European capital markets are losing their competitiveness, particularly when compared to the United States. This threatens to hold Europe back as capital markets are fundamental to finance innovation, deliver the funding needed for the green and digital transformations, and generate the necessary returns to support an ageing population.
Over the past decades, Europe has made significant efforts to develop well-functioning, harmonized, and resilient capital markets. Even as some country-level fragmentation remains, there are common rules, best-in-class regulations, and openness to global inflows. As an example, an investor in France can invest in a Greek company listed in Italy, at a reasonable cost, knowing they are getting a fair price, and that the trade will settle reliably. This has been achieved through considerable efforts by regulators and industry alike.
Trends in equity capital marketing capitalization and liquidity
Between 2016 and 2022, Europe’s equity capital market capitalization (as a share of GDP) rose from 48% to 66%, whereas in the US it increased from 104% to 157%. Liquidity of equity markets (as measured by turnover velocity) decreased from 68% to 52% in Europe, whilst it stayed at 145% in the US over the same time frame.
Europe is not using its capital markets infrastructure to its full potential. Europe has smaller overall capital pools than the US, with pension, insurance, and household assets amounting to six times GDP in the US, compared to only two to three times GDP in leading European economies like France, Germany, and Spain. It also invests far less of those assets through its capital markets, whether directly or indirectly, meaning capital markets are over five times GDP in the US, compared to between one and two times GDP in the same large European economies. This is driven primarily by statutory pension systems that do not invest in capital markets, greater risk aversion of retail investors, and lack of appropriate incentives. Yet, countries like Sweden or Denmark show that one can operate leading capital markets within Europe with available capital pools and deployment to capital markets at rates similar to those of the US.
Activating demand in capital markets — the flywheel effect
There is good news: Capital markets benefit from scale, and a “flywheel effect” exists. Deliberate demand-side and supply-side steps taken over the next five years can set the conditions that will build more momentum, attract additional investors, and create further investment opportunities.
To launch the flywheel, it is crucial to activate the demand side of capital markets. Europe needs to improve retail investors’ access to attractive products and enhance their financial literacy to foster an investment culture. Also, Europe should incentivize retirement savings and create tax structures and vehicles conducive to long-term investments. European capital markets need to be promoted internationally, and accessibility for small- and medium-sized companies needs to be improved, to increase their attractiveness to global investors. Ultimately, these different measures must improve investor outcomes.
Improving supply side dynamics in European capital markets
To maintain a self-reinforcing dynamic, Europe has to continue improving the supply side, too. Developing an integrated and harmonized single market should continue to be a primary goal, accompanied by reforming regulations with a balanced approach, maintaining the leadership in environmental, social, and governance (ESG) finance and boosting securitization markets. Achieving this will require greater collaboration between public and private sectors and leveraging new opportunities enabled by technology. Preserving the diversity of means of funding the economy, both in the short and the long‑term, is also a factor of resilience of the EU capital markets.
While further supply-side measures to improve the functioning of capital markets are necessary, those measures alone are no longer sufficient. Europe needs to grow and deploy its pools of available capital. Without an influx of more capital, Europe’s capital markets will continue to underperform and productivity growth and the green and digital transformation in Europe will inevitably be slower than in other regions.
Our report, “The Capital Flywheel,” sheds light on the development of European capital markets and provides recommendations on how to improve their competitiveness. It reviews progress made towards the capital markets union (CMU) and gathers insights from various capital markets participants on how to succeed in the coming decade.
The report, co-developed by the European Banking Federation (EBF), the European Fund and Asset Management Association (EFAMA), and Federation of European Securities Exchanges (FESE), presents findings informed by interviews with 37 senior industry stakeholders. Their feedback has been synthesized and simplified into a “collective voice” of European capital markets.
