Independent market research for the future investor.

(Giorgio Curti, Jeanne Royer & Sonia Ruan Ye)

“Capital markets are vital to the recovery, because public financing alone will not be enough to get our economies back on track,” said Valdis Dombrovskis, the Commission’s executive Vice-President (European Commission, 2020). On the 24th of July 2020, the European Commission adopted a Capital Markets Recovery Package, in order to facilitate support from capital markets to European businesses who suffered during the Covid-19 crisis. This package contains modifications to the Prospectus Regulation, to MiFID II, and to securitisation rules, which we will go into further detail later on. These changes aim to encourage more investing into the economy, increase banks’ capacity to finance the recovery and permit a rapid re-capitalization of companies. These measures follow the implementation of a banking package on the 28th of April, whose goal is to help banks lend money to businesses and households. A wider Capital Markets Union Action Plan is to be presented by the Commission later in September. 

An overview of the current state of EU capital markets

In light of the European Union (EU) stimulus deal of €750 billion coronavirus relief package, the Eurozone’s outlook has improved since the Covid-19 crisis.

Nevertheless, according to economists surveyed between the 22nd and 28th of July, it would take at least two entire years for the Eurozone’s GDP to reach pre-COVID-19 levels, despite the trillion-euro stimulus packages from the governments and the European Central Bank.

Moreover, around three out of four economists in the survey, or 29 of 38, said their confidence around the prospects for Eurozone economies, from next year onward, had improved (including three who said it had significantly improved). For now, they only marginally upgraded their growth forecasts.

“While the size of the fund is not large enough to be a game changer from a macroeconomic perspective, common issuance of this magnitude of debt is a historic step for Europe and represents a pivotal change in the way the EU tackles crises,” said Angel Talavera, head of European economics at Oxford Economics.

“Given the size and extent of the shock, it [the EU stimulus] can only smooth things out, not completely cancel any of the negative factors,” said Yvan Mamalet, senior Eurozone economist at Société Générale.“

In 2021, the economy is expected to expand 1.4% in the first quarter, followed by 1.1%, 0.8% and 0.6% in the second, third and fourth quarters. These new predictions are slightly better than median predictions for growth at 1.0%, 0.6% and 0.6% which were made just before the deal was agreed, which illustrates the positive impact it has had.

The amendments to capital markets regulations and analysis

• Amendments to the Prospectus Regulation

When a company issues shares and bonds, it is required by the EU Prospectus Regulation to give to its investors a prospectus. This provides investors with information and makes it easier for companies to raise capital through EU Capital Markets. 

In its Package, the Commission proposes a temporary, shorter “EU Recovery Prospectus”, which would be easier for companies to produce, easier for investors to comprehend, and easier to scrutinise for national competent authorities. This measure will help businesses raise capital by making the process simpler for everyone. Other amendments to the Prospectus Regulation intend to facilitate fundraising by banks essential to the recovery of the economy. 

• Amendments to MiFID II

 Important changes will be made to MiFID II, the directive regulating investment firms operating in the EU, in order to relieve some of the administrative burdens and to facilitate the development of European markets. In particular, there will be exemptions from the unbundling of research fee and trading fee charged by investment banks to asset managers.

The unbundling became mandatory in 2018 and was criticised for hampering investment in SMEs, as investors only pay for the research they want, hence often moving away from less lucrative, smaller companies. With the new rules, banks will be allowed to charge research fees as part of trading fees when conducting research into stocks of companies with an equity market capitalisation of less than €1 bn, as well as into fixed income instruments. Historically, combining the two fees has meant offering research for free, which would help fostering investment into SMEs in the aftermath of the economic crisis caused by the Covid-19 pandemic. An increase in the level of research coverage of SMEs is expected, thus improving the visibility of European companies which should, in turn, promote investment. In addition to this, the Commission is proposing a recalibration of the MiFID II requirements, in order to keep transparency towards the clients at a high level as well as ensure high standards of protection and acceptable compliance costs for European firms. 

• Amendments to securitisation rules

The new rules also include the removal of obstacles to securitisation of NPEs, as well as extending the STS framework to on-balance-sheet synthetic securitisation. The STS framework, which stands for simple, transparent, standardised securitisation, is a set of rules governing securitisation in the EU and it sometimes allows investment firms to potentially benefit from preferential capital treatment for exposures. The new rules aim at preserving the ability of banks to continue lending, as they free up capital by selling exposures to investors. It allows them to transfer some of the risk of SME loans to the markets so that they can keep lending to these types of businesses. In turn, this should contribute to the recovery of economic activity after the Covid-19 pandemic.

The new package of rules which will regulate the EU capital markets in the coming years is intended to ease the economic recovery within the bloc. Involving changes to various pieces of regulation, with particular regard to Prospectus, MiFID II and Securitisation Regulations, it aims at simplifying procedures and favouring the flow of investments within the European Union. The general consensus seems to be that the new measures are indeed likely to somewhat counter the negative economic impact of the Covid-19 pandemic, paving the way for a more rapid recovery, especially when paired with the economic stimulus packages launched over the past months. However, much remains to be seen around investors’ sentiment as well as potential subsequent waves of coronavirus, which could hamper investment and lead to a longer, harder recovery process. The lifespan of these measures will play a major role in the curve of the recovery. Indeed, whilst our predictions are that they will stay in place as long as the pandemic is not properly contained throughout Europe, there is uncertainty as to whether they will be kept long-term. It is in our opinion that the modifications to MiFID II and securitisation regulations will most likely be kept, unlike the “EU Recovery Prospectus” as it carries the risk of reduced precision and oversimplified information which could hurt transparency standards.

Glossary

• GDP: monetary measure of the market value of all the final goods and services produced in a specific time period.
• SMEs (Small to Medium-sized Enterprises): these are enterprises who have a staff headcount of 250 or less and a turnover of €50 million or less. They make up for 99% of all EU businesses.
• Securitisation: the procedure where an issuer designs a marketable financial instrument, by merging or pooling various financial assets into one group of repackaged assets, which he then sells to investors.
• On-balance-sheet synthetic securitisation: a type of securitisation where the originator continues to own the underlying exposures, as opposed to traditional securitisation, where the underlying exposures are sold to another entity.
• NPEs (Non-Performing Exposures): term used by regulatory authorities to denote lending contracts or other counterparty exposures that are problematic in the sense of unexpectedly deviating from contractual cash flows due to counterparty behaviour.

Resources

• European Commission (14/07/2020). Coronavirus response: Making capital markets work for Europe’s recovery. Available at: https://ec.europa.eu/commission/presscorner/detail/en/ip_20_1382  [Accessed 28 July 2020].
• European Securities and Markets Authority (2020). Prospectus. Available at: https://www.esma.europa.eu/regulation/corporate-disclosure/prospectus [Accessed 30 July 2020].
• European Commission (2018). Twitter. Three pillars of the Capital Markets Union. Available at: https://twitter.com/EU_Commission/status/973156453824557061 [Accessed 30 July 2020].
• Jorge Valero (2020). New capital markets union strategy to take central role in EU recovery, Euractiv. Available at: https://www.euractiv.com/section/economy-jobs/news/new-capital-markets-union-strategy-to-take-central-role-in-eu-recovery/ [Accessed 29 July 2020].
• James Chen (2019). Securitization, Investopedia. Available at: https://www.investopedia.com/terms/s/securitization.asp [Accessed 29 July 2020].
• European Commission (2020). Coronavirus response: How the Capital Markets Union can support Europe’s recovery. Available at: https://ec.europa.eu/commission/presscorner/detail/en/qanda_20_1377 (Accessed: 30 July 2020).
• Stafford, P. (2020). EU fund managers back fee changes to Mifid II trading rules. Financial Times. Available at: https://www.ft.com/content/a0e8195e-aae1-4370-b8bb-82363e01cc93 [Accessed 30 July 2020).
• Stafford, P. (2020). EU plans flurry of rule changes to boost market recovery. Financial Times. Available at: https://www.ft.com/content/25335912-7dd3-4ad4-ad9f-8200bf583243
• Rebello, R. (2020). Euro zone outlook gets slight boost from EU stimulus deal. Available at: https://www.reuters.com/article/us-eurozone-economy-poll/euro-zone-outlook-gets-slight-boost-from-eu-stimulus-deal-reuters-poll-idUSKCN24U00B (Accessed: 30 July 2020).

Featured Image: Etienne Ansotte, P-042959/00-34, European Commission. https://audiovisual.ec.europa.eu/en/photo/P-042959~2F00-50