Financial markets look to European policymakers

Financial markets look to European policymakers

European policymakers are initiating a smoothing of regulatory burdens on investors. But political risks like the Brexit and a politically motivated Tax on Financial Transactions threaten to counter this tantalizing prospect for financial operators.

Since the financial crisis, bankers have been targeted by an intense regulatory framework — no less than 20 pieces of legislation were introduced by the European Commission since 2007 — including costly compliance rules and mandatory increases in capital requirements. Simultaneously, the recession environment created weak loan growth and shrinking margins for banks and investing firms.

As a result, profitability has been squeezed hard, with lower revenues and weaker returns on assets and equity. Today for instance, JPMorgan generates a return on equity of 12 per cent, which is less than half of the pre-crisis average of 25 to 30.

Public opinion still holds financial market operators on top of the list of those responsible for the crisis, and causing trouble to the industry is popular among left-leaning politicians in Europe.

At least this was the case until leaders realized that in order to see the economy recover, they needed to boost investments. With the arrival of a new Commission in Brussels at the end of 2014 came a review of the burdensome legislation impacting the financial sector as a way to boost capital markets and restart the European economy.

Commission President Juncker has tasked British politician, Jonathan Hill, with the Commissions’ objective of launching an overhaul of this legislation. But while the process has just started, other policymakers are still pushing for a new Tax on Financial Transactions (FTT). On which foot should investors dance considering those mixed signals from European lawmakers?

Towards a softening of regulatory burdens

Juncker’s main campaign promise was to focus on economic growth and job creation and his Hill has taken to do just that by seeking to develop capital markets across the continental bloc in order to overturn the last few years’ investment crash. In fact, since the financial crisis small and medium size businesses have struggled to find financing in Europe, both because of undersized capital markets and a sharp drop in the provision of credit by euro area banks.

The Capital Markets Union plan — launched in September — includes the securitization package that would lower capital requirements for asset-backed securities which fall into the new category of simple, transparent and standardized (STS) debt. The Commission also proposed an overhaul of the prospectus regime for companies that want to issue stocks and bonds, with an adjustment of the threshold for exemptions from 100,000 EUR to 500,000 EUR. The European Securities and Markets Authority (ESMA) will also start providing free and searchable access to prospectuses.

The European legislative body will also conduct a review of the rules on venture capital funds, covered bonds and the European Social Entrepreneurship funds. Most of all, Hill has insisted that under the Commission’s Better Regulation plan — a reform that intends to re-think the way Europe makes and reviews legislation — his cabinet would look at the current legislative package impacting the financial sector in search for improvements.

The FTT, a political tool

As the Commission continues with its plans, some Member States, however, continue pushing for increased taxes on the financial sector. At a European Council meeting (ECOFIN) on December 8, they discussed the Tax on Financial Transactions. According to the Association for Financial Markets in Europe (AFME), this would drive up the cost of capital throughout Europe. But the Financial Transaction Tax has been delayed since it was first proposed in 2011 because no agreement could be found.

It is mainly an effort by governments that were elected on a bank-bashing platform to show consistency: France is a main advocate of the tax since President Hollande was elected with a pledge to fight the financial sector in 2012.

The tax is also popular among voters, and some governments would like a final adoption ahead of important elections. But on December 8, despite the support of the German-French tandem for the tax, the adoption was postponed for another six months considering falling support among other member states — Estonia pulled out of the list of 11 countries that originally supported the plan.

BREXIT joins in the dance

The UK leads the opposition to the tax. With the financial sector accounting for 12% of the national economy, FTT would have a direct impact on the country’s revenue.

Furthermore, considering both the weight of the financial industry in the British economy and the importance of British membership in the European free market for firms setting up their headquarters in London, a Brexit would result in a catastrophe for the financial sector. It would hurt distribution, competitiveness, and legal structures and complicate currency risks for asset managers.

David Cameron’s recent turn to a tougher negotiating position on his fourth demand — to curb migrant’s benefits — raises fears that he will not strike a deal with Brussels, dramatically increase the risk of a Brexit.

In search for balance

Overall, the European Commission is currently in search for a balanced policy that seeks to ensure market safety while offering financial operators more room to maneuver. The European Commission’s public consultations offer an opportunity for investors to express their view on what should be done. Thus 2016 will be full of opportunities for operators to influence Brussels in search for a more favorable legislative framework.

Categories: Europe, Finance

About Author

Julien Freund

Julien is an analyst with a focus on Europe. He has worked as a lobbyist in Paris and Brussels and has written extensively on the rise of nationalist parties. He holds two master's degrees in geopolitics and international relations and in European relations, and received his BA in economics and social sciences from the Catholic Institute of Paris.