Date: 15 October 20200
"Retail investors and asset management are the pillars of a successful Capital Markets Union"
Irish Funds Annual Conference 2020
European Securities and Markets Authority
Good afternoon Ladies and Gentlemen,
I am very pleased to be with you today - even if virtually - and to have the opportunity to deliver a key-note speech, which I will dedicate to the Capital Markets Union (CMU). I would like to thank the Irish Funds Industry Association for inviting me to this important event, which provides a unique opportunity to discuss EU financial markets policy with key Irish stakeholders.
The general concept of the CMU has been with us now for the past six years. However, both the importance and urgency of putting in place all necessary elements have never been more burning. History has showed us countless times that extraordinary circumstances can be the catalyst for decisive changes, and so the COVID-19 pandemic may - quite unexpectedly - allow EU capital markets to begin to realise their potential.
In that context I should mention that the market turmoil in response to the pandemic - combined with lockdowns and quarantine arrangements - actually brought in some cases large numbers of first-time retail investors to the stock markets. Our neighbours
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in Paris, the Autorité des Marchés Financiers, found that in the early phase of the crisis, 150,000 retail clients bought French blue chip stocks for the first time in at least two years. Purchases by retail investors increased fourfold.
Similarly, to the healing process of a lasting condition, a successful CMU policy-making process should start first with an as-accurate-as-possible diagnosis. When it comes to the EU's capital markets, given all its complexities, the diagnosis is everything but straight-forward. For many, the success of the CMU would be primarily dependent on further harmonisation of regulation and reducing barriers for provision of services across EU Member States. I do agree with this view. However, I believe that what is more important, is to acknowledge the too low level of capital market activity across Europe and what needs to drastically change. If we want to see EU capital markets flourish, we need to engage far more with retail and household participants, both directly and indirectly, in this project. In today's speech, I would like to highlight a few ideas on how this could be done and the role that the asset management sector can play.
The right diagnosis
The European Union and its Member States have been relying heavily on their banking systems for decades. The clients' proximity naturally ensured by the large number of providers - just to recall that for example over 600 banks are licenced in Austria1, a country with under 9 million citizens - created a very narrow focus for both capital- seekers and savers. From the macro-economic perspective, such a heavy dependency on the banking sector limits the funding channels available to companies and hence the capital available for growth and for innovative economic activities. The resulting indebtedness may be a source of systemic risk2. This systemic risk is even increasing as a result of the COVID-19 crisis as companies pick up additional bank credit in response to reduced revenues.
See e.g. Langfield, L. and M. Pagano, ECB Working Paper 1797, May 2015, "Bank bias in Europe: effects on systemic risk and growth"
At the same time, in recent years bank deposits have offered near-zero returns on household savings. In contrast, net performance of equity UCITS was around 9% for retail clients, on an annualised basis, in the ten years up to the end of 2019. However, only a small number of households have taken advantage of this development, with traditional products like savings books still being the consumers' favourite and effectively preventing capital market driven alternatives.
This picture of a dominating banking sector that limits capital markets activity is, however, not homogenous across individual EU Member States. While across the EU, the share of households' financial assets held in investment funds is around 10%, at national level recent figures range from under 1% in Ireland, together with Estonia and Latvia, to around 16% in Belgium, for example. The proportion of households that own listed shares goes from around 1% in Estonia, Hungary and Portugal to 20% in Cyprus. Ireland is around the EU average, with households' holdings of listed shares at around 4%3. At the same time, patterns of participation may also vary in relation to indirect holding of financial assets by households, through pensions and insurance policies. For example, the rate of the indirect participation in investment funds varies from under 1% in Greece to over 30% in the Netherlands, Sweden and Denmark. In Ireland and Germany this rate is above 20%4.
Another way to look at the question of citizens' involvement in capital markets is to consider the average portfolio across households. Around 65% of households' savings are held in currency and deposits in Greece, with the remainder in financial investments. There is a reversal of this position in countries such as Denmark and Sweden, where around 80% of savings are invested, either directly or indirectly. In several countries, including Ireland and Luxembourg, the share of households' saving held in currency and deposits is around 50%5.
3 Source: ESMA, Performance and Costs of Retail Investment Products in the EU, 2020. See Chart ASR.PC.4 page 8. https://www.esma.europa.eu/sites/default/files/library/esma50-165-1106-asr-performance_and_costs.pdf
Source: EFAMA, Ownership of Investment Funds in Europe 2019 edition. See Charts 2.12 and 2.13, pages 8-9. https://www.efama.org/Publications/EFAMA_Ownership_Investment_Funds.pdf
5 Source: ESMA, Performance and Costs of Retail Investment Products in the EU, 2020. See Chart ASR.PC.4 page 8. https://www.esma.europa.eu/sites/default/files/library/esma50-165-1106-asr-performance_and_costs.pdf
A quick look outside the Union's borders and across the Atlantic to the United States provides further insight into the role of retail investors in the financial ecosystem. The US, where around 45% of households own mutual funds and which hosts vast, deep capital markets, provides a strong contrast with the EU6. In the US, a long-term trend has been for households to own fund shares rather than single stocks, providing them with diversification benefits7. There is a strong link between deep, liquid capital markets and household participation, as both markets and investors can thrive when we have the right regulatory frameworks in place. Economic studies show that strong legal protections for investors are associated with high levels of participation and with broader, deeper markets8.
In focusing on limited retail participation as one of the causes of the current condition of EU capital markets, I am echoing findings by other policymakers and experts. In particular, I would like to refer to the recently published European Commission Action Plan on Capital Markets Union9 that considers that wider retail participation allowing individual investors to take full advantage of capital markets is a key pre-requisite for a successful CMU.
The right cure
With the a priori situation as just described, starting at too low levels in a number of European countries, there should be plenty of potential to engage retail and households in more extensive capital markets activity in the years come. In order to explore this potential, in my opinion we need to deploy several instruments simultaneously. Those instruments should range from investor protection, transparency and confidence, financial education and additionally - which lies outside ESMA's remit - reforming private pension systems.
Source: Investment Company Institute.
Vanguard research note, 24 January 2020, Unexpected benefits: Measuring the advantages of diversified mutual funds . See figure 1 especially: https://www.vanguard.co.uk/adviser/adv/articles/research-commentary/topical-insights/measuring-the- advantages-of-diversified-mutual-fun.jsp
The link between legal protections for investors and capital markets is established in La Porta, R., F. Lopez-De-Silanes, A.
Shleifer and R. Vishny, 1997, "Legal Determinants of External Finance" The Journal of Finance, 52(3), 1131-1150. Another study by the authors shows that strong investor protections are linked with retail participation: La Porta, R., F. Lopez-De-Silanes, A.
Shleifer and R. Vishny, 1998, "Law and Finance", Journal of Political Economy, 106(6), 1113-1155
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