When it comes to capital markets, Europe could learn a few things from the US. A recent study identifying differences between European and more vibrant US capital markets reveals three areas that could help Europe by bolstering economic growth, including an easier-to-access private-placement market that would facilitate investing in Europe’s mid-sized and larger companies.
Commissioned by the Association for Financial Markets in Europe (AFME) and conducted by the Boston Consulting Group (BSG), the study interviewed a wide range of buy-side investors.
“The desirability of promoting alternative funding avenues for mid-sized and large corporates was consistently mentioned by interviewees,” the study notes. “They believed that a larger and more visible European private placement market would provide a faster and more flexible route for investing in European firms.”
The study further noted that interviewees regarded private placements as an important source of funding for European firms wishing to avoid the costly disclosure requirements that public market issuance often entails. Nevertheless, many European firms turn instead to the US private placement market, which they view as a global market compared to Europe’s more fragmented markets. The analysis estimated the value of US private placement deals at 46.1 billion euros in 2013, more than twice the 20 billion euros in European deals.
A lack of standardization in deal documentation and processes was the main hindrance, according to interviewees, who noted that schuldscheine notes (a type of debt certificate) in Germany, which has the most robust private placement market in Europe, benefitted from more standardize processes. The US market’s more standardized processes and documentation, they added, resulted in a simpler, more cost effective deal process.
The interviewees pointed to the UK’s 2014 removal of interest on private placements from withholding tax as a good example of how the market can be encouraged. In the US, the safe harbor exemption from Securities and Exchange Commission oversight, they said, gives investors greater certainty about regulatory treatment.
“Bond investors need to get comfortable that PP documentation is sufficiently standardized so they can analyze transactions more quickly and on a more cost efficient basis,” said Rick Watson, head of capital markets at AFME. “Otherwise, non-standardized documents raise costs for bond investors since more legal and analytical work is required”
Accordingly, AFME recommends increasing standardization by establishing common documentation and processes for private placements across different European jurisdictions and simplifying regulatory treatment where ambiguity exists. The trade organization notes that subsequent to completing interviews for the study, the Pan-European Private Placement (Euro PP) initiative was launched by the industry, providing a first step for standardized documentation for private placements of corporate bonds.
“Some large, listed European corporates do issue private placements from time to time if they need to access the market quickly, or if they issue a transaction with unusual terms to a small group of investors,” Watson said. He added, “However, except for those who issue German schuldscheine or very recently Euro PP, the large European corporates have mainly used the US private-placement market since it offers better financial terms because it is more established, with standardized terms and a larger investor base comprised mainly of insurers.”
Other impediments to European economic growth cited by interviewees included negative sentiment regarding Europe’s near-term growth prospects, especially when compared with the US, punitive accounting and regulatory capital treatments, and excessive regulation overall. Fragmentation through differing asset definitions, terminology, and borrowing costs in different countries were also seen as impediments.
Another focus of the study that could increase European economic growth was small and medium-sized enterprises. Historically SMEs have depended on bank financing but more recently have been introduced to a range of other financing options, which has led to confusion. Interviewees suggested a more centralized approach to tackling SMEs’ financing and growth concerns, along the lines of the US Small Business Association, which provides a one-stop-shopping for SMEs to get information in a user-friendly way.
The third growth focus was infrastructure, in which Europe outpaced in the US in 2013 in terms of expenditures. Nevertheless, the study notes, the European Commission estimates that Europe requires and additional 1.5 trillion to 2 trillion Euros of infrastructure investment to meet its 2020 goals for energy, transport and broadband. Solutions by interviewees to meet that goal include establishing clear rules on contractual agreements and a European Union legal framework to ‘grandfather’ investments already made to reduce policy and rule volatility, and developing a pan-European definition of infrastructure as an asset class.