The UK’s decision to leave the EU has breathed life back into the capital markets union (CMU) initiative, but it may require another, even bigger, crisis to bring about its full potential.

Brexit injected the European Commission with renewed determination to complete CMU by 2019 to cut the continent’s dependence on the City of London for finance. Indeed, the European Securities and Markets Authority (ESMA) is potentially being groomed to be a European version of the US Securities and Exchange Commission and the Commodity Futures Trading Commission. 

Various securities have been mooted as drivers of CMU, such as corporate bonds. But somehow these don’t look sufficient to truly ignite CMU as some member states such as Germany are not terribly enthusiastic about capital markets.

Instead, it needs something bigger, more fundamental and European. And what could be better than eurozone sovereign bonds issued on behalf of all the member states? It would create a deep, liquid and efficient eurozone capital market able to rival US ones. And it would support the euro’s bid to become the world’s premier reserve currency. 

The idea has support, particularly among true believers of ever closer union of Europe. Martin Schulz, former president of the European Parliament, who is running in the German elections, is a fan.

France’s new president, Emmanuel Macron, promoted the idea, but was quickly slapped down by the German government. Germany fears having to fund the profligacy of others.    

The role of crises

Enter the role of crises. UK observers often misunderstand the key role crises play in eurozone integration. Far from being evidence of structural failings, which of course they are, they are actually seen by the European Commission as useful catalysts to forge integration.

It is euro-crises that have transformed the European Central Bank from a feeble institution into a powerful central bank.

Therefore, spurring a eurozone sovereign debt market would likely require an existential moment for the euro.

The catalyst could come from Italy. Its debt to GDP ratio stands at 132.7% and the country spends 4% of GDP on servicing debt, double the OECD average. Its banking system is saddled with non-performing loans and though that is slowly being fixed, it could accentuate a wider debt crisis under certain circumstances.

These could include the normalisation of interest rates, leading to higher debt servicing costs for Italy or a deflationary global recession, which could bar the country from debt markets.

Saving Italy and the eurozone may then be beyond the ECB, requiring a rescue that pooled everyone’s bond markets so struggling countries could directly benefit from the strong credit ratings of their peers. Such a move would give CMU a whole new meaning.

Of course, there is a good chance eurozone bonds will never happen. Strong public opposition could torpedo any such attempts or maybe Italy manages to slowly grow its way out of trouble.  

But committed Europhiles will dream on …