Shall the investment bank warmly welcome the birth of CMU?

Wai Sang Cheung, Fang Wang

December 2017

Will CMU makes a bigger market pie for investment bank?

As the consequences of the financial crisis 2008, the level of investment in Europe, both private and public, has dropped substantially in the last decade. Compared to the pre-financial crisis peak, the investment volume in EU fell by 15%. The lack of investment in Europe can hampered the economic recovery, long-term growth and competitiveness. Also, the weak investment can have impact on the capital stock, which in turn discourages productivity and job creation (European Commission, 2017).

In order to escape the low global growth and stimulate the investments in Europe, the European Commission (EC) introduces the Capital Market Union action plan. This economic policy may be a solution for helping the health of the economy. This is because CMU is considering one way to reform the financial structure at EU. Also, CMU will help to allocate risks wider thus enhance the stability of the capital market (European Commission, 2015).

The idea of the European Union CMU is to create more integrated market for trading firm’s shares and bonds across the EU by reducing fragmentation and dismantling barriers in financial markets, improving access to funding and fostering the flows of cross-border capital (Irish funds, 2017). CMU can ensure that EU businesses easier to sell their shares or bonds to foreign investors, which in turn to sell them to domestic investors. This could make for the money users more attractive to raising capital on the market. From the point of view of the investors, the shares or bonds they intend to buy should not make any difference whether the shares or bonds come from either domestic companies or foreign companies (Somo, 2015).

CMU, as single integrated market, has one common regulatory framework. This regulatory framework for capital market can reduce the obstacles of cross-border M&A transactions (European Central Bank, 2017). A survey by Herbert Smith and Mergermarket showed that the regulatory interference is one of the threats for global M&A (Armstrong, 2016). For example, in 2016, the M&A deal of Honeywell and United Technologies of $90.7 billion fell through the obstacles of regulatory framework (Hankin, 2016). Therefore, CMU could increase the number of M&A transactions. Because of the financial integration, investment banks have the opportunities to trade their shares and bonds in a larger place than before (Somo, 2015). This makes the change of matching frictions lower. Because there are more participants in the capital market, it is possible that the buyers and sellers could match better and faster than they did before the integration. And from the perspective of investment banks, they can serve better their clients. Overall, CMU would make the market pie bigger for investment bank.

Will the unified regulation help to break down the wall between capital flows?

Single rulebook contributes to a comparatively easier way for investment bank to match tens or thousands of investors and investees within the CMU scale. For instance, an investment bank does not have to worry about the variations of security laws, when they design the framework of products or contracts for their clients at EU. However, in reality, there are some areas where the EU countries differ from each other such as insolvency, corporate, taxation and securities laws. These areas become uncomfortable obstacles for investors and investees, thus discouraging the incentive to invest cross-border. In other words, as the middleman of investor and investee, the investment bank will suffer from the decline of cross-border investment demands. This would be a waste of opportunities for profit-making!

Even investees do desire getting fund for their projects from other EU countries. They come to investment bank for help (like issuing a bond or selling stocks). Nevertheless, it is costly for investment bank to match the cross-border participants. One reason for explaining this is that the security traded within different countries should meet different requirements and laws simultaneously. Imagine that you, as an investment bank, just plan to design a bond for your clients and try to sell them in a broader market, but your brilliant plan would be impeded due to some annoying barriers set to restrict the movement of capital. So your work might be doubled or even tripled because you should care more about the different countries’ laws and standards for bond issuing. Then you can expect that the process of issuing would possibly take a longer time than that you just do it within a single country. However, keep in mind as we mentioned before, the more participants, the less sell-and-buy matching frictions, and thus the better job you did for serving your clients (the funding demanders in this case). So, this means that you definitely prefer to sell the bond not just in a single country but also in the rest of Europe in order to guarantee the quality and quantity of the investors and reduce the matching frictions.

See! The contradiction arose! How to solve it? Of course, as one of the market participants, you basically can do little. But the CMU, which would be constructed to have a common regulatory framework and a less restrictive stance, can achieve the goal (Somo, 2015). Recall the example of Honeywell International’ failure, if the investor faces the same and even less restrictive regular environment, the results could be much more different.


Let us come back to our original question: shall the investment bank welcome the construction of CMU?

As Commissioner Jonathan Hill pointed out,

“Capital Market Union is not about displacing banks, but about complementing the role of banks
-- Commissioner Jonathan Hill (Mijs, 2015).

On the one hand, the solidarity CMU would stimulate the market's vitality by making buyers and sellers fell no difference between cross-border transactions of securities with domestic trades, thus attracting more participants to the capital market. Therefore, it could bring increasing golden opportunities for investment bank. Specifically, as the role of intermediary, investment bank could share a bigger market pie since they could design various less matching friction products to meet more potential clients’ finance requirements at this integrate financial environment.

On the other hand, under the single rulebook framework, the absence of barriers will enhance the flows of capital. The capital flows can be strengthened by efficient market infrastructure and intermediaries (European Commission, 2015). Namely, the investment bank, as one of the middleman, can still keep its central role in the capital market.

In a word, the status of investment bank in the financial world would not be shocked by the introducing of CMU. Instead, the CMU might help consolidate investment banks’ place and could make powerful contribution to the stability of financial market.

Now, if you ask investment banks whether they will accept and welcome CMU? After reading our story in this blog, they probably would say ‘why not? ’