The changing landscape of financial markets in Europe, the United States and Japan. Bruegel Working Paper 2013/02, 18 March 2013

We compare the structure of the financial sectors of the EU27, Japan and the United States, looking at a set of 23 indicators. We find a large variation within the European Union in the structure of the financial sector. Using principal components analysis, we identify robust groups of EU countries. One group consists of the eastern European members that entered the EU more recently.These have substantially smaller financial sectors than the old member states. A second group can be classified as market-based (MBEU) and the third group is more bank-based (BBEU). We compare US, MBEU, BBEU, Eastern EU and Japan with the following main results. First, the groups within Europe are geographically related. Second, in many indicators, MBEU countries are closer to the (market-based) US, while BBEU countries more closely resemble Japan. Paradoxically, however, market-based EU countries also have large banking sectors. Banks in market-based countries have larger cross-border assets and liabilities, and derive a larger fraction of their income from fees, rather than interest income, than banks in bank-based countries. Finally, for most indicators, the ordering of groups of countries is quite stable over time, but while the crisis has had no impact on the relative ordering of the groups, it has slightly widened the gap between the US and all EU regions insome respects. We also find that during the crisis, substitution between market-based and bank-based sources of finance occurred in the US, and to a lesser extent in MBEU and BBEU countries.

Emerging Markets' Euro Nemesis. CEPS Commentary, 9 September 2013

In this new commentary, CEPS Director Daniel Gros argues that the weakening of European demand triggered by austerity is the real cause behind the recent deterioration of emerging markets’ current accounts. As a consequence, unless the US resumes its role as consumer of last resort, the latest bout of financial-market jitters will weaken the global economy again.

European banking disunion. CEPS Commentary, 14 November 2013

In this CEPS Commentary Daniel Gros argues that the purpose of the euro was to create fully integrated financial markets; but, since the start of the financial crisis in 2008, markets have increasingly separated along national lines. So the future of the eurozone depends crucially on whether that trend continues or is reversed and Europe’s financial markets in the end become fully integrated. But either outcome would be preferable to something in between – neither fish nor fowl. Unfortunately, that is where the eurozone appears to be headed.

Austerity: European democracies against the wall. CEPS Paperbacks. July 2013

The crisis in the eurozone has had a dramatic impact on the economic and social fabric of European countries. However important it may be, the economic dimension is only the symptom of a broader problem. The crisis is primarily political in nature. Lorenzo Bini Smaghi argues in this book that the crisis reflects the inability of western democracies to solve problems that have been building for over two decades. He finds that democratically elected officials are loathe to take unpopular decisions that could jeopardise their re-election. Emergency thus becomes the engine of political action, and the justification for corrective measures vis-à-vis the voters. As a consequence, the cure in the form of austerity, administered belatedly and under pressure from the markets, becomes even more painful and unpopular, giving rise to populist movements and endangering democracy itself.

Asset-backed securities: The key to unlocking Europe's credit markets? Bruegel Policy Contribution 2014/07, 24 July 2014

The European market for asset-backed securities (ABS) has all but closed for business since the start of the economic and financial crisis. ABS (see Box 1) were in fact the first financial assets hit at the onset of the crisis in 2008. The subprime mortgage meltdown caused a deterioration in the quality of collateral in the ABS market in the United States, which in turn dried up overall liquidity because ABS AAA notes were popular collateral for inter-bank lending. The lack of demand for these products, together with the Great Recession in 2009, had a considerable negative impact on the European ABS market. The post-crisis regulatory environment has further undermined the market. The practice of slicing and dicing of loans into ABS packages was blamed for starting and spreading the crisis through the global financial system. Regulation in the post-crisis context has thus been relatively unfavourable to these types of instruments, with heightened capital requirements now necessary for the issuance of new ABS products. And yet policymakers have recently underlined the need to revitalise the ABS market as a tool to improve credit market conditions in the euro area and to enhance transmission of monetary policy. In particular, the European Central Bank and the Bank of England have jointly emphasised that: “a market for prudently designed ABS has the potential to improve the efficiency of resource allocation in the economy and to allow for better risk sharing... by transforming relatively illiquid assets into more liquid securities. These can then be sold to investors thereby allowing originators to obtain funding and, potentially, transfer part of the underlying risk, while investors in such securities can diversify their portfolios... . This can lead to lower costs of capital, higher economic growth and a broader distribution of risk” (ECB and Bank of England, 2014a). In addition, consideration has started to be given to the extent to which ABS products could become the target of explicit monetary policy operations, a line of action proposed by Claeys et al (2014). The ECB has officially announced the start of preparatory work related to possible outright purchases of selected ABS1. In this paper we discuss how a revamped market for corporate loans securitised via ABS products, and how use of ABS as a monetary policy instrument, can indeed play a role in revitalising Europe’s credit market. However, before using this instrument a number of issues should be addressed: First, the European ABS market has significantly contracted since the crisis. Hence it needs to be revamped through appropriate regulation if securitisation is to play a role in improving the efficiency of resource allocation in the economy. Second, even assuming that this market can expand again, the European ABS market is heterogeneous: lending criteria are different in different countries and banking institutions and the rating methodologies to assess the quality of the borrowers have to take these differences into account. One further element of differentiation is default law, which is specific to national jurisdictions in the euro area. Therefore, the pool of loans will not only be different in terms of the macro risks related to each country of origination (which is a ‘positive’ idiosyncratic risk, because it enables a portfolio manager to differentiate), but also in terms of the normative side, in case of default. The latter introduces uncertainties and inefficiencies in the ABS market that could create arbitrage opportunities. It is also unclear to what extent a direct purchase of these securities by the ECB might have an impact on the credit market. This will depend on, for example, the type of securities targeted in terms of the underlying assets that would be considered as eligible for inclusion (such as loans to small and medium-sized companies, car loans, leases, residential and commercial mortgages). The timing of a possible move by the ECB is also an issue; immediate action would take place in the context of relatively limited market volumes, while if the ECB waits, it might have access to a larger market, provided steps are taken in the next few months to revamp the market. We start by discussing the first of these issues – the size of the EU ABS market. We estimate how much this market could be worth if some specific measures are implemented. We then discuss the different options available to the ECB should they decide to intervene in the EU ABS market. We include a preliminary list of regulatory steps that could be taken to homogenise asset-backed securities in the euro area. We conclude with our recommended course of action.

Benefits and drawbacks of European Unemployment Insurance. Bruegel Policy Brief 2014/06, September 2014

The issue: Unemployment in Europe has increased to high levels and economic growth has remained subdued. A debate on additional policy instruments to address the situation is therefore warranted. Fiscal stabilisation mechanisms have not provided adequate fiscal stabilisation during the crisis in some countries nor in the euro area as a whole. Different preferences and historical developments mean that national labour markets are differently organised, which sometimes hinders the efficient working of the monetary union. European Unemployment Insurance (EUI) has been proposed as a measure to contribute to fiscal policy management and improve labour markets. | Read more at Bruegel http://www.bruegel.org/publications/publication-detail/publication/847-benefits-and-drawbacks-of-european-unemployment-insurance/

A Financial Markets Policy for the next 5 years. CEPS Commentary, 1 October 2014

Karel Lannoo prefaces his survey of the priorities for the new European Commission in the area of financial markets with a warning that the hangover from the past five years is huge and that public opinion on the role of the financial sector will continue to be critical for some time to come. Implementation and enforcement will need to be followed-up carefully, as any flaws could rapidly attract negative headlines. In this commentary, he finds that three themes stand out: moving back to normal in financial markets regulation, adequate implementation and enforcement, and access to finance. The latter, in particular, should be the overarching theme, in all its dimensions -- access to credit for SMEs, access to capital markets for new ventures and access to finance for households.

Discretion and Accountability: The ESMA Judgment and the Meroni Doctrine. Bruges European Economic Research (BEER) Papers 30/2014

This paper assesses the effectiveness of the Meroni doctrine in the light of the recent judgment in the ESMA case. The first part explains in detail the problem of delegation of powers in the EU from the perspective of the principal-agent theory and complements it with the analysis of the trade-off between different levels of independence and accountability of agencies. A simple economic model is developed to illustrated the relationship between the independence and accountability of an agency. It shows that it is the accountability mechanism that induces the agent to act, rather than the extent of his independence. The paper also explains the inter-temporal interactions between the principal and the agent on the basis of the incentives in place for the different players. The second part is devoted to analysis of the functioning of ESMA in the context of its delegated powers. After the presentation of main aspects of the regulatory framework establishing ESMA, the paper continuous with an analysis and interpretation of the discretionary powers of ESMA. The rather rigid position of the Court of Justice in relation to the Meroni doctrine seems to be unsuitable to delegation of complex regulatory tasks. This is particularly evident in the case of financial markets. Finally, the judgment does not examine in any detail whether and how the principals - i.e. the EU and Member States - are best able to evaluate the quality of ESMA decisions and regulations and whether there are different but more effective accountability mechanisms.

Defining Europe's Capital Markets Union. Bruegel Policy Contribution Issue 2014/12, 13 November 2014

The new European Commission has signalled that it will work to create a ‘capital markets union’. This is understood as an agenda to expand the non-bank part of Europe’s financial system, which is currently underdeveloped. The aim in the short term is to unlock credit provision as banks are deleveraging, and in the longer term, to favour a more diverse, competitive and resilient financial system. Direct regulation of individual non-bank market segments (such as securitisation, private placements or private equity) might be useful at the margin, but will not per se lead to significant capital markets development or the rebalancing of Europe’s financial system away from the current dominance by banks. To reach these goals, the capital markets union agenda must be broadened to address the framework conditions for the development of individual market segments. Six possible areas for policy initiative are, in increasing order of potential impact and political difficulty: regulation of securities and specific forms of intermediation; prudential regulation, especially of insurance companies and pension funds; regulation of accounting, auditing and financial transparency requirements that apply to companies that seek external finance; a supervisory framework for financial infrastructure firms, such as central counterparties, that supports market integration; partial harmonisation and improvement of insolvency and corporate restructuring frameworks;and partial harmonisation or convergence of tax policies that specifically affect financial investment.

The tug of war. Russia's response to changes on the European gas market. OSW Study 50/2014

Russia, being aware of the evolution of the EU gas market and the fluctuations in trends that accompany it, and in an attempt to maintain its position on the European gas market, is sticking to a dichotomous strategy. On the one hand, Moscow has taken an offensive approach: it continues its traditionally critical rhetoric with regard to the legal and institutional changes; by negating the legitimacy of the new rules, it has been making efforts to undermine them by employing legal and political measures; Russia has used such traditional economic means as investments in assets and pushing through the implementation of new gas pipeline construction projects. On the other hand, the evolution of the EU gas market has forced Russia to take steps to adapt to a certain extent: partial changes in the operation of the internal gas sector; promises to further curb Gazprom’s dominant position; the concessions made in trade negotiations with European partners; partial adjustments to the EU’s so called third energy package regulations. Hoping that the unfolding situation on the gas markets will contribute to slowing down the recent liberalisation tendencies in the EU and that EU member states won’t make progress in decreasing their dependence on Russian gas, Moscow is thus preparing itself for the ‘long game’ in gas with its European partners.

The Penetration of Financial Instability in Agricultural Credit and Leveraging. Factor Markets Working Paper No. 2, September 2011

This paper describes the aggregate rural capital markets of the EU and the main differences between the markets of its member countries. The results of our study suggest that the agricultural credit markets are still quite segmented and the segments are country- rather than currency- or region specific. Financial instability in Europe is also penetrating the agricultural sector and the variation of interest rates for agricultural credit is increasing across countries. Perhaps the most dramatic signal of growing financial instability is that the financial leverage (gearing rate) of European farms rose in 2008 by almost 4 percentage points, from 14 to 18%. The 4 percentage-point annual rise was twice the 2 percentage-point rise observed during the economic recession in the late 1980s and early 1990s. The distribution of the financial leverage of agriculture across countries does not, however, reflect the distribution of country-specific risk premiums in the manner that they are observed in government bond yields. Therefore, in those countries that have the weakest financial situation in the public sector and in which the bond markets are encumbered with high country-specific risk premiums, the agricultural sector is not directly exposed to a very large risk of increasing interest rates, since it is not so highly leveraged. For example in Greek and Spanish agriculture, the financial leverage (gearing) rate is only 0.6% and 2.2% respectively, while the highest gearing rates are found elsewhere (in Denmark), reaching 50%.

Mutual recognition in goods and services: an economic perspective. Bruges European Economic Policy (BEEP) Briefing 2/2002

Mutual recognition is a remarkable innovation facilitating economic intercourse across borders. In the EU's internal goods market it has been helpful in tackling or avoiding the remaining obstacles, namely, regulatory barriers between Member States. However, there is a curious paradox. Despite the almost universal acclaim of the great merits of mutual recognition the principle has, in and by itself, contributed only modestly to the actual realisation of free movement in the single market. It is also surprising that economists have not or hardly underpinned their widespread appreciation for the principle by providing rigorous analysis which could substantiate the case for mutual recognition for policy makers. Business in Europe has shown a sense of disenc hantment with the principle because of the many costs and uncertainties in its application in actual practice. The purpose of the present paper is to provide the economic and strategic arguments for employing mutual recognition much more systematically in the single market for goods and services. The strategic and the "welfare" gains are analysed and adetailed exposition of the fairly high information , transaction and compliance costs is provided. The information costs derive from the fact that mutual recognition remains a distant abstraction for day-to-day business life. Understandably, verifying the "equivalence" of objectives of health and safety between Member States is perceived as difficult and uncertain. This sentiment is exacerbated by the complications of interpreting the equivalence of "effects". In actual practice, these abstractions are expected to override clear and specific national product or services rules, which local inspectors or traders may find problematic without guidance. The paper enumerates several other costs including, inter alia, the absence of sectoral rule books and the next-to-prohibitive costs of monitoring of the application of the principle. The basic problems in applying mutual recognition in the entire array of services are inspected, showing why the principle can only be used in a limited number of services markets and even there it may contribute only modestly to genuine free movement and competitive exposure. A special section is devoted to a range of practical illustrations of the difficulties business experiences when relying on mutual recognition. Finally, the corollary of mutual recognition - regulatory competition - is discussed in terms of a cost/benefits analysis compared to what is often said to be the alternative , that is "harmonisation" , in EU parlance the "new approach" to approximation. The conclusion is that the manifold benefits of mutual recognition for Europe are too great to allow the present ambiguities to continue. The Union needs much more pro-active approaches to reduce the costs of mutual recognition as well as permanent monitoring structures for its application to services (analogous to those already successfully functioning in goods markets). Above all, what is required is a "mutual recognition culture" so that the EU can better enjoy the fruits of its own regulatory ingenuity.

European Industrial Policy. Bruges European Economic Policy (BEEP) Briefing 15/2006

This survey of European industrial policy aims to set out and explain the great significance of European integration in determining (changes in) structure and performance of industry in the EU. This influence is explored from the policy side by analysing the transformation of the framework within which both EU and Member States' industrial policy can be pursued. Empirical economic analysis is not included because this BEEP Briefing was originally written for a handbook3 in which other authors were assigned a range of industrial economics subjects. In the last 25 years or so, the transformation is such that the nature and scope of industrial policy at both levels of government has profoundly changed as well. Indeed, the toolkit of measures has shrunk considerably, disciplines have been tightened and the economic policy views behind industrial policy have altered everywhere. The pro-competitive logic of deeper market integration itself is rarely questioned nowadays and industrial policy at the two levels takes on different forms. The survey discusses at some length the division of powers between, and the complementarity of, the Member States' and EU levels of government when it comes to industrial policy, based on a fairly detailed classification of industrial policy instruments. The three building blocks of the wide concept of industrial policy as defined in this BEEP Briefing consist of the EU framework of market integration, EU horizontal industrial policy and its EU sectoral or specific counterpart. Each one is surveyed at the EU level. Preceding these three sections is a discussion of three cross-cutting issues, namely, the indiscriminate use of the 'competitiveness' label in the EU circuit of business and policy makers, the relation between services and EU industrial policy and, finally, that of European infrastructure. One major conclusion is that, today, the incentive structure for industry and industrial markets is dominated by the stringency of the overall EU framework and to some moderate degree by the horizontal approach.

Coltan from Central Africa, International Trade and Implications for Any Certification. Bruges European Economic Policy (BEEP) 23/2012

The exploitation of coltan in Central Africa can be considered a case of conflict minerals due to its nature. Many international organizations and bodies, national governments and private sector organizations seek to address this conflict, in particular via transparency, certification and accountability along the material supply chain. This paper analyses the international trade dimension of coltan and gives evidence on the dimension of illicit trade of coltan. The authors start from the hypothesis that illicit trade of coltan sooner or later will enter the market and will be reflected in the statistics. The paper is structured in the following manner: first, a short section gives a profile of coltan production and markets; second, an overview of the mining situation in the Democratic Republic of Congo (DRC) and related actors. The third section addresses mechanisms, actors and measurement issues involved in the international trade of coltan. The final part draws lessons for certification and conflict analysis and offers some guidance for future research. The paper identifies two main possible gateways to trace illegal trade in coltan: the neighbouring countries, especially Rwanda, and the importing countries for downstream production, in particular China. Our estimation is that the value of such illicit trade comes close to $ 27 million annually (2009), roughly one fifth of the world market volume for tantalum production. With regard to any certification the paper concludes that this will become challenging for business and policy: (a) Central Africa currently is the largest supplier of coltan on the world market, many actors profit from the current situation and possess abilities to hide responsibility; (b) China will need to accept more responsibility, a first step would be the acceptance of the OECD guidelines on due diligence; (c) better regional governance in Central Africa comprises of resource taxation, a resource fund and fiscal coordination. An international task force may provide more robust data, however more research will also be needed.