Capital Markets Union: A Welcome Start (EUC Report)

Lord Davies of Stamford Excerpts

Thursday 4th February 2016 Lords Chamber

[Lord Davies of Stamford (Lab)]

My Lords, it is a pleasure to follow the noble Earl. I agree with the points that he made and agree particularly warmly with his very generous but justified tribute to our chairman, my noble friend Lord Harrison, in the previous session. He was a really perfect chairman and there was no day when we felt that we were not extraordinarily well chaired. This report is just one of the accomplishments of the committee under his chairmanship. I thought at the time that he would be an impossible act to follow, but we now have a new, very effective chairman, the noble Baroness, Lady Falkner, who is taking part in the debate this afternoon. Both these chairmen have the four qualities that seem to be essential for the role. They are always enthusiastic, they are always conscientious, they are always decisive and they are very fair. They may have differences in personality—they are well-known and respected Members of the House—but they have those qualities very strongly.

There are three important considerations in this issue of a capital markets single union. One is a central and obvious one for this country: we have a great deal of human and financial capital invested in the City of London. We stand really better than anybody else in the European Union to benefit from the emerging capital markets union, if it is in fact a real success. That has obvious implications for growth in this country, and for the generation of employment. This is of considerable—indeed, exceptional—national interest within the single market for this country.

Secondly, my noble friend Lord Harrison has made the point well that there is general agreement that it is necessary to try to provide a wider source of finance in the form of both working and long-term capital for British industry and commerce, as well as for continental industry and commerce. The 80% market share in the field of the banking system in the single market is a healthy state of affairs neither for business, commerce and industry, nor for the banking system. To introduce a greater measure of competition and greater sources of finance of this kind is an important undertaking. Again, there is strong welcome for it from both sides of this House and across the whole of the European Union. The noble Lord, Lord Hill, has a task and is being looked to by many people to accomplish it successfully, and I trust and hope that he will.

The third important consideration in this context is that there has been much talk about the relative inadequacy in the euro area of mechanisms allowing for some stabilisation in the event of asymmetric shocks. As the House knows, there is a lot of controversy about the degree of transfer payments that ought to be provided for to make a successful euro area. Whether or not we are members of the euro, we all obviously have an interest in the success and stability of that area.

What is immediately apparent to any observer is that in the United States, which is obviously a successful currency union by whose experience we ought sensibly to allow ourselves to be guided, the capital markets play a major role in that stabilisation process. That is not to say that there are not elements in that process played, importantly in the United States, by federal funds and federal government money, but it is clear that the capital markets play the major role there. That is because in a single-currency area, you eliminate exchange risk for investors within the area, which is one of the automatic results in creating the currency area in the first place. One of the advantages of creating the euro in much of the European Union has been that that effect has been generated. People are therefore naturally inclined to hold more widely diversified portfolios, going across the whole of that area. If they want to buy a pharmaceutical, automotive or retail share for their portfolio, they will not be limited by what is in their own country—previously they would have been, because they would not have wanted to incur foreign-exchange risk in many cases—but they will look equally well at a share or bond in one of those particular sectors in any other country that is part of the same currency union. That process takes some time to develop. It would be unrealistic to expect that we would have achieved the same levels of diversification in the euro area as has been achieved in the United States, but the process is ongoing and it is an important one.

The United States is working very well at present. Texas and Oklahoma lose out from the fall in the price of oil, but California, New York and Massachusetts gain. At the same time a lot of people in Texas have shares and bonds in or other claims on companies in California, New York or Massachusetts. They gain that way. Equally, a lot of investors in those three states will have claims on Texas and Oklahoma; they will share in some of the losses. There is a sharing of risk and a stabilisation mechanism there, and it is desirable that these should develop in the European Union. It will do so pretty much automatically if we can make real progress in creating a capital markets union.

I would like to make two further points to add to the considerations in our report. One is a matter that has become more serious since we published the report. In many ways I am sorry that it has taken us so long to have this debate. Nevertheless, it gives me an opportunity to talk about a new threat. On a recent visit to Brussels I was informed that the Commission may well not be pursuing the idea of an insolvency directive, whose objective would have been to create a common insolvency law throughout the European Union. If that is the case it is regrettable, and a serious reverse for the prospects of the capital markets union. If the point does not appear immediately obvious, I shall explain why. Any investor is concerned with the claims that he or she will have in the event of insolvency. Insolvency does not preoccupy many people if they buy a AAA-rated bond or a blue-chip share, but logically it becomes a disproportionately important issue at the riskier end of investment. For example, private placements, peer-to-peer lending—that has already been referred to—and venture capital are precisely the areas that we want to see expand and where we are at a competitive disadvantage to the United States, where those sources of funds are much more developed. So that is quite serious.

If an investor is confronted with the possibility of such an investment in another country with whose insolvency laws he is not intimately familiar, or not as familiar as he is with his own, he probably will not spend tens of thousands of pounds or euros on getting legal advice on the regime and jurisprudence in insolvency in the country in which he is thinking of making an investment. He probably will just not make the investment there. He will probably make it in his own country, and will not therefore get the single market or the capital markets union effect that we are trying to go for. Insolvency is very important and in my view that objective must be pursued energetically. I hope that the Minister can tell us in his winding-up speech that the Government are committed to an insolvency directive and whether they are doing anything to push the initiative forward. That is very important. The Government appear to have quite a lot of influence in the European Union, if the events of the past two or three days are anything to go by, so I hope that they will add that to their agenda.

My other point is that at present there are two initiatives in the EU in the capital markets and financial area that currently are separate, but that separation is not sustainable, viable or logical. There is a project of banking union and a project of capital markets union. It so happens that we are part of the capital markets union—a very big part, I hope—but not of banking union. I do not quite understand why we are not a part of banking union; in our sub-committee, presided over by the noble Baroness, Lady Falkner, I have asked many experts why we are not and I never get a very respectable answer except “politics”, which in my view is not a respectable answer to an important issue affecting the national interest. First, if we are not members of banking union, it seems that we shall face higher compliance costs in this country because banks operating across the EU will have to have compliance operations covering their activity in the euro area, or in the banking union area, and different compliance arrangements in this country, which is not part of the banking union. That is very undesirable.

Secondly, there will be the inevitable temptation to go in for regulatory arbitrage, which is bad from an economic point of view because it is distortionary and, of course, makes a mockery of the whole system. Thirdly, I do not think that the distinction is robust, viable or sustainable. Take, for example, shadow banking, money market funds, securitisation and indeed the development of a secondary market in securitised bank loans: are those to do with banking union or with capital markets union? The answer could be both as they could be categorised as either, so it is not a very sensible distinction to make. If we try to make it again, we will have regulatory arbitrage, costs, confusion and a lack of transparency and certainty—all the things that we are trying to avoid by creating a capital markets union in the first place. That would be very perverse and unfortunate, and I hope that people will think very seriously about that because this is an area where there is unfinished business and which is very important to this country.

--- Later in debate ---

[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.

[Lord Davies of Stamford]

I am grateful to the Minister for that response to my questions. I was not so much concerned with the important issue he has just mentioned of trying to reduce losses to creditors from insolvency and the cost of the insolvency process, which we all know can be prohibitively high sometimes, including in this country. I was concerned much more with establishing a capital markets union and the importance of insolvency in that context, which I set out in my speech, so I will not repeat it now. Does the Minister have any thoughts on whether that can be advanced further?

[The Earl of Courtown]

I do not have the details in front of me but I will write to the noble Lord on that issue. I hope he will accept that.

I thank my noble friend Lord Flight for raising the issue of the enterprise investment scheme, which I will bring, along with the whole debate, to the attention of my noble friend Lord Hill. That will be a very useful exercise; I know how important he considers the work of the committees of this House. If there is anything more I can add for my noble friend, I will do so.

The CMU is an important part of the Commission’s financial services agenda over the coming years, and if it is successful it will have long-term benefits to businesses and investors here in the United Kingdom and across the European Union. We will of course keep noble Lords updated as appropriate, and I welcome their continued interest in this important issue.