COMMISSION STAFF WORKING DOCUMENT Economic Analysis Accompanying the document Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions Action Plan on Building a Capital Markets Union
Date: 2015-09-30
Institutions: Directorate-General for Financial Stability, Financial Services and Capital Markets Union, European Commission
Subjects: EU financial instrument, EU investment, action programme, capital market, economic analysis, economic integration, investment aid, small and medium-sized enterprises

EUROPEAN 
COMMISSION 

Brussels, 30.9.2015  
SWD(2015) 183 final 

COMMISSION STAFF WORKING DOCUMENT 

Economic Analysis 

Accompanying the document 

Communication from the Commission to the European Parliament, the Council, the 
European Economic and Social Committee and the Committee of the Regions 

Action Plan on Building a Capital Markets Union 

{COM(2015) 468 final} 
{SWD(2015) 184 final} 

EN 

EN 

 
 
 
  
 
Contents 

EXECUTIVE SUMMMARY .................................................................................................6 

Chapter 1  THE IMPORTANCE OF THE CAPITAL MARKETS UNION ........................8 

1.1 Overreliance on banking as an impediment for growth.................................................8 

1.2  The  growth  weakness  became  entrenched  through  the  fragmentation  of  the  EU 
financial sector...................................................................................................................11 

1.3 Objectives of the CMU................................................................................................12 

Chapter 2  TAKING STOCK OF EU CAPITAL MARKETS ............................................16 

2.1 Bank-based versus market-based financial systems ....................................................17 

Optimal  financial  structure  is  dependent  on  the  stage  of  development  of  the 
economy .................................................................................................................. 17 

Relative advantages of bank-based and market-based funding systems................. 20 

Competition or complementary?............................................................................. 22 

2.2. Historical, legal and economic structures as barriers for capital markets development
...........................................................................................................................................24 

2.3 Financial stability and macro-prudential policy oversight for a stronger CMU..........27 

Chapter 3  FINANCING  NEEDS  BY  THE  EUROPEAN  CORPORATE  SECTOR  AND 
INFRASTRUCTURE............................................................................................................31 

3.1 Theory on businesses' access to funding .....................................................................31 

3.2 Do European SMEs lack funding? ..............................................................................33 

3.4 Do European companies face barriers to going public? ..............................................44 

3.5 Debt versus equity financing and the tax-induced debt bias .......................................51 

3.6 Barriers to access infrastructure finance......................................................................53 

Chapter 4  THE  PROVISION  OF  FUNDING  THROUGH  CAPITAL  MARKET 
INSTRUMENTS ...................................................................................................................57 

4.1 Identifying and understanding the investor base .........................................................58 

4.2 Promoting saving and investment by households through capital markets .................62 

4.3 Promoting capital market investments by institutional investors ................................65 

Chapter 5  REAPING  OPPORTUNITIES  TO  PROMOTE  CROSS-BORDER  MARKET 
FUNDING 70 

5.1 Benefits and determinants of cross-border investments ..............................................70 

5.2 Insolvency rules and procedures and company law ....................................................72 

5.3 Withholding tax and other tax barriers to cross-border investments ...........................77 

5.4 Financial market infrastructures ..................................................................................80 

5.5 Supervisory and regulatory convergence.....................................................................82 

Chapter 6  A COUNTRY PERSPECTIVE ON THE CMU ................................................84 

2 

 
6.1 Financing needs ...........................................................................................................85 

6.2 Financing sources ........................................................................................................92 

6.3 Intermediation: linking financing sources with financing needs.................................96 

6.4 How can the CMU benefit EU Member States with different levels of capital market 
development?...................................................................................................................102 

REFERENCES....................................................................................................................106 

3 

 
 
LIST OF ABBREVIATIONS 

Central Clearing Counterparty 

Central Securities Depository 

Capital Markets Union 

European Bank for Reconstruction and Development 

European Central Bank 

European Fund for Strategic Investments 

European Investment Bank 

European Insurance and Occupational Pensions Authority 

European Long Term Investment Fund 

Environmental, Social and Governance 

European Securities and Markets Authority 

European Union 

Euro 

Foerign Direct Investment 

Financial Services Action Plan 

Gross Domestic Product 

International Finance Corporation 

International Monetary Fund 

Initial Public Offering 

Markets in Financial Instruments Directive 

Markets in Financial Instruments Regulation 

Multilateral Trading Facility 

Non-Financial Corporation 

Organisation for Economic Co-operation and Development 

Official Journal of the European Union 

Private Placement 

Public Private Partnership 

Packaged Retail Investment Products (Directive) 

Research and Development 

Small and Medium Enterprise 

Staff Working Document 

4 

CCP 

CSD 

CMU 

EBRD 

ECB 

EFSI 

EIB 

EIOPA 

ELTIF 

ESG 

ESMA 

EU 

EUR 

FDI 

FSAP 

GDP 

IFC 

IMF 

IPO 

MiFID 

MiFIR 

MTF 

NFC 

OECD 

OJ 

PP 

PPP 

PRIPs 

R&D 

SME 

SWD 

 
 
TFEU 

UCITS 

Treaty on the Functioning of the European Union 

Undertakings  for  the  Collective  Investment  in  Transferable 
Securities 

USD 

Dollar of the United States of America 

5 

 
 
 
EXECUTIVE SUMMMARY 

This  Commission  Staff  Working  Document  (SWD)  accompanies  the  Action  Plan 
on  the  Capital  Markets  Union  (CMU).  By  providing  an  economic  analysis  of  the 
functioning  of  financial  markets  in  Europe,  it  substantiates  the  rationale  for  the 
objectives of the CMU and provides the context for the Action Plan. In particular, the 
SWD  analyses  the  evolution  and  the  current  state  of  financial  markets  in  the  EU,  the 
financing  needs  of  the  economy,  the  role  of  investors  and  how  the  two  meet,  and  the 
obstacles to cross border investments in Europe.  

The SWD provides a general context for identifying weaknesses and market failures in 
the functioning of European capital markets, some of which may be suitable candidates 
for  action  for  the  CMU  Action  Plan.  However,  some  structural  problems  or  market 
failures  cannot  be  addressed  effectively  by  policy  action  at  EU  level  or  our 
understanding  of  the  nature  of  the  market  failure  does  not  yet  allow  us  to  frame 
corrective policy action. Other problems may be better addressed through intervention 
at Member States' level or in other ways. It is nevertheless important to analyse these 
issues  in  the  SWD  to  understand  the  context  in  which  EU  level  initiatives  can  be 
usefully deployed through the CMU. This SWD builds on the SWD that accompanied 
the  Green  Paper  on  the  Capital  Markets  Union1,  which  provided  initial  reflections  on 
the  obstacles  to  the  development  of  deep  and  integrated  EU  capital  markets,  and  the 
2015  European  Financial  Stability  and  Integration  Review  (EFSIR)  that  provides  an 
extensive statistical overview of the EU financial system, including capital markets.2 

Chapter  one  explains  how  reducing  the  reliance  on  the  banking  sector  and 
strengthening the integration of EU financial markets can support growth in Europe, and 
introduces  the  concept  and  objectives  of  the  CMU  in  this  context.  Chapter  two 
describes how the banking sector and capital markets have been developing in the EU 
and  explores  their  respective  roles  and  relative  advantages  in  different  stages  of 
development  of  an  economy.  It  demonstrates  that  banks  and  capital  markets  are  two 
vital components of the financial system, not competing but complementing each other 
and  co-evolving.  It  also  explains  why  banks  have  a  dominant  role  in  the  European 
financial  structure  and  what  complementing  this  structure  with  more  market-based 
funding  means  for  financial  stability.  Chapter  three  analyses  how  enterprises,  and  in 
particular SMEs, could benefit from a larger share of financing made available through 
capital  markets.  It  describes  the  various  funding  sources  of  European  non-financial 
corporations  and  explores  their  comparative  advantages.  After  analysing  how  the 
financing needs of a company evolve over its life cycle, it explains why specific capital 
markets  instruments  that  would  be  most  appropriate  to  support  the  development  of  a 
firm remain under-developed in Europe. For non-financial corporations to have access 
to  more  market  funding,  as  argued  in  chapter  three,  investors'  savings  through  market 
instruments have to increase. This is what chapter four analyses. It first describes the 
EU  investor  base,  distinguishing  between  retail  investors,  non-financial  corporations 
and  institutional  investors.  While  households  and  non-financial  corporations  are  the 
largest  ultimate  suppliers  of  funds,  the  intermediation  role  of  institutional  investors  is 

1   European Commission (2015a). 
2   European Commission (2015b). 

6 

 
                                                 
crucial.  The  chapter  then  discusses  how  correcting  information  asymmetries,  tackling 
barriers to cross-border investment by European funds and exploring the development 
of personal pension funds could promote households' investments in capital markets. It 
then analyses various obstacles to more investment by institutional investors in capital 
markets  instruments.  Chapter  five  provides  a  thorough  insight  into  the  barriers  and 
obstacles  to  cross-border  capital  market  transactions.  After  describing  the  economic 
benefits  stemming  from  cross-border  capital  flows,  it  provides  more  detail  on  those 
aspects of capital markets' organisation that appear the most relevant in a cross-border 
context, 
financial  market 
infrastructures,  as  well  as  supervisory  and  regulatory  practices  at  Member  State  level. 
Chapter six documents similarities and differences between Member States as regards 
their financing needs, their funding sources, and the structure and level of development 
of  their  financial  markets.  This  diversity  means  that,  while  all  Member  States  will 
benefit  from  the  CMU,  gains  will  materialise  in  various  forms,  depending  on  the 
specificity of each Member State.  

insolvency  procedures, 

in  particular 

tax  barriers, 

7 

 
Chapter 1  THE IMPORTANCE OF THE CAPITAL MARKETS UNION 

Through the CMU, the European Commission strives to increase the benefits that 
capital  markets  and  non-bank  financial  intermediaries  can  provide  to  the 
economy. Building a CMU is a key initiative in the work programme of the European 
Commission. It is also one of the elements for completing the Economic and Monetary 
Union, as set out in the recently published Five Presidents' Report.3 It would ensure a 
greater  diversification  in  the  funding  of  the  economy  and  reduce  the  cost  of  raising 
capital,  particularly  for  SMEs.  The  motivation  for  the  CMU  also  stems  from  the 
shortcomings  of  the  European  Union  (EU)  financial  system  revealed  by  the  financial 
crisis  that  are  impeding  economic  growth  and  are  holding  back  recovery.  While  there 
are a variety of funding sources available to finance the EU economy, it seems to overly 
rely  on  financing  intermediated  through  banks.  At  the  same  time,  market-based 
financial instruments could be more extensively used, at least in some countries.4 This 
document makes the case that if the EU financial system was more diversified and had a 
larger share of funding channelled through capital markets, this should ultimately lead 
to  a  wider  choice  of  financial  instruments  for  the  benefit  of  both  enterprises  and 
investors  and  a  lower  cost  of  raising  capital,  notably  for  SMEs,  and  increase  the 
attractiveness of Europe as a place to invest.5 The EU economy could move towards a 
higher growth path and be more resilient to economic shocks. 

1.1 Overreliance on banking as an impediment for growth  

The  financial  and  sovereign  debt  crisis  has  taken  a  heavy  toll  on  EU  growth 
performance. Significant GDP loss occurred in many developed countries and became 
permanent. Support programmes for banks entailed non-recovered fiscal costs of about 
5% of GDP or more in Belgium, Greece, Ireland, Luxembourg, the Netherlands, Austria 
and the UK.6 The unemployment rate increased from a pre-crisis low of 7.5% in 2007 to 
11.6%  in  2014  in  the  euro  area,  and  from  7.2%  to  10.2%  in  the  EU.  Compared  with 
2007,  6.5  million  more  people  are  now  unemployed  in  the  EU.  In  addition,  European 
economies are not only suffering from permanent and significant losses of GDP, but in 
addition a reduced potential real GDP growth rate (see Charts 1 and 2).  

3   "[The CMU] will ensure more diversified sources of finance so that companies, including SMEs, can 
tap  capital  markets  and  access  other  sources  of  non-bank  finance  in  addition  to  bank  credit.  At  the 
same  time,  a  well-functioning  Capital  Markets  Union  will  strengthen  cross-border  risk-sharing 
through deepening integration of bond and equity markets, the latter of which is a key shock absorber. 
Truly integrated capital markets would also provide a buffer against systemic shocks in the financial 
sector  and  strengthen  private  sector  risk-sharing  across  countries"  (extract  from  the  Five  Presidents' 
Report on "Completing Europe's Economic and Monetary Union"). 

4   See European Commission (2015b). 
5   This document treats the terms capital markets and financial markets as synonyms although capital in 
the  form  of  non-financial  assets  such  as  machinery  and  equipment,  real  estate  and  housing  or 
intellectual property rights is not covered. Also several financial markets such as derivative markets 
and foreign exchange markets are out of the scope of this paper in line with the coverage of capital 
markets in the CMU Action Plan. 

6   Measured as direct fiscal outlays in Laeven and Valencia (2012). State aid to the financial sector in the 
form  of  recapitalisation  and  asset  relief  measures  amounted  to  EUR 591.9  billion,  which  represents 
4.6 % of the EU's 2012 GDP. 

8 

 
                                                 
Chart 1: Actual and potential GDP in the EU-28 

Chart 2: Actual and potential GDP in the USA 

An investment gap opened in the EU and poses risks to achieving competitiveness 
and sustainable growth. The level of investment (gross fixed capital formation) in the 
EU has dropped by about 10% (EUR 300 billion in 2010 prices) since its peak in 2007 
as a consequence of the economic and financial crisis. Capital inflows from abroad into 
the  EU  have  also  come  down  considerably7,  suggesting  that  weaker  growth  prospects 
have made the EU a less attractive place for financial investment. This investment gap 
poses a threat to reaching the targets set by the Europe 2020 Strategy and needs to be 
closed  to  achieve  the  overarching  European  policy  goals  of  smart,  inclusive  and 
sustainable  growth.  The  European  Commission's  new  Investment  Plan,  including  the 
European Fund for Strategic Investments (EFSI), was adopted to unlock investment to 
fill the gap. The Regulation setting up the EFSI8 explicitly requires that EU projects are 
consistent  with  EU  policy  priorities,  such  as  the  2030  climate  and  energy  package  to 
achieve a low carbon economy.9 The EU's international investment policy is focused on 
providing EU investors and investments with market access and with legal certainty and 
a stable, predictable, fair and properly regulated environment in which to conduct their 
business.10 

7   EU-28 total capital inflows from abroad declined from about 15% of GDP on average 2004-2007 to 
5%  on  average  2009-2013.  This  is  less  due  to  FDI  inflows,  which  have  remained  stable  as  a 
percentage of GDP terms, but more to declining portfolio flows and "other" capital flows, where the 
latter consists to a large extent of financial flows between banks. 

8   Regulation  (EU) 2015/1017 of  the  European  Parliament  and of  the  Council  of 25  June  2015  on  the 
European Fund for Strategic Investments, the European Investment Advisory Hub and the European 
Investment Project Portal and amending Regulations (EU) No 1291/2013 and (EU) No 1316/2013 — 
the European Fund for Strategic Investments 

9   The  low  carbon  transformation  will  require  large-scale  shifts  in  investment  patterns  of  the  private 
sector.  The  International  Energy  Agency  (IEA)  estimated  that  limiting  the  global  increase  in 
temperature to 2°C would require USD 36 trillion (35%) more in investments from today to 2050 than 
under a scenario in which controlling carbon emissions is not a priority. The European Commission 
has estimated that some EUR 200 billion have to be invested annually for Europe to reach the 2030 
targets. 

10   See European Commission (2010). 

9 

 
                                                 
The relatively large reliance on banks weighs on growth and recovery. In the run-up 
to the financial crisis,  banks'  balance sheets and  off-balance sheet  exposure grew  fast, 
and  credit  provided  in  the  form  of  bank  loans  outpaced  GDP  growth.  The  financial 
crisis  imposed  significant  restructuring  and  deleveraging  needs  on  the  sector. 
Subsequently,  the  EU  banking  sector  has  become  considerably  less  supportive  to 
economic  activity  than  in  past  upturns.11  Factors  causing  this  include  the  following: 
(i) pre-crisis  bank  lending  contributed  to  the  accumulation  of  debt  among  private 
households and firms, part of which became unsustainable with the economic downturn; 
(ii) economic recessions tend to be more severe when accompanied by financial crises 
and  especially  banking  crises;  and  (iii) EU  banks  reduced  their  coss-border  activities 
(fragmentation).12  Banks'  asset  quality  eroded  amid  weakening  economic  activity, 
particularly in EU Member States heavily exposed to stress on sovereign bond markets. 
As a result, the share of non-performing loans on banks' balance sheets increased. This 
has  been  identified  as  a  crucial  factor  that  has  held  back  credit  provision  to  the 
economy.13  

High  bank  dependency  means  that  enterprises,  and  particularly  SMEs,  have 
difficulties accessing alternative funding sources when they cannot get credit from 
banks.  For  many  companies,  particularly  in  vulnerable  Member  States,  access  to 
finance  has  become  markedly  more  difficult  with  the  financial  crisis.14  Difficulty  in 
accessing  finance  is  one  of  the  obstacles  that  prevent  SMEs  from  launching  new 
products, broadening their activities and markets, strengthening their infrastructure and 
taking on more employees. This situation is equally true for well-established SMEs and 
those  innovating  ones  that  are  small  and  rapidly  expanding.  Financing  conditions 
remain tight in countries whose economies have been hit most severely by the crisis and 
especially for start-ups, SMEs and/or innovative companies.  

From  a  systemic  point  of  view,  higher  dependence  on  bank  lending  makes  the 
economy  more  vulnerable  when  bank  lending  tightens,  as  happened  in  the  recent 
crisis. In times of economic downturns coinciding with financial crises, capital markets 
have the ability to act as more effective shock-absorbers (see Section 2.1). The shock-
absorbing  capacity  of  capital  markets  is  particularly  high  when  borrowers  can  switch 
between  funding  sources  and  when  funding  is  provided  in  the  form  of  equity.  Thus, 
diversification  of  funding  sources  and  a  higher  share  of  equity  funding  make  the 
financial  system  more  stable.  The  diversification  benefits  apply  equally  to  investors, 
who  enjoy  an  increased  set  of  investment  opportunities  in  deeper  and  more  liquid 
capital markets.  

11   See  Allard  and  Blavy  (2011)  and  Grjebine  et  al.  (2014)  for  empirical  comparisons  of  how  cyclical 

recoveries depend on financial structure. 

12   See Reinhart and Rogoff (2009, 2010), on the latter point, see Section 1.2. 
13   See IMF (2014, 2015a), EIB (2014). 
14   See European Commission (2013). This is documented through the semi-annual surveys on the access 
to  finance  of  enterprises  (SAFE)  and  the  quartlery  ECB  Bank  Lending  Survey.  For  an  economic 
analysis of the issue, see Hoffmann and Sørensen (2015), Ferrando et al. (2015). 

10 

 
                                                 
1.2 The growth weakness became entrenched through the fragmentation of the EU 

financial sector 

The combination of the global financial crisis and euro-area sovereign debt crisis 
has  halted  the  process  of  integration  in  EU  banking  and  triggered  a  process  of 
financial  fragmentation.  By  2007,  European  banks  were  significantly  more 
internationalised than banks in the USA, Japan or China. This resulted primarily from 
their cross-border expansion within Europe. However, the crisis revealed that financial 
integration  in  the  EU  was  hitherto  shaped  by  cross-border  inter-bank  flows,  which 
fuelled local credit bubbles and emerged as pro-cyclical and prone to sudden reversal. 
From 2008, cross-border lending in the euro area and the EU declined in absolute and 
relative  terms.  At  the  same  time,  banking  activities,  assets  and  risks  migrated 
increasingly  back  to  home  jurisdictions.15  In  parallel,  banks  invested  increasingly  in 
domestic  sovereign  bonds,  thereby  exhibiting  home  bias  in  most  Member  States.  In 
Member States that experienced acute sovereign funding stress, banks' access to cross-
border  funding  became  particularly  difficult  and  bank  funding  costs  widened  in  both 
absolute  and  relative  terms.16  Shortfalls  in  private  funding  in  these  banks  have  been 
partially compensated by higher borrowing from the Eurosystem.  

Financial  fragmentation  has  a  significant  effect  on  the  possibility  to  share 
economic  risks  across  borders.  Economic  literature  identified  capital  markets  and 
bank credit markets as having a potentially important role in cushioning the impact of 
economic  shocks.17  By  giving  access  to  foreign  assets,  the  capital  markets  channel 
provides  stable  revenues  to  investors  when  domestic  income  sources  decay.  The  bank 
credit market channel assumes that banks provide stable funding to the economy even 
when  the  economic  activity  weakens  and  credit  risks  increase.  The  literature  on  risk 
sharing  in  the  euro  area  found  that  it  is  underdeveloped  and  that  it  was  not  effective 
during  the  financial  crisis.18  Indeed,  the  credit  market  played  a  small  role  because  the 
severity and persistence of the economic downturn weakened the banking system, and 
because the fragmentation it entailed annihilated the cushioning effect of diversification. 
The  reasons  for  the  capital  market  channel  to  have  had  a  limited  cushioning  effect 
during the crisis were seen in the limited size of capital markets in the EU.19 Economic 
theory has long conjectured a link between financial integration, risk sharing and higher 
economic growth through a "risk-amelioration" channel.20 

The  macroeconomic  consequences  of  a  limited  risk  sharing  became  evident  with 
the weak bank lending in vulnerable Member States that resulted from the crisis. 
An important element of cross-border risk-sharing was unavailable when needed most, 
leaving  corporates  in  vulnerable  Member  States  reliant  on  domestic  banks  that 

15   See Battistini et al. (2013) and Schoenmaker (2013). 
16   For two different approaches to measure the divergence of funding costs for banks, see Gilchrist and 

Mojon (2014) and Thiel (2014).  

17   See Demyanyk et al. (2008), Anderson et al. (2015), and the literature quoted therein. 
18   See Anderson et al. (2015) and the studies quoted therein. 
19   For  a  discussion  of  the  reasons  why  the  EU  capital  market  is  relatively  small,  see  European 

Commission (2015a) and Section 2.2 of this document. 

20   See Obstfeld (1994). 

11 

 
                                                 
encountered  funding  problems  either  because  they  had  to  repair  balance  sheets 
themselves  or  were  exposed  to  a  weak  sovereign.21  In  other  Member  States,  weak 
domestic demand for credit coupled with the unwinding of interbank lending resulted in 
excess  liquidity  in  the  banking  system.22  Since  SMEs  are  particularly  dependent  on 
funding  from  domestic  banks,  the  fragmentation  of  banking  markets  aggravated 
financial constraints in the SME sector. EU cross-border banks did not compensate for 
the decline in credit supply by domestic banks.23 Difficulties to tap foreign sources were 
also  observed  for  other  funding  instruments.  Cross-border  corporate  bond  holdings 
declined substantially during the financial crisis. The home bias in equity fell during the 
financial  crisis,  but  remains  significant,  with  64%  of  EU  equity  holdings  and  61%  of 
euro area equity holdings being of domestic origin.24 

Chart  3:  EU  banks'  total  foreign  assets  and 
liabilities, trillion USD 

Chart  4:  Central  bank  funding  of  banks,  in  %  of 
total liabilities 

1.3 Objectives of the CMU 

The  CMU  complements  the  regulatory  financial  reforms  of  recent  years  and  the 
Banking  Union.  The  aim  of  the  financial  reform  agenda  has  been  to  strengthen 
regulation  and  supervision  of  the  financial  sector  after  the  financial  crisis,  in  order  to 
restore and safeguard financial stability. The Banking Union, partly in response to the 
sovereign  debt  crisis,  addresses  supervision  and  resolution  of  banks,  thereby  targeting 
the  nexus  between  banks  and  the  sovereign  risks  in  participating  countries.  With  the 
overarching  objective  of  maximising  the  benefits  of  capital  markets  and  non-bank 
financial institutions for the real economy, the CMU provides additional value to those 
reforms. 

21   See Fratzscher and Rieth (2015). 
22   See Al-Eyd and Berkmen (2013), Balduzzi et al. (2013). 
23   See  Hoffmann  and  Sørensen  (2015).  They  also  make  the  case  that  cross-regional  banks  had  an 

important role in smoothening the impact of local recessions in the USA and Japan. 

24   See Schoenmaker and Soeter (2014), European Commission (2015b). 

12 

 
 
 
 
                                                 
The CMU has three main objectives: 

a.  The  CMU  will  broaden  the  sources  of  financing  in  Europe  towards  non-
bank  financing  by  giving  a  stronger  role  to  capital  markets.  It  will  offer  to 
borrowers  and  investors  a  broader  set  of  financial  instruments  to  meet  their 
respective needs.25 

b.  The CMU will help deepen the single market for financial services. Capital 
markets  will  benefit  from  the  size  effects  of  the  single  market  and  become 
deeper,  more  liquid  and  more  competitive,  for  the  benefit  of  both  borrowers 
and investors. 

c.  The  CMU  will  help  promote  growth  and  financial  stability.  By  facilitating 
companies'  access  to  finance,  in  particular  SMEs,  the  CMU  will  support 
growth  and  jobs'  creation.  At  the  same  time,  by  promoting  more  diversified 
funding channels to the economy, it will help address possible risks stemming 
from  the  over-reliance  on  bank  lending  and  intermediation  in  the  financial 
system.  By  diversifying  the  risks,  it  will  make  the  whole  system  more  stable 
and help financial intermediaries granting more funding to the economy.  

Capital  markets  enlarge  the  set  of  potential  financing  instruments  and  are 
complementary to bank financing. Non-bank financing does not merely substitute for 
investment  that  was  previously  funded  by  banks,  but  it  enables  additional  investment 
that  banks  would  not  be  ready  to  fund.  As  further  detailed  in  Section 2.1,  market 
financing is usually regarded to being better at dealing with uncertain environments and 
therefore better suited to fund riskier investment projects (with a higher required rate of 
return).26  The  creation  of  the  CMU  not  only  complements  banking  activity,  but  also 
boosts  it  as  banks  provide  important  services  to  participants  in  many  capital  market 
segments  and  receive  from  it  considerable  revenues,  notably  in  the  form  of  fees. 
Besides,  by  providing  a  larger  pool  of  financial  assets  which  could  be  potentialy 
included in open market operations conducted by central banks, deeper capital markets 
could also strenghten the transmission of monetary policy impulses. 

Deep,  liquid  and  efficient  capital  markets  bring  advantages  to  borrowers  and 
investors. They have three main advantages for companies seeking finance: (i) improve 
their  access  to  funds;  (ii) reduce  their  capital  costs  by  creating  competition  among 
investors;  and  (iii) reduce  the  risk  of  disruption  in  financing  by  diversifying  their 
funding  sources  (see  Chapter 3).  On  the  investors'  side,  by  increasing  the  investment 
opportunities, efficient capital markets offer investors a broader set of financial products 
to  (i) meet  their  investment  objectives,  (ii) diversify  and  manage  their  risks,  and 
(iii) optimise  their  risk-return  profile,  while  respecting  their  investment  constraints  – 
whether  in  terms  of  risk,  duration,  or  other  assets'  characteristics  (see  Chapter 4). 
Overall, capital markets (especially equity markets) facilitate entrepreneurial and other 
risk-taking activities, which have a positive effect on economic growth. 

25   The term "borrower" is here used for the counterpart that demands funding independent on whether 

funding is requested in the form of debt or equity. 

26   This is based on the assumption that markets bring together independent opinions from a large number 

of participants and trading aggregates the diverse views.  

13 

 
                                                 
Large  and  well-integrated  capital  markets  can  contribute  to  jobs  and  growth 
through  a  number  of  channels.  They  can  contribute  to  allocative  efficiency  by 
opening  up  investment  and  diversification  opportunities  for  investors  across  Europe, 
improving  access  to  risk  capital  for  borrowers,  and  allowing  greater  competition 
(unleashing  corresponding  benefits  such  as  productivity  gains,  lower  costs,  greater 
choice, financial innovation, etc.). Unobstructed capital flows within the single market 
should  allow  financial  resources  to  reach  the  most  profitable  investments.  Portfolio 
diversification possibilities should also be enhanced because the larger financial markets 
are and the better integrated across borders, the more opportunities they allow to share 
risks among actors and economies.27 Cross-border integration increases the size of the 
relevant  market,  which  allows  for  scale  effects  originating  from  lower  costs  to  run 
market infrastructures, better capitalisation on search costs (see Section 5.1), and higher 
market liquidity. 

Figure 1: A stylised view of the economic benefits of integrated and well-functioning capital markets 

The CMU goes beyond previous initiatives to foster the single market for financial 
services.  The  CMU  shares  some  economic  objectives  with  the  Financial  Services 
Action Plan (FSAP), which led to the adoption of 42 regulatory measures, including 24 
legislative  measures,  between  1999  and  2004.28  The  FSAP  also  aimed  at  reducing 
obstacles  to  cross-border  financial  investment,  thereby  increasing  efficiency  gains 
through  higher  competition  and  realisation  of  scale  effects  and  allowing  a  better 
diversification of risks on integrated financial markets. The CMU continues to build on 
this,  focusing  on 
the 
contribution of capital markets to the EU financial system and funding households and 
companies.  At  the  same  time,  the  role  of  stronger  supervisory  convergence  and 
enhanced financial stability feature more prominently than in the FSAP. 

investment,  strengthening 

to  cross-border 

the  obstacles 

27   Deeper  financial  integration  had  therefore  been  regarded  as  an  essential  complement  to  an  efficient 

functioning of EMU. See European Commission (2008a) and the literature quoted therein. 

28   The  FSAP  was  followed  by  the  Commission  White  Paper  on  Financial  services  policy  2005-2010, 
which  focused  on  the  implementation  and  enforcement  of  existing  regulation  and  on  delivering 
targeted improvements in the existing regulatory and supervisory frameworks. 

14 

 
 
 
 
                                                 
Figure 2: Financing of the economy: size of institutional sectors, 2014, EU 28, EUR billion 

Providers of 
funds (Assets) 

Financial corporations (intermediation)
€94,400 bn  

Users of funds 
(Liablities) 

Households 
€31,100 bn 

 Other Financial Institutions (OFIs) 
€31,100 bn 

NFCs 
€23,900 bn  

Gov. €6,600 bn  

Rest of the 
World 
€34,900 bn  

 MFIs (Banks and MMFs) 
€48,500 bn  

 Insurance corp. and pension funds
€14,800 bn  

Households 
€10,000 bn  

NFCs 
€39,300 bn  

Governments  
€15,600 bn  

Rest of the 
World 
€37,400 bn  

Notes: The height of each box is proportional to the actual size of the sector. Assets and liabilities of the real economy 
and RoW include funds channelled both through intermediation and direct financing. 
Source: ECB, Eurostat and own calculations. 

15 

 
  
  
 
 
Chapter 2  TAKING STOCK OF EU CAPITAL MARKETS29 

Non-bank  finance  is  small  in  the  EU,  though  the  situation  differs  from  one 
Member State to another… The size of capital markets is conventionally measured by 
the  ratio  of  outstanding  financial  assets  relative  to  economic  activity.  International 
Monetary Fund (IMF) standard indicators of capital market size reveal that the EU has a 
particularly  large  capital  market  when  financial  assets  held  by  banks  are  included. 
Should  these  assets  be  excluded  and  the  size  of  capital  markets  be  measured  as  the 
volume of outstanding bonds and shares, financial markets in the USA and Japan would 
be considerably larger. By the same token, several EU Member States (LU, IE, NL and 
DK) have relatively larger capital markets than the USA, suggesting that conditions in 
the EU can be supportive to the development of large capital markets. 

Chart 5: Size of capital markets in % of GDP, 2013 

…  and  enterprises  make  little  use  of  market  financing  sources.  A  large  share  of 
bank  loans  on  the  funding  side  of  European  enterprises  witnesses  the  important  role 
banks  play.  Bank  loans  respectively  represent  14%  and  3%  of  the  total  liabilities  of 
European and US companies, respectively. Conversely, corporate bonds are more used 
as a source of funding by US companies, representing 11% of their total liabilities, to 
compare with 4 % in EU firms. As a result, corporate bonds amount to a third of bank 
credit in the EU whereas they are a more important funding tool than bank loans for US 
corporates. The dominance of market over non-market funding sources in the US is also 
evident when equity is looked at. While the share of equity on firms' balance sheets is 
broadly comparable in the US and the EU, slightly more than half of this equity is in the 
form of listed shares in the US, to compare with about one third in the EU. If not listed, 
shares  are  more  difficult  to  trade  and  therefore  less  liquid,  which  entails  a  higher 
illiquidity  premium  that  investors  require  as  compensation  for  their  longer-term 
engagement. Stock market capitalisation is markedly larger in the USA than in all EU 
Member  States  except  Luxembourg  and  the  UK.  More  detailed  comparisons  suggest 

29   A  more  detailed  description  of  the  EU  financial  system  is  presented  in  European  Commission 

(2015b). 

16 

 
 
                                                 
that access to financial instruments that enterprises may want to use in special situations 
is  easier  in  the  USA.  Examples  would  be  when  they  are  young  and  small  and  cannot 
provide  collateral,  when  their  investments  are  particularly  risky  or  large  compared  to 
firm  size,  when  their  corporate  or  financing  structure  needs  to  be  restructured  etc.  In 
such  situations,  these  companies  may  want  to  tap  non-standard  markets  such  as  high-
yield  bonds,  leveraged  loans,  securitisation,  or  private  equity  markets,  which  are 
underdeveloped in many EU Member States.30 

Chart 6: Liabilities of the EU corporate sector, EU-28 
non-financial corporations, 2013 

Chart  7:  Liabilities  of  the  US  corporate  sector,  non-
financial corporations, 2013 

Source: Eurostat. 

Source: OECD. 

This  chapter  discusses  three  caveats  often  mentioned  with  respect  to  the 
development  of  capital  markets  in  the  EU.  First,  the  advantages  of  a  more  market-
based  financial  system  would  need  to  be  balanced  against  the  advantages  that  bank 
financing provides (Section 2.1). Second, the development of a stronger capital market 
would  be  a  break  with  historical,  legal  and  economic  structures  that  led  to  a  mainly 
bank-based  system  (Section  2.2).  Third,  the  benefits  and  risks  of  a  stronger  capital 
market for financial stability (Section 2.3).   

2.1 Bank-based versus market-based financial systems 

Optimal financial structure is dependent on the stage of development of the economy  

Available  research  fails  to  provide  a  general  rule  determining  which  financial 
structures  are  optimal  with  respect  to  their  contribution  to  economic  growth.  As 
regards the causality between long-term growth performance and the size or structure of 
the  financial  system,  the  ultimate  jury  is  still  out.  However,  empirical  studies  suggest 

30   The comparison to the USA has been subject to numerous studies. See, for example, AFME (2014), 

Anderson et al. (2015), Dixon ( 2014), Vernon and Wolff (2015), Wright (2014). 

17 

 
 
                                                 
that very high credit relative to GDP may lower economic growth.31 A similar threshold 
has not been identified for market financing, especially equity financing (see Table 1). 
Some research even suggests that larger stock markets could be particularly supportive 
to  economic  growth.  Depending  on  criteria  and  circumstances,  studies  highlight 
advantages  of  both  bank-based  and  market-based  financial  systems.  Analogously  to 
firm-level  choices  where  the  optimal  financial  structure  depends  on  the  firm's 
characteristics, the optimal financial structure for a country depends on country-specific 
factors (see Chapter 6). In addition, studies show that economies at different stages of 
economic  development  require  different  mixtures  of  financial  services  to  operate 
effectively.32  For  example,  as  economies  develop,  the  marginal  gain  in  economic 
activity associated with an increase in bank intermediation becomes smaller, while the 
marginal impact associated with a further development of capital markets increases.  

When  it  comes  to  moderating  business  cycle  fluctuations,  the  influence  of  bank 
lending  and  capital  markets  differs  considerably.  In  downturns  that  are  not 
accompanied by financial tensions, healthy banks are the key element to help cushion 
shocks.  But  when  recessions  coincide  with  financial  crises,  bank-oriented  economies 
tend to suffer more than market-oriented ones. Some studies33 show that market-based 
economies  recover  faster  than  bank-based  economies  even  after  controlling  for  the 
origin  of  the  recession,  the  policy  response,  and  the  degree  of  economic  flexibility. 
Accordingly,  heavy  leaning  towards  banks  constraints  the  pace  of  economic  rebound, 
making a diversified system indispensable to cushion economic shocks.  

The  optimal  financial  structure  shifts  towards  capital  markets  along  with  higher 
levels  of  economic  development.  Banks  are  particularly  well-placed  to  serve 
economies  at  an  early  stage  of  development  because  foreign  bank  entry  allows  for  a 
swift  growth  of  the  banking  system,  hence  providing  a  broader  access  to  financing. 
They also have an uncontested role in certain market segments, for example to provide 
funding to firms that are too small to tap market sources. Capital markets take longer to 
develop because they require extensive technical and legal infrastructures (e.g. clearing, 
settlement,  information  provision).  Services  provided  by  financial  markets  become 
comparatively more important for high-income countries because, when economic and 
institutional systems mature, demand for a broader set of risk management and capital-
raising tools increases beyond what banks can typically supply.34  

31   See Popov and Smets (2011), Arcand et al. (2012), Cecchetti  and Kharroubi (2012), ESRB (2014).  
32   See Boyd and Smith (1998), Allen and Gale (2000). 
33   See Allard and Blavy (2011), Grjebine et al. (2014). 
34   See Demirgüç-Kunt et al (2011), Kaeserer and Rapp (2014). 

18 

 
                                                 
Table 1: Selected empirical estimates of the impact of financial development on economic growth 

Study 

Method and data 

Findings 

King 
Levine 
(1993a, 
1993b) 

and 

rates 

Economic  growth 
are 
related  to  measures  of  lagged 
financial  development 
in  80 
countries. 

Rousseau 
and 
Wachtel 
(2011) 

Cross sectional and panel data on 
financial and macroeconomic 
indicators  for  84  countries  over 
the period 1960-2004. 

Pagano 
and  Pica 
(2012) 

Arcand, 
Berkes 
and 
Panizza 
(2012) 

Cecchetti 
and 
Kharroubi 
(2012) 

Growth  regressions  by  Rajan-
Zingales  (1998)  are  re-estimated 
using  UNIDO  data  for  annual 
value added for 28 industries and 
63 countries from 1970 to 2003. 

Analysis  according  to  the  set-up 
described  in  Beck  and  Levine 
(2004).  Data  covers  the  period 
1960-2010 

advanced 

Panel regressions on a sample of 
50 
emerging 
countries  over  the  period  1980–
2009. 

and 

Demirgüç-
Kunt 
Levine 
(2011) 

and 

Quantile regressions are used to 
assess the sensitivity of economic 
and 
activity 
securities  market  development. 
Data  on  72  countries,  over  the 
period 1980-2008. 

to  both  bank 

Langfield and  
Pagano 
(2015) 

and 

regressions  with 

fixed 
Panel 
dummies. 
effects 
Dataset 
748 
observations  for  45  countries 
between 1988 and 2011. 

year 
contains 

Cournède 
and  Denk 
(2015) 

Growth  regressions  on  data  for 
countries 
and  G20 
OECD 
between 1961 and 2011.  

to 

Indicators  of  economic  performance  are 
positively  associated  with  the  size  of  the 
financial  sector  at  the  beginning  of  the  sample 
period.35 
Positive correlation of financial 
size  with  economic  growth  disappears  when 
concentrating on the period since 1990. In order 
to  have  positive  effects  on  growth,  financial 
deepening  needs 
to  be  accompanied  by 
appropriate financial sector policies.  
Financial  development  increases  employment, 
labour  productivity  and  wages.  The  impact  is 
stronger at low levels of financial development. 
Beyond  a  certain  point,  financial  development 
does  not  contribute  significantly 
real 
economic activity. 
The  relationship  between  credit  to  the  private 
is  concave  and  non-
sector  and  growth 
monotone36.  Finance  starts  having  a  negative 
effect  on  growth  when  credit  to  the  private 
sector reaches 100% of GDP. 
The level of financial development is good only 
up to a point, after which it becomes a drag on 
growth.  For  private  credit  extended  by  banks, 
the turning point is closer to 90% of GDP, lower 
than for market-based credit.  
The  sensitivity  of  economic  development  to 
changes  in  bank  development  decreases  with 
economic  development.  The  sensitivity  of 
economic  development  to  changes  in  securities 
increases  as  countries  grow.  The 
market 
demand  for  the  services  provided  by  securities 
markets  increases  relative  to  the  demand  for 
services  provided  by  banks  as  economies 
develop.  
Bank  bias  is  negatively  correlated  with  GDP 
growth,  such  that  an  increase  in  the  size  of  the 
banking  sector  relative  to  stock  and  bond 
market  capitalization  is  associated  with  lower 
GDP growth.  
The composition of finance matters for growth. 
Credit  expansion  to  the  private  sector  slows 
growth  in  most  OECD  countries,  but  greater 
stock  market  capitalisation  exhibits  a  highly 
significant link with stronger GDP growth. 

35 The result are corroborated and extended by other studies including Beck, Levine and Loayza (2000) 

and Demirgüç-Kunt and Levine (2001). 

36  A  similar  hump-shaped  relationship  between  financial  deepening  and  economic  growth  is  found  by: 

Cecchetti and Kharroubi (2012), Beck et al. (2014) and Law and Singh (2014). 

19 

 
 
                                                 
Box 1: CMU, transaction costs and the theory of the firm 

A  number  of  theoretical  approaches  discussed  the  role  of  banks  versus  markets  in  the 
intermediation of savings to investments. The debate roots in a wider theory about the role 
of  firms  and  markets  in  economics  with  the  key  initial  contribution  by  Coase  (1937).  He 
recognised  that  the  use  of  markets  is  not  costless  and  in  some  cases  transaction  costs  are 
lower  if  exchange  is  organised  within  firms.  These  transaction  costs  include  search  and 
information  costs,  bargaining  and  decision  costs,  and  monitoring  and  enforcement  costs. 
New  institutional  economics,  for  example  Williamson  (1985)  used  the  concept  of 
transaction costs to explain the existence of institutions.  

Transaction costs are particularly important for credit contracts beause the lender needs to 
be sure that the borrower pays back, but the former has an information disadvantage with 
respect to the choices the borrower may take, opening scope for moral hazard of the latter. 
Banks  can  ease  the  impact  of  information  asymmetries  and  thus  help  reduce  transaction 
costs  in  financial  exchanges.  For  example,  Leland  and  Pyle  (1977)  formally  show  that  a 
bank  can  communicate  information  to  investors  about  potential  borrowers  at  a  lower  cost 
than individual borrowers. In their model, intermediaries can solve moral hazard problems 
by monitoring the actions of firms. Diamond (1984) shows that the costs of monitoring and 
enforcing debt contracts issued directly to investors is the reason why raising funds through 
an intermediary, acting as a delegated monitor, can be superior. 

Overall,  the  theory  postulates  that  financial  intermediaries  play  an  important  role  in 
reducing  information  and  transaction  costs  arising  from  information  asymmetries,  even  if 
their existence does not replicate the credit market outcomes that would occur under a full 
information environment. A further optimisation of information structures and determinants 
of information costs and other transaction costs will further help overcome credit frictions. 

Relative advantages of bank-based and market-based funding systems 

Those  arguing  for  the  superiority  of  bank-based  financial  systems  emphasise  the 
advantages of banks in information gathering and relationship formation, as well 
as  in  financing  standardized,  lower-risk  and  well-collateralised  projects.37  Given 
the economies of scale and scope in information gathering and processing, banks are in 
a better position than capital markets to address the inherent agency problems between 
debtors and creditors. A large literature has been devoted to understanding the special 
role  played  by  banks  in  acquiring  information  about  borrowers  and  in  mitigating 
asymmetric  information  problems.38  The  long-term  relationship  with  a  bank  allows  a 
firm to develop a reputation for good creditworthiness and ultimately to access finance 
at  a  lower  cost  (the  "certification  effect").  Even  if  other  agents  (such  as  credit  rating 
agencies) may assume a similar function, it is argued that banks have an advantage in 
this regard due to the special knowledge they acquire from performing complementary 
functions  on  a  large  scale  (e.g.  account  keeping  of  borrowers,  provision  of  payment 
instruments).  Market-based  systems  are  more  transparent  as  they  reveal  information 
publicly, thereby reducing incentives for investors to seek and acquire information.39 As 

37   See, for example, Grossman and Hart (1980), Stiglitz (1985), Boyd and Prescott (1986), Singh (1997), 

Allen and Gale (2000), Beck and Levine (2002). 
38   See Leyland and Pyle (1977) and Diamond (1991). 
39   For  example,  there  is  evidence  that  bond  holders  largely  limit  their  monitoring  efforts  to  the 

observation of equity price movements. 

20 

 
                                                 
a  result,  information  asymmetries  related  to  the  debtor-creditor  relationship  are  more 
accentuated in market-based than in bank-based structures. 

Proponents  of  market-based  systems  point  to  the  strength  of  capital  markets  in 
providing  services  to  finance  novel,  longer-duration  and  high-risk  projects.40  It  is 
also  often  pointed  out  that  non-bank  finance  is  generally  more  flexible  than  bank 
finance  (e.g.  as  regards  repayment  schedules  or  providing  finance  based  on  expected 
future  earnings).  Therefore,  by  not  merely  substituting  for  investment  that  was 
previously funded by banks, but enabling additional investment that banks would not be 
ready  to  fund,  capital  markets  enlarge  the  potential  investor  base.  This  is  possible 
because  capital  markets  treat  risk  differently  from  banks.  While  banks  do  not  only 
intermediate between depositors and borrowers but also typically take up themselves a 
major  part  of  the  risk,  capital  markets  bring  investors  and  those  in  need  of  funding 
directly  together,  transferring  a  higher  share  of  the  risk  to  investors.  Dividing 
investment  opportunities  into  numerous  small-denomination  securities  allows  capital 
markets to create a  diverse  menu of investment  options at higher  or  lower risk,  short-
term  or  long-term,  and  allocate  those  according  to  investor  type.  Consequently,  even 
risky  projects  get  matched  with  appropriate  investor  types  and  so  find  the  needed 
funding.  The  described  process  facilitates  direct  financial  interactions  between 
households, corporations, banks and governments, thereby filling in gaps where banks 
are constrained to lend.  

Banks  and  capital  markets  have  a  differential  impact  on  incentive  formation 
through  various  channels.  First,  as  they  are  decentralised  and  more  diversified  by 
nature,  market-based  systems  are  considered  less  susceptible  to  the  development  of 
monopoly  and  oligopoly  powers.  In  such  a  scenario  of  collusion  between  a  bank  and 
firm managers against other creditors, high-collateral and low-productivity projects may 
be fostered, crowding out productive resources from the economy. In such a situation, 
the development of capital markets could provide additional disciplining forces to credit 
decisions  and  thereby  increase  the  efficiency  of  asset  allocation.  Second,  economic 
theory postulates that well-functioning capital markets can act as a disciplining device 
on  managers  and  thereby  enhance  corporate  governance.41  In  banking,  corporate 
governance is complicated by the existence of deposit guarantee schemes, lender of last 
resort  facilities,  and  potential  state  implicit  subsidies.  The  introduction  of  the  Bank 
Recovery  and  Resolution  Directive  and  the  Banking  Union  package  should  reduce 
perceived implicit and explicit public guarantees for banks. Studies examining the role 
of  market  takeovers  as  corporate  control  devices  also  conclude  in  favour  of  market-
based  financial  systems.  The  threat  of  an  acquisition,  which  is  easier  to  realise  with 
well-developed  stock  markets,  helps  align  managerial  incentives  with  those  of  the 
owners. 

40   See,  for  example,  Jacklin  (1987),  Rajan  (1992),  Holmstrom  and  Tirole  (1993),  Dewatripont  and 
Maskin (1995), Acemoglu and Zilibotti (1997), Levine (1997), Allen and Gale (1997, 1999), Boot and 
Thakor (1997, 2000), Weinstein and Yafeh (1998), Wenger and Kaserer (1998), Levine (2002). 
41   See, for example, Jensen and Meckling (1976), Diamond and Verrecchia (1982), Stein (1988). 

21 

 
                                                 
Competition or complementary? 

The  conventional  “bank  versus  market”  dichotomy  suggests  that  the  two 
components are in clear competition.42 If true, the development of the two would be a 
zero-sum game and each segment would develop at the expense of the other. But more 
recent  studies  propose  an  integrated  theoretical  framework,  where  banks  and  capital 
markets not only compete for servicing a limited pool of investment projects, but also 
co-evolve.  Complementarities  between  banks  and  capital  markets  are  becoming  more 
and  more  apparent,  broadening  the  set  of financing  sources  the  ultimate  borrower  can 
choose  from.43  Bank  and  market  funding  offer  different  mechanisms  to  overcome 
information problems such as adverse selection and moral hazard. The banks' capacity 
to  select  and  monitor  credit  risk  can  also  be  separated  from  the  provision  of  funding. 
Such  complementarities  are  easy  to  notice  in  scenarios  where  a  firm  is  contemplating 
either  bonds  issuance  or  bank  credit.  No  matter  which  financial  instrument  is  chosen, 
both  banking  and  non-banking  financial  institutions  may  get  directly  or  indirectly 
involved  in  the  transaction,  i.e.  banks  manage  the  issuance  of  bonds  on  behalf  of  the 
firm,  or  if  they  provide  funding  in  form  of  a  loan  resell  it  on  the  market  as  part  of  a 
securitised product.  

Box 2: Information frictions and incentives for long-term investments 

In  microeconomic  analysis,  financial  issues  are  predominantly  driven  by  information 
frictions,  such  as  asymmetric  information  (see  also  Box  4)  between  creditor  and  debtor 
before  agreeing  on  a  contract  or  incentives  to  exploit  leeway  left  open  in  the  contractual 
terms  to  their  advantage  later  on  (moral  hazard).  Banks  and  markets  offer  means  to  deal 
with different information frictions. Markets help to deal with diverse opinions. They imply 
interaction  among  many  actors,  who may  have  very  different  views,  and  the  price  can  be 
seen as a mechanism to aggregate diverse information. The interaction also allows suppliers 
of  exotic  goods  to  find  buyers.  The  economic  function  of  competition  on  capital  markets 
among buyers and sellers is hence not limited to the discovery of market clearing prices for 
financial assets, but also to detect innovative firms and products. Conversely, involvement 
of  banks  has  advantages  over  market  funding  in  the  unearthing  of  information  if  the 
evaluation  of  the  credit  risk  is  complex  and  requires  the  creditor  to  build  up  special 
expertise.  Moreover,  getting  financial  support  from  a  bank  often  means  building  a  long-
term customer relationship, which can be useful in case of information frictions and when 
one needs to monitor and control the borrower.  

While financial support from a bank to a debtor may facilitate the establishment of a long-
term  financing  relationship,  market  financing  must  not  necessarily  be  more  short-term.  A 
number  of  institutional  investors,  such  as  insurance  companies  and  pension  funds,  have 
long-term liabilities and should therefore be natural long-term investors. The Kay Review 
(2012)  demonstrated  that  short-termism  is  an  issue  in  the  asset  management  industry.44 
Behind this are governance and information problems that are more related to how capital 
markets are organised in practice than with the principle of market transactions.  

42   See Boot and Thakor (1997), Allen and Gale (1997), and Dewatripont and Maskin (1995). 
43   See Song and Thakor (2010).  
44   See Kay Review (2012). 

22 

 
                                                 
The relationship between ultimate savers and institutional investors is subject to principle-
agent problems that can  give rise to a myopic behaviour of the latter. For example, if  the 
ultimate  holders  of  investments  use  short-term  performance  indicators  to  monitor  asset 
managers or formulate short-term targets in investment mandates, then asset managers have 
an  incentive  to  favor  short-term  profits  over  long-term  profitability.  This  effect  will  be 
augmented  if  part  of  the  managers'  remuneration  depends  on  short-term  performance 
indicators.  The  Kay  Review  recommended  discouraging  the  use  of  measures  and  models 
that rely on short-term volatility of returns and deviations from indexes when deciding on 
the  remuneration  of  asset  managers.  A  better  alignment  of  long-term  interests  between 
institutional  investors  and  asset  managers  would  contribute  to  a  longer-term  focus  in 
investment  strategies,  notably  taking  into  consideration  risks  and  opportunities  associated 
with challenges related to the environment, climate change and the energy sector. It could 
also  lead  to  more  investment  into  equity,  as  "perpetual"  equity  is  considered  to  better 
support the financing of long-term investment. 

Myopic investment horizons may also be the result of information limitations. While there 
is  a  wealth  of  data  available  to  support  investment  decisions,  its  translation  into  relevant 
information is often not straightforward. Using price signals or other investors' decisions as 
proxies  for  own  information  gathering  efforts  bears  the  risk  of  herd  behaviour  and 
procyclicality  on  capital  markets.  The  Kay  Review  recommended  that  the  regulatory 
framework enables "companies, savers and intermediaries to adopt investment approaches 
which  achieve  long-term  returns  by  supporting  and  challenging  corporate  decisions  in 
pursuit of long-term value." Long-term investment is subject to long-term risks, for example 
climate  change  could  significanty  erode  the  value  of  some  financial  assets.  Therefore, 
decision-making would also benefit from the disclosure and reporting of environmental and 
climate,  social  and  governance  (ESG)  risk  exposures.45  Integration  of  ESG  issues  in 
investment  strategies,  besides  supporting  climate  friendly  and  sustainable  investment 
opportunities,  can  contribute  to  investors'  protection  against  long-term  risks,  in  line  with 
asset managers' fiduciary duties.46 

There are many areas where markets and banks offer complementary information 
and  funding  services,  among  them:  (i) issuance  of  bonds,  where  banks  provide  a 
number of advisory and administrative services for the issuer; (ii) securitisation, where 
banks  focus  on  credit  analysis  and  markets  focus  on  financing;  and  (iii)  bank  capital, 
where capital markets reduce the financing friction by lowering banks’ cost of equity, 
and enable banks to raise additional equity to expand their lending scope. At the same 
time,  banks'  expansion  and  improvement  in  credit  analysis  tend  to  boost  investors' 
confidence, encourage investor participation in capital markets and spur capital markets 
evolution. Both the banking and capital markets' channels lead to feedback loops where 
each of the two components of the financial system benefits from the development of 
the other. 

The  shift  of  banks  from  their  traditional  relationship-oriented  business  model 
towards  a  more  transaction-oriented  business  model  over  the  last  decades 
underscores  the  strong  links  between  banks  and  capital  markets.  Until  1980, 
banking  was  predominantly  based  on  long-term  relationships  with  bank  customers: 
loans  were  granted  to  households  and  firms  for  a  long  term  and  were  kept  on  the 

45   See also Box 5 and Box 7. 
46   See UNEP (2015). 

23 

 
                                                 
balance sheet for their entire duration. The interests of the bank and the customer were 
thus clearly aligned as bank performance was closely related to the performance of its 
customers.  The  return  on  equity  in  this  period  was  relatively  modest  but  stable  and 
balance  sheets  grew  moderately  with  respect  to  the  growth  of  the  economy.47  As  of 
1980,  however,  and  even  more  so  as  of  2000  in  the  run-up  to  the  crisis,  transaction-
oriented  banking  became  prominent,  putting  a  larger  focus  on  the  short  term.  Banks' 
balance  sheets  expanded  rapidly  following  innovations  such  as  securitisation  and 
returns  on  equity  increased,  leading  to  a  lengthening  of  the  intermediation  chain48  (in 
which banks start to play different and increasingly important roles). 

In  conclusion,  the  recent  economic  theory  emphasises  the  desirability  of  well-
developed  capital  markets  but  pays  less  attention  to  the  respective  importance  of 
capital  market  and  bank  funding.  The  distinction  between  bank-based  and  market-
based  financial  systems  seems  to  be  fading  while  greater  emphasis  is  put  on  their 
complementarity. Quite simply, it turns out that banks and capital markets are two vital 
components of the financial system, not competing but complementing each other and 
co-evolving. 

2.2.  Historical,  legal  and  economic  structures  as  barriers  for  capital  markets 

development 

Financial  structures  do  not  evolve  independently  from  historical,  legal  and 
economic structures. This section investigates factors that seem to have led to a bank-
dominated  financial  system  in  the  EU.  The  comparison  with  the  more  market-based 
system  in  the  US  suggests  that  some  of  these  factors  are  exogenous  at  first  sight: 
different historical starting conditions, as well as differences in legal system and type of 
pension systems, for instance. In the EU, they shape firms' preferences for bank loans as 
they are more used to relationship based services as to transaction based services. And 
they give reason to households' incentive to save in bank deposits, which are considered 
safe  as  protected  by  public  guarantees,  most  apparent  in  deposit  guarantee  schemes. 
While these factors limit the scope for the EU financial structure to converge to the US 
financial  structure,  they  must  not  mean  that  the  contribution  of  capital  markets  to 
economic  activity  has  no  potential  to  develop,  especially  when  legal  determinants  are 
made  more  supportive  to  market  funding.  In  the  end,  legal,  economic  and  financial 
structures are mutually dependent on each other. 

Differences in legal systems have been an important factor in the development of 
financial  systems.  Using  various  indicators  of  legal  differences  across  countries, 
studies  found  that  legal  origin  (US-English  common  law,  French-Latin  civil  law, 
German,  Scandinavian)  and  especially  variables  that  cover  investor  protection  are 
having  a  significant  influence  on  the  size  and  structure  of  financial  systems.49  Capital 
markets  are  more  developed  in  countries  with  a  common  law  tradition  and/or  where 
rules that protect borrowers from expropriation by creditors and controlling owners and 

47   The ratio of the aggregate bank balance sheet expressed as a percentage of GDP remained relatively 

stable at 70% of GDP in the period 1880-1980. 

48   See Adrian and Shin (2008, 2010). 
49   See La Porta et al. (1997), Levine et al. (2000). 

24 

 
                                                 
enforcement  of  legal  rules  are  stronger.  The  World  Bank's  Doing  Business  Report 
provides  indicators  of  business  regulations  in  189  economies  including  almost  all  EU 
Member  States. The report shows that the scoring of  Member States  is  very different. 
National  performances  widely  differ  in  terms  of  business  information  disclosure, 
conflicts  of  interests,  corporate  transparency,  minority  investor  protection,  tax  rates, 
recovery rates, contract enforcement costs, strength of insolvency frameworks, length of 
resolving  insolvency,  etc.  Interestingly,  some  new  Member  States  with  still  small 
capital markets are well placed with respect to some of the legal determinants that are 
favourable  to  capital  market  developments:  Bulgaria,  Cyprus  and  Slovenia  are  in  the 
global top 20 with respect to the World Bank's protecting minority investors index, as 
are  Lithuania  and  Latvia  with  respect  to  the  enforcing  contracts  index.  Over  time, 
internationalisation  of  financial  markets  and  convergence  of  legal  rules  that  govern 
financial  activity  at  an  international  and  EU  levels  should  lead  differences  in  national 
financial systems to dissipate. 

Chart 8: Member States' position in World Banks' indicators of legal determinants  
(lower rank means better performance) 

 Source: World Bank.  

Starting  conditions  have  shaped  differences  in  financial  structures  and  may 
explain  why  capital  markets  took  different  sizes.  Economic  research  on  the  role  of 
historical  factors  in  explaining  economic  institutions  stipulates  that  starting  conditions 
can be essential and may determine the path of economic development over long time.50 
Since  institutions  change  slowly,  there  is  scope  for  inertia,  i.e.  economic  structures 
reflect historical conditions, but may no longer be ideal with a view to current ones. A 
number of observations are consistent with the hypothesis that structural differences in 
the  EU  and  the  US  financial  system  could  be  caused  by  different  starting  positions: 
prior  to  industrialisation,  merchant  banks  had  an  important  role  in  financing  cross-
border  trade  in  Europe  and  were  established  financial  institutions.  Since  the  late  18th 
century, savings banks have popularised bank accounts as means for ordinary household 

50   See North (1990). 

25 

 
 
 
                                                 
to store financial wealth. The significant role of banks may have reduced the need and 
interest to develop capital markets in many European countries. In the US, banks came 
into existence only at the end of the 18th century.51 The need to attract foreign investors 
to  fund  high  US  public  debt  in  the  early  19th  century  seems  to  have  fostered  the 
development of securities markets in the US early on. 

Historical  disasters  deepened  differences  in  financial  developments  in  the  20th 
century. While starting conditions for the development of the financial structures have 
been  different  in  Europe  and  the  US,  there  were  also  a  number  of  events  in  the  20th 
century that are often quoted to explain why capital markets are more developed in the 
US.  Thriving  economic  growth  fuelled  demand  for  market  funding  from  the  late  19th 
century  in  the  US,  and  the  Great  Depression  led  the  country  to  initiate  a  package  of 
financial  reforms  that  seemed  to  have  discouraged  banking  activity,  possibly  to  the 
advantage of capital markets. For example, the Glass-Steagall Act separated investment 
and  commercial  banking  in  1931.  The  Bank  Holding  Company  Act  of  1956  impeded 
inter-state banking.52 Meanwhile, in Europe, the accumulation of financial capital was 
interrupted  by  World  War  I  and  hyperinflation  in  some  countries.  Private  financial 
wealth  evaporated  in  many  European  countries  and  substantially  reduced  the  stock  of 
capital  available  to  be  allocated  on  capital  markets.53  After  World  War  II,  many 
European countries rebuilt their pension system by establishing a pay-as-you-go system, 
whereas pension funds became an important provider of funds on the US capital market. 
This  led  to  significant  differences  in  the  amount  of  savings  made  available  for 
investment in financial securities. Still nowadays, countries with an important pension 
funds sector tend to have larger capital markets.54  

Several major policy initiatives have paved the way to greater financial integration 
in  the  EU.  The  Treaty  of  Rome  enshrined  the  freedom  of  movement  of  capital  and 
freedom  of  cross-border  services  in  1957.  However,  decisive  steps  towards  the 
integration of EU financial markets were taken only by the mid-1980s with the adoption 
of a White Paper on the completion of the internal market. The launch of the euro and 
the Financial Services Action Plan were major milestones in this integration process in 
1999.  They  aimed  at  tackling  obstacles  to  integration  stemming  from  currency  and 
regulatory segmentation.55 Following the EMU and the FSAP, conditions were in place 
for  a  greater  consolidation  and  internationalisation  of  the  EU  banking  sector.  Mergers 
and  acquisitions  activity  intensified,  first  among  domestic  institutions  and  then  across 
borders. Western European banks notably acquired market share in most of the Central 
and  Eastern  European  Member  States.  As  a  result  of  their  expansion  within  Europe, 

51   Calomiris  and  Haber  (2014)  provides  a  historical  overview  of  banking  since  the  18th  century  in  a 

number of countries (the UK, France, the US, Canada, Germany, etc.).  

52   Both were subsequently removed, the former through the Gramm-Leach-Bliley Act in 1999 and the 

latter with the Riegle-Neal Act in 1994. 

53   Picketty (2014) demonstrated that wealth-holding population encountered sizeable losses in the first 

half of the 20th century in Germany and France. 

54   See, for example, Rocholl and Niggemann (2010), Meng and Pfau (2010). 
55   The  Financial  Services  Action  Plan  contained  a  package  of  42  regulatory  measures  (24  legislative) 
geared  towards  achieving  the  following  three  strategic  objectives:  (i)  a  single  market  for  wholesale 
financial  services,  (ii)  open  and  secure  retail  markets,  and  (iii)  state-of-the-art  prudential  rules  and 
supervision. 

26 

 
                                                 
European banks were, by 2007, significantly more internationalised than US, Japanese 
or  Chinese  banks.  Meanwhile,  capital  market  infrastructures  remained  geographically 
more fragmented. They provide the technical habitat for trading, clearing and settlement 
operations  (see  Section 5.4).  Transparency,  liquidity,  price  formation,  information 
disclosure  and  data  collection  capabilities  crucially  depend  on  the  existing  market 
infrastructures.  In 
trading  systems  and  platforms  without 
interconnections have formed an obstacle to more efficient price formation mechanisms 
and to the availability of standardised data, notably in debt markets.  

the  EU,  different 

The economic effect of global financial integration materialised across EU Member 
States in different forms. Most visible has been the rise of financial centres in some, 
mainly larger Member States with more developed capital markets. Member States with 
a less developed financial system had large scope to catch up, but this materialised less 
in  the  form  of  strong  growth  of  the  country's  financial  industry.  Instead,  companies 
benefitted from remote access to capital markets in other Member States, for example 
through  corporates  issuing  stocks  on  foreign  stock  exchanges.  Convergence  of 
framework conditions also allowed foreign investors to access smaller capital markets, 
for  example  foreign  venture  capital  funds  to  invest  in  small  firms  in  small  Member 
States  with  less  developed  domestic  capital  markets.  However,  this  effect  has  been  of 
lesser importance for reasons set out at different places in this document. 

In  conclusion,  underdeveloped  capital  markets  may  have  been  the  cause  of 
reigning legal structures and historical development, and also reflect institutional 
inertia.  Since  banks  were  dominant  providers  of  finance,  the  need  to  develop  legal 
conditions  supportive  to  capital  markets  as  a  complement  was  less  pressing.  Hence, 
strengthening  the  rights  of  investors  or  minority  shareholders  was  a  lower  priority 
because  capital  market  instruments  were  underused.  There  is  likely  a  self-reinforcing 
process between economic and financial structures: industries that are better served by 
bank funding, such as established firms with capital-intensive production and collateral 
tend  to  flourish  more  in  bank-dominated  financial  systems,  which  results  in  a  bias  in 
industrial structures towards bank-dependent firms and more demand for bank services 
than for market funding.  

2.3 Financial stability and macro-prudential policy oversight for a stronger CMU 

Financial stability is a pre-requisite for delivering sustainable growth and jobs in 
the  EU.  Episodes  of  financial  instability  have  historically  been  associated  with 
considerable  economic  costs56,  and  the  global  financial  crisis  revealed  that  a  stable 
financial  system  is  necessary  for  delivering  sustainable  growth.  To  this  end,  the  EU's 
legal  and  institutional  framework  of  financial  regulation  has  been  extensively 
recalibrated in recent years so as to ensure that the financial system is more resilient to 
shocks. Important financial reforms introduced enhanced prudential regulation of capital 
and  liquidity  requirements  for  banks,  reflecting  the  need  for  stronger  oversight  of 
deposit-taking institutions and systemic banks. 

56   The  economic  effects  of  systemic  banking  crises  have  been  extensively  analysed  by  Laeven  and 

Valencia (2008, 2010, 2012).  

27 

 
                                                 
including 

finance  – 

for  market-based 

The CMU should help to enhance financial stability in the EU by promoting more 
diversified funding channels to the wider economy. In doing so, it will help address 
possible  future  risks  stemming  from  a  strong  reliance  on  bank  lending  and 
intermediation in the financial system. Given the central role of banks in the financial 
system 
risk, 
facilitators/intermediaries,  as  well  as  investors  –  the  already  undertaken  financial 
reforms  will  have  important  positive  effects  for  financial  stability  under  the  CMU. 
Additional  macro-financial  stabilising  effects  are  expected  to  materialise  as  a 
consequence of the availability of broader sources of funding for productive investment 
in the EU, helping to avoid constraints to the supply of credit to the economy similar to 
those  that  emerged  during  the  crisis  amid  strong  bank  deleveraging  pressures.  This 
highlights  the  complementarity  of  direct  and  indirect  credit  intermediation  under  the 
CMU, with positive effects stemming from the availability of more diversified sources 
of  debt  and  equity  finance  for  borrowers  in  the  EU,  greater  risk-sharing  and  a  more 
sustainable and smoother credit supply through the cycle. 

as  originators  of 

At the same time, it is important to ensure that the further development of capital 
markets  does  not  allow  other  systemic  vulnerabilities  to  accumulate  unchecked. 
While the banking business is, due to maturity transformation and its role in the money 
creation  process  and  in  the  payment  system,  subject  to  potential  systemic  risks,  non-
bank  financial  institutions  can  also  be  vulnerable  to  runs,  which  may  lead  to 
considerable  financial  losses  for  their  shareholders,  debtors  or  other  counterparts.  A 
more  market-based  financial  system,  involving  increased  direct  investor  exposures  to 
risk,  could  be  more  vulnerable  to  episodes  of  volatility.  In  the  event  of  a  sudden  re-
pricing  of  risk,  contagion  can  propagate  across  markets  and  financial  institutions 
through balance sheet and collateral channels.57 A higher exposure of financial market 
participants to volatility in market prices, for example, can feed into higher risk premia 
and thus lead to increases in the cost of capital for companies and financial losses for 
households. Thus, financial instability can adversely affect economic activity even when 
it does not result in systemic shocks. 

Two sources of potential systemic vulnerability can be identified in a more market-
interconnectedness  and  growing 
based  financial  system:  possibly  greater 
intermediation  by  entities  outside  the  regulatory  perimeter.  First,  while  well-
functioning  markets  support  risk-sharing  in  the  economy,  the  price  discovery  process 
also  entails  externalities  for  other  holders  of  the  same  type  of  asset.  Greater 
interconnectedness  can  lead  to  higher  asset  price  correlations,  which  can  reduce 
portfolio diversification benefits for investors. These effects can create a vicious cycle 
in  times  of  broad-based  sell-offs  in  markets  with  potential  systemic  implications.  A 
second  potential  source  of  vulnerability  is  that  activities  gradually  shift  from  more 
closely supervised and/or strongly regulated areas to less supervised and regulated ones. 
This could be conducive to a situation in which the ultimate risk-takers are taking more 
risks than they can eventually bear. Against this background, concerns have been voiced 
that  the  CMU  project  might  lead  to  a  further  risk  transfer  from  the  more  heavily 

57   By contrast, indirect intermediation via a well-capitalised banking system that also benefits from high 
liquidity buffers, access to central bank liquidity and deposit protection schemes, can be less exposed 
to these risks. 

28 

 
                                                 
regulated  banking  sector  to  less  regulated  areas,  commonly  referred  to  by  the  terms 
'shadow banking', and more recently, market-based finance. 

The  European  Commission  approach  to  market-based  finance  is  to  deliver 
transparent  and  resilient  market-based  financing  while  tackling  major  financial 
risks.  The  financial  reforms  already  put  in  place,  such  as  the  introduction  of  an  EU 
regulatory  framework  for  alternative  investment  funds,  including  hedge  funds  and 
private equity in the Alternative Investment Fund Managers Directive58, are important 
in this respect. Furthermore, and in line with the FSB's 2013 recommendation to address 
the risks inherent to securities lending and repurchase agreements, the recently agreed 
Securities  Financing  Transactions  regulation59  will  ensure 
the  necessary 
information  on  these  transactions  is  reported  to  trade  repositories  and  investors  in 
collective investment undertakings. 

that 

The development of the CMU should be accompanied by appropriate oversight for 
the  financial  system  as  a  whole.  In  recent  years  substantial  efforts  have  been 
undertaken at European and global levels to define, monitor and regulate market-based 
finance activities  and  the  entities  engaged in them. As the CMU takes shape, analysis 
will  be  undertaken  to  determine  the  continued  appropriateness  of  measures  and 
instruments  available  to  address  possible  macro-prudential  risks  stemming  from  more 
market-based finance. In that regard, work is already ongoing internally in the European 
Commission and within the European Systemic Risk Board to assess issues concerning 
market  liquidity  and  interconnectedness  within  the  financial  system,  and  certain 
intermediation  activities  undertaken  by  non-banks.  Given  the  strong  inter-linkages 
within  financial  markets  and  across  sectors,  micro-prudential  supervision  seems  not 
sufficient.  The  main  objective  of  the  essential  complementary  macro-prudential 
oversight is to identify potential weaknesses in the structure and/or the cyclical dynamic 
of  the  system,  and  address  them  through  well-targeted  instruments  and  policy  actions 
where necessary and justified.60 

In  addition  to  strong  micro-  and  macro-prudential  supervision  and  oversight,  a 
well-functioning  CMU  requires  appropriate  consumer  and  investor  protection 
rules.  A  more  market-based  financial  system  relies  on  greater  participation  by  both 
institutional and retail investors and necessitates that the ultimate risk-bearers are well 
equipped  to  independently  evaluate  and  price  risk.  While  this  is  equally  relevant  for 
individual  and  institutional  investors,  retail  investors  face  particular  difficulties  in 

58   Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative 
Investment  Fund  Managers  and  amending  Directives  2003/41/EC  and  2009/65/EC  and  Regulations 
(EC) No 1060/2009 and (EU) No 1095/2010 

59   Commission  Proposal  for  a  Regulation  of the  European Parliament  and  of  the  Council  on  reporting 
and  transparency  of  securities  financing  transactions.  An  agreement  between  the  Commission,  the 
European Parliament and the Council on the final text was reached in June 2015. The formal adoption 
is expected later in 2015. 

60   Macro-prudential  oversight  and  policy  is  used  to  analyse  and  address  sectoral  and/or  systemic  risks 
from two main perspectives: (i) the cyclical dynamics in the risk profile of the system linked to the 
macro-economic  environment;  and  (ii)  the  interconnectedness  of  different  parts  of  the  financial 
system.  Against  this  background,  macro-prudential  policy  tools  allow  for  the  discretionary  use  of 
micro-prudential instruments (e.g. capital buffers and/or liquidity requirements for individual financial 
institutions) on a sectoral or system-wide level. 

29 

 
                                                 
assessing risks and making informed investment decisions, given the associated cost in 
assessing  some  partly  opaque  and  complex  financial  products.  An  important  cause 
behind  this  are  information  asymmetries  in  favour  of  originators  and  distributors, 
rendering  the  full  utility  or  return  from  these  products  difficult  for  consumers  to 
ascertain  until  their  final  maturity  (so-called  'credence  goods').61  Thus,  appropriate 
investor  protection    is  needed  for  enhancing  and  sustaining  consumer  and  investor 
confidence. The European Securities and Markets Authority (ESMA) and the European 
Insurance  and  Occupational  Pensions  Authority  (EIOPA)  have  already  been  given 
increased powers on investor protection through MiFID II62, PRIIPS63, the Short selling 
Regulation64 and other legislative acts.  

61   See De Manuel and Lannoo (2012). 
62   Regulation  (EU)  No 600/2014  of  the  European  Parliament  and  of  the  Council  of  15 May  2014  on 
markets in financial instruments and amending Regulation (EU) No 648/2012 - Directive 2014/65/EU 
of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments 
and amending Directive 2002/92/EC and Directive 2011/61/EU 

63   Regulation (EU) No 1286/2014 of the European Parliament and of the Council of 26 November 2014 
on key information documents for packaged retail and insurance-based investment products (PRIIPs) 
64   Regulation (EU) No 236/2012 of the European Parliament and of the Council of 14 March 2012 on 

short selling and certain aspects of credit default swaps 

30 

 
                                                 
Chapter 3  FINANCING NEEDS BY THE EUROPEAN CORPORATE SECTOR 

AND INFRASTRUCTURE  

This chapter analyses the financing needs of European firms and infrastructures. Section 
3.1  describes  ways  in  which  these  needs  can  be  filled  and  lists  the  company's 
characteristics  that  determine  its  access  to  funding.  Section  3.2  focuses  on  the 
particularities  of  SMEs,  which  are  important  for  the  European  economy  but  face 
considerable funding restrictions. Section 3.3 explains the consequences stemming from 
the lack of verifiable information about SMEs and from the limited financial knowledge 
by  SMEs.  Barriers  preventing  companies  from  going  public,  such  as  high  costs  and 
insufficient  investment  research  coverage,  are  discussed  in  Section  3.4.  Private 
placements  are  shown  as  a  useful  supplement  and  gateway  towards  public  corporate 
bond  issuance.  Section  3.5  analyses  various  corporate  liability  structures  and  explains 
risks stemming from excessive company indebtedness. The specificity of infrastructure 
investment and related funding problems are described in Section 3.6. 

3.1 Theory on businesses' access to funding 

In  order  to  develop  their  business  and  grow,  companies  get  finance  through 
internal  or  external  funding.    The  latter  term  is  used  to  describe  funds  that  firms 
obtain  from  outside  of  the  firm,  such  as  debt  or  equity  issues,  contrary  to  internal 
financing which consists mainly of initial own resources and profits retained by the firm 
for investment. The pioneering work by Modigliani and Miller (1958) suggests that the 
capital structure of a company has no impact on its value when markets are perfect and 
frictionless.  However,  many  capital  markets  are  characterised  by 
information 
asymmetries,  and  studies  show  that  capital  market  imperfections  make  financing 
decisions relevant. For a given level of risk, external financing is typically more costly 
than  internal  financing  due  to  the  additional  transaction  costs  and  a  premium,  which 
compensates  outside  investors  for  the  lack  of  knowledge  of  a  company’s  true 
creditworthiness or prospects.65 In consequence, firms financing decisions are strongly 
determined  by  information  problems.  In  corporate  finance,  the  pecking  order  theory 
highlights the role of asymmetric information in determining the cost of financing.  

As  depicted  in  the  funding  escalator  model  of  corporate  finance,  a  company's 
financing needs depend on various factors. In particular, variables such as its stage of 
development,  growth  objectives,  innovativeness,  sector  of  operation,  and  attitudes 
towards  risk  determine  its  financing  needs.66  In  the  start-up  phase,  a  company  needs 
money  to  develop  its  business  idea.  Given  the  typical  absence  of  retained  earnings  at 
this stage, the firm primarily sources funding externally, often from friends and family 
members for small companies. Although retained earnings increase when a company is 
successful and grows, a firm's external financing stays typically high in the growth stage 
with  the  main  sources  being  bank  funding,  peer-to-business  lending  and/or  private 
equity (especially in the form of venture capital). Once the firm enters the mature stage, 
financing structures adjust to the pace of earnings, a firm's growth and the collateral at 
disposal. At a certain point, the company may decide to go public, offering its stock to 

65   See Myers and Majluf (1984). 
66   See Churchill and Lewis (1983). 

31 

 
                                                 
the general public on a security exchange as a means of equity financing and/or issuing 
bonds.  Finally,  in  a  declining  phase,  once  new  projects  become  scarce,  funding  needs 
become lower. If a firm cannot or does not want to put all retained earnings to profitable 
productive  use,  it  may  decide  to  buy  back  its  debt  or  equity.  While  the  exact  funding 
needs  differ  across  a  company's  lifecycle,  external  funding  features  prominently  in  all 
stages  of  a  firm's  development  either  for  basic  maintenance  or  for  investment  and 
growth.  

Figure 3: The funding escalator of corporate finance 

Source: European Commission. 

Chart 9:Sources of funding used by NFCs (financial liabilities), EU 28, 2014, EUR billion 

Companies  face  financing  constraints.67  These  constraints  affect  firms'  investment 
decisions and growth prospects, and need to be addressed by appropriate policy action. 

67   Other equity includes non-listed shares, retained earnins and other forms of internal resources. 
67   See ECB Bank Lending Surveys. 

32 

 
 
 
 
                                                 
Among other factors, the weak macroeconomic environment has caused corrections in 
financial  markets  and  restricted  the  availability  of  external  funding.68  The  global 
financial  crisis,  followed  by  the  euro  area  sovereign  debt  crisis,  affected  European 
businesses via multiple economic and financial channels and led to a global recession. 
But the negative effects have been uneven across countries, sectors and companies.  

Both a company's characteristics and external factors are important determinants 
of  its  access  to  financing.  The  funding  escalator  model  already  highlighted  the 
importance of the company’s stage of development. It is also harder to access finance 
for  firms  operating  in  countries  whose  regulatory  environment  is  considered  risky, 
burdensome  or  overly  expensive  due  to  extensive  bureaucracy.  Access  to  financing  is 
also easier for firms that are able to resort to foreign capital markets, such as firms that 
are part of a multinational group. 

More  available  company  data  allows  the  development  of  better  measures  for  the 
presence  of  financing  constraints.  Empirical  evidence69  suggests  that  financing 
constraints are widespread and particularly affect smaller, younger, or single-unit firms. 
Their business prospects are more difficult to evaluate for investors, they are perceived 
as riskier because they are less diversified, and they are often not in the possession of 
collateral.  

Since the onset of the financial crisis, European companies and in particular SMEs 
have been facing a more difficult access to funding, reflected by both quantity and 
price restrictions. Some of the reasons have been cyclical, such as the deep recession, 
leading  to  higher  credit  risk  and  lower  profitability.    Other  reasons  have  been  firm-
specific, such as poor credit standing, insufficient profitability, lack of viable business 
plans or operating in industries in need of restructuring. At the same time, some supply 
frictions have also weighed on the amount of financing granted: the financial crisis has 
aggravated funding conditions70 because sources of short and long-term financing have 
been  affected  by  liquidity  problems  and  increased  risk  aversion  in  the  banking  sector. 
Moreover,  rising  sovereign  risk  premia  led  to  higher  interest  rates  on  lending  to  the 
private sector in crisis-ridden countries. Rising late payments by the public sector to its 
suppliers  have  further  weighed  on  the  funding  situation  of  SMEs  in  vulnerable 
countries.  Consequently,  SMEs  operating  in  some  Member  States  have  become 
disadvantaged in relation to their peers in the rest of the EU.  

3.2 Do European SMEs71 lack funding? 

Despite  some  stabilisation  of  the  SME  sector  in  Europe  following  the  global 
financial  and  euro  area  sovereign  debt  crises,  funding  constraints  remain  a 

68   See IMF (2015b). 
69   Beck, T., A. Demirgüg-Kunt, and V. Maksimovic (2008). 
70   See ECB Bank Lending Surveys and Survey on the access to finance of enterprises in the euro area 

(SAFE) by the European Commission and the ECB, June 2015. 

71   The Accounting Directive, 2013/34/EU, defines SMEs as companies that do not exceed the limits of 
at  least  two  of  the  following  three  criteria:  balance  sheet  total:  20m  EUR,  net  turnover:  40m  EUR,  
average number of employees: 250. 

33 

 
                                                 
concern.    The  2014  survey  on  the  access  to  finance  of  enterprises  in  the  euro  area 
(SAFE)  shows  that  small  businesses  are  getting  increasingly  optimistic  about  their 
growth  prospects,  but  it  also  shows  that  many  profitable  and  solvent  SMEs  remain 
concerned  about  their  access  to  finance.  More  than  a  third  of  SMEs  surveyed  did  not 
manage  to  get  the  full  bank  loan  financing  they  applied  for,  with  particular  problems 
reported by micro enterprises.72 Perceptions also differed across countries. 34% of the 
SMEs in Greece, 15% in Ireland and 15% in the Netherlands named access to finance as 
their  most  important  problem,  compared  with  only  7%  in  Germany  and  Austria. 
According to the Organisation for Economic Co-operation and Development (OECD)73, 
many SMEs in Europe could use additional funds productively, but cannot obtain these 
from  the  financial  system.  In  a  previous  edition  of  the  report,  the  OECD  noted  that 
securing suitable financing constitutes a problem especially for innovative SMEs whose 
technology  and  business  models  are  not  supported  by  many  traditional  financial 
institutions. The results of the European Commission's Innobarometer survey74 confirm 
that access to funding is a key obstacle for spurring R&D and the commercialisation of 
innovative  products  or  services.  Market  analysis75  reveals  that  Europe  has  a  smaller 
pool of non-bank funding76 available for investment by SMEs than the US, though the 
size of both economies is similar. 

Barriers  to  funding  faced  by  small  and  innovative  companies  have  notable 
economic implications. More than 99% of all European businesses in the non-financial 
sector are SMEs. Combined, they provide two thirds of private-sector jobs, contribute to 
more than half of the total value added created by business activity in Europe, and are 
crucial  for  income  and  growth  in  the  EU.  At  the  same  time,  economic  research 
considers innovation a crucial driver of long-term productivity and economic growth.77 
Countries  which  are  able  to  generate  innovation  and  to  adopt  new  technologies  grow 
faster. At the current juncture, where many companies need to restructure following the 
protracted recession, there is a particular need to support innovative, growth-enhancing, 
while risky, investment.  

Smaller firms are more constrained in receiving external funding because of their 
high  sensitivity  to  economic  cycles  and  shocks,  which  is  in  turn  due  to  greater 
sectoral  and  geographical  specialization.78  This  disadvantage  is  reflected  in  higher 
interest rates on small loans when compared to large loans as well as in other forms of 
credit  constraints.  A  comparison  of  the  average  cost  of  loans  in  Europe  (see  chart) 
shows a significant gap between lending to SMEs and to large firms. In addition, unlike 
large  corporations,  small  companies  have  limited  access  to  capital  markets  and  thus 
remain  disproportionally  reliant  on  banks.  The  smaller  a  firm,  the  more  restricted  the 

72   See  http://ec.europa.eu/growth/access-to-finance/data-surveys/safe/index_en.htm  for  details  of  the 

results. 

73   See OECD (2015). 
74   See Innobarometer 2014, European Commission: 

http://ec.europa.eu/growth/industry/innovation/facts-figures/innobarometer/index_en.htm. 

75   See AFME (2015). 
76   Including bank and capital markets finance. 
77   See Solow (1956), Romer (1986), Romer (1990), Jones (1995), and Aghion-Howitt (2013). 
78   See, for example, Iyer et al (2014). 

34 

 
                                                 
spectrum  of  potential  non-bank  funding  options  (see  table)  79.  Alternative  sources  of 
financing  are  shown  to  be  accessible  only  to  larger  firms,  firms  having  high  credit 
ratings, and firms located in countries with better developed financial markets. 

Chart 10: Yields of and spread between small and large loans, euro area 

Table 2: Use of financing instruments by non-financial corporations 

(percentage averages out of total sample over 2009-2014) 

Retained earnings 

24 

30 

38 

46 

Micro 

Small  Medium 

Large 

12 
Grants/subsidised loans 
38 
Bank overdrafts 
28 
Bank loans 
26 
Trade credit 
9 
Other loans 
19 
Leasing 
1 
Debt securities 
1 
Mezzanine 
4 
Equity 
Sources: ECB and European Commission Survey on the access to finance of enterprises. 

16 
43 
39 
30 
12 
40 
1 
2 
6 

20 
40 
43 
35 
19 
50 
1 
4 
8 

22 
42 
48 
38 
28 
56 
4 
6 
9 

79   See ECB (2015c). 

35 

 
 
 
 
 
 
 
 
 
 
                                                 
SMEs'  dependence  on  bank  lending  is  often  rooted  in  long-standing  client 
relationship.  The  comparative  advantage  of  banks  in  acquiring  information,  as 
discussed earlier, is particularly relevant for SME financing. A study80 conducted in the 
UK finds that over half of the SMEs seeking finance and eligible for bank funding go to 
their  main  bank.  More  than  two-thirds  of  SMEs  approach  only  one  bank  and  do  not 
shop  around  for  better  offers  if  financing  is  granted.  This  is  possibly  because  SMEs, 
once  a  workable  relationship  with  a  bank  has  been  developed,  see  little  value  in 
devoting too much resources into financial enquiry, an activity that they usually do not 
consider their core business. 

Investments  in  novel,  longer-term  projects,  such  as  in  the  area  of  research  and 
development, carry higher credit risk. Innovative companies often lack collateral that 
could  be  used  to  obtain  credit,  as  investments  in  research  and  development  typically 
mostly translate into intangibles assets, which are difficult to value. At the same time, 
banks need to comply with risk-based capital requirements and thus can allocate only a 
limited share of credit to riskier projects. As a consequence, some innovative, but risky, 
investment opportunities may remain unfunded in financial systems relying exclusively 
on banks. The SME credit gap was estimated at USD 1.5 trillion globally in 201181 – a 
third of it being in high-income OECD countries. 

SME  funding  can  be  increased  by  supplementing  banks  with  non-bank  finance 
providers that have expertise in identifying risky projects. While banks intermediate 
between depositors and borrowers and at the same time take part of the risk themselves, 
capital markets directly link savers and investees. The inherent diversity of views  and 
risk preferences present on capital markets makes it possible even for risky projects to 
get  matched  with  appropriate  investors.  Hence,  the  more  diverse  nature  of  capital 
market funding is suitable not only for well-defined and predictable business projects, 
but also for risky and innovative endeavours.  

There  are  various  ways  in  which  funding  is  provided  beyond  bank  lending  (see 
Chart 11). Leasing, factoring82 and various forms of trade and supply chain finance are 
capable  of  easing  corporate  financial  problems,  but  are  usually  more  expensive  than 
bank  loans.  Loans  by  non-banks,  including  crowdfunding  and  peer-to-business 
platforms, are other potential sources of finance but are underdeveloped to date, even if 
they  often  carry  lower  borrowing  costs  than  bank  loans.  Still  another  source  of 
alternative  finance,  particularly  suited  for  fast-growing  firms,  is  private  equity. 
Depending  on  the  size  of  the  investment  and  the  stage  of  a  company's  growth,  equity 
can  be  raised  through  family  and  friends,  crowdfunding,  business  angels,  venture 
capital, and, when a company matures, listing on a stock exchange.83 

80   See HM Treasury (2013). 
81   For more details see the Enterprise Finance Gap Database by The International Finance Corporation 

(IFC). 

82    i.e. selling the accounts receivables 
83   See http://www.evca.eu/about-private-equity/private-equity-explained/ for more information on 

various forms of equity funding. 

36 

 
                                                 
Chart 11: Alternative sources of funding, outstanding volumes in EUR billion, EU-28, 2014 

Note. When outstanding volumes were not available, turnover or cumulative issuance was issued as a proxy. 
Source:  Factors  Chain  International,  EVCA,  Leaseurope,  Massolution,  IKB  Deutsche  Industriebank,  C/M/S  Bureau  Francis 
Lefebvre and own calculations. 

So far, external equity funding for SMEs is rather limited in Europe. Private equity, 
a key source of funding for companies in a growing phase was significantly hit by the 
financial crisis, with funds raised dropping from over EUR 100 billion in 2006 to less 
than  EUR  20  billion  in  2009  (see  Chart  12).  Business  volumes  recovered  in  recent 
years, and fundraising by European private equity investors reached EUR 45 billion in 
2014. Yet, net funds raised were only EUR 6 billion in 2014. 

Chart 12: Private equity activity, gross annual flows, Europe, EUR billion84 

Notes: Data include venture capital. Funds raised: gross increases of liabilities. Investments: use of liquidity to purchase equity. 
Source: EVCA 2014 European Private Equity Activity. 

84   With data on more than 1.200 European private equity firms, the 2014 statistics by EVCA cover 91% 

of the EUR 548 billion in capital under management in Europe. 

37 

 
 
 
                                                 
Business  angel  investment,  which  refers  to  private  individuals  offering  financial 
support  and  other  operational  counsel  to  start-ups,  also  faced  difficulties  during 
the  crisis.  While  banks  have  been  unable  or  unwilling  to  provide  loans  to  young  and 
innovative  start-ups,  angel  investors,  acting  either  individually  or  through  groups, 
syndicates or networks, have also become more risk adverse and have focused on later 
stage  investments.85  Available  figures  suggest  that  the  amounts  invested  by  business 
angels in the EU remain small and highly concentrated. The statistics by the European 
Trade  Association  for  Business  Angels,  Seed  Funds  and  Early  Stage  Market  Players 
(EBAN)86  show  that  business  angels'  outstanding  investment  in  the  EU  amounted  to 
EUR 5.5 billion in 2013, of which a large part is undertaken in the invisible market87. 
More than half of the annual investment by business angels was estimated to be directed 
to the UK, Spain or France. 

Venture  capital,  which  can  be  a  key  funding  source  for  growing  companies,  is 
usually invested through funds, often provided by institutional investors.88 With a 
market volume of EUR 3.6 billion89 in 2014, venture capital is particularly important for 
financing  innovative  companies.  It  can  in  particular  play  a  determining  role  in 
replacing  or 
stimulating  entrepreneurship,  supporting  young  companies  and 
complementing  traditional  bank  finance.90  Start-up  stage  investment  represents  the 
major  part  of  venture  capital  activity.  Companies  active  in  growing  business  sectors 
such  as  life  sciences,  communications  and  electronics  attract  the  majority  of  the 
available funds.91 

Academic  literature  argues  that  venture  capital  spurs  innovation  by  relaxing 
financing  constraints  that  innovative  firms  face  due  to  asymmetric  information 
and  moral  hazard  problems.  Business  experience  and  research  confirm  that 
companies  backed  by  venture  capital  are  more  likely  to  create  patents,  have  high 
productivity  and  are  competitive.92  The  impact  of  venture  capital  investment  on 
productivity growth has also been studied and shows that enterprises backed by venture 
capital are more competitive than others, feature higher individuality of their products 
and have better technologies.93 Overall, economic analysis94 shows that venture capital 
investment enhances productivity growth. 

85   See Wilson and Silva (2013), OECD (2011). 
86   Calculations based on EBAN Statistics Compendium 2014 
87   I.e. comprising investors not gathered in business angel networks and not having a direct or indirect 

relation with EBAN. 

88   Venture capital is defined by OECD (2013) as a subset of the private equity industry supporting the 
pre-launch,  launch  and  early  stage  development  phases  of  a  business.  In  many  financial  databases, 
including the OECD Entrepreneurship Financing Database, venture capital comprises the sum of early 
stage (including pre-seed, seed, start-up and other early stage) and later stage venture capital. 

89  The amount excludes growth and buyout esuity investments. 
90   See OECD (2014). 
91   See EVCA (2015). 
92    See  e.g.  Kortum  and  Lerner  (2000).  However,  subsequent  studies,  e.g.  Engel  and  Keilbach  (2007) 

show that venture capital investment is not necessarily used to generate patented innovations. 

93   See Szerb (2009). 
94  See e.g. Romain and Van Pottelsberghe (2004) and Tang and Chyi (2008) 

38 

 
                                                 
Despite  positive  effects  on  economic  growth,  venture  capital  constitutes  a  small 
part  of  total  SME  external  financing.  For  most  world  economies,  venture  capital 
represents  a  negligible  percentage  of  GDP,  i.e.  often  less  than  0.03%.  Its  presence  is 
greater  in  Israel  and  the  United  States,  where  the  venture  capital  industry  is  more 
mature.  It  represented  in  2012  around  0.4%  and  0.17%  of  GDP  respectively.  By 
contrast, venture capital investments expressed as a percentage of GDP did not exceed 
0.1%. in any EU country.95 In 2013, venture capital firms invested only EUR 5 billion 
in Europe, an amount significantly lower than the EUR 26 billion invested in the US.  

The financial crisis has severely affected the venture capital industry worldwide. In 
2012, the level of venture capital investments was around 60% of 2007 levels in most 
developed countries.96 In spite of signs of recovery, total venture capital investments in 
Europe  remain  at  around  half  their  pre-crisis  peak  whereas  in  the  US  venture 
investments  surpassed  their  pre-crisis  peak  in  2013.  This  means  that  the  recovery  in 
Europe is progressing sluggishly, with venture capital investment growing by only 6% 
in 2014 compared to 2013.97 This slow growth dynamics highlights the limited potential 
for  a  more  radical  expansion  without  policy  intervention.  Moreover,  the  number  of 
companies backed by venture capital is similar to the level registered in 2007, indicating 
that the average size of the investment in individual companies in Europe has lowered 
over  the  last  years.  Currently,  approximately  3200  European  companies  are  venture-
backed.  Other  estimates  show  that  the  venture  capital  market  is  only  12%  of  what  it 
would be if it were as deep as in the US. If only half of the mentioned gap was closed, 
an additional EUR 25 billion could be raised every year to finance investment.98 

The  main  obstacles  to  the  development  of  venture  capital  investment  are  market 
fragmentation and constraints on the supply side of the market. European venture 
capital 
investors  have  difficulties  with  reaching  critical  size  and  sufficient 
diversification in their portfolios. Three quarters of venture capital funds were in 2014 
smaller  than  EUR  82  million  and  only  20%  of  funds  had  raised  more  than  EUR  100 
million over the last six years.99 Moreover, the activity is concentrated in a few Member 
States, such as the UK and France. Larger venture capital funds would be able to realise 
scale economies, specialize and thus possibly attract additional capital commitments for 
individual companies. However, the high degree of  fragmentation along national lines 
limits  the  growth  of  the  market  and  prevents  economies  of  scale  from  materializing, 
which implies relatively high transaction costs.100  

95   See EVCA Yearbook 2014. 
96   See OECD (2013). 
97 Anecdotical evidence shows a slightly more dynamic growth in venture capital investment in Europe in 
2015Q1,  in  particular  in  technology  companies.  See  European  tech:  In  Silicon  Valley’s  shadow, 
Financial Times, July 21, 2015 7:25 pm. 

98   Calculations by EVCA. 
99   See EVCA (2015). 
100  See Section 5.3 for a discussion on the impact of differences in tax treatment across the EU on market 

fragmentation. 

39 

 
 
                                                 
On  the  supply  side  of  the  market,  private  institutional  investors  such  as  pension 
funds,  funds  of  funds,  banks  and  insurance  companies  have  traditionally  been 
important  sources  of  funds  for  venture  capital  investment.101  However,  regulatory 
or self-imposed constraints on their asset allocation may prevent institutional investors 
from scaling up their investments in this asset class. The small size and fragmentation of 
European  venture  capital  funds  represent  additional  barriers  to  investment  by 
institutional investors. Moreover, since venture capital funds use equity issuance to exit 
from  their  investment,  the  declining  liquidity  on  equity  markets  is  an  important 
deterrent to venture capital investment. 

National business growth funds102 and related private- or public-led consortia can 
help  pool  funding  resources  and  thus  unlock  the  potential  of  fast-growing 
businesses.  By  pooling  funds,  large-scale  investment  projects  could  more  easily  be 
funded. In particular, allocating public financial resources to a pan-European Fund-of-
Funds  programme  could  help  attract  more  private  capital  back  to  venture  capital, 
particularly from non-EU sources. A Fund of Funds could act as a useful intermediary 
bridging the gap between large institutional investors and smaller venture capital funds. 
Thereby, it could provide access to larger pools of international capital and enable more 
SMEs to be financed and for longer periods of time. 

Box 3: Case studies of business growth funds 

A.  France  –  BPI  scheme  (public-private  co-financing):  The  French  Banque  Publique 
d'Investissement (Bpifrance) was created in 2012 In partnership with banking and finance 
establishments,  Bpifrance  funds  SMEs  along  different  stages  of  the  funding  escalator.  It 
provides  cash  to  cover  R&D  expenses  and  equity  seed  capital  to  strengthen  a  company’s 
financial  structure  and  thus  prepare  it  for  initial  fundraising. 
  It  also  provides 
industrialisation  loans  to  fund  downstream  expenditure  for  R&D  projects;  participatory 
development  contracts  to  strengthen  the  equity  capital  base  to  implement  development 
projects,  innovation  loans  to  finance  the  launch  of  innovations;  and  reindustrialisation 
assistance  to  fund  investment  expenditure.  Through  innovation  development  contracts  the 
fund  helps  to  fund  non-tangible  investment  and  working  capital  requirements  associated 
with an innovation.  

B. Fondo Italiano D'Investimento: The Fondo Italiano d'Investimento SGR manages three 
closed-end investment funds for qualified investors, for a total amount exceeding EUR 1.5 
billion,  one  active  in  the  private  equity  sector  investing  in  companies  with  a  turnover 
ranging from EUR 10 to 250 million and in other funds and investment companies; another 
active as venture capital fund of funds and another as private debt fund of funds. 

C.  UK  -  Business  Growth  Fund  (private  led):  Launched  by  five  major  UK  banks  as  a 
large-scale investment vehicle to invest in SME equity, this fund pools money to make large 
scale investments in growing companies. Investments between EUR 3 million and EUR 15 
million  are  made  in  established,  profitable  companies  with  a  turnover  of  up  to  EUR  150 
million  .  Investment  is  provided  as  equity  capital,  alongside  loans  and  trade  finance.  The 

101  Government agencies have also become a significant provider of vencture capital since the financial 

crisis. Their market share increased to 30% from 11% in 2008. 

102  A  business  growth  fund  can  be  defined  as  a  portfolio  of  stocks  that  has  capital  appreciation  as  its 
primary goal. The portfolio mainly consists of investments in companies with above-average growth 
potential, which re-invest their earnings in further expansion.  

40 

 
                                                 
Fund focuses on growth capital, not buy-outs, taking stakes of less than 40%. Scale effects 
drive  down  portfolio  costs,  making  SME  equity  investments  more  attractive.  In  addition, 
investment in the fund is treated as a risk-weighted asset (rather than requiring a deduction 
from  capital)  and  the  banks  are  able  to  benefit  from  the  capital  treatment  within  CRD IV 
which  covers  risk-weighting  for  Collective  Investment  Undertakings.  In  2013,  the  fund 
invested GBP 1.47 billion through a total of 652 deals.  

D. Danish Growth Fund (public-private co-financing): Re-launched in 2001 as a strategy 
to  develop  venture  capital  markets  in  Denmark,  this  government-backed  investment  fund 
co-finances  high-risk  and  knowledge-based  SMEs.  The  fund  has  USD  2  billion  capital 
under  management  and  annually  co-finances  500-800  SMEs.  It  uses  both  equity  and  loan 
instruments  to  leverage  private  investors  and  focuses  on  profitable  growth  companies. 
Facing  a  lack  of  sufficiently  experienced  venture  capital  management  teams,  the  fund 
decided to build capacity to invest directly in companies alongside the support of existing 
venture  capital  funds.  The  initiative  resulted  in  dynamic  growth  of  the  Danish  venture 
capital  market  and  a  significant  increase  in  the  Danish  venture  capital  funds'  returns.  The 
market has also consolidated, leading to fewer and bigger venture capital funds 

E.  Spain  -  Fond-ICO  Global  (public):  This  public  venture  capital  fund  of  funds  is  a 
financing facility of the state-owned bank Instituto de Crédito Oficial. With a total of USD 
1.2 billion of funds available, the fund seeks to promote privately managed venture capital 
funds. Its action is directed by the following principles: collaboration with private venture 
capital  and  private  equity  investment;  forming  private-public  partnerships  without 
interfering in the market; simplicity (recurrent schemes) and transparency (public tenders). 
Until  end-2014,  ICO  helped  to  create  23  new  venture  capital  and  private  equity  funds, 
committing  EUR  631  million.  It  aims  at  creating  about  40  new  venture  capital  funds 
mobilising an amount of around EUR 4 billion to be invested in Spain.  

SMEs  can  obtain  non-bank  funding  not  only  via  private  equity  but  also  through 
peer-to-peer  investment  and  borrowing.  However,  despite  their  rapid  expansion, 
securities-based crowdfunding103 and peer-to-business lending104 still represent a small 
share of SMEs' funding. Today, there are approximately 400 crowdfunding platforms in 
Europe, and the funds raised through crowdfunding have grown from EUR 487 million 
in 2012 to EUR 2 957 million in 2014, at an average yearly growth rate of 146%, almost 
reaching the size of the venture capital market.105 The number of start-ups and SMEs in 
Europe financed through crowdfunding has grown from 1084 in 2012 to 5801 in 2014.   

103  Crowdfunding refers to an open call to the public to raise funds for a specific project. Crowdfunding 
platforms  are  websites  that  enable  interaction between  fundraisers  and  the  crowd. Financial  pledges 
can be made and collected through the platform. Two main types of crowdfunding help SMEs to find 
financing  while  offering  some  financial  return  to  investors.  Equity-based  crowdfunding  enables 
entrepreneurs  and  start-ups  to  raise  early-stage  capital  directly  from  individual  investors  and 
increasingly  business  angel  groups  and  venture  capital  firms  as  well.    Lending-based  crowdfunding 
refers to campaigners borrowing money and promising to pay back the capital on specified terms with 
interest. For further details on crowdfunding, see European Commission (2014a).. 

104  Peer-to-peer business lending or peer-to-business lending allows SMEs to obtain credit from a pool of 

both individual and institutional investors without a bank as intermediary. 

105  Moving Mainstream, European Alternative Finance Benchmarking Survey, University of Cambridge 

and EY. 

41 

 
 
                                                 
Greater awareness of securities-based crowdfunding and peer-to-business lending 
among  investors  and  businesses  is  expected  to  result  in  an  accelerated  growth  of 
the market. Moreover, more crowdfunding and peer-to-business lending could have a 
positive signalling effect for SMEs towards other sources of finance. At the same time, 
perceived uncertainty on the laws applicable to crowdfunding platforms is an obstacle to 
further  development.  Due  to  the  lack  of  a  precise  definition  of  crowdfunding  and  the 
absence  of  applicable  EU  legislation,  localised  platforms  that  want  to  operate  cross-
border have to comply with several – and often divergent - national rules.106 Although, 
at present, the crowdfunding market remains localised, significant potential exists in this 
area  in  the  future  thanks  to  digitalisation  and  technological  progress.107  An  important 
fact explaining differences between the UK and the rest of Europe is that investing in 
early stage companies is incentivised via targeted regulation in the UK.108  

Insufficient  clarity  about  the  rights  of  investors  participating  in  crowdfunding 
platforms weighs on their popularity. Only some EU countries, e.g. Germany, Spain, 
France, Italy, Austria and the UK, have introduced specific legislation on crowdfunding, 
which  includes  for  example:  registration  of  platforms,  organisational  requirements, 
capital requirements, professional requirements, liability. In a similar context, Belgium 
and  Austria  amended  their  prospectus  rules  to  better  fit  the  crowdfunding  business 
model while Germany, Austria, Finland are considering legislative changes in the near 
future.  Still,  rules  on  the  operation  of  crowdfunding  platforms  and  related  investor 
protection mechanisms are still absent in many EU countries. 

The  anonymous  nature  of  the  peer-to-peer  market  and  the  lack  of  comparable 
credit  information  about  borrowers  seeking  funding  on  the  platforms  constitute 
further obstacles. Gathering and processing credit information is a resource-intensive 
activity that might not be undertaken if the associated costs are too high. Consequently, 
the potential of crowdfunding that could complement traditional sources of finance and 
contribute to helping start-ups move up the "funding escalator" remains underused.  

The  lack  of  verifiable  information  about  SMEs  restricts  access  not  only  to 
crowdfunding  but  also  to  other  funding  sources  (see  more  details  in  Box  4). 
Investors and lenders need verifiable information about a company before supporting it 
financially. Financial statements and a firm's credit history and payment behaviour are 
essential  to  assess  the  repayment  capacity  of  an  SME.  In  addition,  companies 
themselves  use  credit  information  services  to  assess  the  creditworthiness  of  clients  or 

106  Differences  in  tax  treatment  also  have  an  impact  on  market  fragmentation,  see  Section 5.3  for  a 

discussion. 

107  The  UK  dominates  the  market  with  EUR  2  337  million  raised  in  2014,  accounting  for  79%  of  the 
overall European market. Behind the UK, the top countries in terms of funds raised via crowdfunding 
in 2014 are: France (EUR 253 million), Germany (EUR 236 million), Sweden (EUR 207 million), the 
Netherlands (EUR 155 million) and Spain (EUR 101 million). 

108  Since 1 April 2014, the Financial Conduct Authority (FCA) has been responsible for the regulation of 
the  consumer  credit  market  including  regulating  loan-based  crowdfunding  platforms.  The  rules  in 
place aim to ensure access to clear information for consumers interested in lending to individuals or 
businesses.  A  number  of  consumer  protection  requirements  are  applied  on  firms  operating  in  the 
market, for example, client money must be protected and firms must meet minimum capital standards. 
Firms running crowdfunding platforms also also required to have resolution plans in place. 

42 

 
                                                 
suppliers.  Those  SMEs  about  which  information  is  missing  may  be  rejected  as  a 
potential  investment  target  already  during  the  pre-screening  process.  Usually  the  bank 
that  has  built  up  a  long-term  relationship  with  an  SME  and  knows  well  its  financial 
situation,  indebtedness  and  payment  behaviour109  is  the  best  placed  to  assess  its  true 
creditworthiness. But the sharing by banks of data with other market participants (such 
as  business  registers,  credit  bureaus  and  business  information  and  scoring  firms)  is 
limited  and  varies  from  one  Member  State  to  another110.  Positive  credit  data 
coverage111,  while  important  because  it  provides  information  about  the  credit  quality 
and behaviour of borrowers, also differs considerably between Member States. The lack 
of  standardised,  verifiable  and  accessible  credit  information  about  SMEs  represents  a 
significant  barrier  for  alternative  finance  providers  to  invest  into  European  SMEs. 
Therefore,  tackling  this  shortcoming  is  a  prerequisite  to  broaden  SMEs'  possible 
funding avenues.  

Information problems prevent the securitisation of SME loans from taking off. The 
assessment  of  the  creditworthiness  of  an  SME  loan  is  much  more  difficult  than  a 
mortgage  loan.  The  monitoring  effort  is  significant  due  to  the  heterogeneity  of  the 
businesses  and  information  limitations.  This  makes  the  securitisation  of  SME  loans 
more  complex  and  difficult  than  the  securitisation  of  a  pool  of  mortgages.  As  a 
consequence, addressing information challenges is key to stimulate growth in the SME 
loans' securitisation market. 

Box 4: Credit market failure due to asymmetric information 

When  lenders  cannot  adequately  assess  the  credit  quality  of  borrowers,  they  typically 
respond to such information asymmetry by raising interest rates on loans. This behaviour is 
at the root of the adverse selection problem: higher interest rates drive low-risk borrowers 
out  of  the  market,  while  more  high-risk  borrowers  step  in.  Moreover,  borrowers  may  be 
incentivised  to  invest  in  riskier  projects  to  compensate  for  the  higher  interest  rates  (an 
instance of moral hazard). In addition, some borrowers may not repay their debts, as in the 
absence of information about their creditworthiness they could still obtain loans from other 
lenders  (another  example  of  moral  hazard).  The  presence  of  asymmetric  information  can 
ultimately lead to credit  restrictions, even in competitive  markets, and to dysfunctional or 
missing markets.112  

Insufficient  financial  education  is  another  obstacle  restricting  SMEs'  access  to 
external  funding.  SMEs  tend  to  lack  knowledge  on  alternative  sources  of  finance  as 
well  as  on  which  information  to  submit  to  potential  investors  or  lenders  and  how. 
Another problem is the lack of awareness about credit reports and credit history. Many 
SMEs  are  not  able  to  get  their  own  credit  history  and  use  it  to  obtain  alternative 
financing.  The  lack  of  transparency  on  banks’  feedback  to  SMEs  about  their 
creditworthiness  makes  it  even  harder  for  SMEs  to  build  their  financial  knowledge. 

109  Payment behaviour includes on-time payments, late payments, payments in arrears, defaults, etc.  
110  See Chapter 7 in European Commission (2015b) for more details. 
111 Positive credit data encompasses information about credits that helps formulate a view on a company's 
total  credit  exposure.  Examples  of  positive  credit  data  include:  the  total  amount  and  type  of  loans; 
credit limits; guarantees; borrowing limits; cash levels; details relating to credit card commitments. 

112  See Stiglitz (1981), (2002); Akerlof (1970) 

43 

 
                                                 
Banks' feedback to borrowers varies in quality in Europe and only about half of SMEs 
find the feedback received by banks useful as regards obtaining future funding113.  

Lack  of  financial  knowledge  by  SMEs  considerably  narrows  their  financing 
options.  According  to  the  SAFE  survey,  one  SME  out  of  three  is  not  confident  about 
talking  with  banks  and  only  20%  are  comfortable  in  negotiating  with  equity  investors 
and venture capital firms. The smaller the firm size, the more limited its confidence in 
its  own  financial  competence.  Another  report114  shows  that  only  a  quarter  of  those 
responsible for making finance decisions in SMEs possess financial qualifications, and 
for SMEs as a whole only a minority have a financially trained person. Alongside the 
lack of in-house expertise, SMEs also experience problems with using external advice. 
Only  9%  of  SMEs  asked  for  advice  when  seeking  an  overdraft  and  only  16%  when 
seeking a bank loan. The resulting knowledge gap and the lack of a recognised source of 
business finance advice for SMEs, able to guide them through the complexities of bank 
and  non-bank  finance  and  help  them  secure  access  to  the  most  appropriate  form  of 
finance, hampers the use of financing options by SMEs.  

Finally,  limited  research  on  SMEs115  impedes  their  visibility  and  further 
contributes  to  SME  funding  shortages116.  Despite  the  importance  of  SMEs  for  the 
European  economy,  little  is  known  in  a  detailed  and  systematic  manner  about  these 
specific  companies,  their  activities  and  business  profiles.  For  instance,  50%  of  SMEs 
listed  on  Euronext  Amsterdam,  Brussels,  Paris  and  Lisbon  do  not  benefit  from  any 
financial  research  and  16%  are  followed  by  only  one  analyst  while  NASDAQ  OMX 
estimated  in  2013  that  only  10%  of  listed  companies  were  covered  by  financial 
analysis.117 An empirical study confirms the significant impact of analyst coverage on 
corporate  investment  and  financing  costs.118  A  decrease  in  analyst  coverage  increases 
information asymmetry and thus raises the cost of capital.  

3.4 Do European companies face barriers to going public? 

The  larger  a  firm,  the  broader  the  spectrum  of  available  external  financing 
options... Corporate finance theory and business firm evidence suggest that larger firms 
can  more  easily  meet  their  funding  needs  than  smaller  firms,  as  mentioned  at  the 
beginning of this chapter. In addition to bank loans, larger firms can finance their needs 
using existing purchase orders or accounts receivable factoring. They can also use their 
assets  to  obtain  a  secured  business  loan  or  line  of  credit.  Lastly,  they  may  acquire 
financing  through  issuing  debt  and/or  equity.  Fixed  transaction  costs,  minimum 
denominations,  lack  of  business  histories,  lack  of  brand  and  insufficient  collateral 
impede smaller firms from accessing external finance.   

113  See CSES (2012). 
114  SeeHM Treasury (2012). 
115  See Reid and Adams (2011). 
116  See OECD (2009). 
117  See ECSIP (2014). 
118  See Derrien and Kecske (2013). 

44 

 
                                                 
… but certain market segments are accessible only to the largest firms. Issuing debt 
or  equity  is  the  start  of  a  new  phase  for  a  company.  Besides  the  need  to  prove  to 
investors  that  its  business  has  competitive  strengths  and  an  acceptable  risk  profile,  a 
company  that  goes  public  has  to  change  in  many  respects.  Among  other  things,  its 
management and corporate governance structure needs to be adapted, its accounting and 
reporting  systems  have  to  be  enhanced,  its  capacity  to  communicate  information  with 
different  stakeholders  must  be  stepped  up.  For  all  these  reasons,  and  also  because 
raising capital on equity and debt markets involves high average transaction costs and 
heavy  listing  or  issuance  regulatory  requirements,  going  public  remains  largely  the 
domain  of  large  firms.  In  2015,  of  the  23  million  SMEs  in  Europe,  only  11  370  (less 
than  0.05%)  are  admitted  to  trading  on  a  regulated  market  or  a  multilateral  trading 
facility119. 

The  corporate  bond  market  in  the  EU  has  grown  recently  but  is  still  relatively 
illiquid and heterogeneous. Aided by historically low interest rates, total issuance by 
non-financial  corporations  of  euro-area  denominated  corporate  bonds  nearly  doubled 
between 2008 and 2014 to EUR 340 billion. Despite high primary issuance from large 
mulitnationals  in  recent  periods,  liquidity  in  the  secondary  markets  has  decreased.  A 
wide  diversity  of  issuances,  in  terms  of  maturity  and  coupon  structures,  results  in 
limited standardisation. Much of the corporate bond market is tailor-made and 'buy to 
hold'. Nevertheless, low secondary market liquidity impacts on bond prices and market 
volatility, and can be detrimental for primary issuance.  Higher liquidity premiums lead 
to  higher  costs  of  funding  for  corporations.  Market-makers  play  a  crucial  role  in 
providing  liquidity.  A  withdrawal  of  these  activities  and  a  reduction  in  dealer  banks' 
inventories, post the financial crisis, may be contributing to the lower secondary market 
liquidity.  A number of factors, both cyclical and structural, can be cited as potentially 
impacting  market  liquidity.  There  is  also  a  view  that  the  important  steps  taken  to 
strengthen  the  bank  balance  sheets  and  improve  their  resilience,  may  have  also 
unintendedly increased market-makers' costs, and possibly reduced their willingness to 
act  as  liquidity-providers.  Studies120  show  that  a  more  integrated  and  liquid  European 
market for corporate bonds would give  European firms a  broader choice of financing. 
There are market initiatives in the US addressing this concern, e.g. by agreeing to gather 
and sift more timely data about dealer inventories, as well as by establishing “all-to-all” 
trading platforms that involve both buy-side and sell-side traders. 

Corporate bond issuance is commonly used by large firms which can obtain more 
easily  credit  ratings  and  issue  bonds  in  large  denominations,  typically  purchased 
by  financial  institutions.  While  there  are  national  initiatives  for  retail  bond  markets, 
mainly  selling  mid-cap  bonds121,  such  markets  are  usually  small  and  have  a  limited 
reach. Initiatives to pool small-cap bonds122 or bundle them with other instruments such 

119 See FESE (2015).   
120 ECB (2014). 
121  For example, in 2010 BondM market was launched in Germany and ORB in the UK, in 2012 IBO was 

launched in France, and in 2013 ExtraMOT PRO was launched in Italy and MARF in Spain.  

122  E.g. The small-cap bond fund Micado in France is a successful example of such bundling. 

45 

 
                                                 
as securitisation123 have had limited impact so far. However, of higher impact have been 
public  and  private-led  initiatives  to  promote  bonds  meeting  specific  environmental, 
social and governance criteria. 

Box 5: The emerging market of Green Bonds 

The brand new market of green bonds, financial instruments which are aimed at financing 
projects  generating  an  environmental,  social  or  governance  (ESG)  benefit,  has  emerged 
over the last couple of years.  

Initially,  green  bonds  were  mostly  issued  by  public  entities  aiming  at  alleviating  the 
market  failure  that  the  specific  beneficiary  projects  (yielding  positive  externalities  for 
society  as  a  whole)  were  not  adequately  funded  from  the  society's  point  of  view.  The 
European  Investment  Bank  (EIB)  pioneered  it  in  2007  by  issuing  the  first  green  bond, 
which was linked to climate action investments. Historically, supra-national development 
banks,  such  as  the  EIB,  the  World  Bank,  the  European  Bank  for  Reconstruction  and 
Development  (EBRD)  and  the  International  Finance  Corporation  (IFC)  have  been  the 
most prolific issuers. Together with national development banks, they continue to be the 
prime issuers, representing 44% of the green bond issuance in 2014.124 However, issuance 
of ESG bonds by the corporate sector increased sharply in 2014 and represented one third 
of the market, primarily in the energy, utilities, consumer goods and real estate sectors.125 
This  reflects  the  increasing  appetite  of  investors  for  this  type  of  instruments.  The  third 
group  of  issuers,  regional/municipal  entities,  represented  13%  of  the  volume  of  green 
bonds  issued  in  2014.  Notably  thanks  to  the  arrival  of  new  issuers  such  as  national 
development  banks,  companies  and  local  public  entities,  the  market  size  tripled  in  2014 
over  2013,  with  a  total  of  EUR  36.6  billion  of  green  bonds  issued  by  73  issuers. 
According to Standard & Poor's estimates, the global market for green bonds could reach 
USD 100 billion in 2015.  

The  increased  appetite  for  ESG  bonds  is  explained  by  the  fact  that  labelling  a  bond  as 
ESG helps investors select investment projects that hedge the risks associated with poor 
environmental  management,  deteriorated  employee  relations  and  weak  governance. 
However,  despite  this  recently  strong  growth,  the  green  bond  market  remains  marginal, 
representing less than 0.1% of the global outstanding debt securities market.  

To  provide  for  some  standardisation  of  this  emerging  market,  market  participants  have 
been  developing  voluntary  guidelines  known  as  "Green  Bond  Principles".  These  Green 
Bonds  principles,  which  were  last  updated  in  March  2015,  are  intended  to  (i)  provide 
issuers guidance on the key components involved in launching a credible Green Bond, (ii) 
aid  investors  by  ensuring  the  availability  of  information  necessary  to  evaluate  the 
environmental  impact  of  their  Green  Bond  investments,  and  (iii)  assist  underwriters  by 
moving the market towards standard disclosures which will facilitate transactions. Green 
Bond  Principles  include  guidelines  on  (i)  the  use  of  proceeds  (e.g  renewable  energy, 
energy  efficiency,  sustainable  waste  management,  sustainable  land  use,  bio-diversity 
conservation, clean transport, sustainable water management, climate change adaptation), 
(ii) the process for project evaluation and selection, (iii) the management of proceeds, and 

123  E.g.    the  Viveracqua  Hydrobond  project  in  Italy:  a  group  of  eight  Italian  water  utility  companies 

issued ABS backed by their mini-bonds on a cross-collateralised basis. 

124  Source: Climate Bonds Initiative, https://www.climatebonds.net/ 
125  The largest corporate issuers in 2014 were GDF Suez, Toyota, Iberdrola and Unibail-Rodamco. 

46 

 
                                                 
(iv)  reporting.  While  the  Green  Bond  Principles  are  perceived  as  an  important  first  step 
towards  product  standardisation,  significant  work  remains  to  clearly  establish  which 
projects  or  assets  qualify  as  green.  There  is  also  an  increasing  demand  for  a  third  party 
verification  of  key  aspects  regarding  the  "green"/sustainable  nature  of  the  projects 
financed  with  the  proceeds  of  green  bonds  and  the  information  provided.  A  lack  of 
transparency  and  harmonisation  in  processes  and  reporting  also  have  to  be  addressed  to 
ensure the integrity and accuracy of the information provided to investors and improve the 
credibility of the sector. 

Private  Placements  (PPs)  offer  a  useful  supplement  to  public  corporate  bond 
issuance.  They  constitute  a  well-established  distribution  channel  for  qualified 
investors  around  the  world.  The  US  private  placement  market  is  globally  the  most 
mature  with  annual  issuance  fluctuating  around  USD  35  billion.  In  Europe,  despite 
constant  expansion,  the  market  is  significantly  smaller  with  about  EUR  17  billion  of 
deals  in  2014,  as  opposed  to  nearly  three  times  as  much  in  the  US.  The  growth  of 
existing European markets and the intensifying cross-border issuance, reflected mainly 
by increased tapping of the US market by overseas investors, indicate a growing global 
demand for these products.  

Box  6:  What  are  private  placements  and  why  are  they  beneficial  for  issuers  and 
investors? 

In contrast to public offerings, where instruments are offered to the general public, private 
placements (PPs) are issued directly to appropriately qualified market participants. On the 
sell-side, these are usually authorised financial intermediaries, including placement agents, 
banks or investment funds/firms, while on the buy-side entities usually comprise authorised 
financial institutions, including pension funds and life insurance companies, and may also 
involve  mezzanine  funds,  stock  funds  and  trusts,  high  net  worth  individuals,  and  certain 
corporate investors. Financial instruments issued are mostly debt instruments (in a loan or a 
bond format) but can also include equity and hybrid products.  

The  key  potential  benefit  of  private  placements  for  SMEs  is  the  diversification  of  their 
funding  without  the  need  to  secure  formal  credit  ratings  required  for  publicly  traded  debt 
issuance. With no minimum size limit, privately placed bonds can cater also to the needs of 
smaller companies.  Private placements are flexible because they start from the premise that 
eligible  market  participants  can  arrange  investment  transactions  between  themselves 
without needing the normal protection designed for retail investors. Instead, fund managers 
negotiate  terms  with  involved  parties  and  tailor  investment  proposals  to  meet  individual 
requirements.  The  otherwise  regulatory  safeguards  for  retail  investor  protection  that  are 
waived  in  a  private  placement  include  mandatory  disclosure  requirements;  procedures  for 
product  registration  or  approval  by  supervisory  authorities;  promotion,  distribution  and 
marketing;  and  conduct  of  business  rules.  Participants  in  a  transaction  rely  on  private 
contract law to establish their rights and obligations during a private placement's lifetime. 

Thanks to their flexible nature, private placements have lower regulatory and administrative 
costs than public offerings. Private placements also allow parties to maintain a higher level 
of privacy over their financing arrangements and to achieve a higher degree of flexibility in 
the amount of financing required. For investors, private placements are an important mode 
to  meet  particular  investment  requirements  and  objectives,  and  to  obtain  a  stake  in  a 
company which they would not be able to achieve in case of public issuance.  

47 

 
Besides  having  an  insufficient  size,  European  private  placement  markets  remain 
fragmented.  Private  placement  activity  in  the  EU  is  concentrated  in  a  few  Member 
States.  The  German  Schuldscheine  have  historically  played  an  important  role  in  the 
long-term  financing  of  German  companies.  With  EUR  9  billion  of  deals  in  2013,  the 
German PP market accounts for 50% of the EU total. The French PP market, known as 
"Euro-PP",  represents  approximately  a  quarter  of  the  EU  total,  with  EUR  4  billion  of 
activity in 2013. In the UK, a number of significant institutional investors provide UK-
style PP to UK companies, but there is no well-established PP market so far.  

Several factors cause the European PP market to lack size and depth. On the issuer 
side,  one  potential  reason  is  the  insufficient  size  of  European  firms  (e.g.,  in  terms  of 
number of employees). Despite a similar number of SMEs operating in the US and EU 
economies,  the  average  SME  size  is  significantly  greater  in  the  US  than  in  Europe.126 
The analysis of firm dynamics127 confirms that the United States has a high proportion 
of  industries  with  an  above-average  firm  size  relative  to  the  rest  of  the  world,  while 
European countries tend to have smaller firms in most industries. 

Chart  13:  Schuldschein,  annual  gross 
EUR billion 

issuance,  

Chart  14:  Euro  PP,  annual  gross  issuance,  EUR 
billion 

Note: 2014: expected issuance  
Source:  IKB  Deutsche  Industriebank  (German  Market  Outlook 
2014) and own estimates. 

Note: 2014 expected issuance 
Source: C/M/S Bureau Francis Lefebvre. 

Another  important  barrier  relates  to  the lack  of  standardised  documentation.  PP 
contracts  are  governed  by  national  law128  and  there  is  currently  no  single  set  of  legal 
arrangements  supporting  private  placement  between  local  buy-side  and  sell-side 
participants129.  While  the  flexibility  of  terms  of  contract  has  economic  benefits,  it 

126  Medium-sized  companies  in  Europe  have  an  average  size  of  80  to  100  employees,  while  in  the  US 
they typically have more than 180 employees. Similarly, large EU companies have an average size of 
about 1,000 employees while large companies in the US have an average size of 3,000 employees. 

127  Bartelsman, Haltiwanger and Scarpetta (2009). 
128  For instance, contracts for German Schuldscheine are governed by the BGB (German civil code); and 
the  Euro-PP  by  the  French  civil  Code.  The  Loan  Market  Association  provides  documentation 
governed by English law.  

129  See Europan Commission (2008b). 

48 

 
 
                                                 
creates  additional  legal  and  advisory  fees  resulting  from  the  need  for  individual 
agreements  to  be  drafted  for  each  transaction.  Differences  between  EU  private 
placement  regimes  make  it  impossible  to  extend  private  offerings  across  EU  Member 
States  without  adjusting  the  marketing  material  or  even  the  offer  itself.  Meanwhile, 
documentation standardisation is widely considered as one of the key enablers in the US 
PP market.  

Another  aspect  hindering  private  placement  activity  in  Europe  are  high  costs 
related  to  regulatory  requirements.  Studies130  show  that  the  cost  of  financial  due 
diligence for investors only starts to pay for itself at the issue size  of  around EUR 20 
million131.  One  argument  in  favour  of  easing  disclosure  requirements  for  sales  to 
institutional or high net worth investors is that these investors are supposed to be in a 
position  to  either  conduct  their  own  credit  analysis  or  access  supporting  professional 
advice.  Therefore  they  are  less  in  need  of  the  protection  afforded  by  the  disclosures 
required by the registration process. 

A  further  difficulty  is  insufficient  information  on  the  creditworthiness  of  issuers. 
The absence of a framework in Europe facilitating the assessment of PP risks limits the 
growth of the market. In the US, a large part of the success of the US PP market was 
attributed to the role of the National Association of Insurance Commissioners (NAIC), 
where  US  PPs  receive  credit  scores  by  the  NAIC  and  investors  are  provided  with 
regulatory guidance on capital weighting. Reliable credit analysis is considered as a key 
component of a functioning PP market but it is unclear whether such initiatives should 
be led by the public or the private sector. 

As  companies  mature  and  grow,  public  equity  markets  provide  an  increasingly 
relevant funding option. Accessing additional equity capital, reducing the overall cost 
of capital, raising public awareness, and spreading the risk of ownership among a larger 
group of shareholders are the main drivers for issuing public equity. The possibility to 
spread ownership is especially important for original shareholders who want to redeem 
some of their profits while still keeping a stake in the company. For example, venture 
capitalists  use  in  particular  initial  public  offerings  (IPOs)  as  an  exit  strategy  allowing 
them to cash in on successful companies that they helped to start-up, even if many exits 
are done via trade sales132 rather than IPOs. A big advantage of IPOs versus exiting via 
trade  sales  is  its  positive  effect  for  company  employees  in  the  form  of  stock  options. 
Another  advantage  is  an  increased  public  awareness  of  the  company  because  going 
public  often  generates  brand  recognition.133  In  addition,  the  listing  on  public  markets 
provides  an  immediate  valuation  of  a  company’s  performance  and  value.  This  greater 
transparency enhances the discipline of a company’s management and improves internal 

130  See Caudoux and Geffroy (2015) 
131  In 2014, the average ticket size of the deals in France was EUR 60 mn with a minimum ticket size of 
EUR 15 million. In Germany, the minimum size of a PP is EUR 15-20 million and efforts made in 
Germany to reduce ticket sizes failed. In 2005/06, some German Banks set up originate to distribute 
"platforms" for small ticket "Schuldscheine" but overall performance has been poor. 

132  A  trade  sale  is  a  common  way  for  a  company's  management  to  withdraw  from  the  business  and  it 
entails the disposal of a company's shares, assets and even liabilities, to a strategic or financial buyer, 
in whole or in part.  
133  See ESMA (2012). 

49 

 
                                                 
governance. Finally, evidence shows that taking a company public reduces the overall 
cost of capital and gives the company a more solid standing when negotiating interest 
rates  on  existing  or  future  debt.  Empirical  evidence134  might  confirm  the  described 
benefits, even if the direction of causality is unclear and selection bias must be assumed 
to exist. For example, companies listed on the AIM, a submarket of the London Stock 
Exchange  for  smaller  companies,  show  on  average  a  turnover  growth  of  37%  and 
employment growth of 20% in the year after their IPO. Another study135 finds that an 
IPO often leads to a relatively large rise of the size of a firm. 

Corporate financing via equity markets is currently very small in Europe. Of the 
23 million SMEs in the EU, only about 11.000 are listed on a stock exchange or traded 
on  exchanges  or  Multilateral  Trading  Facilities  (MTFs).  Moreover,  the  share  of  listed 
SMEs  has  gone  down  in  recent  years,  driven  by  a  low  number  of  entrants  and  even 
more  by  the  decision  of  listed  companies  to  de-list  and  go  private.136  Although  2014 
was the most successful year since 2007 in terms of IPO activity in Europe, the market 
dynamics remain weaker than before the financial crisis. 

Chart 15: European IPO activity 

Source: PwC, IPO Watch Europe Q1 2015. 

The  limited  activity  on  European  equity  markets  may  be  affected  by  high  costs 
incurred  by  companies  when  going  public.  In  the  case  of  a  listing,  such  costs 
typically include the generation of financial reporting documents, payment of audit fees 
and creation of investor relation departments.137 While information disclosure is crucial 
to  broaden  the  pool  of  capital  funding  while  ensuring  an  appropriate  level  of  investor 
protection,  it  may  impact  negatively  the  cost  of  raising  capital.  Data  shows  that 
compliance costs and disclosure requirements related to an IPO are particularly high for 

134  See U.S. Department of the Treasury, IPO Task Force  (2011) Rebuilding the IPO On-Ramp Putting 

Emerging Companies and the Job Market Back on the Road to Growth. 

135  See Carpenter (2002). 
136  See Demarigny (2010). 
137  See Jenkinson,  Ljungqvist (2001). 

50 

 
 
                                                 
smaller  firms.  A  study138  estimates  that  listing  costs  can  account  for  10  to  15%  of 
proceeds for IPOs of less than EUR 6 million and only 3 to 8% for IPOs above EUR 50 
million.  For  many  firms,  initial  and  on-going  listing  costs  outweigh  the  benefits  of 
listing. 

A  variety  of  other  factors  effectively  serve  as  a  deterrent  to  access  to  equity 
markets by enterprises. These obstacles include the lack of harmonisation of company 
and  insolvency  law,  as  further  elaborated  in  Chapter  5.  Other  obstacles  include 
insufficient  investment  research  coverage  and  lack  of  comparable  information  on 
companies  (as  explained  for  the  case  of  SMEs  in  the  previous  section).  Also,  cultural 
barriers  impede  the  development  of  cross-border  equity  markets  for  mid-caps.  Many 
firms  work  in  their  local  language  and  lack  visibility  across  borders  so  need  to  be 
funded locally.139 In addition, many mid-caps are family-run, and the founding family 
and management may be reluctant to shift control of the companies to other parties, in 
particular  of  foreign  origin.  Finally,  a  low  level  of  liquidity  characterizes  the  mid-cap 
segment. Medium-sized companies are intrinsically of a smaller scale than blue-chips, 
which reduces their attractiveness to institutional investors. Furthermore, recent market 
developments like high-frequency trading have tended to reinforce the attractiveness of 
large caps, at the expense of stocks of smaller companies. Although more than 90% of 
listed  companies  are  below  the  top  capitalisation  (EUR  1  billion),  these  companies 
benefit from less than 10% of market activity, in terms of either market capitalisation, 
the  number  of  trades  or  turnover140  Liquidity  considerations  have  recently  become 
particularly important in investor decisions. 

The  creation  of  dedicated  equity  platforms  for  medium-sized  companies  has 
proven  effective  in  reaping  the  economic  benefits  of  listing  on  a  stock  exchange 
without  incurring  high  administrative  and  regulatory  costs.  In  most  markets,  such 
platforms  act  as  a  second-tier  listing  alternative  to  the  main  stock  exchange  and  are 
characterized by lower listing requirements and costs than the main board. At the same 
time, they provide medium-sized companies with the opportunity to IPO once they have 
become well-established. Several platforms of this kind operate successfully around the 
world.141  In  Europe,  access  to  public  equity  markets  is  supported  by  a  dedicated  sub-
category (“SME Growth Market”) under the Multilateral Trading Facility category.142  

3.5 Debt versus equity financing and the tax-induced debt bias 

From the perspective of an owner of a company  in  need  of financing, equity and 
debt  instruments  each  have  specific  advantages  and  disadvantages.  The  first 
advantage  of  equity  is  that  it  does  not  have  to  be  repaid,  meaning  that  the  cash  flows 

138  See EU IPO Task Force (2015). 
139  Domestic  investors  account  respectively  for  79%  on  the  AIM  (an  MTF  of  the  LSE  for  smaller 

companies) and 95% on New Connect (an MTF operated by the Warsaw Stock Exchange). 

140  See ESMA (2012). 
141  e.g.  the  Alternate  Investment  Market  (London),  TSX  Venture  (Canada),  HK  GEM  (Hong  Kong), 

Mothers (Japan), Alternext (Europe) and AltX (South Africa). 

142  See for more details: Markets in Financial Instruments Directive (MiFID II), 
http://europa.eu/rapid/press-release_MEMO-14-305_en.htm?locale=en . 

51 

 
                                                 
generated  by  the  company  can  be  used  to  further  grow  the  company  or  diversify  it  in 
other  areas.  Another  main  advantage  is  that,  by  lowering  the  debt-to-equity  ratio,  it 
strengthens  the  financial  structure  of  the  company,  which  puts  it  into  a  more 
comfortable  situation,  notably  in  case  of  an  adverse  economic  shock.  One  main 
disadvantage  of  equity  versus  debt  is  that  the  main  shareholder  partially  gives  up 
ownership of the company and therefore some control over the conduct of its business. 
Also, if the profits generated by the firm are sizable, the necessity to distribute part of 
them to other owners is likely to make the cost of equity capital higher than the cost of 
debt.  

Debt financing is often a straightforward way to finance the acquisition of assets or 
operating expenses to grow one's business before the necessary funds are earned. 
On the one hand, debt financing is particularly adapted for firms pursuing an aggressive 
growth strategy. Closely related is the advantage of paying off debt in instalments over 
a  period  of  time.  Relative  to  equity  financing,  an  owner  would  also  benefit  by  not 
relinquishing  any  ownership  or  control  of  the  business.  On  the  other  hand,  the  most 
obvious disadvantage of debt financing is that the company has to repay the loan, plus 
interest.  Failure  to  do  so  exposes  the  company's  assets  to  repossession  by  the  lenders, 
and ultimately the company to a potential bankruptcy. As debt financing is borrowing 
against future earnings, meaning that future profits will be used to pay back debt instead 
of  for  example  growing  the  company,  a  high  leverage  can  severely  limit  future  cash 
flow and stifle growth. 

Tax considerations are also important for owners of a company in need of financial 
support.  One  tax  aspect  that  has  particular  significance  is  the  asymmetry  in  the  tax 
treatment  of  debt  and  equity,  the  so-called  "debt-equity  bias".  In  most  EU  countries, 
corporate tax systems favour debt over equity by allowing the deductibility of interest 
expenses, while the return on equity financing usually does not receive any form of tax 
relief  -  and  is  in  fact  often  subject  to  significant  taxation  both  in  terms  of  dividend 
payments and capital gains. On average, at the EU level in 2014, the cost of capital for 
equity has been estimated to be 45% higher than the cost of capital for debt because of 
taxation.143 Although  the estimate  is surrounded by a large uncertainty, the amount of 
the debt subsidy appears considerable. In 2007, it would have been equal to 4.9%, 2.4% 
and  3.5%  of  the  GDPs  in  the  US,  Euro  area  and  UK,  respectively.144  In  the  current 
environment  of  low  interest  rates,  the  foregone  tax  revenues  are  lower,  but  they  are 
likely to come back again to the pre-crisis levels when interest rates go up. 

By  favouring  debt  over  equity,  the  tax  system  tilts  the  structure  of  the  financial 
market  towards  debt  instruments.  Ultimately,  it  may  affect  the  efficiency  of  the 
market  in  terms  of  asset  allocation.  Furthermore,  the  debt-equity  bias,  together  with 
differences in the tax treatment of debt and equity across Member States and in the legal 
definition of debt and equity result in market fragmentation. 

A  higher  leverage  makes  companies  more  fragile  and  economies  more  prone  to 
crises. Companies with a large amount of debt and a low level of equity are more likely 

143  Source: Commission services based on ZEW data.  
144  See The Economist (2015). 

52 

 
                                                 
to go bankrupt  in  economic downturns. Also,  manipulating the location of  group debt 
for tax optimisation reasons may increase bankruptcy risks of the entities where the debt 
is  located  if  there  is  no  full  sharing  within  the  group.  More  specifically,  empirical 
evidence  confirms  that  the  corporate  debt  bias  leads  to  an  excessive  leverage  in  the 
corporate sector. For example, De Mooij (2011) estimated that a one percentage point 
higher corporate income tax rate increases the debt-asset ratio by between 0.17 and 0.28 
percentage points. This also applies to the financial sector, in which excessive leverage 
increases the risk of a financial system crisis. In particular, De Mooij et al. (2013) find 
that  a  reduced  tax  bias  is  associated  with  a  lower  aggregate  bank  leverage,  and  the 
complete elimination of the tax bias would on average decrease the leverage ratio145 of 
banks by between 2.2 and 4.2 percentage points. This in turn would result into a lower 
probability  of  banking  crisis.  Removing  the  debt  bias  would  also  reduce  substantially 
the costs in terms of public resources that are mobilised in case of a crisis in the range 
of  30  to  70%,  even  when  using  the  most  conservative  estimates  for  the  impact  of 
taxation on indebtedness.146 

The  debt  bias  may  also  have  a  negative  impact  on  growth.  Cournède  et  al.  (2015) 
conclude from a study over a 50-year period that in most OECD countries more debt is 
typically associated with slower growth while more stock market financing generates a 
positive growth effect. 

Other  tax  incentives  may  be  used  to  support  investment  in  specific  financial 
instruments, economic sectors or actors in some instances. Tax incentives to support 
investment  in  smaller  companies  and  start-ups  are  not  uncommon.147  In  particular,  an 
increasing number of Member States are encouraging business angel and venture capital 
investment  through  tax  incentives  as  a  means  of  increasing  the  supply  of  early  stage 
venture capital. Some Member States have introduced tax schemes to support specific 
beneficiaries  (e.g.  social  enterprise),  instruments  (e.g.  mini-bonds)  or  platforms  (e.g. 
crowdfunding  or  private  placements).  Schemes  to  support  employee  ownership  also 
usually  benefit  from  tax  incentives  to  attract  a  stable  funding  source  as  well  as  to 
stimulate retails investors' investment in equity or bonds products.148 However, taxation 
being  a  national  prerogative,  tax  incentives  vary  widely  from  one  Member  State  to 
another. 

3.6 Barriers to access infrastructure finance  

The  EU  has  identified  a  lack  of  infrastructure  investment  as  a  key  constraint  on 
future growth. The high debt overhang and subdued investor sentiment limit demand 
for  investment  funding.  At  the  same  time,  public  investment  has  been  on  a  secular 
declining trend in Europe since the 1970s from about 5% to about 2.5% of GDP in the 
2000s.  The  most  recent  estimates  for  EU  (national  and  cross-border)  infrastructure 
investment needs for the period until 2020 arrive at a figure of around EUR 1 trillion, 

145 Defined in the study as total liabilities divided by total assets 
146  See Langedijk et al (2014). 
147 For example, the Enterprise Investment Scheme in the UK is one of the longest operating tax reliefs 

for individuals investing in smaller companies. 

148 The Inter-University Center (2014). 

53 

 
                                                 
notably  in  Trans-European  Networks  (TENs)  in  the  area  of  transport,  energy  and 
telecommunication.  Taking  into  account  other  areas  of  'classic'  infrastructure  such  as 
water, sewage treatment or waste management, total infrastructure investment needs in 
the  EU  could  reach  EUR  2  trillion  for  the  period  up  to  2020.  Besides,  in  order  to 
contribute to key objectives of the Energy Union and in particular the transition to a low 
carbon  and  climate  resilient  economy,  the  EU  would  need  to  mobilise  significant 
investments  in  Europe  in  power  grids,  generation  as  well  as  energy  efficiency  and 
innovation.  Investments  in  these  sectors  are  general  of  smaller  size  than  traditional 
Public Private Partnerships (PPPs) and therefore struggle to get access to finance. They 
also  require  assistance  in  project  preparation  as  they  are  not  as  sophisticated  as  large 
PPPs.  The  investment  needs  related  to  both  the  achievement  of  the  2030  climate  and 
energy  targets  and  the  modernisation  and  transformation  of  the  energy  system  in  EU 
Member  States  are  estimated  to  amount  to  over  EUR  200  billion  on  average  per  year 
through 2030.149  

Infrastructure  investment  faced  funding  constraints  after  the  financial  crisis.  On 
the supply side, several major banks retreated from this business field or have become 
more selective. The  decline  of  the  monoline insurers reduced the availability of credit 
insurance,  which  had  a  crucial  role  in  enhancing  credit  quality  of  infrastructure 
investment and thereby pulled in investors that sought limited exposure to risks. Whilst 
there has been some market recovery and liquidity has returned to some sectors of some 
markets,  many  projects,  perceived  as  carrying  higher  risk  (e.g.  risk  associated  with 
greenfield  projects,  the  predictability  of  demand,  the  very  long-term  development 
period,  or  the  cross-border  element  of  the  project),  are  still  unable  to  secure  adequate 
funding. On the demand side, the generation of a strong pipeline of projects structured 
in a suitable way to attract private investors has been identified as a crucial element of 
the  Investment  Plan  for  Europe  to  improve  and  increase  the  number  of  projects  for 
investors  to  invest  in.  While  low  interest  rates  motivate  institutional  investors  such  as 
insurance  corporations  and  pension  funds  to  search  for  new  long-term  investment 
opportunities that match their long-term liability structure, actual private investment in 
infrastructure  has  not  yet  picked  up.  It  falls  short  of  the  high  needs  identified  for 
infrastructure investments.  

Long-term  finance  is  provided  by  different  types  of  investors.  Private  capital  for 
infrastructure investment is provided in two main forms, corporate finance and project 
finance.  A  wide  range  of  financing  instruments  and  investment  vehicles  is  used  to 
finance  infrastructure  investments,  including  listed  infrastructure  equity  (corporate 
equity),  listed  and  unlisted  infrastructure  funds  (mainly  equity),  corporate  bonds  of 
infrastructure  companies,  project  bonds,  project  finance  and  finance  through  Public-
Private-Partnerships  (PPPs).  Bank  lending  has  been  the  main  source  of  funds  for 
infrastructure  projects.  However,  the  share  of  bond  financing  has  been  increasing 
recently,  representing  23%  of  European  project  finance  debt  issuance  by  value  (EUR 
15.1  billion)  in  2014,  compared  with  just  3%  in  2008.150  In  2014,  European  PPP 
transactions  represented  an  aggregate  value  of  EUR  18.7  billion  across  82 

149  See  European  Commission  (2014c)  for  the  impact  assessment  of  the  2030  climate  and  energy 

framework.  
150  Source: AFME 

54 

 
                                                 
transactions151. Regarding the use of financing instruments and vehicles, the landscape 
is  very  diverse  across  EU  Members  States.  The  UK  accounts  for  35%  of  all 
infrastructure investments made through PPPs while in a number of EU Member States, 
PPPs  do  not  play  any  role  at  all.    The  project  bond  market  (debt  issuance  by  project 
finance  companies  for  investment  by  institutional  investors  or  other  financial 
institutions) in the EU is rather small and underdeveloped (with the exception of the UK 
before  the  financial  crisis).  Furthermore,  public  funds  can  be  leveraged  to  activate 
private  investment  in  infrastructures.  In  this  regard,  the  European  Fund  for  Strategic 
Investments  (EFSI),  established  in  the  context  of  the  European  Commission's 
Investment Plan, aims at mobilising up to EUR 315 billion in additional investment in 
infrastructure, education, research, innovation and SMEs. The Investment Plan will also 
help provide greater regulatory predictability and remove barriers to investment, making 
Europe more attractive for investment. Public sector finance, either directly at central, 
regional  and  local  level,  or  indirectly  through  national  promotional  banks  or  financial 
institutions, contributes about 1/3 to infrastructure investment in the EU. 

The choice of the most efficient financing by the sponsor or procurement authority 
depends  on  a  variety  of  factors.  Such  factors  are:  the  size  of  the  transaction,  its 
complexity, the type of transaction, bank and capital market conditions at the relevant 
time,  issuance  and  swap  costs,  the  need  for  special  terms  such  as  non-standard 
covenants,  the  time  available  for  marketing  and  the  preparation  of  the  financial 
documentation,  strategic  considerations  such  as  investor  diversification  and  public 
visibility. 

Institutional investors could become a larger and more important source of long-
term  finance  for  infrastructure  investment  in  the  EU.    Large  pension  funds  or 
insurers are able to raise and commit sufficient capital by virtue of their own resources. 
The balance sheets of most institutional investors are dominated by long-term liabilities. 
Hence,  that  long-term  investment  improves  their  maturity  structure.  Long-term 
investment also carries typically an "illiquidity premium", i.e. higher interest rates, and 
reduces  asset  management  costs  due  to  lower  average  turnover.  Moreover,  many 
smaller investors could also diversify their investments in these kinds of assets, if they 
would  not  be  restricted  from  doing  so  due  to  their  size  and  the  absence  of  readily 
available  pooling  mechanisms.  Local  pension  plans,  municipalities,  pension  schemes 
run by the liberal professions or corporate pension plans would benefit from investing 
through the newly established European Long Term Investment Funds (ELTIFs).  

There  are  numerous  obstacles  to  long-term  finance  for  infrastructure,  in 
particular for greenfield projects, some of which go beyond the scope of the CMU 
Action Plan. The key feature that characterises infrastructure investment is its inherent 
significant  uncertainty  due  to  the  technical  complexity  of  the  projects,  the  long-term 
investment  horizons,  the  importance  of  the  macroeconomic  environment,  regulatory 
stability, and political commitment. Many large-scale investments that only pay off over 
the  long  term  are  concentrated  in  highly  regulated  sectors,  e.g.  energy,  digital 
infrastructure or transport. Predictability regarding the future course of regulation would 
unlock  projects  that  are  typically  affected  by  uncertainty.  Despite  some  improvement 

151  See AFME-ICMA (2015). 

55 

 
                                                 
recently,  investors'  attitude  towards  risky  projects  remains  lukewarm,  particularly 
during  the  construction  phase  of  larger  projects  and  for  projects  involving  innovative 
technologies. Fair value accounting principles may also be detrimental to the long-term 
financing horizon of institutional investors. Lack of data on the financial performance of 
infrastructure investments has also been identified as a major challenge. A larger supply 
of  appropriate  investment  pooling  vehicles  could  broaden  the  investor  base  and 
diversify project and risk exposure of investors.  

Box 7: Uncertainties in long-term project finance 

There  are  four  main  sources  of  uncertainty  for  investors  to  overcome  when  deciding 
whether  to  invest  in  long-term  infrastructure  projects.  First,  there  are  the  uncertainties 
inherent  to  the  project  itself  given  that  its  long-term  nature  entails  specific  risks,  for 
example linked to potentially changing contractors or process innovations during the project 
period.  Assumptions  must  be  made  about  expected  progress  that  may  turn  out  to  be  too 
optimistic  or  pessimistic.  Second,  there  is  the  problem  of  timescales  –  most  will  require 
investments  with  a  long  maturation  process.  Time  matters  as  it  is  directly  related  to 
investors having to lock up their liabilities with corresponding expectations over future rates 
of return. The problem is that infrastructure projects often take time before bearing fruits (in 
terms of market rewards).  On top of this, investments are sometimes subject to dead ends, 
detours, and demanding changes that can be both costly and time-consuming. Third, there 
are  uncertainties  in  the  economic  environment.  Predicting  the  rules  of  the  game  for 
investment  and  the  level  and  volatility  of  long-term  interest  rates  depends  directly  on  the 
propensity  of  investors  to  take  risks  and  allocate  long-term  capital  to  specific  projects. 
Prevailing  economic  conditions,  especially  long-term  macroeconomic  stability,  are  a  key 
driver of risk appetite. Volatility in real interest and exchange rates makes the net present 
value  calculations  of  projects,  particularly  cross-border  ones,  much  harder  to  predict.  
Fourth,  the  life  of  political  commitments  and  decisions  may  differ  from  the  life  of  the 
project.  With  the  strain  and  tight  scrutiny  on  many  public  sector  budgets  following  the 
crisis, many investors need clear long-term assurance to overcome renegotiation concerns. 

56 

 
Chapter 4  THE  PROVISION  OF  FUNDING  THROUGH  CAPITAL  MARKET 

INSTRUMENTS 

This chapter describes the EU investor base and how capital markets investments 
by retail and institutional investors can be promoted. For non-financial corporations 
to  have  access  to  more  market  funding,  as  argued  in  the  previous  chapter,  investors' 
savings through market instruments have to increase. The first section describes the EU 
investor  base,  distinguishing  between  retail  investors,  non-financial  corporations  and 
institutional  investors.  Both  have  in  common  that  they  have  strong  links  with  banks. 
They  differ  in  their  capacity  to  deal  with  information  frictions.  The  second  section 
focuses  on  households'  investment  choices  and  discusses  how  correcting  information 
asymmetries,  providing  financial  advice  and/or  education,  tackling  barriers  to  cross-
border  investment  by  European  funds  and  exploring  the  development  of  personal 
pension  fund  could  promote  households'  investments  in  capital  markets.  The  third 
section argues that, for institutional investors' investments to take off, barriers such as 
limited  market  size,  access  to  transparent  and  comparable  information,  investment 
restrictions on specific asset classes and prudential requirements on certain investments 
would need to be tackled. 

Economic  theory  postulates  that  lack  of  market  size  and  depth  may  inhibit 
investors' interest in capital market instruments. Even the largest national markets in 
the  EU  could  lack  critical  size,  leading  to  an  unduly  small  investor  base  and  limited 
financial  instruments  to  choose  from.  If  capital  markets  are  not  sufficiently  liquid, 
issuers  face  a  small  investor  base  on  primary  markets,  investors  face  low  liquidity  on 
secondary  markets,  and  traders  on  secondary  markets  have  few  instruments  to  choose 
from  and  few  counterparts  to  deal  with.  Increased  market  size  may  encourage  market 
entry and vice versa. This "chicken-and-egg" problem is comparable to a coordination 
failure  or  a  market  failure  since  each  group  would  be  better  off  and  a  more  intensive 
user of capital markets if the other groups were more active users. Issuers, investors and 
also  traders  face  underlying  trade-offs  resulting  from  obstacles  to  the  flow  of 
information:  issuers  are  reluctant  to  unveil  information  about  their  business  to 
everybody, as business competitors may exploit it to the disadvantage of the issuer.152 
Investors on primary markets would benefit from liquid secondary markets, but possible 
buyers  are  discouraged  from  trading  with  them  because  they  face  an  information 
disadvantage with respect to the position of the issuer. 

152  Incentives and obstacles for information disclosure are discussed in Edmans et al. (2013), and Beyer 

et al. (2010). 

57 

 
                                                 
Chart 16: Overview of the provision and use of funding by non-financial sectors, financial intermediation and 
markets, EU 28, 2014, EUR billion 

Note: MFIs include central banks. 
Source: ECB, Eurostat and own calculations. 

Chart 17: Breakdown of markets and bank asses by sector, EU-28, 2014, EUR billion 

Notes:  NFCs:  non-financial  corporations,  MFIs:  monetary  and  financial  institutions  (banks),  Gov:  governmnets,  OFIs:  other 
financial  institutions,  ICPFs:  insurance  corporations  and  pension  funds.  Core  credit:  credit  to  households  and  non-financial 
corporations, Gov credit: credit to governments, Non-core credit: other credit including wholesale funding provided, interfinancial 
credit and others. Credit can be provided through loans or by buying bonds and equity. For MFIs, central banks are not included 
Source: ECB and own calculations. 

4.1 Identifying and understanding the investor base 

Households are the traditional ultimate supplier of funds in the economy, mainly 
through  financial  intermediaries.153  The  EU  households'  total  financial  assets  are 
worth  almost  220%  of  GDP.  Only  a  small  share  is  currently  held  in  direct  market 
instruments,  i.e.  financial  securities:  listed  shares  and  bonds  each  represented  4%  of 
households'  financial  assets  at  end-2013.  Investments  in  funds  represent  6%  of 
households' financial assets.154 The largest parts of their financial assets are in the form 
of bank deposits (30%), pension  entitlements (20%), and claims against life-insurance 

153  For  a  more  detailed  analysis  of  saving/investment  and  financial  assets  and  liabilities  in  the  EU  and 

Member States, see European Commission (2015, EFSI). 

154  Many households hold equity in their own, often unlisted, firm (non-listed shares and other equity in 
Chart 18). The frontiers between households and firms are thus somewhat blurred in some statistics 
because the standard classification covers non-financial corporations and treats not incorporated firms 
as part of the household sector. 

58 

 
 
  
                                                 
companies (16%). When considering the potential total supply of funds that households 
can provide to the economy, considering real estate property is important, because this 
is  the  single  most  important  and  illiquid  household  asset.  For  those  countries,  where 
data  is  available,  property  in  real  estate  constitutes  about  40%  of  total  household 
assets.155  

Chart  18:  Households'  composition  of  financial 
assets, 2013, EU-28 

Chart 19:Acquisition of net financial assets by sector, 
EU-28, % of GDP 

Source: Eurostat. 

Source: Eurostat. 

Non-financial  corporations  have  recently  also  become  significant  ultimate 
suppliers of funds. Non-financial corporations (NFCs) have on aggregate turned from a 
user  (net  borrower)  to  a  supplier  of  funds  (net  lender)  in  the  EU  and  several  of  its 
Member States over the last years. NFCs supply about half of the amount of funds that 
households supply, i.e. EUR 142 billion relative to EUR 273 billion in the EU-28 per 
annum  in  2014.  Many  firms  hold  large  amounts  of  financial  assets.156  According  to 
2013 data157, these were in the EU-28 almost EUR 15 trillion or 106% of GDP, again 
broadly half of the stock held by households. Very few are held in market instruments 
or  via  financial  intermediaries.  Financial  assets  of  the  NFC  sector  are  predominantly 
non-listed equity (40% of GDP), loans (13% of GDP), both reflecting linkages within 
the corporate sector, and deposits (19% of GDP). The financial sector also provides net 
funds  to  the  economy,  originating  from  the  profits  generated  in  the  sector.158  Foreign 
investors have not been a net lender to the EU over the last years. Mirroring the EU's 
current  account  surplus,  more  than  EUR  100  billion  each  year  was  invested  or  lent 
abroad in net terms in 2012-2014 and, given ageing populations in the EU, the direction 
of  international  capital  flows  is  expected  to  remain  the  same.  Still,  sovereign  wealth 
funds have become relevant institutional investors as they allocate sizeable portfolios on 
global capital markets. 

155  For further details about non-financial assets, see European Commission (2015b), Chapter 2, Box A. 
156  In this context, it is also notable that business succession could become a relevant issue. 5% of SMEs 
are owned by people aged 60-65 years, thus who will soon retire and sell or transfer their business. 

157  Consolidated provisional data. 
158  For  an  analysis  of  the  difference  between  the  traditional  loanable  funds  intermediation  and  the 

"financing through money creation" channel, see Jakab and Krumhof (2015). 

59 

 
 
                                                 
Chart 20: Investment funds, asset allocation, euro area, 20014 

Source: ECB. 

The  large  share  of  savings  channeled  through  the  financial  system  signals  an 
important role of institutional investors. The financial claims of  households against 
banks  and  various  non-bank  financial  intermediaries,  encompassing  life-insurance 
corporations, pension funds and other investment funds, are further channeled into the 
economy. In the euro area, insurance companies and pension funds each hold assets that 
amount to approximately 85% of GDP.159 Debt securities and investment funds 'shares 
represent  the  largest  share  of  securities  held  by  insurance  corporations  and  pension 
funds, respectively. Investment funds' asset allocation consists of broadly a third in debt 
securities, equity and other financial instruments.  

The mirror image to more market instruments for the financing of firm activity is 
more ultimate savings invested through or in the form of market instruments. For 
example, households in the USA, UK and Sweden keep a proportionately small share of 
financial  wealth  in  bank  deposits,  reflecting  the  smaller  role  of  banks  in  funding  the 
economy  than  in  the  EU-28.  Chart  21  illustrates  the  relative  weights  of  non-bank 
financial  institutions  in  terms  of  financial  assets,  showing  the  important  role  of 
investment  funds  and  insurance  companies.  These  non-bank  financial  intermediaries 
provide  significant  funding  to  banks.  Aggregate  data  for  the  EU  suggests  that  8%  of 
insurance  companies'  and  pension  funds'  financial  assets  are  in  form  of  deposits.  This 
figure  comes  down  to  around  6%  for  investment  funds.160  However,  institutional 
investors channel an even larger part of the funding that they receive to banks, as they 
also hold equity and bonds issued by other financial institutions. Approximately 12% of 
debt securities held by non-bank financial intermediaries, and 5% of equity, are claims 
against banks.  

159  This compares to assets of more than 300% of GDP on banks' balance sheets. 
160  The  share  is  4-5  %  for  insurance  companies,  pension  funds  and  investment  funds  in  2011  in  the 

OECD in Celik and Isaksson (2014). 

60 

 
 
                                                 
Chart  21:  Financial  assets  held  by  non-bank 
financial  corporations,  euro  area,  EUR  billion 

Chart 22: Financial assets held by investment funds 
broken  down  by  investment  policy,  euro  area, 
EUR billion  

Source: ECB. 

Source: ECB. 

The difference in exposure to tradable financial securities between households and 
institutional investors reflects corresponding differences in their ability to address 
the  underlying  information  problems.  Actual  households'  portfolio  choices  seem 
aligned  with  their  limited  means  to  assess  the  credit  risk  and  business  prospects  of 
borrowers.  The  high  share  of  financial  assets  held  in  the  form  of  bank  deposits  is 
indicative  of  households’  legitimate  interest  in  holding  assets  that  are  liquid,  have  a 
stable  nominal  value,  and  represent  claim  against  a  trusted  financial  institution.161 
Claims  against  non-bank  financial  intermediaries  facilitate  diversification  of  risks  and 
allow  access  to  the  intermediaries'  risk  management  capacity,  which  are  both  more 
difficult to achieve via direct holdings of securities if the amount of wealth at disposal is 
small.  Conversely,  institutional  investors'  portfolio  choices  are  often  explicitly 
determined by risk-return considerations. Hence, the share of funding that they direct to 
the banking sector primarily reflects the returns and risks that investments in banks offer 
relative to investments in other parts of the economy. If institutional investors decided 
to provide direct credit to non-banks, they would need to build up capacity to assess and 
manage  credit  risks.  By  investing  in  banks,  they  get  indirect  exposure  to  credit  risk 
without  the  need  to  build  this  capacity.  Beyond  that,  limitations  due  to  investor 
mandates or regulation and ownership linkages with banks may be factors that drive the 
share of funding directed to banks higher.  

Investors' desire to re-allocate portfolios towards more market-based instruments, 
a larger equity component or more cross-border exposure should mainly be driven 
by  risk-return  preferences.  Standard  economic  theory  suggests  that  actual  portfolio 
allocations  reveal  investors'  genuine  preferences  under  the  assumptions  that  these 
investors can freely choose the assets to invest in and that competition will equalise risk 

161  Tax  incentives  as  well  as    legal  protection in  the  form  of  deposit  guarantees  for  bank  deposits  may 
also  incentivise  households  to  hold  bank  deposits.  Moreover,  bank  deposits  serve  transactional 
purposes. 

61 

 
 
 
                                                 
and  liquidity  adjusted  returns  among  asset  classes.  However,  under  pre-defined  risk-
return  preferences,  asset  allocation  may  not  be  optimal  as  influenced  by  different 
factors.  For  example,  lack  of  access  and  high  transaction  costs  can  be  deterrents  to 
investment in some assets. Distorted prices resulting for example from differences in the 
tax treatment of financial assets, incomplete information and ineffective regulation will 
be another factor influencing investment choices.162  

4.2 Promoting saving and investment by households through capital markets 

The  actual  composition  of  households'  financial  portfolio  seems  to  be  mainly 
driven by economic factors. Households' limited interest in tradable securities such as 
bonds and listed shares could be well driven by high transactions and information costs 
relative  to  expected  returns  from  such  assets.163  The  better  legal  protection  that  bank 
deposits  enjoy  compared  to  other  financial  assets  is  another  factor  influencing 
investment choices. Shares provide some shelter from inflation, but create exposure to 
the business cycle and vice versa for bonds. However, most households save mainly in 
the form of house ownership, which also offers protection from inflation, but is highly 
illiquid.  Saving  in  the  form  of  financial  wealth  and  particularly  holdings  of  risky 
financial  assets  are  concentrated  among  wealthier  households.164  The  wealthier  the 
household, the more diversified its asset portfolio, and the more educated the household, 
the  higher  the  share  of  risky  assets.  Theory  provides support to this behaviour: equity 
holdings  offer  limited  diversification  gains  if  households'  non-financial  income  is 
closely  correlated  to  the  business  cycle.165  The  rising  share  of  bank  deposits  over  the 
last years and the fact that it increased particularly in vulnerable Member States suggest 
that  households  attribute  an  important  role  to  safety  and  predictability.  Losses  from 
investments in capital markets may also have a durable effect on portfolio choices. For 
example,  the  fall  in  equity  valuations  after  2000  led  households  in  most  EU  Member 
States  to  disinvest  from  quoted  shares.  In  most  of  the  larger  EU  Member  States,  this 
trend only reversed after 2005. Trust is a fundamental element of capital markets and it 
has been shattered by the financial crisis. In 2013, only 35% of retail investors trusted 
investment  services  providers  to  respect  consumer  protection  rules.166  Consumer 
protection  rules  are  seen  as  instrumental  in  restoring  retail  investors'  trust  in  capital 
markets.167 

While correcting information asymmetries can partly mitigate the risks stemming 
from uninformed financial investing, aspects of investor behaviour can still lead to 

162  Relevant  issues  include  that  nominal  instead  of  real  interest  is  taxed,  that  saving  for  retirement  is 
treated favourably, that mortgage interest can be deducted from tax, how capital gains of asset sales 
are taxed, and how inheritance taxes treat capital, see Campbell (2006). 

163  Modest transactions costs were found a significant determinant of non-participation in stock markets 

among US households, see Vissing-Jorgensen (2002). 

164  See Arrondel et al. (2014), Picketty (2014), OECD (2015), McCarthy(2004). 
165  See Vissing-Jorgensen (2002). 
166 See European Commission (2013), Market Monitoring Survey, 2010-2013. 
167  The EU strategy to restore trust in capital markets builds on  making sure that (i) consumer protection 
elements  of  existing  financial  services  legislation  is  properly  implemented  and  enforced,  (ii)  
consumers are provided with unbiased advice, (iii) suitable products are offered to retail investors, and 
(iv) products are transparent. 

62 

 
                                                 
poor investment decisions. The behavioural economics literature168 has illustrated that 
investor  decisions  are  influenced  by  cognitive  capacity  and  financial  literacy,  but  also 
by biases reflecting personal circumstances and psychological factors.169 Despite these 
limitations,  empirical  research  finds  that  most  households  deal  well  with  the 
information  restrictions  they  face  in  their  allocation  of  financial  wealth.  Some 
households, however, make mistakes, mainly pertaining to inadequate diversification in 
financial asset allocation and paying excess fees to intermediaries and advisors. 170. 

Financial  education and better  access to financial advice could help address high 
information  costs  that  discourage  households'  investment  in  capital  market 
instruments.  It  is  not  yet  evident  that  policy  measures  aiming  at  improving  financial 
literacy  are  efficient.  While  many  countries  started  financial  education  programmes, 
there  is  still  little  empirical  support  to  their  effectiveness  and  particularly  cost-
effectiveness.171  Since  most  measures  are  recent,  long-term  changes  to  behaviour  are 
not  yet  measureable.  It  is  also  questioned  whether  policies  that  exploit  behavioural 
economics  to  "nudge"  behaviour  contributes  to  improved  financial  literacy.  It  might 
therefore be more effective if households could obtain professional financial advice on 
affordable  terms.  In  the  majority  of  Member  States,  consumers  have  limited  access  to 
independent  consultation  on  investment,  insurance  or  saving  decisions  on  terms  that 
they  are  willing  to  pay.  Advisers  employed  by  financial  institutions  often  receive 
commission-based  pay  and  have  therefore  an  incentive  to  narrow  their  counsel  to 
products provided by their employer. Independent financial advisers are mostly used by 
the  wealthiest  households,  which  can  afford  the  cost  of  financial  advice.  For  many 
households, tax advice seems more relevant than financial advice, and many consumers 
are reluctant to pay upfront fees for financial advice. While financial advice could help 
overcome  information  problems,  a  number  of  factors  hold  back  the  development  of  a 
market  for  financial  advice.  For  example,  typical  retail  investment  portflios  are 
normally  small  and  may  not  cover  the  fixed  cost  of  a  full  and  independent  financial 
advisory service. 

Transaction costs may discourage a more widespread investment by households in 
investment  funds,  whose  development  cross-border  is  also  withheld  by  different 
factors.  For  households,  investment  in  funds,  for  example  Undertakings  for  the 
Collective Investment in Transferable Securities (UCITS), offer several advantages, in 
particular  diversification  gains,  limited  information  costs  and  targeted  exposures  to 
risks.172  Investment  funds  are  important  investors  in  debt  securities  and  in  equity  and 
have  become  an  increasingly  important  holder  of  corporate  bonds  over  the  last  years, 

168  See Chater, Huck and Inderst (2010) for a detailed literature review.  
169 De Meza et al. (2008) find that even though ordinary biases in decision-making are exacerbated by the 
specific characteristics of financial products, some of these biases persist even in financially literate 
individuals as they are closely related to psychological factors. 

170  For a review of empirical studies, see Campbell (2006). On suboptimal diversification in households 

portfolios, see also Polkovnichenko (2005). 

171  See, for example, Gale and Levine (2010), Lewis and Messy (2012) and the literature quoted therein. 
172  Households' information needs are met according to harmonised rules across the EU, understandable 
information provided to investors via the Key Information Document (KID), diversification rules, list 
of eligible assets (mainly listed underlying or highly liquid assets), possibility to be redeemed on the 
short term, etc. 

63 

 
                                                 
thereby  helping  larger  firms  to  reduce  bank  dependency.173  They  have  proven 
instrumental in fostering cross-border risk sharing. For example, while euro area banks 
reduced  international  exposures  and  re-focused  activity  on  domestic  markets  after  the 
crisis, investment funds increased their share of foreign debt and equity holdings during 
the  financial  crisis.174  Direct  ownership  by  private  households  of  UCITS  is  relatively 
low  in  Europe.175  Transaction  costs,  which  include  fees  and  charges  of  acquiring  or 
holding funds' shares vary significantly across Member States.176 They tend to be lower 
in Member States in which capital markets have a larger role in funding the economy, 
such as the UK, the Netherlands and Sweden. Market fragmentation and  a small fund 
size  result  in  proportionally  higher  costs  in  running  funds  and  prevent  the  EU  fund 
industry to realise scale effect to the same extent as their US counterparts do. A number 
of factors seem to hold back cross-border competition and cross-border mergers, which 
would via consolidation pressure lead to larger funds. Among them are local marketing 
and disclosure requirements, as UCITS are currently subject to different requirements in 
many  of  the  countries  in  which  they  are  sold.  This  means  that  several  host  regulators 
impose differing standards as to the content of the marketing material, prior approval of 
documentation, price of units and information publication in newspapers. Other factors 
limiting the take-up of cross-border funds in Europe are diverging national tax treatment 
and  reporting  requirements,  fees  to  be  paid  for  cross-border  notifications  and  the 
obligation to appoint a local paying agent. As a result, Europe has a multitude of funds, 
including  bonds,  equity,  money  markets,  mixed  and  specialised  funds,  distributed  by 
many  different  providers,  which  often  also  sell  their  own  funds.  At  end-2014,  there 
were 36 148 individual UCITS in the EU, which is four times more than the number of 
US  mutual  funds.  The  average  European  UCITS  fund  is  valued  at  EUR  200  million, 
which is one-seventh the size of typical US mutual funds which holds on average EUR 
1.6 billion in assets.177 

Capital  markets  are  not  yet  offering  a  wide  choice  of  products  to  households 
because  of  fragmentation.  Cross-country  comparisons  suggest  that  countries  with  a 
sizeable pension fund sector also tend to have deeper capital markets, for example the 
USA, the Netherlands and the UK.178 For many households, housing and life insurance 
are  important  means  to  save  for  the  long  term,  while  personal  pension  products  are 
hardly used. For instance, the personal pension product market is very limited in some 

173  In  early  2015, euro  area  investment  funds held  almost  EUR  300 billion of debt  securities  issued  by 
non-financial  corporations.  This  compares  to  outstanding  debt  securities  by  euro  area  non-financial 
corporations  of  EUR  1100  billion.  Under  the  assumption  that  euro  area  investment  funds  hold  only 
debt securities issued by euro area non-financial corporations, investment funds would have increased 
their share of total corporate bond holdings to 26% in early 2015 from 15% in 2008. 

174  ECB investment statistics show that the share of foreign debt securities in investment funds' holdings 
of debt securities increased to above 45% in 2015 from 30% in 2008, the share of equity assets to 48% 
from 40%.. 

175  According  to  EFAMA  (2014)  direct  ownership  by  private  households  accounted  for  24%  of 

investment fund ownership in the EU. 

176 The concept of transaction costs used here covers all the costs of using a financial intermediary. See 

Box 1 

177  EFAMA, International Statistical Release (2015); Funds of funds are not included, except for FR, DE, 

IT, LU. 

178  See, for example, Rocholl and Niggemann (2010), City of London (2011) and Meng and Pfau (2010). 

64 

 
                                                 
Central and Eastern EU Members, such as  Poland, Romania,  or Hungary. In addition, 
where they are somehow developed, personal pension products are developed to a very 
diverse  extent:  the  volumes  are  significantly  higher  in  Denmark  than  in  Spain  and 
France.179  Given  the  ageing  of  the  European  population  and  the  increasing  need  for 
citizens to save in order to be able to maintain their living standards in their old days, 
there could be demand for these products. A number of reasons may explain why this 
market  has  not  developed.  Since  personal  pension  products  typically  operate  on  a 
voluntary  basis  and  involve  implicit  and  explicit  contracts  over  several  decades,  trust 
and  understanding  are  particularly  important.  Governance  through  national  rules 
resulted in cross-border market fragmentation: personal pension products are subject to 
various  rules  at  EU  level  or  to  no  EU  legislation  at  all.180.  This  prevented  personal 
pension  providers  to  maximise  scale  economies  and  risk  diversification,  thereby 
reducing  choice  and  increasing  cost.  Households  would  benefit  from  more  choices  of 
personal  pensions  products  that  would  offer  capital  and  inflation  protection,  and  in 
particular  from  simple,  cost-effective,  transparent  and  trustworthy  methods  of 
personalised  savings  for  retirement.181  Growing  private  pension  provisions  would 
increase investment flows into capital markets. This, in turn, would support the diversity 
of participants in capital markets, particularly given the propensity of pension funds to 
allocate capital to a range of investment strategies and exploit the scale effects the single 
market for financial services offers. A developing market for personal pension products 
would  stimulate  competition  and  innovation  and  drive  down  costs.  In  this  context,  in 
line  with  the  mandate  given  by  the  European  Commission,  EIOPA  is  currently 
conducting a consultation to further explore the potential and possible characteristics of 
a standardised personal pension product, for example through a pan-European or "29th" 
regime.182 

4.3 Promoting capital market investments by institutional investors 

investment  products 

Institutional  investors  need  meaningful  information  ensuring  transparency  and 
comparability  across 
irrespective  of  the  channel  of 
distribution.  Although  institutional  investors  are  better  equipped  than  households  to 
deal with information problems, they need sufficiently clear information on the possible 
investment options to compare  them  and  to  make  an  informed  decision.  Disclosure  of 
investment  product  features,  associated  costs,  returns,  risks  and  benefits,  can  be  a 
powerful way of allowing investors to make informed choices about where and how to 
invest. Consistent disclosures and conduct rules across similar investment products are 
crucial  for  investors  not  to  be  nervous  about  investing  in  certain  products/markets 
because of concerns that transparency and investor protection may not be as robust for 
some  investment  product  or  in  certain  European  countries  they  are  investing  in. 
European  institutions  have  made  significant  progress  in  improving  the  disclosure 
requirements over the last years.  

179  See: EIOPA (2014). 
180  20 out of the 74 Personal Pension Products surveyed in the EIOPA database have no EU legislation 

applicable, see EIOPA (2014).  

181  A  personal  pension  product  would  also  be  a  solution  for  individuals  working  in  independent 

profession, or working in different Member States throughout their carreer.  

182  See EIOPA(2015), Lanoo et al. (2015). 

65 

 
                                                 
Box 8: Information problems are less severe on larger markets  

The  possibility  to  free-ride  on  information  gathered  by  other  people  creates  the  risk  of 
underinvestment in information collection in the first place. Economic research elaborated 
on  various  channels  through  which  more  participants  on  a  capital  market  would  reduce 
information problems. For example, information gathering is generally costly and will only 
be  undertaken  if  one  expects  to  be  able  to  pay  it  off  by  trading  profitably  on  its  basis. 
Agents  can  capitalise  on  costly  information  gathering  activity  only  if  other  agents  cannot 
free-ride  on  it,  for  example  by  imitating  their  trading  strategy.  The  possibility  for  these 
agents to disguise their trading strategy in a largely populated market gives them therefore 
more  incentives  to  undertake  costly  information  gathering  activity.183  A  second  argument 
that the impact of dominant market positions that are due to asymmetries in information or 
resource  endowment  are  in  general  less  severe  on  markets  with  many  participants.  The 
reason is that better informed players have a smaller impact on the market price if there are 
many other participants, unless the latter tend to imitation strategies and herd behaviour.  

A  variety  of  investment  restrictions  may  explain  the  rather  limited  portfolio 
exposure of institutional investors in specific asset classes. Banks have reduced their 
investment  in  a  number  of  asset  classes  over  the  last  years,  such  as  long-term 
infrastructure  projects  and  SME  lending.184  Rising  participation  of  institutional 
investors  in  these  areas  in  particular  would  help  fill  the  funding  gaps  caused  by  the 
retreat of banks. However, institutional investors have little exposure to these less liquid 
assets.  This  limited  exposure  may  sometimes  create  asset-liability  mismatches.  For 
instance, as pension funds face long-term liabilities, it would seem reasonable for them 
to invest predominantly in longer-term assets. Also, institutional investors are generally 
less exposed to funding risks than banks and are generally investing more in equity.185 
Barriers to investment on capital markets could be due to various market or regulatory 
failures.  They  include  insufficient  liquidity  and  fragmented  financial  information,  as 
well as structural factors, the importance of which varies for different types of investors. 
Asset  managers  are  generally  most  concerned  about  liquidity,  legal  frameworks  and 
difficulties  in  terms  of  information  access  and  costs  associated  with  necessary  due 
diligence and risk assessment on certain types of capital markets transactions. Investors 
such  as  insurers  and  pension  funds  are  arguably  less  worried  about  secondary-market 
liquidity  given  the  long-term  nature  of  their  liabilities,  but  are  often  constrained  by 
industry benchmarks and investment mandates, as well as in the case of pension funds 
by regulatory requirements.186 While those are important for governance of the financial 
intermediary with respect to ultimate holders and for prudential reasons, they limit the 
scope for investment in certain assets and cross-border. 

183 See Milgrom and Stokey (1982).  
184 See HLEG (2013), IMF (2014).. 
185  In the euro area, banks hold about EUR 1 500 billion in equity and investment funds, which represents 
5% of their total assets. Insurance corporations hold 10%, pension funds 11%, investment funds 15% 
of their balance sheet in shares and other equity. 

186  OECD  (2014)  catalogues  (i) portfolio  ceilings  on  pension  fund  investment  by  broad  asset  classes, 
(2) quantitative restrictions on foreign investment and (3) other quantitative restrictions classified by 
type of regulation. 

66 

 
 
                                                 
Asset allocation in insurance and pension funds,  
total assets 2014 in % 

Total 
billion, 
national 
currency 

Currency 
and 
deposits 

Loans 

Bonds 

Shares 
and other 
equity 

Investment 
funds 

other 

Insurance corporations 

FR 
DE 
IT 
NL 
other EA 
UK (2013) 
USA 
(2013) 

2418 
1884 
679 
511 
1350 
1516 

1.4 
19.3 
4.2 
2.9 
7.7 
5.3 

1.5 
14.1 
1.4 
16.8 
3.5 
2.4 

59.8 
17.4 
65.2 
39.7 
47.8 
25.7 

7511 

1.0 

0.0 

51.6 

Pension funds 

1256 
543 
124 
241 
1673 

NL 
DE 
ES 
other EA 
UK (2013) 
USA 
0.6 
(2013) 
Source: ECB and OECD (for UK and USA). 

1.1 
29.2 
12.6 
5.8 
2.6 

16892 

2.9 
5.1 
0.0 
0.7 
32.0 

23.9 
10.7 
58.4 
36.1 
23.6 

0.2 

21.1 

10.6 
11.5 
10.3 
4.7 
8.6 
24.8 

29.1 

12.3 
2.7 
10.5 
29.2 
16.7 

50.7 

20.7 
28.8 
16.9 
19.5 
20.1 
NA 

6.0 
8.9 
1.9 
16.4 
12.2 
41.8 

NA 

18.2 

49.2 
44.0 
10.3 
25.5 
NA 

NA 

10.6 
8.3 
8.2 
2.7 
25.1 

27.4 

Lowering  barriers  to  investment  will  alter  asset  allocations.  Current  prudential 
regulation may impact on the possibility or appetite to invest into specific assets through 
the calibration of capital charges and the qualitative and quantitative investment limits. 
Market  practitioners  state  that  financial  regulation  is,  on  the  one  side,  dissuading 
investment in assets such as in infrastructure, (private) (non-listed) equity and (unrated) 
debt  for  securitized  assets  and,  on  the  other  side,  creating  comparative  advantages  to 
other  asset  classes.187  Occupational  pension  funds  are  said  to  be  exposed  to  national 
restrictions  on  their  investment  opportunities.  The  removal  or  recalibration  of  these 
restrictions  will  need  to  be  carefully  assessed  against  prudential  objectives  and 
principles of consumer protection.  

187  See HLEG (2013). ESRB (2015) flags favourable treatment of sovereign debt in bank and insurance 

regulation.  

67 

 
 
 
 
 
 
 
                                                 
Chart  23:  Securitisation  in  Europe,  total  in  EUR 
billion 

Chart  24:  Securitisation,  outstanding  amounts 
breakdown by collateral 2014 

Notes:  ABS:  asset-backed  securities;  CDO:  collaterised  debt  obligations;  MBS:  mortgage-backed  securities;  CMBS:  commercial 
mortgage-backed  securities;  RMBS:  residential  mortgage-backed  securities;  SME:  small  and  medium-sized  enterprises;  WBS: 
whole business securitisation. RMBS in 2010-Q4 = EUR 1.350 billion. 
Source: AFME, SIFMA, ECB and own calculations. 

Though  EU  securitisations  performed  far  better  than  their  US  counterparts  during  the 
crisis,  until  now  market  issuance  did  not  pick  up  again.  Since  the  beginning  of  the 
financial  crisis,  European  securitisation  markets  have  remained  very  subdued  in  terms 
of  new  issuance  volumes.188  Low  demand  for  securitisation  products  reflects  a 
problem of negative perceptions, caused by the role played by securitisation markets in 
the US subprime crisis. This negative perception is reflected in low investor confidence 
in  securitised  products  and  relatively  onerous  capital  charges  on  such  products  under 
prudential  regulation.  Yet,  this  has  little  to  do  with  the  actual  performance  of  EU 
securitisation  during  and  after  the  financial  crisis  itself189.  Looking  at  AAA-rated 
securities, products backed by US residential mortgages (RMBS) reached default rates 
of 16% (subprime) and 3% (prime). By contrast, default rates of AAA EU RMBS never 
rose  above  0.1%.  The  divergence  is  even  bigger  for  BBB-rated  products  where  US 
RMBS' default rates peaked at 62% and 46% (subprime and prime, respectively) while 
EU  products'  default  rates  peaked  at  0.2%.  Set  in  the  wake  of  the  US  securitisation 
markets crash, capital requirements for exposures to securitisation have been calibrated 
on  such  markets'  performance,  leading  to  "an  unduly  conservative  treatment  of 
relatively 
less  risky  securitisations".190  Moreover,  securitisation  may  receive 
unbalanced  regulatory  treatment,  for  example  versus  covered  bonds.191  Since  a  bank 

188  In contrast, US securitisation markets have recovered more strongly, but they are structurally different 
from  EU  markets  with  almost  80%  of  securitisation  instruments  benefiting  from  public  guarantees 
through the US Government Sponsored Agencies (e.g. Fannie Mae and Freddy Mac). 

189  EU  securitisation  here  refers  to  the  origin  of  assets  that  back  the  security,  not  the  origin  of  the 

financial  institution that issues the security. 

190  European Banking Authority (2014), see also Bank of England and ECB (2014). 
191  Covered  bonds  are  also  referred  to  as  ‘on  balance-sheet’  securitisation,  because  the  collateral  pool 
remains  on  the  banks’  balance  sheet.  Although  covered  bonds  with  characteristics  identical  to  a 
specific  securitisation  tranche  may  merit  lower  capital  charges  due  to  the  dual  recourse  rights 

68 

 
 
 
 
                                                 
 
can choose in favour of either funding option, covered bonds may currently appear more 
attractive.192  

conferred on investors (i.e. underlying asset pool and the bank itself), some argue that the capital risk 
weights are effectively tilted in favour of covered bonds.  

192  Finally, the current macroeconomic environment with ample access to central bank liquidity at ultra-

low interest rates may not be conducive to banks' incentive to undertake securitisation activity. 

69 

 
                                                                                                                                               
Chapter 5  REAPING  OPPORTUNITIES  TO  PROMOTE  CROSS-BORDER 

MARKET FUNDING 

This Chapter provides a more thorough insight into the barriers and obstacles that relate, 
in particular, to cross-border capital market transactions. It starts with a brief overview 
of the economic benefits stemming from cross-border capital flows, before dwelling in 
more detail on those aspects of capital markets organisation that appear to be the most 
relevant  in  a  cross-border  context.  These  cover  insolvency  procedures,  company  law, 
tax  barriers,  financial  market  infrastructures,  as  well  as  supervisory  and  regulatory 
practices at Member State level. 

5.1 Benefits and determinants of cross-border investments 

There  is  a  broad  consensus  in  the  literature  that  cross-border  investment  is 
beneficial  to  both  the  investing  and  the  recipient  economies.  The  main  benefits  of 
cross-border  financial  integration  are:  greater  efficiency  of  the  economy  and  of  the 
financial  system,  and  better  capacity  to  smooth  the  business  cycle.193  Although  these 
economic benefits of financial integration are undeniable, cross-border capital flows194 
can also pose policy challenges and imply significant risks, especially if they are large 
and debt-based. Large and rapid increase of foreign debt, in particular of short maturity, 
can  generate  macroeconomic  imbalances,  unless  properly  channelled  into  an  efficient 
use of the recipient economy. Possible negative effects include asset price inflation and 
rapid credit growth, raising the risk of sudden reversals and the need for adjustments in 
the  real  economy  associated  with  boom  and  bust  cycles.  Foreign  direct  investment 
(FDI) and equity portfolio investment are found to be more conducive to efficient cross-
border risk sharing than bond portfolio investment or credit flows, which tends to bring 
stability to the economy.  

Cross-border  market  integration  helps  creating  larger  capital  markets.  Lifting 
national barriers brings more market participants, hence enhancing liquidity. As markets 
grow larger, agents have greater incentives to spend resources in information gathering 
(see Box 8). The larger the market, the better can risks be allocated, i.e. transferred from 
risk-averse  to  risk-loving  agents.  The  postulated  economic  effect  assumes  that,  on 
average, if agents can reduce or hedge their exposure to risks, they are comfortable with 
taking  on  more  risk.  A  large  investor  base  also  allows  to  segment  markets  into  more 
specialised financial assets to be traded with a sufficient number of traders.  

The  quality  of  host  country  institutions  is  one  of  the  key  determinants  for  cross-
border  investment  a  country  attracts.  Empirical  research  confirms  that  legal  and 
institutional characteristics have a significant impact on the type and amount of capital 
received from abroad. These include information disclosure, accounting standards, costs 

193  See ECB (2012) and the literature quoted therein. 
194  Consisting of FDI, portfolio investment and other investment: FDI can be subdivided into reinvested 
earnings,  intracompany  loans  and  private  equity  (greenfield,  brownfield,  mergers  and  acquisitions); 
portfolio investment includes bonds and shares; whilst other investment mainly consists of interbank 
loans, trade credit and government aid. 

70 

 
                                                 
of legal disputes.195 World Bank indicators reveal enormous differences in issues such 
as  getting  credit,  protecting  minority  investors,  paying  taxes,  enforcing  contracts, 
resolving insolvency across the EU Member States (see Section 2.2). The roots of these 
differences  are  in  different  informal  norms  and  enforcement  practices  developed 
historically  in  the  Member  States.  At  the  same  time,  cross-border  comparisons  found 
that  the  quality  of  institutions  is  a  decisive  determinant  of  an  economy's  income 
especially  those  that  protect  property  rights  and  help  enforce  contracts.196  The 
fragmentation  of  financial  markets  will  subsist  without  genuine  convergence  of  the 
functioning of institutional framework conditions to the best practice in the EU. 

The availability of information about the host country is another important driver 
for  cross-border  investment.  Cross-border  investment  implies  higher  information 
costs  and  often  higher  transaction  costs,  which  prevents  private  households  from 
investing abroad and so contributes to the home bias.197 In a 2012 Eurobarometer poll, 
94%  of  the  respondents  said  that  they  "have  never  purchased  a  financial  product  or 
service from another Member State". 20% did not consider doing so, arguing that they 
neither  "see  the  benefit  or  the  need".  Therefore,  cross-border  asset  holding  is 
concentrated among institutional investors, whose rising market share has been shown 
to  have  significantly  contributed  to  the  internationalisation  of  capital  markets.198 
Investment  funds  are  internationally  diversified  because  they  employ  specialised 
analysts to understand the many relevant dimensions of foreign investment: familiarity 
with  the  foreign  issuer,  its  business  fields,  accounting  practices,  property  rights, 
insolvency law, etc. Yet, certain transaction costs are high and difficult to reduce even 
for  institutional  investors,  for  example  in  the  case  of  risky  investment.  When  the 
borrower  is  unlikely  to  pay  back,  a  number  of  legal  issues  occur,  which  are  more 
difficult  to  assess  in  a  cross-border  context,  such  as  company  law,  securities  law, 
insolvency procedures, access to collateral etc. differ across countries. 

The aforementioned frictions constitute barriers to the free movement of capital in 
the  EU.  The  principle  of  free  movement  of  capital  (Art.  63  TFEU)  prohibits  all 
restrictions  on  the  movement  of  capital  and  on  payments  within  the  EU  as  well  as 
between  Member  States  and  third  countries.  Recent  major  legislative  steps  by  the  EU 
are  facilitating  the  movement  of  capital  in  Europe  by  providing  full  harmonisation  in 
specific  areas,  in  particular  the  banking  sector  (Capital  Requirements  Regulation199, 
Banking Union) and the insurance sector (Solvency II 200). However, the absence of full 
harmonization  in  several  other  financial  markets'  areas  can  open  the  door  for  national 

195  Daude and Fratzscher (2008) find that portfolio  investment is sensitive to the degree of information 

disclosure, accounting standards, the risk of expropriation and costs of disputes. 

196  See Rodrik et al. (2002) 
197  Distance and telecommunication costs have been shown to be significant determinants of home bias, 

see Portes and Rey (2005), Jochem and Volz (2011), Van Nieuwerburgh and Veldkamp (2006). 

198  See Schoenmaker and Bosch (2008), Schoenmaker (2014). 
199  Regulation  (EU)  No  575/2013  of  the  European  Parliament  and  the  Council  of  26  June  2013  on 
prudential  requirements  for  credit  institutions  and  investment  firms  and  amending  Regulation  (EU) 
No 648/2012 

200  Commission  Delegated  Regulation  (EU)  2015/35  of  10  October  2014  supplementing  Directive 
2009/138/EC  of  the  European  Parliament  and  of  the  Council  on  the  taking-up  and  pursuit  of  the 
business of Insurance and Reinsurance  

71 

 
                                                 
legislative ('gold plating) or administrative rules that may go beyond EU legislation and 
de facto restrict capital flows. 

Quality  of  regulation  and  enforcement  are  central  to  attract  investment  from 
outside  the  EU.  Investors  from  abroad  may  have  even  more  difficulties  overcoming 
information frictions in view of their larger geographical distance and possibly different 
legal and cultural background. Trust in the quality of legal framework conditions and in 
particular of their enforcement has been identified as crucial for an economy to attract 
foreign financial investment.201 Since unfamiliarity with foreign legal conditions means 
investors  have  to  carry  extra  costs  when  investing  in  foreign  jurisdictions,  similarity 
between  rules  across  jurisdictions  would  spur  cross-border  investment.  This  factor 
explains the importance law makers attach to regulatory convergence and international 
cooperation  when  developing  regulation.  Along  similar  lines,  the  role  of  international 
associations in developing standards on behalf of the private investors' community can 
hardly been underestimated as a factor crucial for cross-border investment. 

5.2 Insolvency rules and procedures and company law 

Insolvency rules have a key role in addressing the debt overhang and high level of 
non-performing loans, which hurt the European economy. First, lenders are unable 
or  unwilling  to  provide  funding  to  firms  having  non-performing  loans  or  they  charge 
prohibitive rates. This results in less credit being available to the economy.  Second, as 
highly  indebted  companies  use  their  profit  to  repay  their  debts,  lagging  debt 
restructuring leads to lower investments. Third, excessively leveraged banks and firms 
are more vulnerable to economic or financial shocks 

In many EU Member States, insolvency procedures fail to maximise the prospects 
for asset recovery. About half of all newly created companies do not survive their first 
five  years  of  activity.  In  order  to  survive,  these  companies  require  access  to  a 
restructuring  procedure  with  creditors  as  well  as  emergency  fresh  financing,  likely 
requiring  special  legal  protection.  The  possibility  to  restructure  debt  would  help  those 
that  are  viable  avoid  entering  into  liquidation  procedures.  An  insolvency  regime  that 
encourages  more  debt  restructuring  can  improve  the  creditworthiness  of  viable 
companies by facilitating their deleveraging. 

201  See Carjavall and Elliot (2009), CRA (2009), Kaditi (2010). 

72 

 
                                                 
Chart 25: Strength of insolvency framework and non-performing loans 

Many European insolvency and restructuring frameworks seem unclear, inflexible 
and costly.202 The effectiveness of insolvency laws can be measured by their ability to 
lead to predictable outcomes at the end of procedures which are short, cost-effective and 
offering  less  recourse.  For  example,  the  debt  discharge  period  takes  between  five  to 
seven  years  in  most  EU  countries,  compared  to  less  than  one  year  in  the  US.  This 
shorter  discharge  periods  allowed  US  households  to  recover  more  quickly  from  the 
financial crisis and is deemed to be one factor behind the swifter economic recovery in 
the US compared to the EU.203 Moreover, less recourse insolvency laws have positive 
microeconomic effects: if debtors are not required to hand-over income, the incentive to 
work increases. In the US those debtors not required to hand over income earned in the 
following year on average over USD 6 000 more income than those debtors required to 
hand-over  income,  and  were  23%  less  likely  to  default  on  primary  home  loans.204  In 
contrast,  most  EU  Member  States  require  handing-over  assets  and  income  and  are 
therefore full-recourse. The current recourse regime, with limited risk-sharing between 
financial investors and firms, may disincentivise small companies from taking risks and 
growing. Easily accessible restructuring procedures could improve the predictability of 
the  outcome  of  insolvency  proceedings  and  reduce  the  transaction  costs  generated  by 
the insolvency administration. 

Ineffective  and  divergent  insolvency  regimes  represent  an  investment  deterrent. 
Disparate insolvency regimes in the EU generates unpredictability for EU cross-border 
investments.  This  was  confirmed  by  the  responses  to  the  Green  Paper  on  the  Capital 
Markets  Union.  When  making  investment  decisions,  investors  look  at  their  rights  and 
expected losses in the event of financial difficulties. If before making an investment it is 
not  possible  to  predict  clearly  what  will  happen  with  the  investment  throughout  its 
lifecycle, it is also not possible to identify, quantify and manage risks which can affect 

202  See Davydenko et al (2008). 
203  See Gros (2014). 
204  The U.S. does not require debtors to hand-over assets and income under Chapter 7 of U.S. Code for 

natural persons and is therefore non-recourse. 

73 

 
 
                                                 
this  investment.  This  will  impact  the  readiness  of  investors  to  invest  in  particular 
markets.  The  insufficient  clarity  and  predictability  in  case  of  insolvency  deter,  in 
particular, corporate higher-risk segments (such as mezzanine and high-yield debt). 

Differences  in  insolvency  frameworks  particularly  impede  the  flow  of  capital 
across the EU. In the context of 28 divergent insolvency regimes in the EU, investors 
are facing high costs in assessing the risks associated with the potential bankruptcy of 
the company in which they invest. Companies in financial difficulty which do not have 
effective  early  restructuring  possibilities  in  their  home  country  have  an  incentive  to 
relocate to Member States with more effective systems.205 At the same time, relocation 
triggered  by  differences  in  insolvency  regimes  might  lead  to  the  application  of  a 
different insolvency regime than originally expected by creditors. This adversely affects 
minority creditors even though the restructuring itself could be beneficial to the body of 
creditors and the company as a whole. Additional costs for creditors after the relocation, 
i.e. costs of legal advice and costs related to a shift in the centre of main interests, may 
be  a  barrier  for  creditors  to  properly  manage  their  interests  in  recovering  the  debt, 
especially when the debt is relatively low. 

Despite  ongoing  efforts  to  improve  European  insolvency  and  restructuring 
procedures,  important  differences  persist  across  Member  States.  World  Bank 
indicators suggest that resolving an insolvency can take between less than one year in 
Ireland, Belgium and Finland and more than three years in Bulgaria, Romania, Greece 
and the Slovak Republic (Chart 26). The recovery rate varies between 30% in Croatia 
and Romania  and 90% in  Belgium and Finland (Chart 27).  A study commissioned by 
the  European  Parliament  had  shown  that  disparities  between  national  insolvency  laws 
can  create  obstacles,  competitive  disadvantages  and  difficulties  for  companies  with 
cross-border activities or ownership within the EU.206 Unlike the US where bankruptcy 
is  regulated  at  the  federal  level,  in  the  EU  insolvency  proceedings  are  regulated  at 
national  level.  In  the  absence  of  EU  action,  the  discrepancies  between  the  Member 
States''  insolvency  legislations  are  likely  to  continue  to  create  costs  for  cross-border 
creditors,  incentives  for  forum-shopping  and  obstacles  to  the  re-organisation  of  cross-
border groups of companies. 

205  The high costs of relocating make it very difficult if not impossible for SMEs to benefit from better 

restructuring possibilities in other Member States. 

206  INSOL (2010). 

74 

 
                                                 
Chart 26: Number of years required to enforce a contract or resolve an insolvency 

Chart 27: Recovery rate in enforcing a contract  or resolving an insolvency 

75 

 
 
 
 
 
 
 
 
Box 9: European Commission recommendation on a new approach to business failure 
and insolvency 
The  European  Commission  has  addressed  a  Recommendation207  to  the  Member  States  to 
encourage  them  to  put  in  place  minimum  standards  on  early  restructuring  procedures  and 
second  chance  for  natural  persons.  The  Recommendation  has  been  partially  taken  up  by 
some  Member  States,  especially  by  those  receiving  insolvency  recommendations  in  the 
context of the European Semester exercise addresing macro-economic imbalances.208 Even 
those  Member  States  which  have  taken  up  the  European  Commission  Insolvency 
Recommendation did so in a selective manner, meaning that differences remain. 

The Recommendation and the subsequent evaluation of its implementation notably focused 
on preventive restructuring procedures, as enterprises do not have the same opportunities 
to deal with their financial difficulties everywhere in the EU. Several conditions contribute 
to the efficiency of restructuring procedures, but six in particular seem to stand out: 

(i)  The  possiblity  to  file  early  with  the  objective  of  avoiding  insolvency:    The  later  a 
business initiates restructuring proceedings, the higher the costs of restructuring and the 
lower the management powers and success rate.  

(ii)  The  position  of  the  debtor:  In  order  to  encourage  debtors  to  address  their  financial 
difficulties at an early stage, they should be left in principle in control of the day-to-day 
operation  of  their  business.  This  would  also  ensure  that  the  least  disruption  to  the 
activity of the enterprise. 

(iii) The possibility of a stay on individual enforcement actions: During negotiations on 
a  restructuring  plan,  the  debtor  should  be  able  to  apply  to  a  court  for  suspension  of 
individual  enforcement  actions  which  could  otherwise  jeopardise  the  success  of  the 
restructuring process. 

(iv)  Adoption  of  the  restructuring  plans  by  creditors:  Restructuring  plans  should  be 
adopted by creditors representing the majority stipulated under national law. 

(v)  The  protection  for  new  finance  granted  in  restructuring  procedures:  Encouraging 
new financing is necessary to ensure the success of a restructuring plan. 

(vi)  The  involvement  of  courts  when  third  party  rights  could  be  affected:  While  the 
Recommendation  encourages  some  limits  to  the  extent  of  court  involvement,  certain 
steps  in  a  restructuring  process  require  court  involvement,  notably  when  the  rights  of 
dissenting creditors are affected. 

The  Recommendation  also  focused  on  second  chance  provisions,  urging  Member  States  
to provide for a reasonable discharge period of maximum three years from the opening 
of  liquidation  of  assets  proceedings  or,  in  cases  where  a  repayment  plan  has  been 
approved, from the moment the plan is put into application. 

207 See European Commission (2014b).  
208 See European Commission (2015c). 
http://ec.europa.eu/justice/civil/commercial/insolvency/index_en.htm 

76 

 
                                                 
 
While the Recommendation has provided useful focus for those Member States undertaking 
reforms  in  the  area  of  insolvency,  it  has  not  succeeded  in  having  the  desired  impact  in 
facilitating the rescue of businesses in financial difficulty and in giving a second chance to 
entrepreneurs because of its only partial implementation in a significant number of Member 
States, including those having launched reforms. These differences in the implementation of 
the  European  Commission  Recommendation  mean  continuing  legal  uncertainty  and 
additional costs for investors in assessing their risks and persisting barriers to the efficient 
restructuring of viable companies in the EU, including cross-border enterprise groups. 

Inefficient  and  divergent  insolvency  proceedings  in  the  EU  prevent  speedier  debt 
restructuring.  Instrumental  in  this  context  was  also  the  larger  market  for  distressed 
debt in the USA compared to the EU. The US high-yield209 and distressed debt market 
has  a  well-diversified  investor  base,  including  more  traditional  distressed/alternative 
investors (e.g. private equity and hedge funds), as well as pension funds, insurers, and 
investment  funds.  In  contrast,  the  investor  base  is  much  smaller  in  Europe,  with  US 
investors  currently  dominating  both  high  yield  bond  and  loan  markets  in  the  EU.  The 
comparison with the US demonstrates that the problem of non-performing loans is more 
difficult to resolve without effective restructuring and insolvency tools.210  

Another  area  where  important  institutional  differences  are  observed  is  company 
law.  World  Bank  indicators211  provide  a  good  illustration  for  diversity  in  approaches 
across  EU  Member  States  in  this  area.  For  example,  despite  harmonisation  achieved 
through  the  existing  shareholder  rights  directive,  cross-border  exercise  of  shareholder 
rights  is  still  difficult.212  The  length  and  complexity  of  equity  holding  chains  together 
with diverging national rules and inadequate market practices make cross-border voting 
difficult and sometimes impossible. Efficient minority protection is particularly relevant 
in companies with controlling or dominant shareholders, which is the prevailing model 
in  continental  Europe.  These  different  national  models  are  often  rooted  in  national 
traditions and aim at responding to the specific needs of local markets. However, these 
divergences  make  cross-border  investment  more  difficult  and  costlier  as  investors  are 
faced with a great variety of rules and models of functioning. The disadvantage, relative 
to  domestic  insiders213,  becomes  particularly  severe  in  case  of  investments  that  face  a 
non-negligible probability of defaulting. 

5.3 Withholding tax and other tax barriers to cross-border investments 

A  further  barrier  to  cross-border  investment  in  Europe  is  the  diversity  in  the 
application  of  withholding  taxes.  While  many  Member  States  require  companies 
paying  dividends,  interest  and/or  other  securities'  income  to  deduct  a  withholding  tax 

209  High-yield  debt  instruments  are  bonds  or  loans  which  are  issued  by  corporate  borrowers  with  non-
investment  grade  credit  ratings  –  on  the  S&P/Fitch  and  Moody's  rating  scales  this  is  equivalent  to 
BB+  or  Baa3  (and  below),  respectively.  In  this  context,  securities  that  had  previously  had  an 
investment-grade rating, and are subsequently downgraded (known as "fallen angels"), are also part of 
the high-yield debt asset class 
210  See Liu and Rosenberg (2013).  
211  See World Bank (2015). 
212  This was highlighted by numerous responses to the public consultation. 
213  See Schoenmaker (2014). 

77 

 
                                                 
and  remit  it  to  the  local  tax  authorities,  the  tax  treatment  applied  to  different  types  of 
investors  and  the  investment  products  varies  widely.  Withholding  taxe  rates, 
exemptions and relief procedures are subject to different domestic rules. 

The  diversity  and  complexity  of  procedures  to  claim  tax  treaty  benefits  on 
investment  income  poses  further  obstacles.  Rates  of  withholding  tax  on  securities 
income can often be reduced or even eliminated under double taxation treaties between 
countries  or  under  domestic  law.  However,  the  procedures  for  claiming  the 
reductions/exemptions are often demanding, resource-intensive and costly for investors, 
and  are  therefore  a  deterrent  to  cross-border  investments,  as  pointed  out  in  several 
reports  of  expert  groups  tasked  by  the  European  Commission.  214  Some  countries 
require  individual  investors  to  make  claims  for  relief  themselves  rather  than  allowing 
financial institutions to do so on their behalf even though this is a nearly impossible task 
for the investors in question because they lack the expertise to make these claims. An 
investor  may  need  to  make  claims  in  several  Member  States,  because  the  financial 
institution  acting  on  his  behalf  may  have  invested  in  several  countries.  The  forms  for 
making  the  claims  may  differ  radically,  change  periodically,  and  be  in  languages  that 
the  investor  does  not  understand.  It  is  estimated  that  approximately  56  different  tax 
reclaim forms exist within the EU.  A further complication is that, in today's globalised 
world,  there  is  often  a  chain  of  financial  institutions  between  an  investor  and  the 
Member  State  of  the  source  of  income.  Alternatively,  Member  States  may  allow 
financial  institutions  to  make  claims  for  relief  on  behalf  of  investors  but  in  that  case 
they may insist that the claims are made by local financial institutions, denying foreign 
financial  institutions  the  opportunity  of  doing  so.  Finally,  the  length  of  time  that  a 
Member State takes to pay out refunds of withholding tax under tax treaties or domestic 
law can vary from a few weeks to several years.   

The economic impact of the complexity of reclaim procedures for withholding tax 
is significant. The European Commission estimated three types of costs associated with 
an  inefficient  withholding  tax  system:215  (i)  the  opportunity  cost  to  investors  due  to 
delayed claims and payments of tax refunds estimated at EUR 1.84 billion per year; (ii) 
the foregone tax relief associated with investors not claiming the tax to which they are 
entitled  because  of  the  complexity  and  duration  of  the  procedures  estimated  at  EUR 
5.47 billion per year; and (iii) the actual amount of costs for tax administrations related 
to the reclaim procedures (paperwork, etc) estimated at EUR 1.09 billion per year. 

Despite  the  initiatives  that  have  been  taken  in  this  area,  difficulties  in  claiming 
withholding  tax  relief  remain  a  major  barrier  to  cross-border  investment.  The 
European  Commission  adopted  in  October  2009  a  Recommendation  on  Withholding 
Tax  Relief  Procedures216,  which  aimed  at  facilitating  cross-border  claims  for 

214  See Giovannini Group (2001, 2003); the 2006 and 2007 reports by the EU Clearing and Settlement 
Fiscal  Compliance  Experts'  Group  ("FISCO");  the  2013  Report  by  Tax  Barriers  Business  Advisory 
Group (T-BAG) 

215  See European Commission (2009b). 
216  Commission recommendation of 19 October 2009 on withholding tax relief procedures C/2009/7924 

78 

 
                                                 
withholding  tax  relief  on  investment  income.217  The  OECD  also  worked  in  the  same 
field,  developing  with  its  members,  including  EU  Member  States  and  the  European 
Commission, a package218 of documents and procedures that was designed as a single 
system  for  use  throughout  the  world  by  financial  institutions to claim withholding  tax 
relief  on  behalf  of  investors,  while  reporting  regularly  to  tax  administrations  so  as  to 
ensure investor compliance. But there have been few improvements to Member States' 
withholding tax relief procedures, and there are no substantial moves in the direction of 
the  single,  streamlined  relief  system  that  most  of  the  financial  industry  claims  is 
necessary219.  

A  related  problem  is  the  discriminatory  tax  treatment  of  some  investors.  For 
instance,  in  the  European  Commission's  White  Paper  on  Pensions220,  a  study  on 
discriminatory taxation of cross-border investments by pension funds and life insurance 
companies was announced. EU pension funds have assets under management of around 
EUR 2.5 trillion, insurance companies around EUR 7 trillion. They may have invested 
considerable parts of their assets in other Member States. If taxes on these cross-border 
investments  are  levied  contrary  to  EU  law,  the  amounts  unduly  levied  would  be 
considerable and would negatively influence investment decisions.  

Finally, taxation should not be a deterrent to cross-border investment activities by 
venture  capital  funds.  A  2008  European  Commission's  Experts'  Group  report  on 
removing  tax  obstacles  to  cross-border  venture  capital  investments221  pointed  to 
mismatches  between  Member  States  as  regards  the  tax  treatment  of  the  five  major 
components  to  a  venture  capital  fund  and  its  investments  (the  investors,  the  venture 
capital fund itself, the venture capital management company, the portfolio company and 
the  advisory  companies).  This  can  lead  to  double  or  triple  taxation  and  result  in  the 
tendency  for  venture  capital  to  be  restricted  to  domestic  national  markets  rather  than 
extending  across  the  larger  EU  and  international  markets.  However,  the  above 
mismatches can also be used to avoid taxes in one or more jurisdictions. In addition to 
cross-border  dimension,  an  increasing  number  of  Member  States  are  encouraging 
business angel and venture capital investment through tax incentives schemes to support 
investment in SMEs and the supply of early stage venture capital.  

217  The Recommendation notably (i) encouraged Member States to apply at source, rather than by refund, 
any withholding tax relief applicable to securities income under double taxation treaties or domestic 
law;  and  (ii)  where  tax  relief  at  source  is  not  feasible,  quick  and  standardised  refund  procedures 
should  be  in  place,  listing  possible  elements  of  such  refund  procedures.  The  Recommendation  also 
encouraged Member States to authorize financial intermediaries meeting specific conditions, such as 
accepting  liability  for  mistakes  and  committing  to  regular  reporting  arrangements  to  source  and 
residence states,  to claim at source the tax relief on behalf of the investor. 

218 TRACE (Treaty Relief and Compliance Enhancement) – Implementation Package for the adoption of 

the Authorised Intermediary System, January 2013. 

219  First Report of the Commission AEFI expert group on the implementation of Directive 2014/107/EU 

for automatic exchange of financial account information, March 2015. 

220  White  paper  "An  agenda  for  Adequate,  Safe  and  Sustainable  Pensions",  COM(2012)  55  final, 

16 February 2012.  

221  Report of Expert Group on removing tax obstacles to cross-border Venture Capital Investments 

79 

 
                                                 
5.4 Financial market infrastructures 

Fragmented market infrastructures act as barriers to the free movement of capital. 
Financial  market  infrastructures  provide  essential  services,  such  as  trading  order 
execution,  confirmation  and  registration  of  trades,  clearing  and  settlement,  custodian 
services  and  collateral  management.  They  also  collect,  record  and  disseminate  data 
about  trading  volumes  and  prices  throughout  the  financial  system.222 Financial market 
infrastructures include stock  exchanges, trade repositories, clearing  houses and  central 
counterparties (CCPs), central securities depositories (CSDs) and custodians. There are 
also  different  types  of  trade  execution  channels:  direct  trading,  voice  broker  and 
electronic  trading  (e-trading).  Numerous  market  infrastructure  providers  offer  their 
services  in  the  EU:  ESMA  lists  104  regulated  markets  and  153  multilateral  trading 
facilities;  it  authorised  16  central  counterparties  and  6  trade  repositories;  the  CSD 
factbook  lists  30  CSDs  in  the  EU  of  which  20  in  the  euro  area  including  two 
international CSDs.223   

There is evidence that cross-border trades are on average still more expensive than 
domestic  trades.224  For  example,  some  fund  management  firms  may  incur  up  to  ten 
times  higher  costs  on  identical  services  simply  due  to  securities  being  registered  and 
held with intermediaries domiciled in different Member States. The difference in costs 
for post-trading services between domestic and cross-border transactions may have even 
grown in the period 2006-2009, due to the fact that the decrease in domestic costs has 
been more rapid than the decrease in cross-border costs. Such cost differences may stem 
from a number of factors: (i) cross-border barriers such as divergent securities holdings 
laws; (ii) economies of scale and the ensuing variation in costs across jurisdictions225; 
and (iii) variation in the exact type of service provided. As the financial crisis incited a 
shift  towards  collateralised  transactions,  infrastructures  that  foster  cross-border 
collateral management have become particularly relevant.   

Trading and post-trading systems condition the level of transparency and the way 
information  is  processed  in  markets.  Dissemination  of  information,  efficient  price 
formation  and  homogeneous  data  availability  can  be  hampered  by  fragmented 
architecture, aggravating the lack of liquidity. This is particularly true for debt markets: 
corporate  bonds  are  still  overwhelmingly  traded  over-the-counter  via  telephone  and 

222  For  an  overview  of  the  payment,  clearing  and  settlement  system  in  the  EU  Member  States  and  the 

euro area, see CPSS (2012). 

223  See ECSDA (2014).  
224  See Oxera (2011). 
225  Economies of scale are a significant factor in the business model of financial market infrastructures. 
This is for example reflected in the established practice of volume discounts. It implies that using a 
broker or custodian in a jurisdiction other than that where the securities were issued is generally more 
expensive  (unless  it  is  a  global  player  facing  many  cross-border  transactions  in  this  security)  than 
using a local agent, due to the lower transaction volumes in this particular class of securities. Thus, the 
relative cost of trading securities domiciled in a specific country is likely to reflect the general cost of 
trading in that country. Typically, trading costs are higher in some of the smaller and less developed 
markets.  When  an  investor  located  in  a  bigger  financial  centre  transacts  in  securities  in  a  smaller 
financial centre, the trading cost is likely to be higher relative to domestic transactions. The combined 
effect of scale economies and variation in costs across financial centres provides incentives for listing 
and trading in major financial centres. 

80 

 
                                                 
recorded  manually.  As  a  result,  transaction  prices  for  traded  bonds  have  not  been 
publicly available. The low level of electronic trading reflects a number of factors, such 
as  the  heterogeneity  of  securities,  correlated  trading  and  low  turnover.  The  associated 
lack of data on trades mean that aggregate market information/data are also scarce and 
that  quality  of  data  is  low.  Heterogeneous  data  formats  provided  by  different  sources 
make it difficult to aggregate data on market activity and the distribution of prices. This 
situation  involves  significant  information  costs,  and  hampers  market  activity  and 
liquidity.  In  response  to  the  observed  shortcomings,  a  new  common  EU  legal 
framework for financial markets and trading venues has been created, imposing a set of 
transparency  requirements  throughout  the  trading  cycle.226  As  of  January  2017, 
enhanced transparency regime with regard to both pre- and post-trade transparency will 
apply as part of the MiFID II/MiFIR227 framework, which also contains provisions on 
consolidated tape. This should improve the price formation process and contribute to an 
increased use of electronic platforms.  

Different  trading  systems  and  platforms  without  interconnections  are  still  an 
obstacle  to  EU  market  efficiency.  The  Giovannini  reports  in  2001  and  2003  already 
singled  out  the  need  to  improve  connectivity  networks  to  common  system  platforms; 
interoperability  between  markets/systems  through  common  standards  and  common 
technical  protocols;  open  access  to  infrastructures,  convergence  of  market  rules  and 
practices;  and  transparent  pricing  procedures.228  Interconnection  can  be  achieved 
through compatible and/or shared trading platforms, eliminating the need for redundant 
investment  in  different  trading  systems  and  benefiting  brokers  that  engage  in  cross-
border  transactions.  Concentrated  order  flows  would  lead  to  more  precise  price 
discovery.  On  the  other  hand,  efficiency  is  currently  still  impeded  by  cross-country 
legal  and  regulatory  differences229,  high  information  costs,  home-country  bias  and  the 
fragmentation of the EU clearing and settlement systems. Different exchanges, clearing 
houses and CSDs operate in each country, whilst a major part of the EU level activity is 
anyway  concentrated  in  a  few  of  them.  Recent  regulation,  particularly  the  European 
Markets  Infrastructure  Regulation230  (EMIR)  and  Central  Securities  Depositories 
Regulation231  (CSDR),  will  enhance  cross-border  access  and  interoperability  between 
CCPs  and  CSDs  and  is  also  expected  to  foster  competition  in  clearing  and  settlement 
services  and  raise  consolidation  pressure  helping  to  increase  efficiency  in  EU  market 
infrastructures.  

226  Including CSDR, EMIR and MiFID 2 / MiFIR. 
227  Regulation  (EU)  No 600/2014  of  the  European  Parliament  and  of  the  Council  of  15 May  2014  on 

markets in financial instruments and amending Regulation (EU) No 648/2012 

228  See Giovannini Group (2001, 2003). 
229  Disparities  in  national  rules  discourage  cross-border  trading,  since  investors  and  companies  have  to 
familiarise  themselves  with  the  regulatory  regimes  in  various  countries.  Furthermore,  national 
accounting and disclosure requirements vary across the EU, whilst tax treatment is also uneven, both 
as  regards  the  taxes  applicable  and  the  mechanisms  for  their  collection.  Finally,  many  countries 
provide incentives for domestic investment through prudential rules and taxation. 

230  Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC 

derivatives, central counterparties and trade repositories 

231  Regulation  (EU)  No 909/2014  of  the  European  Parliament  and  of  the  Council  of  23 July  2014  on 
improving  securities  settlement  in  the  European  Union  and  on  central  securities  depositories  and 
amending Directives 98/26/EC and 2014/65/EU and Regulation (EU) No 236/2012 

81 

 
                                                 
In  mid-2015,  the  ECB  launched  the  TARGET2-Securities  platform  (T2S)  to 
address the fragmented infrastructure for transferring financial assets for trading 
and collateral operations. It provides settlement services for securities transactions in 
central bank money and it is built as a multicurrency system. T2S will be fully deployed 
by February 2017, covering almost all securities transactions in euro, and it is expected 
to  bring  numerous  benefits,  including:  (i)  lower  processing  costs  for  cross-border 
transactions; (ii) direct securities settlement in central bank money; and (iii) economies 
of  scale  without  the  need  to  merge  securities  depositories.  T2S  will  facilitate  cross-
border collateral management by incentivising the EU post-trade industry to harmonise 
market  practice,  rules  and  standards.  The  CSDR  complements  the  operational 
integration  provided  by  T2S  and  gives  further  momentum  to  the  post-trade 
harmonisation efforts. 

5.5 Supervisory and regulatory convergence 

Implementation, application and enforcement of EU rules on capital makets may 
be  characterised  by  a  number  of  inconsistencies  related  to  supervisory  and 
regulatory aspects, due to diverging national approaches and practices.232 Some of 
these divergences are warranted to accommodate national specificities, while others are 
rather due to different interpretations of the underlying principles, leading to situations 
where  rules  overlap  or  contain  inconsistent  legal  requirements.  This,  in  turn,  creates 
legal  uncertainty,  opportunities  for  regulatory  arbitrage,  and  disincentives  to  cross-
border  investments.  On  the  other  side,  supervisory  convergence  aims  at  promoting  a 
more  uniform  supervisory  culture  across  the  EU,  preventing  regulatory  arbitrage  and 
ensuring  a  consistent  supervision  of  market  participants.  A  consistent  and  effective 
application  of  the  EU  legislation  can  help  to  ensure  a  level  playing  field  for  market 
players across the EU and legal certainty. This is in particular achieved by eliminating 
possible undue barriers to investment arising from divergent interpretation of EU rules 
or  from  differences  in  national  supervisory  practices,  while  allowing  for  a  degree  of 
national  discretion  in  certain  cases.  Legal  certainty  and  a  level-playing  field  in  EU 
capital  markets  create  a  robust  'ecosystem'  for  investors  to  supply  more  capital  and 
funding across borders. 

Supervisory convergence is needed to give teeth to the EU consumer and investor 
protection rules. The 2014 European Commission consumer scoreboard found that the 
markets for investment products, private pensions and securities rank lowest in terms of 
trust  in  providers,  comparability  of  offers,  overall  satisfaction  and  the  incidence  of 
complaints  and  problems.233  An  important  cause  behind  this  are  information 

232 The Commission report on the functioning of the ESAs, as well as in the EU Court of Auditors' special 
report  (no  5/2014)  identified  that  the  degree  of  effectiveness  of  the  ESAs  in  ensuring  consistent 
implementation,  application  and  enforcement  of  relevant  EU  law  is  partly  influenced  by  their 
governance  and  funding  arrangements.  The  high  dependence  on  national  competent  authorities  for 
resources  and  staff,  as  well  as  nationally-focused  decision-making  procedures  entail  challenges  in 
implementing positions in the interest of the EU as a whole. 

233 These investment products rank lowest with a score of 69.9 out of a maximum of 100. Bank-provided 
services such as consumer loans, mortgages, credit cards and bank accounts, and private life insurance 
fare slightly better, with scored ranging from 70.6 to 74.2. 

82 

 
                                                 
asymmetries in favour of originators and distributors, rendering the full utility or return 
from  these  products  difficult  for  consumers  to  ascertain  until  their  final  maturity.234 
While this is relevant for both individual and institutional investors, retail investors face 
particular  difficulties  in  assessing  risks  and  making  informed  investment  decisions, 
given the relative opacity and complexity of some financial products. Since information 
frictions are even more salient in the context of cross-border investments, transparency 
on  costs  and  risks  of  investment  products  is  even  more  relevant  for  trust  of  investors 
than on domestic capital markets. Consumer and investor protection rules that equip the 
ultimate risk-bearers in a more market-based financial system to independently evaluate 
and  price  risk  seem  to  be  a  precondition  for  greater  participation  by  both  institutional 
and retail investors235.  

Regulatory  convergence  could  reduce  the  multiplicity  of  reporting  obligations, 
which act as a drag on investment. Enhanced transparency implies various reporting 
and  disclosure  obligations,  which  entail  an  administrative  and  financial  burden  for 
market  participants.  This  is  even  truer  for  cross-border  investments,  where  market 
participants  are  faced  with  divergent  interpretation  of  EU  rules  and  different 
requirements  from  one  jurisdiction  to  another.  On  the  other  hand,  more  transparency 
should lead to lower search and monitoring costs for intermediaries and investors (i.e. 
more  transparent  price  formation),  as  well  as  better  investor  protection.  Recent  EU 
rules,  such  as  MiFID  II,  are  expected  to  enhance  the  comprehensiveness  and 
comparability of information on costs and charges related to various financial products. 
MiFID II/MiFIR also includes a transparency regime that has been extended to equity 
instruments other than shares as well as non-equity instruments. The standardisation of 
disclosure  requirements  should  help  enhance  transparency,  investors'  trust  and  market 
efficiency. 

234 De Manuel and Lannoo (2012). 
235 This could notably be supported by the horizontal nature of the consumer/investor protection mandate 
that  has  been  given  to  the  European  Supervisory  Authorities  (ESAs).  The  European  Securities  and 
Markets  Authority  (ESMA)  and  the  European  Insurance  and  Occupational  Pensions  Authority 
(EIOPA) have been given increased powers on investor protection, notably through MIFID II, PRiPS, 
the  Shortselling  Directive  and  other  legislative  acts.  MiFID  II  also  imposes  reinforced  investor 
protection rules on investment firms. 

83 

 
                                                 
Chapter 6  A COUNTRY PERSPECTIVE ON THE CMU 

EU Member States differ significantly with regard to their economic and financial 
structures. This chapter documents differences across EU Member States as regards the 
financing  sources  used  by  companies  to  fund  their  activity  (Section  1)  and  the  ways 
households  save  (Section  2).  Both  constituencies  represent  the  ultimate  users  of 
financial  markets'  intermediation.  Savings  are  channelled  to  investments  via  various 
financial intermediaries and markets, which also differ by size, degree of maturity and 
the  composition  of  assets  (Section  3).  This  diversity  means  that,  while  all  Member 
States will benefit from the CMU, gains will materialise in various forms, depending on 
the specificity of each Member State (Section 4). 

CMU  is  not  meant  to  trigger  a  convergence  of  financial  structures  to  a  single, 
uniform template because there is no universal financial structure optimal for each 
Member State. Most differences in financial structures across countries stem from legal 
and  historical  determinants  and  also  from  the  interdependency  between  economic  and 
financial  structures  themselves.  A  number  of  these  economic  determinants  are  well-
established. For example, in economies characterised by a large number of small firms, 
the optimal financial structure may exhibit greater bank dependence. On the other side, 
for  economies  where  large  firms  dominate,  stronger  reliance  on  market-based  finance 
may be suitable. Stronger specialisation in high-tech firms, in turn, goes hand in hand 
with  a  larger  market  share  of  private  equity  and  venture  capital;  likewise,  a  stronger 
presence  of  start-ups 
in  new  business  areas  may  generate  opportunities  for 
crowdfunding.  Finally,  some  countries  have  large  financial  sectors  exporting  financial 
services,  which  implies  that  the  country's  financial  structure  is  determined  by  both 
domestic and foreign factors . 

The  economic  literature  identified  a  number  of  relevant  factors  that  determine 
both  economic  and  financial  structures.  Alongwith  legal  frameworks  on  the 
enforceability of ownership rights and the ease of property transfer, GDP per capita has 
proven  significant  in  cross-country  estimates  of  the  determinants  of  financial 
structures.236  For  instance,  richer  economies  typically  are  endowed  with  a  more 
developed financial structure, with the causality potentially running both ways: a more 
developed  financial  system  also  supports  innovation  and  thus  economic  growth. 
Although this empirical result was derived based on samples comprising countries from 
various  regions  of  the  world,  differences  in  both  GDP  per  capita  and  the  size  of  the 
financial system are also notable in the EU, suggesting that this factor is relevant in a 
more  specific,  European  context.  Differences  in  demographic  profiles  also  matter,  in 
particular  as  regards  the  amounts  of  funds  made  available  to  the  economy.  A  large 
population offers scope for scale effects, which are particularly beneficial for financial 
market activity, and the ageing profile of the population has an impact on households' 
savings  behaviour.  But  the  share  of  savings  that  will  ultimately  be  made  available  to 
firms  also  depends  on  other  economic  variables,  such  as:    households'  investment  in 
housing, the population's age structure, the magnitude of public debt and the countries' 
current account position. All of these considerations vary considerably across the EU.  

236  See Beck et al. (2008), Cihak et al. (2012), Almarzoqi et al. (2015). 

84 

 
                                                 
Different starting conditions imply different potential benefits from the CMU and 
different  policy  priorities  at  national  level  to  draw  the  maximum  benefit.  The 
interdependency of financial and economic structures suggests that outliers in financial 
statistics are not necessarily to be interpreted in terms of over or under-performance, but 
need to be considered in the context of underlying explanatory factors. Yet, comparison 
with  peers  can  be  indicative  of  structural  changes  that  are  more  or  less  promising  to 
realise. A further important factor is the fact that the openness of EU economies allows 
firms to tap funding from foreign financial systems. A number of financial centres have 
developed as regional hubs to cater for some of the neighbouring economies' financial 
needs. As a consequence, access to foreign financial markets can be as important as the 
development of stronger local capital markets to cater for a country's financial needs. 

6.1 Financing needs 

Since  national  corporate  sectors  differ  by  their  level  of  development,  level  of 
investment  and  liability  structure,  financing  needs  and  the  degree  to  which  they 
can  be  satisfied  also  differ  across  EU  Member  States.  The  crisis  has  revealed  and 
magnified important asymmetries across Member States in this area. The proportion of 
bank  loan  acceptances  has  fallen  significantly  along  with  declining  enterprise 
investment.  The  sharpest  falls  were  observed  in  countries  most  affected  by  the  crisis. 
The  situation  has  improved  recently  and  some  convergence  in  terms  of  credit 
availability  has  taken  place,  but  substantial  cross-country  disparities  remain,  as 
evidenced  by  the  ECB's  Bank  Lending  Survey237.  For  example,  the  cost  of  credit 
remains higher and access to credit is more constrained in Portugal, Spain and Italy as 
compared to Germany and France (Chart 28).  

237  See ECB Bank Lending Surveys. 

85 

 
                                                 
Chart 28: Interest rates on loans to non-financial corporations, selected Member States 

Source: ECB. 

in 

the  development  of 

Financing needs in Europe are substantial. The share of corporate investment relative 
to GDP exceeds 10% in most countries and is highest in the rapidly growing economies 
of Central and Eastern Europe. This is contributing to the narrowing of the income gap 
(Chart 29). While important progress and convergence have been achieved in the area of 
infrastructures  and 
productivity,  discrepancies  remain 
institutions.  The  level  of  corporate  capitalisation  and  integration  into  European  and 
global  networks  also  lags  behind  their  counterparts  in  Western  Europe.  In  these 
"catching-up"  economies,  a  large  share  of  the  capital  required  for  investment  comes 
from abroad in the form of foreign direct investments. In other countries, such as Greece 
or  Cyprus,  the  low  investment  rate  reflects  the  financial  and  sovereign  debt  crisis.  In 
fact, concerns about the government's ability to service its debt increased the credit risk 
of  companies  operating  in  these  countries,  weighing  on  investment.  Besides,  in 
anticipation of increased taxation, domestic and foreign-led investment reduced further. 
The fall in investment has not been an exclusive feature of crisis-stricken euro Member 
States,  but  also  of  euro  area  core  and  non-euro  area  countries.238  The  investment  plan 
and establishment of EFSI is a consequence of the identification of an investment gap. 
Finally, in some countries, such as Luxembourg, the subdued level of investment could 
be  due  to  the  move  towards  a  more  service-oriented  economy  at  high  income  levels. 
Luxembourg is an outlier, given the high dependence of the economy on the financial 

238  See Baldi et al. 9201), Barkbu et al (2015) European Commission (2014d). 

86 

 
 
                                                 
sector, which contributes 27% to the country's income.239 For comparison, in the EU as 
a whole the financial sector's contribution to income is 5.4%. 

Chart 29: Corporate investment and expenditure on research and development, % of GDP, 2014 or 2013 

Source: Eurostat. 

A number of factors affect corporate financing needs and the prospect of satisfying 
them. Credit conditions differ significantly among Member States due to them being in 
different  phases  of  the  economic  cycle,  varying  levels  of  competition  in  the  financial 
system and differences as regards the soundness and efficiency of financial institutions. 
The industrial structure is another important determinant, as sectors such as production 
of  energy,  real  estate  and  also  agriculture  are  particularly  capital-intensive.  When 
comparing  EU  Member  States,  the  energy  sector  represents  a  significant  share  of 
investment in Bulgaria and Slovakia, the real estate sector in Germany and Austria and 
the  agricultural  sector  in  Bulgaria  and  Latvia.240  Since  manufacturing  is  also 
disproportionately  investment-intensive,  a  large  manufacturing  sector  and  especially  a 
large  share  of  manufacturing  of  computers,  motor  vehicles,  coke  and  petroleum 
refinement  implies  higher  capital  needs.  Company  size  also  matters  in  explaining 
differences in accessing funding. For larger companies, concerns with their capacity to 
finance their investment needs are smaller because their spectrum of potential funding 
sources  is  broader  and  includes  stock  or  bond  issuance.  In  the  EU,  the  share  of  large 
companies  in  overall  corporate  turnover  is  relatively  homogeneous,  ranging  between 
50% and 70%. Still, the proportion of large companies is higher in Germany, UK and 
Ireland  while  Malta,  Greece,  Estonia  and  Latvia  have  corporate  sectors  where  smaller 
companies play a larger role (Chart 30). The larger an economy, the larger the relative 

239  Measured as share of the financial sector in gross value added. 
240  There is no sectoral investment data for Poland, which has a large agricultural sector. 

87 

 
 
 
                                                 
weight of big companies tends to be, possibly because companies expand more easily if 
home markets are large. 

Chart 30: The importance of large companies in an economy, Turnover of corporations with more than 50 
employees as % of total, 2012 or 2011 

Source: Eurostat. 

As  described  in  Chapter  3,  SMEs  are  particularly  vulnerable  to  adverse  economic 
conditions and constraints in credit supply. Statistical analysis confirms these trends, 
showing a correlation between company size and borrowing costs. As much as 45% of 
SMEs surveyed in Cyprus, 32% in Greece and 29% in Slovenia stated that insufficient 
access to finance was among the most pressing problems they were facing. More than 
15% of small companies in Lithuania, Portugal, Croatia, Spain and Ireland answered in 
the same way.241 The European Commission's access to debt finance index summarises 
information about problems that SMEs encounter when they request bank loans (Chart 
31). Relatively low scores for countries such as Romania, Cyprus and Greece confirm 
difficulties experienced by local SMEs in obtaining access to bank loans compared the 
EU average. 

241  See SAFE (2015). 

88 

 
 
 
                                                 
Chart 31: SMEs' access to debt finance, 2013, index 

Source: European Commission. 

Another  key  factor  explaining  differences  in  the  availability  of  credit  is  the 
accumulated corporate debt level. On the one hand, a high level of debt has an impact 
on a company’s creditworthiness and reduces its repayment capacity. On the other hand, 
high corporate indebtedness limits the capacity of financial institutions to grant credit, 
or  makes  it  more  expensive  in  terms  of  capital  requirements.  The  highest  corporate 
indebtedness  ratios,  measured  by  outstanding  bank  loans  to  GDP,  are  observed  in 
Cyprus (136%), Malta (65%) and the Netherlands (62%). Denmark, Greece, Spain, Italy 
and Portugal have corporate debt to GDP ratios above 50% while corporate sectors in 
Central and Eastern Europe are the least indebted.242  

In several countries, high corporate debt coincides with high interest rates charged 
on corporate loans, which further hampers investment. Currently, the interest rates 
on  corporate  bank  loans  are  the  highest  in  Cyprus  (4.5%),  Greece  (5.6%),  Portugal 
(3.5%) and Ireland (2.9%), as well as in Slovenia (3%) and Latvia (2.7%).243 All these 
countries  experienced  issues  in  the  banking  sector  during  the  financial  crisis.  In 
Bulgaria  (6.5%),  Romania  (6.1%)  and  Croatia  (6%)  currency  risk  may  play  a  role,  in 
addition to credit risk. 

As  highlighted  in  Chapter 3,  Research  and  Development  (R&D)  is  essential  to 
enhance  competitiveness,  innovation  and  growth.  R&D  expenses  are  typically 
highest in more advanced economies: they represent more than 2% of GDP in Sweden, 
Denmark, Germany, Austria, Belgium, France, Netherlands (Chart 29). They are lower 

242  Source: Eurostat's data on sectoral balance sheets. 
243  ECB data on new lending to corporations, all  maturities, observations of June 2015, except Greece, 

for which the latest available data is from May 2014. 

89 

 
 
 
                                                 
in countries where the economic activity is still suffering from the consequences of the 
crisis  (Greece,  Cyprus,  Malta,  and  to  a  lower  extent  Spain  and  Italy),  and  in  most 
countries  of  Central  and  Eastern  Europe  (with  the  exception  of  Slovenia).  As  R&D 
projects  are  capital-intensive  and  risky,  they  require  appropriate  financing.  The  state 
may  provide  part  of  the  needed  funding,  but  investment  from  private  sources  is 
indispensable.  The  use  of  capital  markets,  in  particular  venture  capital,  for  corporate 
funding  correlates  with  national  investment  in  R&D.  The  Nordic  countries  as  well  as 
Germany and France are characterised by both relatively high R&D expenditures and a 
more  intensive  use  of  venture  capital,  while  Slovakia,  Romania,  Latvia,  Cyprus  and 
Bulgaria  are  endowed  with  less  developed  capital  markets  in  combination  with  a  low 
level of investment in R&D. 

Venture  capital  activity  varies  greatly  across  Europe.  The  Commission's  access  to 
equity  finance  index  summarises  information  about  the  use  of  venture  capital  and 
business  angel  funding  across  EU  Member  States  (Chart  32).  It  shows  favourable 
financing environments in Ireland, Estonia, Denmark, Netherlands and Finland, whereas 
these  equity  instruments  are  least  used  in  Luxembourg,  Greece  and  Spain.  Low 
utilisation of both private equity and venture capital are observed for Southern European 
Member States and those in Central and Eastern Europe. 

Chart 32: SMEs' access to equity finance, 2013, index 

Source: European Commission. 

As  mentioned  in  Chapter  3,  corporate  financing  needs  can  be  covered  by  own 
resources  or  external  funding.  The  latter  may  be  provided from  domestic  or  foreign 
sources  and  it  may  be  channelled  via  the  financial  sector  (banks,  capital  markets)  or 
intra-group,  by  parent  or  associated  companies.    In  the  EU,  bank  loans  constitute  the 
main  source  of  external  funding  for  corporations  (Chart  33)  and  bank  loans  represent 
between  30%  and  50%  of  the  balance  sheet.  Cypriot  and  Greek  companies  are  most 
reliant on bank loans, which account for more than half of their total liabilities. In both 

90 

 
 
countries,  securities  markets  play  a  minor  role  in  corporate  funding.  In  contrast,  three 
groups of countries can be distinguished as relying to a lower extent on bank financing: 
(i) the  first  group  includes  the  UK,  France  and  Germany  -  as  explained  earlier,  firms 
grow  more  easily  in  larger  economies,  so  their  average  size  is  bigger,  which  supports 
the  development  of  stock  and  bond  markets;  (ii) in  Nordic  countries,  public  equity  is 
also an important source of funding for NFCs, exceeding on average 20% of the balance 
sheet; (iii) the third group of countries with lower dependence on bank credit includes 
Slovakia,  Lithuania,  Estonia,  Czech  Republic  and  Poland  -  this  is  partly  explained  by 
the fact that, in the relatively smaller and less developed markets of Central and Eastern 
Europe,  companies  rely  to  a  bigger  extent  on  own  resources  (e.g.  retained  profits), 
which are part of their equity.  

Chart 33: Funding of companies: banks vs stock exchange, Loans and listed shares as % of total liabilities of non-
financial corporations, 2014 or 2013 

Source: Eurostat. 

Debt  securities  markets  play  an  increasing,  but  still  relatively  minor,  role  in 
providing funding for European corporations. France stands out with a 10% share of 
bonds  on  the  corporate  balance  sheet,  followed  by  the  UK,  Portugal,  Austria  and 
Finland (Table 3). But corporate bonds are still quasi-inexistent in some other European 
countries  (e.g.  Greece,  Romania,  Lithuania  and  Cyprus).  Over  recent  years,  debt 
securities have become a considerably more important source of funding, accounting for 
a third of new funding in the EU on average between 2010 and 2014. Use of corporate 
bond  issuance  has  increased  in  those  countries  where  bond  issuance  was  already  high 
before  the  crisis.  In  Belgium,  Portugal  and  Italy,  issuance  of  corporate  bond  has 
increased  much  more  than  expected  given  their  starting  position  before  the  financial 
crisis.  As  regards  other  funding  sources,  the  role  of  trade  credit  remains  important  in 
some countries, in particular in Central and Eastern European. It accounts for almost 20 
%  of  corporate  sector  liabilities  in  Malta  and  Slovakia  and  is  also  high  in  Lithuania, 
Latvia, Czech Republic and Slovenia.  

91 

 
 
 
Table 3: Liability structure of non-financial corporations  
(% of total, 2014 or 2013) 

Other equity
38.4
44.7
46.2
32.6
26.7
58.4
45.1
32.5
38.0
34.5
29.3
42.2
37.3
40.3
51.5
52.4
51.1
27.9
33.6
37.5
38.3
29.1
47.4
36.3
47.6
26.9
38.7
25.2

Listed shares
17.1
1.8
7.5
25.0
27.6
2.4
7.5
6.8
13.0
22.1
14.0
9.4
1.2
0.8
4.5
13.3
4.1
3.1
14.3
8.4
14.3
8.9
6.9
8.7
0.5
28.6
21.9
28.3
Source: Eurostat. 

BE
BG
CZ
DK
DE
EE
IE
EL
ES
FR
HR
IT
CY
LV
LT
LU
HU
MT
NL
AT
PL
PT
RO
SI
SK
FI
SE
UK

6.2 Financing sources 

Bonds
3.2
1.4
5.7
3.1
3.2
2.7
1.3
0.0
0.9
10.4
3.4
4.8
0.4
1.1
0.2
5.0
1.2
3.8
6.2
7.7
3.3
8.5
0.0
1.7
2.5
7.4
5.0
8.8

Loans
36.7
41.8
24.3
26.5
25.5
29.4
36.1
53.7
42.5
26.5
47.1
36.3
58.2
38.3
28.3
25.6
34.8
40.8
40.3
38.6
30.1
37.8
30.9
39.4
27.4
31.7
27.9
19.7

Trade credit
2.4
3.6
10.6
4.6
3.5
4.3
5.6
0.9
2.6
4.3
0.6
1.5
2.8
10.2
10.4
2.5
4.8
19.5
2.4
3.7
5.8
2.6
1.9
8.8
18.3
2.5
1.7
1.1

Other
2.3
6.7
5.7
8.2
13.5
2.8
4.4
6.0
3.1
2.2
5.5
5.8
0.1
9.2
5.1
1.3
4.0
4.9
3.1
4.1
8.3
13.1
12.8
5.1
3.6
2.9
4.8
16.9

Households  across  Member  States  have  different  propensities  to  save,  saving 
traditions  and  investment  preferences.  Income  levels  and  population  structures  are 
also dissimilar. Despite these differences, it is remarkable that most households in the 
EU  hold  most  of  their  disposable  financial  assets  in  the  form  of  currency  and  bank 
deposits. Broadly speaking, with the exception of Luxembourg, the higher the income 
level in an economy, the smaller the percentage of financial assets held by households 
in the form of currency and deposits. It is in the Netherlands, Denmark and Sweden that 
the share of households' holdings in the form of currency and deposits is the lowest, and 
in  Greece,  Slovakia,  Croatia  and  Cyprus  that  it  is  the  highest.  Also,  households  in 
Germany and Austria keep much more financial assets in this form than their peers with 
comparable income levels. 

The  second  largest  investment  class  is  insurance  and  pension  products,  with  a 
higher  propensity  for  households  to  invest  in  these  products  in  countries  with  a 
high income level (Chart  34).  Households in  the Netherlands, UK, Ireland, Denmark, 

92 

 
 
 
 
Sweden  and  France  hold  a  larger  share  of  their  financial  assets  in  insurance  products 
and  pension  funds  than  in  bank  savings  and  cash  holdings.  In  Germany,  the  share  of 
assets invested in insurance products and pension funds is roughly equal to the share of 
assets  kept  in  the  form  of  bank  savings  and  cash  holdings.  The  share  of  households' 
holdings in insurance products and pension funds is much lower in Member States with 
a lower GDP per capita. For example, households' investment in insurance products and 
pension funds is smallest in Bulgaria and Romania. But when compared to peers with a 
comparable income level, the share of financial assets in insurance and pension products 
is  relatively  low  in  Austria,  Belgium  and  Finland  and  it  is  relatively  high  in  Poland, 
Croatia, Slovakia and Portugal. 

Chart 34: Assets of households: bank deposits versus insurance and pension fund products, (% of total, 2014 
or 2013) 

Source: Eurostat. 

European households still invest only a limited percentage of their financial wealth 
directly in listed shares, bonds and investment funds (Chart 35). In 22 of the 28 EU 
Member  States,  less  than  5%  of  households'  financial  assets  are  held  in  the  form  of 
either bonds or listed shares. More sizable investments in listed shares are reported in 
Finland,  Spain  and  Sweden,  and  in  bonds  in  Italy,  Malta  and  Hungary.  A  commonly 
used  alternative  to  direct  investment  in  capital  markets  is  investment  funds.  In  many 
countries, assets entrusted to investment funds correspond roughly to the sum of assets 
invested  directly  in  listed  shares  and  debt  securities.  In  approximately  half  of  the  EU 
Member  States,  households  hold  less  than  5%  of  their  financial  assets  in  the  form  of 
investment  funds.  Households'  investments  in  listed  securities  are  larger  in  Belgium, 
Spain  and  Hungary  (more  than  10%  of  total  financial  assets).  In  all  Member  States 
except Germany, Hungary, Austria and Romania, households hold more unlisted shares 
and  other  equity  than  listed  shares  (Table  4),  which  reflects  the  importance  of  family 
business. 

93 

 
 
 
Chart 35: Assets of households: direct holding of securities versus investment funds, % of total, 2014 or 2013 

Source: Eurostat. 

Marketable  financial  assets  seem  to  be  a  substitute  for  insurance  and  pension 
products  as  household  assets,  particularly  in  Member  States  with  higher  income 
levels.  Household  holdings  of  marketable  financial  securities,  i.e.  listed  stocks,  bonds 
and investment funds are also higher as a share of their total financial assets in Member 
States  with  high  income.  However,  the  cross-country  correlation  between  the  share  of 
households'  financial  assets  held  in  marketable  securities  and  the  income  level  is  less 
clearcut than for other asset classes. The largest proportion of assets held in marketable 
financial  securities  is  found  in  Italy,  Finland,  Malta  and  Belgium.  While  a  traditional 
high supply of government bonds may motivate high holdings of bonds in Belgium and 
Italy, it offers little explanatory power for Finland and Malta. Market instruments seem 
to  be  particularly  strong  substitutes  to  claims  against  insurance  and  pension  funds  in 
those  EU  Member  States  with  higher  income  levels.  For  example,  Finland,  Italy, 
Belgium and Malta match their high ranking in market instruments with a small share in 
insurance and pension products and vice versa for the UK and the Netherlands, Ireland 
and Denmark. 

Rising income levels in European countries where the economy is catching up with 
the  rest  of  the  EU  may  lead  to  higher  household  demand  for  non-bank  savings 
products  in  the  future.  Households'  interest  in  allocating  their  savings  to  non-banks 
increases as they get richer. Member States with still low income levels may therefore 
expect rising demand for non-bank products in tandem with 'catch-up' growth. Whether 
these households will move towards insurers and pension funds or direct capital market 
instruments  will  depend  on  country-specific  factors,  notably  such  as  tax  incentives  or 
the cost of financial intermediation. 

In  many  EU  Member  States,  NFCs  have  also  become  an  important  source  of 
savings  for  the  economy.  Although  traditionally  a  net  borrower,  the  corporate  sector 

94 

 
 
has actually become a cumulative net lender in all Member States except Belgium, the 
Czech  Republic,  France,  Italy,  Croatia,  Portugal  and  Sweden.  A  net  lending  position 
means that NFCs acquire net financial assets. In other words, their surpluses invested in 
various financial instruments may be accessed by companies with funding needs or by 
other  sectors,  for  example  governments  or  foreign  firms.  This  change  towards  an 
atypical net lender position started in Europe in 2009.   

The  proportion  of  NFCs'  financial  assets  held  in  the  form  of  deposits  is  typically 
higher  in  Member  States  with  lower  per  capita  income.  In  comparison  with 
households, NFCs hold a lower portion of their financial assets in the form of deposits. 
Still,  this  proportion  is  higher  than  5%  of  their  total  assets  in  all  Member  States.  The 
role of deposits for firms is also different. Most firms use currency and bank deposits 
not  as  a  saving  instrument,  but  rather  to  ensure  their  liquidity.  Even  though  holding 
bank  deposits  is  necessary  for  transaction  purposes,  the  fact  that  these  represent  more 
than  40%  of  firms'  total  assets  in  some  Member  States  (Bulgaria,  Czech  Republic, 
Greece, Croatia, Lithuania, Romania) suggests a strong bias in these countries in favour 
of holding financial assets with banks. When comparing the importance of currency and 
deposits in the balance sheet of European NFCs, it appears that it is higher in Member 
States with lower per capita income. 

invest 

less  than  households 

Corporations 
insurance,  pension  products, 
investment  funds  and  listed  shares  while  they  hold  more  unlisted  shares,  other 
equity and other types of financial assets. Unlisted shares account for more than 30% 
of  financial  assets  of  NFCs  in  France,  Sweden,  Finland  as  well  as  Ireland  and 
Luxembourg (Table 4). Other assets include mainly loans, trade credit and receivables / 
payables. 

in 

Table 4: Financial assets: households and non-financial corporations  
(% of total, 2014 or 2013) 
Currency and 
deposits

Insurance and 
pension funds

Investment funds

Unlisted shares

Listed shares

Bonds

Other equity

BE
BG
CZ
DK
DE
EE
IE
EL
ES
FR
HR
IT
CY
LV
LT
LU
HU
MT
NL
AT
PL
PT
RO
SI
SK
FI
SE
UK

HH
31.2
38.1
50.9
16.4
39.3
27.3
36.7
66.5
43.0
28.5
57.8
32.0
56.0
30.1
36.1
54.8
29.4
49.3
22.1
41.4
44.0
44.5
28.7
49.1
63.1
31.5
14.0
23.8

NFC
11.5
43.8
46.5
7.4
13.5
27.6
9.7
64.7
24.6
18.3
47.7
27.2
35.9
38.4
42.5
5.9
25.0
34.0
18.4
18.6
35.4
21.8
54.3
27.1
20.2
16.4
15.0
31.5

HH
23.3
6.9
13.2
50.4
36.8
10.9
45.9
4.5
16.2
35.6
22.1
18.5
7.3
12.2
7.8
15.2
9.1
10.1
62.1
20.8
26.5
19.6
4.2
16.8
22.2
17.1
39.2
59.2

NFC
1.0
0.4
1.4
0.9
1.6
0.8
0.3
0.5
2.2
1.9
3.4
1.7
1.1
1.4
0.8
0.1
0.6
0.6
2.1
2.0
3.1
1.8
1.5
2.2
0.7
1.7
1.0
0.2

HH
12.5
0.5
5.6
7.3
9.5
0.8
0.0
2.6
11.4
6.8
1.7
8.0
0.0
1.1
0.9
9.6
10.8
3.1
2.9
8.6
5.6
3.6
3.4
3.6
6.5
9.1
8.1
4.2

NFC
1.2
4.5
1.5
5.3
4.5
1.2
0.0
0.4
6.2
6.3
1.5
0.9
0.1
0.2
0.2
0.3
2.0
0.8
0.2
3.4
4.3
1.7
1.2
0.6
0.1
3.0
1.7
0.0

Source: Eurostat. 

HH
6.5
0.0
3.9
1.6
3.8
0.1
0.1
1.4
1.3
1.9
0.2
16.5
1.4
0.9
3.4
5.5
8.5
15.2
0.7
7.3
0.3
4.0
0.6
0.7
1.9
3.6
1.0
0.8

NFC
0.8
1.4
4.0
6.1
1.6
2.0
0.5
1.8
4.5
2.1
0.0
5.8
3.5
2.6
1.4
1.0
2.3
0.7
2.2
2.2
1.7
1.1
0.4
0.5
5.1
2.0
2.8
5.4

95 

HH
4.1
0.9
1.1
6.1
4.7
1.0
4.0
0.7
8.3
4.0
3.6
2.1
1.6
0.2
1.7
5.8
1.2
6.2
1.4
3.3
2.9
1.6
3.8
3.9
0.0
13.1
7.1
3.3

NFC
8.5
1.9
0.1
3.1
10.7
0.4
0.0
0.3
5.8
3.3
0.5
9.3
1.0
0.0
0.2
0.2
9.3
0.7
0.0
2.7
0.8
2.6
0.6
1.0
0.8
0.7
4.5
1.5

HH
14.4
18.2
12.2
9.8
1.3
55.2
10.1
20.2
13.9
8.6
2.4
10.8
31.5
-
39.1
8.5
3.5
9.6
7.7
0.5
5.6
7.4
21.8
3.2
0.2
18.4
10.6
3.4

NFC
23.6
10.7
11.3
23.6
27.8
16.7
49.5
19.5
27.0
35.6
21.6
3.3
21.5
-
9.4
70.9
18.9
26.7
42.6
10.0
2.2
17.7
3.0
2.2
25.7
41.7
40.5
4.1

HH
6.8
25.0
8.4
7.7
3.9
0.0
-
0.0
3.8
8.9
9.7
11.4
0.0
-
0.4
0.1
23.6
0.0
0.8
15.7
13.0
10.9
16.5
15.1
0.0
5.0
18.9
2.0

NFC
3.7
2.9
1.4
15.1
19.5
3.0
-
0.0
7.2
3.1
2.3
32.7
6.5
-
0.0
0.0
0.9
0.0
0.4
36.0
8.7
1.0
0.2
13.0
5.8
1.0
0.6
38.7

Other assets

HH
1.2
10.4
4.7
0.7
0.7
4.7
3.2
4.2
2.1
5.7
2.6
0.7
2.2
55.5
10.5
0.5
13.9
6.5
2.4
2.4
2.2
8.5
21.0
7.7
6.1
2.2
1.1
3.4

NFC
49.7
34.3
33.9
38.5
20.7
48.3
40.1
12.8
22.5
29.4
22.8
19.0
30.5
57.4
45.5
21.6
40.9
36.5
34.0
25.0
43.9
52.3
38.8
53.4
41.6
33.5
33.9
18.6

 
 
6.3 Intermediation: linking financing sources with financing needs 

Even  though  banks  are  by  far  the  largest  financial  intermediaries  in  all  Member 
States, their importance varies significantly from one country to another. In most 
EU  countries,  total  assets  of  the  banking  sector  represent  twice  to  four  times  national 
GDP (Table 5). However, this ratio is much higher in Malta, Ireland and Cyprus, which 
underlies  the  importance  of  the  export  of  financial  services  in  these  countries. 
Luxembourg  is  an  outlier,  with  total  bank  assets  exceeding  GDP  up  to  twenty  times 
reflecting  the  country's  role  as  financial  hub  that  provides  financial  services  to  other 
economies. On the other hand, in the still converging financial markets of Central and 
Eastern Europe, total  assets  of  the banking sector typically are about the same size as 
national GDP, the lowest level of banking penetration being recorded in Romania (60% 
of GDP), Lithuania (70%) and Slovakia (78%). 

While  loans  typically  represent  the  bulk  of  the  banking  assets  in  the  EU,  most 
banks also invest in capital markets. Except for Luxembourg and Ireland which both 
have  a  large  financial  sector  and  hold  the  largest  share  of  their  assets  in  bonds,  loans 
represent  by  far  the  most  important  asset  on banks'  balance  sheets,  i.e.  57.6%  of  total 
banking assets on average (Table 6). Except for Luxembourg and Ireland again, bonds 
are the second most important asset class on EU banks' balance sheets, accounting on 
average  for  17.9%  of  total  assets,  of  which  the  largest  part  is  government  bonds. 
Holdings  in  equity  securities  are  much  more  limited,  the  average  equity  portfolio 
represents only 3% of banks' assets. On average, investments in unlisted shares is higher 
than  investments  in  listed  shares,  representing  1.8%  of  banks'  assets  and  being 
particularly high as a percentage of assets in Spain, Italy, Hungary and Austria. 

While  banks  transform  households’  deposits  mainly  into  loans,  insurance 
companies  and  pension  funds  are  the  key  institutional  investors  intermediating 
funds  from  households  to  capital  markets.  The  importance  and  balance  sheet 
structure  of  insurance  companies  and  pension  funds  varies  greatly  from  one  Member 
State to another (Table 5). Luxembourg stands out with assets of insurance companies 
representing 300% of its GDP. Other countries with a sizable insurance sector are Malta 
(132% of GDP), Denmark (109%), France and Sweden (97%), and Belgium (78%). On 
the other hand, countries in Central and Eastern Europe typically have small insurance 
sectors.  Regarding  pension  funds,  the  Netherlands  stands  out  with  total  assets 
amounting to 154% of GDP. Except for Denmark where pension funds' assets represent 
75% of GDP, this ratio typically does not exceed 20% in other Member States.  

The structure of the asset portfolio of insurance companies and pension funds also 
varies  significantly  from  one  Member  State  to  another  (Table  7).  Typically,  bonds 
constitute  the  largest  asset  class  (45%  of  total  assets  on  average),  followed  by 
investment  funds  (25%).    However,  in  eight  Member  States,  the  proportion  of  bonds 
exceeds 60% (going up to 70% in the Czech Republic), while in nine others it is below 
30% (e.g. 17% in Germany). Investment funds represent almost half of the institutional 
investors’  assets  in  Finland  and  Lithuania,  but  almost  nothing  in  Malta.  Shares,  both 
listed and unlisted, account for nearly 10% of the portfolio of EU insurers and pension 
funds on average. Still, differences in equity holdings between one country and another 
remain  significant.  For  example,  while  Polish  and  Irish  insurance  companies  and 
pension  funds  hold  about  a  quarter  of  their  assets  in  listed  shares,  Danish  institutions 

96 

 
stand out as the largest investors in unlisted shares, as they represent 17% of their asset 
portfolio. 

Diversity  across  Member  States  is  also  a  key  characteristic  of  the  European 
investment fund sector. Luxembourg and Ireland, which are the two main EU hubs for 
fund  registration  and  management,  are  outliers  in  the  EU  investment  funds  sector  – 
assets held by investment funds represent 53 and 6.4 times national GDP, respectively 
(Table 5). In other EU Member States, the size of the asset portfolio held by investment 
funds ranges between 20% and 100% of GDP in countries with significantly developed 
capital  markets,  while  it  is  below  15%  of  GDP  in  all  Central  and  Eastern  Europe 
countries.  The  investment  funds  sector  is  particularly  underdeveloped  in  Lithuania, 
Latvia,  Croatia  Greece,  Czech  Republic,  and  Bulgaria,  where  investment  funds'  assets 
represent less than 3.5% of GDP. 

97 

 
Table 5(a): Financial intermediation in Member States via institutions 
(% of GDP, 2013, 2014 or 2015) 

% of GDP

Banks

BE
BG
CZ
DK
DE
EE
IE
EL
ES
FR
HR
IT
CY
LV
LT
LU
HU
MT
NL
AT
PL
PT
RO
SI
SK
FI
SE
UK

(assets)
254.7
108.6
120.3
291.3
242.7
108.8
519.5
199.2
246.0
273.6
129.9
184.6
461.9
123.3
70.2
1865.7
97.2
669.1
307.3
213.1
82.1
233.8
60.4
107.5
78.1
265.3
256.3
571.1

Investment 
funds
(assets)
26.5
3.4
2.7
101.6
53.4
13.9
642.4
2.3
20.5
41.6
1.6
11.1
14.0
1.5
0.7
5287.3
11.8
82.4
89.0
48.9
12.5
8.5
5.6
5.9
5.2
38.4
70.0
:

Insurance 
companies
(assets)
77.8
:
:
108.8
60.0
:
:
7.9
:
97.1
8.8
:
:
4.5
2.7
300.3
8.3
132.5
62.1
32.5
:
:
2.4
:
8.4
32.2
97.3
:

Pension 
funds
(assets)
5.0
:
:
75.1
16.3
:
:
0.2
:
:
18.7
:
:
8.3
4.6
2.5
4.3
0.0
154.3
5.8
:
:
3.8
:
9.7
1.8
24.9
:

IC&PF

(assets)
82.8
10.5
18.2
183.9
76.1
15.4
174.2
8.1
38.0
0.0
27.5
41.1
37.7
12.8
7.3
302.8
12.6
132.5
213.9
38.3
27.8
45.1
6.2
24.0
18.1
34.0
122.1
214.3

Source: Eurostat, ECB.  

98 

 
 
Table 5(b): Financial intermediation in Member States via markets 
(% of GDP, 2013, 2014 or 2015) 

% of GDP

Listed shares of 
NFC 

Bonds of NFC Securitisation

(capitalisation) (outstanding) (outstanding)
9,9
3,1
7,9
9,6
4,4
7,0
1,0
0,9
2,0
24,2
4,8
8,1
5,5
0,7
0,0
42,0
2,0
4,3
11,7
11,6
4,8
19,8
0,1
2,9
4,3
15,6
20,2
22,7

58,1
7,1
10,4
82,7
43,8
8,6
186,4
13,3
36,5
65,2
30,4
18,8
7,4
3,6
9,4
110,5
8,3
10,9
47,7
18,8
17,3
22,6
9,3
14,2
2,7
68,2
88,1
74,4

17,0
-
-
0,1
2,3
-
18,2
13,6
15,6
3,2
-
9,4
-
0,0
-
-
-
-
36,8
0,6
0,1
20,0
-
-
-
0,5
-
14,3

BE
BG
CZ
DK
DE
EE
IE
EL
ES
FR
HR
IT
CY
LV
LT
LU
HU
MT
NL
AT
PL
PT
RO
SI
SK
FI
SE
UK

Private 
equity 

Venture 
capital 

(investment) (investment)

0,239
0,006
0,194
0,486
0,247
-
0,274
0,000
0,151
0,395
-
0,113
-
-
-
0,057
0,165
-
0,472
0,088
0,061
0,153
0,052
-
-
0,348
0,330
0,424

0,028
0,006
0,006
0,026
0,023
-
0,049
0,000
0,009
0,030
-
0,002
-
-
-
0,009
0,031
-
0,026
0,019
0,005
0,029
0,004
-
-
0,060
0,066
0,038

Source:  Eurostat,  ECB,  Securities  Industry  and  Financial  Markets  Association  (SIFMA),  European  Private  Equity 
and Venture Capital Association (EVCA).  

The size of the stock market also varies greatly from one Member State to another. 
The  capitalisation  of  publicly-listed  NFCs  relative  to  GDP  (of  the  country  where  the 
NFC  is  registered)  is  highest  in  Ireland  (190%)  and  Luxembourg  (110%),  where  the 
financial sector is particularly developed (Table 5). Public equity markets are also large 
in  the  UK  (where  the  capitalisation  of  listed  NFCs  represent  74%  of  GDP),  Nordic 
European  countries  (88%  in  Sweden  and  68%  in  Finland)  and  some  older  Member 
States  (65%  in  France,  58%  in  Belgium  and  44%  in  Germany).  In  all  Central  and 

99 

 
 
 
 
Eastern Europe countries except Poland and the Czech Republic, public equity shares of 
NFCs represent less than 10% of GDP.244 

In all EU Member States, corporate bond markets are smaller than stock markets 
(Table 5). However, national differences exist. Relative to size, Luxembourg has the 
most  developed  bond  market,  with  the  value  of  outstanding  bonds  reaching  42%  of 
GDP. The size of the national bond capital market exceeds 15% of GDP in France, UK, 
Sweden,  Portugal  and  Finland.  On  the  other  side  of  the  spectrum,  several  Member 
States  feature  very  small  corporate  bond  markets,  in  particular  Romania,  Latvia  and 
Lithuania (below 1%), Ireland and Greece (1%), Estonia, Hungary and Spain (2%).   

The  level  of  development  of  securitisation  indicates  the  degree  to  which  financial 
intermediaries  (primarily  banks)  use  capital  markets  to  fund  their  portfolios.  It 
also varies greatly between Member States. Although securitisation is predominantly 
used  for  mortgage  and  consumer  products,  some  corporate  loans  and  bonds  are  also 
used as underlying assets. The Netherlands has the largest securitisation market (37% of 
GDP), with  the bulk  of  the collateral being mortgage loans (Table 5). Some countries 
also  have  relatively  developed  securitisation  markets,  with  stocks  of  securitised  assets 
representing  between  15%  and  20%  of  GDP  (Portugal,  Ireland,  Spain,  UK).  In  some 
other  large  European  countries,  even  though  the  amount  of  securitised  assets 
outstanding is relatively low as a percentage of GDP, the securitisation market is also 
sizable in absolute numbers (France, Germany, Italy). In most other countries, the value 
of the outstanding securitised assets relative to the size of the economy is very small.245  

Private  equity  and  venture  capital,  even  if  limited  in  all  EU  Member  States,  are 
important  sources  of  funding,  especially  for  higher  risk  and  innovative  projects. 
They can still be regarded as niche solutions compared to traditional financing venues. 
Taking all types of private equity investment into consideration, private equity activity 
is highest in the most developed capital markets (the large Member States, Benelux, the 
Nordic countries), but even in these countries it remains below 0.5% of GDP (Table 5). 
Venture  capital,  used  for  start-ups  and  more  risky  undertakings,  constitutes  a  small 
fraction of private equity. This type of financing is most developed in Finland (0.07% of 
GDP), Sweden, Ireland and the UK.  

244  Note that the importance of listed shares of NFCs as a percentage of GDP is significantly lower than 

total market capitalisation, as financial institutions are not included in the ratio. 

245  The available data has incomplete coverage. 

100 

 
                                                 
Table 6: Structure of assets of banking sectors in EU Member States 
(% of total, 2014 or 2013) 

Currency and 
deposits

Loans

Investment 
funds

BE
BG
CZ
DK
DE
EE
IE
EL
ES
FR
HR
IT
CY
LV
LT
LU
HU
MT
NL
AT
PL
PT
RO
SI
SK
FI
SE
UK
Ave. 

22.2
18.3
21.9
9.0
14.5
19.3
21.4
9.1
5.2
16.4
13.3
8.1
10.0
31.5
15.5
36.3
22.7
2.5
15.6
14.0
6.1
10.0
15.6
11.8
7.5
14.0
18.3
15.9
15.2

Source: Eurostat. 

38.5
64.4
51.8
78.4
44.8
70.8
29.7
64.3
58.3
44.4
73.2
64.4
79.8
54.9
71.0
26.8
53.0
59.9
62.9
60.9
69.2
58.3
63.4
63.1
69.1
46.9
60.4
31.4
57.6

0.1
0.2
0.6
0.7
2.2
0.0
0.0
0.2
0.0
0.9
0.2
0.3
0.1
0.9
0.0
0.4
0.2
0.1
0.0
1.0
0.2
2.4
0.1
0.0
0.3
0.3
3.0
0.0
0.5

Insurance 
and pension 
funds
0.0
0.0
0.2
0.0
0.0
0.0
0.0
0.0
0.0
-
0.1
0.1
0.0
0.0
0.0
0.0
0.1
0.0
0.8
0.0
0.0
0.4
0.1
0.1
0.0
0.0
0.0
0.0
0.1

Bonds

Listed shares

Unlisted 
shares

Other equity

Financial 
derivatives

Other

21.3
11.1
20.7
7.1
19.7
5.5
45.3
19.7
24.2
15.7
10.5
20.3
7.7
9.8
10.4
32.5
17.4
35.2
16.1
15.2
20.9
20.7
18.8
22.2
22.7
12.3
5.8
12.9
17.9

0.3
0.3
0.1
0.5
1.4
0.0
0.0
1.3
2.0
2.8
0.0
0.6
0.1
0.0
0.0
0.1
0.3
1.0
0.5
0.4
0.0
1.2
0.0
0.7
0.1
0.4
0.9
0.2
0.5

2.2
2.2
1.4
1.7
1.2
3.3
1.1
2.8
5.6
-
0.7
4.0
0.4
-
2.1
0.9
3.1
0.3
3.0
3.1
0.7
2.1
0.7
0.7
0.2
0.4
2.5
0.9
1.8

0.1
0.1
0.4
0.0
1.3
0.0
-
0.0
1.9
-
0.5
0.3
0.2
-
0.0
0.0
0.7
0.0
0.0
4.0
0.1
1.3
0.9
0.5
0.0
0.8
0.0
1.7
0.6

0.0
0.1
2.1
0.4
12.2
0.2
1.8
1.2
1.3
8.0
0.2
1.8
0.1
0.3
0.6
1.5
2.0
0.7

1.4
1.2
0.0
0.0
0.3
-0.1
21.5
6.4
36.9
3.8

15.3
3.1
0.7
2.2
2.8
0.8
0.6
1.4
1.4

1.3
0.2
1.6
2.5
0.4
1.5
0.6
0.3
1.1
0.1
1.6
3.5
0.5
0.6
0.1
3.2
2.7
0.0
1.9

101 

 
 
 
 
Table  7:  Structure  of  assets  of  insurance  companies  and  pension  funds  in  EU 
Member States 
(% of total, 2014 or 2013) 

Currency and 
deposits

Loans

Investment 
funds

BE
BG
CZ
DK
DE
EE
IE
EL
ES
FR*
HR
IT
CY
LV
LT
LU
HU
MT
NL
AT
PL
PT
RO
SI
SK
FI
SE
UK
Ave. 

3.0

24.0

4.8

1.4

23.5

19.2

6.6

17.7

15.5

1.6

4.3

4.7

32.2

14.3

4.2

8.5

6.2

7.4

1.7

3.6

6.0

11.7

9.1

8.7

13.7

5.0

2.9

3.8
9.5

7.4

1.7

0.8

2.8

11.4

0.0

0.4

0.9

1.0

0.9

2.2

1.6

3.6

0.4

0.1

1.0

0.2

42.9

6.6

3.3

1.1

0.2

0.1

1.7

0.2

2.3

2.1

4.9
3.6

13.2

6.2

11.6

31.8

36.3

39.0

28.2

13.5

6.3

21.9

6.6

13.8

25.8

29.0

46.7

37.8

27.5

0.6

45.7

40.3

10.8

11.4

32.1

18.7

15.0

48.9

40.8

21.5
24.3

Source: Eurostat
* Only insurance companies' assets for France.

Insurance 
and pension 
funds
1.4

0.0

4.9

0.3

-

0.0

8.3

2.0

3.4

-

1.2

0.1

3.4

0.0

0.0

14.4

2.1

0.0

0.3

2.4

1.4

0.6

5.6

0.3

0.2

-

0.2

21.5
3.0

Bonds

Listed shares

Unlisted 
shares

Other equity

Financial 
derivatives

Other

65.5

43.9

70.5

36.3

17.0

26.9

26.2

56.5

62.5

64.1

68.4

66.1

25.8

40.8

44.3

28.5

59.5

26.4

29.8

42.8

47.0

64.4

43.1

60.6

66.8

35.5

29.8

28.7
45.6

3.4

9.1

0.9

1.4

0.6

3.9

23.2

0.9

4.9

3.8

13.6

4.0

4.2

0.6

1.0

5.8

2.5

11.8

8.3

0.7

27.8

4.2

6.0

4.2

0.7

3.2

18.6

3.1
6.2

5.1

5.5

1.4

16.7

7.3

8.3

1.5

1.1

0.7

6.6

0.2

6.1

1.4

-

0.0

3.2

0.1

0.0

2.4

2.8

2.0

0.6

0.1

2.4

0.7

2.5

2.4

0.2
3.0

0.0

0.0

0.6

0.6

1.2

0.0

-

0.0

0.7

0.9

0.6

3.0

0.1

-

0.0

0.0

0.4

0.0

0.0

3.4

0.0

2.3

0.6

0.6

0.2

0.0

1.3

11.6
1.1

0.1

0.0

0.1

7.0

0.3

0.0

0.6

0.0

0.0

0.1

0.1

0.5

0.0

0.0

0.0

0.0

0.0

0.4

2.3

0.0

0.1

0.0

0.0

0.0

0.0

0.2

0.6

3.8
0.6

1.0

9.7

4.4

1.8

2.4

2.6

4.9

7.4

5.1

0.0

3.0

0.0

3.6

14.9

3.8

0.7

1.4

10.5

2.9

0.8

3.7

4.6

3.2

2.8

2.7

2.4

1.3

0.8
3.7

6.4  How  can  the  CMU  benefit  EU  Member  States  with  different  levels  of  capital 

market development? 

All  EU  Member  States  are  expected  to  benefit  from  more  developed  and  better 
integrated  capital  markets.  The  key  gains  for  local  companies  are  the  broader 
availability of financing instruments and a larger pool of investors from which funding 
can be obtained. In particular, start-ups looking for seed money will be able to get funds 
from  business  angels  and/or  private  equity  and  venture  capital  funds  operating  in  the 
region  or  in  another  EU  Member  State.  This  additional  funding  will  first  enable  new 
companies  to  come  into  existence  and  then  allow  them  to  grow,  with  will  directly 
benefit the local economy. At a later stage, the development of the CMU will make it 
easier for companies to get funding by issuing listed securities (bonds and/or equity).  

On the investor side, retail and institutional investors will have access to a broader 
range of investment products. As financial products from national and other European 
to  diversify  portfolios  (whether 
suppliers  become  available, 
geographically,  sectorally,  from  a  maturity  or  asset  class  perspective,  or  otherwise) 
should  increase.  This  should  therefore  result  in  a  more  efficient  capital  allocation.  In 
addition, increased competition, also from foreign suppliers, to capture retail investors' 
savings will bring benefits in terms of maximisation of returns, limitation of costs and 

investors'  ability 

102 

 
 
 
diversification of risks, therefore enabling an optimisation of their portfolios' risk-return 
profile. 

As highlighted in earlier sections of this Staff Working Document, EU economies 
will become less dependent on bank funding and their financing flows will become 
more sustainable and stable. In countries where banks are dominant, borrowers able to 
attract other funding sources will be less dependent on banks. A more diverse financial 
system that includes capital markets alongside banking markets tends to be better able 
to absorb shocks and less vulnerable to financial crises. This also holds true at national 
level. 

For  EU  Member  States  where  capital  markets  are  already  well-developed,  the 
CMU will generate more business for already well-established exchanges but also 
other  capital  markets  stakeholders  –  such  as  banks,  investment  funds,  institutional 
investors, market operators and intermediaries, etc. Such new business can take various 
forms: arrangement of the issuance of securities, auxiliary services linked to issuing and 
trading,  development  of  existing  or  new  investment  products,  etc.  Some  of  these 
services  require  economies  of  scale  to  be  profitable,  thus  are  best  delivered  in  large 
financial  centres,  but  also  in  smaller  financial  centres  that  serve  as  regional  hubs  to 
neighbouring  Member  States.  Scale  economies  and  increased  openness  should  stir 
competition in and among financial centres, leading to lower costs and the development 
of more tailor-made financial products. This should benefit domestic as well as foreign 
customers. Growth in financial services could also stimulate technical progress in other 
parts of the economy. 

The  CMU  may  encourage  renewed  cross-border  financial  activity  by  banks  and 
other  financial  intermediaries  to  the  benefit  of  those  Member  States  which 
particularly suffered from sovereign debt crisis. The financial crisis left a legacy of 
high debt levels in the public and the financial sectors in several Member States. Even 
though  financial  support  programmes  and  the  Banking  Union  reduced  the  nexus 
between sovereign borrowers and banks, credit conditions are assessed as still relatively 
difficult  in  some  Member  States.  Potential  borrowers  would  benefit  if  they  were  less 
reliant  on  funding  from  domestic  sources  and  could  turn  to  foreign  lenders.  Foreign 
banks have so far shown little appetite to increase retail lending in Member States with 
a  weaker  banking  system  or  to  acquire  banks  under  adjustment  pressure  in  these 
countries.  The  CMU  may  contribute  to  the  defragmentation  of  lending  markets  in  the 
EU. 

Significant benefits are also expected in Member States where capital markets are 
still structurally under-developed. In several EU countries with a still relatively low 
per  capita  income  and  a  less  developed  financial  sector,  there  is  a  strong  need  for 
investment,  in  particular  in  infrastructure.  As  regards  Central  and  Eastern  Europe, 
although the privatisation process of state-owned enterprises that started in the 1990s is 
well advanced, it is not yet complete. Besides, further capital inflows and foreign direct 
investment (FDI) are necessary to continue the reform process and support productivity 
improvement  and  growth  in  per  capita  income.  For  example,  analysts246  believe  that 

246 See for example, McKinsey (2013) 

103 

 
                                                 
further  growth  in  Central  and  Eastern  Europe  requires  critical  “enablers”  such  as 
investments  in  infrastructure,  education  and  innovation  as  well  as  regulatory  and 
institutional reforms. 

Better  developed  local  capital  markets  are  essential  to  finance  these  investments, 
with the help of both domestic and foreign funding sources. Local capital markets, 
when  open  to  foreign  investment,  can  attract  foreign  capital.  As  a  consequence,  local 
firms get greater market access and credit constraints get relieved. In addition, the cost 
of capital for local firms and households decreases thanks to competition, and the risk 
sharing across countries improves.247 As foreign investors need to evaluate and monitor 
their  investments,  their  rising  information  activity  may  also  raise  local  standards  in 
terms  of  quantity  and  quality  of  the  information  provided.  The  standardisation  of  the 
information  requirements  should  in  turn  attract  additional  foreign  investors.  Foreign 
investment is also likely to put pressure on the receiving country to improve its business 
and  regulatory  environment.  This,  in  turn,  favours  the  creation  and  development  of 
companies, creating a "virtuous cycle". Finally, local companies may also benefit from 
the  intensified  screening  activity  by  investors  and  the  discovery  process  this  entails, 
which may encourage innovative activity. 

Studies show that the development of local capital markets significantly improves 
the  availability  of  long-term  financing  for  local  investment  projects.248  More 
developed local capital markets allow firms to better manage the maturity and interest 
rate  risks  associated  with  long-term  investments  (such  as  investments  in  equipment, 
buildings, R&D or intangible assets) by allowing a better match between the duration of 
assets  and  financial  liabilities.  The  development  of  a  local  bond  market  and  to  some 
extent  the  derivatives  market  that  supports  it  could  in  particular  bring  this  benefit.  A 
larger local equity market can also improve local firms’ access to long-term capital. 

Funding  costs  for  borrowers  can  be  lowered  thanks  to  competition.  For  example, 
bond  finance  provides  a  source  of  competition  to  bank  loans  and  may  offer  relatively 
cheap  financing  to  large,  reputable  firms  that  have  the  scale  and  credentials  to  tap 
capital  markets.249  In  addition,  as  mentioned  in  Section  2.1,  market  discipline  can 
improve the quality of  the information disclosed by firms, which has a positive impact 
on  their  cost  of  funding.  This  facilitates  the  expansion  of  well-performing  national 
companies, both domestically and across borders. All in all, broadening funding sources 
and  reducing  borrowing  costs  should  benefit  European  corporations  and  stimulate  the 
economy and therefore growth and jobs at a national level. 

The optimal balance between local capital market development and integration in 
global  capital  markets  will  depend  on  country  factors  such  as  economic  size  and 
stage  of  development.  While,  as  explained  earlier,  the  development  of  local  capital 

247  See, for example, Borensztein et al. (2006). At the same time, studies also show that the liberalization 
of financial markets can trigger the migration of trading to international financial sectors, hampering 
domestic market development, e.g. high-quality firms may try to escape local markets, lowering the 
average quality of local issuances. For more details see Laeven (2014), De la Torre, et al. (2006). 

248  See Laeven (2014). 
249 See Laeven (2014). 

104 

 
                                                 
markets  can  bring  several  advantages  to  the  local  economy,  the  size  of  the  borrowers 
and  investors'  pools  also  has  to  be  taken  into  consideration.  For  some  investment 
products, in particular those held over the long term, the existence of a deep and liquid 
market is not a pre-requisite. Still, for some financial products that typically thrive in a 
fully-fledged physical capital market, limited pools of potential borrowers and investors 
may constitute an important obstacle. 

In  this  context,  and  as  more  and  more  national  companies  get  funding  on 
international  capital  markets,  regional  capital  markets  are 
increasingly 
developing. The CMU is expected to further foster the emergence of new or the growth 
of existing local financial centres, such as for example the Warsaw Stock Exchange250 
and  the  restructured  NewConnect,  Warsaw's  alternative  trading  market.251  Such  new 
financial  centres  may  build  up  expertise  in  specialised  niches  for  corporates  and 
investors with specific funding and investment needs. 

To  conclude,  while  all  EU  countries  are  expected  to  benefit  from  the  CMU, 
national  specificities  may  represent  challenges  in  some  instances  but  more 
importantly  opportunities  for  a  broad  range  of  national  stakeholders.  Also, 
realisation  of  the  full  benefits  of  CMU  will  depend  crucially  on  the  commitment 
and rigor of its  implementation at national level. 

250  Currently,  one  third  of  stocks  traded  on  the  Warsaw  Stock  Exchange  (WSE)  are  stocks  of  foreign 
companies. Its international success is notably attributable to the high presence of remote members250 
and its solid public trust. According to the IPO Watch Europe Report for Q2 of 2015, the WSE is one 
of EU largest markets in terms of the number of IPOs and a leader in Central and Eastern Europe by 
the value of trading in stocks and the capitalisation of listed companies. 

251  NewConnect is expected to become an important hub for growing companies in the region to access 
additional  financing.  The  platform  offers  lower  costs  for  floated  companies,  and5  a  simplified 
entrance  criteria  along  with limited  reporting  requirements. The  exchange  is  conducted  outside  the 
regulated market as an multilateral trading facility. Similar trends and related benefits are observable 
in other EU regions. 

105 

 
 
 
 
                                                 
REFERENCES 

Acemoglu,  D.  and  Zilibotti,  F.  (1997a),  Agency  costs  in  the  process  of  development, 
Seminar  Papers  607,  Stockholm  University,  Institute  for  International  Economic 
Studies. 

Acemoglu,  D.  and  Zilibotti,  F.  (1997b),  Was  Prometheus  Unbound  by  Chance?  Risk, 
Diversification,  and  Growth,  Journal  of  Political  Economy,  Vol.  105,  No. 4,  pp.  709-
751. 

Adrian,  T.  and  Shin,  H.S.  (2008),  Financial  Intermediaries,  Financial  Stability,  and 

Monetary Policy, Federal Reserve Bank of New York Staff Report No. 346.  

Adrian,  T.  and  Shin,  H.S.  (2010),  The  Changing  Nature  of  Financial  Intermediation, 

Federal Reserve Bank of New York Staff Report No. 439. 

AFME (2014), An agenda for capital markets union, November 2014. 

AFME  (2015),  Bridging  the  growth  gap,  Investor  views  on  European  and  US  capital 

markets and how they drive investment and economic growth, February 2015. 

AFME-ICMA  (2015),  Guide  to  Infrastructure  Financing:  Bank  loans,  debt  private 

placements and public bonds – smoothing the pathway for effective funding 

Aghion P., Akcigit U., Howitt P. (2013), What Do We Learn From Schumpeterian Growth 

Theory? NBER Working Paper No. 18824 

Akerlof  G.  A.  (1970),  "The  Market  for  Lemons":  Quality  Uncertainty  and  the  Market 
Mechanism,  The  Quarterly  Journal  of  Economics,  Vol.  84,  No.  3.  (Aug.,  1970),  pp. 
488-500. 

Al-Eyd, A. and Pelin Berkmen, S. (2013), Fragmentation and Monetary Policy in the Euro 

Area, IMF Working Paper No. 13/208. 

Allard,  J.  and  Blavy,  R.  (2011),  Market  Phoenixes  and  Banking  Ducks,  Are  Recoveries 

Faster in Market-Based Financial Systems?. IMF Working Paper No. 11/213. 

Allen,  F.  and  Gale,  D.  (1997),  Financial  Markets,  Intermediaries,  and  Intertemporal 

Smoothing, Journal of Political Economy, Vol. 105, No. 3, pp. 523-46. 

Allen,  F.  and  Gale,  D.  (1999),  Corporate  Governance  and  Competition,  Center  for 
Financial  Institutions  Working  Papers  99-28,  Wharton  School  Center  for  Financial 
Institutions, University of Pennsylvania. 

Allen,  F.  and  Gale,  D.  (2000),  Asset  Price  Bubbles  and  Monetary  Policy,  Center  for 
Financial  Institutions  Working  Papers  01-26,  Wharton  School  Center  for  Financial 
Institutions, University of Pennsylvania.  

Almarzoqi,  R.M.,  Ben  Naceur,  S.  and  Kotak,  A.  (2015),  "What  Matters  for  Financial 

Development and Stability?", IMF Working Paper No. 15/173. 

Anderson,  N,  Brooke,  M,  Hume,  M.  and  Kürtösiová,  M.  (2015),  A  European  Capital 
Markets  Union:  implications  for  growth  and  stability,  Bank  of  England  Financial 
Stability Paper No. 33. 

Arcand, J. L., Berkes, E. and Panizza, U. (2012), Too much finance? IMF Working Paper 

No. 12/161. 

Arrondel,  L.,  et  al.  (2014),  How  do  households  allocate  their  assets?  Stylised  facts  from 
the Eurosystem household finance and consumption survey, ECB Working Paper No. 
1722.  

106 

 
Baldi,  G.  et  al.  (2014),  Weak  investment  dampens  Europe's  Growth,  DIW  Economic 

Bulletin 2014, No. 7.  

Balduzzi, P., Brancati, E. and Schiantarelli, F. (2013), Financial Markets, Banks' Cost of 
Funding,  and  Firms'  Decisions:  Lessons  from  Two  Crises,  IZA  Dicussion  Paper  No. 
7872.  

Bank of England and ECB (2014), The case for  a better functioning securitisation market 

in the European Union, A discussion paper, May 2014. 

Barkbu, B. et al. (2015) Investment in the euro area, why has it been weak? IMF Working 

Paper No. 15/32. 

Bartelsman, E., Haltiwanger, J. and Scarpetta, S. (2009), Measuring and analyzing cross-
country differences in firm dynamics, in: Dunne, T., Bradford Jensen, J. and Roberts, 
M.J.  (eds.),  Producer  Dynamics:  New  Evidence  from  Micro  Data,  University  of 
Chicago Press. 

Battistini, N., Pagano, M. and Simonelli, S. (2013), Systemic Risk and Home Bias in the 

Euro Area, DG ECFIN Economic Papers No. 494.  

Beck, T., Demirguc-Kunt, A., Levine, R. and Maksimovic, V. (2000), Financial structure 
and  economic  development  -  firm,  industry,  and  country  evidence,  Policy  Research 
Working Paper Series 2423, World Bank. 

Beck, T., Demirgüg-Kunt, A. and Maksimovic, V. (2008), Financing patterns around the 
world: Are small firms different? Journal of Financial Economics Vol. 89, No. 3, pp. 
467-87. 

Beck,  R.,  G.  Georgiadis  and  R.  Straub  (2014),  “The  Finance  and  Growth  Nexus 

Revisited”, Economics Letters, Vol. 124, No. 3, pp. 382-385. 

Beck,  T.  and  Levine,  R.  (2001),  Stock  markets,  banks,  and  growth:  correlation  or 

causality?, Policy Research Working Paper Series 2670, World Bank. 

Beck, T. and Levine, R. (2002), Industry Growth and Capital Allocation: Does Having a 
Market- or Bank-Based System Matter?, NBER Working Papers 8982, National Bureau 
of Economic Research. 

Beck,  T.  and  Levine,  R.  (2004),  Legal  Institutions  and  Financial  Development,  NBER 

Working Papers 10417, National Bureau of Economic Research, Inc. 

Beck, T., Levine, R., and Loayza, N. (2000), Finance and the sources of growth, Journal 

of Financial Economics, 58(1-2), 261–300. 

Beck,  T.,  Demirguc-Kunt,  A.  and  Martiez  Piera,  S.  (2008),  "Banking  services  for 
everyone? Barriers to Bank Access and Use around the World", World Bank Economic 
Review Vol. 22, pp. 397-430. 

Berkes,  E.,  Panizza,  U.  and  Arcand,  J.-L.  (2012),  Too  Much  Finance?,  IMF  Working 

Papers 12/161. 

Beyer,  A.  et  al.  (2010),  The  financial  reporting  environment,  Review  of  the  recent 

literature, Journal of Accounting and Economics, 50, pp. 296-343. 

Bhide,  A.  (1993),  The  hidden  costs  of  stock  market  liquidity,  Journal  of  Financial 

Economics, 34, 1, pp. 31-51. 

BMG (2013) SME journey towards raising finance, Research Report. 

107 

 
Boot, A. and Thakor, A. (1991), Off-balance sheet liabilities, deposit insurance and capital 

regulation, Journal of Banking and Finance, 15, 4-5, pp. 825-846. 

Boot, A. and Thakor, A. (1997), Can Relationship Banking Survive Competition?, CEPR 

Discussion Paper 1592. 

Borensztein, E., Eichengreen, B. and Panizza, U. (2006), Building Bond Markets in Latin 

America. 

Boyd,  J.H.and  Prescott,  E.C.  (1986),  Financial  intermediary-coalitions,  Journal  of 

Economic Theory, Vol. 38, pp. 211-232. 

Brunnermeier,  K,  De  Gregorio,  J.,  Lane,  P.,  Rey,  H.  and  Shin,  H.S.  (2012)  Banks  and 
cross-border capital flows: policy challenges and regulatory responses, VOX column, 7 
October 2012. 

Calomiris,  C.  and  Haber,  S.  (2014)  Fragile  by  Design:  The  Political  Origins  of  Banking 

Crises and Scarce Credit, Princeton University Press.  

Calvet, L., Campbell, J. and Sodini, P. (2009), Measuring the Financial Sophistication of 

Households, NBER. 

Campbell,  J.  Y.  (2006),  Household  Finance,  Journal  of  Finance,  Vol.  61,  Issue  4,  pp. 

1553–1604, August 2006.  

Caprio, G. and Honohan, P. (2008), Banking Crises, Department of Economics Working 

Papers 2008-07, Department of Economics, Williams College. 

Carvajal,  A.  and  J.  Elliott  (2006),  The  Challenge  of  Enforcement  in  Securities  Markets: 

Mission Impossible?, IMF Working Paper No. 168. 

Caudoux,  A.  and  Geffroy,  J.,  Financing  solutions  to  sustain  the  growth  of  SMEs  and 
MTEs and lay the foundation for future competitiveness, Banque de France, Financial 
Stability review, No°19, 2015, p. 44 

Cecchetti, S. and Kharroubi, E. (2012), Reassessing the impact of finance on growth, BIS 

Working Papers 381, Bank for International Settlements. 

Çelik,  S.  and  Isaksson,  M.  (2014),  Institutional  investors  and  ownership  engagement, 

OECD Journal: Financial Market Trends, Vol. 2013/2 

Centre for Strategy and Evaluation Services (2014) Market Practices and Policies on SME 

Rating, Report Commissioned by the European Commission 

Chater,  N.,  Huck,  S.  and  Inderst,  R.  (2010),  Consumer  Decision-Making  in  Retail 
Investment  Services:  A  Behavioural  Economics  Perspective,  Final  Report  for  the 
European Commission, DG SANCO, November 2010. 

Čihák,  M.,  Muñoz,  S.,  Sharifuddin,  S.  T.  and  Tintchev,  K.  (2012),  "Financial  Stability 

Reports: What Are They Good For?", IMF Working Paper No 12/1. 

City of London (2011), Insurance companies and pension funds as institutional investors: 

global investment patterns, Special Interest paper September 2011.  

Coase, R. (1937), The Nature of the Firm, Economica, Vol. 4, No. 16, pp. 386–405. 

Constâncio,  V.  (2015),  European  Financial  Integration  and  Stability,  speech  27  April 

2015.  

Cournède  B.,  Denk,  O.,  Hoeller  P.  (2015)  OECD  Economic  Policy  Paper,  Finance  and 
Inclusive Growth, OECD Economics Department Working Papers, No. 14, June 2015 
OECD Publishing, Paris. 

108 

 
Cournède,  B.  and  Denk,  O.  (2015),  Finance  and  economic  growth  in  OECD  and  G20 
countries,  OECD  Economics  Department  Working  Papers,  No.  1223,  OECD 
Publishing, Paris. 

CRA  (2009),  Assessing  the  Effectiveness  of  Enforcement  and  Regulation,  Study 
commissioned by the City of London Corporation, LIBA, ICMA, SIFMA and FOA. 

CSES  (2012),  Evaluation  of  Market  Practices  and  Policies  on  SME  Rating,  Centre  for 
Strategy and Evaluation Services, Report commissioned by the European Commission.  

Cunliffe,  J.  (2015),  Financial  stability,  the  Single  Market  and  Capital  Markets  Union, 
speech at City of London Corporation and Open Europe conference, 20 January 2015.  

Daude,  C.  and  Fratzscher,  M.  (2008),  The  pecking  order  of  cross-border  investment, 

Journal of International Economics, Vol. 74, No. 1, 2008, pp. 94-119. 

Davydenko  et  al  (2008),  Do  Bankruptcy  Codes  Matter?  A  Study  of  Defaults  in  France, 

Germany and the UK, LXIII The Journal of Finance Vol. 565, pp. 603 – 604. 

De la Torre, A., Gozzi, J.C. and Schmukler, S.L. (2006), Financial Development in Latin 
America:  Big  emerging  issues,  limited  policy  answers.  World  Bank  Policy  Research 
Working Paper No. 3963.  

De  Manuel,  M.  and  Lannoo,  K.  (2012),  Rethinking  Asset  Management:  From  Financial 

Stability to Investor Protection and Economic Growth, CEPS, April.  

De Meza, D., Irlenbusch, B. and Reyniers, D. (2008), Financial Capability: A Behavioural 

Economics Perspective, Financial Services Authority, Consumer Research 69.  

De  Mooij,  R.  (2011),  The  Tax  Elasticity  of  Corporate  Debt:  A  Synthesis  of  Size  and 

Variations, IMF Working Paper No. 11/95. 

De Mooij, R., Keen, M. and Orihara, M. (2013), Taxation, Bank Leverage, and Financial 

Crises, IMF Working Paper No. 13/48 

Demarigny Report, An EU-listing small business act, March 2010. 

Demirguc-Kunt,  A.  and  Levine,  R.  (1996),  Stock  Market  Development  and  Financial 
Intermediaries: Stylized Facts, World Bank Economic Review, World Bank Group, 10, 
2, pp. 291-321. 

Demirguc-Kunt, A., and Levine, R. (2001), Financial Structures and Economic Growth: A 
Cross-Country  Comparison  of  Banks,  Markets,  and  Development.  Cambridge,  MA: 
MIT Press. 

Demirgüç-Kunt, A. and Levine, R. (2009), Finance and Inequality: Theory and Evidence, 

Annual Review of Financial Economics, Annual Reviews, 1, 1, pp. 287-318. 

Demirguc-Kunt A., Feyen, E., Levine, R. (2011), The Evolving Importance of Banks and 

Securities Markets, World Bank, Policy Research Working Paper WPS5805. 

Demyanyk,  Y.,  Ostergaard,  C.  and  Sørensen,  B.E.  (2008),  Risk  sharing  and  portfolio 

allocation in EMU, DG ECFIN Economic Paper No. 334.  

Derrien  F.  and  Kecske  A.  (2013)  The  Real  Effects  of  Financial  Shocks:  Evidence  from 

Exogenous Changes in Analyst Coverage, Journal of Finance. 

Dewatripont,  M.  and  Maskin,  M.  (1995),  Credit  and  Efficiency  in  Centralized  and 

Decentralized Economies, Review of Economic Studies, 62, 4, pp. 541-55. 

Diamond,  D.  W.  (1984),  Financial  intermediation  and  delegated  monitoring,  Review  of 

Economic Studies, 51, pp. 393-414. 

109 

 
Diamond, D. W (1991), Monitoring and Reputation: The Choice between Bank Loans and 

Directly Placed Debt, Journal of Political Economy, 99, 4, pp. 689-721. 

Diamond,  D.  W  and  Verrecchia,  R.  E.  (1982),  Optimal  Managerial  Contracts  and 

Equilibrium Security Prices, Journal of Finance, 37, 2, pp. 275-87. 

Dixon, H. (2004), Unlocking Europe’s capital markets union, Centre for European Reform 

Edmans,  A.,  Heinle,  M.  and  Huang  Ch.  (2013),  The  real  costs  of  disclosure,  CEPR 

Discussion Paper No. 9637.  

ECSDA (2014), CSD Factbook, European Central Securities Depositories Association.  

ECSIP  (2013),  Improving  the  Market  Performance  of  Business  Information  Services 

regarding SMEs, ECSIP consortium, Report for the European Commission.  

EGMI (2011), Expert Group on Market Infrastructures Report, 10 October 2011. 

EIB  (2013),  Private  Infrastructure  Finance  and  Investment  in  Europe,  European 

Investment Bank, Working Papers 2013/02, Georg Inderst. 

EIB (2014), Unlocking Lending in Europe, European Investment Bank.  

EIOPA (2014), Database of pension plans and products in the EEA: Statistical Summary, 

December 2014. 

EIOPA  (2015),  Consultation  paper  on  the  creation  of  a  pan-European  personal  pension 

product (PEPP), EIOPA CP 15/006. 

Engel,  D.  and  Keilbach,  M.  (2007),  Firm  Level  Implications  of  Early  Stage  Venture 
Capital  Investment  -  An  Empirical  Investigation,  Journal  of  Empirical  Finance  14(2), 
150-167. 

ESMA, Report on helping small and medium sized companies access funding, 2012. 

ESRB (2014), Is Europe overbanked?, European Systemic Risk Board, ASC Report No. 4. 

ESRB (2015), ESRB report on the regulatory treatment of sovereign exposures, European 

Systemic Risk Board, March 2015.  

EU  IPO  Task  Force  (2015),  Rebuilding  IPOs  in  Europe.  Creating  jobs  and  growth  in 
European  capital  markets,  EuropeanIssuers,  the  European  Private  Equity  and  Venture 
Capital  Association  and  the  Federation  of  European  Securities  Exchanges,  23  March 
2015. 

European Banking Authority (2014), EBA Report on qualifying securitisation – respone to 

the Commission's call for advice on January 2014 on long-term financing.  

European Central Bank (2012), Euro area cross-border financial flows, Article in Monthly 

Bulletin, February 2012. 

European  Central  Bank  (2014),  Financial  Integration  in  Europe,  European  Central  Bank 

2014 report. 

European Central Bank (2015a), Financial Stability Report, European Central Bank, May 

2015. 

European Central Bank (2015b), Financial Integration in Europe, European Central Bank 

2015 report. 

European Central Bank (2015c), Non-bank financing for euro area NFCs during the crisis, 

Box 6 in Economic Bulletin, Issue 4. 

110 

 
European  Commission  (2008a),  EMU@10:  Successes  and  challenges  after  ten  years  of 

Economic and Monetary Union, European Economy 2/2008.  

European  Commission  (2008b),  Impact  Assessment  report  on  private  placement,  Staff 

Working Document SEC(2008)2340. 

European  Commission  (2009a),  Report  of  Expert  Group  on  removing  tax  obstacles  to 

cross-border Venture Capital Investments.   

European  Commission  (2009b),  The  Economic  Impact  of 

the  Commission 
Recommendation on Withholding Tax Relief Procedures and the FISCO Proposals, 
Staff working document  C(2009)7924. 

European  Commission  (2010),  Towards  a  comprehensive  European 

international 

investment policy, Communication COM(2010)343 final. 

European  Commission  (2013),  Ex  ante  assessment  of  the  EU  SME  Initiative,  Staff 

Working Document SWD(2013)517.  

European Commission (2014a), Unleashing the potential of crowdfunding in the European 

Union, Communication COM(2014)172 final. 

European  Commission  (2014b),  Recommendation  on  a  new  approach  to  business  failure 

and insolvency, Communication C(2014)1500 final. 

European  Commission  (2014c),  Impact  Assessment  accompanying  the  document  "A 
policy  framework  for  climate  and  energy  in  the  period  from  2020  up  to  2030",  Staff 
Working Document SWD(2014)15 final. 

European Commission (2014d), Drivers and implications of the weakness of investment in 

the EU, box in European Commission DG ECFIN autumn 2014 forecast. 

European Commission (2015a), Initial reflections on the obstacles to the development of 
deep  and  integrated  EU  capital  markets  Accompanying  the  document  Green  Paper 
Building a Capital Markets Union, Staff Working Document SWD(2015)13. 

European  Commission  (2015b),  European  Financial  Stability  and  Integration,  Staff 

Working Document SWD(2015)98, 2015. 

European  Commission  (2015c),  Evaluation  of  the  implementation  of  the  Insolvency 

Recommendation, Communication C(2014)1500 final. 

EVCA  (2015),  Venture  Capital  in  Europe:  A  missed  opportunity?  European  Venture 

Capital Association, 25 March 2015. 

EVCA  (2013),  European  Private  Equity  Activity,  Statistics  on  Fundraising,  Investments 

and Divestments, European Venture Capital Association. 

EVCA  (2015),  2014  European  Private  Equity  Activity,  European  Venture  Capital 

Association. 

Ferrando,  A.,  Popov,  A.  and  Udell,  G.F.  (2015),  Sovereign  Stress,  Unconventional 

Monetary Policy, and SME Access to Finance, ECB Working Paper No. 1820. 

FESE (2015) A Blueprint for European Capital Markets, Federation of European Security 

Exchanges, October, www.fese.eu. 

Fratzscher,  M.  and  M.Rieth  (2015),  Monetary  policy,  bank  bailouts  and  the  sovereign-

bank risk nexus in the euro area, ECFIN Economic Paper, forthcoming. 

Gale,  W.  G.  and  Levine,  R.  (2010),  Financial  Literacy:  What  Works?  How  Could  It  Be 

More Effective? Brookings Institution  

111 

 
Gilchrist, S. and Mojon, B. (2014), Credit Risk in the Euro Area, NBER Working Paper 

No. 20041. 

Giovannini  Group  (2001),  Cross-Border  Clearing  and  Settlement  Arrangements  in  the 

European Union.  

Giovannini Group (2003), Second Report on EU Clearing and Settlement Arrangements.  

Goldsmith,  R.W.  (1969),  Financial  Structure  and  Development,  Yale  University  Press, 

New Haven, CT. 

Greenwood, R. and Scharfstein, D. (2013), The Growth of Finance, Journal of Economic 

Perspectives, Vol. 27, No. 2 (Spring), pp. 3–28. 

Grjebine,  T.,  Szczerbowicz,  U.  and  Tripier,  F.  (2014),  Corporate  debt  structures  and 

economic recoveries, CEPII Working Paper No. 19. 

Gros, D. (2014), The Transatlantic Growth Gap, CEPS Commentary, August. 

Grossman,  S.J.  and  Hart,  O.D.  (1979),  A  Theory  of  Competitive  Equilibrium  in  Stock 

Market Economies, Econometrica, 47, 2, pp. 293-329. 

Guiso, L., Jappelli, T. and Terlizzese, D. (1996), Income Risk, Borrowing Constraints, and 

Portfolio Choice, American Economic Review 86(1), 158-172. 

HLEG  (2013),  Finance  for  Growth,  Report  of  the  high  level  expert  group  on  SME  and 

infrastructure financing. 

HM  Treasury  (2012),  Report  on  boosting  finance  options  for  business,  Department  for 
Business,  Innovation  and  Skills,  Industry-led  working  group  on  alternative  debt 
markets March 2012. 

HM Treasury (2013), SME journey towards raising finance, BMG Research Report (2013) 

Department for Business, Innovation and Skills, October 2013. 

Hoffmann, M. and Sørensen, B. E. (2015), Small firms and domestic bank dependence in 

Europe's Great Recession, ECFIN Economic paper, forthcoming.  

Holmström,  B.  and  Tirole,  J.  (1994),  Financial  Intermediation,  Loanable  Funds  and  the 
Real  Sector,  IDEI  Working  Papers  40,  Institut  d'Économie  Industrielle  (IDEI), 
Toulouse. 

IMF  (2011),  Long-Term  Investors  and  Their  Asset  Allocation:  Where  Are  They  Now?, 

Chapter 2 in Global Financial Stability Report, September 2011. 

IMF (2014), Global Financial Stability Report, April 2014. 

IMF (2015a), Global Financial Stability Report, April 2015. 

IMF (2015b), World Economic Outlook, Uneven Growth Short- and Long-Term Factors, 

April 2015. 

INSOL (2010), Europe, Harmonisation of Insolvency Law at EU level, PE 419.633. 

Inter-University Center (2014), The promotion of employee ownership and participation. 

Iyer, R. et al (2014), Interbank liquidity crunch and the firm credit crunch: Evidence from 

the 2007-2009 crisis. Review of Financial Studies, Vol. 27, No. 1, pp. 347-372.  

Jacklin, C. (1987), Demand deposits, trading restrictions, and risk sharing. 

Jakab, Z. and Kumhof, M. (2015), Banks are not intermediaries of loanable funds — and 

why this matters, Bank of England Working Paper No. 529. 

112 

 
Jenkinson, T. and Ljungqvist, A. (2001), Going Public: The Theory and Evidence on how 

Companies Raise Equity Finance. 

Jensen,  M.  C.  and  Murphy,  K.  J.  (1990),  Performance  Pay  and  Top  Management 

Incentives, Journal of Political Economy, 98, pp. 225-264. 

Jensen,  M.  C.  and  Meckling,  W.  H.  (1976),  Theory  of  the  Firm:  Managerial  Behavior, 

Agency Costs and Ownership Structure. 

Jochem, A. and Volz, U. (2011), Portfolio holdings in the euro area – home bias and the 
role  of  international,  domestic  and  sector-specific  factors,  Bundesbank  Discussion 
Paper, Series 1: Economic Studies, No. 07/2011.  

Jones  (1995),  R&D-Based  Models  of  Economic  Growth,  The  Journal  of  Political 

Economy, Vol. 103, Issue 4 (Aug., 1995), 759-784. 

Eleni  A.  Kaditi,  E.  (2010),  Foreign  Investments  and  Institutional  Convergence  in 

Southeastern Europe, KU Leuven Discussion Paper No. 260. 

Kaserer, C. and Rapp, M.S. (2014), Capital Markets and Economic Growth – Long-Term 

Trends and Policy Challenge, Research Report, March 2014. 

Kay  Review  (2012),  The  Kay  Review  of  UK  Equity  Markets  and  Long-term  Decision 

Making,  BIS/12/917.  

Khan, M. S., Senhadji Semlali, A. and Smith, B.D. (2001), Inflation and Financial Depth, 

IMF Working Papers 01/44, International Monetary Fund. 

Kick,  T.,  Onali,  E.,  Ruprecht,  B.  and  Schaeck,  K.  (2014),  Wealth  shocks,  credit-supply 
shocks,  and  asset  allocation  -  Evidence  from  household  and  firm  portfolios,  ECB 
Working Paper No. 1662.  

King,  R.  G.  and  Levine,  R.  (1993a),  Finance  and  growth:  Schumpeter  might  be  right, 

Quarterly Journal of Economics, 108(3), 717-737.  

King,  R.  G.  and  Levine,  R.  (1993b),  Finance,  entrepreneurship  and  growth,  Journal  of 

Monetary Economics, 32(3), pp 513-542. 

Kortum,  S.  and  Lerner,  J.  (2000),  Assessing  the  impact  of  venture  capital  on  innovation 

Rand Journal of Economics Vol. 31, 4, pp. 674-692. 

Law, S. H. and Singh, N. (2014), Does too much finance harm economic growth? Journal 

of Banking and Finance: Vol. 41(C), pp. 36-44. 

Laeven, L. and Valencia, F. (2012), Systemic Banking Crises Database: An Update, IMF 

Working Paper No. 12/163. 

Laeven, L. (2014), The Development of Local Capital Markets: Rationale and Challenges, 

IMF Working Paper 14/234. 

Langedijk  S.,  Nicodème  G.,  Pagano  A.  and  Rossi  A.  (2014),  Debt  Bias  in  Corporate 

Taxation and the Costs of Banking Crises in the EU, Taxation Papers, No. 50. 

Langfield S., Pagana M. (2015), Bank bias in Europe: Effects on systemic risk and growth, 

ECB Working Paper Series No. 1797, May 2015. 

Lanoo, K., Pollack, A. and Stæhr, O. (2015), Keep Capital Markets Union simple, CEPS 

EMCI commentary No. 38, July. 

La  Porta,  R.,  Lopez-De-Silanes,  F.,  Shleifer,  A.  and  Vishny,  R.  W.  (1997),  Legal 

Determinants of External Finance, Journal of Finance (1997), pp. 1131-1150. 

113 

 
Leland, H. E. and Pyle, D.H. (1977), Informational Asymmetries, Financial Structure, and 

Financial Intermediation, Journal of Finance, 32, 2, pp. 371-87. 

Levine,  R.  (1997),  Financial  development  and  economic  growth:  views  and  agenda, 

Journal of Economic Literature, 35, pp. 688-726. 

Levine,  R.  (2002),  Bank-Based  or  Market-Based  Financial  Systems:  Which  Is  Better?, 

Journal of Financial Intermediation, 11, 4, pp. 398-428. 

Levine,  R.,  Loayza,  N.  and  Beck,  T.  (2000),  Financial  intermediation  and  growth: 

Causality and causes, Journal of Monetary Economics Vp. 46,No. 1, pp. 31-77. 

Levine, R. and Zervos, S. (1998), Stock markets, banks, and economic growth, American 

Economic Review, 88, pp. 537-558. 

Lewis,  S.  and  Messy,  F.-A.  (2012),  Financial  Education,  Savings  and  Investments:  An 
Overview, OECD Working Papers on Finance, Insurance and Private Pensions, No. 22. 

Lewis,  V.  L.  and  Churchill,  N.C.  (1983),  The  Five  Stages  of  Small  Business  Growth. 

Harvard Business Review, Vol. 61, Issue 3, p. 30-50. 

Liu, Y. and Rosenberg, Ch.B. (2013), Dealing with Private Debt Distress in the Wake of 

the European Financial Crisis, IMF Working Paper No. 13/44. 

Lucas,  R.  E.  (1988),  On  the  mechanics  of  economic  development,  Journal  of  Monetary 

Economics, 22, pp. 3-42. 

McCarthy,  D.  (2004),  Household  Portfolio  Allocation:  A  Review  of  the  Literature, 
Prepared  for  presentation  at  the  International  Forum  organized  by  the  ESRI,  Tokyo, 
Japan, February 2004.  

McKinnon,  R.  I.  (1973),  Money  and  Capital  in  Economic  Development.  Brookings 

Institution, Washington, DC. 

McKinsey  Global  Insistute  (2013),  "A  new  dawn:  Reigniting  growth  in  Central  and 

Eastern Europe" 

Meng,  C.  and  Pfau,  W.D.  (2010),  The  Role  of  Pension  Funds  in  Capital  Market 

Development   

MiFID  II/MiFIR,  Regulation  (EU)  No.  646/2012  of  the  European  Parliament  and  the 
Council  of  4  July  2012  on  OTC  derivatives  ,  central  counterparties  and  trade 
repositories  (EMIR),  Directive  2014/65/EU  (MiFID  II)  and  the  accompanying 
Regulation  (MiFIR)  of  the  European  Parliament  and  of  Council  of  15  May  2014  on 
markets in financial instruments. 

Milgrom, P. and Stokey, N. (1982), Information, trade and common knowledge, Journal of 

Economic Theory, 26, pp. 17–27. 

Modigliani, F. and Miller, M. H. (1958). The Cost of Capital, Corporate Finance and the 

Theory of Investment. American Economic Review, 48, 261-97. 

Myers, S. C. and Majluf, N.S. (1984), Corporate financing and investment decisions when 
firms have information that investors do not have. Journal of Financial Economics 13 
(2): 187–221. 

North,  D.  (1990),  Institutions,  Institutional  Change  and  Economic  Performance, 

Cambridge University Press.  

Obstfeld, M. (1994), Risk-taking, global diversification, and growth, American Economic 

Review, 84, 5, pp. 1310-1329. 

114 

 
OECD  (2011),  Financing  High-Growth  Firms:  The  Role  of  Angel  Investors,  OECD 

Publishing, Paris. 

OECD (2013), Entrepreneurship at a Glance, July 2013. 

OECD (2014), Venture capital, in Entrepreneurship at a Glance 2014, OECD Publishing, 

Paris. 

OCED  (2015),  How  does  the  concentration  of  household  wealth  compare  across 

countries? Chapter 6 in In it together: why less inequality benefits all, Paris 2015. 

OECD (2009), Top Barriers and Drivers to SME Internationalisation, Report by the OECD 

Working Party on SMEs and Entrepreneurship, OECD. 

OECD (2014), Annual Survey of Investment Regulations of Pension Funds,  

OECD (2015a), Finance and Inclusive Growth, OECD Economic Policy Paper No. 14. 

OECD (2015b), Financing SMEs and Entrepreneurs - An OECD Scoreboard, April 2015. 

Oliver Wyman (2014), Towards better capital markets solutions for SME financing. 

Oxera (2011), Monitoring prices, costs and volumes of trading and post-trading services, 

Oxera, May 2011. 

Pagano,  M.  (1993),  Financial  Markets  and  growth,  an  overview,  European  Economic 

Review, 37, pp. 613-622. 

Pagano, M. and Pica, G. (2012), Finance and employment, Economic Policy, 27(69), 5-55. 

Picketty, T. (2014), Capital in the Twenty-First Century, Cambridge, MA: Belknap Press. 

Polkovnichenko,  V.  (2005),  Household  Portfolio  Diversification:  A  Case  for  Rank-
Dependent Preferences, Review of Financial Studies, Vol. 18, Issue 4, pp. 1467-1502.  

Portes, R. and Rey, H. (2005), The determinants of cross-border equity flows, Journal of 

International Economics Vol. 65, No. 2, pp. 269-296. 

Rajan,  R.  G.  (1992),  Insiders  and  Outsiders:  The  Choice  between  Informed  and  Arm's-

Length Debt, Journal of Finance, 47, 4, pp. 1367-400. 

Rajan, R. and Zingales, L. (1998), Financial dependence and growth, American Economic 

Review, 88(3), 559-586. 

Reinhart,  C.M.  and  Reinhart,  V.R.  (2010),  After  the  Fall,  NBER  Working  Paper  No. 

16334. 

Reinhart,  C.  M.  and  Rogoff,  K.S.  (2009),  The  Aftermath  of  Financial  Crises.  American 

Economic Review Vol. 99, No. 2, pp. 466-72. 

Reinhart, C. M. and Rogoff, K.S. (2010), Growth in a Time of Debt. American Economic 

Review Vol. 100, No. 2, pp. 573–78. 

Robinson, J. (1952), The generalization of the general theory in: The Rate of Interest and 

Other Essays. MacMillan, London. 

Rocholl, J. and Niggemann, T. (2010), Pension Funding and Capital Market Development,   

Rodrik,  D.,  Subramanian,  A.  and  Trebi,  F.  (2002),  The  primacy  of  institutions  over 
geography and integration in economic development, NBER Working Paper No. 9305 

Romain, A. and van Pottelsberghe, B. (2004), The Economic Impact of Venture Capital, 

Deutsche Bundesbank. 

115 

 
Romer, P. M. (1986), Increasing Returns and Long-Run Growth, The Journal of Political 

Economy, Vol. 94, No. 5. (Oct., 1986), pp. 1002-1037 

Romer,  P.  M.  (1990),  Endogenous  Technological  Change,  The  Journal  of  Political 

Economy, Vol. 98, Issue 5, p. S71-S10. 

Rousseau,  P.  L.  and  Wachtel,  P.(2011),  What  is  happening  to  the  impact  of  financial 

deepening on economic growth? Economic Inquiry, 49, 276–288.  

S&P (2015), Annual League Table for private placement deals in Europe. 

Scharfstein, D. and Stein, J.C. (1988), Herd behavior and investment, Working papers WP 
2062-88, Massachusetts Institute of Technology (MIT), Sloan School of Management. 

Schoenmaker,  D.  (2013),  Post-Crisis  Reversal  in  Banking  and  Insurance  Integration:  An 

Empirical Survey, DG ECFIN Economic Papers No. 496. 

Schoenmaker, D. (2014), New Evidence on the Home Bias in European Investment, DSF 

POLICY BRIEFS No. 34/ September 2014.  

Schoenmaker, D. and.Bosch, T. (2008), Is the home bias in equities and bonds declining in 
Europe?,  Investment Management and Financial Innovations, Vol. 5, Issue 4, 2008.  

Segoviano, M. et al.. (2015), Securitization: The Road Ahead, IMF Discussion Note SDN 

15/01. 

Senhadji  S.  A.  and  Khan,  M.S.  (2000),  Threshold  Effects  in  the  Relationship  Between 

Inflation and Growth, IMF Working Papers 00/110, International Monetary Fund. 

Singh, A. (1997), Growth: its sources and consequences, MPRA Paper 54978, University 

Library of Munich, Germany. 

Solow (1956), A Contribution to the Theory of Economic Growth - The Quarterly Journal 

of Economics, Vol. 70, No. 1. (Feb., 1956), pp. 65-94. 

Song, F. and Thakor, A.V., (2010), Financial System Architecture and the Co-evolution of 

Banks and Capital Markets, Economic Journal, 120, 547, pp. 1021-1055. 

Stiglitz, J. E. (1981), Credit Rationing in Markets with Imperfect Information, American 

Economic Review, 1981, vol. 71, issue 3, pages 393-410. 

Stiglitz,  J.  E.  (1985),  Economics  of  Information  and  the  Theory  of  Economic 
Development,  NBER  Working  Papers  1566,  National  Bureau  of  Economic  Research, 
Inc. 

Stiglitz, J. E. (2002), Globalization and its discontents. New York: W.W. Norton. 

Szerb, L. (2009), The opportunities of Hungarian SME’s in venture capital investments.) 
In: Ulbert, J. (ed.) Az iskolateremtő. Pécsi Tudományegyetem, Közgazdaságtudományi 
Kar, pp. 247-258. 

Tang,  M.  C.,  and  Chyi,  Y.-L.  (2008),  Legal  Environments,  Venture  Capital,  and  Total 

Factor Productivity, Contemporary Economic Policy 26, 468-481. 

The Economist (2015), The size of the subsidy: Finance's Bermuda triangle, 16 May 2015 

Thiel, M. (2014), Fragmentation of wholesale funding markets – an empirical approach to 
measure country-specific risk premia in banks' bond spreads, ECFIN Economic Brief, 
Issue 32. 

UNEP  (2015),  Fiduciary  duty  in  the  21st  century,  United  Nations  Environment 

Programme Finance Initiative, Report, Sept 2015. 

116 

 
U.S. Department of the Treasury, IPO Task Force (2011), Rebuilding the IPO On-Ramp 

Putting Emerging Companies and the Job Market Back on the Road to Growth. 

Välilä,  T.,  Kozluk,  T.  and  Mehrotra,  A.  (2005),  Roads  on  a  downhuill?  Trends  in  EU 

infrastructure investment, EIB Papers, 10, 1, pp. 19-38. 

Van  Nieuwerburgh,  S.  and  Veldkamp,  L.  (2005),  Information  Immobility  and  the  Home 

Bias Puzzle, NYU Working Paper. FIN-04-026.  

Vernon,  N.  and  Wolff,  G.  (2015),  Capital  Markets  Union:  A  Long-Term  Vision, 
prepared  for  the  informal  ECOFIN  meeting  in  Riga  on  April  25,  Bruegel  Policy 
Contribution 2015/5. 

Vissing-Jorgensen,  A.  (2002),  Towards  an  explanation  of  household  portfolio  choice 
heterogeneity: Non-financial income and participation cost structures, NBER Working 
Paper No. 884. 

Wachtel,  P.  and  Rousseau,  P.L.  (2000),  Inflation,  Financial  Development  and  Growth, 
Working  Papers  00-10,  New  York  University,  Leonard  N.  Stern  School  of  Business, 
Department of Economics. 

Walker, B., Carpenter, S., Anderies, J., Abel, N., Cumming, G. S., Janssen, M., Lebel, L., 
Norberg,  J.,  Peterson,  G.  D.,  and  Pritchard.,  R.  (2002),  Resilience  management  in 
social-ecological  systems:  a  working  hypothesis  for  a  participatory  approach. 
Conservation Ecology 6(1): 14. 

Weinstein D. E. and Yafeh, Y. (1998), On the Costs of a Bank-Centered Financial System: 
Evidence from the Changing Main Bank Relations in Japan, Journal of Finance, 53, 2, 
pp. 635-672. 

Wenger,  E.  and  Kaserer,  C.  (1997),  The  German  System  of  Corporate  Governance  -  A 
Model Which Should Not Be Imitated, Papers 14, American Institute for Contemporary 
German Studies. 

Williamsons,  O.E.  (1985),  The  Economic  Institutions  of  Capitalism:  Firms,  Markets, 

Relational Contracting, New York: Free Press. 

Wilson, K. E. and Silva, F. (2013), "Policies for Seed and Early Stage Finance: Findings 
from  the  2012  OECD  Financing  Questionnaire",  OECD  Science,  Technology  and 
Industry Policy Papers, No. 9.  

World Bank (2015), Protectig minority investors: Going beyond related-party transactions, 

World Bank Doing Business. 

Wright, W. (2014), Driving growth: Making the case for bigger and better capita markets 

in Europe, New Financial.  

117