London is home to Europe’s biggest capital market. Brexit poses significant policy questions for the EU27 as to how capital market activity should be managed and regulated once the UK has left the EU.
The EU’s ambition is to create an ‘onshore’ capital market within the Union, and this has become the focus of the capital markets union (CMU) project since Britain voted to leave. The CMU project, which has been going since 2014, aims to create a deeper, more integrated market for cross-border financing and investments within the EU. The ambition is laudable: deeper integration of capital markets could make the European economy more stable, more effectively channel funding to the best investments, and give investors and firms more options.
However, progress was slow even before Brexit. Integration of capital markets requires changes to many different areas of policy, including business and financial law, taxation, accounting and insolvency regimes.
The UK’s imminent departure probably ends the prospect of the development of a global-scale capital market within the EU. This raises a fundamental question for the Union: how integrated into global capital markets does the EU want its domestic capital markets to be?
Continental European capital markets are small, relative to the US, because EU industry is overwhelmingly reliant on banks for finance. While some argue that the banking model of corporate financing is appropriate for European business, global pressure on bank balance-sheets suggests that banks alone are insufficient to fully finance growth. Companies will increasingly be forced to look for financing elsewhere.
With the UK leaving, Europe’s major hub of non-bank capital will soon be outside the EU’s regulatory purview. The EU will need to decide whether to keep London at arm’s length while pursuing an inward-looking strategy, or instead open up its market to London and the rest of the world.
This dilemma poses a fundamental policy challenge for the EU. Deeper integration with the UK and the rest of the world would increase European businesses’ access to international capital and could boost European growth. However, deeper integration might also result in a loss of EU regulatory control, given the relatively small size of EU markets compared to New York and London: European corporates could continue to seek finance outside the Union as a result.
For the UK, the concomitant policy challenge is how far it diverges from EU rules and mechanisms, since some form of ‘equivalence’ is likely to be the price of frictionless admission to EU markets. Regardless, in the current environment there is no plausible route to a ring-fenced, closed EU capital market. The EU should accept that global capital markets are here to stay and seek to maximise its involvement in those markets, and therefore its voice in their regulation.
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