Deutsche Börse Proposes Principles for European Capital Markets Union

Terry Flanagan

Deutsche Börse has presented a paper in Brussels on the proposed European capital markets union which recommended greater use of central counterparties, central securities depositories and more transparency over trading in unregulated dark pools.

On 28 January 2015 the European Commission launched a project to create a capital markets union for all 28 EU member states. The union aims to reduce reliance on bank funding, open up new methods of financing by developing Europe’s equity and venture capital markets and make the region more attractive to investors.

Deutsche Börse proposed six principles for establising a functioning capital markets union – developing initiatives to revive investor confidence; improving non-bank funding to support economic growth; promoting financial stability; improving transparency; harmonising regulation and standards at a European level and shaping the regulatory and supervisory environment. The European Parliamentary Research Service has estimated that a fully integrated and effectively regulated EU-wide set of financial markets could save around €63bn per year.

The exchange said regulators and policymakers have understood the role of central counterparties, central securities depositories and exchanges in strengthening the safety and integrity of financial markets.

The paper said CCPs in Europe are highly regulated and the standards in place should prevent disruption of CCPs themselves and ensure continuation of the operations at all times.

“Where appropriate, Capital Markets Union initiatives should encourage wider use of CCPs and related market infrastructure services, in order to improve risk management and thereby increase financial stability,” added Deutsche Börse.

The exchange also argued that CCPs that clear derivatives should not be interconnected. The paper said: “Should this happen, it would increase risk and endanger the functioning of CCPs, which would counter the positive effects of market infrastructure on financial stability.”

Deutsche Börse has a vertical operating model in which all trades on the exchange have to be cleared by its Eurex subsidiary, while some rival exchanges offer clients a choice on where they clear trades.

The paper said CSDs offer a wide range of post-trade services and are well positioned to offer collateral management services. “They already act as a central service point for both asset holdings and market connectivity, whilst being a well-regulated and neutral trustee that is not engaged in proprietary trading,” added the exchange, which owns Clearstream, the international CSD.

The paper estimated that improving the collateral value chain would allow banks to reduce their Basel III equity capital requirements by up to 20%, or €40bn.

CSDs will become increasingly important when the first wave of the TARGET2-Securities, or T2S, project goes live in the middle of this year. The platform will allow real-time settlement of all securities transactions against central bank money across Europe.

Deutsche Börse said a large amount of trading in various asset classes is still OTC and the lack of transparency can cause a serious threat to market stability during stressed periods, as seen in the recent credit crisis. It recommended that regulators should continue to encourage the use of trading platforms and clearing houses for multilateral trading and central clearing of OTC trades where possible.

The paper said: “OTC markets should be encouraged to “switch on the light” for dark pools where possible, while being conscious of maintaining the value proposition of OTC markets as feasible.”

Since February last year both sides of OTC and exchange-traded derivatives across a range of asset classes in the EU have been required to be reported to an authorised trade repository. Last August additional reporting obligations came into effect covering the notional values of derivatives and collateral requirements.

In November Esma issued a consultation paper on trade reporting to improve the data it was receiving which proposed changes to the technical standards.

“In order to fully assess this reporting and derive benefit from it, further streamlining is needed, but the potential is clear,” said Deutsche Börse. “However, it should be accompanied by the clear commitment to request data only where it is necessary and useful and where it will be meaningfully analysed in order to support stable financial markets.”

Reto Francioni, chief executive of Deutsche Börse Group, said in a statement “Our policy paper stresses the link between the economy and the financial markets: a strong economy needs strong financial markets to finance its growth.”

Commissioner Jonathan Hill, responsible for Financial Stability, Financial Services and Capital Markets Union, said in a statement last month: “We need to identify the barriers that are stopping capital from flowing and work out how to knock them down one by one. That will be the purpose of the Green Paper we will launch in a few weeks’ time.”

The Commission intends to unveil an action plan on the capital markets union in the third quarter of this year.

Sir Jon Cunliffe, deputy governor for financial stability at the Bank of England, said in a speech last month that the capital markets union in the EU will require more diverse forms of borrowing such as forms of finance in which investors directly acquire assets, like equity and corporate bonds, as well as indirect forms of finance such as securitisation markets. He said that equity provides the most efficient form of risk-sharing and this area should be a priority for the Commission.

Spain’s BBVA research said in a note last year that a capital markets union will be a significant structural change for the European financial system but will take time. In Europe bank lending represents around 70% of funding to the economy, a much higher share than the US.

The analysts warned that barriers to capital flows in the region do not just exist in financial markets, but also involve insolvency laws, company law, governing laws, information requirements, and taxation across member states.

“In principle, this project should not be seen as an initiative which aims at achieving the merging of European stock exchanges or fixed income markets, although this might end up happening as a result of increased integration and competition,” added BBVA.

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