## sdnea2019007 — Executive Summary (A Capital Market Union for Europe)

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### Purpose and central conclusions
- Purpose: weigh the merits of a capital market union (CMU) for Europe, identify major obstacles, and recommend a set of carefully targeted policy actions.
- Central diagnosis:
  - European capital markets are relatively small, leading to strong bank-dependence, and are split sharply along national lines.
  - Key frictions: transparency, regulatory quality, and insolvency practices.
  - No single grand bargain required: targeted steps on the three priority areas should be feasible and effective.

### Key quantitative facts on market structure and outcomes
- Household and firm funding patterns:
  - About 40 percent of EU households’ savings are held as bank deposits, compared with 10 percent in the United States.
  - Only 30 percent of EU nonfinancial firms’ liabilities are securities.
  - More than half of EU long-term investors’ assets are domestic claims.
- Corporate funding costs and sensitivities:
  - Firms in some euro area countries pay up to 250 basis points more on debt than their peers in other euro area countries.
  - Consumption is four times more sensitive to local shocks in the EU than in the 50 US states.
- Market size comparisons:
  - Bank assets: 300 percent of GDP in the euro area, 85 percent of GDP in the United States, 500 percent of GDP in Japan.
  - Listed equity: 68 percent of GDP in the euro area, 170 percent of GDP in the United States, 120 percent of GDP in Japan.
  - Private sector debt securities outstanding: almost 85 percent of GDP in the euro area, 65 percent of GDP in Japan, 100 percent of GDP in the United States.
- Cross-country and intra-EU variation:
  - Total tradable claims exceed 200 percent of GDP in France, the Netherlands, and Sweden; about 135 percent of GDP in Portugal; less than 70 percent in Poland, the Czech Republic, Latvia, and Lithuania.
  - Only 20 percent of euro area households hold stocks or investment fund units.
  - Only one-third of euro area households invest in voluntary pension and insurance schemes.
  - Nonfinancial firms: 48 percent tradable financing in one reported comparison; euro area firms rely less on market-based finance—only 30 percent of the sector’s financing comprises tradable instruments versus some two-thirds in the United States.
- Investment funds and institutional investors:
  - Assets of investment funds in the euro area amount to €13 trillion, or 110 percent of GDP.
  - Hedge funds and private equity funds in the EU: about $690 billion and $650 billion, respectively (overwhelmingly managed from the United Kingdom); by comparison, the United States has $2.6 trillion in hedge fund assets and $1.5 trillion in private equity assets.
  - Investible assets of life insurers and private pension funds in the euro area are about €6 trillion, or about 50 percent of GDP, compared with almost 90 percent in the United States.
- Home bias and national segmentation:
  - Almost half of EU insurers’ equity holdings are in firms based in the insurer’s home country; rises to 60 percent in Spain; 70–75 percent in Germany, the Netherlands, and Austria; and 80 percent in France.
  - Pension funds’ equity home bias is highest in France, Portugal, and Spain and generally well in excess of US pension funds’ home-state bias.

### Costs of market fragmentation: three channels
- Uneven corporate funding costs:
  - Overreliance on banks and thin capital markets lead to stratified and elevated funding costs; local banks’ market power can raise borrowing rates.
  - Local stock market illiquidity can push up equity cost of capital.
- Restraints on innovation and growth:
  - Bank-dependence and thin capital markets limit funding for start-ups and firms with limited collateral, hurting venture capital access and innovation.
- Forgone macroeconomic smoothing:
  - Limited portfolio diversification opportunities for savers reduce private-sector cross-border shock absorption, making domestic demand more sensitive to local shocks.

### Quantified impacts from staff empirical work
- Capital market development index:
  - IMF staff index aggregates stock market capitalization and turnover; capitalization of smaller firms; total value and number of issuers of private sector debt securities; international placements of debt.
- Cross-country funding-cost dispersion:
  - A Greek firm may pay up to 250 basis points a year more on debt than a comparable French firm.
  - An Italian firm may pay 80 basis points more than a similar Belgian firm.
  - Dispersion is higher for small or unlisted firms: small Greek firms pay on average some 325 basis points more than their French peers.
- Firm growth and tangibility:
  - Controlling for firm size, profitability, sectors, and countries: for every 10 percentage points of lower “tangibility” relative to average, a firm will grow nearly 3 percentage points more slowly in, say, the Slovak Republic than in France.
- Risk-sharing and consumption sensitivity:
  - For every 1 percentage point drop in national GDP growth below the EU average:
    - Private consumption falls by some 80 basis points, on average, for countries in the EU.
    - Private consumption falls by 75 basis points if the country is in the euro area.
    - By contrast: about 20 basis points for the 50 US states; 10 basis points for Canadian provinces.
  - Capital market channels in the euro area smooth only 10 basis points of domestic growth shocks through capital market investment income and another 10 basis points via the savings channel.
  - Data indicate 65 percent of EU countries’ external claims are on other EU countries; comparable smoothing via external income: some 45 basis points and 29 basis points for the US states and Canadian provinces, respectively.
- Insolvency and cross-border flows:
  - Each 1 standard deviation improvement in the secured recovery rate (example: Portugal raising 69 percent to the United Kingdom’s 95 percent) would multiply cross-border credit by a factor of 1.5.
  - If national insolvency regimes with the lowest secured creditor recovery rates converged to best-in-class recovery rate of about 95 percent, interest cost reductions could be:
    - Some 25 basis points for countries such as Portugal and Italy.
    - Closer to 50 basis points for Greece and Estonia.
  - For countries where secured recovery rate and regulatory quality both exceed the average by 1 standard deviation, smoothing is some 25 percentage points stronger.
  - Risk sharing is higher by 11 percentage points in countries with capital market EATRs at the mean.

### Barriers to integration identified by survey and data
- Three key barriers emphasized:
  - Transparency: informational frictions in securities markets, issues with withholding tax relief/refund procedures, affordability of research on small issuers and unlisted firms, and need for centralized, standardized, ongoing issuer reporting.
  - Regulatory quality: uneven regulatory quality across countries restrains cross-border claims; supervisory convergence needs strengthening; centralization of oversight of systemic intermediaries recommended.
  - Insolvency practices: deficient insolvency regimes in some countries significantly hold back cross-border claims and account for much cross-country dispersion in firms’ debt financing costs.
- Survey findings (21 national regulators and large market participants):
  - The United Kingdom topped rankings across almost all assessed areas.
  - Deficiencies flagged across many countries: information availability on listed and unlisted firms; insolvency practices; capital market regulation.
  - More than half of respondents cited home and host restrictions on cross-border product offerings and the comparability of accounting standards as important deterrents.
  - More than 40 percent cited administrative burdens, minority investor rights, securities laws, and limited liquidity in both debt and equity markets.
  - Most respondents favored more-efficient withholding tax refund procedures.

### Policy priorities and specific recommendations
- Overarching priorities: focus on transparency, regulation, and insolvency procedures.
- Transparency recommendations:
  - Require centralized, standardized, and ongoing reporting by all issuers.
  - Task ESMA with putting information collected in national registries on a central platform and mandate that issuers transmit their financial statements directly to ESMA.
  - Address affordability challenges for research on small issuers and unlisted firms; revisit MiFID-II prohibition against bundling research costs into execution fees.
  - Streamline cross-border withholding tax procedures: allow exemption or offsetting at source where tax information has already been exchanged; create a single electronic processing portal and standardize reclaim forms, ideally with an English language option.
- Regulation and supervision recommendations:
  - Centralize oversight of systemic intermediaries; vest ESMA and the ECB with supervisory powers over CCPs, jointly with relevant NCAs.
  - Bring systemic euro area investment firms under the Single Supervisory Mechanism where appropriate; ESMA to coordinate.
  - Strengthen ESMA’s supervisory convergence tools and governance; consider an independent executive board with full-time members for convergence decisions.
  - Take further steps to support a cost-efficient, tax-effective, portable pension product (PEPP): revive greater national compartmentalization for portability and consider lowering the PEPP’s regulatory ceiling on administrative costs by some 5 basis points over time.
  - Maintain close regulatory cooperation with non-EU countries, notably post-Brexit United Kingdom.
- Insolvency recommendations:
  - Adopt EU minimum standards for corporate insolvency and debt enforcement processes, including common standards for the ranking of claims.
  - Institute EU-level systematic monitoring of member states’ progress, with the Commission taking the lead, modeled on IMF and World Bank monitoring practices.
  - Improve mechanisms for enforcement of immovable collateral and data collection on insolvency and debt enforcement.

### EU institutional context, CMU progress, and implementation gaps
- Institutional features and challenges:
  - Multilayered oversight across sovereign states: NCAs handle most supervision; ESAs mainly harmonize but have limited mandatory powers.
  - ESMA issues Level 3 guidelines and conducts peer reviews but cannot mandate NCA compliance with Level 3 guidelines or force implementation.
  - Only about half of EU member states have fully transposed all relevant directives.
  - Variable NCA capacity and legal powers; notable misconduct cases initially went undetected (examples cited in the source).
- CMU Action Plan developments and gaps:
  - Completed/advanced items:
    - Prospectus Regulation (in effect since mid-2019): streamlined “growth prospectus”; ESMA to store qualifying prospectuses.
    - Securitization Regulation (in effect since January 2019): STS securitization with reduced capital charges and lower ECB collateral haircuts for eligible issues.
    - Venture Capital Regulation (amended 2018): raises assets-under-management cap above €500 million; broadens qualifying investment definition to include unlisted entities with up to 500 employees.
  - Ongoing/proposed initiatives:
    - Prudential oversight of investment firms: political agreement February 2019 proposing banking licenses for investment firms with assets of more than €30 billion.
    - Pan-European personal pension (PEPP): draft regulation agreed February 2019 allows as few as two national subaccounts.
    - ESA review (political agreement March 2019): would strengthen ESMA’s supervisory convergence tools and introduce a comply-or-explain regime for guidelines or recommendations.
    - EMIR-II (political agreement March 2019, awaiting Council approval): strengthens ESMA’s powers over EU and third-country CCPs.
  - Dilutions and outstanding gaps:
    - Governance enhancements for ESAs were diluted; prospectus approver responsibilities retained by NCAs.
    - Directive on Restructuring and Insolvency and draft Directive on Credit Servicers are silent on several critical issues, including the hierarchy of claims.

### Implementation challenges and trade-offs
- Trade-offs:
  - Increased cross-border interconnection can channel contagion; equity claims have shock-absorbing properties but financial stability requires active supervision and macroprudential management.
  - Policy principle: proportionality—market discipline and strong ex post enforcement for most entities, intrusive prudential oversight for systemic actors (e.g., CCPs, large investment firms).
- Political economy and sequencing:
  - Progress requires political will to overcome resistance from vested interests, including incumbent banks and national authorities that may tacitly condone home bias.
  - Areas outside EU treaty reach (for example, taxes) will require more time and member-state engagement.
  - Achieving CMU should complement, not displace, a well-functioning banking union and must be matched by fiscal responsibility and structural reforms.

*International Monetary Fund — A CAPITAL MARKET UNION FOR EUROPE (EXECUTIVE SUMMARY, sdnea2019007)*

### EXECUTIVE SUMMARY ___________________________________________________________________________ 3

### sdnea2019007 - EXECUTIVE SUMMARY ___________________________________________________________________________ 3

### Executive summary: purpose and central conclusions
- Purpose: weigh the merits of a capital market union (CMU) for Europe, identify major obstacles, and recommend a set of carefully targeted policy actions.
- Central diagnosis:
  - European capital markets are relatively small, leading to strong bank-dependence, and are split sharply along national lines.
  - Key frictions: transparency, regulatory quality, and insolvency practices.
  - No single grand bargain required: targeted steps on the three priority areas should be feasible and effective.

### Key quantitative facts on market structure and outcomes
- Household and firm funding patterns:
  - About 40 percent of EU households’ savings are held as bank deposits, compared with 10 percent in the United States.
  - Only 30 percent of EU nonfinancial firms’ liabilities are securities.
  - More than half of EU long-term investors’ assets are domestic claims.
- Corporate funding costs and sensitivities:
  - Firms in some euro area countries pay up to 250 basis points more on debt than their peers in other euro area countries.
  - Consumption is four times more sensitive to local shocks in the EU than in the 50 US states.
- Market size comparisons:
  - Bank assets: 300 percent of GDP in the euro area, 85 percent of GDP in the United States, 500 percent of GDP in Japan.
  - Listed equity: 68 percent of GDP in the euro area, 170 percent of GDP in the United States, 120 percent of GDP in Japan.
  - Private sector debt securities outstanding: almost 85 percent of GDP in the euro area, 65 percent of GDP in Japan, 100 percent of GDP in the United States.
- Cross-country and intra-EU variation:
  - Total tradable claims (listed equity and debt securities of financial and nonfinancial corporations) exceed 200 percent of GDP in France, the Netherlands, and Sweden; about 135 percent of GDP in Portugal; less than 70 percent in Poland, the Czech Republic, Latvia, and Lithuania.
  - Only 20 percent of euro area households hold stocks or investment fund units.
  - Only one-third of euro area households invest in voluntary pension and insurance schemes.
  - Nonfinancial firms: 48 percent tradable financing in one reported comparison; euro area firms rely less on market-based finance—only 30 percent of the sector’s financing comprises tradable instruments versus some two-thirds in the United States.
- Investment funds and institutional investors:
  - Assets of investment funds in the euro area amount to €13 trillion, or 110 percent of GDP.
  - Hedge funds and private equity funds in the EU: about $690 billion and $650 billion, respectively (overwhelmingly managed from the United Kingdom); by comparison, the United States has $2.6 trillion in hedge fund assets and $1.5 trillion in private equity assets.
  - Investible assets of life insurers and private pension funds in the euro area are about €6 trillion, or about 50 percent of GDP, compared with almost 90 percent in the United States.
- Home bias and national segmentation:
  - Almost half of EU insurers’ equity holdings are in firms based in the insurer’s home country; rises to 60 percent in Spain; 70–75 percent in Germany, the Netherlands, and Austria; and 80 percent in France.
  - Pension funds’ equity home bias is highest in France, Portugal, and Spain and generally well in excess of US pension funds’ home-state bias.

### Introduction: rationale and risks
- Rationale:
  - EU treaties enshrine capital mobility; substantial EU financial legislation exists to support cross-border activity.
  - Europe needs more private cross-border risk sharing through banks and capital markets to support economic convergence, growth, and shock absorption.
- Risks:
  - Capital markets can channel contagion; arm’s-length finance relies on public disclosure with imperfect investor protection.
  - Banks benefit from deposit insurance and relationship lending; capital markets have limited public safety nets.
  - Financial stability risks require vigilance and active macroprudential management.

### The European landscape: structure and Brexit implications
- Structure:
  - Europe combines a large banking system with relatively small capital markets and extensive public pension systems, leaving a smaller corpus of privately managed capital market assets.
  - Investment funds are the largest capital market segment; UCITS funds can be marketed across the EU; AIFMD funds may be marketed only to professional investors.
  - Investment banks (universal banking groups) provide underwriting, distribution, depositary, and prime brokerage services; CCPs and CSDs are key infrastructure.
- Brexit challenges (fourfold):
  - First: UK departure would shrink the size of EU markets and could disrupt European network links.
  - Second: Brexit could reduce market liquidity and increase transaction costs by dispersing trading and clearing.
  - Third: Some global channels may be disrupted (e.g., London’s transatlantic links to New York and dollar funding pipelines).
  - Fourth: Migration of activity from London to the EU27 requires urgent upgrades to oversight capacity and financial infrastructure.
- Specific Brexit impacts highlighted:
  - Volume of listed equities and private sector bonds in the EU would fall significantly; a large share of derivatives would be carved out.
  - A mass of euro clearing might migrate from 3 UK-based CCPs to the 13 CCPs in the EU27.
  - Disruption to fund industry practices (e.g., delegating investment decisions to managers in London) could be costly.

### Costs of market fragmentation: three channels
- Uneven corporate funding costs:
  - Overreliance on banks and thin capital markets lead to stratified and elevated funding costs; local banks’ market power can raise borrowing rates.
  - Local stock market illiquidity can push up equity cost of capital.
- Restraints on innovation and growth:
  - Bank-dependence and thin capital markets limit funding for start-ups and firms with limited collateral, hurting venture capital access and innovation (noted in executive summary and later sections).
- Forgone macroeconomic smoothing:
  - Limited portfolio diversification opportunities for savers reduce private-sector cross-border shock absorption, making domestic demand more sensitive to local shocks (consumption sensitivity noted above).

### Barriers to integration identified by empirical work and survey evidence
- Three key barriers emphasized:
  - Transparency: informational frictions in securities markets, issues with withholding tax relief/refund procedures, affordability of research on small issuers and unlisted firms, and need for centralized, standardized, ongoing issuer reporting.
  - Regulatory quality: uneven regulatory quality across countries restrains cross-border claims; supervisory convergence needs strengthening; centralization of oversight of systemic intermediaries recommended.
  - Insolvency practices: deficient insolvency regimes in some countries significantly hold back cross-border claims and account for much cross-country dispersion in firms’ debt financing costs.
- Empirical and survey findings:
  - New survey of practitioners highlights informational issues in securities markets and withholding tax procedures.
  - New empirical work finds that cross-border claim volumes are significantly held back by uneven regulatory quality and deficient insolvency regimes; insolvency explains much of the dispersion in firms’ debt costs.

### Policy priorities and specific recommendations
- Overarching policy priorities: focus on transparency, regulation, and insolvency procedures.
- Transparency recommendations:
  - Require centralized, standardized, and ongoing reporting by all issuers.
  - Address affordability challenges for research on small issuers and unlisted firms.
  - Streamline cross-border withholding tax procedures.
- Regulation and supervision recommendations:
  - Centralize oversight of systemic intermediaries.
  - Strengthen supervisory convergence tools to buttress investor protection where it falls short.
  - Take further steps to support a cost-efficient, tax-effective, portable pension product.
  - Pursue close regulatory cooperation with non-EU countries.
- Insolvency recommendations:
  - Adopt a “name and shame” approach: set minimum insolvency standards and systematically monitor countries’ progress in observing them.
- Implementation rationale:
  - These targeted steps should be feasible without a new grand bargain and would materially advance capital market integration while mitigating associated risks.

### Concluding assessment
- Integration benefits:
  - Expanding arm’s-length cross-border finance via tradable instruments would broaden investor bases, even out funding costs, improve venture capital access, and enhance shock absorption through better portfolio diversification.
  - Capital markets would complement, not replace, banking—supporting diversity in European finance.
- Trade-offs:
  - Increased interconnection can channel contagion; however, equity claims have recognized shock-absorbing properties.
  - Financial stability will require active supervision and macroprudential management as integration proceeds.

*International Monetary Fund — A CAPITAL MARKET UNION FOR EUROPE (EXECUTIVE SUMMARY, sdnea2019007)*

### 24.      An index developed by the IMF staff finds wide variation in the level of capital market

### An index developed by the IMF staff finds wide variation in the level of capital market development across Europe

### Capital market development and cross-country funding-cost dispersion
- IMF staff index aggregates: stock market capitalization and turnover; capitalization of smaller firms; total value and number of issuers of private sector debt securities; international placements of debt.
- The index ranks the United States at the top globally, but shows wide differences within the EU and the euro area.
- IMF staff analysis of firms within the euro area finds large cross-country dispersion in debt funding costs among similar firms:
  - A Greek firm may pay up to 250 basis points a year more on debt than a comparable French firm.
  - An Italian firm may pay 80 basis points more than a similar Belgian firm.
  - Dispersion is higher for small or unlisted firms: small Greek firms pay on average some 325 basis points more than their French peers.
- Empirical control variables include sector, firm size, profitability, leverage, fixed asset endowment, and country fixed effects (see Background Note 2).

### Restraints on innovation and growth
- Limited funding choices increase exposure to idiosyncratic banking risks; bank-dependent economies take longer to recover from financial crises.
- Firms with limited tangible assets (start-ups, knowledge-based sectors) are particularly disadvantaged by shallow capital markets because they lack collateral that manufacturing firms can pledge.
- IMF staff estimates on firm growth:
  - Real value-added growth of firms with fewer tangible assets increases with capital market development.
  - Controlling for firm size, profitability, sectors, and countries: for every 10 percentage points of lower “tangibility” relative to average, a firm will grow nearly 3 percentage points more slowly in, say, the Slovak Republic than in France.
- Example metric for low-tangibility firms: firms with ratios of fixed assets to total assets 10 percentage points below EU industry average. Value added defined as earnings before interest, taxes, depreciation, and amortization + wages.

### Forgone macroeconomic smoothing (risk sharing)
- Limited cross-border portfolio diversification → less private risk sharing and greater sensitivity to local shocks.
- Cross-border equity claims are especially effective at private risk sharing because equity income losses can be borne by foreign investors; debt holdings do not smooth as effectively because fixed payments continue barring default.
- Measured sensitivity of private consumption to asymmetric GDP shocks:
  - For every 1 percentage point drop in national GDP growth below the EU average:
    - Private consumption falls by some 80 basis points, on average, for countries in the EU.
    - Private consumption falls by 75 basis points if the country is in the euro area.
    - By contrast: about 20 basis points for the 50 US states; 10 basis points for Canadian provinces.
- Capital market channels in Europe contribute little to income smoothing:
  - Only 10 basis points of domestic growth shocks are smoothed through capital market investment income in the euro area.
  - Another 10 basis points of smoothing are attributable to the savings channel (changes in net cross-border portfolio asset holdings).
  - Data on bilateral portfolio holdings suggest that 65 percent of EU countries’ external claims are on other EU countries.
  - Comparable smoothing via external income: some 45 basis points and 29 basis points for the US states and Canadian provinces, respectively.

### Barriers to capital market integration — survey of regulators and market participants
- IMF survey respondents: 21 national regulators and large investment, pension, venture capital, private equity funds, and insurance companies (Background Note 4).
- Life-cycle framing for a representative capital market instrument covered underwriting, issuance, distribution, secondary trading, and insolvency/default.
- Survey-identified issues along the life cycle:
  - Underwriting/issuance/distribution: national differences in listing requirements; restrictions on cross-border offerings; administrative burdens.
  - Secondary market trading: availability of company information, reliable audits, comparable accounting standards; withholding tax rates and ease of claiming refunds; regulatory quality and investor protection (including minority investor protection).
  - Default/bankruptcy: efficiency of insolvency and debt enforcement frameworks, court effectiveness, administrative costs, speed of decision-making, recovery values on impaired claims.
- Key survey findings:
  - The United Kingdom topped rankings across almost all assessed areas and was widely viewed as Europe’s leading capital market jurisdiction.
  - Deficiencies flagged across many countries: information availability on listed and unlisted firms; insolvency practices; capital market regulation.
  - More than half of respondents cited home and host restrictions on cross-border product offerings and the comparability of accounting standards as important deterrents to integration (the latter seen as less of an issue within the euro area).
  - More than 40 percent cited administrative burdens, minority investor rights, securities laws, and limited liquidity in both debt and equity markets.
  - Access to trading platforms and listing requirements were areas of lower concern.
  - Most respondents favored more-efficient withholding tax refund procedures to reduce double taxation and delays; reducing delays and uncertainties in establishing eligibility for withholding tax exemptions was strongly favored.

### Quantified gains from reducing barriers
- Empirical approach summarized:
  - Regress nonfinancial firms’ funding costs on firm characteristics, bank lending rates, and capital market depth to identify policy variables affecting cross-country funding-cost dispersion.
  - Panel regressions to assess impact of lowering barriers.
  - Bilateral portfolio claims regressed on policy variables in source and destination countries to assess impact on cross-border flows.
- Data sources and measures used:
  - Regulatory quality: Worldwide Governance Indicators.
  - Panel data on effective average tax rates (EATRs) on capital market investments, accounting for bilateral tax treaties: Leibniz Centre for European Economic Research.
  - Secured corporate recovery rates: World Bank’s Doing Business database.
- Data concordance with survey:
  - Example EATRs in 2017 for Austria: 25 percent for German investors to 21 percent for Portuguese investors (Leibniz Centre for European Economic Research 2017).
  - Secured-claim recovery rates ranged from more than 90 percent in some countries to 35 percent in others.
  - Standardized z-scores computed; z-scores exhibit a correlation coefficient of more than 0.5 with survey point-in-time scores.
- Main quantified impacts:
  - Insolvency and debt enforcement quality are principal drivers of wide dispersion in debt funding costs for unlisted firms:
    - If national insolvency regimes with the lowest secured creditor recovery rates in the euro area converged to those with the highest rates (best-in-class recovery rate of about 95 percent), interest cost reductions could be:
      - Some 25 basis points for countries such as Portugal and Italy.
      - Closer to 50 basis points for Greece and Estonia.
  - Risk sharing improvements:
    - For countries where secured recovery rate and regulatory quality both exceed the average by 1 standard deviation, smoothing is some 25 percentage points stronger.
    - Risk sharing is higher by 11 percentage points in countries with capital market EATRs at the mean (EATRs = effective average tax rates).
  - Investment attractiveness:
    - Higher secured recovery rates and more robust capital market regulation are associated with larger bilateral portfolio liabilities (private investors respond positively to higher recovery rates and regulatory reassurance).
- Other policy areas noted as influential: tax rates and contract law (including enforcement of contracts).

*Source: IMF staff analysis as presented in the content unit.*

### 48.      Whereas better regulatory quality tends to attract both debt and equity investments,

### sdnea2019007 - 48.      Whereas better regulatory quality tends to attract both debt and equity investments,

### Cross-border credit, recovery rates, and regulatory quality
- Each 1 standard deviation improvement in the secured recovery rate—equivalent to Portugal raising its rate of 69 percent to the United Kingdom’s 95 percent—would multiply cross-border credit by a factor of 1.5.
- Better regulatory quality tends to attract both debt and equity investments; better recovery rates specifically catalyze cross-border debt claims.
- Empirical relationship illustrated (Austria and U.K. example): higher secured corporate recovery rates and better regulatory-quality scores are associated with higher log of gross bilateral portfolio claims.

### Economic benefits and country-level example
- More cross-border private risk sharing benefits both suppliers and users of funds.
- Estonia example:
  - If Estonia could lift its secured creditor recovery rate to best-in-class levels, its average corporate debt funding cost could fall by some 48 basis points.
  - Resulting channel: Estonia would attract more cross-border bond flows (e.g., from German savers), who would earn higher returns than on German bank deposits.
  - Connecting to more-developed markets could raise value-added growth for Estonian start-ups and potentially lift Estonia’s overall growth potential.
  - In a virtuous circle, private consumption in both Germany and Estonia would become less sensitive to domestic economic outcomes.

### Policy issues and guiding principles
- Public policy principle: proportionality—focus on transparency, windup, investor protection, and other prerequisites for market discipline while subjecting systemic actors to intrusive prudential oversight.
- Key regulatory and insolvency principles:
  - Emphasize market discipline as main restraint on risk taking in capital markets.
  - Prioritize conduct-of-business oversight to protect investors, ex post enforcement to deter misconduct, and insolvency procedures to preserve value and facilitate exit.
  - Prioritize ability-to-fail over prudential controls for most nonbank financial intermediaries, recognizing that some nonbanks (e.g., CCPs, large complex leveraged investment firms) require strict prudential oversight.
  - For major institutional investors, oversight should address fitness and propriety of fund managers; licensing, governance, auditing, and disclosure; client-asset segregation; concentration; and liquidity-risk management.
  - Efficient insolvency procedures are important: efficient reorganization, effective realization of collateral in liquidation, and a clear hierarchy of claims are vital. Early intervention for investment firms recommended to preserve value.
  - Smooth market functioning depends on sanctity of property rights, strong contract and corporate law, protection of minority shareholders, robust accounting and auditing standards, transparent tax rules, and robust enforcement of private contracts.

### EU institutional arrangements and challenges
- The EU’s multilayered oversight reflects 28 sovereign states with diverse legal frameworks, tax systems, and capacities.
- National competent authorities (NCAs) handle most supervision and enforcement; European supervisory authorities (ESAs) mainly harmonize.
- ESAs and supervisory framework:
  - ESMA, the European Insurance and Occupational Pensions Authority, and the European Banking Authority foster harmonized practices.
  - ESMA issues Level 3 guidelines and conducts peer reviews but cannot mandate NCA compliance with Level 3 guidelines or force implementation of peer-review recommendations.
  - ESMA’s fine-imposition powers are tightly defined and yield fines well below those of some counterparts.
- Persistent divergences:
  - Transposition of directives allows legislative discretion; some directives are silent on issues; some vest NCAs with regulatory options.
  - Only about half of EU member states have fully transposed all the relevant directives.
  - Variable quality and capacity of NCAs: many NCAs lack adequate legal powers and capacity; notable misconduct cases initially went undetected (examples include “self-placement” by banks and “closet indexers” among UCITS equity funds where ESMA estimates as many as 5–15 percent may be “closet indexers”).

### CMU Action Plan: progress, initiatives, and gaps
- CMU action plan (2015) main areas: (1) financing for innovation; (2) raising capital in public markets; (3) facilitating long-term investment, especially in infrastructure; (4) fostering more choice for retail and institutional investors; (5) supporting securitization; (6) reducing barriers to a unified EU capital market. Midterm review June 2017 added priorities, including oversight changes in view of Brexit.
- Notable completed or advanced items:
  - Prospectus Regulation (in effect since mid-2019): facilitates market access for smaller firms; introduces exemptions, a streamlined “growth prospectus” for certain SME issues; tasks ESMA with storing qualifying prospectuses.
  - Securitization Regulation (in effect since January 2019): encourages simple, transparent, and standardized (STS) securitization; STS label eligibility allows reduced capital charges and lower ECB collateral haircuts.
  - Venture Capital Regulation (amended 2018): widens fund managers allowed to manage EU venture capital funds by raising the assets-under-management cap above €500 million; broadens qualifying investment definition to include unlisted entities with up to 500 employees (up from 250); qualifying funds are exempt from some AIFMD requirements.
- Ongoing and proposed initiatives:
  - Prudential oversight of investment firms: proposal (political agreement February 2019) to require investment firms with assets of more than €30 billion, including affiliates, to obtain a banking license; euro-area firms would come under the Single Supervisory Mechanism (SSM); smaller firms to face a new, less-exacting prudential regime.
  - Pan-European personal pension (PEPP): voluntary defined-contribution product originally envisaged with 28 “national compartments” for tax compliance and portability; draft regulation agreed February 2019 allows as few as two national subaccounts, reducing portability.
  - ESA review (political agreement March 2019 on core elements): would strengthen ESMA’s supervisory convergence tools; ESMA would define up to two supervisory topics for all NCAs, coordinate peer reviews, and subject NCAs to a comply-or-explain regime for ESMA guidelines or recommendations.
  - Extended ESMA mandates: greater coordinating role in market abuse cases; direct supervision and authorization of administrators of critical EU price benchmarks and large data reporting service providers pursuant to MiFID-II.
  - EMIR-II (political agreement March 2019, awaiting Council approval): strengthens ESMA’s powers over EU and third-country CCPs; for EU CCPs, stronger role in supervisory colleges, authority to adopt decisions directly to CCPs, and participate in onsite inspections; for third-country CCPs of systemic importance, ESMA powers to demand information, conduct onsite inspections, take supervisory measures, and impose penalties.
- Dilutions and outstanding gaps:
  - Proposed governance enhancements for ESAs (independent executive boards with full-time members) were diluted; governance changes limited to strengthening chair powers.
  - Prospectus approver responsibilities originally envisaged for ESMA were retained by NCAs in revised proposals.
  - The Directive on Restructuring and Insolvency (in effect since mid-2019) and draft Directive on Credit Servicers, Credit Purchasers, and the Recovery of Collateral address debtor-in-possession, stays of enforcement, restructuring plans, protection of new financing, and minimum expectations for insolvency practitioners and the judiciary; however, both texts are silent on several critical issues, including the hierarchy of claims.

*Source: sdnea2019007 (IMF staff note).*

### 78.      The survey conducted for this note gathered useful views on how best to upgrade

### A CAPITAL MARKET UNION FOR EUROPE

### Survey findings on oversight and reform priorities
- A strong majority of respondents singled out insolvency reform as a top priority.
- There was significant support for moving to more-unified capital market supervision in the euro area (see Figure 15).
- Some respondents favored establishing a single consumer protection body for the euro area, perhaps loosely modeled on the US Consumer Financial Protection Bureau.
- Source statement in the chapter: "The survey conducted for this note gathered useful views on how best to upgrade oversight."

### Further steps to integration — overview
- The note focuses on a small number of targeted, actionable initiatives at the EU or euro area level to address main obstacles: transparency, regulation, and insolvency.
- It accepts that areas outside EU treaty reach (for example, taxes) will require more time for progress.

### A. Enhancing Transparency
- The Prospectus Regulation and ESMA’s free and searchable online prospectus database are positive steps, including simplified prospectus rules for smaller issuers to enable more SMEs to issue securities with an EU passport.
- The note urges requiring centralized, standardized, and ongoing reporting by all issuers, modeled on the U.S. SEC’s EDGAR system and similar Canadian mechanisms.
- A proposed multi-step process for Europe:
  - Task ESMA with putting information collected in national registries on a central platform.
  - Mandate that issuers transmit their financial statements directly to ESMA.
  - Ensure comparable accounting standards and task ESMA with reviewing the information received.
- Supporting transparency on unlisted firms:
  - The Business Registers Interconnection System: 25 national corporate registers have been linked since 2016 through the European e-Justice portal.
  - Revisit the MiFID-II prohibition against bundling research costs into execution fees to assess whether it discourages market research on small issuers and SMEs.
- Improve withholding tax refund procedures:
  - Allow exemption or offsetting at source for withholding taxes on a broad set of securities where tax information has already been exchanged.
  - Create a single electronic processing portal and standardize reclaim forms, ideally with an English language option.
  - The European Commission’s Code of Conduct on Withholding Tax is identified as a useful, if nonbinding, starting point.

### B. Sharpening Regulation and Supervision
- Regulatory reform should be guided by a principle of proportionality: strong ex post enforcement and tough oversight of systemic actors while ensuring market discipline for most entities.
- The note does not call for a Single Supervisory Mechanism (SSM) for capital markets; instead it favors selectively enhancing ESMA’s powers and duties, backed by new resources and legal reforms.
- Centralized oversight for Central Counterparties (CCPs):
  - Vest ESMA and the ECB with supervisory powers over CCPs, jointly with relevant NCAs, to ensure rigorous application of EMIR and contain systemic risk.
  - All CCPs should enjoy access to central bank facilities to place deposits and draw liquidity; the ECB, in cooperation with non-euro-area EU central banks, should lead policy development and engage intensively in prudential supervision of CCPs.
- Supervision of systemic euro area investment firms:
  - Bring systemic euro area investment firms under the SSM, as already agreed, to curb arbitrage via migration of business out of London; ESMA could be given a coordinating role.
- Strengthen ESMA’s supervisory convergence tools and governance:
  - Consider introducing an independent executive board with full-time members for decisions related to regulatory and supervisory convergence.
  - This is particularly important given Brexit and the likely emergence of a multi-node EU27 capital market.
- Revisit the structure and consumer protection calibrations of the new PEPP product:
  - Revive the initial proposal requiring each PEPP to maintain a significant number of national compartments to achieve meaningful portability.
  - Consider moderating the PEPP Regulation’s consumer protection safeguards to ease administrative burden.
  - Over time, the PEPP’s regulatory ceiling on administrative costs could be lowered by some 5 basis points to levels comparable with those in the United States to improve returns to savers.
  - Greater ease in withholding tax refunds would also support portability.
- Maintain close regulatory cooperation with non-EU countries, notably a post-Brexit United Kingdom, and seek maximum regulatory cooperation with all leading third-country jurisdictions.

### C. Improving Insolvency Procedures
- Weak insolvency and debt enforcement regimes are identified as a major obstacle to integration; importance lies in recovery values and ease of market exit to make market discipline work.
- Data and monitoring:
  - Ensure reforms are informed by careful data gathering and analysis; insolvency data tend to be scattered and unreliable.
  - Use the EU Justice Scoreboard and reporting under the new Directive on Restructuring and Insolvency to collect information on debt enforcement and corporate insolvency cases.
- EU minimum standards and enforcement mechanics:
  - Consider setting EU minimum standards for corporate insolvency and debt enforcement processes, including common standards for the ranking of claims across the union.
  - Improve mechanisms for enforcement of immovable collateral where current processes are ineffective and prone to delays in some member states.
- Systematic monitoring:
  - Institute EU-level systematic monitoring of member states’ progress in observing such standards, with the Commission taking the lead, modeled on the IMF and World Bank’s Reports on the Observance of Standards and Codes.

### Conclusion and implementation challenges
- The note urges targeted policy steps led by EU institutions, complemented by member state actions, to enhance information, upgrade prudential oversight of systemic actors, strengthen investor protection, and improve insolvency procedures.
- Achieving CMU will require political will to overcome resistance from vested interests, including incumbent banks and national authorities that may tacitly condone home bias.
- The CMU should complement, not displace, a well-functioning banking union; regulatory approach must facilitate effective market discipline with intrusive prudential oversight of systemic actors.
- Progress toward financial integration must be matched by fiscal responsibility and structural reforms, including fiscal adjustment and product and labor market reforms to improve countries’ attractiveness as investment destinations.

*Source: IMF survey of EU capital market practitioners (see Background Note 4).*

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_Source: https://www.imf.org/-/media/files/publications/sdn/2019/sdnea2019007.pdf_