Cameron should not ignore EU Capital Markets Union reforms

DISCLAIMER: All opinions in this column reflect the views of the author(s), not of EURACTIV Media network.

Pound sterling and euro notes

Pound and euro notes. [Shutterstock]

Many small business in Europe struggle to get the financing they need. Here’s how to fix it, write Thomas Aubrey, Renaud Thillaye and Alastair Reed.

Thomas Aubrey is a senior adviser at Policy Network and chief executive and founder of Credit Capital Advisory. Renaud Thillaye is deputy director of Policy Network and Alastair Reed is a policy researcher at Policy Network.

One item that is unlikely to be top of David Cameron’s EU reform agenda is the Capital Markets Union (CMU). Immigration, access to welfare benefits and democratic legitimacy appeared to dominate Cameron’s discussions with his fellow leaders at the European council meeting last week. Beyond its mundane title though, the CMU has the potential to transform the way that European businesses are funded, thereby bringing much needed dynamism to the economy. This is the sort of pro-growth European reform that the UK should be leading. But for such reforms to work, the UK must cooperate with other member states to hold Jean-Claude Juncker to his commitment for the EU to be “big on the big things and small on the small things”.

In order to drive an economic renaissance, Europe needs to reorient itself towards supporting growth and innovative businesses as they drive the bulk of job creation. Europe has far more stable firms that are not adding jobs, while the US has far more firms that are both growing and shrinking. This more dynamic profile means that the odds are stacked in the US’s favour when it comes to producing new, big companies.

Europe has plenty of capital for businesses. There is more SME financing in Europe than the US. But this is not allocated to where it is needed most. Many high growth and innovative businesses consequently struggle to get the financing they need. Above all, Europe lacks equity financing that can help transform young firms into larger and more successful enterprises.

The levels of business angel and venture capital investment are respectively three- and five-times higher in the US due to a number of factors. Most countries in Europe tax equity far more heavily than debt. The returns on venture capital in Europe have been close to zero for the last decade. And rigid insolvency legislation in some states prevents firms from restructuring, which on top of long pay-back periods, punishes failure and discourages entrepreneurship. In 2009 the European economy lost around 1.7 million jobs due to insolvency.

The draft proposals outlined by the European Commission in February for SME financing were broad in scope. But to ensure that firms are able to finance their growth activities and drive job creation, there needs to be a greater focus on creating a deeper equity culture. Three policies in particular would help support this drive.

First, tax incentives for business angel and venture capital investors should be encouraged. The UK has led the way, introducing generous tax reliefs that have significantly boosted financing for early-stage companies. The political barriers to such growth-enhancing measures are prohibitive in many countries though, owing in part to fiscal pressures. To help overcome this, such measures should be treated as structural reform and therefore not constitute a breach of the EU’s fiscal rules. A bond guarantee programme should also be considered to help member states to fund these reforms in the short term.

Second, the European Investment Fund should start issuing long-term, low-cost loans to new “small business investment companies”. These loans would allow investors to provide a combination of debt and equity to firms, providing a more viable investment model. As has been demonstrated in the US, such a scheme would be self-financing and not require extra public resources in the medium term.

Third, minimum insolvency standards should be enforced across the EU with a directive if necessary. Many jurisdictions still do not allow debt restructurings, out-of-court settlements and the use of fast-track procedures. These procedures are crucial if businesses are to survive. Higher minimum standards will also give investors greater confidence to operate across borders.

Alongside these policies, the Commission should continue its work on high-quality securitisation to help free up capital for the banking sector. It also needs to do a better job of persuading member states to learn from each other’s world-leading best practices on business support. From Germany’s system of chambers of commerce, to Turin’s innovation ecosystem, France’s credit mediation scheme, Poland’s education reforms, and the changes to Sweden’s pension system, the diversity of the EU permits much higher levels of experimentation in public policy which needs to be exploited where successful.

The Commission has been clear from the outset that the CMU project is one for the long term. The big challenges of reform, many of which are at the member state level, should therefore be tackled head-on. Politically challenging reforms to the tax, legal and business support environment in member states must be prioritised if Europe’s economy is to boom once more. A booming European economy is clearly in the interests of the UK, and something that David Cameron can ill afford to ignore.

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