ESMA Report – More Effective Capital Markets in the EU | European Securities and Markets Authority
ESMA Report Summary
The May 2024 report, "Building More Effective and Attractive Capital Markets in the EU" by the European Securities and Markets Authority (ESMA) outlines comprehensive strategies and recommendations to enhance the effectiveness and attractiveness of capital markets within the European Union (EU). This position paper emphasizes the need for a robust capital market framework that meets the financing needs of businesses, empowers individual investors, and maintains competitiveness on a global scale.
ESMA's position paper is part of a larger, renewed effort to strengthen capital markets across the EU. In the face of evolving financing needs, particularly following recent global disruptions, the EU's capital market ecosystem has come under scrutiny. ESMA presents 20 key recommendations targeting different market participants: citizens, companies, regulators, and supervisory bodies. These recommendations extend beyond conventional financial regulation and call for a collective effort from national governments, co-legislators, and the financial industry.
The State of EU Capital Markets
Capital markets are the lifeblood of modern economies. They provide essential financing for businesses, foster innovation, and promote wealth creation for individual investors. Despite their importance, EU capital markets remain relatively underdeveloped compared to global peers. A primary concern is Europe’s over-reliance on the banking system and the fragmented nature of its capital markets.
The Capital Markets Union (CMU) initiative, launched in 2015, aimed to address structural issues by diversifying financing sources and deepening financial integration across EU member states. However, progress has been slow. By the end of 2023, the EU27's share of global equity market capitalization stood at just 11%, compared to 45% for the U.S. Similar trends were seen in public listings and IPOs, where the EU lagged behind other major global markets.
A major obstacle to the development of EU capital markets is the fragmentation of its infrastructure. For example, there are 27 different Central Securities Depositories (CSDs) and 14 Central Counterparties (CCPs) in the EU, compared to only one CSD and eight CCPs in the U.S. This fragmentation leads to inefficiencies and higher costs for market participants. The asset management sector portrays a similar picture, with over 30,000 UCITS funds operating in the EU compared to approximately 12,000 mutual funds in the U.S., which limits the scalability and competitiveness of EU funds.
Broadening EU Investment Opportunities
A significant portion of EU citizens' savings is held in bank deposits, despite these often offering negative real returns. By mobilizing these savings into capital markets, EU households can diversify their investments, potentially unlock higher returns, and contribute to the funding needs of European businesses.
The paper highlights that even small shifts in household savings patterns—such as a 5% shift from deposits to capital market investments—could unlock an additional €1.8 trillion for economic growth. To facilitate this shift, ESMA recommends the creation of simple, cost-effective investment products for retail investors, supported by financial education and advice.
National governments are encouraged to offer tax incentives to promote retail investment and to establish frameworks similar to Sweden’s ISK accounts or Italy’s PIR accounts. These tax-efficient savings vehicles make it easier for citizens to participate in capital markets. Additionally, pension systems should play a more active role in providing long-term capital for EU markets, as countries with well-developed pension schemes, such as Sweden and the Netherlands, demonstrate.
Boosting European Company Finance
?One of the primary goals of the CMU was to reduce the reliance of European companies, especially SMEs, on bank financing by offering diverse funding sources. However, non-financial firms in the euro area still rely heavily on banks for funding—70% of financing comes from banks, compared to only 30% from capital markets.
To foster the growth of capital market financing, ESMA calls for a broader range of financing options, including equity financing, corporate debt, private equity, and venture capital. Particular attention is given to the role of securitization as a complementary financing tool, which could help enhance the relationship between bank and market-based financing. Addressing the continued fragmentation of trading and post-trading infrastructures, the paper advocates for the development of pan-European markets with sufficient liquidity and visibility to attract international investment.
Regulatory Agility and Supervisory Consistency
The regulatory framework governing EU capital markets is seen as rigid and complex. ESMA calls for a more agile, principles-based approach to financial regulation, which would allow for greater flexibility in responding to market developments and emerging risks. By simplifying the regulatory process and empowering ESMA to adjust technical rules without reopening legislation, the EU could cut red tape and reduce the regulatory burden on market participants.
Additionally, supervisory consistency among EU national authorities is critical for ensuring a level playing field. Discrepancies in supervisory practices can lead to regulatory arbitrage and hinder cross-border operations. ESMA recommends closer collaboration among national authorities, including joint supervisory work on large cross-border firms, and further centralization of certain supervisory tasks to improve efficiency and reduce costs for firms.
Initiatives and Recommendations
The paper calls for a unified, strategic approach to building more effective and attractive capital markets in the EU. By enhancing market structures, simplifying regulations, and mobilizing long-term capital, ESMA envisions a future where EU capital markets play a pivotal role in fostering economic growth, supporting innovation, and strengthening global competitiveness.
Pensions and Long-Term Savings in Capital Markets
?One of the key recommendations from the ESMA report is that pensions and long-term savings must play a more substantial role in supporting the growth and stability of EU capital markets. As the population ages and the demand for sustainable retirement income grows, pension systems can serve as significant pools of long-term investment capital, benefiting both the citizens and the broader economy.
The report notes that while some EU member states have well-developed pension systems, there is still substantial room for improvement across the EU as a whole. Member states are encouraged to reflect on their long-term savings trends and the adequacy of their pension systems in light of shifting demographics and evolving economic needs.
ESMA emphasizes that pension systems should not only ensure the long-term financial security of citizens but also contribute to the growth of capital markets. Well-designed pension systems, particularly those that include a mix of public and private savings, can channel more capital into market-based investment products, providing higher returns for savers while fueling economic growth and innovation.
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Three- Pillar Pension Model
ESMA encourages the wider adoption of the three-pillar pension model, which has been successfully implemented in several EU countries, such as Sweden and the Netherlands. This model comprises:
The report highlights that the three-pillar model strikes a balance between state-guaranteed security and private market-driven growth, creating a diversified system that reduces reliance on any single source of income in retirement. ESMA also suggests that member states should explore expanding occupational pension schemes and introducing new incentives to encourage greater participation in private savings accounts.
Pan-European Personal Pension Product (PEPP)
?Another key initiative discussed in the report is the development of the Pan-European Personal Pension Product (PEPP). PEPP is a voluntary personal pension scheme designed to provide EU citizens with more options for retirement savings. It allows individuals to invest in a single pension product across different EU countries, promoting cross-border pension portability and capital market integration.
The PEPP initiative aligns with ESMA's broader goal of creating a more integrated capital market across the EU. By offering citizens more opportunities to save for retirement while contributing to the development of European capital markets, PEPP can help increase investment liquidity and broaden access to long-term savings products.
ESMA recommends a renewed focus on the PEPP initiative, encouraging national governments and the European Commission to explore ways to incentivize its use. The report notes that PEPP could play a critical role in deepening capital markets by creating larger, more diversified pools of investment capital.
Tax-Incented Retirement Savings
ESMA also emphasizes the importance of tax incentives in promoting long-term savings and retirement investment. It calls on member states to review their tax policies to better support retirement savings and investment in capital markets. The report points to several successful examples of tax-efficient savings products already in place in certain EU countries, such as:
These tax-efficient schemes not only incentivize long-term savings but also help channel more household savings into capital markets. By adopting similar tax policies across the EU, member states can encourage broader participation in retirement savings, contributing to a more stable and resilient financial system.
Enhancing Institutional Investment
The report highlights the crucial role that institutional investors, such as pension funds, play in the EU’s capital markets. Pension funds are among the largest suppliers of long-term capital, providing essential funding for businesses, infrastructure projects, and innovation. Their long-term investment horizons make them ideal contributors to sustainable economic growth.
ESMA calls for more robust development of pension fund schemes across the EU, emphasizing that well-regulated and well-capitalized pension funds can provide both higher returns for retirees and deeper pools of capital for European markets. Encouraging pension funds to invest more in capital markets, rather than being overly reliant on government bonds or low-risk assets, can help support a more dynamic and diversified economy.
The report also notes that increased retail investment in pension products can be stimulated through appropriate tax incentives and financial education. This would not only strengthen pension fund assets but also empower EU citizens to take greater control of their financial futures.?
Financial Education for Retirement Planning
Another key recommendation is the need for financial education to support citizens in making informed decisions about their retirement savings. ESMA underscores the importance of ensuring that EU citizens are aware of the benefits of participating in capital markets through pension and retirement savings products.
The report calls for national education systems to include financial literacy programs that focus on long-term savings and retirement planning. This should begin at an early age and continue throughout adulthood, particularly when individuals are faced with significant financial decisions, such as choosing retirement savings plans or investment products.
By improving financial literacy, the EU can help citizens understand the advantages of diversifying their savings into capital market investments, rather than relying solely on low-return bank deposits. This could contribute to a broader retail investor base and enhance the overall health of EU capital markets.
Employee Share Ownership and Pension Savings
The report also encourages the promotion of employee share ownership schemes, which can serve as a valuable form of long-term capital investment for pension savings. These schemes incentivize employees to invest in their own companies, thereby fostering a culture of ownership and financial engagement. They also provide an additional source of retirement savings for workers, diversifying their investment portfolios and strengthening their long-term financial security.
The report suggests that the European Commission could evaluate the introduction of a pan-European vehicle to facilitate cross-border employee share ownership schemes, making it easier for companies operating across multiple EU countries to offer such programs to their employees.
?Conclusion
The ESMA report highlights the critical role that pensions and long-term savings must play in the development of effective and attractive EU capital markets. By promoting the adoption of the three-pillar pension model, expanding the use of the Pan-European Personal Pension Product (PEPP), and incentivizing retirement savings through tax policy and financial education, the EU can mobilize substantial pools of capital to support economic growth, innovation, and long-term financial security for its citizens.
These initiatives, combined with the broader efforts to integrate and harmonize EU capital markets, position pensions and retirement savings as essential components of a resilient and competitive European economy.
A big year for big-picture reports from Europe. And interestingly, they all say pretty much the same thing!