Fintech Could Demolish Europe’s Capital Markets Union Barriers

When it announced the Capital Markets Union (CMU) project in 2015, under then-finance minister Lord Jonathan Hill, the European Commission knew that it would be a tough order to fill. Indeed, it had known this for years, after the Giovannini Group identified a number of obstacles relating to differing trading practices, settlement periods, tax practices and other areas between the 28-member bloc in the early 2000s that would need to be harmonized for any true single market in securities trading to arise.

Some of these problems, known as “Giovannini Barriers,” and later renamed “EPTF Barriers,” following a report from the European Post-Trade Forum in March 2017, have been solved through pan-European projects such as Target2-Securities, but a number of problems remain—and they are some of the trickiest to solve.

But at least one influential trade body believes that fintech may hold the answer to CMU’s problems. Werner Frey, managing director, post-trade, at the Association for Financial Markets in Europe (AFME), tells WatersTechnology that the group has proposed a two-step path forward for resolving these issues.

“A swift dismantling of these barriers is necessary, but because these barriers have been narrowly defined and will not fully meet the objective of a comprehensive European post-trade reform, we propose a second simultaneous step,” he says. “This is to define a medium to longer-term strategy, and in this context, it would be very important to take into consideration the possibility that technological solutions in the financial area could provide.”

These won’t be a silver bullet, Afme warns, but the implementation of technologies including distributed ledgers could ease many of the issues associated with these barriers. Frey says that these have been identified in large part by the EPTF.

“The current situation with regards to withholding taxes is the most critical barrier to the reform,” Frey says, “There is no harmonized procedure among the EU member states with regards to reclaiming withheld taxes, or even better—as the Organisation for Economic Co-operation and Development (OECD) has been proposing—to providing, where possible, tax relief at the source.”

The core issue, he adds, is that the Commission has yet to propose a binding solution, having published so far only a recommendation that was hardly followed by any of the member states. “If investors remain unsure whether and when a reclaim of withholding taxes will be honored, this is obviously not very helpful for a CMU,” Fray says.

Other outstanding barriers sound simple in theory, but in practice are extremely difficult to resolve. Often, Frey points out, there is no “common definition of who is a shareholder in many European countries.” In addition, in critical areas such as harmonizing practices around corporate actions, the Commission has taken the path of issuing directives—which are open to interpretation by member states when instituting them in law—rather than regulations, which enter as written on to the statute books of EU nations.

“As the shareholder’s rights directive is a directive and not a regulation, it needs to be transposed into national law, and there we see the risk that the fragmentation that has largely been reduced or even abolished by the private sector initiative could resurface by different transpositions of the amended directive into national law,” he says.

These problems could be ameliorated, at the very least, by fintech developments such as distributed ledger—indeed, corporate actions has emerged as an early use case for the technology, which is ultimately expected to have a significant impact on how post-trade processes are conducted in Europe.

Still, Frey warns, while the potential for impact is there, and current legislation should be forward-thinking in terms of taking this into account, it shouldn’t mean a halt in ongoing efforts to resolve these obstacles to CMU.

“We should not wait for fintech to be possibly a remedy to the defined EPTF barriers,” Fray says. “Members are aware of the fact that fintech could be helpful in the post-trade space although at this point we are not aware of such solutions being available.”