Professor: In support of streamlined financial rules for SMEs 

Thomas Philippon is Professor of Finance at the Stern School of Business, University of New York.

To read a shortened version of this interview, please click here. 

What lessons from your study of the financial sector in the US can we draw for Europe and what comparisons can we make, bearing in mind that although Europe has started to catch up, it is still less developed than its US counterpart? 

Europe is definitely catching up but it has been faster in the domains which are more useful for large, established companies. Catching up has been much slower in the financial services sector, which deals with emerging companies. 

If you look at the growth in the US financial sector, I would say it has been more balanced in the sense that the foreign sector is providing services to everyone, from General Electric to a start-up in California. 

In terms of its economic relevance and social importance, I think it is important to provide services to large companies but it is even more important to provide services to small emerging firms. The US has been doing both. 

In Europe, we have traditionally been providing more services to already-established businesses. The process of European integration has maybe even increased this imbalance, because it is easier to achieve a return of scale for large companies. We have not done it for the financing of emerging firms which is also needed. 

From a European perspective, what can we do to change this imbalance compared to the US and is the opening of markets enough? 

An opening of the markets is always a good start. Of course, it is not just because of finance that small and medium-sized enterprises in Europe do not grow. One also has to think about the labour market, good market access and culture. 

But finance is part of the explanation. What I have realised from teaching in the US is that the kids in university know that if they have a crazy idea, they can find someone to finance it, and so they try. The availability of finances is a factor in itself for the creation of new firms, since supply creates demand there. 

So is it rather a cultural question? 

It looks cultural, but I think it changes with the setup. Due to the kind of regulation and impediments, it is more difficult for emerging companies than it is for larger companies. For large companies, you only have to make sure that they can trade across borders and that good and liquid stock markets exist. Fine, we have that. 

London is the number one - even better than the US in many dimensions - for trading derivatives and in terms of sophisticated financial products. If any large firm in Europe needs to hedge any kind of currency risk, it is going to do just as well as and if not even better than in the US. 

Trading of equity is also pretty liquid all over Europe. You can still improve the margins but in general I think those sectors are already very efficient and very well integrated. 

The same is not true for the financing of emerging firms. It is more risky because you do not only have to deal with the financing part but also with the management and the legal aspect. For example, if you want to have an efficient market for risky debts - whether it is leveraged loans or high-yield bonds - you need to have efficient bankruptcy codes in case of financial distress. 

It is very important to have a clear, well-understood and efficient system to resolve financial distress. We not only lack that in Europe in the sense that often bankruptcy codes in any given European country are on average less efficient than in the US, but even if they were as efficient, the fact that they are all so different means that you cannot integrate. 

If you are a specialist on high-yield debt in a given country, you cannot use your knowledge in another European country because the bankruptcy laws are so different. That means that you will have to hire someone to do it and then you do not have this integration anymore. 

But then in terms of regulation, bankruptcy codes are very complicated and it is much harder to make any progress on that front than for cross-border flows of financial products, which is relatively easy. The market is already there and you just have to make sure that the market is properly regulated and then it works fine. Any kind of standardisation of bankruptcy codes is a very complicated thing to do. That is really the task for regulators in the future. 

What can regulators do at European level, in particular with regard to the financing of SMEs? 

Direct support is not what we need. The EU should not be in the business of financing firms. What we need is a good environment for SME financing. That means that the regulators' job should be about disclosure and harmonisation of the various codes. Disclosure is very important. 

Small, emerging firms are very risky and they are likely to end up in financial distress. Therefore for them, the bankruptcy code is very important. What is the relevance of the bankruptcy code for firms such as LVMH or Deutsche Bank? For them, it does not matter because they are not going to go bankrupt. 

But if you finance a start-up then the bankruptcy code is extremely important, because the likelihood that you are going to have financial distress is very high. Secondly, for a small firm, it is hard to obtain information. Again, for large companies, this is not a constraint, but for small firms, disclosure really becomes the key issue. 

Everything that has to do with regulation of bankruptcy laws and disclosure of information is of key importance for these firms. 

Do you think more targeted regulation at the EU level would be better or should it remain in the national sphere? 

Bankruptcy rules are completely up to the national level, because they are deeply embedded in the legal system of the respective country so you cannot just change them like that. The idea is not to make them the same, as this is not going to happen. What you need to do is to identify areas where, first of all, harmonisation is possible, and, secondly, where you are likely going to have a big effect. In the area of financial distress rules, a couple of points exist on which we could make progress – without rewriting the whole bankruptcy code because this is not possible. 

Some analysts argue that Europe should help develop the pension industry especially with regard to demographic trends. What could we do on a European regulatory level to help develop this industry? 

The management of the funds works quite well, but we have some issues with the allocation of assets, for example for risky ventures. On the other hand, distribution is an issue, therefore allowing wider access for a larger share of the population would be useful. 

However, studies in this area show that people do not react very strongly to lowering fees or monetary incentives, so the big impediment there is a lack of information. In that sense, I would be very much in favour of information campaigns to explain. There is also a lack of sophistication in Europe as people just do not know what these products are. So they do not want to invest because they simply do not know about them. 

Moreover, banks certainly do not have a big incentive to market these products, because this is not their business, and so they remain a little bit confidential. I think that is a big impediment. 

I have a fairly unorthodox view on that. I do not think that fees or taxes are going to be in first order here. You rather need to teach people and give them some information. 

What is your opinion on taxing finance in Europe? Is it comparable to the US? And what is your view on tax competition in the EU? 

The debate in the US is whether some specific types of financial firms should have preferential tax treatment, and particularly applies to private equity and hedge funds. Because of the usual tax loopholes, they could essentially recognise some of their labour income as a capital gain and pay only half of the taxes, 15% instead of 35%. 

This is a typical loophole. I think the lesson is to have the same tax rate everywhere and a simple tax system, which would be much more efficient. 

The only thing where the US is not doing well is simplifying its tax code - there we could easily beat them. The tax code in the US is a complete nightmare and they never succeeded in simplifying anything. So we certainly could do better than that. 

We have tax competition in Europe, where countries want to attract businesses through their tax systems. This system is very inefficient. All the data show that lowering taxes to attract businesses simply does not work very well. It rather costs you a lot of money so playing this game at the European level is silly. We are playing that game also at world level, look at all the tax havens. I would be very much in favour of stronger enforcement on this but I think politically it is going to be hard. But I have to say that when you think about measures which could improve the way Europeans see Europe I can hardly think about something better than that.