blocks to movement of capital and the specificities of local markets that will need to be addressed. In the next phase of the journey towards a capital markets union, we will need to make progress by analysis, knowledge sharing and facilitation of technical assistance rather than through legislation to enable markets to develop. Rightly, the Commission has indicated that bottom-up industry led approaches and sharing national best practices will be at the core of this European initiative. We strongly welcome this new way of working. Revision and reform of existing EU legislation will undoubtedly be required and possibly some further harmonisation; but we believe industry and Member State led initiatives will be among the principal means of achieving CMU. The new Investment Plan for Europe is both emblematic of the shift away from healing the damage of the crisis towards achieving jobs and growth, and an important means of achieving it. Like President Juncker s Investment Plan, CMU will underpin economic growth in Europe.

2 The need is acute. Europe saw growth flatline at 0.1% in , and its capital market integration has gone into reverse. Global capital flows remain more than 60% below their 2007 peak; Europe accounts for 70% of this drop and intra-eu flows have fallen by 74% 234. In this paper we set out the principles we believe should underpin the development of the Commission s Action Plan for the CMU and the actions we think are essential in the immediate, medium, and longer term to develop the capital markets that will sustain and strengthen Europe into the future. PRINCIPLES FOR DEVELOPING A CAPITAL MARKETS UNION In developing our priorities, we have employed the following principles. These principles would form a reasonable basis for drawing up the Action Plan that follows this Green Paper. Key Principle 1: Every initiative should aim to contribute to sustainable growth and competitiveness in the EU CMU measures should improve competitiveness and growth in the EU. Europe s share of global GDP has fallen from 30% in 2007 to 23% in Over the same period, Member States average ranking on the World Economic Forum s Global Competitiveness Index has fallen from 34 to 38 out of 144. Europe s competitiveness on Financial Market Development has particularly suffered, with average rankings falling from 36 to At the EU as well as Member State level we must therefore strive to improve competitiveness, a key driver of growth, and attract international investment which has also declined by 9.5 billion (13.5%) over the same period 7. Key to this will be both clarity of strategic direction and ambition in respect of CMU and maintaining financial stability in order to provide certainty to investors both in Europe and internationally. Financial markets are the foundation of economic prosperity, setting the framework for the investment decisions that lead to job creation and growth. A successful CMU will underpin Europe s future economic strategy. All measures enacted as part of the CMU programme must be thoroughly assessed for their impact on both growth and competitiveness and must not undermine the stability of the financial system. We welcome the Commission s current focus on improving the impact assessment process and suggest that impact on growth should be given far greater weight. This applies not only to prospective legislation, but also the substantial number of outstanding Level 2 measures, which will have a considerable impact on the overall legislative framework. 1 Eurostat 2 McKinsey Global Institute Report (2013): Financial globalization: Retreat or reset? 3 ECB s Financial Integration Report Commission Staff Working Document on the movement of capital and freedom of payments, March As measured by International Investment Position,

3 Key Principle 2: Initiatives should be assessed and prioritised on the basis of impact and feasibility The Commission must prioritise effectively and concentrate on areas which will genuinely make a difference to completing the single market in capital. The Commission should not shy away from tackling difficult issues where progress has stalled in the past. But CMU should not be used as cover to push through controversial changes which will make little progress towards the initiative s objectives. Nor should we risk progress stalling in lengthy negotiations over measures that are not clearly central to addressing barriers to the growth of capital markets across the EU. In this stage of its development, we need measures that are supported by a strong evidence base and can deliver material impact on jobs and growth in a reasonable timeframe. We recognise the importance of improving the supply of finance to SMEs. Several of our recommendations support this goal. However, it is important to recognise that SMEs do not need to directly access capital markets to feel the benefits of CMU. The Commission should be clear that CMU will also benefit those firms that will always rely on bank funding, because CMU will help banks focus on their core role in the economy. Businesses of all sizes in all sectors will benefit, being better able to access appropriate funding channels. In this way high growth businesses will flourish and investment will remain inside the Union. Key Principle 3: The Commission should require a high burden of proof to justify the creation of new market infrastructures or institutional change Wholesale markets are in the process of significant reform. The revised MiFID will introduce the Organised Trading Facility, trading obligations for certain derivatives and shares, new pre and post-trade transparency requirements, SME growth markets and a consolidated tape, while reforms under EMIR and CSDR are also in the process of being implemented. This is the most comprehensive suite of financial market reforms ever undertaken and the Commission should avoid making significant further changes to market structure. Rather than establish new infrastructures via legislation, the Commission should focus on removing barriers and creating the right incentives to allow the market to develop the most appropriate solution. This Key Principle also applies in the context of European institutions. While fine tuning of the European System of Financial Supervision (ESFS) may be required, no major changes are necessary to deliver CMU. In particular the UK could not support the transfer of direct supervision of UK market infrastructures or firms to European level. Supervisory responsibility must align with the responsibility for the fiscal backstop and resolution of financial infrastructure and institutions. For example, there is already a single EU rulebook set by the EMIR regulation that implements internationally agreed standards, and NCAs exercise supervisory responsibility in cooperation with a college of other EU authorities. It would be reasonable to expect that supervisory oversight will be carried out more effectively in jurisdictions where the responsibility for maintaining the safety and soundness of CCPs also sits with the jurisdiction that would bear the implications of failure. Fragmenting and duplicating responsibilities will create risks that far outweigh any speculative gains from consolidation at EU level. Capital Markets Union will require safe and resilient market infrastructures and a level playing field between them, which the current supervisory model (itself only 4 years old) was designed to achieve.

4 UK PRIORITIES The UK welcomes the open nature of the Commission s consultation, which should provide a firm evidence base on which to base policy responses. The Action Plan must set out, on the basis of this consultation, a set of evidenced priorities that have impact. In the immediate term, Capital Markets Union should focus on: 1. Restarting the securitisation market The Commission should adopt a proposal for a Directive on simple, transparent and standardised securitisation. The Directive should establish a clear set of criteria to designate qualifying securitisations and an effective and robust verification mechanism. Legislation should enable appropriate prudential capture of risk, ensure appropriate incentives for issuers and investors and enable securitisation to compete fairly with other asset classes. In particular this would enable medium sized banks, which typically use standardised models, to take advantage of opportunities to diversity their funding and serve the real economy. 2. Lowering the barriers to accessing capital markets The Commission should review the Prospectus Directive to strike a better balance between access to capital markets and investor protection. This should: i. Raise the exemption thresholds, so more small offers can be carried out without a prospectus ii. Review prospectus content to prevent excessively lengthy documents iii. Review whether the current arrangements for ex ante approval of prospectuses are appropriate in all cases iv. Ensure the costs faced by SMEs are significantly reduced Responses to a UK Government consultation in 2010 suggested that preparing a prospectus for a 5m ( 7m) public offer can cost between 350,000 and 600,000 ( 490, ,000), putting the capital market beyond the reach of too many SMEs. Reforms in the areas outlined above would allow more SMEs to access markets at lower cost, without compromising investor protection. 3. Supporting development of a pan-european private placement market The Commission should: i. Support the development of market standards, standard legal documentation, and in due course, a secondary market ii. Share best practice, particularly of successful withholding tax initiatives. iii. Explore the costs and benefits of emulating the US National Association of Insurance Commissioners credit scoring system Last year, the UK introduced a new exemption from withholding tax for private placements. In response, six major institutional investors committed to invest around 9 billion ( 13 billion) in private placements and other direct lending to UK companies over the next five years. Other Member States should consider their own exemptions and the Commission should seek to establish and share best practice. In the US, National Association of Insurance Commissioners credit scores are a key feature of the successful private placement market. The NAIC, a central body for state-level insurance regulators, provides ratings services to US insurers investing in private placements The Commission could carry out a cost-benefit analysis of the idea of an EU equivalent.

5 4. Opening the market for SME lending by establishing minimum standards for SME credit information The Commission should recommend minimum standards to ensure: i. Credit information is of a high quality which includes both positive data, such as payment performance, and negative data, such as defaults. ii. There is adequate infrastructure in place to allow data to be shared. iii. Information is shared on an equal basis between banks and non-banks. There is currently a high degree of diversity in the EU in terms of what credit information is shared, by whom, how it is shared and who has access to it. This diversity means harmonisation in this area is likely to be difficult to achieve in the short term, while the largely domestic nature of these markets also points towards Member State action being more effective than European legislation in tackling the issue. We support the excellent work of the Commission in mapping the information that is currently available throughout the EU. The Commission should use this work to establish best practice and form the basis of official recommendations. 5. Removing barriers to funds operating cross-border The Commission should support the role of investment funds as alternative finance providers and identify and remove barriers to their operation across the EU. The Commission should review UCITS and AIFMD: i. Removing scope for Member States to impose additional requirements ii. Removing requirements for UCITS to appoint paying agents in each jurisdiction iii. Ensuring digital media is on an equal footing to traditional paper disclosure methods Investment funds are a significant source of funds in the EU. Commission work should focus on increasing this source of non-bank funding by identifying and removing barriers to growth and their operation cross border. Under both the AIFMD and the UCITS passports, some national regulators have imposed super-equivalent requirements. This increases legal uncertainty for managers, adds cost, and discourages them from operating in other jurisdictions. The Commission should review these Directives in order to identify barriers with a view to achieving greater consistency, which would encourage funds to market cross border, increasing competition and choice in the market and creating new investment and financing opportunities. Legislation should also be updated to ensure it reflects emerging electronic distribution practices. In the medium term, Capital Markets Union should focus on: 6. Establishing vibrant venture capital markets in every Member State The Commission should study the effectiveness of Member State interventions in venture and seed capital markets with a view to establishing best practice and issuing Country Specific Recommendations. The EIB and EIF should publish details and analysis of their investment returns. Member States take varied approaches to supporting venture capital, but there has been little independent study comparing interventions. The Commission should establish best practices to assist Member States in designing effective interventions tailored to their jurisdictions. Institutional investment in European venture capital is hampered by a perception of poor returns. As a significant investor in the sector, EIB and EIF should publish details of their investment returns to the fullest extent possible under their transparency framework.

6 7. Developing European corporate bond markets ESMA should ensure MiFID II pre-trade transparency requirements are appropriately designed to support liquidity. The Commission should undertake a root-and-branch review of European corporate bond markets including drawing upon the conclusions of the UK s Fair and Effective Markets Review. MiFID II brings significant reforms to the transparency of corporate bond transactions. Inappropriate calibration in this area could have significant impact on secondary market liquidity. ESMA should introduce new requirements very carefully, closely following the level 1 provisions. There are a range of views regarding the extent and nature of possible illiquidity problems in European corporate bond markets and the likely efficacy of potential solutions. A comprehensive review in this area would enable any future policy interventions to be appropriately targeted. This review can build on international work looking at market-based finance and shadow banking including the UK s Fair and Effective Markets Review, which will report in June. 8. Promoting international consistency, cooperation and trade The Commission should actively engage in dialogue with key international partners to promote internationally consistent standards. The Commission should agree to a set of principles aimed at ensuring third country provisions are appropriately designed. Divergent standards lead to market fragmentation and regulatory arbitrage, undermining financial stability and European competitiveness. The Commission should seek to promote international consistency, making it easier for businesses to operate and capital to flow across international borders. Europe must remain open to international business. The Commission should establish a set of principles governing the design of third country provisions to ensure that, where regimes are appropriate, they are tailored to their justification for existence and are coherent with the international regulatory context. Equivalence assessments must be outcomes-based and proportionate. 9. Ensuring the ESAs contribute to a competitive Europe The ESAs should focus on fulfilling their existing mandate. The Commission should review the ESA Regulations, to include a binding requirement for all ESAs to consider competition. The ESAs have a critical role to play in ensuring high standards of implementation and co-ordinated supervision, which are fundamental to the success of CMU. While new ESA powers are not necessary for the development of CMU, the institutions can become more effective. To this end, the ESAs should have a binding requirement to consider competition when discharging their existing powers, particularly when drafting legislation. Competition is at the heart of efficient, open, and resilient economies and must therefore be at the heart of a successful Capital Markets Union. The ESAs should employ competition considerations as an additional tool to make financial services markets work better and more efficiently for all participants.

7 Over the longer term, Capital Markets Union should focus on: 10. Building capability in all Member States The Commission should undertake a comprehensive review of capital markets capability to: i. Establish best practices for Member State interventions aimed at promoting capital markets capability and assisting national governments where necessary ii. Recommend an EBRD technical assistance programme aimed at improving capability in Member States with underdeveloped capital markets iii. Support Member States to create business and investor education programmes and cross border apprenticeships Attitudes, awareness, and capability in respect of market based financing are not uniform across the EU, with the need more acute in some Member States. These Member States need assistance on a fundamental level to address local cultural barriers and build supply and demand from the bottom up. The Commission should assist these Member States where necessary, helping them to design business and investor education programmes and cross border apprenticeships to build skills and experience and pursue an EBRD technical assistance programme. We believe there is a very positive and substantial agenda for action required to develop a strong capital markets union including a mix of industry led initiatives, reviewing and refining the existing legal framework and indeed further legislation. However, we do not see value in progressing the following measures: 1. Transfer of direct supervisory responsibilities to European institutions Supervision of market infrastructures such as Central Counterparties and Central Securities Depositaries must remain at Member State level. Creation of a single supervisor would not remove barriers to capital flows or have relevance to the development of markets. 2. A 29 th regime for harmonisation of personal pensions This would not contribute to CMU objectives and cannot be justified on subsidiarity or proportionality grounds. 3. Tax harmonisation Member States tailor tax systems to the specific features of their jurisdiction. Measures to attempt tax harmonisation that would be lengthy and difficult to achieve given direct tax is a Member State competence and decided by unanimity. Furthermore, it is unlikely that such measures could be justified on subsidiarity grounds. 4. Harmonisation of insolvency laws Full harmonisation of insolvency laws is not practicable in the short or medium term. CMU should provide Member States with the impetus to consider whether their insolvency regime acts as a barrier to cross border investment. The Commission should focus on supporting Member States to build effective infrastructure and supporting professional services.

8 NEXT STEPS Improving the provision of capital market financing to business and achieving a single market in capital are long term goals and will take many years to achieve fully. We need to start now, taking action where there is a clear evidence base in support of initiatives by the Commission and by Member States. We can also take the time to complete further in-depth research on some important issues where we still need to build the evidence base to support action. With the right programme of reforms, we should be able to look back at the end of Commission s mandate to see significant progress, with burgeoning capital markets in every Member State. Flows of capital between Member States will increase, with businesses of all sizes finding it easier to access capital both in the home market and elsewhere. Businesses will be better informed about their financing options and the financial sector better able to meet their funding needs. The EU will be more competitive, with higher growth and better productivity. The EU will be a more attractive destination for international investors; and all investors will feel more confident about pursuing a wider range of investment opportunities and channels. The issues outlined in this note are important to the UK and, we believe, would be key drivers of this transformation. They should form a central part of the CMU reform programme. Given the relatively short time we have had to consider the issues in the Green Paper, there will be areas for action which the UK may want to build upon or has not yet identified. In particular, the Bank of England and FCA will also submit their own responses to this consultation. The UK is fully prepared to consider any measures which contribute to CMU where action can be justified by evidence and respects the principles of subsidiarity and proportionality. In line with the Commission s Better Regulation initiative, legislative proposals should be subject to a robust impact assessment, be directed at achieving the Commission s own objectives for CMU and should be pursued only where non-legislative measures are known not to be sufficient. With the most developed capital markets in Europe, the UK has a key role to play in building a Capital Markets Union. The UK will participate actively in the debate that follows this Green Paper to set the direction of CMU. The Commission must act decisively and above all, the CMU Action Plan should send a clear message: Europe is open for business.