Karel Lannoo

  • "Tax remains a predominantly national matter in Europe, making it difficult for Europe to exploit its scale"

Expert commentary by Karel Lannoo, Chief Executive Officer, Centre for European Policy Studies (CEPS)

With the end of quantitative easing approaching and a likely rise in interest rates, firms need to prepare for a considerable increase in the cost of financing. The low interest rates of the last four years, since the establishment of the Capital Markets Union (CMU), no doubt explain why capital markets financing has remained so underdeveloped in Europe, but there is more. Even if markets are up across different segments – IPOs, private equity and venture capital – overall they are still at low levels given the position in the cycle, and bank financing remains dominant. In addition, Europe continues to struggle with how to leverage its scale, as demonstrated by the Spotify IPO, which listed in the US. The increasingly likely advent of a chaotic Brexit in Europe’s largest capital market will not make Europe more attractive.

Latest data from the European Investment Bank’s Investment Survey indicates that firms broadly continue to prefer bank finance over any other means. In an experiment using a sample of almost 1,000 cases, firms were willing to pay an extra 8.8% interest over the cost of equity in order to avoid having to offer shares. Even with a lending option requiring 100% collateral, firms were willing to pay some 5% more for a loan. This demonstrates that deeper issues are at stake, which require a more radical approach if Europe wants to create a more balanced financial system.

The need to rebalance our financial system is even more urgent if one considers that much growth today is coming from intangibles. Banks like collateral. They are not keen to provide debt financing for the acquisition of the intangible assets that are so important to innovation. The European Investment Bank’s analysis shows that firms with more diversified financing (e.g. trade credit, bank financing, grants and equity financing) invest more in intangibles and innovation.

However, the importance of intangibles requires a change in tax systems that are largely based on fixed assets and debt finance. Interest payments on debt finance are tax deductible, but profits are taxed, as are dividends on equity. Dividends of foreign companies are taxed twice, once at in their home country, and once in the country of the recipient.

Tax remains a predominantly national matter in Europe, making it difficult for Europe to exploit its scale. The same applies to listing standards, notwithstanding four rounds of EU harmonisation in 1989, 2003, 2010 and 2017. Unlike the US, the EU still does not have a single authority that could vet an appeal to a pan-European investor base. Under current rules, a listing must be authorised in the company’s home country, then notified to 27 or more authorities, to obtain permission to call upon local investors – another reason that Spotify chose the US market.