18 June 2015

European Commission makes progress on Capital Markets Union

In February this year the European Commission released a Green Paper on an EU-wide Capital Markets Union and invited views on its proposals.  The consultation period closed last month, with over 700 responses submitted, signalling that market participants are enthusiastic about this flagship initiative. And another important milestone was passed last week, when the Commission held a public hearing to present its findings and confirm its main priorities.

February's Green Paper was welcomed by the private equity and venture capital industry, not least because it specifically mentioned the positive role the industry plays in the European economy. Building on that endorsement, the response submitted by the European Private Equity and Venture Capital Association (EVCA) highlighted how the industry can assist in the flow of capital across borders and increase investment in key areas, especially into small and medium sized enterprises (SMEs), and the current and past chairmen of the EVCA both repeated that message during speeches at last week's public hearing. Jonathan Hill, EU Commissioner for Financial Services, Financial Stability and Capital Markets Union, confirmed that the message has been received, saying  that "…strengthening our venture capital ecosystem must be a key priority".

Three main areas emerged from the consultation responses: increasing access to finance; creating opportunities for investors; and dismantling obstacles to cross-border investment. Bank lending is a central source of finance for companies, but SMEs with a higher risk, higher return strategy can struggle to secure it. For them, equity financing is crucial, and a key part of the CMU will be to improve access to this important source of growth capital.

The EuVECA regime – a  voluntary alternative to AIFMD for smaller venture capital funds, which has not had as much take-up as hoped – will be reviewed to increase both the number of funds who qualify for the regime and the type of investments these funds can make. The Prospectus Directive (PD) was also a key area of interest for respondents, and the Commission has recognised that a review of this legislation is a priority. While investor protection should not be jeopardised, there is significant scope to reduce the regulatory burden on companies raising public capital, especially smaller companies. A less demanding alternative route does currently exist within the PD regime, but very few companies have been able to use it.

Respondents also highlighted the growing trend for many investors, including pension funds and insurance companies, to invest more in debt instruments than in equity, and the Commission has acknowledged that regulation may be playing a part in this. The proposal to give lower risk weightings to both ELTIFs and infrastructure investments under Solvency II will be welcomed by insurance companies, but as stated in the EVCA consultation response, "infrastructure" should cover not only direct investment but also infrastructure funds, and both the construction and operational phases of infrastructure projects.

It is clear that dismantling obstacles to cross-border investment will present significant challenges, particularly since some are rooted in the different approaches taken by national laws. For example, withholding tax and double taxation are obvious barriers to cross border investment, and can push investors towards debt financing, while insolvency laws differ significantly across different EU countries. While there are no obvious solutions, the Commission says that options need to be explored.

More specific to private equity and venture capital are the barriers created by "host" members states which have been imposing fees and other requirements for funds marketing with an AIFMD or EuVECA passport. These obstacles could be dealt with relatively quickly by the EU authorities, as there seems to be no legal justification for them. And while it is good news that France has now dropped its requirement for a local paying agent for passported funds, the CMU initiative could certainly be the means to eliminate the fees that many member states are still charging.

The timetable for the CMU is relatively ambitious: the next step is an Action Plan, due in September. And, while it is clear that a true single market for capital is a long term project, there are also a number of quick wins, many of which could help the private equity industry. But there are also dangers: many respondents to the consultation clearly think that more regulation is needed to harmonise the market, and this could take the CMU initiative into more worrying territory. It is therefore important that the industry continues to push the Commission to progress the long term and short term initiatives which they have already announced, while resisting the imposition of new obstacles to cross border finance.  The good news is that it seems, so far, to be pushing at an open door.

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