Why are European stock markets in crisis?

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European stock markets have reached record highs, but they are in crisis. Trading volumes are declining, initial public offerings are rare, and some of their largest companies prefer the attractiveness of the United States.

This lackluster activity has prompted decision-makers in the region to take action. They are trying to revive their faltering markets with incentives designed to boost investment in local companies and encourage companies to list at home.

However, these ambitions are riddled with political, financial and cultural obstacles that for years have proven overwhelming. At the same time, the US market is growing larger than ever.

“Capital markets are on the policy agenda in almost every finance ministry across Europe,” said William Wright, founder of markets think tank New Financial. “It is a very difficult political and cultural problem.”

1. What is the problem in Europe and why is it important?

Before the financial crisis, the performance of major stock markets in the United States and Europe followed each other closely, even if Europe lagged Wall Street.

But since 2008, the gap has widened significantly. Thanks to the growth of Silicon Valley's tech giants, the continued rise of the US market has attracted more money from asset managers and pension funds around the world, creating a virtuous cycle.

2. What's missing? Rocket fuel in Silicon Valley

The lack of activity in European markets is due to multiple reasons. The region's economic performance since the 2008 financial crisis has been much slower than that of the United States.

Europe also lacks the fast-growing technology companies that have fueled the surge in US stocks, while domestic investors have historically been more risk averse than their American counterparts and less keen to back new companies that have not yet achieved profits.

In the same period, China and India emerged as dynamic capital markets, with a host of new companies registered locally.

The European market structure is complex, especially compared to the United States, which has few listing venues and a single clearinghouse through which trades are terminated.

By contrast, almost every European country has its own place for inclusion, which politicians often regard as a source of national pride. Stock trading and post-trade activities take place in many markets, resulting in liquidity being divided.

In the United Kingdom, pension funds have faced pressure from regulators to cover their obligations by investing in bonds. Their holdings of UK listed stocks subsequently declined over decades.

Retail investing has exploded during the coronavirus pandemic in the United States, as ordinary people poured government stimulus money into meme stocks. But Europe lacks a mainstream and thriving retail investment culture.

3. The response of a divided Europe

Supercharging Europe's capital markets to fuel their domestic economies is a critical issue for politicians.

But the solution itself is complex, especially in the European Union, which includes 27 member states. The rules of trade are now being rewritten in Brussels, while individual countries are also amending their own regulations in a bid to strengthen their national markets.

European Union politicians are eagerly trying to unleash growth through an ambitious plan for a capital markets union, which includes facilitating the listing of companies and supporting investors for them.

Brussels last month approved a new listing law that includes making initial public offerings use clearer language and allowing company founders to retain greater control through shares with greater voting weight than other investors.

In the UK, Finance Minister Jeremy Hunt launched a series of measures to help London create and retain more high-growth companies. This includes transferring retirement funds to startups and simplifying the IPO documents that companies share with investors. The UK financial regulator is also planning to reform listing categories.

Both the UK and the EU are developing live stock trading databases to collect basic trading information such as prices and trade sizes. Supporters said it would make stock trading in Europe more transparent and attractive to international investors.

Jeremy Hunt, UK Counselor

“I want the world's fastest-growing companies to grow and list here, making the London Stock Exchange not just Europe's Nasdaq, but much more.” . . “We want it to be the world capital of capital.”

Giorgia Meloni, Italian Prime Minister

“The base allows us to attract investment compared to something that has not always worked in the past.”

Individual European Union countries take their own national measures. Italian Prime Minister Giorgia Meloni is working to pass a controversial “capital bill” that aims to make going public more attractive and keep companies listed in Italy.

The Finance for the Future law was passed in Germany late last year. The threshold for a company to go public has been reduced from a minimum market capitalization of €1.25 million to €1 million, while the tax exemption for employee stock ownership has been increased to make holding shares more attractive.

However, French Finance Minister Bruno Le Maire's comments reflect growing frustration with the pace of progress in reviving the EU's capital markets.

Last month, he proposed that three or four countries move forward with accelerating the pace of capital markets union, by creating a savings product together and allowing joint supervision of their markets.

Christian Lindner, German Federal Minister of Finance

“We must ensure that global technology leaders not only emerge in Silicon Valley, but also find a home in Germany. We need to improve the environment for startups.”

Bruno Le Maire, French Minister of Finance

“I'm tired of the discussions. I'm tired of the empty statements. Do you really think that China and the United States will like our statements? We need decisions and we need strong decisions.”

European politicians ultimately hope to create policies and incentives that fuel a virtuous cycle of more investment in the region's companies, better-performing stock markets, more liquidity and trade, and highly competitive companies and economies.

Results may take years to achieve.

“In isolation, any single policy announcement would look largely disappointing,” New Financial's Wright said. “But overall and over time, I think it will have a big impact.”