With the goal of creating a single market for capital in Europe, the Capital Markets Union (CMU) aims to harmonize investment regulations, while increasing choice and certainty for investors. The removal of regulatory barriers could reduce marketing and distribution costs for asset managers operating in multiple jurisdictions, but greater cross-border competition may also pressure margins.
Brexit adds urgency to 2019 deadline
Key insights
- The CMU may make it easier for asset managers to distribute and market funds across borders but could also stiffen competition and pressure margins
- Streamlining rules for cross-border investments could encourage smaller funds to market in multiple jurisdictions.
- Uniform standards could stimulate investment in covered bonds in undeveloped markets
The CMU project's mission is to drive deeper and more integrated capital markets, fostering less expensive and more diverse funding options for businesses while decreasing European investors' over-reliance on bank finance. Since the release of a 33-item action plan in 2015, significant progress on the CMU has been achieved, with two-thirds of the actions adopted or submitted, including:
- a new regime for prospectuses to allow more seamless access to public markets
- plans for funding sustainable investment
- harnessing the power of fintech
The European Commission (EC) set a 2019 deadline to finalize proposals and secure the agreement of legislators, but the United Kingdom's withdrawal from the EU in March of the same year has added urgency to the project.
New clarity over covered bonds
Recent work on the CMU has involved the harmonization of rules for covered bonds, cross-border marketing, and securitization. A key plank of the project is the alignment of standards for covered bonds, one of the EU's largest debt instruments, but also one of its most fragmented, with the four largest jurisdictions accounting for two-thirds of the market.1
The United Kingdom's withdrawal from the EU in March of the same year has added urgency to the project
In March 2018, the EC announced an agreement on a common definition for covered bonds and their features, along with the Member States that would supervise them and the introduction of rules for an EU covered bond label. The proposals also include unifying over-collateralization rules and mandatory liquidity to reassure investors and lower risk.
The EC estimates the new rules could deliver potential annual savings for borrowers of up to EUR 1.9 billion.2 For asset managers, harmonization may entail greater certainty in marketing covered bonds as a uniform asset class, while reducing the complexity of risk assessments. The standardization could also open opportunities to develop covered bond markets in jurisdictions that lack them, while attracting investors from third countries.3
A second initiative announced by the EC in March 2018 involves reducing barriers to entry in different jurisdictions through the alignment of rules for cross-border investments and marketing. Currently, 70 percent of all assets under management are held by funds registered for sale only in their domestic market, while only 27 percent of UCITS funds and three percent of alternative investment funds (AIFs) are registered for sale in more than three EU member states.4 “Some of the key national barriers are deep-rooted and achieving real change will be a challenge for all stakeholders," said KPMG Ireland partner Darina Barrett.5
The new measures dismantle requirements for fund managers to appoint local agents when marketing an AIF or UCITS fund in another Member State
The new measures dismantle requirements for fund managers to appoint local agents when marketing an AIF or UCITS fund in another Member State. This rule change, and the harmonization of pre-marketing requirements, could save asset managers up to EUR 440 million annually, while making it more affordable for smaller funds to distribute across borders.6
In addition, the EC has proposed changes to the delegation rules that allow investment companies to manage money on behalf of clients in different countries. Under this initiative, regulators will not have to await approval from the European Securities and Markets Authority (ESMA) before granting delegation rights to individual asset managers. Around 90 percent of assets under management within the EU use delegation arrangements. Several other proposals are still under discussion, among them that ESMA will be given the power to recommend that delegation rights be withdrawn.7
Not all market participants are onside with the new rules, however. The European Fund and Asset Management Association (EFAMA), an industry group, has stated that the amendments proposed are 'insufficient' and wants any changes the delegation rules to be abandoned.8
Boost to securitization
The CMU is also driving efforts to revive a securitization market yet to recover from the 2008 financial crisis. The EC has agreed on “simple, transparent and standardized” forms of securitization which are stricter on asset quality and subject to tougher scrutiny from regulators.9 Announcing the move in June 2017, EC Vice President Valdis Dombrovskis said the changes were a “cornerstone proposal” in the EU's attempt to improve the financing of the “real economy.”10
Debate over the effectiveness of the overall CMU project is likely to intensify as the clock ticks towards the 2019 deadline, but fund managers should welcome the prospect of more clarity over cross-border investment rules and potential for additional business in the long-term as capital markets develop. Lower barriers to entry could also foster greater competition.
"On the one hand, by making it easier for firms to distribute and market funds across borders, it will reduce the cost and complexity of firms' business and increase the size of their potential market," said William Wright, founder and managing director at New Financial, a capital markets think tank.11 "On the other hand, by increasing competitionin the industry, it could accelerate the erosion of margins and increase pressure on transparency.”