Capital Markets Union: A Welcome Start (EUC Report)

Baroness Bowles of Berkhamsted Excerpts

Thursday 4th February 2016 Lords Chamber

[Baroness Bowles of Berkhamsted (LD)]

My Lords, I declare my financial services interests as entered in the register, in particular as a non-executive director of the London Stock Exchange Group and Prime Collateralised Securities ASBL.

I welcome this report. It is now some time since it was published and events have moved on, as envisaged and suggested in the report. I have been widely quoted in it, including a contribution from the seminar on pages 31 and 41, so I feel somewhat as if I am being given a fourth and fifth bite at the cherry.

I thank the previous sub-committee chair, the noble Lord, Lord Harrison, the new chair, my noble friend Lady Falkner of Margravine and all noble Lords who have served on both the former and present committees for their interest and attention when I have given evidence on this and other reports.

The most frequently asked questions about CMU, especially in the early days, were “Why?” or “What’s changed?” or “What’s new?” I will dwell on those for a moment because I think they answer some of the questions about culture that were raised earlier. As has already been pointed out, CMU is founded on the freedom of movement of capital set out in the Treaty of Rome, so one way or another we have been aspiring to it for rather a long time. There has always been deep envy of the liquid capital markets in the United States. To try to emulate those, we had the financial services action plan which was a big step in the right direction.

More recently, the financial crisis and major international initiatives on systemic risk, coupled with the review of that financial services action plan, stimulated the 40 or so pieces of financial markets legislation between 2009 and 2014 which I had the privilege of negotiating. Consumer protection, culture, systemic risk and limiting both contagion and arbitrage were key objectives in that legislation.

One might ask what is left; in one sense the answer is “Not a lot”, other than getting all that legislation fully functioning and tweaking it where necessary. A stocktaking consultation has just closed, but quite a lot of what has been legislated still awaits secondary rule-making. It will not be operational until 2017 or 2018, in just the same way as the UK’s own legislation on ring-fenced banks is taking a while to get fully functional. So stocktaking needs to be an ongoing story.

However, the response to the great financial crisis—to give it its historic name— shifted shape over time and eventually turned to incentives for increasing capital markets rather than just worrying about them. It could be seen that the same old factor of deep markets had helped the US to be less reliant on banks and to recover more quickly. On top of that was the policy response to bailing out banks, which made rules to protect national balance sheets—usually rendered as protecting taxpayers. That was done through a process of bailing in bondholders—that is, converting them into equity—which means they are no longer let off the hook.

That then raises the question: who are the bondholders? They are, of course, investors, many of them institutional investors looking after the savings and pensions of ordinary individuals—workers and taxpayers. The situation where a failing bank causes knock-on failures has to be avoided. So spreading the “bail-inable” bonds in a wide market is an important corollary to rules about sharing out a failed bank’s losses.

There are some who suggest that capital market union is more relevant for the eurozone. This is an interesting point which is both true and not true. It is true that the monetary union’s construct, without mutualisation of sovereign debt, urgently seeks to decouple banks and sovereigns and to have mechanisms to spread risk. So it is not surprising that the European Central Bank was first in the recent calls for a financial markets union, later renamed the capital markets union. Even though the ECB says that it does not want to be the supervisor of the capital markets union, it has a big influence on the culture and thinking around the whole project.

I said that it was not true in one sense. It is not true also in the sense that the logic of having better capital markets to stimulate jobs and growth, to have less reliance on banks and to be able to spread risk to the market rather than a national balance sheet applies outside the eurozone as well. To spread it wider than the local shock is better for stability; institutional investors have multi-currency exposures anyway.

All this drove the CMU proposals and, despite some mutterings, it is jolly useful to have mood music from all sides that capital markets are good. Some of us have tried really hard to create that. Until now it has been countries from within the eurozone that have been far more sceptical about the benefits of markets, had underdeveloped markets themselves, and have held back market-opening proposals or simply have not understood what it was all about. That has made legislative negotiations on markets matters excruciatingly difficult—although, despite the pain, the UK did rather well. However, this shows again that there is a change in culture and that the future looks brighter on this horizon.

Does eurozone enthusiasm mean that it would try to do things for itself? Would this stimulate attempts to rival the City and construct different rules about what had to be done in the eurozone? Any suggestion of that was jumped on very quickly, even as there was the turnaround in mandate from the old Commission and Parliament to the new. Common sense has broken out all around in accepting that the UK and the City are a major asset and central to the CMU project. The current Commission President, Jean-Claude Juncker, made bold statements to that effect at a very early stage.

Whether the eurozone countries choose to have a single supervisor is still being touted around, but it is a trickier project than banking union due to the number and diversity of market participants and with no substantial organisation to bolt it on to. This assumes it is true that the ECB does not want it.

However the eurozone might choose to share supervision or not, the economic governance section of the draft EU reform documents clarifies that the UK can retain its own supervision. The answer to those who wonder why we are not part of a banking union is that it is the link between supervision and sovereignty, rather than the link between rules and sovereignty.

How much the eurozone might need a subset of rules for itself will depend a lot on attitudes after EU reform, but I cannot see it as constructive for the eurozone to be overly clubby or for the UK to be overly aloof. Neither leads to an effective capital markets union. I referenced the draft EU reform document and I must say that, on balance, what is in the economic governance section is very good in its intent, but I am pretty desperate to get my hands on some of the drafting.

As the report highlights, it is a good start to do those things that will not get bogged down: the simple, safe securitisation that has been referred to. But of course it is not always that easy to do things simply. You fall between self-certification—can you do due diligence?—and having outside certification. So we are back to something that might be criticised, such as rating agencies, or do you ask a regulator to do it? Most regulators do not want the liability. That is one conundrum that awaits to be resolved.

On adjustments to the Prospectus directive, I recall the discussion about whether it could be more than €100 million in the last revision. The point is, if we put it up to €200 million that might be SMEs in some countries but all they have in some other countries, so they would not have a main market; they would have only a small market. In desperation, I suggested that they use a purchasing power parity multiplication factor, which seems to be the sort of thing that we are now agreeing for benefits that go to other countries. Maybe someone could do something useful around purchasing power parities if the size of markets in some of the smaller member states or less-developed markets becomes an issue.

We definitely need to mend insurance regulation that has militated against long-term investment, and I cannot say that without pointing out that it was the UK that drove Solvency II and its mistakes, and is still overzealous in its application. Now is the time to stop the warring over French, German and UK preferences and get it fixed.

Longer term, there will be other measures and here are some thoughts. Can we build a better insolvency regime? If we cannot do it for insolvency, can we do it through pre-insolvency and presumptive paths for what happens in a failure, which is akin to what has been done in the recovery and resolution work? Can we get to grips with the unfair tax advantage given to debt? As an aside, I worry that while everyone says that it is a good idea to encourage equity, international banking regulation requires an increase in debt instruments to meet bail-in targets. There are no calls for major new legislation, but it is a fact that changes to legislation have to be legislated for. If you have some good industry standards that you want to use cross-border, the only way you can get that in force without arbitrage or barriers is, alas, to have legislation.

It is very easy to say in prose that there must be a balance of simplifying or enabling and consumer protection. It is rather harder to legislate for it when everyone wants their own protections kept. Finally, it should be appreciated that disclosure requirements, which are disliked by industry, are often what keeps heavier-handedness at bay. That is often the deal. You can put in a disclosure requirement instead of trying to ban something.

CMU is actually a mix of passion, policy and pragmatism. The passion is to provide jobs, created through more opportunities for business to find funding and a passion to buffer the national balance sheet and the services that we cherish from future banking collapse. The policy is the universal awareness that jobs will come from stimulating capital markets; it is not about doing down banks because they will be involved, but not all things belong in banks. The pragmatism is the basic theme that this is far more about “Let us make this work” than “Let us get regulating”. Of itself, the EU is moving in our direction. That is a backdrop that I dreamed about.