Access to capital is one of the major challenges facing SMEs around the globe, but European businesses face the additional hurdle of being heavily reliant on traditional bank financing. The European Commission is working toward diversifying the region’s financial ecosystem. Earlier this year, the Commission introduced the idea of uniting the markets of the 28 Member States of the European Union into a single market. The Capital Markets Union (CMU) would encourage cross-border investing and financing, and generally ease access to funding for SMEs across the continent. This past week, officials have made new strides in turning the CMU into a reality, but not without controversy.
Historically, small business finance has been the provenance of the banking industry. European SMEs receive 70 percent of their funding from banks and a scant 30 percent from non-bank sources. For comparison, in the U.S., those figures are generally reversed. In real numbers, if European capital markets were equal to that of the U.S., an added $100 billion could have been made available to fund business growth.
Private firms across Europe have already begun to increase lending activities. Symon Drake-Brockman of London-based Pemberton Asset Management anticipates funds, like the one he leads, could represent up to $56 billion of lending in Europe by 2025. Boosted by the trillions of euros, these firms manage for pension funds and insurers, many are willing to build loan books. This is a trend Drake-Brockman only sees expanding.
“You will see a number of us develop what I would consider as large regional lending businesses, where the scale of what we do will be not dissimilar to some of the banking groups active in mid-market corporate lending,” he told Reuters.
Pemberton is not alone; the Reuters article highlights multiple firms entering the market. M&G, the asset management arm of global insurer Prudential, is expanding into the space, for example. Less than three decades after launching a private finance group with just four employees, the multi billion asset manager now has a team of 90 working on private debt deals. Just this month, the London Pensions Fund Authority brought on a private firm to oversee the fund’s first foray into alternative credit. Increased lending by non-bank entities fits into the vision of a diverse system that complements the banking system, but does not directly address a key component: a pan-European market.
All 28 Member States across the EU have differing rules and markets. Establishing a cohesive mandate that addresses the various financing conditions in the EU’s members will be an uphill battle.
SMEs in particular have been hard hit by constricted bank lending following the global financial crisis. The situation is improving, but many banks are still repairing the damage and cannot meet the higher credit demand that accompanies recovery.
Meanwhile, the concerns of investors have been less addressed. Part of that process is upholding the investor’s need for trustworthiness and transparency. The challenges investors face are numerous, and not everyone is thrilled to see increased private interest in the private debt market. There are some who fear the quality of the borrower will decline. Funds may be more willing to lend to borrowers who were unable (or unqualified) to gain funding elsewhere.
The proposed CMU hopes to address this concern through improved credit information. If and when a central market is established, policymakers say there must be an easy-to-use, multi-national creditworthiness evaluation criterion in place. In order to evaluate potential borrowers, investors will need some way to assess risk, while regulators will need to introduce a policy that satisfies the taxation needs of each nation. The biggest hurdle to all of this is establishing rules that work for investors across the EU and meet the needs of each economy.
Following the introduction of the Capital Markets Union in February, the Commission sought feedback from interested and impacted parties. After taking feedback into consideration, a finalized action plan is expected in the fall; the foundations of a Capital Markets Union should emerge by 2019.
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