Financing recovery: EC proposes package to support EU businesses

November 2020 | FEATURE | FINANCE & INVESTMENT

Financier Worldwide Magazine

November 2020 Issue

To support the region’s economic recovery from the devastating impact of coronavirus (COVID-19), the European Commission (EC) has proposed changes to capital market rules to encourage greater economic investment across the European Union (EU).

The EC’s proposals – which encompass targeted amendments to Directive 2014/65/EU on Markets in Financial Instruments (MiFID II), as well as the Delegated Directive (EU) 2017/593 (to increase the regime for research on small and midcap issuers and on fixed-income instruments) – are designed to allow for the rapid recapitalisation of companies and to increase banks’ financing capacity.

Collectively, the proposed amendments are part of the EU’s ‘Capital Market Recovery Package’, which also contains adjustments to the Prospectus Regulation and securitisation rules. The Package is a cousin of an earlier ‘Banking Package’ to facilitate bank lending to households and businesses throughout the European Union (EU).

The EC’s proposed amendments are subject to legislative review by the European Parliament and by the Council of the European Union.

“Capital markets are vital to the recovery, because public financing alone will not be enough to get our economies back on track,” states Valdis Dombrovskis, executive vice-president of the EC for An Economy that Works for the People. “One way of doing so is to help businesses raise capital on public markets. These targeted amendments will make it easier for our businesses to get the funding they need and to invest in our economy.”

“The yardstick by which the success, or otherwise, of the recovery packages is measured will be difficult to determine, as they are part of a multifaceted response to the pandemic.”

One of the key proposals put forward in the EC’s recovery package is to exempt companies with an equity market capitalisation of less than €1bn from the unbundling requirement imposed by MiFID II, a move designed to encourage greater analyst coverage and thus boost trading in the stock. In addition, the EC has proposed an optional exemption, under certain conditions, from the current research unbundling requirement if execution services and the provision of research pertain to small and midcap issuers.

“As part of the EC response to COVID-19, there is a desire to stimulate investment and financial activity, as well as increase research provision, especially on small-to-medium enterprise (SME) stocks, which will help generate capital flows toward such instruments,” says Steve Kelly, special adviser at Euro IRP. “European regulators, spearheaded by the Autorité des Marchés Financiers (AMF), have long been concerned that the MiFID II rules on research may have unintended consequences of curtailing investment activity, and these proposals are a way of ameliorating that effect.”

Generally speaking, the EC’s proposals have thus far been cautiously welcomed by European fund managers. “On one level, it should potentially make it easier for smaller buy-side firms to access research, as they recharge ultimate clients, rather than carry the costs themselves,” explains Mr Kelly. “In the fixed income space, unbundling requirements were a fundamental change to existing practice, and have therefore been hard to implement, resulting in a confused marketplace.”

Key challenges

While the recovery package proposed by the EC has been broadly welcomed, substantial challenges surround their interpretation and implementation. There is also concern among some investment banks as to how long the proposals should be implemented for.

In Mr Kelly’s view, a number of challenges need to be overcome, particularly in relation to the rebundling of research services costs. “Firstly, there are various EC approval processes, which can often be somewhat arcane,” he says. “More important is the need to satisfactorily define what research qualifies. For example, would research on a larger equity whose business model impacts very directly on a buy-side firm’s SME portfolio be in scope?

“Is macro research underpinning asset allocation decisions in scope for fixed income investing?” he continues. “And what level of reporting or oversight will be needed to police the new rules? Looking more broadly, it seems likely the rules will create regulatory divergence between the EC and the UK, with inevitable complexities for international buy-side firms.”

Yardstick

The EC’s measures to finance the region’s economic recovery from the COVID-19 crisis will take time to have an impact. Furthermore, the yardstick by which the success, or otherwise, of the recovery packages is measured will be difficult to determine, as they are part of a multifaceted response to the pandemic.

“It will be hard to draw direct cause and effect correlations,” says Mr Kelly. “An upsurge in economic activity is bound to be multifaceted in origins, and greater investing flows into either SME or fixed income likewise would be down to many factors. Perhaps for SME, if impacted stocks were required to list regular analyst coverage, and this tracked over time, then one useful metric could emerge. Another yardstick would be buy-side firms setting up new SME or fixed income fund vehicles.”

While the measures taken by the EC will take time to kick in, for the moment, many EU countries are coming to terms with the prospect of a deep recession (the EU economy is expected to shrink 8.3 percent in 2020, with Italy and Spain, two of the countries hardest hit by the pandemic, both likely to shrink by over 9 percent) followed by a long and hard road to recovery.

Fraser Tennant