The EU claims it wants its capital markets to be as deep and liquid as those in the US – in line with its programme for capital markets integration. Despite numerous attempts to create a Capital Markets Union, the European capital markets are far from integrated. Stanislas Yassukovich – the euromarket pioneer who was Deputy Chairman of the Stock Exchange during and after the 1986 Big Bang – goes further and argues that there is ‘certainly [no “single market”] in financial services. …As there is no unified capital market and no European stock exchange, the regulation of financial services, focused largely on investor protection, is at national not EU level’.
Excessive financial regulation
Where there are financial regulations at EU level, these tend to be protectionist, excessive or ineffective – and this is impeding rather than promoting the process of integration. Here are some examples:
• Markets in Financial Instruments Directive (MiFID) II – dealing with the trading of and the provision of services by investment intermediaries relating to financial instruments (e.g., shares, bonds, units in collective investment schemes and derivatives). Jeff Sprecher, CEO of Intercontinental Exchange, has described MiFID II – which came into effect in January 2018 – as ‘a terrible piece of legislation that imposes tremendous costs on the industry’. MiFID II grew out of the G20 financial regulation principles established in 2009 to reduce systemic risk following the Global Financial Crisis, but has been criticised as being excessively complex and its implementation was delayed by a year.
One particular issue is the unbundling of investment research and transaction costs. MiFID II, in order to achieve full cost transparency for end customers, has ended the standard industry practice of brokerage firms providing investment research free of charge in return for execution business. McKinsey has estimated that the profits of European asset managers that pay for research in full will be reduced by 15-20%. Larry Fink, CEO of BlackRock, expressed concern that MiFID II could lead to a dearth of research coverage focused on smaller listed companies.
Crispin Odey, of Odey Asset Management, believes that MiFID II will lead to fewer trades, reduced price discovery and less efficient markets. Another issue is the reporting of trades to regulators within a specified time – the cost of which has encouraged some hedge funds, such as Brevan Howard and Tudor, to register under the Alternative Investment Fund Managers Directive [AIFMD] rather than under MiFID II. The total cost to the finance industry of implementing MiFID II has been estimated at more than €2.5bn. Within months of its introduction, trading in a number of futures and options contracts was moved from London to the US and European investment banks were losing business to their US rivals.
• The Capital Requirements Directive IV is damaging for EU financial markets in terms of restrictions on cross-border lending and a bankers’ bonus cap.
• Solvency II. The Treasury select committee announced an inquiry into the ‘manifest shortcomings’ of the Solvency II Directive dealing with insurance companies. It received numerous criticisms from industry practitioners, including the risk of procyclicality and market distortion, and the volume and complexity of data required from firms.
The effect of all these regulations – which were designed to protect investors – is to reduce competition – which ends up being detrimental to investors. A clear illustration of this comes from a report from New City Initiative, entitled M&A in Asset Management: Is it stifling competition? The report shows that fund managers’ costs have ‘increased exponentially’ as a result of regulations such as MiFID II, AIFMD, PRIIPs, UCITS V and GDPR which have increased the burden on compliance departments. This, in turn, has led to mergers across the fund management industry because ‘larger enterprises can better absorb the increasing costs that come from running an asset management business in 2019’. But there is a risk that these mergers ‘are drowning out competition and undermining investor choice’. It pointed out that the top 20 largest fund managers have 43% ($41tn) of the top 500 assets under management: ‘For investors, this represents serious risk concentration risk’.
Excessive reliance of bank borrowing
In addition to excessive regulation, there is another important factor that is limiting the growth of Europe’s capital markets and that, according to Larry Fink, CEO of BlackRock, is Europe’s ‘excessive reliance’ (around 70%) on borrowing from banks and insurers to fund growth. He claimed that the problems European companies face when accessing bond and equity markets had ‘stifled economic recovery’ on the continent: ‘In the years since the crisis, much of Europe’s economic potential has been locked up. Strengthening capital markets and retirement systems can help unlock that potential, and doing so will be vital to Europe’s economic future’. He also said that European bond markets are complicated by different insolvency laws across member states: ‘The lack of a unified European corporate bond market raises costs for companies, deters investors and holds down liquidity’.
Fink praised the European Commission’s efforts to unify European capital markets, under the Capital Markets Union project, but he also warned that the EU was ‘pulling itself in two directions’, claiming that other initiatives, such as new capital rules for insurers under Solvency II, could ‘severely restrict a key source of funding for European companies. While a long-term objective is greater funding from capital markets, limiting insurance companies’ capacity for investment before capital markets are fully developed could significantly damage growth’.
Underlying all this is a widespread and long-standing hostility on the European continent to money and finance, given the risk that they cannot be completely controlled from the centre and so can disrupt well-laid plans. This is clearly reflected in the Plan for a European Economic Community launched in Germany in 1942 – as I explained in a previous Briefing for Brexit. Modern-day France is also opposed to ‘finance capital’ – as exemplified by François Hollande who, when elected President, announced that his ‘only real enemy’ was the ‘world of finance’.
The failure of the banking system to fund European equivalents of Apple, Amazon, Facebook, Alibaba and Tencent has led Ursula von der Leyen, the next European Commission President, to consider launching a €100bn ‘European Future Fund’, since these US and Chinese tech giants have ‘the potential to obliterate the existing innovation dynamics and industrial position of EU industry in certain sectors’. This top-down approach to meeting this challenge is entirely consistent with the underlying economic philosophy behind the 1942 Plan which is ‘state economic leadership’ over heavily regulated private sector companies which are expected to operate as efficiently as possible using the latest available technologies. By contrast, the laissez faire approach adopted by the UK has resulted in the UK being Europe’s largest recipient of foreign direct investment in high tech, with more than £9bn invested between 2015 and 2018, and £5.5bn in the first seven months of 2019 alone.
A threat to the City of London
The City of London is not only a global financial centre, it is also Europe’s financial centre – it does six times more business in the EU than vice versa. It is therefore deeply concerning that the Withdrawal Agreement and Political Declaration would allow the EU to continue to regulate our financial services after Brexit. Christine Lagarde, the new president of the European Central Bank, has also made it abundantly clear that she wants to move as much as possible of our financial services to the continent after we leave. Given the failure of the Single Market in financial services, the implications of this act of vandalism – all in the name of ‘completing the Single Market’ – for the future of financial services both in the UK and the EU are mind blowing.