Europe’s conflicting insolvency rules create uncertainty among investors, discourage cross-border investment and delay the restructuring of companies facing financial difficulty, writes Paul McGhee. Ironing out these inconsistencies will give businesses a better chance of bouncing back and deliver growth to the real economy, he argues.
Paul McGhee is Director of Strategy at the Association for Financial Markets in Europe (AFME).
The Single Market is Europe’s major achievement and a project which still has much to contribute. On the financial services agenda, the European Commission has an ambitious agenda to build a banking union and a capital markets union. Reforming insolvency law in Europe would serve both ends, as we show in a new study co-authored with Frontier Economics and Weil Gotshal & Manges LLP.
Whereas the United States has its Chapter 11 framework, Europe still has a patchwork of conflicting insolvency regimes. The most effective national regimes – such as Germany, the UK and Finland – offer firms the best chance to preserve asset value, restructure quickly and bounce back. While regimes in other countries, such as Hungary, Lithuania and Malta are underperforming according to World Bank data.
The least effective regimes delay restructuring and can draw firms and creditors into long, costly and complex proceedings to carve up a dwindling asset base. Clearly, such ineffective insolvency regimes are a major deterrent to cross-border investment.
The financial services Commissioner, Lord Hill, has identified greater harmonisation of European insolvency rules as a priority for capital markets union. There is strong economic evidence to support this decision. Existing research suggests that firms have better access to finance in countries with stronger insolvency regimes. And strong insolvency rules also promote deeper and more efficient capital markets and higher levels of entrepreneurship.
Crucially, effective insolvency frameworks also help economies to de-lever faster. This is a pressing challenge for an EU banking system still burdened with a high stock of non-performing loans (NPL). The IMF argues that tackling the NPL backlog would free up bank balance sheets and could unlock up to €500 billion of new lending in the Euro area. That is why both the IMF and the ECB see insolvency reform as essential.
Our report offers a first estimate of the potential economic impact of insolvency reform in Europe. It shows that improving the insolvency recovery rate by 10 percentage points should reduce corporate bond spreads by 18 to 37 basis points. Applied across the economy, this lower risk premium could add 0.3% to 0.55% to EU GDP over the long-term, or between €41 and €78 billion. The biggest gains in absolute terms would accrue in large economies such as Italy and Spain. However, smaller Member States such as Bulgaria, Croatia and Greece stand to gain the most in relative terms; adding as much as 2% to long-term GDP if they can bring their insolvency regime up to the European average.
So how does Europe unlock these major economic gains? Progress is already being made in individual Member States, notably Italy, the Netherlands and the Czech Republic. But these reforms are not coordinated or consistent. They are piecemeal advances rather than a big step forward for the Single Market. What is needed is limited and carefully targeted harmonisation of insolvency laws at EU level.
Fresh impetus should come from a new legislative proposal which the Commission will publish by December. We have outlined four priorities for the new EU proposal.
- First, all Member States should have a Chapter 11-type stay of proceedings to enable quick and effective restructuring.
- Second, new financing to provide working capital should be accorded super-priority status.
- Third, creditors need stronger rights to propose viable restructuring plans.
- And fourth, national insolvency agencies should regularly report on their results to help inform investors and policymakers.
Insolvency reform is a classic single market project, and one which will benefit European entrepreneurs, provide greater certainty to investors and strengthen the whole financial system. It is a long overdue reform, but one which until now has been seen as slow, complex and the sole preserve of ministries of justice.
That is changing. The inertia caused by Europe’s conflicting and slow insolvency regimes has been flagged as an important issue for banking union, and as a major barrier to a successful capital markets union. As a result, insolvency law is moving up the policy agenda and, crucially, finance ministries are starting to lead the debate.
The European Commission will shortly consult on its initiative on insolvency reform, which will be led by the Justice Commissioner, Věra Jourová, and by Lord Hill. Europe has the opportunity to take a big step forward, and the Commission will have the full support of financial markets participants in pushing this essential reform.