Capital Markets, Debt Finance and the EU Capital Markets Union: A Law and Finance Critique

Abstract

Modern, globalised financial markets are the offspring of a process of liberalisation of capital that started with the collapse of Bretton Woods in the 1970s and culminated with the deregulation policies of the late 1990s. As a result, financial markets have grown dramatically and become increasingly integrated at a global level. Much of the growth and innovation that occurred over the past decade has taken place in the realm of capital market finance, and in particular in the context of debt finance, where new transactional models and products have been engineered since the 1980s.

This paper contends that, contrary to conventional belief, the excessive development of capital market finance has been one of the catalysts behind the crises and scandals exploded over the past fifteen years. In particular, the employment of innovative debt transactions was instrumental to the creation of excessive levels of risk-taking and leverage. These had catastrophic consequence, both at firm level and at systemic level.

While much regulation has been enacted in the aftermath of crises and scandals over the past fifteen years, the way in which debt transactions in capital markets are designed and entered into remains largely unregulated. Moreover, regulators have so far neglected the role that leverage and debt creation have in the economy and the consequence that these phenomena have on the wider social context. On the contrary, the recent policy design in the EU is promoting a renewed implementation of an old design, the Capital Markets Union (CMU). This revolves around disintermediated, market-based forms of financing, which should represent an alternative to the traditionally predominant (in Europe) bank-based financing channel. This paper contends that the European policy design fails to appreciate the dangers associated with capital markets finance and its ensuing debt creation effects. It argues that, despite some regulatory efforts, a suitable architecture for the regulation of disintermediated capital markets is still missing.

Keywords: Capital Markets Union; Debt Finance; Leverage; Financial Innovation; Financial Regulation