The problems that have dogged the development of the EU’s Capital Markets Union (CMU) are well known – such as member states’ indifference, completing interests and weak equities cultures – but the bigger issue lies around solutions and then getting them implemented.
“The current iteration of CMU that was launched in 2019 largely repeats and acknowledges the same problems as the previous version that was launched in 2015,” said Rachel Cockshutt, head of regulatory change, Europe at Royal Bank of Canada, speaking at an online conference hosted by the Association for Financial Markets in October 7-9.
Ms Cockshutt said that as all CMU initiatives were supposed to be complete by now the challenge is not identifying the problem, “it is delivering the solution”.
She said the lesson to be learned from the Markets in Financial Instruments Directive (MiFID) II, in the context of the development of CMU, is that everyone agreed on what the outcomes should be for that regulatory text, namely more transparency and investor protection, but that is not necessarily what was delivered.
Many industry sources complain that MiFID II reporting requirements are overly burdensome and don’t always enhance transparency. Meanwhile, there are issues with the accuracy of the data being reported and if it is even being fully used by supervisors.
Ms Cockshutt said there was a risk that the same could happen with CMU. “Agreeing on the problem is not the difficulty, agreeing on the solution is where the real difficulty lies and it remains to be seen if that is really something Europe can deliver on, both in the context of the MiFID review and in the broader context of CMU,’” she said.
The European Commission is currently reviewing MiFID and the accompanying regulation, MiFIR. For the short term it is proposing a series of ‘quick fixes’ to these texts to help the EU recover faster economically from the Covid-19 pandemic and longer term to spur the development of CMU as a bigger source of capital for European enterprises and households.
Fragmentation concerns
Martin Parkes, managing director, global public policy group at BlackRock, said one of the biggest concerns the US fund giant has about investing in European markets is fragmentation.
He said with the UK in the EU, MiFID had primary markets and a primary national regulator overseeing them. “Post-Brexit you have a multi-hub market, you have ESMA [the European Securities and Markets Authority] playing a very different role to what the FCA [the UK’s Financial Conduct Authority] plays and a lot of different areas of markets with different strengths and how do you bring that all together?”
In particular, he wondered how this could be done in a way that “dynamises” for example the Nordic growth markets, the Spanish primary market and on dealers whether they are “in Amsterdam, the Paris ecosystem or the German ecosystem? How do you bring all that together? I think that is the challenge for the MiFID review going forward,” he said. “And that will be a very different dynamic from the dynamic we had under MiFID II.”
Post-Brexit you have a multi-hub market… a lot of different areas of markets with different strengths and how do you bring that all together?
Mr Parkes said another key priority for BlackRock along with investor protection is the European Consolidated Tape (ECT). The idea behind ECT is to collate real-time exchange data, such as prices of shares and their trading volumes and then disseminating it to investors, giving them a unified view of markets across the EU.
“The fragmentation of data sources leads to fragmentation of liquidity. Do investors know on any deal whether they are getting the best available price in European markets? That's an incredibly difficult question to answer,” he said.
He added that for the EU, which is competing against markets such as the US, data fragmentation is a key handicap and that for BlackRock the creation of an ECT for equity and non-equity markets is a top priority. It also sits at the top of the agenda for the EU authorities as well. However, like CMU, it has failed to materialise due to a raft of issues, such as difficulties for data providers in being able to sign up and comply with Approved Publication Arrangements (APAs).
However, not all financial firms, such as investment banks, which are big players in capital markets, necessarily see an ECT as a top priority.
The US experience
Meanwhile, the US has the Consolidated Tape Association, which oversees the dissemination of real time trade data from US exchanges. One of the hopes for institutional investors is that an ECT would drive down data costs in the EU, though that has not happened in the US for certain types of exchange data where there have been vociferous complaints by asset managers over price gouging by exchanges.
“A lot of what the EU is doing short term in terms of the ‘quick fix’ and the rest of the MiFID review, there is a mixed bag in there as well,” said Simon Andrews, executive director, group public and regulatory affairs at Standard Chartered Bank.
He explained that there are some positive changes being proposed by the EU authorities in terms of reviewing MiFID II. He noted that MiFID II was developed in the immediate aftermath of the 2007-9 global financial crisis when attitudes towards financial services were very different. At the time, financial services were deeply unpopular with the general public and politicians wanted to do whatever it took to reign in banker excesses and safeguard financial stability. This entailed much tougher rules for financial firms.
“I think there is a recognition now that the impact of that may have been too extreme in some cases, it has had detrimental effects and the EU is taking the right steps in a lot of cases to address those problems,” said Mr Andrews.
One area of nervousness over reforming MiFID and MiFIR, apart from the potential uncertainty of the outcome, is over how it might impact the existing investment firms have made to comply with these regimes.
“On the buy side, one thing I will say is that there has been a huge infrastructure for data exchange that has been put in place to comply with MiFID II and on the product governance side between product manufacturers distributors and consumers,” said Mr Parkes. “If we start changing, that this is not just a simple piece of legislation, this means big IT, a big internal infrastructure change project.”
Retail to the rescue?
Retail investors could play an important part in making CMU a reality according to regulators and the panel of experts assembled by AFME largely seemed to agree. Incentivising their greater involvement may mean re-thinking some regulatory texts, though.
François Villeroy de Galhau, the governor of the Bank of France, recently estimated that across the EU there is some €360bn in savings sitting on the sidelines in cash – a potentially big prize for the asset management sector. Importantly, those are funds that could be directly supporting businesses and capital markets and give CMU a big boost in the process as well as help revive the pandemic-ravaged European economy.
Where there is a debate is over how to foster those incentives. As part of protecting investors, particularly retail ones, the EU authorities have pondered whether a new category should be carved out for sophisticated investors who would be allowed to buy more complex products. Germany, which holds the six-month presidency of the EU, favours that approach.
Across the EU there is some €360bn in savings sitting on the sidelines in cash – a potentially big prize for the asset management sector
Currently, the rules split investors between professional and non-professional.
The panellists were concerned about adding more layers of bureaucracy and complexity, creating more categories of investor when it would be better in their view to focus on outcomes.
Ms Cockshutt thought that the elective professional categories are largely fit for purpose, but noted some firms do find them challenging to comply with.
“Perhaps there is certainly an argument for re-looking at perhaps what those criteria are, and are they leading to overly restrictive in clients being able to opt up,” she said, adding that this is particularly pertinent to some clients who are experienced and knowledgeable, but for some reason don’t meet the threshold to be considered a professional investor. “So I think there is certainly room for that to be looked at,” she said.
Thorny question of inducements
The debate veered onto how MiFID II deals with client inducements and how it ended up as a compromise largely because the UK favoured banning them as part of its Retail Distribution Review. Other European countries, such as France and Germany, want inducements maintained due to the structure of their financial services industry where banks routinely sell investment products directly to their retail clients as part of their business models. This is much less common in the UK.
“What we need to think about is what are good outcomes for investors,” Mr Parkes said. He explained that questions need to be asked about the role of inducements and also the likely future distribution models and how they are funded. Other areas worthy of investigation he said are issues around trust, friction costs, conflicts of interest and the complexity of investment.
“I think the key term is conflict of interest which is really what the inducement rules are intended to address,” said Mr Andrews. “It is not to protect investors from any kind of conflicts at all costs, the goal is to produce the best investor outcome and one of the considerations is where there are conflicts of interest that impede that outcome.”
However, he felt there is a problem in the way MiFID deals with inducements, describing it as too formulaic. “And [it] risks becoming more formulaic,” he warned.
Mr Andrews cited as an example recommendations on inducements made by ESMA in April. “The definition of what constitutes an inducement is arguably too broad,” he said, adding that ESMA’s paper even sees fees charged by underwriters and placing agents for primary issuance as a potential inducement.
He noted that this particular topic has already been discussed with several law firms and even the FCA had opined that in the UK at least these fees are not inducements, but instead payments for a separate service.
Mr Andrews warned that blanket bans on inducements or very broad definitions of what constitutes an inducement could unleash all kinds of other problems and risk losing perspective on the ultimate goal of protecting investors.
“There is a clear theme coming through pretty much all of our responses, which is one of balance of outcomes and objectives versus overly complex or as some have described it, blunt tools to get there,” said Ms Cockshutt. “And I think that really needs to be a focus for how MiFID is moved forward because it is clear that in a number of areas, while the right objectives are there, the means that are being taken to get there just aren't quite working.”
This article first appeared in The Banker's sister publication Global Risk Regulator.
