On the Capital Markets Union. A conversation with Finance Watch’s Chief Economist, Thierry Philipponnat

For years, the Capital Markets Union (CMU), recently rebranded as the Savings and Investments Union, has been a cornerstone of European discussions. In the second part of Ursula von der Leyen’s presidency, the idea of deepening the CMU to tackle Europe’s enormous investment needs is given greater prominence, continuing an effort that has been going on for years. AK Europa continues to be extremely critical of many of the proposals and measures within the framework of the CMU. From AK’s point of view, the protective interests of private retail investors and employees as well as financial market stability must by no means be subordinated to private capital interests.

Overall, the path towards CMU has been complex so far. Although numerous initiatives have been launched, significant structural and regulatory hurdles remain. How can we mobilise sufficient public investment to cover the cost of climate change mitigation and adaptation? What are the risks associated with the Capital Markets Union and what is standing in the way of its completion?

AK EUROPA: The Capital Market Union has been in discussion for years and consists of many different initiatives and projects, some of which are also unrelated. Can you give us a quick overview over what has been addressed in the past?

Thierry Philipponat: The inception of the Capital Markets Union was Jean-Claude Jucker’s maiden speech before the European Parliament over 10 years ago, inspired by his predecessor’s Banking Union initiative. The EU’s 28 member states at the time all had separate capital markets. The idea was that if you bring all those capital markets together, there will be a deeper capital market.  So, there will be more access to private capital for European companies and therefore it will be good for the development of the European economy.

The reference since they started the CMU has been the US capital market, which indeed is unrivalled in its enormous depth and its ability to bring massive amounts of capital to companies. A number of initiatives have been taken with the goal of reaching a similar market capitalisation in the EU. In Finance Watch’s view, some of those initiatives made sense, some were of limited interest and some of them were not even good. Some examples are the simplification of the prospectus regulation for issuers, the promotion of securitisation via the STS framework or having a single tape providing information on stock market prices. Other examples include the creation of ELTIFs, European Long-Term Investment Funds, or the pension initiative PEPP, which goes in the direction of having, if not common pensions, at least compatible and portable pension systems across the EU.

All of those debatable initiatives were low-hanging fruit, the easiest targets, and there is no doubt that they did not create a capital markets union. Why? First, because the Capital Markets Union is about having one rule for everybody and having a supervisor applying the rules the same way in all the countries. Today, we have 27 EU countries with 27 so-called NCAs, National Competent Authorities, who have different approaches, who barely coordinate with one another, and who effectively apply the rules in a non-coherent manner. Added to that come very divergent transpositions of EU directives. The aim is to have one single supervisor to apply the same rule to everybody.

AK EUROPA: Mr. Philipponnat, would you only address financial capital market rules or go further than that? Insolvency rules for example are also very often mentioned in the context of the Capital Markets Union.

Thierry Philipponat: In addition to capital market rules, insolvency rules, corporate law rules and tax issues must be addressed as well. Those are the three biggest issues, on top of having a single supervisor applying harmonised rules for capital markets. Insolvency rules are fundamental when you look at the bond market. Obviously, one of the questions when you’re a bond investor is what happens to me as a creditor of the company if the company goes bankrupt. As long as you have different insolvency rules, by definition, you cannot have the same market for Austrian bonds and for Spanish bonds. Corporate law is very important for equity investors. Typically, corporate law will tell you how you organize your Annual General Meetings, how the board functions, who holds which power, whether shareholders can pass resolutions, etc. The third issue is tax law. Today, there are huge discrepancies within the EU between the tax treatment of issuers and of corporations. Some EU countries even play on the tax side to attract issuers to their marketplaces. So-called regulatory arbitrage has become common practice among member states, systematically undermining all serious efforts towards a Capital Markets Union.

When reading the Draghi report, the Letta report and the Noyer report, one proposal that comes up again and again is the promotion of private pension funds. Can the ongoing debates be interpreted as a step towards privatisation of the pension system under the guise of the Capital Markets Union?

Thierry Philipponat: From a purely financial technical point of view, if you have all pension systems investing all pension money into capital markets, you have a huge pool of capital available for companies to tap. But of course, pensions are before anything else about people, about political choices. Many pension systems working on capitalisation are having big financial troubles at the moment. The commitments towards future pensioners might not be met given the performance of capital markets. Aside from the purely technical, the political and social implications are enormous. In many countries, trade unions strongly oppose such reforms, and they will keep fighting them, as well, in the future.

Other than private pension funds, which initiatives do you see coming with the Capital Markets Union under its new name of Savings and Investments Union?

Thierry Philipponat: At this point in time this is hard to tell. There have been talks about savings accounts for EU citizens that would simplify investing into the capital markets. I am not convinced this is going to change anything. Such a concept has been tried before, for instance in France, and despite the new legal wrapping, those accounts did not make a difference for regular people to start investing into equity. The tax incentives that came along with those equity accounts were mostly used by the wealthy and the privileged that were already investing in equity.

At the end of the day, I believe it all comes down to differences in culture. Denmark has an equity market capitalization of 190% of GDP, close to the US, while Italy’s is around 35%. Those cultural differences will be hard to tackle by regulation.

Within the debate on the CMU, there are voices advocating for a European safe asset. Could you elaborate on the role of a safe asset and its connection to the CMU?

Thierry Philipponat: The safe asset debate comes from the dominant way of investing. There is something called a risk-free interest rate and a credit spread added on top when money is lent to a borrower. The risk-free rate is the interest rate paid by a safe asset, so an asset that is supposed to be risk-free. Today in the EU, given that the Euro is an incomplete currency, there is no such thing as a safe asset. Technically, when any Eurozone country borrows money in Euro, it borrows in a foreign currency, a currency it doesn’t control. When the US borrows in dollars, it controls the currency. When Japan does the same thing, the UK, Switzerland, they control the currency. When Austria, Belgium, France, Italy, even Germany, borrow in Euro, they cannot just print the money needed for paying back. Moreover, there is no budget and no common fiscal policy behind the Euro. A safe asset is something we could have in the EU that would look like a T-bond, the T-bond being the US safe asset. The answer to this is European bonds, which would require resources at EU level for paying them back. That means either higher contributions by the member states, which would be challenging, or giving the EU its own resources, which is an even bigger and a highly political debate.

The Capital Markets Union is often presented as a crucial step for the EU’s financial future. Yet, your report suggests that even its full implementation may fall short of expectations. Could you elaborate on your findings?

Thierry Philipponat: It all started because we heard so many high-level EU leaders say that, as we generally have sufficient investment capital in the EU, we only needed to complete the Capital Markets Union, and if we did that, the job would be done. The basic assumption for our report was that the Capital Markets Union would be successfully completed, which we know we are very far away from. Does that mean that we have solved the problem, that we have found all the money that we need? The conclusion of our report ‘Europe’s coming investment crisis’ is that in the best-case scenario, only a third of the money needed can come from capital markets for one very simple reason: private money will only come if the return is high enough to cover the risk assessed when the investment is made. No adequate return, no private money.

Assuming we face a significant shortfall in total investment, what consequences might this have for the EU?

Thierry Philipponat: We need the money to build the indispensable infrastructure we need to adapt to climate change, for instance, to adapt to rising ocean levels. The European Environment Agency estimates that rising sea levels will cost the EU economy 1 trillion euros per annum, that’s 6% of EU GDP. The impact of climate change on GDP will be huge. We need to invest in infrastructure to protect the EU economy from this risk. These investments, as essential as they are, will not be profitable because they will not generate cash flows. So, private money won’t come. The alternative would be that in 20 or 30 years’ time, the EU’s GDP would be 6% lower just because of rising sea levels. A year ago, we published a report called ‘Finance in a hot house world’, which estimated that the negative economic impact of climate change could be between 30% and 50% by 2070. This is a nightmare, not only from a human and social standpoint, but also in terms of public revenues. We need to invest, and the CMU can be part of the solution, but we need to find the remaining two-thirds of the money we need from the public purse.

You mention public funding as essential. How can we mobilise these public funds?

Thierry Philipponat: Our rules governing public money are not adequate today. In our report we suggest three possible technical solutions. We have to push and say, hey, we don’t have a choice. We have to adapt to this world that is changing so dramatically and so quickly. The first technical solution is to change the rules of the Stability and Growth Pact, the SGP rules. We know it’s a very difficult debate, but these rules are absurd. There’s no science behind them, it’s just a snapshot of the state of EU finances 35 years ago. At that time, the EU average in terms of debt was 56%, so they went for a 60% limit. France was running a public deficit of 2.6%, so they opted for 3% to give themselves some latitude. If we continue to apply those rules, we will hit a brick wall. The second possible solution, and we’re very pleased to see that the Draghi report mentions this, is the possibility to issue debt at EU level. This is also highly political. Three hours after the Draghi report was presented, Germany, Mr Lindner, made a statement saying that there’s no way we’re going to borrow money at the EU level. The third technical possibility is monetary financing. We know that’s a big taboo today.

Why does monetary financing remain such a controversial topic in economic discussions?

Thierry Philipponat: No one, certainly not us, is saying that monetary financing is always good under all circumstances. But the way monetary financing is completely banned in the treaties today makes no sense. First, monetary financing is nothing new. A century ago, when the UK was a superpower, it used monetary financing enormously. The United States has been using monetary financing systematically, especially during the war times. Even Germany used monetary financing in the 1980s. Second, it is not true that monetary financing is necessarily inflationary. Money creation by central banks has been enormous over the past 35 years to support financial markets. But the inflation we’ve seen for the last 3-4 years is not a monetary phenomenon but a supply shock that came from Russia’s war on Ukraine, which has affected food and energy prices. The third thing is that we assume that we have competent central bankers that can be trusted with powerful financial tools.

We have to grow up, we’re the only jurisdiction in the world where monetary financing is prohibited by law. Because of the prohibition of monetary financing of public deficits by central banks in the EU, we have what is called QE, quantitative easing. Private banks buy the debt on the primary market and then resell it to the European Central Bank on the secondary market. Effectively, this is “monetary financing” with extra steps. This practice creates enormous reserves for private banks and these reserves are remunerated. In 2023, the remuneration in the EU amounted to 140 billion euros or 1% of EU GDP. So, if we are going to create money, we might as well do it directly for the public budgets.

How realistic is it to promote these ideas to finance the massive investment needs in the face of often-proposed austerity and frugality measures?

Thierry Philipponat: The frugal ones are not those who think they are. I think we are the frugal ones who realise that if we don’t invest today, we will lose more tomorrow. If we do nothing, our deficits will get even worse. On adaptation to climate change, there are some fascinating studies that show that the return on investment for adaptation is about one to ten. If you invest one euro today, you will save 10 euros tomorrow. So, who’s the frugal one? The one who doesn’t want to invest a euro today, or the one who says, I want to save 10 euros for tomorrow?

This article was originally published in AK Europa. Find part 1 and part 2 of their interview on AK Europa’s website.