As home to investors and companies that prefer the allure of American markets over their domestic counterparts, the European Union has arrived at a crossroads. A window of opportunity has arrived for creating a new framework that supports efficient capital markets, creating growth and jobs and enabling retail investors and pension savers meet their long-term financial needs.
Josina Kamerling, head of regulatory outreach at the CFA Institute in Brussels, critically observes the current landscape of European capital markets, pointing out their inefficiency in serving the broader economy. The European framework for public markets and capital markets “is not really serving the economy,” said Kamerling in an interview with Investment Officer, underlining the importance of these markets for both institutional investors and retail investors.
And the evidence is clear. In a striking illustration of the divergence between European and US stock markets, JPMorgan's equity strategy team in February identified the contrasting performances. As the fourth quarter reporting season progressed, a significant portion of U.S. companies, 60%, had disclosed their earnings. This level of transparency is contrasted with Europe, where only 33% of companies have reported their fourth quarter earnings by 9 February. According to JPMorgan, the US market is experiencing earnings growth of about +5% year-on-year, demonstrating a robust and positive trajectory. Meanwhile, Europe finds itself on the opposite end of the spectrum, with earnings growth trailing at -8% year-on-year.
Research from LXV Research meanwhile finds that in the ten years since the global financial crisis, European stocks have markedly underperformed US stocks. The narrative has shifted dramatically post-2011. From October 29, 2011, to November 20, 2018, the MSCI Europe Index posted a total return of 35.8% in US dollar terms, lagging the S&P 500's return by a stark 102.8% over the same period. This period marked a prolonged bull market for US investors, while their European counterparts faced frustration over their investments' relative stagnation, LXV concluded.
‘There is fragmentation. There are governance issues’
“When you look at the earnings per share in the US, it is four-fold from 10-15 years ago, and we are nowhere near that,” said Kamerling. “It is very difficult to list on stock exchanges. There is fragmentation. There are governance issues. There is a big difference between the big companies that are delisting and going elsewhere. Innovative growth companies don’t want to list in Europe because it is too cumbersome. There is a lot of preparatory work, the costs are high and they are not even sure how they will get the right investors. Let alone the retail investors who are left behind in this issue.”
Some national markets have taken up initiatives enabled by the EU, such as for instance the new laws for collective shareholder redress adopted in the Netherlands. Although a new EU directive has come into effect, the landscape still lacks an even playground for investors.
“Shareholders in the Netherlands are very active but in Belgium it’s different,” Kamerling said. “Take Wirecard. There is no collective redress in Germany. Again, there is a barrier towards investing in our own markets when it is so much easier to invest in the U.S.”
New kind of consciousness needed
Another building block for a well functioning capital market in Europe is developing a new kind of consciousness that recognizes the different needs of all stakeholders, from retail savers to international stock exchanges and the growth companies in between. “You can’t have a public market turning on itself, and have all these superduper rules protecting whatever, but not really looking at the needs of companies or investors that go into that market. That’s, I think, the crux of our thoughts on this issue.”
The CFA Institute, together with Brussels-based investor lobby group Better Finance, has launched an urgent appeal to governments and policy makers for a comprehensive overhaul of the European capital markets framework.
This time around, the discussions about a capital markets union should go beyond the European Commission in Brussels, in the hands of the influential DG Fisma financial markets policy unit. “It’s actually far more about connecting a capital market that’s going to serve a purpose for European investors, for European companies, to keep them in Europe. That is when yoy need to connect the internal market and the actual economies to the CMU,” said Kamerling.
Making that connection is not easy, she acknowledged, also given the wide fragmentation among the different parts of the policy-making factory. “This is a really difficult exercise. We deal with national economies. We have fragmentation in a way that pushes for development to happen at a national levels. You have the ministries of finance cooperating with Fisma, You have the ministry of the economy collaborating with (DG) Ecfin, or partly with (DG) Envi. You have the ministries of justice that are collaborating on corporate governance. So (fragmentation)’s all over the place, and it is not leading to a focused approach.”
Looking for sweet spots
That’s something that the CFA Institute and Better Finance hope to address with their paper on the review of the EU listing rules , a topic that also is subject of a vote in the EU parliament in the week of 22 April. “There are sweet spots between the institutional investors, the retail investors and the finance professionals,” said Kamerling.
Like with the Banking Union, when the banking sector was pushed to integrate and make itself subject to EU-level supervision following the 2007-8 Great Financial Crisis, EU politicians and Brussels-based policy makers now are about to determine the willingness to recommit to a truly integrated capital markets union.
Earlier plans for such a CMU have failed miserably. Yet last month, Eurogroup finance ministers took charge of a push to relaunch it. An important step in this trajectory will be the presentation of the Letta Report on 17 April. Former Italian prime minister Enrico Letta has been asked to prepare a report on the future of the EU internal market.
Kamerling hopes the EU-level discussion on efficient capital markets will shift towards cultivating a more inclusive, efficient, and appealing market structure that can retain its entrepreneurs and investors.
