It was hard not to be mesmerised by the record-setting flow surging through hard currency bond markets this past week. Almost US$220 billion. That’s a third up over the same period in 2019. With demand pushing aggregate supply of new trades way in excess of the amount of debt on offer (2.5x for euro trades, almost 3x for sterling), it arguably could have been a lot more.
Neither US-Iran tensions, US-China issues, Brexit, nor other economic, political and geopolitical risk factors stood a chance this past week of getting between investors flush with cash from year-end squaring and fund inflows, and issuers super keen to get their funding years off to a rousing start while the going was good.
With abundant central bank liquidity on hand on top of aggressive investor bidding, the technicals were clearly always going to favour sellers. So it proved, as credit broke through the lows of January 2018 to territory not seen since before the global financial crisis.
Right in the middle of the new-issue frenzy, however, ECB Vice President Luis de Guindos gave a speech to a conference on Europe’s role in the global financial system, which restored a sense of stark reality or better put, a feeling of déjà vu depression. In his speech, he voiced some vital concerns about the state of Europe’s capital markets. None of them new, they revolved around an old topic that seems to be going nowhere fast: Capital Markets Union (CMU).
One current concern about Europe’s capital markets is the impact of Brexit and what happens to the major global financial centre that is London. Given the sheer amount of European syndication, sales, trading and clearing still conducted from the UK capital, it’s a valid concern. But even beyond that issue, “from a global standpoint, European capital markets are too small and fragmented,” de Guindos said.
Hmmm. I’m not so sure. Eurozone statesmen, politicians and policymakers have known about the shortcomings as they see them of European capital markets for several years. But here’s the problem as I see it: the EU machine continues to bang the drum of banking and capital markets unions as silver bullets. But I don’t think they’re realistically ever going to be achieved. I’ll go even further: I don’t think they’re necessarily the answers.
Call me a cynic but I just think the issues that will need to be dealt with to get us there are just too complex and politically challenging and the funding benefits to issuers unclear. “There”, as de Guindos reminded us, being: “to develop an ecosystem that will allow the development of strong European financial markets and intermediaries which are able to compete internationally”.
Sounds easy on paper, but the tax, insolvency and bankruptcy harmonization across the eurozone, the deposit insurance scheme, the benchmark yield curve, the eurozone reference asset, and the backstop to the Single Resolution Fund (to provide assurance around bank resolution) required as a minimum to get us to capital markets and banking nirvana have so far eluded politicians and policymakers.
Having de Guindos remind us – again – what the European capital markets ecosystem requires (policies to support the development of the markets’ size and scope, removing barriers between EU capital markets, expanding funding sources for companies, broadening the role of the non-bank financial sector) doesn’t get us any closer to achieving it.
So the new European Parliament and Ursula von der Leyen’s new European Commission want to make CMU a centrepiece of their legislative agenda, no doubt supported by Christine Lagarde, the new president of the European Central Bank. Sounds impressive. But I’ve no reason to believe they’ll be able to solve the issues to any greater degree than their predecessors did.
The Commission has set up a High-Level Forum on Capital Markets Union, which will meet once a month up to June 2020 with a view to drafting a next CMU Action Plan. Separately, the Next CMU High-Level Group (a different group) has already published a set of proposals to relaunch CMU. Its report (Savings and Sustainable Investment Union) calls for strong and determined political action at EU and national levels organized around four capital market “absolute priorities” and sub-divided into 20 “transformational recommendations”.
It wants more long-term savings and investment opportunities; to massively develop equity markets; increase financial flow fluidity between EU financial marketplaces; and develop debt, credit and FX financing tools in ways that increase the international funding currency role of the euro.
For the latter priority, the transformational recommendations are to create the conditions to establish the euro as a reference asset currency (including a euro-area-wide benchmark yield curve); establish sovereign green bonds as a flagship product for EU’s capital markets; revitalize securitization (including SME ABS) and neutralize regulation between securitization and covered bonds; and ensure an efficient and competitive pan-European payment market.
Separately again, the European Capital Markets Institute, a forum operating under the umbrella of the Centre for European Policy Studies (the EU public affairs think tank), wants to rebrand the project altogether: Rebranding Capital Markets Union: A market finance action plan
The world does not need a fragmented bunch of high-level groups of “experts” writing reports that say the same thing; reports that are long on grandiloquent statements of intent but with nothing to magically wish that intent into reality – even if the intent is really what capital markets need.
If the global plan to project the euro more fulsomely onto the global funding stage is difficult enough, the very fact that the capital markets already have a competing global reference currency in the US dollar will hardly make things easier. At the end of the day, the capital markets inhabit a world of currency arbitrage and basis swaps. The existence of a very large pool of US and global investors offering cost-effective diversification opportunities for European borrowers and vice versa isn’t going to disappear.
European issuers accounted for half the total volume of bond issuance in the past week. But 22% of debt sold by European borrowers was in the form of Yankee issuance. An almost identical percentage sold by US borrowers was in euros a.k.a. Reverse Yankees. That’s the nature of the beast.
Pretty much all of the corporate issuance in the market last week came from multinationals. As long as capital markets are open, large companies will find access.
So if CMU is really about creating access to the bond market for small and medium-sized companies, I’m not at all sure they need integrated or harmonized pan-European capital markets to secure (by definition) much smaller amounts of funding, even if over time they come to rely less on bank lending (which I don’t think is 100% given) in favour of bond finance.
Isn’t this misty-eyed notion of a small company in one eurozone country raising cross-border bond finance from investors based in other eurozone countries ultimately seeking a solution to a funding problem that doesn’t exist? In other words, isn’t this all about eurozone policymakers and politicians desperate to give companies and investors something politicians and policymakers want companies and investors to desperately want to need?