Capital Markets Union: A Welcome Start (EUC Report)

Baroness Falkner of Margravine Excerpts

Thursday 4th February 2016 Lords Chamber

[Baroness Falkner of Margravine (LD)]

My Lords, it is a great pleasure to follow the two senior members of the committee, the noble Lord, Lord Davies of Stamford, and the noble Earl, Lord Caithness, who I am delighted to see is on the road to recovery after his recent illness.

Listening to what the committee says about the noble Lord, Lord Harrison, it feels, sitting in the chair as I do now, as if he is a very hard act to follow. However, it is a stellar committee served by a stellar secretariat, and I have great pleasure to be leading it at this point in time.

The noble Lord has covered the main elements of the proposals that foreshadowed the subsequent action plan launched by the noble Lord, Lord Hill, in late September last year to bring about an improvement in capital markets in the EU. Given the wide spread of issues that other noble Lords have spoken about, I shall confine my remarks to one or two current issues that have come to light since the report was published.

In commenting on the publication of the committee’s report, I express the committee’s frustration that the business managers of this House do not seem able to schedule business in any sort of timely manner. I am sorry that the noble Lord, Lord Boswell, is not here to hear this. That is a widely repeated refrain across the sub-committees yet just the other night we rose at 7 pm, and there have been many similar previous occasions. So we come to a situation where, by the time we finally discuss matters covered by a report as long ago as 20 March 2015, a lot of water has passed under the bridge regarding things that are of huge import to this country’s financial sector.

I should add that the UK’s financial sector does not hold back. On the Commission’s Green Paper consultation on capital markets union, which is the subject of this report, 95% of the responses came from the United Kingdom, with 65% from Belgium—presumably because organisations based there have an interest in it—and 57% from France. This demonstrates that the UK not only engaged actively but did so because it will be a huge beneficiary of the proposed changes, as we were told across the board when we visited Brussels last week.

To quote the noble Lord, Lord Hill, in the Financial Times last September when he launched the Action Plan on Building a Capital Markets Union:

“This is a good example of the practical benefits that membership of the single market can bring. But to make the most of it, and to help influence the rules which will set the terms of engagement for years to come, the UK needs to be shaping the system—not looking on while others set the rules”.

These are very wise words in the now excitable atmosphere of the UK renegotiation.

We have seen over 40 legislative and non-legislative measures in the area of financial regulation since the crisis of 2008. Many of them have been necessary, but it has taken some time for the scale of the problem of illiquidity in capital markets to become apparent, for the rigidity of national insolvency laws regarding capital markets—something commented upon a moment ago by the noble Lord, Lord Davies—to be overcome, and for the retail financial services sector to be kick-started across the EU, which is sorely needed. The EU economy is roughly the same size as that of the US but its equity markets are less than half the size. I think that the noble Lord, Lord Hill, estimated that if European venture capital markets were as deep as those in the US, over the past five years EU companies could have raised an extra €90 billion of badly needed investment.

I said I would update the House on one or two of the measures, and the House has already heard from noble Lords on both of them. One of them concerns securitisation, the first major piece of work undertaken under this heading. It is intended to create a simple, transparent and standardised framework for the regulation of securities in order that a prudent and diligent investor in asset-backed securities will be better able to analyse and price the risk involved. This should considerably reduce the capital charges imposed on banks and insurers when they invest. It will also bring much-needed transparency to the pricing of risk through standard templates and require originators, sponsors and original lenders to retain risk of not less than 5%. In other words, it will ensure that those investors and insurers have a dog in the fight, albeit a very small dog at 5%. That shortcoming was exposed during the sub-prime mortgage crisis in the US in 2008.

The UK has a significant interest here: it accounted for 22% of European securitisation issuance in 2014 and 46% of the investor base. However, the proposals have come under fire as they do not envisage an overarching regulator determining whether a securitisation meets the criteria required. This criticism is mainly from France, I should add, where the concern is that only the biggest investors would have the expertise and resources to enter the market, but this remains a valid concern, as the urgent need is also to enable SMEs to access capital markets more readily. I hope that in due course, as the proposals bed down, the secretariat of the noble Lord, Lord Hill, will have another look at this.

A further change has come about with agreement on Solvency II, which came into force on 1 January and will impact the insurance industry hugely as it revises and updates the current solvency framework in the EU. It does this through reducing the risk of insolvency, reduces losses to policyholders and gives an early warning to supervisors so that they can intervene promptly if capital falls below the required level. It intends to promote confidence in the financial stability of the insurance sector though creating a more level playing field. It has taken a long time to get here—its origins go back to 2002—and its effects will undoubtedly take some time to work through, but overall, despite the reservations of some parts of the UK insurance industry, I argue that it can only be a good thing to level the playing field.

We are in the middle of scrutiny of the Prospectus Regulation and it is too early to say where this will end up. However, since the Minister is here, I hope that he will take on board the following thoughts: that we as a committee find it a little frustrating that we do not receive more feedback from relevant Ministers as to their consultation with stakeholders. This regulation will considerably impact on the SME sector raising the threshold definition of an SME from €100 million to €200 million in market capitalisation. It would be important for us—particularly in the case of regulations where we are the backstop of scrutiny—to hear what industry voices have said and what their discussions with the Treasury have revealed in terms of our scrutiny function.

Finally, let me turn to the issue of economic governance as set out in President Tusk’s detailed proposals on Tuesday. The section on economic governance says that eurozone members should respect the rights and competences of non-participating member states. He goes on to argue that facilitating the coexistence between different perspectives within a single institutional framework is important and that the equality of member states before the treaties should be upheld.

I accept that it is still early days but there is a need for clarification on a number of fronts. Mr Tusk refers to discrimination in the text but goes on to say that different treatment must be based on objective reasons. The question arises as to how we define objective reasons and whether it is to be left to the court to adjudicate between objective reasons on the one hand and action arising on the basis of financial stability on the other, an area where differential treatment is allowable. I suspect that differential treatment will be allowable but only up to a point, and the question will be: which point? I hope the Minister will be able to relate these concerns back to the negotiating team.

Today’s Financial Times says in its headline that the safeguards’ impact on the City remains unknown. This is not a party political point; it is imperative that we gain clarity on this before the European Council and its final conclusions on the negotiation on 18 and 19 February.

To conclude, the sub-committee’s report is titled Capital Markets Union: A Welcome Start. The noble Lord, Lord Hill, has started on this exercise. We wish him all success in delivering the capital markets that Europe so badly needs.

--- Later in debate ---

[The Earl of Courtown (Con)]

My Lords, I thank all those who have contributed to the debate, particularly the erstwhile chairman of the committee, the noble Lord, Lord Harrison. I am grateful for the report that he and his committee members and secretariat have produced.

The noble Lord, Lord Davies of Oldham, requested me to answer the questions posed in the numerous speeches in the debate. I shall make every effort to do so in my speech, but if perchance I cannot give the full detail, I will write to noble Lords.

The noble Baroness, Lady Falkner, and the noble Lord, Lord Dykes, and other noble Lords talked about the timeliness of the debate, and I am sure the business managers who scheduled it will have taken note of the noble Baroness’s comments.

As has been outlined in the debate, on 20 March last year this House published its report entitled Capital Markets Union: A Welcome Start. It was based on the European Commission’s Green Paper Building A Capital Markets Union, which was published in February 2015. Since those documents were published, the capital markets union project has seen significant developments.

At the end of September last year, the European Commission published its action plan for a capital markets union, based on its review of the many consultation responses to its Green Paper. I am pleased to note that the reforms proposed in the action plan are strongly aligned with the recommendations of the committee report from March. The list includes measures that the noble Lord, Lord Harrison, highlighted in his speech, such as reforms to modernise prospectuses and to revive securitisation in the EU, and other actions covered in the committee’s report, such as improvements to credit information on SMEs.

More broadly, the committee report called for a pragmatic approach to reforms across the CMU that would benefit all 28 member states—an approach which I believe has been reflected in the Commission’s action plan. My noble friend Lord Hill has made it clear that creating CMU will be a step-by-step consultative process, and that decisions on the design of reforms will be evidence based and subject to rigorous economic impact analysis.

I shall use my time today to set out briefly the Government’s views on the action plan, highlight the action the Government have been taking and respond to some of the issues that have been raised in the debate today. The CMU action plan has the full support of the Government: we think it represents the sort of work the European Commission should be undertaking.

Building on the substantial financial reforms following the financial crisis, the Commission has shifted its focus to strengthening Europe’s economic recovery by generating jobs and growth in the European Union—an agenda I am sure we all support. As part of this, it has identified further integrating and deepening Europe’s capital markets as a key priority. Developing Europe’s capital markets will help bring greater balance, improve the range of options for firms seeking finance, and enhance risk diversification by ensuring that market-based finance is strengthened as a complement to bank finance.

The CMU action plan sets out the initiatives the Commission will pursue. My noble friend Lord Hill has succinctly described the project’s aim as linking savings more efficiently with growth. Importantly, the Commission is not just tackling a problem, as the United Kingdom Government have been advocating for some time, but is doing so in a way firmly rooted in the better regulation agenda that the Prime Minister and others have been calling for.

Delivery of CMU forms part of the Government’s agenda for a more competitive European Union. If we are to make Europe more competitive, we need to create a true single market in capital, by breaking down the barriers that stop flows between member states and prevent businesses accessing the finance they need to grow and succeed.

As noble Lords will have seen, the action plan is thematic, identifying six key areas for reform. These include: financing for innovation, start-ups and non-listed companies; making it easier for firms to access and use public markets; measures on long-term infrastructure and sustainable investment; fostering retail and institutional investment; leveraging bank capacity; and facilitating cross-border investing.

As the noble Lord, Lord Harrison, noted in his speech, the Commission has made swift progress on a set of priority measures. These include proposals and live negotiations on securitisation, and the rules around prospectuses. Consultations have also been launched on venture capital rules, and a call for evidence on the cumulative impact of current EU financial services legislation. The Government support these priorities, and have been actively engaging in negotiations and responding to consultations.

The action plan features a range of reforms that will help SMEs, particularly high-growth innovative businesses, get access to the finance that they need. CMU will help by giving them access to more investors across the single market—by pooling investment resources, by helping venture capitalists and angel investors, and by making it easier to list on public markets.

From a UK perspective, it is not just our smaller firms that will benefit. Breaking down barriers across the single market will help British firms diversify their investments at lower cost, and offer our competitive products to savers across the single market. The Government have been heavily engaged in the CMU work to date, and will continue to strive to influence these reforms as they develop.

The noble Lord, Lord Harrison, in his excellent speech, said how important it was to ensure that the capital markets union delivers for small businesses. Helping small businesses grow and prosper is a key priority for the Government, both as part of the capital markets union and more widely. We want to ensure that growing and innovative companies are key beneficiaries of the CMU.

We call on the Commission to make a number of reforms to help small businesses in particular, and this has been reflected in the Commission’s approach. Examples include improving small businesses’ credit information, supporting crowdfunding and business growth funds, and lowering the cost to small businesses of listing on public markets, as well as reviving securitisation. The Commission has committed to delivering these reforms and we will continue to engage with its work to make sure that capital markets union delivers for small businesses.

The noble Lord, Lord Harrison, also asked what discussions had taken place with the Dutch presidency. As the noble Lord is aware, discussions have taken place with the Dutch presidency, as with all member states and the Commission. Any more information on the actual discussions I will pass on by writing to the noble Lord on those issues.

The noble Lord also talked about the benefits for the United Kingdom of the single market. As my right honourable friend the Prime Minister set out in his Statement to the Commons yesterday, and my noble friend the Lord Privy Seal reaffirmed today, the draft text published by Council President Tusk earlier in the week set out clear mechanisms to deal with the rule-making and bureaucracy of the EU, complete the single market and sign international trade deals.

There is also a stand-alone competitiveness declaration that spells out that more can be done to exploit fully the potential of all strands of the single market. We need to breathe new life into the internal market, and Europe must boost its competitiveness in key areas, such as energy and the digital market.

[Baroness Falkner of Margravine]

I did not want to interrupt the noble Earl’s flow, but I asked a very specific question about concerns that have arisen in the light of the Prime Minister’s Statement. I wonder whether the Minister will give us a reassurance that he will take those concerns back to the Treasury.

[The Earl of Courtown]

My Lords, of course I will. The noble Baroness makes a good point. All concerns of noble Lords who have asked for reassurances, as the noble Lord, Lord Harrison, did, will go back to the department for further thought.

As my right honourable friend the Prime Minister has said, these changes will make sure that Europe works for all the British people who want to work, have security, get on and make the most of their lives.

My noble friend Lord Caithness talked about the financial sector operating in silos. The capital markets union is intended to further integrate capital markets and to strengthen the linkages between the various agents and consumers—the intermediaries and recipients of investments.

My noble friend also talked, as did other noble Lords, including the noble Lord, Lord Davies, and the noble Baroness, Lady Bowles, about the cultural obstacles in the CMU. It is right to identify the cultural obstacles. Evidence shows that 94% of EU citizens have never bought a financial product outside their home member state. Encouragingly, the CMU seeks to tackle these issues. My noble friend Lord Hill has recognised these challenges. Examples of the steps taken include a special working group established to look at specific national barriers of this nature, with plans being drawn for those member states with more experience in tackling these cultural issues to share experience and best practice with others.

The noble Lord, Lord Davies of Stamford, raised the subject of insolvency. The Government welcome the Commission’s proposals around improving the effectiveness of insolvency frameworks, and the intention of promoting business recovery and returning capital to creditors. Reform should be targeted at those member states currently without suitable laws for the rescue of viable businesses in distress. The Commission should also seek to address the underlying gaps in capability and infrastructure in some member states, and any proposals should be evidence based and take into account any regimes that already successfully support business rescue.