French economist Nicolas Véron is a senior fellow at Brussels-based think tank Bruegel, which he co-founded in 2005, and at the Peterson Institute for International Economics in Washington DC. He talks about what needs to be done to achieve fully integrated capital markets in the EU, how the recent crises have affected Europe’s efforts to develop a single market for capital, and whether the EU is making the most of the opportunity of Brexit in the area of financial integration.

Six years on from the Brexit referendum, the EU is still not fulfilling its full potential as an attractive place for market financing. Is the EU missing the opportunity of Brexit when it comes to financial integration?

The EU had a pretty integrated wholesale financial system before Brexit, with a clearly identified hub in London. London was acting as the central venue, with centralised supervision by the UK authorities under UK law. Now London is off-shore, it is clearly not sustainable for the EU to have the same critical reliance on London as it had when London was on-shore. What that means in practice is that we lose in market integration because the activity we have on-shore is scattered in various financial centres. This is not a problem in itself, but these financial centres are under different legal and policy regimes and that’s where the problem is. There are two possible solutions to this. One is that one of the EU on-shore financial centres would replace London. The other is that we have policy integration, so that activities can remain scattered geographically but are integrated in terms of the policy regime and oversight framework. Clearly the latter solution is better. But it would mean new impetus for policies that frankly have stalled – such as Banking Union and Capital Markets Union. And at this point, it is clear that Brexit has not triggered an acceleration of those policies.

You mention the Capital Markets Union – the Commission has already put forward a raft of measures under its Capital Markets Union agenda to support market integration. What is still missing to allow us to achieve deep and fully integrated capital markets in the EU?  

This debate is not new. I believe it goes back to 1965, with the first Commission report on financial markets integration. And frankly, many of the questions that were raised in that report are still open. So in a way it’s not surprising that the Capital Markets Union agenda is not moving quickly because it’s a long-term structural agenda. With that in mind, I would have two observations. First, one may question the wisdom of calling it a Capital Markets Union, as if it were a clearly defined project with a clearly defined start and end. I would argue that this is the case for Banking Union – it had a start and it hopefully will have a date of completion. I’m not sure that this is the same for Capital Markets Union to the same extent, so I would question the label. The good old days when we called it the ‘single market policy for financial services’ had some charm for me – but that makes me a nostalgic! The second, more substantial, observation is that the package of measures proposed by the Commission, going all the way back to 2014 when Jean-Claude Juncker first proposed Capital Markets Union as a label, have been useful but not transformational. I think – especially when you compare it with Banking Union, which is still very much unfinished, but where there has been a structural transformation – everything so far in ‘Capital Markets Union land’ looks a little bit incremental.

Have the recent crises – specifically the Covid-19 pandemic and Russia’s aggression against Ukraine – undermined our efforts to develop a genuine single market for capital in the EU? Or have they actually reinforced the need for one?

The pandemic has stopped a number of workflows and has delayed others, such as the one on anti-money laundering. But it has also resulted in one big transformation, not in the area of DG FISMA but something that has huge importance for what we are talking about and that is NextGenerationEU, which has demonstrated that large-scale issuance of EU bonds is possible. The consequences of that transformation will take time to unfold, but I expect them to be very constructive and a positive move in the direction of building a more integrated and better-developed European capital market. So that’s a plus. As for the Ukraine crisis I think it’s frankly too early to say, because we are still at an early stage, sadly. I am inclined to believe, but with no certainty, that the Banking Union agenda could have made more progress, and there could have been a better compromise in June, if Russia hadn’t invaded Ukraine. But of course we can never know. One of the big questions about the Ukraine war is whether it will create the need for more EU bond issuance, along the lines we’ve seen with NextGenerationEU. And again, I don’t think anybody has an answer at this point.

Looking at financial stability risks, the EU is still very reliant on some UK-based clearing infrastructure. Some believe that Europe should just legislate and move all the clearing business to the EU. What are your thoughts on this?

I applaud the Commission for its restrained and measured approach so far. Because the clearing infrastructure is very ‘sticky’, and the London-based clearing infrastructure is a global infrastructure, it’s not just a European infrastructure. I am thinking in particular of the reliance on London Stock Exchange clearing house LCH for derivatives clearing, which is at the core of this debate. So it’s important not to frame this issue in narrowly EU terms because that’s not what it is, particularly when it comes to market liquidity. I haven’t been convinced yet that relocation is necessary, even in the long term. Because the long-term vision for the EU market is that it is globally connected. So I’m not sure what the right answer is long term, but I think the Commission has been right to be cautious. Speaking of clearing and financial infrastructure, I want to highlight what I think is an obvious paradox and that is that the EU now has an EU-level supervisory capacity for LCH.Clearnet through the Central Counterparties (CCP) outfit that has been created within the European Securities and Markets Authority (ESMA). But it doesn’t have it for its own domestic critical infrastructure, which remains under national supervision with relatively loose supervisory coordination at ESMA. I think I’m stating the obvious if I say this doesn’t make any sense.  

How close do you think we are to a truly integrated and independent EU-level supervision of capital markets?

I think the story of Banking Union and of anti-money laundering supervision has demonstrated the centrality of the question of supervision. Obviously I believe supervisory integration is needed for Capital Markets Union. But here I would make two additional points. Firstly, one thing we’ve learned primarily through the ‘Eurozone crisis’ is that it’s not really plausible that we would achieve a Capital Markets Union without completing the Banking Union. We can debate how far we are from completing Banking Union, but I think everyone agrees that we are not there yet. Even with the strong Single Supervisory Mechanism (SSM) at the European Central Bank, which is a pretty impressive achievement. Secondly, I would say that it is a bit simplistic to say ‘let’s just give more powers to ESMA over more market segments’. The reason for that is that ESMA was not designed initially as the EU market supervisor, just like the other European supervisory authorities (ESAs). It was designed for the more modest purpose of coordination of supervision and arguably doesn’t have the governance and funding framework to be an effective, independent supervisor itself. This is not a comment on individuals, but rather on the architecture and legislation that establishes that architecture. And the only way to fix that is through change to the ESMA regulation. In a way, the SSM, and soon the Anti-Money Laundering Authority, show the way. And you could say the same to a certain extent of the Single Resolution Board. You need a more compact board, you need financing by levies on industry, those elements that establish an architecture that makes ESMA’s supervisory decisions de-politicized, independent and based on the supervisory mandate, which I’m not sure is the case with the current architecture. So this would be an important caveat: let’s not think of policy integration as just accruing more mandates on ESMA, at some point there has to be a reform of ESMA that makes it fit for purpose as an effective, independent supervisor. Finally, at a more general level, I would say I have perhaps a kind of old-fashioned view of the role of the Commission – I think it’s there to keep the discussion honest among Member States. So although I’d like to see faster progress, ultimately I think that these things take time.

Nicolas Véron speaks here in his capacity as a policy observer at Bruegel and the Peterson Institute. He is also an independent non-executive board member of DTCC Data Repository (Ireland) Plc, which is supervised by ESMA.