The European Commission is looking at financializing the economy following the American model

Strict financial regulations are the norm in the European Union. The Covid-19 pandemic, however, is causing a change in European orthodoxy regarding capital markets. The European Commission, the executive of the European Union, decided on Friday to amend the regulations applicable to financial markets so as to facilitate companies' access to funding on the capital markets and to facilitate the practice of securitization in order to support European banks.

Overall, as part of its economic recovery strategy, the Commission has enacted a package of amendments to the Prospectus Regulation, MiFID II (Financial Instruments Markets Directive) and Securitization Rules. According to the European Executive, all amendments are at the heart of the capital markets union project, "which aims to better integrate national capital markets and ensure equal access to investment and funding opportunities across the EU".

First of all, the Commission has proposed specific changes to the status of prospectuses.

"The EU Recovery Prospectus: Easy to make - easy to read - easy to check. The prospectus is a document that companies must disclose to their investors when issuing shares and bonds. The EU executive proposes the creation of an" EU Recovery Prospectus »- a type of prospectus in abbreviated form - for undertakings with a public market history. This temporary prospectus would be easy for companies to draft, easy to read for investors and easy to audit for national competent authorities. Its size would be reduced from hundreds of pages to just 30. This will help businesses raise capital, for example by issuing shares, instead of borrowing even more.

A second set of specific amendments to the Prospectus Regulation aims to facilitate the collection of funds by banks that play a key role in financing the recovery of the real economy", the Commission said in a statement.

The Commission has also made some specific changes to MiFID II requirements in order to reduce certain administrative burdens borne by experienced investors - institutional ones - in the relationships between companies. "Less experienced investors - such as households investing their savings for retirement - will remain as protected as before," the Commission claims.

"These changes refer to a number of requirements that have already been identified (in the MiFID / MiFIR public consultation) as being overly burdensome or hampering the development of European markets. The current crisis makes eliminating unnecessary burdens and providing opportunities to emerging markets even more important. Therefore, the Community Executive proposes recalibrating the requirements to ensure that there is a high level of transparency for customers, while guaranteeing the highest standards of protection and acceptable costs of ensuring compliance for European companies".

• The EU executive wants to support banks by making securitization easier

The Commission has also proposed a package of measures to amend the Securitization Regulation and the Capital Requirements Regulation with a view to facilitate the use of securitization by European banks.

We remind that securitization was one of the major catalysts of the global financial crisis of 2007-2008, as the practice (securitization of subprime mortgages into bond-type instruments - a cause of the crisis) led to excessive risk-taking by the major Wall Street financial institutions. The problem in the US turned out to be that the rating of those instruments did not adequately reflect the real risk.

"Securitization is a tool by which banks can bundle loans, turn those bundles into securities and sell them on the capital markets. The purpose of these changes is to facilitate the use of securitization in Europe's recovery, allowing banks to expand their lending activity and to remove non-performing exposures from their balance sheets. "It is useful to allow banks to offload some of the risk of lending to SMEs to the markets so that banks can continue lending to SMEs," the Commission said.

Securitization, among other changes, is likely to lead to stronger financialization of the European economy, following the American model where companies are financed via the capital markets rather than via banks, as opposed to the EU economy. EU countries have been in talks for some years about changing the financing structure of the economy to mimic the American model, as the ultra-low interest rates in recent years have significantly weakened banks' balance sheets and their ability to finance the real economy, even without the impact of the Covid-19 crisis.

• Valdis Dombrovskis: "In September a more comprehensive action concerning the union of the stock exchanges will be presented"

"Furthermore, the Commission proposes the elimination of the regulatory obstacles which exist when it comes to the securitization of non-performing exposures. This can help banks eliminate non-performing exposures which, given the crisis caused by the coronavirus, may increase. The changes presented today (Friday - ed. note) is based on the wide ranging studies conducted in 2019 and 2020 by the European Banking Authority", the Commission shows.

Valdis Dombrovskis, the vice-president of the European Commission, hinted that "in September will be presented a a plan of action for the union of the capital markets".

"In particular, the Commission proposes to create a specific framework for simple, transparent and standardized balance sheet securitization that would benefit from prudential treatment that reflects the real degree of risk of those instruments. In addition, the Commission proposes to remove existing regulatory barriers to the securitization of non-performing exposures. That can help banks eliminate non-performing exposures that are likely to increase due to the coronavirus crisis. The changes presented today (Friday - No) are based on the activity and extensive analyzes conducted in 2019 and 2020 by the European Banking Authority", the Commission points out.

At the same time, Valdis Dombrovskis, the EC's executive vice president for the economy, hinted that "a broader action plan on the union of capital markets will be presented in September".

• Iancu Guda: "The changes will not bring about structural changes for the financing of the European economy". The problem in Europe, in Guda's opinion, is taxation

When it comes to the Commission's approach, analyst Iancu Guda told us that he doesn't believe it will bring about structural changes when it comes to the financing of the European economy.

Iancu Guda said: "I don't think that (the changes) will significantly stimulate IPOs on the capital market. First of all, in Europe, companies finance too little using the capital market compared to the United States, especially as a result of the fiscal context. If you don't bring substantial changes in terms of taxation, any change or decrease in regulation or overregulation - which indeed, for some companies, either with stability or with long history, complicate the investment process for specialized investors - is slim".

"The changes will not bring about structural shifts in the financing of the European economy." The problem in Europe, in Guda's opinion, has to do with taxation.

The analyst is of the opinion that unprecedented measures are needed in this regard as well, such as the proposal for the issuing of common bonds by the European Union.

"If, where the capital market is concerned, for the financing of companies, only the current legislation on reporting is polished, I don't think it will be a spark that will lead to an explosion of companies financing through the capital market", Iancu Guda thinks.

According to him, the problem in Europe is related to taxation: "I think that the problem is on the investor side. It is necessary for investments in the stock market to be incentivized as much as possible, in order to increase the number of investors that can ensure liquidity on the buy side. And similarly, on the supply side, changes can be made of a fiscal nature that would stimulate financing through the stock market, to the detriment of the banking market, where interest payments are deductible in most countries in Europe. I don't see what juicy deductibles could be implemented, concretely, but I think that specialists in this area could conceive some tax breaks, which on one hand would encourage investors to make long term placements. For example, on long term capital gains, taxes should be lower than the ones paid by those that make short term gains. (...) And on the bid side of the investment universe, bringing tax breaks to companies, which would motivate them to prioritize this option".

"But for retail, both for investors and companies that would get listed, they are looking rather inconsequential", the analyst concludes.

Guda also says that the reporting aspect and the related bureaucracy strongly discourage small companies. Regarding changes to MiFID II and securitization, Guda says they are "good but for niche investors, such as institutional investors. But for retail, both on the part of investors and on the part of listed companies, they seem inconsequential," the analyst concludes.

• Adrian Vasilescu, BNR: "It has been proven that the American system is more efficient than the one using banks"

In turn, Adrian Vasilescu, an adviser to Governor Mugur Isărescu, pointed out that the European Union has long considered boosting financing through the capital markets.

He told us: "That is considering that Europe is lagging behind the American stock exchanges, which bases its funding on the capital markets and less on banks. (...) The American system has proven to be more efficient, in the sense that it brings equity stakes. (...) I think that many ideas have been learned from the 2008 - 2011 crisis (in the EU). Because the issue of securitization was raised then and the analyses conducted over a long time show that in periods of over-regulation, capital movement has been slower, and in periods of less regulation capital movement has been faster".

Essentially, Adrian Vasilescu believes that "regulation must be effective, while not burdensome". At the same time, he says changes in capital market financing are coming to relieve banks of the effort of financing the real economy.

"Many development programs will follow, especially after this crisis. There will still be a need for strong financial stimulus packages, and banks will not be able to meet all their needs. The capital market must be brought to the fore here", says Vasilescu, who added that the program announced by the Commission on Friday complements the 750 billion euro approved last week by EU leaders.

• Adrian Codirlaşu, chairman CFA România: "In the USA regulations aren't that strict, and that is visible in in development between the two markets"

In the opinion of Adrian Codirlaşu, the president of CFA Romania, the news is a positive one, as financial services are over-regulated in the European Union.

He told us: "MiFID also brings over-regulation. It has been seen that it has hindered the research side and a better servicing on customer side. So it has not fulfilled its purpose. (...) On the research side, MiFID practically requires the financial institutions that did research to ask for money for that, and nobody is willing to pay. Before it was free".

The president of CFA România also noted that deregulation would reduce costs both for financial institutions, as well as for customers, as well as lead to a more accelerated development of the financial markets.

"In the United States there are no regulations as strict as those in Europe, and that can be seen in the development gap between their respective markets and institutions," Adrian Codirlaşu says.

Regarding securitization, the analyst notes that the loosening of regulations will make it easier for banks to sell-off their non-performing loans.

"I think that the European Union will be the pleasant surprise of the crisis. They have now taken action much quicker and that action is extremely powerful, unlike what happened in 2008, when the EU recovered much slower than the US. That is a good thing and will be visible in the economic growth", the president of CFA România concluded.