Europe desperately needs more economic growth. But one proposed solution — a harmonization of banking rules, regulations and the lowering of financial barriers to kickstart the 28-nation European Union — could be tossed overboard if Britain leaves the bloc later this month, the continent’s top financial industry lobbyist said.
Michael Cole-Fontayn, the chairman of the Association for Financial Markets in Europe, the continent’s top industry group, said the E.U.’s proposed “capital markets union” could be thrown into jeopardy if Britons on June 23 vote to leave the bloc, removing a key motor for free-market thinking and reform in the sector.
“It is probably the single most positive and energizing force for change in the European Union at the moment,” Mr. Cole-Fontayn said of the proposed E.U. financial markets union in an interview with Handelsblatt Global Edition, on the sidelines of the annual FundForum gathering of fund managers in Berlin. He is also the European chairman of U.S. custodian bank BNY-Mellon, the oldest bank in the United States, founded by Alexander Hamilton, and the world’s largest custodial bank.
A “Brexit” could deal a major blow to the European Union’s hopes of forging a single market for capital, which in theory would spur lending across the continent and, in turn, stoke economic growth in countries such as Germany and France, where the speed of GDP growth lags market economies in Britain and the United States.
Without Britain in the European Union, Mr. Cole-Fontayn, who is British, said he was skeptical that Europeans remaining in a smaller bloc would have the commitment or support to press ahead with badly needed financial market reforms to roll back national barriers that slow economic development.
“I think it would be very hard to envisage a truly successful capital markets union without the full force and power of the U.K. actively engaged,” Mr. Cole-Fontayn said. Even so, he urged the rest of the European Union if need be to push on with plans to create a single capital market regardless of the outcome of the Brexit vote.
“[Capital markets union] is probably the single most positive and energizing force for change in the European Union at the moment.”
The idea behind a capital markets union is simple: About 80 percent of lending in Europe is currently done by banks, and just 20 percent from capital markets, which includes non-banking lenders such as savings and loans and other lending specialists. The opposite is true in the United States, which relies on non-bank lending.
In Europe, banks simply aren’t lending enough, and the result in part are stagnant or slow-growing economies. Many banks are still battling to retire debts racked up in the 2008 financial crisis. Others are diverted by deep restructurings. To stoke E.U. growth, lending needs to come from somewhere other than big banks.
Sean Tuffy, senior vice president of Dublin-based fund administrator Brown Brothers Harriman, said shifting from a system that relies on banks to a 50-50 model could significantly boost growth in Europe.
Mr. Cole-Fontayn acknowledged that opening financial markets goes hand in hand with banks restoring trust in the financial system since the 2008 financial crisis. While banks have turned a corner since the crisis, he acknowledged that polishing the image of the banking sector is still a work in progress.
The following is the full interview of Mr. Cole-Fontayn by Handelsblatt Global Edition.
Handelsblatt Global Edition: Eight years after the financial crisis, there remains widespread distrust of financial markets. There’s also a weariness of European integration. Given those forces, how can you convince the public that a capital markets union is necessary in Europe?
Michael Cole-Fontayn: There is maybe one word that links all of those, and that is the word disruption. The banking industry was massively disruptive to world economies in the financial crisis, and as a result of that, the organizational structures, the regulatory environment, the economic environment, the public reaction to that, and even the technology disruption and revolution, are all combining to force massive changes on financial services. How we can rebuild trust is really important.
With regard to Europe, there is a challenge between the more populist elements that say ‘We want to bring decision making and control from the center to the local population.’ That is disruptive to a [European Union] project of trying to conduct at the center all those things that can be conducted at the center, and which should make people’s lives more effective, more efficient to enable them to have more control. At many different levels, reform needs to take place, and whether it’s in really tough things to deal with like local insolvency laws, withholding tax practices, a myriad of other cross-border regulations that relate to information delivery, the building blocks are increasingly being put in place.
Capital markets union is really the front office, front-end investment opportunity that links hopefully the small and medium-size enterprises, the national infrastructure and risk reduction for the banking system together with investment opportunities or both individuals and institutions. It is probably the single most positive and energizing force for change in the European Union at the moment. It has a lot of attention from regulators, it has a lot of attention from governments, from an infrastructure enabling and project enabling point of view, and yet it has also been a very challenging project to implement.
Why has it been so challenging?
It’s been challenging because there is no one big idea. There are visions about how new markets for capital can be enabled and encouraged to give small and medium-size enterprises more choice, so they don’t just have to go to the bank. There is also an opportunity for big national infrastructure projects to be funded from markets other than the bank market. If you combine these ideas with things like venture capital, private placements, peer-to-peer lending, crowd funding, all the types of solutions that are being enabled by European institutions like the European Investment Fund and encouraged by the European Commission, by the Juncker plan, there are lots of enablers and positive intent that is in place.
So we as an institution, but also as an industry, are very positive about capital markets union. Yet if you go to each nation and say what does capital markets mean for your market, I think each national government will find it quite hard to explain why it’s good at a national level.
There’s also concern about freeing up financial markets that caused the 2008 crisis…
And when you boil it down to the micro ideas, like securitization, it sounds a bit scary. And yet if this is means of reducing risk and reliance on the banking system, then it’s a very positive event. If it’s about introducing more sources and more flexibility for small and medium-sized enterprises to seek financing, that’s a good idea. So ultimately the capital markets union should support the growth and jobs agenda for Europe.
Is there a genuine desire among European policy makers to reduce the responsibility of Europe’s big banks for growth?
It’s not about the responsibility of banks. It’s about reducing the over-reliance on bank funding and also at the same time enabling banks to be better managers of risk, through being able to transfer risk in a simple, standardized and transparent way. The securitization that is envisioned under capital markets union is exactly that. But it’s also got to fulfill certain criteria that build trust. If it is simple to understand, simple in structure, if you’re not mixing all sorts of different types of underlying loans or collateral on assets, and if it’s transparent to the potential investors, then they will be able to understand the risk, understand the structures and appreciate the potential for a high level of return.
How do you explain that to the average citizen?
I think at a retail level, individuals can enjoy that opportunity through financial technology, making available peer-to-peer lending, crowd funding and other such investment opportunities. And, here in Germany, there’s a long history and culture of financial advisors, which can really benefit from a capital markets union because it means more products and solutions that can help financial advisors generate better outcomes for their clients.
And, at a citizen level, if you feel you can invest in the growth and success and jobs of your individual country, then that’s something that connects the citizen back with capital markets union. So it’s about making that link: If you’re in Germany and you want to help finance small and medium-sized enterprises in Spain or Portugal or Italy via the internet, you can find endless opportunities to do that. Financial technology again enables this to happen.
What would impact of British exit from the European Union be on a capital markets union? Can you envisage it without Britain?
I think it would be very hard to envisage a truly successful capital markets union without the full force and power of the U.K. actively engaged in helping provide solutions. But there ought to be nothing that prevents the capital markets union from finding its own internal momentum. It just won’t be delivered as effectively and efficiently as it might be. The challenge will be, whatever the outcome of the U.K. referendum, to maintain that momentum.
What are the consequences for the financial sector? Could you imagine Britain joining a capital markets union, even if it leaves the European Union, to maintain its financial ties with the continent?
Most of the financial institutions that are nominally headquartered in the U.K. also have capacity and reach and talent across the European Union. BNY Mellon is an example. We have a very significant institutional bank that is headquartered in Brussels and we have branches throughout the major European financial markets. We will be absolutely capable of continuing to provide services and solutions to our clients whether they’re in the U.K., through our U.K. legal entities, or whether they’re in the euro zone or wider Europe.
Frictional costs will undoubtedly go up [in the event of Brexit] and that’s something that ... no-one needs that at the moment.
So operational continuity and resilience is not an issue. The issue is the frictional costs that will arise out of the potential loss of passporting rights and so the ability to distribute funds across borders, to distribute data across borders, to enable talent to move freely across borders, to make sure that contracts are enabled to comply with all the relevant regulatory requirements. Frictional costs will undoubtedly go up, and that’s something that the financial services industry, whether you’re on the buy side or whether you’re on the sell side or whether you’re on the services solution side, no-one needs that at the moment. It will be a risk event that will need to be managed. I think, whatever the outcome of the referendum, one should absolutely understand that it is a process and not an event.
Will the financial lobbies push for both sides to maintain ties even in the case of a“Brexit”?
Absolutely. Certainly at AFME we very much believe in the strength of those linkages and the strong dialogues between all the components of financial markets and capital markets – the politicians, the regulators, the investors, the issuers, the underwriters, the secondary market support, the broker research and so on. We want to make sure that the negotiations allow for continuity. I don’t think it is in anybody’s interest that there is ongoing systemic disruption, shock, and cost, because ultimately that impacts jobs and growth.
Do you expect U.S.-based banks and non-banks to profit from a closer European integration and a capital markets union? Could the United States gain a bigger foothold in European markets as a result?
Certainly U.S. financial institutions are very positive about capital markets union and the opportunities. You can see from the membership of AFME that all the major globally systemic financial institutions in Europe are represented and the major wholesale institutions in the U.S. are represented as well. We absolutely are united in wanting to see a very strong, vibrant, reforming Europe.
Moving to trust in banking: It seems that a series of regulatory investigations and fines over banking practices have continued well beyond the 2008 financial crisis. How can you convince the public that banks have turned a corner?
A crisis as significant as the financial crisis, and the impact that it had on global economies and individuals, will inevitably have a very long tail to it of lessons to be learned and matters to be addressed. Certainly there continue to be both matters that are still being investigated by regulatory authorities, whether it’s market manipulation or mis-selling. I think the good news is that financial institutions want to get those settled as quickly and efficiently as possible. You will see financial institutions reaching agreements with justice departments and regulators, settling the cases as quickly as possible and as efficiently as possible, and also settling the cases with their shareholders as quickly and efficiently as possible. Addressing shareholder concerns is very, very important. Whether those concerns are around business strategy and focus, whether they’re around culture and conduct, whether they’re around market integrity, these are all things that are really, really important. There is not an institution that is not focused on making sure that it is culturally resilient. The amount of management turnover would be evidence of that.
Some of the challenges from the financial crisis came from opaque financial products…
I think there is plenty of transparency that is being introduced into the market. The bigger challenge is whether it is adding to clarity. Some of the financial products and solutions that are out there may still be complex for an individual to understand and that is why they need to rely on trusted advisors. And I think most people who work with a financial advisor want to trust them. To navigate the complexity of financial markets, they want them to provide clarity on what is the outcome, but also what is the risk. That trust comes from integrity of behavior.
Is all of this misbehavior a legacy of financial crisis? Or is it still continuing today?
I think that there is a wholesale change that is taking place. But I say ‘taking place’ because it is still being embedded. The tone from the top of organizations is very positive, I think the echo from the bottom is positive and we need to make sure that we continue to invest in the integrity of our institutions at a time of great disruption. Translating change and explaining change is very important. Maintaining a resilient culture that is embracing change and is able to endure and add value is the objective.
The Dutch are requiring their bankers to take an oath, promising no misconduct. What do you think about that approach?
It certainly concentrates the mind. Certainly in the U.K., the introduction of the senior manager regime has been similar in terms of concentrating the mind, making sure that accountability and responsibility are not just words but they are embedded in organizational culture, behavior, evidenced in decision making and that all reasonable steps are being taken.
Could you see these practices being adopted Europe-wide?
One can certainly learn from all of the approaches that are taking place. They all have one end-aim in mind and that is to make sure that never ever again does the financial services industry, the banking industry, cause such a systemic loss of value.
Christopher Cermak is an editor with Handelsblatt Global Edition in Berlin, covering financial markets, banks and the economy. To contact the author: email@example.com