CMU, the come-back!
It appears that the CMU, i.e. Capital Market Union, which was one of the main objectives of the Vander Leyen Commission, is back in the limelight, or is likely to become a priority for the next Commission next summer. It was an important, vital, and courageous objective. However, we can't say that we've made any real progress during this five-year term. This is regrettable, even if we are aware of some of the "good reasons" that those in charge might cite to justify the delay. The crucial question, of course, is whether we can use regulation to develop this capital market and reduce dependence on bank loans.
“Baby come back!” (The equals).
We would all admit that corporates need more diversification of financing options available to them, especially when interest rates are so high. As rates raised fast and high, corporates and the “real economy” have in top of their mind more expensive costs of funding and are looking for diversification of sources of financing, to complement bank borrowings. Therefore, the corporates, key end-users, are pleased to notice that CMU is coming back on the agenda of the Euro Group, and later to the new coming Commission. We can accept that no real progress has been achieved so far and that we need to see significant changes on the market.
In 2024 and 2025, companies will face a new wave of loan renewals, and therefore much higher interest rates (i.e., from a zero percent floor rate plus margin to a 4% EUR rate plus margin, i.e., a 3 to 5-fold increase on average). These renewals will be complicated to obtain, especially as banks become more cautious, excluding certain economic sectors, and running the risk of widening spreads. This is where diversification comes into its own. When the storm arrives, it's a good idea to have diversified your sources of financing, optimized your working capital, and renewed or secured your loans. Yet some people, like the cicadas in Jean de Lafontaine's fable, have not foreseen this scenario. Why not? Certainly, for the sake of simplicity, because costs were lower, because capital markets remain more difficult to access, more complicated and, of course, potentially more expensive.
A better balance between bank borrowings and capital markets
Is it wishful thinking to wish a better balance between bank lending and capital market operations? The aim would be to achieve a better balance between the two, as is the case in the USA. But the question is how to achieve this through European regulation alone. Is a CMU-type regulation enough to change everything? Probably not. More is needed, because the problem is cultural, depending on local customs and practices, the costs of one versus the other, and legal constraints. It's a whole range of elements that need to be considered and implemented. Nevertheless, the regulatory aspect is obviously the most important element if the EU is to tackle simplification and cost reduction. CMU needs to make a genuine change to get the point where the capital markets have the “right size” for an economy of our size.
A Kantian shift for the capital markets union
We can admit that a capital markets union (CMU) is an indispensable project in the current economic context that we have so far failed to advance, for two reasons, according to Christine Lagarde: (1) if we look at historical examples, the conditions for capital markets to develop in Europe have not yet been satisfied. Most importantly, we have lacked a unifying project around which CMU can be anchored. But this is now changing. (2) Perhaps because we have lacked such a project, we have relied too much on a “bottom-up” approach to integration. The solution, in my view, is to make a “Kantian shift” in our approach to CMU, she added. To attract more capital to Europe, we also need to be more innovative and more open to innovation than in the past. Regulations are not enough to change the game. As explained, it's a combination of factors. As treasurers and associations, we need to help educate potential users of the capital market. And let's not forget, in parallel, the "banking union" projects, useful for achieving the objectives set by the EU. And let's not forget to include the "financial market union" and ensure a large OTC derivatives market, necessary for an efficient capital market. The use of OTC derivatives is an essential complement to a unified capital market. It is up to all stakeholders to increase borrowers' "awareness" to better balance the two types of financing. In this context, we must not forget the ESG dimension, which is fortunately growing in importance (but complicating the debate still further).
Private credit, the “golden moment”
If this is a “golden moment” for private credit, how might it play out and what are the risks? Higher rates and the regional banking turmoil earlier this year have spurred a growing conviction that private credit will bloom. “Debanking” is in its infancy. Private credit, according to Jamie Dimon, could be dancing in the street. This current shift underscores just how much the market structure of finance is changing. We know that several major banks have already out deals, and more are likely to follow. The regime shift in rates means loan losses are likely to rise as financing costs normalize and weaker balance sheets are exposed. This could be challenging for private credit providers. Therefore, whatever the alternative solutions to the classic bank funding, they are also driven and impacted by the economic context. For many corporates the priority is not to diversify to guarantee access to funding, but rather to minimize costs of financing. Therefore, I believe that until the pricing is aligned and more equal, it will be tough to change habits and usage, and to shift to capital markets or other financing sources.
Challenge for the new Commission and the EURO-GROUP?
This is undoubtedly a major challenge for the next Commission. Without claiming that it's a cliff to climb, we can reasonably admit that it's a major challenge, but one that's complicated to achieve quickly. It seems to us that we need to act on several elements at once to change the situation and rebalance funding sources. Private financing has certainly grown rapidly in recent years. However, high interest rates threaten to disrupt all financiers. As we can see, the situation is critical, and the moment important. We can't avoid acting. However, the method to be applied remains complicated to identify, otherwise it would be a done deal. Let's think about Christine Lagarde's recent comments and work together to develop this CMU, without seeing it as an unattainable Chimera. “Faced with such an immense financing challenge, the moment for action is now. So, I encourage all of us to be bold and not to let this moment pass” (source: Christine Lagarde – November 2023)
François Masquelier, CEO of Simply Treasury December 2023 - Luxembourg