Financial Markets (Dis)Integration in a Post-Brexit EU: Towards a More Resilient Financial System in Europe 3030360512, 9783030360511

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Financial Markets (Dis)Integration in a Post-Brexit EU Towards a More Resilient Financial System in Europe Dieter Pesendorfer

Financial Markets (Dis)Integration in a Post-Brexit EU

Dieter Pesendorfer

Financial Markets (Dis)Integration in a Post-Brexit EU Towards a More Resilient Financial System in Europe

Dieter Pesendorfer School of Law Queen’s University Belfast Belfast, UK

ISBN 978-3-030-36051-1    ISBN 978-3-030-36052-8 (eBook) https://doi.org/10.1007/978-3-030-36052-8 © The Editor(s) (if applicable) and The Author(s), under exclusive licence to Springer Nature Switzerland AG 2020 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. Cover illustration: Marina Lohrbach_shutterstock.com This Palgrave Macmillan imprint is published by the registered company Springer Nature Switzerland AG. The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

Contents

1 Introduction  1 2 Financial (De)Globalization and Financial Market (Dis)Integration 35 3 Finance-Led Capitalism and Neoliberal Financial Market Integration in Europe129 4 Brexit and Financial (Dis)Integration: Between Cakeism, Project Fear, and Reality193 5 Finishing Capital Markets Union253 6 Finishing the Banking Union315 7 Conclusion: The Future of Financial Markets (Dis)Integration363 Index375

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CHAPTER 1

Introduction

‘The question today is whether financial systems are safer. The short answer is that they are safer, but not safe enough. Above all, we must be concerned about increasing efforts to roll back some post-crisis regulations. Countries need to resist the pressures. Indeed they need to push on because more work and political will is required to fully implement the existing reforms.’ Christine Lagarde (2019: 9)

European economic and financial markets integration have become widely recognized as a success story as part of the broader European integration process that led to peace and prosperity between former imperialist rivals that had a history of repeated wars over European and global dominance. From the early years on closer cooperation and the pooling of resources have been seen by many admirers as leading to the most successful regional integration project in history and as unique model of capitalism in the wider global economy that has generated a relatively high level of social welfare and wellbeing, although with quite some variation within the different countries and regions. The World Bank praised Europe’s distinct ‘golden growth’ model as powerful ‘convergence machine’ that must meet the expectations of Europeans who want ‘economic growth to be smarter, kinder, and cleaner’ (Gill et al. 2012). Deeper integration promised not just peace, more efficiency, wealth and social cohesion but also regaining economic and political power that had been lost by the nation © The Author(s) 2020 D. Pesendorfer, Financial Markets (Dis)Integration in a Post-Brexit EU, https://doi.org/10.1007/978-3-030-36052-8_1

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states in an increasingly globalized world economy controlled by great powers, transnational corporations, and financial markets. Despite numerous shortcomings, problems, and failures to deliver on specific targets over the decades, European integration created sufficient attractiveness for the majority of European countries to join the original six member states of the European Economic Community (EEC) or to get at least in close relationship with these core countries and the European Union (EU) emerged after further enlargement rounds as a powerful economic bloc of 28 member states that are part of an economic union and 19 of those member states share a common currency with the euro which has become the world’s second most important currency immediately after it was introduced 20 years ago. The European Single Market that guarantees the ‘four freedoms’ of free movement of goods, capital, services, and labor, all central to deeper economic, financial and capital markets integration, has established an even greater economic bloc with significantly reduced internal borders and regulatory obstacles, constituting with over 500 million consumers one of the largest markets in the world economy. With an extended membership, although with some important exemptions for the non-EU members, the Single Market consists of all 28 EU member states and Norway, Iceland, and Lichtenstein which are all members of the European Economic Area (EEA). Additionally, Switzerland is partially integrated on the basis of a Free Trade Agreement of 1972, several sectoral trade agreements signed in 1999 and 2004 and an additional 100+ bilateral agreements, which requires the country to take over relevant EU legislation in the covered sectors. The creation of the Single Market in 1992 and the currency union in 1999 were not just seen as major boosts for economic and financial markets integration but because of their design features also as deeply conflicted, neoliberal, market fundamentalist strategies that have amplified the power of large corporations and finance and forced member states, no longer able to control their own currencies with national monetary policy, to adopt fiscal discipline and deregulatory and market-friendly policies that would increase financial stability and Europe’s competitiveness in the global economy. Financial markets integration in Europe as well as economic and monetary integration and the Single Market were still incomplete, not least because of the different country groups within the core and periphery of integration creating fragmentation and different levels of integration; service sectors generally lagged behind the integration of trade in goods and only some financial markets and their regulatory governance were truly European, others remained

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split along national borders creating competitive pressures in global as well as European competition while also some protection within the European market. Contrary to the promises by its supporters, financial integration did not create more stability but more instability. Lack of social and economic cohesion resulting from the economic and monetary system undermined stability by reproducing macroeconomic imbalances and was insufficiently addressed by policymakers guided by the premise that the EU should never become a transfer union, in which wealth is redistributed from richer to poorer member states and regions to significantly reduce social and economic disparities. Transformations in capitalism and its financial system led to rising inequality and problematic developments in the ‘real economy’ of non-financial firms, while the aging society put additional pressure on the national welfare systems. When the Global Financial Crisis (GFC) of 2007–2009 put the European markets and political systems under extreme stress and the following multi-year European sovereign debt crisis starting in 2009 created an unprecedented existential crisis for the EU and European integration, fundamental flaws and problems in the design and operation of EU economic, monetary, and financial governance and systems were exposed. The Eurozone became widely seen as not delivering ‘shared prosperity’; instead it turned into an area ‘highly vulnerable to political and economic shocks’. Martin Wolf (2016) came to a widely shared, deeply unfavourable conclusion: ‘The painful truth is that the eurozone has not only suffered poor overall performance, but has also proved to be a machine for generating economic divergence among members rather than convergence.’ Social peace broke in several member states, and desperate people turned to violence after finance had shown its own face of violence towards society. Finance-led capitalism had brought European integration to the brink of collapse with economic turmoil unseen since the Great Depression, some markets disintegrating, and European societies still adopting to the social and economic fallout a decade after the start of the crisis. The dramatic and destabilizing events in Europe led to reflexive calls for more integration but also to concerns whether integration went too far and is now on a path towards hyper-­ integration (Majone 2014). For critics of neoliberal financial globalization and neoliberal European integration these crises were no surprise but more a matter of time when they would occur as radical reform proposals for an alternative (financial) globalization and European integration from the pre-crisis decades were ignored. A Eurozone crisis and the disintegrative tendencies this could create was even predicted by neoliberal scholars

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that saw significant flaws in the Eurozone design (see Chap. 3). However, the EU, the Eurozone countries, and the euro as a global reserve currency survived thanks to costly emergency actions, economic recovery and unprecedented unconventional monetary measures, and wide-ranging reforms of financial regulation. In the eyes of supporters of European integration, surviving such a major crisis of a century is clear proof of the resilience of the EU that remained much more stable over the crisis years than several of the member states’ political systems. The EU moreover learned lessons and used the crisis as an opportunity to address some of the reasons for economic instability and launched new ambitious projects for ‘a deeper and fairer economic and monetary union’, with a more integrated Economic and Fiscal Union, more democratic accountability, and a ‘genuine Financial Union’ consisting of a European Banking Union (EBU) for the Eurozone member states but open to the others and a true Capital Markets Union (CMU) for all EU member states. These policies for deeper economic and financial integration and more risk-sharing across European economies also include an agenda for ‘sustainable finance’ and for more ‘inclusive growth’ and ‘financial inclusion’. Together they should make the European economic, monetary, and financial system more resilient to future stress and even sustainable, meaning not leaving the next generations worse off than the current at a time when the current generation is already seen as worse off than the previous (Bialik and Fry 2019; O’Connor 2018) and the EU is challenged by multiple crises originating from within and outside. Some have argued that financial integration policies have become a ‘general tool of statecraft’ which the EU has started to use to circumvent budgetary and other constraints and now uses finance and financial markets as ‘new strategies of governance’ (Braun et  al. 2018: 104). The GFC as a systemic crisis of ‘finance-dominated capitalism’ (Hein 2012) and financial globalization with liberalized financial markets led to numerous calls to see the crisis as opportunity to introduce long-overdue measures to ‘tame finance’ and to make future crises less severe and more manageable; yet the global and European reforms were more continuity than radical transformation and more piecemeal, reactive and insufficiently active interventions. Even regulators such as the governor of the Bank of England, Mark Carney (2015), criticized at least parts of them as ‘half measures’ that undermine economic recovery and financial stability and warned especially about most severe risks in the euro area. High levels of government debt in several member states and bad loans, low profitability,

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and other problems in the European banking sector are still seen as some of the most serious vulnerabilities in the post-GFC global financial markets (c.f. IMF 2019a). The International Monetary Fund (IMF 2019b) acknowledged for the euro area ‘some progress’ but concluded that ‘in many cases political consensus on the path forward is missing.’ According to the Director of the IMF’s European Department, Poul Thomsen (2019), the risks to stability in the euro area ‘remain serious’ and a ‘lack of reforms means that little progress has been made on closing productivity gaps across member states, leaving some countries with low potential growth rates and high unemployment’. The latest report on risks and vulnerabilities in the EU financial system by the European Supervisory Authorities (EIOPA et al. 2019) expected a rise in market volatility and less favourable macroeconomic environment that could increase various risks. The EU still has a limited risk sharing and economic stabilization capacity and the major new projects to finalize the incomplete Financial Union, EBU, and CMU promote deeper integration while also creating their own new risks that could undermine financial stability and create financial disintegration and severe turbulences. The chance for a radical overhaul of the global economic system, its financial architecture, the European financial system and its governance and structure was missed. However, a decade after the GFC reforms are still unfinished and ongoing in an overall climate in which radical critics, leading scholars as well as key regulators and lawmakers call for a transformation of capitalism to save the system and for additional regulatory measures to transform finance. While radical critics demand nothing less than an ‘alternative (financial) globalization’ based on a fundamental overhaul of the global trading and financial system and even democratization of finance, leading regulators are nowadays calling for sustainable finance and inclusive capitalism and they are also more willing to look at the systemic implications of finance and to accept that the financial system is inherently instable and requires stricter regulation and supervision than in the decades before the GFC.  Yet only a small number of regulators has questioned whether financial globalization has gone too far and what the ‘right size’ of the financial system would be and what that would mean for regulatory intervention. A good number of regulators and policymakers is already reassuring that the financial sector has become safe and resilient and that it would now even need deregulation and frameworks that support growth, a revival of markets that flourished before the crisis, and new financial innovation and engineering. This largely reflects the financial

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industry’s continued powerful position reflected also in the flaws of the dominant economic and finance theories. The crises did not strengthen the countervailing powers necessary for radical change; Occupy Wall Street, London, or Frankfurt were only temporarily able to mobilize larger protests and to raise public awareness about the operation and consequences of finance-led capitalism but had little influence on reform decisions. Neither older or newer non-governmental organizations (NGOs) and their transnational movements or leading critical scholars specialized in finance had much of an impact. The powerful financial industry might have lost some battles and is now at least temporarily facing new and stricter regulation, supervision and enforcement but overall the industry activities are still seen as mostly ‘appropriate’, while ‘the architects of reform are working around the edges’ (Wray 2013: 696). Financial integration and financial globalization policies faced a short period of intense public scrutiny and high expectations from the public to get the reforms right but policy- and lawmaking returned already to the usual elite circles that dominate the technical discussions in ‘quiet times’. Financial industry spent even larger amounts for lobbying than usual over the past decade. Many of the reforms reflect different interests within the sector and various markets have been (re)created. However, despite some markets crashing and not recovered, neither the size of finance, nor its products or activities were fundamentally changed, the trend towards capital concentration in financial markets continued, and the key features of finance-led capitalism remained in place (see Chap. 2). Moreover, finance started a discussion about the unintended consequences of regulatory reforms and overregulation over recent years, a language adopted also by regulators and the European Commission and already resulting in various areas in new liberalization and deregulation measures to boost finance, financial innovation, and financial integration in new markets. Yet there is still pressure for continuing stricter reforms of finance and especially Europe faces unique challenges that need to be addressed. In this post-GFC climate leading EU politicians and regulators saw an opportunity for deeper integration and have been warning against postponing urgently needed reforms during the calmer years as this would only magnify future problems (c.f. de Guindos 2019; Rehn 2018). Calls for deeper integration have also faced criticism with some arguing that unity and financial stability could be better strengthened with more diversity in European financial markets and their regulation (Dorn 2015; Persaud 2015) or that integration could be better achieved through cooperative competition (Majone

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2014). Moreover, European economies and finance remain for many a serious threat to global and European financial stability. This book provides a critical analysis of the progress that has been made in stabilizing and reforming this inherently instable and unsustainable system and the challenges that are ahead for European financial markets integration at a time when the EU is faced with numerous internal and external challenges. Not just the decision to leave the EU and the Single Market by the United Kingdom (UK) as the second largest EU economy and the region’s provider of key financial services has created unparalleled challenges and a clear threat of financial disintegration in post-Brexit Europe, also a fast changing global environment including the rise of new emerging powers and a deep crisis of the multilateral trading system and its core institution, the World Trade Organization (WTO), have led to serious concerns and questions about whether financial globalization went too far and whether this has caused trends towards economic nationalism, deglobalization and economic and financial disintegration and how they will affect European economies and societies. At the same time the EU must respond to the challenges of redesigning the financial system in ways that it can contribute to economic development in the disruptive digital age, the renewal of major infrastructure and the investment needed to transform the wider economy into a fairer, more sustainable, decarbonized, circular, green economy.

1.1   The Advantages of Financial Markets Integration and Financial Globalization Studying European financial (dis)integration must start with the theories explaining the nature, drivers, and direction of financial markets integration and clarify its relationship to financial and economic globalization. To identify and discuss the benefits of deeper financial integration and financial globalization it is first necessary to understand the difference and similarity between these central concepts. Both have been defined and used in different ways but generally in relation to each other. Financial globalization is often described as the increase in cross-border and international financial flows within the multicontinental networks of trade and finance that make up the world market. For Oxelheim (1996: 21) financial globalization is a process that ‘involves complex cross-border and cross-sectoral integration in which capital movements and financial services are key

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determinants’ and that leads to the ‘transformation of national segmented financial markets into integrated parts of the global financial market’. Financial globalization would lead to financial liberalization and deregulation which would result in ‘perfect integration’. Oxelheim (ibid.: 46) assumed that this perfect level of integration would only entail an absolute minimum of regulation ‘required to guarantee the infrastructure of the financial market’. This would include ‘a set of regulations that promotes the soundness of a financial market and guarantees competition’. For James Tobin (2003: 13) financial globalization is about the markets of assets and debts and how they expand across borders. In a more abstract terminology Dymski (2005: 440) describes financial globalization as ‘the homogenization of formerly idiosyncratic national systems’. For Jan Tinbergen (1965: 96) economic integration was the most desirable structure of international economy that could be achieved with free trade and a more or less interventionist system of international economic policy with an ‘optimum degree of centralization’. However, integration reality would be less than the optimum because of political interests to limit integration to areas from which political actors expect more narrow economic advantages. Balassa’s (1961) theory of economic integration expanded on the free trade criteria and described a fully integrated system as one with absence of all forms of discrimination that might impinge on trade. Based on the assumption that discrimination matters, integration is ‘the bringing together of parts into a whole’, and in Balassa’s understanding it is a process and a state of affairs. The process abolishes the various forms of discrimination that exist between economic units in different countries. Integration as a state of affairs describes the absence of discrimination at a particular point in time. Integration is also more than cooperation. Economic integration then occurs in different degrees starting with free-­ trade area to customs union, common market, economic union, and complete or total economic integration. According to Alan Greenspan (2007: 365), ‘A ‘fully globalized’ world is one in which unfettered production, trade and finance are driven by profit seeking and risk taking that are wholly indifferent to distance and national borders’ and this would be unachievable as people would see such a world as too risky. He seemed to suggest that globalization had reached its limits at least for trade liberalization. In a more technical language, Dell’Ariccia et al. (2008: 1) interpret the level of financial globalization ‘as the extent to which countries are linked through cross-border financial holdings, and […] by the sum of countries’ gross external assets and liabilities relative to GDP’. For Held

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et al. (1999: 189) global financial markets are characterized by the ‘development of new financial instruments, the deregulation of national financial markets and the growth of international banks and other financial institutions’. For ‘measuring the extensity and intensity of international finance’ they suggested ‘to distinguish between financial openness, financial enmeshment and financial integration’. Openness can be measured by studying the legal restrictions on international financial transactions within national economies. Enmeshment reflects how much a country’s financial services sector is engaged in cross-border activities but also how much foreign financial institutions are involved in the domestic market. Finally, the reduce financial integration to ‘the extend to which the prices of, and the returns to, assets are equalized between different national financial markets.’ A good measurement for financial integration would therefore be the ‘convergence between returns to, or prices of, bundles of similar financial assets.’ However, what Held et al. describe as ‘financial enmeshment’ is more commonly defined as financial integration. Prasad et  al. (2003: 7), for example, emphasized in an International Monetary Fund (IMF) paper the conceptional difference between financial globalization as ‘an aggregate concept that refers to rising global linkages through cross-­ border financial flows’ and financial integration referring ‘to an individual country’s linkages to international capital markets.’ However, because of the close relationship between the two concepts and because growth of financial globalization goes hand in hand with deeper financial integration they used the two terms interchangeably. Financial integration has also been defined as ‘the process of moving toward a single financial market’ (Fonteyne 2007: 5), which includes both the convergence of prices and returns and the borderless activities of financial institutions. As Fonteyne highlights, this has been a trend that can be observed globally, although much faster within certain regional trading blocs. It is therefore best understood as ‘a geography-specific concept’ based on the assumption that national economies that start out in ‘financial autarky’ remove barriers for cross-border structures and activities to create successively ‘a single financial market’, representing ‘complete integration’ (Faruqee 2007: 20). We can therefore distinguish between international, regional, and transnational financial integration and between complete and incomplete financial integration and the latter can be distinguished and measured regarding the different levels of depth reached in specific countries or regions. Another distinction can be made between de jure and de facto integration (Oxelheim 1996), whereby ‘the former can be seen as a necessary—but

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non-sufficient—condition for the latter’ (Macchiarelli and Koutroumpis 2016). For comparing different levels of integration language such as ‘less or more integrated’ markets (Stansell 1993), ‘fuller integration’ (Aburachis 1993), or ‘deeper integration’ is used. According to Turner (2012: 36), ‘financial deepening’ is reflected in an increased ‘access to a wide[r] array of different financial markets and services’, for which theory expects a more efficient allocation of capital. Helleiner (1994) distinguished ‘open’ from ‘repressed’ systems. Progress in integration can also be measured in the level of ‘financial fragmentation’. Remaining barriers to integration cause market imperfections and segmentation which are generally seen as causing costs because they reduce the possibility of diversification gains in a larger, more competitive market (Alford 1993). In short, the discussion about financial integration is rather comparable to debates about competition—including about competition between countries and free(r) trade, which is not surprising given that financial integration opens national system to competitors, investors, and customers in other markets. In competition theory ‘perfect competition’ occurs only in ‘perfect markets’, yet markets in the real world are rather ‘imperfect’ (Robinson 1969). Regarding capital markets, regulatory obstacles and legal constraints have been described as imperfections that make international markets ‘less than perfectly integrated’ (Stansell 1993: ix). Obstacles can either be removed by liberalization and deregulation or by harmonization, all leading to more similarity between formerly different regulatory systems. Such convergence of regulation has been described as both, a driver and a precondition of financial integration (Jordan and Majnoni 2002). There is also a close relationship to the assumptions about how trade liberalization affects growth and development. In this area a system of free trade represents the optimum level of integration in a perfect global market, but liberalization so far has only achieved freer trade between countries. In any case, states play a key role in the globalization of finance and in creating obstacles to cross-border financial flows and in removing them (Strange 1986; Helleiner 1994). Numerous benefits have been attributed to financial integration and rather identical to financial globalization, including, for example, economic and financial development, improved use of world resources, better financial markets with improved access to finance and more competition, lower costs for financial intermediation, greater risk taking and risk sharing, faster innovation and technological progress (c.f. Fonteyne 2007: 6; Obstfeld and Taylor 2004; Valiante 2016: 16ff). The International

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Monetary Fund (c.f. IMF 1998) has advocated international market integration and argued that all countries would benefit from more integration and improved ‘resource allocation associated with market-based competition for financing’. Financial integration theories assume that those benefits are greatest when all remaining parts of financial markets fragmentation have been overcome in the final state of complete or perfect integration. But they also ascertain that the reality has been incomplete and ‘uneven integration’ with ‘uneven rewards and risks’ (Obstfeld and Taylor 2004). Dell’Ariccia et al. (2008) argued that financial integration was most beneficial to advanced economies while the economic benefits to emerging market and developing countries was more moderate. As these advantages are attributed to the economic effects of deeper markets integration, they indirectly also mean that the financial globalization and financial integration policies leading to them contribute somehow to these benefits. How much countries benefit from financial globalization depends on various factors such as capital control regimes and ‘persistent factors’ such as ‘different degrees of institutional quality and domestic financial development’. In short: ‘Countries gain or lose from financial integration depending on their domestic economic and institutional conditions’ (Dell’Ariccia et al. 2008: v). Over the past decades, international institutions such as the IMF have therefore promoted best practices for global financial integration as well as regional financial integration as a building bloc of truly globalised financial markets that would lead to more resilience and sustainability. Europe’s financial markets integration was guided by these theories and expectations. Mario Draghi (2006: 2), back then governor of the Bank of Italy until 2011 before becoming president of the ECB, argued: ‘Efficient and well-regulated markets, apart from performing their normal function of allocating financial resources in the best way possible, are crucial to ensuring that the system is robust enough to withstand violent shocks, however unlikely.’ In line with mainstream economic thinking he advocated policies that would speed integration which would then ‘contribute to orderly and lasting economic growth’ (ibid.: 3). Gertrude Tumpel-­ Guggerell (2008: 1), member of the ECB’s executive board, emphasized: ‘There is enough economic evidence to convince even the most hardened sceptic that financial integration at European level will create substantial gains for society as a whole. Financial integration will foster a more efficient allocation of resources, increase competition, reduce costs, lead to higher trading activity, and more transparent pricing and thereby raise the

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overall potential for stronger economic growth. It will increase consumer choice, open a multitude of new investment opportunities, strengthen the EU banking sector and make Europe a centre for financial innovation.’ However, even before the GFC supporters of financial integration accepted that financial integration does not come without risks. Integrated but still fragmented systems such as the European still face contagion risk and can be affected by fundamental spillovers. Financial contagion is already possible at a very low level of financial integration, while spillovers ‘require a higher threshold of integration’ (Faruqee 2007: 29). Both risks are increasingly likely with deeper integration. Therefore, adequate risk management is necessary to ‘seize the benefits that integration has to offer’ (ibid.: 40). Beside economic advantages, financial globalization was also advocated for its positive effect on politics: states would become limited in their actions by financial markets that would have a disciplining effect against bad regulation and wasteful government spending by creating hard budget constraints. The disciplinary power of markets was now hailed for its superiority over bad regulatory state interventions and went along with demands to depoliticize regulatory bodies and central banks by making them ‘independent’ from direct political interference. The underlying economic processes driving globalization and globalized financial markets that created hard constraints on public spending and policies could not have come into existence without political support from states and international financial institutions such as the International Monetary Fund (IMF) supportive to the neoliberal idea that the rise of financial liberalization and deregulation was progress over the previous system of ‘embedded financial markets’ under the post-World War II Bretton Woods regime (Chwieroth 2010). In short, theories claiming the superiority of globalized financial markets and financial market integration policies understand markets as the main contributors to financial stability and resilience and policy intervention beyond liberalization, deregulation and harmonization if needed to remove barriers as a potential risk and as an obstacle for truly globalized markets. The regulation and supervision of deregulated and liberalized markets should then be left either to markets themselves or where this is not possible to ‘independent’ institutions that are protected from political interference in their daily work. However, a closer look at globalizing financial markets will show that with the rise of financialization and the emergence of finance-led capitalism financial instability increased and remains also after the GFC at a dangerously high level. The problem

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with globalization of finance is the transition to finance-led capitalism and particularly some highly problematic market structures, products, and activities within this highly instable and fragile system.

1.2   Financial Markets Integration, Finance-Led Capitalism, and Instability A well-functioning money and market economy is based on monetary and financial stability to allow efficient allocation of resources and create certainty for investment (Crockett 1997). In theory (financial) globalization and financial markets integration supported by the right kind of policy interventions that remove obstacles to deeper integration and create a more competitive, transnational or global market should lead to more stability and growth. This abstract assumption leads to the conclusion that more financial globalization and deeper financial integration are beneficial, ignoring the key question about what kind of financial globalization and integration and what quality of finance. Financial integration driven by deregulation in the 1980s was linked to a paradigmatic change. However, financial history clearly shows that not all forms of financial systems, financial structures, products, and activities are beneficial, and some are highly toxic, contribute to financial instability and crashes, and are therefore socially harmful. Stability can be broadly understood as a situation in which the financial markets system with all its elements can perform its key functions and withstand stress and shocks without the need of interventions based on the strongest measures available to regulators to act against instability and interventions that even go beyond the existing regulatory and supervisory frameworks and practices. In short, in a stable financial system banks and other financial institutions can and usually do still fail and go into bankruptcy, stress and shocks can and do occur, but markets and regulators can and do cope with those issues like in other industry sectors without affecting the wider economy. A system would be more stable if it has a high capacity to absorb shocks and stress, while structures, products, and activities that can amplify stress are kept under control at a low level. But obviously financial instability must exist when amplifying risks are too high and regulators take emergency action designed for such situations to stabilize an unstable system. Financial instability is linked to the existence of fragility and systemic risk that can result in financial crises under certain circumstances. Financial regulators and supervisors have

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been given a variety of emergency powers to intervene when markets collapse and since the GFC they increasingly focus on systemic crises and system risks and they even developed ‘unconventional’ policies and measures. Frequent interventions throughout the history of capitalism reflect a general tendency towards an instable financial system. Financial systems have never stayed stable for a very long time and those systems that were more resilient, defined by less severe or even an absence of financial crises, have not been sustainable and did not survive, as we will discuss in more detail in Chap. 2. Lessons from the past therefore provide important lessons for designing a sustainable and resilient financial system, but they do not provide a model to which we could simply return. Financial markets integration policies aim at overcoming fragmentation of markets, and they might achieve that with deregulation and liberalization or harmonization of regulation or a combination of these approaches. However, these interventions frequently lead to new fragmentation by creating different spaces within the global economy in which different legal systems and different markets persist or new ones emerge, and regulatory competition and arbitrage become the rules of the game. Offshore finance is the clearest example of such non-cooperation and extreme competition resulting from a combination of abolishing capital controls and harmonizing international tax policies. As long as financial globalization is less than perfect, it will be based on national or regional markets that ‘compete both with each other and with international markets’ (Oxelheim 1996: 21) and it is especially the wealthy and the large corporations that can exploit national or regional differences for ‘arbitrage between less efficient and more efficient markets on a global scale’ (ibid.). While some forms of differences in regulation and supervision have sometimes resulted in a healthy competition between different markets and countries that created a race to the top towards ‘best practices’ and even strict standards, the competition during the last decades of neoliberal globalization has frequently led to a ‘race to the bottom’ in form of deregulation and liberalization, and a business-friendly regulatory environment with lax supervision and lax enforcement. International standards were often based on soft law, giving ‘rise to a fragmented architecture of financial oversight and supervision’ (Brummer 2014: 99), and countries’ implementation varied to allow advantages. Contrary to the abstract economic model of financial integration, real-world market developments, the profit-driven behavior of financial institutions and their extensive use of financial innovation as well as neoliberal policy (non)interventions resulted in both highly competitive

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and highly harmonized markets that have created tensions and contradictions with serious consequences for financial (in)stability. As shown in the previous section, integration theory expects an increase in the overall system’s stability if there is more financial globalization and more financial market integration. ‘Market integration’, claimed Draghi (2006: 3), ‘improves the ability to absorb shocks; it strengthens the stability of the system.’ One of key advantages of financial globalization was seen in ‘the broadening reach of financial institutions and markets, creating an ability to disperse risk much more widely than previously’ (Lipsky 2007). Securitization should allow to distribute risks not just widely but to those who are able to take them on. Investors should speculate but also protect themselves against risks and significant losses via hedging based on portfolio diversification as a ‘financial market version of limited liability’ (Cerny 2005: 44). Yet the real-world effects have repeatedly been otherwise and ‘increased stability’ was often only instability. The promise of risk diversification ignored new information asymmetries and inappropriate behavior in the securities and derivatives markets with many investors lacking the ability to understand the underlying risks or to be able to bear their costs. As the Stiglitz Report (2010: 91) found: ‘Markets, regulators, and the models used by bankers, credit rating agencies, and investors to assess risks overestimated the benefits of risk diversification and underestimated the costs of the information asymmetries and herd behavior of investors.’ Securitization has also complicated sovereign debt restructuring resulting in high social costs (ibid.). When bubbles bust it also becomes obvious that the market did not allocate resources efficiently and that too many resources were misallocated into a sector driving the boom. Financial busts can then depress output of economies for long periods. This has been partly reflected in recognition of ‘uneven integration’ with ‘uneven rewards and risks’ across countries among some financial integration scholars. Until the GFC and in line with this logic, problems were largely attributed to emerging market economies and their incomplete integration but not to the most advanced financial systems with the most advanced and most sophisticated systems of risk management. However, financial crises also occurred in the advanced economies. Yet only the asset price bubble collapse in 1991–1992  in Japan and the following prolonged period of economic stagnation caused some wider consideration of financial instability in international monetary policy circles. The mainstream view got throughout the 1990s challenged by critical scholars who have argued that globalized financial markets would need much stronger global

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regulation and oversight (c.f. Eatwell and Taylor 2002; Tobin 2003: 13). However, their reform proposals were not taken seriously in the neoliberal climate before the GFC (see Chap. 2). European monetary and financial integration is a bit of an outlier as there were from the outset some serious doubts against the creation of a monetary union; however, the main supporters still promised more growth and stability (see Chap. 3). The crises of the last decades fit into the larger picture of financial globalization and instability. Across all countries financial (integration) history is a sequence of periods of relatively stable financial structures that enable increasing investment creating economic booms in which euphoria leads to all kinds of market manipulation and fraud but especially to extreme speculation and leverage resulting in bubbles that sooner or later bust and result in an increasingly fragile financial structure before panics, crashes, and eventually crises occur with the latter sometimes so severe that they not only generate manageable trouble and justifiable costs considering the previous benefits. By putting the entire capitalist money and market system at risk and by disrupting enormously the wider economy of non-financial firms—the so-called real economy—during periods of deep economic downturns with high unemployment levels financial crises can turn ferocious and cause massive social suffering. Deeper integrated financial markets also increase the financial contagion risk, meaning financial distress can more easily spread from one country to another and from one geographical region to others, either gradually or ‘fast and furious’ (Reinhart and Rogoff 2009: 241). In short, history is full of periods of financial expansion and integration supporting prosperity, growth and development and of periods of deep financial and economic crises during which financial markets have disintegrated and become more fragmented again, reflected in the described pattern that was first developed by Charles Kindleberger and Hyman Minsky based on Minsky’s financial instability hypothesis that understands the financial system in the global economy as well as in national financial systems as basically fragile and crises as symptomatic of an inherent instability of the internationalized and globalized financial markets (Aliber and Kindleberger 2015; Detzer and Herr 2015; Kindleberger 1978; Minsky 1975, 1986). Hyman Minsky’s now famous financial instability hypothesis was largely ignored until the GFC, when he became finally acknowledged as a major scholar for understanding financial crises. He spoke of bankers as ‘merchants of debt’, who ‘cannot make a living unless business, government, and households borrow’ (1986: 279). Capitalist finance, he shows, does

1 INTRODUCTION 

17

not result in equilibrium based on the pursuit of self-interest by each financial institution. ‘Financial fragility, which is a prerequisite for financial instability, is, fundamentally, a result of internal market processes’ (ibid.: 280). Minsky described the cycle in financial regulation and how a longer period without any serious financial difficulties would result in an ‘euphoric economy’ in which the ‘Cassandra-like warnings’ of increasing financial instability and the ‘increasing fragility of the financial system’ are ignored by regulators, market participants, and experts. This is the time when hedging, extreme speculation, and Ponzi finance structures grow rapidly. In such periods, financial institutions would engage in what Minsky describes as an ‘unfair game’ and actively ‘invent and innovate in order to circumvent authorities’ (ibid.: 279) and thereby destabilize the economy. Minsky and Kindleberger belong to the Keynesian school of economics. John Maynard Keynes was the influential British economist who helped design the financial system emerging after the Second World War and provided the ideas for national economic policies for the following decades that were aiming at full employment and growth before they became discredited and replaced by monetarism (see Chap. 2). But Keynesian ideas were never fully implemented; moreover, they have continued to evolve and provide valuable critique of financial globalization and markets integration. Post-Keynesians generally belief that financial instability in markets must be countered by the right policy interventions. Minsky and Kindleberger understood them as ‘precautions’ that are necessary to stabilize an otherwise unstable system. They have not aimed at replacing capitalism but have argued for taming and reembedding financial markets. Building on the central banks as Lenders of Last Resort as key institutions, Minsky’s proposals for reforms were based on active state intervention via ‘big government’ with a fair taxation system and a highly active central bank. A basic precondition for stabilizing the system would be a robust financial structure and environment. Another precautionary measure from Keynesians is a financial transaction tax (FTT) that aims to reduce speculative transactions while not harming investment in the real economy by introducing a moderate tax for all purchases and sales. It would therefore incentivize long-term investment over short-term speculation. James Tobin introduced the idea of a ‘currency transaction tax’ first in 1972 (Tobin 1996, 2003), building on Keynes’ (1936) original vaguely dropped idea to put a tax on stock market transactions. Tobin hoped that such a tax would ‘diminish speculative volatility’ and ‘would enable national monetary authorities to respond to cyclical differences in

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e­ conomic conditions’ (Tobin 2003: 12). However, only some of these precautions have become features of contemporary financial markets regulation. In the absence of a more interventionist approach towards finance financial structures and activities transformed significantly over the past decades and these transformations made them even more instable. As we will see in Chap. 2 in more detail, financial instability risk has significantly increased over recent decades because of neoliberal financial globalization and integration, a combination of specific market and technological developments and policies that were more trusting in free markets than in regulatory interventions by state actors. Capitalism underwent significant transformations and especially since the 1970s finance became ever more powerful and more dominant. One of these changes is the creation of asset money and liquidity, resulting in ‘fast liquidity expansion’, transformation of risk and a new form of financial instability. This was the transition to the ‘new finance’ that found innovative ways to package loans into securities and exotic synthetic financial derivatives. Various new financial products were described as ‘financial alchemy’ and most sophisticated forms of risk management (Montgomerie 2007; Nesvetailova 2010), even compared to ‘medieval alchemy’ (Dowd and Hutchinson 2010) or modern day ‘selling snake oil’ (c.f. Akerlof and Shiller 2009: 87). Susan Strange (1998) called this the casino-type speculation and ‘mad money’. Productive and other assets have been transformed into financial assets which the financial market transforms into liquidity. The value of the asset in the financial system not only reflects a particular ‘stream of income but becomes a capital value based on its discounted future income, which can be sold in whole or in part or borrowed against’ (Roche and McKee 2007: 46). In this new system instability can easily result from ‘a spontaneous collapse in asset bubbles’, or regulatory change or ‘because a few overgeared megadeals go sour’ (ibid.: 47). The Bank of International Settlements had before the GFC pointed towards the risks of increased liquidity and that ‘too much money’ was chasing ‘too few assets’. Borio and Lowe (2002) had shown that ‘financial imbalances can build up in a low inflation environment’. They demonstrated empirically, how a ‘sustained rapid credit growth combined with large increases in asset prices appears to increase the probability of financial instability’. Monetary responses to credit and asset markets would therefore be ‘appropriate to preserve both financial and monetary stability’. They called for a prudential and a monetary response, which however did not follow before the GFC. ‘If the BIS model is right’, Roche and McKee concluded on the

1 INTRODUCTION 

19

basis of updated calculations (2007: 51), ‘we should be somewhere near the peak with abnormal high returns on a variety of assets and high turnover based on increasingly flimsy stories.’ Financial institutions have become more complex and more interlinked, and the already described tendency to capital concentration led to the emergence of mega-institutions that often control highly centralized markets while distributing risks throughout the entire system. These key institutions have become systemically important, meaning their collapse would have damaging effects on the wider economies in which they are operating, multiplying the traditional problems a bank run has caused. This made them too-big-to-fail (TBTF), too-connected-to-fail but also too-­ big-­to-manage and too-big-to-jail. Such financial institutions have again and again taken on extreme risks be it in anticipation that they would be bailed out by the government with taxpayer money if things go wrong or under the illusion that they are highly diversified and therefore could cope with extreme risks. In this new climate and driven by rising profit expectations from riskier activities, banks have been transformed from intermediaries with the social function of being a servant to society by collecting savings and providing loans to individuals and businesses to make investments into ‘deceivers’ that are engaging in extreme speculation, often against their own clients, and with affecting the entire economy and society in a profound way (Dembinski 2009). With a historically unique amount of financial innovations, new products and activities have been developed out of any reasonable proportion to the size of the real economy. Finance was transformed from a predominantly relationship-based system to one based on financial transactions and, as we will see later, there is a tendency to replace bank-based systems with capital markets-based systems. Part of this development in the past decades is the increasing number of shadow banking institutions and activities, including hedge funds, private equity funds, money market funds, structured investment vehicles, limited-purpose finance companies and other ‘alternative investment funds’, securitization, derivatives and especially over-the-counter derivatives, or high-frequency trading (HFT) based on algorithmic high-­ speed super-computing. The term ‘shadow banking’ has been introduced by the financier Paul McCulley in 2007 and it has since then been used for non-bank financial institutions that enjoy little or no regulatory oversight (McCulley 2007, 2009; Nesvetailova 2018). In a staff paper by the Federal Reserve New York Pozsar et al. (2010) defined them as ‘financial intermediaries that conduct

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maturity, credit, and liquidity transformation without access to central bank liquidity or public sector credit guarantees’. However, in line with the above critique of banks no longer being intermediaries Prates and Farhi (2015) understand these shadow institutions as money managers that take ‘part in credit risk withdrawals from banks’ balance sheets’ through financial innovation and especially through securitization and credit derivatives. Securitization of credit allows banks to reduce their illiquidity. In combination with other off-balance-sheet activities banks were able to become extremely leveraged and undercapitalized. The consequence was a shift from the ‘originate to hold model’ under which bank loans stay on their balance sheets until maturity to the ‘originate to distribute model’ under which loans are sold and converted into securities which then moreover become the basis for financial derivative products. In the most liberalized jurisdictions banks were able to become significant market makers and players, ‘adapting to and reinforcing the securitization process’ (Cerny 2005: 45). Banks’ activities and the massive expansion of securitization and derivatives allowed shadow banking institutions to grow rapidly since the mid-1980s and they have fundamentally transformed the financial system. Supporters of this development have argued that these innovations have increased liquidity in markets and therefore made them more stable. Even states and municipalities moved from sound investment to high risk forms of speculation, with several ending up in related scandals and lawsuits. Critics have identified the financial innovations as highly problematic developments constituting casino capitalism. Warren Buffet famously called OTC derivatives ‘weapons of mass destruction’ that fundamentally undermine financial stability that others described as rise of derivatives capitalism (Altvater and Mahnkopf 1996). Before the GFC shadow banking had become larger than the regulated banking sector. Shadow banking and OTC derivatives played a key role in the GFC as they turned out to be highly toxic elements of this new over-leveraged, highly speculative financial system (Lysandrou and Nesvetailova 2015). They multiplied and redistributed the risks throughout the global financial system and made the GFC a systemic financial crisis (Prates and Farhi 2015: 570). This system moreover lacked any consequences for reckless behaviour. Fraudulent borrowers obtained loans or mortgages they could not afford, mortgage brokers, investment banks, rating agencies, and hedge funds all had their conflicts of interest and strong incentives to increase risks and instability. Brokers and their appraisers received bonuses for every new loan or mortgage. Investment banks charged large fees for creating

1 INTRODUCTION 

21

securitization products but held little liability for the consequences, while studies showed that many of their products were designed to fail; rating agencies were paid by the issuer of products and they were even involved in creating these toxic products but took no responsibility for failures; and hedge funds took huge fees from investors for purchasing securities promising high returns, but again with little consequence for defaults. In short, financial globalization and financial integration has created a system based on a highly problematic incentive structure and with institutions that became increasingly removed from the traditional role of banks as intermediaries connecting savings and investment. Regulators and mainstream researchers of finance and banking have largely ignored financial innovation, the increases in opacity and complexity, and failed to fully understand their significance or the dynamics that have been created by financialization since the 1980s (Nesvetailova 2018). HFT, the use of algorithmic high-speed computing and big data is another major transformation in finance that is creating increased instability. HFT is the algorithmic trading of shares in very high volumes and very high speed. Supporters of HFT have argued that there is nothing new in financial firms using the latest technology and gaining advantages from having more or earlier information. Moreover, those activities would lead to higher liquidity and more efficiency in markets. However, critics have shown that HFT has created an entirely new level of opaqueness and complexity that has extraordinary consequences. Trading speeds have increased so significantly that they are far beyond human perception, creating in milli-, micro- and even nanoseconds amounts of data that make it extremely time-consuming, if not impossible for regulators to follow or analyze after a crash what went on. In the meantime, HFT firms have gained significant market shares—in the U.S. roughly 55% of trading volume in equity markets, in the EU 40% (Foucault and Moinas 2019: 9). Serious concerns about HFT have increased in recent years following ‘several disruptive market events such as the 6 May 2010 flash crash in US stock markets, the 15 October 2014 US treasury flash crash, the 1 January 2016 Shanghai flash crash, or the British pound flash crash of 7 October 2016’ (ibid.). Stock exchanges improved emergency breaks in response to these events. Michael Lewis’ (2014) bestseller Flash Boys raised attention among a wider audience, describing these relatively new financial institutions as predators and as opaque black boxes. The stock market becomes ‘rigged’ and is no longer a relatively fair and competitive market. Indeed the perception of manipulation of markets led large individual investors to

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demand protection from those predators and they thought to have found it in ‘dark pools’. These new trading venues, created by brokers, dark pool companies, or stock exchanges themselves, promised large investors trading without interference of HFT firms or disclosure to the public but also outside any regulatory oversight. Mattli (2019: 2) describes this evolution as a new global market fragmentation. The once leading stock exchanges are no longer the leading platforms for trading and a rising number of off-­ exchange trading venues are now engaged in equity, options, and foreign exchange markets. ‘In this hyperfast fragmented global marketplace’, he writes (ibid.), ‘algos battle algos for trading dominance (i.e. preferential execution position), and the most sophisticated trading supercomputers deal not only in securities but increasingly across asset classes, including futures, fixed income, currencies, and commodities, and across hundreds of markets and dozens of countries.’ The average investor has no idea about this transformation and the institutional investors who tried to escape via dark pools found out that HFT firms were also sold access to these venues. In the U.S. the FBI and the SEC joined forces to investigate these practices of abuse. Some jurisdictions restricted the access to dark pools to fund managers and experienced investors or regulated the volume that can be traded via dark pools. HFT is so far also largely accepted within certain rules. However, these new firms and practices have raised significant questions about their activities and specific financial products that create extreme risks and instability. Even from a more conservative perspective these developments have raised serious questions about what constitutes a fair market. The idea ‘that banking […] may not make a positive contribution to economic development’, if the system has problematic structures, ‘laws, regulations and customs’, has been around for some time (Kindleberger 1974: 5; Cameron 1972: 8). Critique about finance intensified throughout the 1990s, when critics of neoliberal globalization and financial markets integration got increasingly concerned about the rise of financial transactions and the financial sector and their increasingly harmful impacts on the wider economy and society (Aglietta 1998). Altvater and Mahnkopf (1996) criticized financial innovation resulting from deregulation and the emergence of derivative capitalism as a ‘house of cards’ that could easily collapse while contributing to the fiscal crisis of the nation states. They also showed that tax evasion correlated with public debt in OECD countries. Nation states had increasingly come under pressure from global financial markets to deregulate and cut taxes. In 1998 the ‘Association

1 INTRODUCTION 

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pour la Taxation des Transactions financière et l’Aide aux Citoyens’ (Attac—Association for the Taxation of financial Transactions and Aid to Citizens) was founded in France as a new international NGO aiming to inform and organize the wider society about finance and increased financial instability, risks and inequality, with finance criticized for its dominant impact on all aspects of economic, public, social, and cultural life. Based on an international charter and advocating ‘another world’ based on an ‘alternative globalization’, this NGO quickly expanded into an international network with relatively strong groups especially in France and Germany—the German social movement featured in the Bourne Supremacy (2004) movie when the hero played by Matt Damon uses one of their demonstrations in Berlin as a cover. In 2001, the World Social Forum was established following the Battle for Seattle in November 1999 to organize the opposition against neoliberal globalization, provide a counter-platform to the World Economic Forum and advocate a transnational social movement for an ‘alternative globalization’ and ‘global resistance’ against the institutions and policies of corporate globalization (International Forum on Globalization 2002). In the first half of the 2000s, the term financialization emerged in the academic literature bringing together the critical debates about globalization, neoliberalism, and finance (Epstein 2005a; Krippner 2005; Stockhammer 2004). However, after a longer period of widespread belief that the financial system had not only become at least in the most developed economies rather stable thanks to global financial integration and modern, highly-sophisticated risk management practices by ever larger financial firms, but also contributed massively to economic growth, the discourse is rather changed since the GFC of 2007–2009. Before critique of the dominant role of finance over the real economy and society was largely marginalized. Especially the critical literature on financialization has pointed out that the increased role of finance, created by deregulation and liberalization, has led to more instability and ever more costly crises. Lord Turner, then chairman of the British Financial Services Authority that had just lost its reputation as a world-class regulator, regarded especially parts of the complex financial instruments as ‘socially useless’ and areas such as derivatives and securitization as ‘grown too big’ and he supported additional taxes on finance to downsize the sector (Monaghan 2009). Paul Volcker, former chairman of the Federal Reserve, once polemicized that the only useful innovation of the past decades was the ATM, targeting the rise in speculative products

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and activities with questionable social value in the financial sector (New York Post 2009). Bank regulation is based on the principle understanding that banking is different to other business sectors and requires special regulation. Without such regulation financial instability would undermine the entire economic process. In a crisis, the value of bank assets can change dramatically and cause systemic risks, which make them a special case when they fail and become insolvency cases. Derivatives, for example,—used for hedging, arbitrage, or speculation—can suddenly turn toxic because of their opaqueness combined with their ‘mark-to-market’ price calculation. Dramatic value changes in a bank’s assets and related uncertainties make it unlikely in a systemic crisis that another bank would use the chance for what might be a lucrative takeover and trust and lending between banks quickly comes to a stop, even in situations where troubled banks have just been recapitalized. The underlying problem here is obviously a weakness in the insurance system within the banking industry, based on securitization and diversification and only theoretically resulting in smart hedging of all risks. Banks that are no longer sound then have to be bailed out by the taxpayer, resulting in public outrage about the privatisation of profits and socialisation of losses. The powerful market mechanism of ‘creative destruction’ (Schumpeter 1992 [1942]) cannot work in its supposed way, meaning the destruction of failing businesses via bankruptcy improving the overall competitive situation on the market and allowing the remaining competitors increasing profits does not happen because of the systemic implications this might have. With the rescue of failed banks or other financial institutions, necessary because of their systemic relevance, the state might also intervene via competition policy to address the matter of market distortions resulting from state aid as the European Union did over the past years. However, the ‘too-big-to-fail’ (TBTF) literature shows three problematic areas: firstly, these institutions receive quite significant subsidies simply because investors perceive them as TBTF; secondly, so-­ called ‘zombie banks’ might survive for a longer time and contribute to enormous social damage by increasing the fallout of a financial crisis; and thirdly, some countries’ financial sectors have become so large that they might be too-big-to-safe. In short, we see that financial globalization and financial markets integration can not only lead to more stability but can drive developments that result in rising instability and this has happened since the 1980s with the transition to finance-led capitalism. Questions about what constitutes a

1 INTRODUCTION 

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stable financial system and what constitutes instability as well as what would be the ‘right regulatory framework’ supporting a more resilient and more stable financial system remain highly controversial and deeply political (see Chap. 2). Based on the analysis of the evolution of the global financial system and the related theories, I will argue in this book for a more interventionist, more precautionary approach to financial integration and financial regulation. Such an approach is especially justified in the light of the disasters created by neoliberal financial globalization, financialization, and finance-led capitalism and in particular the lessons from the insufficient changes to this system that have been adopted since the GFC.

1.3   Aims and Contents of this Book This book is about the policy responses in Europe to the latest crises, the GFC and the subsequent European sovereign debt crisis that started in 2009, and in particular the interventions to finalize the European Monetary Union, and to create a genuine Financial Union that includes improving financial markets and banking supervision and regulation, and deepening financial markets integration in a key phase of development in which one of the EU’s largest economies and home to the EU’s regional and global financial center has decided to leave. Regional integration projects are responding to rapidly changing global environments and underlie the same logics and contradictions as financial (de)globalization and global financial (dis)integration, and global (in)stability necessarily affects regional systems. The EU’s financial integration agenda has been designed in response to a challenging international and European environment to re-establish financial stability, to support economic recovery, and to boost Europe’s competitiveness in the global economy while at the same time transforming finance into a more resilient and sustainable system that also helps to achieve international environmental and climate change commitments. This ambitious agenda needs now to cope with a possible post-­ Brexit environment. The fallout of the financial and economic crises hit Europe hard and brought the European integration project to the brink of collapse. GDP per capita only slowly returning to pre-crisis levels, high unemployment, a dramatic increase in poverty levels, years of depression and painful austerity policies in several member states have led to enormous social tensions and a rise in populism. A deeply unsustainable and instable international and European economic and financial system, design flaws in the economic and monetary union, developments and practices in

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modern finance, and failures in regulating and supervising financial institutions that operate increasingly across borders have caused an existential crisis. In short, decreasing the unsustainability and increasing the resilience of European financial markets is an agenda of highest importance for the long-term survival of the European integration project, while the UK must reposition itself in financial globalization and compensate any reduction in European financial Single Market access in other markets to defend its global position. As a result, the EU and the UK will have to make some significant regulatory adjustments and strategic choices in their future financial markets (dis)integration policies. This book is based on the motivation to contribute to the discussions about the future of financial markets (dis)integration in Europe. This book will investigate the EU’s efforts of completing European Monetary Union, Capital Markets Union and Banking Union as a strategic response to regulatory competition and global deregulatory tendencies and the possible effects of Brexit on European financial markets integration. Based on theories of financial integration and especially critiques of financial integration having gone too far and debates about how to downsize finance and make the system more resilient and sustainable, the book aims to explore the trends in financial markets (dis)integration with a particular focus on the dark sides of financial integration and financialization. The agenda behind deeper financial integration in Europe is understood as a project of continuity of neoliberal policies and part of a new wave of deregulation but also harmonization with a potential to undermine the stability of the European financial system. Serious threats to financial stability continue to exist both in European and in international financial markets and make future systemic crises likely. For the EU failure could easily result not just in some sort of temporal and manageable financial disintegration but in a collapse or break-up of the Union. The UK’s termination of EU membership—at the time of writing this book still an uncertainty—poses another challenge for deeper financial integration as the decision already resulted in some financial disintegration. For the City of London as the leading global and European financial center this challenge has largely been downplayed by British Leave supporters especially with the claim that the EU would already have become too dependent on the City’s services and the economic argument would simply support to keep and expand the existing level of integration. Yet, key EU member states have actively started to attract relocation of some of London’s business to their own financial centers and the EU has taken measures to

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s­ upport this process. Criticized by Britain’s brexiteers and a nervous financial sector as a wrong way to achieve the goal of a more resilient, sustainable European financial market, the EU seems to clearly act in a long-term strategic interest. The book will analyse these recent developments in financial markets (dis)integration in the light of the importance of avoiding a new wave of deregulation that is already emerging in the EU, the US, and certainly in a Post-Brexit UK outside the Single Market. The book will call for radical regulatory reforms to tame and downsize finance, to address the problematic structures, products, and activities in contemporary financial markets. A fundamental policy change is necessary to secure a more sustainable and resilient financial system. To set out the background for this study, Chap. 2 will proceed with discussing the evolution of the two waves of financial globalization and the fundamental changes that occurred with the transformation of the post-WWII financial order into neoliberal globalization and finance-led capitalism. The chapter will show that the evolution of the international financial system repeatedly offered the opportunity for alternatives and draws important lessons from the history of finance and financial regulation. Chapter 3 analyses the EU’s experience of neoliberal globalization and financial integration. The GFC as well as the Eurozone crisis and the problems of economic recovery have revealed serious weaknesses and fault lines in the governance of European financial markets and especially with regard to the supervisory architecture of the region’s systemically important banks as well as to key problems created by market dynamics and failures in a situation of a not entirely unexpected major crisis, in which crisis management and crisis resolution are required within a few days, if not within several hours. Chapter 4 focuses what Brexit means for the UK’s financial industry and what challenges possible future relationships create and how they affect financial globalization and European financial (dis)integration. Chapter 5 deals with a major European initiative is to boost financial market integration via the creation of a ‘true’ Capital Markets Union (CMU). Launched by the Juncker Commission as a key element of its priority to create ‘a deeper and fairer internal market’, the major aim of CMU, first presented in a Commission Green Paper published for consultation and resulting in an Action Plan, is to make Europe more attractive for investment and to make the European financial market structurally more like the U.S. markets. CMU is designed with an overall approach with highly problematic deregulatory and reregulatory elements that are not contributing to the aim of making financial markets more

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resilient and serving the ‘real economy’. Especially, the Commission’s claim that this would be the best option to assure financial stability, boost growth, and serve the interest of small and medium-sized enterprises (SMEs) seems to lack theoretical and empirical support and there are good reasons to expect rather the opposite effect. Chapter 6 investigates the European Banking Union, the other major project launched by the European Commission to create a Financial Union and to boost market integration and to address key shortcomings in EMU. The final Chap. 7 will draw the overall conclusions on the progress the EU has made in financial integration following the GFC and Eurozone crisis and what challenges arise for creating a more resilient and sustainable financial system for Europe.

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EIOPA, EBA, ESMA, Joint Committee of the European Supervisory Authorities 2019, Joint Committee Report on Risks and Vulnerabilities in the EU Financial System: Spring 2019, JC 2019 15, 2 April 2019. Epstein, G.A. 2005a, ‘Introduction’, in Epstein, G.A. (ed), Financialization and the World Economy, Edward Elgar, Cheltenham, 3–16. Epstein, G. (ed.) 2005b, Financialization and the World Economy, Edward Elgar, Cheltenham. Faruqee, H. 2007, ‘Key Concepts, Benefits, and Risks’, in J. Decressin, H. Faruqee & W.  Fonteyne (eds), Integrating Europe’s Financial Markets, IMF, Washington, DC., 19–40. Fonteyne, W. 2007, ‘Toward a Single Financial Market’, in J. Decressin, H. Faruqee & W.  Fonteyne (eds), Integrating Europe’s Financial Markets, IMF, Washington, DC., 1–16. Foucault, T. & Moinas, S. 2019, ‘Is Trading Fast Dangerous?’, in W. Mattli (ed.), Global Algorithmic Capital Markets: High Frequency Trading, Dark Pools, and Regulatory Challenges, Oxford University Press, Oxford, 9–27. Gill, I.S. & Raiser, M. et  al. 2012, Golden Growth: Restoring the Lustre of the European Economic Model, World Bank, Washington, D.C. Greenspan, A. 2007, The Age of Turbulence: Adventures in a New World, Allen Lane, London. Hein, E. 2012, The Macroeconomics of Finance-dominated Capitalism—and its Critics, Edward Elgar, Cheltenham. Held, D., McGrew, A., Goldblatt, D. & Perration, J. 1999, Global Transformations: Politics, Economics, and Culture, Stanford University Press, Stanford. Helleiner, E. 1994, States and the Reemergence of Global Finance: From Bretton Woods to the 1990s, Cornell University Press, Ithaca & London. IMF 1998, ‘The Asian Crisis: Causes and Cures’, Finance & Development, June 1998, vol. 35, no. 2, https://www.imf.org/external/pubs/ft/fandd/1998/06/ imfstaff.htm. IMF 2019a, Global Financial Stability Report: Vulnerabilities in a Maturing Credit Cycle, IMF, Washington, D.C. IMF 2019b, ‘Euro Area—IMF Staff Concluding Statement of the 2019 Article IV Mission, 13 June 2019. International Forum on Globalization 2002, Alternatives to Economic Globalization, Berrett-Koehler Publishers, San Francisco. Jordan, C. & Majnoni, G. 2002, ‘Financial Regulatory Harmonization and the Globalization of Finance’, Policy Research Working Paper 2919, The World Bank. Keynes, J.M. 1936, The General Theory of Employment, Interest and Money, Macmillan, London. Kindleberger, C.P. 1974, The Formation of Financial Centers: A Study in Comparative Economic History, Princeton Studies in International Finance No. 36, Princeton University, Department of Economics, Princeton, New Jersey.

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Kindleberger, C.P. 1978, Manias, Panics, and Crashes: A History of Financial Crises, Basic Books, New York. Krippner, G.R. 2005, ‘The Financialization of the American Economy’, Socio-­ Economic Review, vol. 3, 173–208. Lagarde, C. 2019, ‘Governing Finance: Redefining a Broader Sense of Purpose’, in A. Gonzáles & M. Jansen (eds.), Women Shaping Global Economic Governance, CEPR Press, London, 9–11. Lewis, M. 2014, Flash Boys: Cracking the Money Code, Allen Lane, London. Lipsky, J. 2007, ‘Through the Looking Glass: The Link Between Financial Globalization and Systemic Risk, Speech by John Lipsky, First Deputy Managing Director of the International Monetary Fund, Joint IMF/Chicago Federal Reserve Conference, 27 September 2007. Lysandrou, P. & Nesvetailova, A. 2015, ‘The Role of Shadow Banking Entities in the Financial Crisis: A Disaggregated View’, Review of International Political Economy, vol. 22, no. 2, 257–279. Macchiarelli, C. & Koutroumpis, P. 2016, ‘The Current State of Financial (Dis) Integration in the Euro Area: In-dept Analysis’, IP/A/ECON/2016-03, PE 587.314, European Parliament, Policy Department A: Economic and Scientific Policy, Brussels, Belgium. Majone, G. 2014, Rethinking the Union of Europe Post-Crisis: Has Integration Gone Too Far?, Cambridge: Cambridge University Press. Mattli, W. 2019, Darkness by Design: The Hidden Power in Global Capital Markets, Princeton University Press, Princeton. McCulley, P. 2007, ‘Teton Reflections’, Global Central Bank Focus, PIMCO, https://www.pimco.com/en-us/insights/economic-and-market-commentary/globalcentral-bank-focus/teton-reflections. McCulley, P. 2009, ‘The Shadow Banking System and Hyman Minsky’s Economic Journey’, CFA Institute, https://www.cfainstitute.org/-/media/documents/ book/rf-publication/2009/rf-v2009-n5-15.ashx. Minsky, H. 1975, John Maynard Keynes, Columbia University Press, New York. Minsky, H. 1986, Stabilizing an Unstable Economy, Yale University Press. Monaghan, A. 2009, ‘City is too big and socially useless, says Lord Turner’, The Telegraph, 26 August 2009. Montgomerie, J. 2007, ‘The Alchemy of Banks: The Consumer Credit Industry after Deregulation’, in L. Assassi, A. Nesvetailova & D. Wigan (eds.), Global Finance in the New Century: Beyond Deregulation, Palgrave Macmillan, Basingstoke, 102–112. Nesvetailova, A. 2010, Financial Alchemy in Crisis: The Great Liquidity Illusion, Pluto Press, London. Nesvetailova, A. 2018, ‘Shadow Banking: The Political Economy of Financial Innovation’, in A.  Nesvetailova (ed.), Shadow Banking: Scope, Origins and Theories, Routledge, London and New York, 1–15.

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New York Post 2009, ‘The only thing useful banks have invented in 20 years is the ATM’, 13 December 2009. O’Connor, S. 2018, ‘Millennials poorer than previous generations, data show’, Financial Times, 23 February 2018. Obstfeld, M. & Taylor, A.M. 2004, Global Capital Markets: Integration, Crisis, and Growth, Cambridge University Press, Cambridge. Oxelheim, L. 1996, Financial Markets in Transition: Globalization, Investment and Economic Growth, International Thomson Business Press, London. Persaud, A. 2015, Reinventing Financial Regulation: A Blueprint for Overcoming Systemic Risk, APress, New York. Pozsar, Z., Adrian, T., Ashcraft, A. & Boesky, H. 2010, ‘Shadow Banking’, Federal Reserve Bank of New York Staff Report no. 458. Prasad, E., Rogoff, K, Wei, S.-J. & Kose, M.A. 2003, ‘Effects of Financial Globalization on Developing Countries: Some Empirical Evidence’, IMF, Washington, DC, https://www.imf.org/external/np/res/docs/2003/031 703.pdf. Prates, D.M. & Farhi, M. 2015, ‘The Shadow Banking System and the New Phase of the Money Manager Capitalism’, Journal of Post Keynesian Economics, vol. 37, 568–589. Rehn, O. 2018, ‘Don’t Delay Eurozone Reform due to Political Uncertainties’, remarks by the Governor of the Bank of Finland, https://www.bis.org/ review/r181128h.pdf. Reinhart, C.M. & Rogoff, K.S. 2009, This Time Is Different: Eight Centuries of Financial Folly, Princeton University Press, Princeton. Robinson, J. 1969, The Economics of Imperfect Competition, 2nd ed., Macmillan, London. Roche, D. & McKee, B. 2007, New Monetarism, Independent Strategy. Schumpeter, J.A. 1942, Capitalism, Socialism and Democracy, Routledge, London [1992]. Stansell, S.R. (ed.) 1993, International Financial Market Integration, Blackwell, Cambridge. Stiglitz, J.E., Sen, A. & Fitoussi, J.-P. 2010, Mis-Measuring Our Lives: Why GDP Doesn’t Add Up, The New Press, New York. Stockhammer, E. 2004, ‘Financialisation and the Slowdown of Accumulation’, Cambridge Journal of Economics, vol. 28, 719–741. Strange, S. 1986, Casino Capitalism, Blackwell, Oxford. Strange, S. 1998, Mad Money: When Markets Outgrow Governments, University of Michigan Press, Ann Arbor. Thomsen, P.M. 2019, ‘On Capital Market Finance in Europe’, speech by the Director, European Department, IMF, at the Conference on Capital Markets Union, Financial Markets Group, London School of Economics and

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Political Science, https://www.imf.org/en/News/Articles/2019/06/25/ sp061419-on-capital-markets-finance-in-europe. Tinbergen, J. 1965, International Economic Integration, 2nd ed., Elsevier, Amsterdam. Tobin, J. 1996, ‘Prologue’, in M. ul Haq, I. Kaul & I. Grunberg (eds.), The Tobin Tax: Coping with Financial Volatility, Oxford University Press, Oxford. Tobin, J. 2003, World Finance and Economic Stability: Selected Essays, Edward Elgar, Cheltenham. Tumpel-Guggerell, G. 2008, ‘Towards an Integrated Securities Market—The TARGET2-Securieis Project’, speech at the 12th FESE Convention, Stockholm, 18 June 2008, https://www.bis.org/review/r080619e.pdf. Turner, A. 2012, Economics After the Crisis: Objectives and Means, MIT Press, Cambridge, MA. Valiante, D. 2016, Europe’s Untapped Capital Market: Rethinking Integration after the Great Financial Crisis, Rowman & Littlefield International, London. Wolf, M. 2016, ‘More perils lie in wait for the eurozone’, Financial Times, 7 December 2016, 13. Wray, L.R. 2013, ‘A Minskyan Road to Financial Reform’, in M.H. Wolfson & G.A.  Epstein (eds.), The Handbook of the Political economy of Financial Crises, Oxford University Press, Oxford, 696–710.

CHAPTER 2

Financial (De)Globalization and Financial Market (Dis)Integration

‘We have been here before. No matter how different the latest financial frenzy or crisis always appears, there are usually remarkable similarities with past experiences from other countries and from history. Recognizing these analogies and precedents is an essential step toward improving our global financial system, both to reduce the risk of future crisis and to better handle catastrophes when they happen.’ Reinhart & Rogoff (2009: xxv) ‘The fact that a period of internationalisation a century ago was followed by fragmentation of financial markets can be considered a warning that—at least in theory—regulatory change can reverse the interpenetration of national financial markets’. Marauhn (2006: 3)

Finance is at ‘the core of the globalization tendency’ (Weiss 1998: 178). The globalization of finance is a process inherent to capitalist development as a powerful trend and deeply related to capital accumulation and the expansion of trade. The emergence and deepening of financial globalization are driven by the evolution of transnational and global finance and by businesses, especially MNCs with their significant impact on the growth of cross-border transactions and financial flows. This trend is reflected in two major waves of financial and economic globalization, both creating their

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own historical forms and features, which have shaped the theoretical debates and controversies about financial globalisation and integration. The first wave started in the nineteenth century and led to a period of relative peace and prosperity in Europe before it ended with the First World War (WWI). International financial flows remained unregulated, but trade became increasingly supported by bilateral trade treaties since Britain and France had signed the Cobden-Chevalier Treaty of 1860, leading to a period of trade liberalization inspired by Adam Smith’s (1776) new free(r) trade doctrine and critique of mercantilism. Years of financial and economic disintegration and destabilization followed this first wave with two world wars and an unstable inter-war period that only led to some reintegration but failed to restore a stable regime for fuller integration. This deglobalization period was characterized by war economies, economic nationalism and imperialism, the Wall Street Crash of 1929 and protectionist measures massively hindering financial flows and breaking up global trade. Then, at the end of the Second World War (WWII) the second wave of globalization took off. Under a new multilateral regime global trade and financial integration have grown almost annually until 2008 with a sharp exponential increase in the value of global exports since the 1950s and only a few years with a moderate decrease. With the transition towards more liberalized and deregulated markets from the 1970s onwards and after a slower trade growth during the 1970s, early 1980s caused by two oil price shocks and other factors economic globalization trends speeded up dramatically, not least because of significant transformations in finance, before plummeting back a couple of years with the economic fallout of the GFC of 2007–2009. Over the last decade, economic and financial globalization have been slowly recovering from this shock but growth in many markets has remained slower than in the period before. The second wave of economic globalization is often divided into up to four stages (sometimes also called waves): During the first stage, the post-­ war financial order lasting until 1971, nation states played an active role for the wider economy via state interventionism aiming to create full employment and national welfare systems. In Western Europe key industries were nationalized and run under public ownership to provide key public utilities usually as a monopoly. And international financial flows became restricted with capital controls. However, the OECD adopted in 1961 its ‘Code of Liberalisation of Capital Movements’ to address the many barriers that had been erected in the years of economic recovery and development and to guide their gradual removal. This measure and vari-

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ous market developments prepared the ground for the next stage. The second stage is characterized by the transformation of the post-war system into a more open international and global system with the state turning increasingly into a national competition state and markets becoming more powerful. Privatisation, deregulation, and reregulation transformed states and markets, leading to neoliberal globalization in which markets became seen as superior to state intervention. The third stage started in 1989 with the end of the Cold War and the integration of the former ‘Second World’ into the global trading and financial system. During those last two stages a massive transformation of international capital markets and trade relations took place that has been described as hyper-globalization (Rodrik 2011) and transition to finance-led capitalism, in which markets have outgrown states and now limit the possibility for state intervention even further. More recently, the term globalization 4.0 was introduced for the latest stage. The World Economic Forum in Davos in 2019, for example, focussed discussions around this latest buzz word that stands for a world economy increasingly influenced by the emergence of new powers and by the shift towards a digital economy that not only transforms the production of goods but also the service provision across borders. According to Baldwin (2019) this latest stage in globalization is a ‘globotics upheaval’, a dramatic change in global competition towards more unfairness created by an increasing number of disruptive technologies. Such technologies are expected to have also a significant impact on the future of finance, be it as opportunities or threats coming from the increasing use of big data, digital currencies and blockchain, or advances in machine learning used in trading and financial engineering. Many of today’s debates about how to intervene into financial globalization, how to design the optimal financial integration policies, how to improve financial regulation, and how to create a more ethical, more resilient, more sustainable and maybe even more precautionary financial system are rooted in controversies about what made previous periods of financial integration and international financial regulation relatively stable and what destabilized them and whether there are any forms of market interventions and policy responses from the past that could and should be revived. These questions are also related to considerations about how to deal with powerful big business in general, how best to design the global economic system, and how to intervene best into highly dynamic markets that are permanently changing due to new technologies and innovation, the latter often specifically designed to circumvent existing regulatory bur-

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dens. A view at this big picture of the evolution of the global economic system is necessary to understand the fundamental changes in the world capitalist system, the power shifts between the dominant nations and the emergence of new powers, the transformations of capitalism as a mode of production and accumulation regime, of the international financial system, and of the global trading system, and what that means for financial integration and disintegration. Before the journey into the investigation of European financial integration since the GFC can therefore begin, it is necessary to explore the bigger picture that led to the current state of European financial markets (dis)integration and the challenges Europe and the EU are facing. This chapter will firstly reflect on the significant transformations that came with the globalization of finance since the first wave of globalization based on the gold standard and created today’s deeply instable and crises-shaken finance-led capitalism, it will then discuss the responses to the GFC before proceeding to the challenges of transforming finance-led capitalism into a more ethical, more sustainable, and more inclusive capitalism. The chapter will conclude with unresolved issues of the regulatory reforms and questions about how to tame finance-­ led capitalism.

2.1   From the Gold Standard to Bretton Woods to Finance-Led Capitalism Financial markets had already been global in a ‘golden age’ between 1870 and 1914, a period overlapping with the second half of the Pax Britannica in which the British Empire was the hegemonic power guaranteeing relative peace between the great powers (Hirst and Thompson 1996). During those years, capital flows were like in the periods before unrestricted but had reached such a high level that it constituted the first wave of financial globalization, in which markets remained self-regulating under the laissez-­ faire paradigm, while the international monetary system became based on the gold standard with the British sterling providing the anchor for the international system (Arner 2007). The gold standard had removed the uncertainties of bimetallism under which arbitragers used the price fluctuations between gold and silver that constituted this system for speculation. Shiller (2012: 161) has argued that this period of unregulated financial markets can hardly be understood as a competitive market and had more similarity with a casino. As Skidelsky (2018: 56) asserts, ‘inter-

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national trade was relatively non-competitive’ and the whole system was based on a relationship between the center and periphery through the empire and the golden age of imperialism that cemented that first wave of (financial) globalization. Yet, financial crises occurred frequently and made national interventions, banking laws, and the creation of central banks necessary. The first central bank was the Swedish Riksbank founded in 1668, followed by the Bank of England in 1694, before other countries in Europe and the rest of the world followed this trend. Purposes and modes of operation have changed throughout their history. Originally founded to provide government finance and deal with government debt or to serve some clearing functions, they became ‘the bank for bankers, facilitating transactions between banks or providing other banking services’, which made them the ‘lender of last resort’ (LOLR) that could provide the necessary emergency funding to banks in situations of financial crises (Bordo 2007). International monetary cooperation became also necessary to stabilize the global trading and monetary system. The first wave of financial globalization ended abruptly when the First World War (WWI) started. Back then, it had not only become clear that the gold standard had a high requirement for international cooperation and trust, foremost between European countries and that at a time when still not every country had a central bank that could provide emergency liquidity to distressed financial institutions and monetary policy in general was still rather underdeveloped; obviously this system could therefore easily collapse. And this happened when budget deficits, high inflation, and unemployment forced countries to suspend gold convertibility. The gold standard had reached its limits not just with a very particular political environment coming to its end but also with gold supplies falling behind the needs of an expanding world economy (Eichengreen 1996: 43). The role of the British Empire was weakened by the rise of the United States of America (U.S.A.) as new hegemonic power, leading to further disruption in the international monetary system and international capital markets (Eichengreen 2006: 44). Throughout the interwar period, financial markets remained fragmented, capital flows became highly restricted as states began stopping ‘hot money’ and destabilizing speculation, and no new international monetary system emerged to replace the failed gold standard that was revived after WWI only to be replaced with free floating currencies from 1931 onwards (Eichengreen and Flandreau 1997; Isard 2005). In that turbulent period, the Bank for International Settlements (BIS) was established in 1930 as the first international financial institution, originally to settle reparation

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payments imposed on Germany but also with a mandate to assist national central banks in guaranteeing monetary and financial stability. The Great Depression of the 1930s and the Second World War (WWII) made continued cooperation difficult; however, the BIS, located in Basel in neutral Switzerland, was kept alive by adopting a neutral role to provide support for basic bank operations and to be ready to assist post-war reconstruction. Since then the BIS has become a key international financial institution with a mandate to regulate capital requirements for banks and coordinate central banks policies and approaches. Another lasting innovation of that period was deposit insurance, incorporated into the U.S. Banking Act of 1933. Bank failures had already a hundred years earlier led to insurance of bank obligations, first introduced by New York and then followed by other U.S. states, based on the idea that banks should pay into an insurance fund to protect creditors of banks. Deposit insurance also allowed regulators to enforce capital requirements, another innovation in banking supervision. Now, following a period of numerous bank failures throughout the 1920s and in the aftermath of the Wall Street Crash of 1929 and a banking crisis in 1932–1933 influenced by a variety of factors including currency speculation, the banking system became strengthened by federal deposit insurance and the creation of the Federal Deposit Insurance Corporation which reinstalled public confidence and ended bank runs (FDIC 1998). Deposit insurance was until its introduction seen as a reward for bad banking; since then it remained a controversial issue given the risk-risk trade-off between risk free deposits and the moral hazard related to excessive risk-taking of banks that might result in bank bailouts, especially since various financial institutions have become ‘too big to fail’. In short, it is a dilemma that exists because providing a safety-net against bank runs also creates incentives for more risk-taking and other forms of reckless banking practices and a measure designed to protect against panics and financial crises becomes at the same time one that increases fragile financial institutions at a micro level and financial instability at the macro level. Despite such concerns, most OECD countries and an increasing number of developing countries had already some form of deposit insurance in the early 2000s. A study from before the GFC showed that during the 1990s banks in countries with higher deposit insurance were poorer capitalized and therefore riskier (Laeven 2004). Other research concluded that deposit insurance does only contribute to more financial stability if it is combined with strict regulation and supervision (Demirgüç-Kunt and Kane 2002: 698).

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Already earlier, regulators invented emergency interventions such as shutdowns of trading platforms and bank holidays. The New York Stock Exchange had to stop trading in 1873 following such an intervention; London and many other financial centers in Europe took this measure at the beginning of WWI. Such measures have since then led to shifting that trading underground and therefore not halting the panic that was the justification for the measure. The declaration of bank holidays was used in various U.S. states in 1907 to counter a market panic, then again in 1932 and first on the federal level in 1933. These innovations were later followed by the introduction of trading limits for some commodity and financial markets, including circuit breakers in stock markets (Aliber and Kindleberger 2015: 247f), a measure that has in recent years gained new attention given the challenges related to high-frequency and algorithmic trading that has enormously transformed the speed in trading, causing new regulatory challenges (see Sects. 2.4 and 5.2). Towards the end of WWII, the international financial system was fundamentally redesigned and financial markets became embedded in a relatively strict regulatory environment at the international and foremost national levels for the relatively short period that had started with an international conference in 1944. Named after the Bretton Woods area around Mount Washington in New Hampshire this historic ‘International Monetary and Financial Conference of the United and Associated Nations’ in the Mount Washington Hotel created the international financial regime for the world economy after WWII.  The following period of financial expansion and rapid global growth with various national economic miracles is in large associated with the economic theory of John Maynard Keynes. Drawing the lessons of the economic recession of the 1930s, this eminent economist and founder of modern macroeconomics had successfully challenged the premises of classical economic theory by regarding capitalism and its financial system not as stable and tending towards equilibrium with a highest practical level of employment but as basically instable because credit to firms and investment in productive capital is always risky and this uncertainty can lead to a large-scale breakdown. In a rather modern way, he understood market agents would not always act rational but based on expectations and views of the future that can be wrong and are always influenced by broader society. As a result, herding behavior can lead to unsustainable expansion culminating in financial crises. The Keynesian belief since then is that financial crises could never be avoided as they are symptomatic of an inherent instability in the international capi-

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talist system, but government intervention and the right set of institutional arrangements could keep them manageable while precautionary measures and early interventions could make them less severe and in consequence less costly for society. Breaking with the doctrine of laissez-faire Keynes saw markets not as self-correcting but as unable to achieve full employment and undermining stability; the state therefore had a responsibility to intervene and manage the economy. Importantly, he rejected in his General Theory (Keynes 1936) the view that falling investment could be best responded with lowering interest rates and reduction of public debt to return to equilibrium and advocated instead that the best way to react to an economic depression is to raise the level of aggregate demand for goods. In short, government has the power to intervene in crises and can increase growth and employment via active demand management. To be able to do so, the state should accumulate budget surpluses in good times to be able to provide countercyclical demand management via deficit spending during economic downturns. Via a wise taxation the state could moreover regulate income distribution and create a fairer society. In the 1940s and in agreement with Keynes an increasing number of economists started to share the belief that the lack of financial regulation and monetary policy coordination as well as escalating national protectionist measures in the pre-war period were responsible for the economic disasters of the 1920s and 1930s. To avoid the mistakes of the past and building on an earlier idea originally outlined in 1930, Keynes had already in 1941 proposed to create an International Clearing Union (ICU) as a kind of super central bank that would have powers to interfere with national economic policies but remain largely democratically controlled by the member states with no state having a veto right and with safeguards for smaller and weaker states. The Bretton Woods system included a strong commitment to a broad interventionist and cooperative strategy to boost investment and long-term growth and to avoid mass unemployment that became also known as the Keynesian Welfare State in its translation to national state interventionist economic policies with distinct demand management regimes that were then dominant until the 1970s (Hall 1989). In preparation for Bretton Woods, the UK government put forward two proposals (Keynes 1942, 1943). However, despite the overall strong influence of Keynes on the thinking of the economists present at the conference and on the emerging post war economic paradigm, the Bretton Woods agreements, largely negotiated by the U.S. delegation led by Harry Dexter White from the State Department and the British led by

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Keynes, reflected foremost the U.S. position in the emerging consensus (Ikenberry 1993; Meier 1982). White had proposed an International Stabilization Fund that provided less liquidity than the ICU proposal, allowed less flexibility in exchange rates because of concerns about deficit-­ financing, limited the liability of the U.S. as largest post-war creditor, and did not address the issue of trade surpluses (Meier 1982: 38f). His original plan foresaw that this stabilization fund as well as a Bank for Reconstruction and Development would be United Nations (UN) bodies (Haines 1943; White 1942, 1943). Besides the Keynes and White plans, France had made ‘suggestions regarding international monetary relations’ (Alphand et  al. 1943) and Canadian experts proposed an International Exchange Union (Canadian Government 1943). The conference participants finally agreed on two major international financial institutions (IFIs) along the line of the U.S. proposals: The International Bank for Reconstruction and Development (IBRD) and the International Monetary Fund (IMF), both located in Washington and remaining outside the UN structure. Both institutions were originally ‘relatively independent of their political creators’ but became subsequently more adjusted to ‘the changing vision of global order’ of the U.S. as hegemonic power (Woods 2006: 9). However, the real ‘battle’ was already decided during the negotiations which were much more dramatic and controversial and in which Keynes got frustrated about how the Americans exploited Britain’s vulnerability as the U.S. was not just the rising new hegemon trying to eliminate Britain as an economic and political rival but had secured the support from Latin American countries in a coalition of ‘dollar-starved allies’ as Steil (2013: 348) has shown: ‘An ascendant anticolonial superpower, the United States, used its economic leverage over an insolvent allied imperial power, Great Britain, to set the terms by which the latter would cede its dwindling domination over the rules and norms of foreign trade and finance.’ The IBRD was founded to help post-war Europe’s economic recovery and restoring global trade by providing the necessary funding for finance and investment. However, with the Marshall Plan taking over that role in response to the emerging Cold War (see Sect. 3.1), it became specialized on providing loans to middle-income developing countries and the International Development Association (IDA), founded in 1960, started to offer loans and grants to the world’s poorest countries. Since then these two institutions have been commonly referred to as World Bank. By supporting investment in infrastructure, education, and health with leveraged loans and other support, the World Bank has been providing essential sup-

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port for developing countries’ integration into the world economy. While its operation in the first years was described as working ‘to no one’s ­satisfaction’ (Eichengreen and Kenen 1994: 6), it became during the past decades a key global institution pushing for neoliberal globalization and making financial support to developing countries dependent on opening their markets with liberalization and privatization policies. The second Bretton Woods institution, the IMF, fundamentally different from Keynes’ ICU proposal and close to the White plan, was given a mandate first to control pegged but adjustable exchange rates and then to promote monetary cooperation between nations, intervene as LOLR providing loans to troubled economies based on strict conditionality to stabilise a system of exchange rates and to tackle imbalanced growth of international trade. Providing emergency loans to states that lost access to the private financial markets and to enforce painful structural adjustment programs in exchange while increasingly advocating deregulation and liberalization of (financial) markets and deeper financial markets integration became the main task of the IMF, while it remained rather unsuccessful in addressing trade imbalances. Keynes had originally called for strict rules to deal with countries with trade surpluses, worried about how prolonged trade surpluses would create tensions and instability over time. He suggested that countries that did not use their trade surpluses to address the underlying trade imbalances would have to face serious financial consequences. Enjoying a trade surplus at that time and creating a global market for U.S. exports, the U.S.A. as the post-war hegemonic superpower successfully opposed the idea, and as a result no restrictions on lasting trade surpluses were introduced to govern the global economy—a problem that has especially in recent years re-emerged and led to current trade wars and calls for urgent countermeasures. Also, while Keynes’ original plan designed an institution that would provide financial stability as a public good by only working in the interest of every single member state and on the basis of incentives for states to cooperate, the Bretton Woods institutions became dominated by Western and foremost U.S. interests and empowered to force countries to change their economic policy preferences, reflected in the IMF in the concept of conditionality and its governance structures (Woods 2006). The IMF lost somehow influence in the years before the GFC as the leading economies relied increasingly on G’s (G7, G8, G10, G20, G22, G30) in striving for global financial stability and coordinating crises responses (Baker et al. 2005: 10). Proponents of neoliberal globalization demanded decommissioning of the Bretton

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Woods IFIs and their replacement by new global institutions including a UN International Insolvency Court, a UN International Finance Organization, Regional Monetary Funds, a UN Trade Disputes Court, and a UN Organization for Corporate Accountability (International Forum on Globalization 2002). However, the dominant powers gave continued support to the IFIs and the IMF came out of the GFC stronger than ever. Especially over the last decade, reform debates about voting shares have become more pressing with calls to adjust them to the new power structures in the global economy since the emerging powers’ support was needed for the response to the GFC. The ideological change from originally advocating Keynesian interventions, including capital controls and other restrictions on the financial sector, to supporting liberalization, deregulation, and deeper financial integration became known as the ‘Washington Consensus’. This label was introduced by Williamson (1990) summarizing the policy recommendations of the Washington based IFIs. It represents a change from ‘embedded liberalism’ (Ruggie 1982) with ‘repression of finance’ (Helleiner 1994; McKinnon 1973) to ‘liberation of finance from its post-war constraints’ (Panitch and Gindin 2008: 19). Adopted by the IFIs, this set of financial and economic globalization policies became widely blamed by critics of neoliberalism for causing rising inequality, economic disasters, and financial fragility and instability. While the World Bank’s work on developing countries is of less importance for this study’s focus on European financial integration, the World Bank’s evolution into the World Bank Group includes some highly important developments that have impacted neoliberal financial integration and globalization in Europe. In 1988, the Multilateral Investment Guarantee Agency (MIGA) was founded to provide political risk insurance and credit enhancement guarantees, helping financial institutions in developed countries protecting their investments in developing countries further. Yet more importantly, the World Bank Group became also home of the International Centre for Settlement of Investment Disputes (ICSID), founded in 1966 as an international arbitration institution, but becoming especially relevant with the “litigation explosion” (Franck 2007) since the 1990s following the massive increase of bilateral investment treaties (BITs) and international investment agreements (IIAs), which “have become the most important legal mechanism for the encouragement and governance of foreign direct investment” (Elkins et al. 2006: 2). These investment laws have created a widespread system of preferential treatment and have given economic

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actors strong protection against state interference that could undermine their ‘legitimate’ profit expectations. By institutionalizing arbitration ­tribunals for investor-state dispute settlement (ISDS) these treaties established not just strong investor protection but also a system that has led to ‘regulatory chill’ as lawmakers became fearful that public regulation could result in significant damage awards directly enforceable worldwide (Kleinheisterkamp 2015). ISDS’s controversial nature has led to strong opposition especially in Europe’s civil society, forcing the EU to rethink its approach and leading to the idea of replacing ISDS with an Investment Court System (ICS), advocated by the European Commission as new gold standard in investor protection and already successfully incorporated into EU trade deals, although not ratified, such as the Comprehensive Economic and Trade Agreement (CETA) between the EU and Canada. ICS remains controversial with continued concerns about impacts of strong foreign investor protection on future regulation. Deeper financial integration is necessarily linked to deeper trade relations between countries. Capital flows have crossed borders for centuries to support trade in goods, expansionist ambitions of empires, imperialist and hegemonic countries or blocs, wars, nation building, decolonialization and development. Regarding international trade, a significant change was made with the shift from bilateral trade agreements to a multilateral trading system at the end of WWII. The Bretton Woods conference had set up a Commission to work on an International Trade Organization, largely prepared by Anglo-American negotiations, then incorporated into the Havana Charter and signed in 1948, but never coming into existence, after the U.S. Senate regarded it as a threat to sovereignty and refused ratification (Irwin et al. 2008). Instead the General Agreement on Trade and Tariffs (GATT), resulting from those negotiations, became an ad hoc and informal institution dealing with trade in goods and leading to successive rounds of trade liberalisation that successfully reduced tariffs on trade in goods and boosted indirectly financial integration as trade in (financial) services was left aside, until the World Trade Organization (WTO) replaced the GATT system in 1995 as a permanent institution with an extended mandate that transformed the former political, diplomatic trading system into one that is now rule-based and includes beside the GATT (GATT 1994 building on GATT 1947) and other agreements, including one on Trade-Related Investment Measures, also a General Agreement on Trade in Services (GATS). However, agreement on financial services was not reached at that point and after an interim agreement was negotiated in

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1995 extended negotiations ended in 1997 and the agreement on finance entered into force in 1999. The Financial Services Annex in GATS “applies to measures affecting the supply of financial services” (Article 1a) and allows members to take “measures for prudential reasons […] to ensure the integrity and stability of the financial system” (Article 2a). GATS also encourages members to recognize prudential measures of another member and specifies that this ‘may be achieved through harmonization or otherwise’ and can ‘be based upon an agreement or arrangement with the country concerned or may be accorded autonomously’ (Article 3a). The extended negotiations on financial services resulted in schedules with commitments in financial services and most-favoured-nation exemptions, annexed to the Fifth Protocol to the GATS. Many members committed to allowing the commercial presence of foreign financial service suppliers by eliminating or relaxing limitations on previously existing rules on foreign ownership of domestic financial institutions. The judicial form of commercial presence and restrictions on expansion of existing operations were also liberalized by many member states. Since the early days of the WTO, the inclusion of services has been hailed as ground-breaking progress reflecting the increased importance of the service sectors especially in the most advanced economies. During the GATT years, services were seen to require a close physical proximity between service providers and consumers; they fell under a wide range of internal domestic regulatory policies with great variation across different sectors, and many service sectors were seen as performing functions integral to the production of goods. The theory of comparative advantage has provided the classical argument for free trade since David Ricardo formulated it in 1817 but it remained reserved for justifying the liberalization of trading rules for goods. Now, the dominant view saw services as separate markets for which comparative advantage and therefore deregulation and globalization are equally important as for the trade of goods. However, the GATS was also criticized for reflecting the spirit of the time when it was negotiated and that trade in services has since then been radically transformed thanks to new technologies and digitalization (Sauvé 2014). Liberalizing trade in financial services has continued to play a key role in this wider globalization effort. The WTO (1997) hailed the completion of the financial services negotiations as major achievement, putting the multi-­ trillion-­dollar trade in financial services ‘under the WTO’s multilateral rules on a permanent and full most-favoured-nations basis’ with an agreement covering ‘more than 95 per cent of trade in banking, insurance,

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securities and financial information.’ For regulatory reasons and foremost to allow national financial supervisors to intervene directly in situations of crisis into the operations of financial institutions operating in their markets, however, the WTO framework for finance remained largely incomplete with several limitations on market access and on national treatment, as will become relevant later when Brexit is discussed (see Chap. 4). A more ambitious approach came with the negotiations on a Trade in Services Agreement (TiSA), proposed in February 2013 by the European Commission as a new plurilateral agreement on trade in services. This idea was pushed by a group of 23 WTO members (with the 28 EU member states counting as one) that had declared themselves ‘Really Good Friends of Services’ grouping. Then U.S. President Obama launched a similar process. The aim was deeper financial integration via liberalization and deregulation based on a trade treaty that could theoretically at a later stage become multilateralized by incorporation into WTO law. Like usual for trade deals, negotiations were behind closed doors and not public and documents only available to participants. Responding to criticism about lacking transparency, the EC launched a public consultation on TiSA in 2013 and after some leaks the EU made its position papers and negotiation reports available to the public. TiSA aimed at deeper financial integration by further liberalizing trade and investment in services and expanding regulatory disciplines. Critics saw in the negotiations a failed model of financial deregulation already enshrined in WTO rules, that some countries wanted to critically debate after the GFC but the debate was blocked by the governments now pushing for TiSA. The secrecy would also be a reversal of the WTO’s trend towards more disclosure. Critics highlighted that this would result in dangerous deregulation after the regulatory reforms adopted since the GFC and in restrictions on governments to adequately regulate services in the future. Regarding the latter, a standstill or rachet clause was of considerable concern as this would require parties to the treaty to keep their markets at least as open as they were at the time when the original commitments to the agreement were made. Future governments or EU institutions could therefore become restricted by these commitments in responding to financial crises (Kelsey 2014). Liberalization pressures on public services and services of general public interest resulting in increasing competition in these areas undermining the public interest constitute a further dangerous shift towards finance-led capitalism. The Commission responded to critics by pointing out that TiSA would like GATS contain as safeguard clause, the ‘Prudential Carve Out’, and

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that like any other trade deal TiSA would be subject to the EU’s Trade Sustainability Impact Assessment. The safeguard clause is a weak defence with a high burden of proof. The leaked documents that had been published by Wikileaks showed that the U.S. was reluctant to agree on harmonizing financial regulation. However, in 2016 and after 21 negotiation rounds, negotiations were halted after the initiative had no longer political support by the U.S. administration of President Donald Trump. At that time, the EC was still hoping for continuation once the political situation changes; though in the meantime, European Commission representatives have become more critical about further liberalization of finance given increased tensions in the global economic system with rising economic nationalism and with Brexit looming. This will become an issue when strategic questions related to financial markets integration in Europe and responses to the Brexit challenge will be discussed. Recent years brought also and addition to preferential and regional trade agreements (PTAs and RTAs) with a ‘new generation’, deep and comprehensive, more ambitious free trade agreements (FTAs) supplementing the WTO system such as the earlier mentioned CETA. Sometimes described as compensation for the lack of progress in further WTO liberalization negotiations, resulting from fundamental conflicts of interest among the large and diverse WTO members and the unwillingness of the developed countries to meet the development demands and calls for a fairer trading system from the poorer and less developed countries, these new agreements have been defended by supporters as stepping stones towards more liberalized and globalized markets or as ‘second-best’ to non-discriminatory global freer trade (Pomfret 1997), while critics see them as dangerous “termites” in the system, undermining the most-­ favoured-­nation principle and creating more harm than benefits (Bhagwati 2008). European integration is the ‘original sin’ in these debates that identified various concerns related to PTAs and RTAs such as protectionism, discrimination, increased transaction costs, and complex and often manipulated rules of origin. The Sutherland Report (2004), commissioned to discuss the challenges to the multilateral trading regime at the WTO’s tenth anniversary, came to the conclusion that ‘MFN is no longer the rule, it is almost the exception’ and this would have profound impacts on the future of the WTO (Sutherland et al. 2004: 19); the 2013 WTO annual report considered regional integration as ‘a major concern’ creating significant challenges to the multilateral trading system on the future of the world trading system came to the conclusion The discussion about

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deep and comprehensive trade deals reflects increased regulatory competition in the global economy. The currently stalled negotiations between the U.S. and the EU of the Transatlantic Trade and Investment Partnership (TTIP), CETA, and various other trade deals were interpreted to be necessary to protect Western countries ability in the coming great-power competition to control regulation in the future and not losing the dominant influence on international standard setting to China. The Chinese influence on global financial markets is expected to grow, with China having now the largest banks in the world and having entered the capital market-based finance with a fast-growing shadow banking system (Braun et al. 2018: 111). Like TiSA, PTAs such as TTIP and CETA have been criticized for being based on “the pre-crisis model of extreme financial deregulation” (Public Citizen 2015) and as another aspect of the threat of rolling back post-crisis reforms. In short, the multilateral trading system underlying the second wave of financial integration and economic globalization has become a major battlefield for rolling back financial reforms. Several trade-related financial integration policies have been pushed over recent years and, while some of them succeeded and others remained unfinished, they all reflect a strong support for neoliberal globalization and finance-led capitalism. For now, the WTO remains the most powerful multilateral institution in protecting a liberal trading order with indirect importance for the globalization of finance. However, multilateralism entered crisis mode and rising competition is increasingly undermining the post-Bretton Woods arrangements. Before the GFC, the WTO created unique pressures on countries to liberalize their economies, but also provided the institutional structure supporting global trade expansion, making it attractive for non-member states to join. In its aftermaths, the WTO has repeatedly warned against protectionist measures of its members intended to boost domestic economic recovery but undermining globalization and reported a historically high level of protectionism among G20 countries, while member states also threatened to use or even used the powerful WTO dispute settlement system against such discriminatory measures. But with the U.S.’s refusal to agree on the appointment of new Appellate Body members, the WTO is at the time of writing in mid-2019 close to losing its ability to hear new appeal cases. The background to this situation is a bigger problem in the global economy. The U.S. but also other countries have increasingly become concerned about economic imbalances, currency manipulations, and dumping of various products, ranging from aluminium and steel to

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solar panels, that threaten their own markets. It turns out that it was a significant failure at the Bretton Woods conference not to incorporate powerful mechanisms to deal with those issues. A major reform of the international economic system remains a precondition for a more stable, more resilient, and more sustainable global economy. Currency wars are basically the result of competitive devaluations in countries wanting to improve their trade advantage that lead to similar responses in other countries. Currency fluctuations were a big problem in the interwar period with devaluations of numerous currencies and massive speculation. Currencies were then regulated in the Bretton Woods system before liberalization strengthened market powers, leading to the assumption that currency manipulations by central banks could not happen anymore. Bretton Woods had originally established a fixed exchange rate between currencies based on the US dollar’s fixed convertibility into gold with some limited scope for adjustments, but that system declined for some years before collapsing in 1973 when major currencies began to float against each other as the old system was no longer sustainable for the expanding world economy in which the rise of transnational corporations had led to increasing cross-border transactions of goods and services. The U.S. developed an interest in floating to counter inflation that had started to become a problem. The UK was already suffering from inflation and a deteriorating balance of trade which led to speculation against the British currency. European countries were also increasingly dissatisfied that the U.S. was no longer the creditor but since 1985 a net debtor that had begun to use the exorbitant privilege allowing the U.S. to run painless deficits as long as surplus countries remained willing to hold dollars. The new international financial architecture1 kept the U.S. dollar as most 1  Some have argued that Bretton Woods did not really end but remained “alive and well” if not narrowly defined as a “system of fixed exchange rates and current account convertibility” but as “an exchange rate system that supports open trade and the financing of imbalances” and given the continuity of the Bretton Woods institutions. In that understanding Bretton Woods “evolved” and successfully adopted to new challenges (Dornbusch 1993). Others have labeled the international financial order after 1973 “Bretton Woods system reborn” based on the idea that the main feature of this system is a core—the country providing the global reserve currency as an exorbitant privilege, namely the U.S.—and a periphery of economies that are committed to export-led growth, first Europe and Japan, then more recently Asia. In that understanding, Europe moved from the peripheral status of emerging market economies to a new stage without yet winning the privilege of having a reserve currency that would allow living beyond the regions means (Dooley et al. 2003; Eichengreen 2007).

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important currency for invoicing and settling international transactions and allowed countries pegging their currencies against another country’s currency or a basket of currencies, to adopt another country’s currency or to establish a currency union. Throughout that period, financial markets became increasingly international since 1982 and global since 1993 while financial regulation turned from national controls to international cooperation, but also to international regulatory competition and a wide range of areas governed by industry’s self-regulation following liberalisation and deregulation. With ever more powerful capital markets, currencies again got under speculative attacks resulting in currency depreciations that raised contagion fears, especially after a period of crises in the 1990s (Arner 2007). Following the GFC, key central banks coordinated their interventions and reduced interest rates, before starting unconventional new monetary policies such as quantitative easing (QE) to increase money supply in the banking system and boost lending and investment for economic recovery. How to exit from these unconventional monetary policies remain without harming the economy remains a key challenge for central banking. In the meantime, these new unconventional measures form the tools of a ‘cold currency war’ in which central banks do not directly intervene in foreign exchange markets as in classical currency wars, but use interest rate cuts, negative interest rates, QE, and yield curve control instead. This cold currency war has been heating up over recent years. The challenges for international monetary cooperation have raised the question whether a return to Bretton Woods or even to the gold standard might be an advantage. With the benefit of hindsight, the Bretton Woods era is often described ‘as a golden age of exchange rate stability and rapid economic growth’ (Bordo and Eichengreen 1993: xi), a ‘paradise lost’ that had assured ‘price stability, full employment, and effortless balance of payments adjustment’ (Eichengreen 1997) and as a period without any significant banking crises (Reinhart and Rogoff 2009: 205). The post Bretton Woods system on the other hand saw a massive increase in significant financial turbulences: Laeven and Valencia (2012) counted 147 banking crises, 218 currency crises, and 66 debt crises over the period 1970–2011. The underlying changes driven by a wave of deregulation and privatization can be attributed to a new neoliberal hegemony replacing the post-war Keynesian economic paradigm. This system has also been described as one of increasing importance of finance over the real economy, of finance-led capitalism, or financialization—a system that massively increased social inequality and came with the GFC of 2008–2009 close to

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its collapse. This massive financial meltdown and economic downturn was predictable and indeed predicted, and it could have been made less severe with earlier regulatory intervention (c.f. Financial Crisis Inquiry Commission 2011). Instead, it became the worst crisis and recession since the Great Depression of 1929. The IMF estimated its costs at U.S. $11.9 trillion, the equivalent to roughly a fifth of the entire world’s global economic output. The Organization for Economic Cooperation and Development (OECD) calculated a significant loss in productivity in OECD countries as the main lasting macroeconomic damage with clear effects on future growth, capital stock, and investment (Turner and Ollivaud 2018). The Bretton Woods system is nevertheless not a system to return to as it was only a “transitional system” still based on gold to which the U.S. dollar was pegged which made it prone to instability because of “the inelasticity of gold supplies” in a rapidly expanding world economy (Eichengreen 2007: 38). Moreover, instability was already increasing within this system since the 1960s with rising levels of fragile and speculative finance (Minsky 1986). Calls for international financial reform before the GFC were numerous, especially after the East Asian financial crisis of 1997–1998 that led to calls for more regional financial integration (Jomo 1998, Chandrasekhar and Ghosh 2013; Sheng 2009) and included proposals for a World Financial Authority (Eatwell and Taylor 1998, 2000) and especially calls for the introduction of a financial transaction tax or Tobin Tax became prominent in various jurisdictions. This latter idea was often regarded as a kind of return to Bretton Woods’ elements of capital controls (c.f. Bello et  al. 2000; Haq et  al. 1996). The idea gained new support in various European countries after the GFC and has since then, as we will see later, influenced debates about deepening financial markets integration. Because of economic imbalances and the economic and financial crises, the dominance of the dollar as a key feature of the Bretton Woods system and its successor is increasingly questioned since the U.S. has no longer the dominant share in global economic output and is no more the largest importer and main provider of trade credit. In today’s world economy, the U.S. is outperformed in exporting by China and by Germany and its share of global experts shrunk to 13%, its share in Foreign Direct Investment is below 20%, creating ‘an uneasy tension with the peculiar dominance of the dollar’ (Eichengreen 2011: 2). To remain the leading global reserve currency, the U.S. needs not only to have a strong position in the global economy, the country also must provide financial stability and trust to avoid that other countries do not abandon the dollar.

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Yet, the U.S. benefited from the GFC; according to Eichengreen (ibid.: 3), the ‘dollar’s depreciation […] improved the U.S. external position by almost $450 billion’. Again, like in the 1970s, dissatisfaction with the U.S. dollar’s role in the global economy is rising. The EU has challenged the dollar with the introduction of a single currency but still has a way to go to strengthen the currency’s international role, which is one of the current aims in reforming the Economic and Monetary Union. China aims too to replace the dollar’s role. The Chinese renminbi was acknowledged formally by the IMF as a global reserve currency in 2015, followed by the IMF’s decision a year later to add the Chinese currency to the Special Drawing Rights basket which—created in 1969 as an international reserve asset originally linked to the value of gold and the U.S. dollar and nowadays reviewed frequently to reflect the relative importance of currencies in global trading—consisted before of the U.S. dollar, the euro, the Japanese yen, and the British pound sterling. In short, the U.S. still provides the international currency but in an ever more competitive environment that impacts the further globalization of finance. In this climate accusations about currency manipulations between the great powers have become an element in trade wars.

2.2   Transformations of Capitalist Money and Market Economies Financial markets integration depends on the existence of well-­functioning markets not just for financial products and activities but for the totality of exchanges of goods and services which require financial transactions in a money economy. Markets have a long history throughout the evolution of barter and trade that shows how and when they work both in periods of expansion and contraction. Allowing an efficient exchange of commodities between people with different skills, ideas, interests, or products who have the money or commodity to participate gives them clear advantages. Yet they never come without downsides as they are frequently exploited, manipulated and used for fraud or other criminal behaviour, and even strictly legal activities or products can have externalities or suffer under information asymmetries not reflected in market prices and transactions and therefore not taken into account within the market system. As locations for the exchange of commodities and because of their benefits and risks, markets have always been regulated, especially the most successful

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ones, sometimes in more, sometimes in less intrusive ways aiming to influence their creation, operation, and expansion. But only in capitalism ­markets developed into the central self-regulating mechanism for exchange and transformed societies into market and money economies in which the market is no longer only a specific place but an entire geographical area and increasingly an open and global market in which prices are formed for commodities and sellers compete for customers to realize profits that allow them to survive in competition. All transactions necessary for production, distribution, service provision, and consumption become part of highly dynamic, profit-driven money and market economies and ever more products and activities become commercialized and monetized and part of increasingly transnational, international, and global markets. Capitalist money and market economies have this tendency towards more open markets with deeper economic and financial integration and towards capital concentration which is strongest around the regional and global hubs for international trade and finance. Money in this system is no longer just a unique commodity as a universal medium of exchange invented to simplify the trade of commodities between people with different interests and needs by expressing all commodity values in comparable prices. Money in capitalism develops an independent existence but still relates back to the production processes in the real economy. At the national level, paper and electronic money were invented based on a promise of payment reflecting the quantity of the money as commodity. Its emission became controlled by the state via their central banks that take monetary policy actions in relation to the business cycle and the overall evolution of capitalism. Throughout the history of capitalism, money was first representing the value of metals—first metals such as gold or silver, before shifting to the gold standard. Paper money and coins then played an increasing importance, with nation states guaranteeing the value of their currencies (Galbraith 1975). The transition from paper money pegged against the value of gold to money without intrinsic value and its value only guaranteed by government created fiat money and fiat currencies around the world. Over time, the ‘power money’ of coins and bills has been significantly extended with ‘broad money’, deposits, bank loans, credit and debit cards, and over more recent decades a massive amount of securitized debt and financial derivatives emerged on top and entirely out of proportion to the size of the underlying economic activities in the real economy. This created an ‘inverted pyramid of global liquidity’ (Roche and McKee 2007) boosted by global imbalances, arbitrage, hedging, and extreme specula-

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tion. Since the 1980s and especially in the 1990s, the amount of securitized debt and derivatives grew exponential because of structural changes in finance; financial deregulation and financial innovation was set towards ‘collision course’ (Blundell-Wignall et al. 2018: 41) making the financial system more fragile and increasing financial instability. The invention of securitization and financial derivatives came from the private financial sector, but they became protected by the public just like the deposits in banks that have become largely protected by industry-financed deposit insurance with taxpayer backstop to avoid bank runs that could undermine economic and financial stability. At the global level the monetary sphere evolved as the international financial system that not only serves the exchange of goods but creates credit relationships with loans and debts that can result in international debt crises but always create political and economic dependencies between countries and their markets. Loans and debts were traditionally seen as a relationship with responsibilities on both sides. Reckless loans to irresponsible states could have consequences and sovereign defaults occurred frequently throughout history (Reinhart and Rogoff 2009). However, in recent decades with the emergence of finance-­ led capitalism new financial institutions entered the game as ‘holdout creditors’ and used new financial products and strong investor protection laws in the most investor-friendly countries to enforce the rights of the private lenders over public debtors. This process has undermined the previously established sovereign debt restructuring processes which allowed the private sector involvement in bearing the cost of unsustainable public debt restructuring and made restructuring much more complicated. This has resulted in enormous social costs in the societies affected while financial institutions such as hedge funds specializing on such situations and strategies to gain financial returns on distressed debt have been described as vulture funds or predatory financial actors with practices that reflect a rising ‘disaster capitalism’ (Klein 2007). The United Nations and the IMF have acknowledged that these developments undermine orderly sovereign debt restructuring that had become structured in informal circles such as the ‘Paris Club’ that brought together creditor countries’ representatives to agree on debt restructuring in exchange for structural reforms and the ‘London Club’ informally representing commercial banks for the same purpose (Lucatelli 1997). Both the UN and the IMF have started discussions in recent years about necessary reforms that would allow prompt, orderly, and predictable restructuring of unsustainable sovereign debt and deter disruptive litigation (c.f. IMF 2001; UNCTAD 2016). Based on

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experiences with financial crises in Mexico, Asia, and Russia and with litigation cases in Peru in 1996 and Argentina since 2005, and then more recently the experiences of Greece with the ‘holdout problem’ there is still no solution for how to avoid a ‘messy’ situation becoming even ‘messier’ (Krueger 2003). Compared to developing countries, western countries have been more likely since the 1990s to incorporate collective action clauses (CACs) into their loan agreements signed at the issuance of sovereign bonds that has allowed them a more orderly and predictable debt restructuring. EU member states agreed to include CACs clauses in their international debt issuance in 2003 but not all acted upon that non-­ compulsory guidance. Bianco (2014: 727) described the EU’s approach as ‘a first sign of awareness’ yet with an approach that was too accommodative to bondholders, making ‘successful utilisation of CACs an unlikely event’ and creating a new litigation risk. In the meantime, more recent court decisions have further undermined CACs. Some countries such as Belgium introduced laws ‘to combat vulture fund activities’ and to limit the claims they could make from government bonds bought at highly discounted prices (UNCTAD 2016: 21). At the international level, a public-­ private expert group led by the U.S.  Treasury and with IMF involvement developed a ‘single-limb’ clause based on a high threshold allowing debtors and a qualified majority of creditors to impose their agreed terms also on dissenting creditors. The approach was then included in the International Capital Markets Association (ICMA) model contractual clauses for sovereign bonds (Sobel 2018; IMF 2014, ICMA Model Clauses). The Eurogroup has proposed to introduce a single-limb CACs by 2022 and change the European Stability Mechanism Treaty accordingly (EPRS 2019; European Council 2018). However, it remains uncertain how courts will react to this change and how countries will be affected that present a higher risk of sovereign default as CAC bonds reflect a higher credit risk. The long-term effect has to be seen. The supply of money and credit in capitalist societies became the responsibility of national central banks. Their LOLR function has created the moral hazard problem that because banks can be bailed out even if they behaved irresponsible and took on excessive risk they start behaving accordingly. Central banks have therefore tried to find disincentives against such moral hazard. As guarantors of monetary stability central banks must protect the domestic and external value of their currency: at the national level they have to aim for price stability against inflationary and deflationary pressures, which are increasingly influenced by greater international

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economic interconnectedness, and in global markets they need to protect the exchange rate reflecting the interests of importers and exporters. Plans to introduce a global currency for the world economy—Tinbergen (1965: xvi and 83f) called this ‘the simplest’ and ‘best theoretical solution’ for international payments and their integration but a ‘luxury’ ‘in a world threatened by wars’ and conflicts—have failed and states found other ways to coordinate monetary policy around an anchor currency and measures agreed between the most important central banks (see Chap. 2). Currency adjustments are necessary to counter economic imbalances resulting from cross-border trade. Throughout history this led to ‘currency wars’ and in more recent decades to the expectations that countries and their central banks would no longer be able to manipulate their currencies since liberalization of capital flows put the markets in charge of valuing currencies. Yet since the GFC discussions and accusations about currency wars came back into international relations and play a key role in questions about economic imbalances and financial instability (see Chap. 2). Currency crises have occurred frequently in capitalist history. From time to time competing alternative currency systems were developed to re-establish stability and maybe even a fairer form of economic exchange; and in some periods, especially during or immediately after financial crises, they were tested at local and regional levels and some were even rather durable, but none proved popular or successful enough to replace fiat money in form of government-issued currency. Since the 1990s, various ideas had a revival as part of the sustainability discourse that led to discussions how alternative, mostly complementary, local currencies could contribute to a fairer exchange within communities and advance sustainable development. More recently, cybercurrencies, cryptoassets or digital currencies emerged as alternative private payment systems (if not more for speculation and fraud) and another example of financial innovation that intend to function outside any state interference and central bank control, with central banks increasingly interested in what their real nature is, how to regulate them, and how they might (de)stabilize the financial system. Digital currencies could soon become backed by central banks. Not everybody is optimistic about the future of these alternative currencies: Borio (2019: 18) paraphrased ‘Churchill’s famous line about democracy, “the current monetary system is the worst, except for all those others that have been tried from time to time”.’ ‘Money makes the world go round’, sung Liza Minnelli and Joel Grey in ‘Cabaret’. Capitalist money and market economies have without much

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of a ‘clinking, clanking sound’ established a clear hierarchy between markets: the money market steers the market for goods and services, which then impacts on the demand in the labor market and consequently affects employment and wages. Money becomes a factual constraint for the economy and society. Open and more integrated global markets put national currencies in competition to and against each other and in these global markets private actors dominate. As a result, the world market turns into a factual constraint too, taking over the top position in the hierarchy, in which the nation state, society, national markets, and money become increasingly controlled by the world (money) market (Altvater and Mahnkopf 1999). The emphasis on money and market economy is an important one, given that classical and neoclassical economics tended to simplify capitalism as a market economy. Adam Smith (1776) developed the economic theory of classical capitalism by providing the arguments why ‘the wealth of nations’ would depend on the free play of self-regulating market forces, the division of labor and specialization in production, and free trade between nations. His powerful argument for free trade was directed against mercantilism, the dominant economic theory from the sixteenth to the eighteenth century, that had claimed that trade would be a zero-­ sum game in which one country’s economic benefit would be at the expense of a rival country, advising countries to protect home industry, generate a trade surplus and accumulate specie such as gold or silver back then via a favorable balance of trade. Smith fundamentally opposed this view and argued that trade creates a win-win game and is beneficial if countries use their absolute advantages. Countries should therefore specialize in exporting products that they can produce with same resource input at greater quantity than other countries, while not using import and export controls which would only protect domestic industries but hurt the nation. Like in the domestic market, in international trade wealth increase would too depend on competition, international specialization and division of labor. The domestic and global market in this system would act like an ‘invisible hand’ leading to the optimum outcome for society based on individuals solely acting in their economic self-interest. Money, however, was for Smith simply ‘the great wheel of circulation’ (ibid.: 481) and ‘the universal instrument of commerce, by the intervention of which goods of all kinds are bought and sold, or exchanged for one another’ (ibid.: 52). He had some concerns about usury and speculation and about the role of paper money in a system based on the gold standard. He could not foresee

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into what financial markets would transform. In the nineteenth century, finance transformed significantly with ‘the emergence and proliferation of markets for long-term debt and shares in capitalist enterprises’ that led to modern large joint stock companies (Toporowski 2018: 417). These large firms had now access to capital markets and established their long-term funding via bonds or equity which made them less dependent to credit shortages. However, they also became dependent on short-term borrowing from banks which caused instability in periods of investment booms and led to the banking crises of ‘classic capitalism’ that were explained with ‘under-consumption’ theories (ibid.). The new corporate structure also created pressures on firms to have sufficient liquidity by holding excess capital. Financial expansion allowed companies now to buy the long-term debts or shares of their rivals instead of competing with them for customers. ‘The trusts and monopolies that dominated capitalism by the end of the nineteenth century’, concluded Toporowski (ibid.: 419), ‘were the creation of capital markets’. The financial crisis mechanism changed from a bank reserve drain to capital market crashes as the secondary market for long-term securities emerged to provide liquidity (ibid.: 421). The results of those transformations were the Vienna stock market crashes in 1873 and 1931 and the notorious Wall Street Crash in 1929 that had followed a spectacular rise of the New York stock market based on an ‘orgy of speculation’ (Kindleberger 1987: 96). Central banks had to intervene to take pressures off the markets. However, the following liquidity panic expanded to mortgages and then to rapid fall in industrial production. The rate of bank failures increased significantly and led in the U.S to a bank panic in 1930. The U.S. had just adopted the Smoot-Hawley Tariff Act and European countries quickly followed with protectionist measures that led to a decade of depression in the global economy. Central banking was not very successful in the 1920s and 1930s. In that period, European central banks developed the practice to bailout banks in troubles. In the 1950s, central banks experimented with Keynesian ideas that aimed to achieve both, low inflation and full employment, but these policies came under increasing pressure in the 1970s when inflationary pressures and unemployment were rising. However, the establishment of deposit insurance and heavy regulation led to a situation with ‘no banking crises from the late 1930s to the mid-1970s anywhere in the advanced world’ (Bordo 2007). Since the 1980s, monetarism became the new dogma for central banking. Combined with other market fundamentalist ideas central banks reduced their focus and claimed that they have become

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highly successful. Price stability with low levels of inflation, a transparent monetary policy, and central bank independence became the leading ideas for central banking that should generate financial stability and would be most suitable in the age of globalization. In the U.S., the Federal Reserve proclaimed that its policy had led to the Great Moderation that significantly reduced the volatility of business cycle fluctuations and supported growth. This claim has remained contested and Keynesians continue to argue that central banks’ interest rate policy cannot prevent inflation or deflation, if unaided by other, more interventionist economic policy measures (c.f. Skidelsky 2018: 360). Money became especially in neoclassical and monetarist economics neglected or as Lord Mervyn King (2016: 78), the former governor of the Bank of England, put it: ‘many economists have been reluctant to use the word’. In these theories the free market would create an equilibrium and most economists focused on what creates equilibrium in markets, not on disequilibrium. Monetarists like Milton Friedman had argued that only mistakes in monetary policy would lead to financial instability (Crockett 1997; Friedman and Schwartz 1963), and liberalized and deregulated financial markets were since the 1970s increasingly seen as efficient, self-­ correcting, and fair. Markets would be inherently stable if there are no unexpected fluctuations in the money supply. Only bad policies could undermine financial stability. Hayek (1976) advocated currency competition that would provide better money than government intervention and claimed that ‘good money’ could ‘come only from self-interest, not from benevolence’. In his monetary theory he remained convinced that busts cannot be avoided without also avoiding the booms causing them, an idea that was clearly influential on central bankers’ behaviour in the years before the GFC. His most radical ideas, however, were never adopted. Banking was still seen as special and potentially risky and in need of prudential regulation; yet the stability risks could be avoided by using the wider financial system for risk diversification. However, money remained as a puzzle in the controversies between different schools of economic thought. ‘No matter how hard macroeconomics tries to keep money in the background’, concluded Wray (2011), ‘it refuses to play its assigned role as a neutral veil’. Unbelievable as it may seem, money and finance remained for most economists a ‘disturbance’ (Toporowski 2005), yet it was exactly those theories that had become the mainstream and guided the key monetary and financial regulators. King (2016: 79), describing the GFC as a result from a widening disequilibrium since the late 1980s, blamed Adam

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Smith’s invisible hand for the ignorance of economists for the significance of money, while claiming that the GFC came after ‘20  years of ­unprecedented growth and stability’ and carefully avoiding putting any blame for the GFC on markets or regulators. Leading central banks including the Bank of England and the Federal Reserve had developed unrealistic models with representative agents with rational expectations and without any financial sector. However, they also engaged in much more speculative thinking to anticipate the future development in certain markets. Alan Greenspan (2007: 167), chair of the Federal Reserve from 1987 to 2006 and by the Time magazine listed as one of the 25 people to blame for the GFC, describes the consideration of the high-tech boom in the mid-1990s as ‘pretty speculative’ within the Federal Reserve’s Federal Open Market Committee. The risk perception in this and other areas was largely ideological and based on strong free market beliefs. Central banks should not diffuse booms and bubbles before they bust as they might intervene too early or even cause a recession. In any case, intervention at this level would cost prosperity. Instead they should provide enough liquidity to the markets to protect the payment and market systems, whenever this becomes necessary. The Fed under Greenspan also opposed the idea to increase capital buffers for banks. Such central bank policies and interventions supported the wealthy and contributed to increasing inequality. Innovation in finance was in Greenspan’s view a necessity and the financial system needed foremost ‘flexibility’ and no forms of protectionism (ibid.: 376). Writing just before the GFC got really started, Greenspan (ibid.: 10) praised ‘we are living in a new world—the world of a global capitalist economy that is vastly more flexible, resilient, open, selfcorrecting, and fast-changing than it was even a quarter century earlier.’ The George W. Bush administration in the U.S. had run a campaign on the ‘ownership society’. Greenspan was for ideological reasons supportive and more than willing to accept an increasing number of foreclosures and a tightening of credit availability when the subprime mortgage bubble busted stating ‘that the benefits of broadened home ownership are worth the risk. Protection of property right, so critical to a market economy, requires a critical mass of owners to sustain political support’ (ibid.: 233). Little seemed he aware of the connections to the securities and derivatives markets and the wider systemic implications that would soon shake the U.S. and global economies and their financial systems. He was fiercely opposed to regulation and trusted more in markets controlling themselves than in strong regulatory and supervisory powers. He criticized, for exam-

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ple, the idea that CEO compensation should be regulated hoping that ‘shareholders will look beyond their focus on investment returns and pay attention to CEO compensation’ (ibid.: 427). CEO pay has increased dramatically under finance-led capitalism. In the U.S. the CEO-to-worker compensation was at a 20-to-1 ratio in 1965, a 59-to-1 ratio in 1989, a 299-to1 ratio in 2014, and a 271-­to-­1 ratio in 2016 (Mishel and Schieder 2017). Excessive executive pay swept over from the U.S. to Europe and other markets and led to a global debate about pervert incentives in finance-led capitalism and how they contribute to short-term shareholder value orientation in corporate governance. However, market fundamentalists like Greenspan assumed financial institutions would generally be better regulated by pressures from the market and from counterparties than by regulators. The UK under Thatcher and other countries had also transformed finance with deregulation and liberalization based on free market ideology and boosted home ownership and private pension systems to increase the size of the new finance. Across the world in all major economies there was little concern by market fundamentalists about the massive increase in CEO compensation or the increasingly fraudulent behavior necessary to increase debt levels of households and companies during the boom years. Reflecting on his role, Greenspan argued that the GFC was a rather unpredictable ‘once in a century credit tsunami’, but he also confessed in a congressional hearing in October 2008 that he had ‘made a mistake in presuming that the self-interest of organizations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms’. Now he was shocked that ‘a critical pillar to market competition and free markets’ had broken down (House of Representatives 2008). In Mervyn King’s postGFC analysis the major problem creating instability in the system was that private institutions were given the power to create money via credit creation which he labels ‘financial alchemy’ as risk becomes transformed into safety, a classical argument that had emerged in crises debates since the 1930s and resulted in calls for specific structural changes in banking (Pesendorfer 2013a). However, instability also resulted from central banks’ narrow focus on inflation targeting as a monetary policy strategy developed to reduce inflation since the 1980s (Bernanke and Mishkin 1997). Central bankers as the guardians of monetary stability claimed that they had developed dynamic models that would allow understanding the evolution of the system based on past experiences and making the right judgment calls on policies. They also welcomed that inflation targeting

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was useful in guaranteeing political legitimacy for their independence (c.f. King 2004 for this view). Central bank policy has been extended in extraordinary ways since the GFC. To counter the economic fallout of the crash, central banks introduced unconventional monetary policies such as quantitative easing with large-scale asset purchases and cuts of bank rates towards zero. Praised by some that these measures have saved the system from collapse, made the system more resilient and that central banks actions would have had at best moderate effects on inequality (c.f. Bernanke 2015; Lenza and Slacalek 2018), others see it as a continuation of pre-crisis approaches that generally serve the rich disproportionately and increase inequality (Colciago et  al. 2018; Montecino and Epstein 2015). The final verdict on it is still to come, while experts try to figure out how to return from those extraordinary measures to standard practices without disrupting economic recovery. Now since 2012, a debate from heterodox, largely Post-Keynesian theory in monetary theory, that had started in the late 1990s (Wray 1998) but goes back to Abba Lerner’s idea of ‘functional finance’ from the 1940s, has re-emerged and has even received some serious consideration in mainstream debates (Wray 2018). This Modern Monetary Theory (MMT) tries to combine the key economic aims of full employment and price stability and has suggested that monetary policy should not try to achieve some arbitrary ‘sound’ balance between spending and revenues but that monetary and fiscal policy should be used to achieve full employment and price stability and that they can do so without undermining financial stability and causing a sovereign default. Another powerful idea gaining wider attention in this post-crisis climate is that central banks could replace quantitative easing—the large-scale purchase of assets from financial markets by central banks to stimulate economic activity—with a drop of ‘helicopter money’ directly to all citizens in a jurisdiction. The original idea goes back to a thought experiment of Milton Friedman (1969) of what would happen if a helicopter dropped in a unique event $1000 in bills from the sky for the public to pick up. The consequences of such fundamental changes in central banking and monetary policy are one of the contemporary controversies, with the most common argument against helicopter money the concern how you could stop governments from repeatedly dropping more money to finance their spending. Mainstream monetary and finance theory was also based on an explicit distinction between monetary policy for monetary stability and prudential policy and regulation for financial stability that led to split responsibilities.

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This has become a rather superficial and problematic distinction given that the two aims are not just closely related to each other, but ‘inseparable’ (Ricks 2016: 1). In both areas, free market ideas played an increasing importance since the 1970s. In regulating financial markets, the approach focused on the soundness of individual institutions in form of ‘prudential regulation and supervision’ which ignored the system-wide interlinkages and complexities as well as new problems arising outside the regulated areas that had significantly increased over the past decades. For the UK, Lord Turner identified this major flaw in the financial regulator’s approach with the wrong assumption that if individual financial institutions have a sound risk management system in place, the overall system would also be sound and stable (FSA 2009). The rise of finance resulting from financial globalization, financial market integration and related policies were understood as progresses leading to more efficiency, higher liquidity, more growth, more risk-sharing, and overall to high financial stability. In the mainstream literature, ever larger financial institutions, extreme leverage and high liquidity based on ever more complex financial products were understood as sophisticated forms of risk management with the largest institutions best equipped to deal with any kind of market shocks thanks to their assumed superior risk diversification. Capital concentration in form of a relatively small number of very large financial institutions now dominating key markets was therefore seen as guarantor for financial stability and economic prosperity. The emergence and vast growth of new financial institutions and rapid financial innovation in the areas of securitization and complex derivative transactions, largely occurring outside any regulatory oversight, were supported as developments that would increase market efficiency and liquidity, allowing efficient risk sharing throughout the entire economic system. Less developed and less integrated financial systems characterised often by stricter product regulation and generally lower developed capital markets with lower levels of liquid assets based on less complex securitization were frequently criticized in this mainstream literature and these jurisdictions were challenged to modernize (c.f. Carey and Stulz 2006). International financial institutions such as the International Monetary Fund supported and advocated the idea of financial globalization and deeper financial integration (c.f. Decressin et  al. 2007; Enoch et al. 2014). The deregulation and liberalization literature based on neoclassical economic theory and the Efficient Market Hypothesis (EMH), originally developed by Eugene Fama (1965, 1970), led to a general expectation among leading experts that financial markets would

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be self-correcting, driven by rational markets and leading to efficiency and equilibrium. The EMH claimed that financial markets are ‘efficient’, meaning that assets traded on financial markets would always be valued correctly. Capital markets would quickly respond to any new information and incorporate it into prices. With prices now reflecting all known information, such a system allows investors to earn above-average returns when they are willing to accept above-average risks. Markets can still make errors in valuation and market participants can still be rather irrational, but investors would not be able ‘to earn above-average risk adjusted returns’ (Malkiel 2003: 60). Industry self-regulation in significant areas, ‘light-­ touch’ and risk-based regulation, and an overall business-friendly regulatory framework were turned into best practice models that should assure minimal government interference into markets. Regulatory competition between financial centers and with offshore finance supported the trend towards an ever-increasing importance of finance. Moreover, the system was assumed to contribute to more wealth, that scale and complexity of finance would add economic value and make the overall economic system more efficient and less risky (Turner 2010: 4). The Law and Finance literature has emphasised that the liberalization and deregulation agenda had led to ignoring the significance of legal and institutional designs in financial markets, advocating that deregulated and liberalized financial markets would still need the right regulatory framework (Arner 2007). This insight, however, only became acknowledged after the financial meltdown of 2008–2009. Behavioral Economics is another theory that made it from an outsider into mainstream literature and helped overcoming some of the main simplifications and errors of the pre-crisis thinking. Key regulatory bodies have since then incorporated insights from both debates into their practice. Behavioral Economics argues that various social, cultural, psychological, cognitive, and emotional factors affect economic decision-­ making in financial markets and the broader economy and that you can use that insight for designing better markets and better market regulation (Shiller 2000). Shiller as a leading representative of this theory, however, remained much more enthusiastic than other critics of contemporary finance. In his view financial innovations are of valuable importance ‘once professionals learn how to use them properly’ (Shiller 2003: 244), and he has even strong hopes in democratizing and humanizing finance with more financial innovation (ibid.: 13, Shiller 2012). In this new environment, risk and uncertainty returned into debates about post-GFC economics, finance, and regulatory reforms. The basic

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truth that money automatically creates uncertainty and instability and that finance tries to bridge the uncertainties between a given point in time and the future is now widely accepted. King (2016) acknowledges this as ‘radical uncertainty’ and calls for its incorporation into macroeconomics and monetary policy. Uncertainty and instability have very much been the key topics in (Post-)Marxist and (Post-)Keynesian economics, nowadays described as heterodox (non-mainstream) economics, that generally regards economic systems in opposite to the equilibrium model as complex, evolving and unpredictable and financial systems as instable but provides a much less unified theory ‘to that of neoclassical equilibrium’ (Turner 2012: 46). In the broader context of financial globalization, researchers focussing on the political economy of international monetary and financial issues have put forward some more radical reform proposals over the past decades and moreover highlighted the political, social, and cultural purposes of money and finance, including the role of power, ideas, and interests (c.f. Bello et al. 2000; Eatwell and Taylor 2002; Helleiner 2005: 152). These and other critical scholars have emphasized that the changes in finance over the past decades have fundamentally transformed capitalism and led to increased financial instability. The financial sector has grown much more than the underlying real economic activities and as a result the power of financial markets and institutions has grown significantly. In short, the problems are much bigger than recognized in free market theories and they are related to the transition to finance-led capitalism and financialization. When money comes into play, it takes on a part of its own and it starts to create motives and affects decisions in a rather unpredictable way based on expectations of market participants. Finance-led capitalism has done so in an unprecedented way compared to earlier stages of capitalist development. This new stage of capitalism has been characterized by an unparalleled growth of the financial sector, including the growth of financial markets and firms within and across countries, the financialization of non-financial firms, and the financialization of households. These transformations had a significant impact on how contemporary capitalism operates. Markets now dictate what credible policies are and if countries adopt policies that markets regard as not credible, they cannot be sustained for long (Kirshner 2003). Financial globalization and markets integration led to a new accumulation regime that has resulted in rising inequality in the most advanced economies since the 1970s. The slogan ‘we are the 99 percent’ of the Occupy movement or the surprising popularity of Thomas

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Piketty’s (2014) book ‘Capital in the Twenty-First Century’ reflected this reality. Leading international institutions such as the OECD, the World Bank and the IMF—at the center of pushing a neoliberal agenda over the past decades—started work on inequality in response to these pressures without dropping their support for financial globalization and financial integration. IMF economists questioned at least ‘some neoliberal policies’ and their impacts on increased inequality and called for ‘a more nuanced view of what the neoliberal agenda is likely to be able to achieve’ (Ostry et al. 2016). The World Bank (Gill et al. 2012) called the EU a powerful ‘convergence machine’ thanks to its unique regional economic integration and driven by trade and financial integration. Restarting this machine would not be difficult. And in another report, the World Bank suggested that this convergence machine would only need a simple upgrade to deal with the technological revolution ahead (Ridao-Cano and Bodewig 2018). The WTO insisted since the GFC that there would be nothing wrong with the rules for the global economy and its multilateral trading regime that would still generate the advantages of globalization; however, it would be the responsibility and task of member states to address the negative effects of globalization with redistributive interventions. Financial globalization, generating enormous advantages and wealth but also the rising inequality, has been driven by market developments and technological innovations not just in the financial sector but in the wider global economy as well as by financial integration policies including measures to deregulate and liberalize but also to reregulate markets and to harmonize regulation across jurisdictions. Regional and international monetary cooperation, transnational commercial and investment law, global, regional and transnational trade regulation but also domestic macroeconomic and trade policies as well as company and finance law all play crucial roles for deeper financial markets. Throughout history periods of domestic, transnational and regional expansion of markets led to a widely shared perception that capitalism as a system of highly dynamic, competitive and increasingly global markets promises a better future. Free(r) trade and more international financial flows resulting from deeper integration have been seen as beneficial since Adam Smith. David Ricardo’s (1817) classic refinement that even the poorest countries without any ‘absolute advantage’ but with a ‘comparative advantage’ would benefit from free trade expanded Smith’s promise of prosperity to all countries. Financial globalization has been attributed to an historic increase in wealth and liv-

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ing standards for a fast-rising global population. In general terms, economic integration and the spreading and deepening of international financial markets reduce local and national variation of product standards and variation in the provision and operation of (financial) services and increase cross-border transnational, regional, international, and even global market structures, (financial) products, financial transactions and other activities. Financial integration theory (see Sect. 1.1) is also arguing that more globalized or at least regionally integrated financial markets are superior to national autarky or less integrated markets as they increase market efficiency and fairness, support international trade, allow higher growth and development including in poorer regions and countries, and provide better protection against crises. Economic and financial systems have shown variations of market imperfections over time and in different market areas. Capitalism and different forms of capitalisms evolved with different regulatory styles to address such imperfections throughout their history. True free markets never existed and as Karl Polanyi (1944) showed even laissez-faire capitalism required state intervention to come into existence. However, even if free markets existed, they would never be a panacea as they are never perfect markets and always produce market failures. Adam Smith already observed negative developments within the free market. ‘People of the same trade’, Smith (1776: 226) lamented, would use every opportunity for ‘conspiracy against the public’ and form cartels to increase prices, reduce competition pressures, and make higher profits. It is this observation that made it into many antitrust and competition law textbooks, although he explicitly rejected in the same paragraph the idea that law could do anything against such business practices. In his skeptical view all that law could provide was doing ‘nothing to facilitate’ them. Antitrust or competition law has nevertheless become a key area of state intervention in regulating capitalist money and market economies in a highly competitive world economy. Emerging from strong distrust against big companies, the formation of cartels, monopolies, or other anti-competitive behaviors countries across the world have created more or less interventionist policies to protect markets and consumers. For the financial sector some areas are dealt with by competition authorities, others by financial regulators. Competition and competition law matter for finance in various area such as market structures and size, market efficiency and fairness, innovation in the sector, the quality of the products and services, the access to finance, and the overall costs for financial services. In EU member states’ bailouts of financial insti-

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tutions state aid provisions have additionally played a role to avoid unfair advantages for individual failing financial institutions from state subsidies. Competition law, however, failed in its contemporary neoliberal version to address or stop problematic developments in the sector. Both intense competition and lack of competition have become problems: unfair competition from tax havens or offshore finance has become a general market feature undermining states’ capacities to provide public services and also creating unfair competitive advantages for larger corporations over smaller purely domestically operating ones; in several markets rather monopolistic or oligopolistic structures emerged that allow market manipulation and fraud; mergers and acquisitions created financial mega-firms that have become systemically important and therefore too-big-to-fail, often with significant cross-border impacts on financial instability; the unfair competition between regulated and unregulated parts of the industry was not recognized as a concern; capital requirements privileged large corporations over small and medium-sized enterprises (SMEs); the privileges of finance compared to sectors in the real economy were also not recognized as issues: finance is often described as undertaxed compared to other industries and high profits in finance undermined investment in the real economy leading to ‘growth without production’ and ‘profiting without producing’ (Lapavitsas 2013); consumers of financial services were insufficiently protected against fraud, market manipulations and toxic products; and the application of competition law, including weak enforcement, led to an overall increase systemic risks. Beside these older problems competition law and central bankers became more recently concerned about the entry of large technology firms into financial services, raising complex risk-risk trade-offs between financial stability, competition, and data protection.

2.3   The Rise of Finance-Led Capitalism: How Neoliberal Financial Market Integration Has Increased Financial Instability Finance offers key services for states, businesses, and individuals in planning the future, be it for financial transactions or investment that pays off later or insurance against unforeseeable catastrophic events. Rising living standards have supported a growth in the demand for financial services as the amount of savings, accumulated capital, and the desire for protection

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against risks increased. In periods of growth and financial expansion there is generally widespread support for financial integration and countries put energy into improving their investment climate, while markets explore the opportunities provided by the latest technological developments and financial innovation flourishes to maximize profits. But during periods of deep economic contraction, deglobalization, and financial disintegration capitalism itself has frequently become questioned and protectionist measures returned that reduced the openness of countries. Especially since the 1970s, financial globalization dramatically increased the vulnerability of states in the global economy by leading to hyper-globalization. This new system is characterized by further fundamental transformations: the key international institutions have driven a neoliberal agenda which became the hegemonic theory and practice of economic and financial integration of the late 20th and early twenty-first century, nation states have become ‘national competition states’ (Cerny 1990; Fougner 2006) and ‘consolidation states’ (Streeck 2015), the role of markets and their regulation has radically changed, the political systems, markets and companies have become short-term oriented, large corporations have become more powerful and learned how to tailor international and transnational treaties as well as domestic laws in their special interest, and capitalism itself has turned into finance-led or finance-dominated capitalism. This transformation is not just about the liberalization and deregulation of finance but also a liberalization and deregulation of corporate law with a focus on shareholder value, a ‘deregulation of labour markets, reduction of government intervention into the market economy and of government demand management in economic policy, [and a] redistribution of income from (lower) wages to profits and top management salaries’ (Hein 2012: 1). With escalating competition between national economies various smaller economies discovered the competitive advantage of copying the business model of offshore financial centers and joined the group of tax havens. Over the last three decades, corporate taxation fell significantly across all advanced economies (IMF 2019). That capital markets moved beyond state control and that states could no longer control or even manipulate their currencies for trade advantages or to respond to domestic pressures was now praised as a huge advantage of markets disciplining government behavior by stopping governments from departing from strict fiscal rules. The state gave up the role of active involvement in business sectors, often via nationalization and state ownership; it was transformed into an ‘enabling state’ that no longer “rows” but “steers” as Osborne and Gaebler

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(1993) famously coined the new phrase for the “competitive” and “market-­driven government”. The state also transformed into a new regulatory state, that leaves sector-specific regulatory oversight and i­ ntervention to independent agencies or to industry self-regulation. This extremely business-friendly environment, created by markets and states, expanding since the 1970s has been described as neoliberalism or as regulatory capitalism as a new order with yet more public, private, and hybrid public/ private regulation but still leading to market and governance failures (Levi-Faur and Jordana 2005; Braithwaite 2008). Finance-dominated capitalism and neoliberalism has been most developed in the Anglo-Saxon model of liberal market economies (LMEs) and spread since the 1970s to other countries, including the coordinated market economies (CMEs) and mixed and other variations (Hall and Soskice 2001). The LMEs have created the most developed financial systems and capital markets and the most liberal systems of corporate law. Yet talking about an Anglo-Saxon model does not mean that the U.S. and UK capital markets and their regulation would not also have remaining differences since they became themselves more similar following the 1980s liberalization and deregulation (Jordan 2014: 110). With rocketing profits in the financial sectors and high returns on equity, profit making in the economy became increasingly generated via financial channels while productive activities lost importance (Krippner 2011: 4). This system became based on extreme leverage, extreme speculation, and short-termism undermining the long-term stability and making the system deeply unsustainable and resulting in rising current account imbalances at the global level and within the EU.  With finance-led capitalism rising, the ‘most advanced markets’ in the LMEs became propagated as the most dynamic and most flexible systems, allowing fast adjustments needed in the age of globalization and therefore providing the superior system to which all other countries should converge. Different capitalisms and their advantages and disadvantages in global competition have been compared for a long time. Shonfield (1965) compared the U.S., the UK, France, Germany and some other European countries by studying their economic trends, approaches to planning, and market ideologies. His analysis showed Germany as a highly dynamic economy for which state intervention had provided long-­ term planning security in industry, while the UK was held back by a stop-­ and-­ go policy that changed with every new government creating uncertainty for investors and businesses. In the age of the new information and communication technologies in the 1980s, the U.S. and Japan seemed

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to be most successful, while Europe was generally perceived as falling behind. For the age of finance-capitalism, Hall and Soskice (2001) with their Varieties of Capitalism theory challenged the dominant assumption that LMEs had become superior by arguing that countries’ competitiveness depends on institutional complementarities between complex domestic arrangements encompassing rules and practices in education, labor, corporate governance, and finance. Different capitalisms generate different advantages in global competition. The Anglo-Saxon LMEs would especially be superior in sectors where easy access to risk capital and a highly flexible labor market are important; CMEs on the other hand have traditionally strong relationship-based banking systems, a highly skilled and specialized workforce, and other features supportive for other industry sectors. To protect these advantages, they must resist the temptation to adopt the much deeper capital markets and other features existing in the LMEs. Yet the dominance of finance affected all varieties of capitalism, with financialization as the new phenomenon meaning ‘the increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of the domestic and international economies’ (Epstein 2005: 3). This system created numerous corporate and financial scandals, speculative bubbles and economic and financial crises, with the GFC of 2007–2009 becoming the most severe crisis since the Wall Street Crash of 1929 and the following Eurozone crisis constituting a specific fallout from its particular European model of finance-led capitalism. At the beginning of the GFC, many politicians and pundits in continental Europe saw this as a crisis of Anglo-Saxon capitalism which had become too extreme but which could not affect continental economies, only to be proven wrong by the following events that showed it is a continued crisis of an inherently instable finance-led capitalism. Despite the list of advantages attributed to perfect integration and even to deeper integrated financial markets (see Sect. 1.1), financial globalization and integration have become highly controversial topics within the globalization debate. Since the end of WWII economic globalization has increased global trade and transnational financial transactions as well as vulnerability of national economies significantly. The liberal international economic order of Bretton Woods had included protections for states from financial speculation that were abolished with what Coleman (1996: 2) called ‘the most extensive legislative overhaul of financial services since the Great Depression in the decades since the 1970s’. The ideas behind those radical changes were based on ‘monetar-

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ism and neo-liberal views of finance’. Monetarism was the new economic paradigm developed by Milton Friedman that replaced Keynesianism by shifting the focus from government expenditure and deficit spending to controlling money ­supply and advocating tax cuts to boost investment, spreading in variation and different speed throughout the world since the 1970s. In a first period of the Bretton Woods years national controls persisted and a new international monetary system provided stability for economic recovery and growth which were more important at the time than free finance (Helleiner 1994). Already in the 1950s, financial markets became increasingly international, in the 1970s the process speeded up with the removal of various restrictions and markets quickly became global in a new period of neoliberal globalization. Deregulation and liberalization of capital and financial markets as the new powerful trends throughout the world have led to an ever-increasing importance of financial motives and interests that made it difficult to continue with the policies of the Bretton Woods period. Leading neoliberal economists such as Milton Friedman, Friedrich Hayek, and George Stigler who opposed state interventionism by upholding free markets, limited government, and personal liberty under the rule of law had built networks and think tanks such as the Mont Pèlerin Society that pushed their ideas in a new epistemic community. Their agenda received significant support from big business (Helleiner 1994; Mirowski and Plehwe 2009) as well as from U.S. President Ronald Reagan and UK Prime Minister Margaret Thatcher during the 1980s. Reaganomics, however, was no pure neoliberalism as it combined tax cuts with high public spending, funded by increased borrowing, and Thatcher gave her blessing to the EU Single Market that led to a large amount of new European regulation (see Chap. 3). In that new environment, sovereign states have lost the capabilities to control and tame markets although it was them that played the key role beside new technologies and other changes in markets in this transition and an increasing number of state actors adopted the new economic paradigm (Strange 1986; Helleiner 1994). That finance has gone global and now operated increasingly outside the framework of nation states was hailed as success by supporters of financial globalization. With money flowing virtually unregulated across borders looking for ever higher returns, financial markets turned into “creatures of investors and the private sector” responding “solely to the profit motive” (Kapstein 1994: 4).

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The characterization of globalization as neoliberal, however, has remained controversial. The term has been defined in different ways and included scholars with rather opposing ideas, ranging from the Austrian School, the Chicago School, to German Ordoliberalism. Although these schools share a strong support for free markets and competition, their recommendations for monetary policy, financial integration, and financial regulation show a great variety. As for the success of neoliberalism as an economic and political concept, it has been repeatedly argued that neoliberalism only existed in the Anglo-Saxon varieties of capitalism or that it never existed in terms of markets really becoming fully liberalized and deregulated. With the observation that the result of such policies was not a hollowing out of the state and the emergence of an unregulated free market, but reregulation in form of even more states and private regulation (Vogel 1996), Braithwaite (2008) opposed the claim that we would life in an era of neoliberalism as a fairytale. Others, however, have distinguished between neoliberal theory and neoliberal practice and defended the use of neoliberalism as a valuable description of contemporary finance-­ led capitalism despite the theories’ inconsistent influences on politics and policies (c.f. Pesendorfer 2012). Macartney (2011) used the term neoliberalization as a process. Applying it to financial market integration, he described it as a ‘precondition and product of the global restructuring of capitalism’ and argued that neoliberalization has led to new discourses on competitiveness, market liberalization, institutional reconfiguration, and corporate governance reforms. Bob Jessop (2018) describes neoliberalization as a ‘variegated, partial and hybridized process’ that evolves around ‘a core policy set that compromises: liberalization, deregulation, privatization, recommodification, internationalization, reductions in direct taxation, and decriminalization of predatory economic activities’ and especially the ‘decriminalization of financial crime’. The French regulation theory described the evolution from the post-­ WWII fordist period to post-fordism starting in the 1970s as an ongoing transition toward a finance-dominated regime of accumulation, in which ‘barriers between banking and non-banking activities are removed’ and the system of market finance with its predominance of institutional investors becomes crucial and responsible for a shift towards short term maximization of their equity ‘under the constant threat of hostile mergers and leveraged buy-outs’ (Aglietta 1998: 69). The term finance-led capitalism has since then become adopted by European post-Keynesian economists

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(Guttmann 2016). Susan Strange (1986) was another pioneer in criticizing the increasing importance of finance and the emergence of extreme speculation in ‘casino capitalism’. Throughout the 1990s, neoliberal globalization critics had argued that neoliberalism and globalization themselves have become expressions of the supremacy of finance which has significant political and distributional implications. These literatures were then resulting in the financialization concept (Epstein 2005) that describes the ongoing crisis of capitalism as an unsustainable system of massive wealth redistribution and multiple sources of instability and fragility that lead to ever more costly crises (c.f. Epstein 2005; Lapavitsas 2013; Krippner 2011). In this context, the concept of financialization is part of a broader debate about a significant shift in the structure of the most advanced economies, referring to ‘a broad based transformation in which financial activities […] have become increasingly dominant’ (Krippner 2011: 2). Building on Karl Polanyi’s Great Transformation (1944), Krippner emphasized the importance of state action in creating and driving financialization via deregulation, liberalization and other neoliberal policies. Liberalization, deregulation and globalization of financial markets and financial innovation especially since the 1980s have been interpreted as ‘a very successful market fundamentalist project’ (Soros 2008: 95) which—despite enormous innovation in risk management—brought back financial crises as a systemic risk. Leading economists like Joseph Stiglitz (2002) also remained skeptical about the benefits and warned about contagion risks that had evidently become a problem in the second half of the crises of the 1990s. Others saw international capital markets in a major transition and in need of reforms (c.f. Eatwell and Taylor 2002). Mishkin (2006: 8f.) defended financial globalization against critics and presented the financial revolution as a powerful driver to lift disadvantaged nations into prosperity. However, he also acknowledged the destructive forces that badly designed financial globalization can release and called for ‘cautionary lessons for countries hoping to globalize successfully’ (ibid.: x). Rather typical for the pre-GFC period (c.f. Obstfeld 2009; Rodrik 1998), Mishkin (2006: 211) analysed the failures in emerging market economies for which he suggested in opposite to others who recommended implementing the policies and approaches from the most advanced economies that these would not work in poor countries.

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2.4   Regulating Finance after the Global Financial Crisis In the shadow of the worst financial meltdown since the Great Depression, many policy makers and pundits have observed that “a crisis is a terrible thing to waste.” That is true. We will plant the seeds of an even more destructive crisis if we squander the opportunity this crisis has presented us to implement necessary reforms. That opportunity would be a terrible— indeed, a tragic—thing to waste. Roubini and Mihm (2010: 301)

The GFC was widely seen as a unique opportunity and a policy window for more radical change in financial regulation, especially among the critics of neoliberal financial globalization. However, whether that opportunity was used to create a much more stable and resilient financial system that will make the costs of future crises less severe or wasted by modifying some of the most extreme features of the system without addressing the underlying real sources of financial instability, is one of the major controversies in the rich literature that has emerged over the past decade on the GFC. It is little surprising that this literature is neither agreeing on what the causes of the GFC were, whether it was a result of government or market failure or a combination, whether it could have been avoided or made less costly if early intervention would have happened, or what regulation and supervision could and should achieve. What is certain and widely accepted is that a decade after the GFC, the global and European financial systems remain fragile, and the financial markets conditions could easily and abruptly deteriorate if dramatic political and economic events occur. The IMF (2018), one of the key neoliberal international financial institutions that failed to predict the GFC resulting from its policy recommendations, took stock of the financial reforms over the last decade since the GFC and answered the question whether we are ‘safer’ by pointing towards some ‘undeniable’ progress. ‘New supervisory and regulatory standards, tools, and practices have been developed and implemented across the globe’. A new financial architecture had been put in place and a repeat of the Great Depression was avoided with internationally coordinated measures. Yet the report also highlighted ‘clouds […] on the horizon’ and expects that the overall resilience of the system will still have to be tested in a future crisis. It would therefore be ‘crucial for countries around the world to complete and implement the global regulatory reform agenda and to resist the call to roll back reforms’ (ibid.: vii). The IMF’s 2019 Global Financial

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Stability Report surveyed the vulnerability over the period since 2000 for 29 systematically important economies. It identified vulnerabilities across regions and sectors including sovereigns, firms, banks, nonbank financial institutions, and households. The rising corporate debt levels and companies with high leverage and weak earning prospects and other vulnerabilities could easily amplify ‘if adverse shocks materialize’. Like in the previous year, the IMF called on countries to address the vulnerabilities. Representatives from the IMF, key central banks and regulators have repeatedly warned in recent years, not to pause reforms in the calmer period and to resist rolling-back reforms. The latter is in response to growing pressure from financial industry to address overregulation and ‘unintended consequences’ of regulatory reforms that were adopted in a rush in response to high public expectations and demands not to undermine financial innovation. Throughout history financial crises have led to regulatory intervention to manage the economic fallout and to establish a new regulatory framework that would make future crises less severe by allowing early intervention. Such periods of stricter regulation and stronger supervisory powers are in contradiction to policy recommendations from market fundamentalists who were much more supportive of the periods of deregulation and liberalization that repeatedly followed once countries returned to economic recovery. This dynamic results in a pattern of regulatory change from more state regulated to more privately regulated markets which was part of the financial instability inherent to capitalism as described by Minsky. Gerding (2014) adopted Minsky’s work for a framework based on a ‘Regulatory Instability Hypothesis’, which includes ‘five dynamics’ that ‘weaken financial regulations just as the storm clouds of a financial crisis gather’ (ibid.: 3): a regulatory stimulus cycle, compliance rot, regulatory arbitrage frenzies, procyclical regulations, and herd-promoting regulations. Since the GFC, this typical pattern has reemerged, of course, with very particular features related to the contemporary state of financial globalization and financial integration. It is therefore not surprising that the IMF like many other financial regulators have warned not to forget financial history again and ‘to resist the call to roll back reforms’ (Lagarde 2019). Even regulators have started a discussion about ‘regulation as a burden’ and the need for ‘smart regulation’ that ‘eliminate(s) unnecessary burdens’ (Dombret 2017), and at the EU level we also see a new call to remove ‘barriers’ to financial integration (see Chaps. 5 and 6). To break the usual cycle in the creation of financial instability Gerding proposed to

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re-think the design of regulatory institutions and to transform them into ‘adaptive institutions’ that operate on the basis of ‘adoptive laws’ and countercyclical rules. He also suggested to create new watchdogs that could ‘fight against deteriorating regulation, ill-conceived interpretative changes, and lax enforcement’ (Gerding 2014: 506). A public body should be created for that purpose that issues reports for regulatory reforms. ‘Regulatory contrarians’ within the financial regulators should also be used following examples of inspector generals and ombudsmen (ibid.: 507). Other reforms include regulatory peer reviews and more transparency. Tucker (2019) made a similar proposal for central banking, suggesting that central bank staff should annually ‘publish a complete statement of all relaxations and tightenings of regulatory and supervisory policy’ and this data should then be assessed independently by external audit, ‘possibly by the central auditor of the state’. Tucker did not describe whether the data would be widely available for the public and for independent researchers and how this information would be limited by confidentiality rules. Overall, these kind of reform proposals do not go as far as suggestions in the ‘regulatory capture’ literature such as, for example, the classical proposal by Ayres and Braithwaite’s (1992) ‘responsive regulation’ approach that suggested to have strong public interest groups accessing information and reporting back to the broader public. The background of such reform proposals has always been that once a crisis is over, the public loses interest in a topic and regulators quickly become cosy and captured by industry interests that are much stronger during ‘quiet politics’ (Culpepper 2011). Countercyclical rules and ‘adoptive laws’ found their way into post-­ GFC financial reforms which have also been based on an acknowledgment of systemic risk and the need to not just improve prudential regulation and supervision but also to establish a macroprudential framework with new institutions responsible for its implementation and enforcement. However, the principal problem remains that finance has become global with regard to key markets while regulation is still largely limited to the national level—or the regional with further integration of European financial markets. The G20 has become the main forum for policy coordination among the leading economies, but the new international financial architecture is still based on regulatory competition and regulatory arbitrage and an overall reformist policy agenda that did not put into question the key features of finance-dominated capitalism and try to transform this system into a fair and more stable system, which is no longer finance-dominated.

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Roubini and Mihm (2010: 300) concluded that ‘the likelihood of future crises’ has increased and we might have as a result in the coming era not a Great Moderation but a ‘Great Instability’. ‘Asset bubbles and busts’, they argue, ‘may occur more frequently, and crises once thought to occur only once or twice a century may hammer the global economy far more often’ (ibid.). If governments would fail to ‘reduce the frequency and virulence of asset booms and busts’, ever more frequent and severe crises could lead to ‘protectionist trade policies; financial protectionism, with restrictions on foreign direct investment; capital controls; and a broader rejection of any policies that promote free markets’ (ibid.). More government and ‘increased regulation’ would be necessary ‘to keep booms and busts from occurring’ and to make ‘free markets function better’ (ibid.: 301). There overall conclusion for regulation is: ‘Crises may be here to stay, but governments can limit their incidence and severity’ (ibid.). Yet how governments can do that and resist the pressure from markets is one of the highly controversial topics of our time. Mainstream neoliberal thinking has been adopted to behavioral economics and (post)Keynesian and other heterodox economic theories remain largely marginalized. While there are increasing pressures to address post-crisis overregulation, it has been argued that smart meta-regulation and system stewardship would provide solutions (Ali 2012). Smart regulation usually means that regulation should be adaptive to markets and financial innovation for the sake of growth and jobs creation. It also means that regulators should remain independent agencies or central banks. Tucker (2018) has argued that since central banks emerged out of the GFC as ‘third great pillar of unelected power alongside the judiciary and military’ it would be necessary to establish clear principles that allow central bankers, technocrats, regulators, and other agents of the administrative state to become ‘stewards of the common good’. The most important common goods in finance are system resilience and financial stability. However, the legitimacy of independent central banks has come under severe pressure in recent years which is part of an ongoing discussion about what central banks and other financial regulators should do, if they even can be ‘independent’ and whether the neoliberal conception of central banking is compatible with achieving other social goals. In a more traditional way, debates have focussed on how to avoid that financial regulators and supervisors get captured by industry interests and can serve a ‘public interest’ especially when they already share the same ideas about finance and financial stability.

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In the aftermath of the GFC, financial regulation had shifted globally as well as in Europe from extreme market fundamentalism towards more regulatory intervention, and some had expected an even more radical swing towards stricter regulation based on the assumption that this was a crisis not only of finance but of the underlying dominant economic paradigm of neoliberalism that had emerged since the 1970s. This swing was sometimes described as a regulatory pendulum reflecting the idea that (financial) regulation would go from one extreme to the opposite. The end of neoliberalism was already predicted during the 1990s when several key European countries shifted to the left and social democratic parties took power, in some countries in coalition with green parties (c.f. Bischoff et al. 1998). However, finance-led capitalism had increased the vulnerabilities of national economies significantly and global financial markets seemed to force governments into discipline. Some experts thought that finance had become too complex and too opaque and only a major international financial crisis could increase awareness of the dangers from a highly fragile financial system that could then create sufficiently strong public pressure for reversing the trends of neoliberal globalization and finance-led capitalism (Helleiner 1996). Now, with the GFC revealing the dark side of modern finance, the greed, the extreme speculation and leverage, the unregulated ‘shadow’ activities and institutions that had evolved without any regulatory oversight, the toxic products, fraud and market manipulations by the ‘masters of the universe’ and unnoticed by supervisory guardians, capitalism itself was entering crisis mode. Since the trust in the market as a discovery mechanism steered by Adam Smith’s (1776) “invisible hand” had so dramatically failed, demands for an end to market fundamentalism and for a strong “visible hand” of strict regulatory intervention got suddenly attention (Griffith-Jones et  al. 2010; Grant and Wilson 2012) as markets were on trial (Lounsbury and Hirsch 2010). ‘Never let a good crisis go to waste’ became the slogan echoed in the reform debates by all those like Roubini and Mihm (2010) who did not belief that a crisis was a cure to all the wrongs in the system leading markets to self-correction solely thanks to more risk-averse and risk-aware economic actors and without any regulatory intervention. Skepticism in efficient and self-correcting markets and the severity of the crisis led to rethinking the very nature of contemporary capitalism. The Financial Times started a series on the “Future of Capitalism”, the New York Times one on “A Great Divide”, the Guardian one on ‘Broken Capitalism’, and international financial institutions translated concerns about financial

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­ lobalization and rising inequality into a new agenda for “inclusive capitalg ism” and calls for more financial integrity (c.f. Lagarde 2014; Cournède et al. 2015). The EU incorporated ‘sustainable and inclusive growth’ into its ‘Europe 2020’ growth and jobs strategy for which Eurostat developed indicators to measure progress towards ‘smarter, greener, more inclusive growth’. Experts within international financial institutions and national central banks started a debate whether financial globalization has gone too far, whether there is now ‘too much finance’ that no longer has any positive effect on economic growth, and what the right size of finance would be (Arcand et al. 2012; BIS 2012; Cecchetti and Kharroubi 2015; Haldane 2012; Obstfeld 2015; Turner 2010). Arcand et  al. 2012, for example, found that once credit to the private sector exceeds 100% of GDP, ‘finance starts having a negative effect on output growth’. Many scholars pointed towards ‘how finance exploits us all’ (Lapavitsas 2013), how ‘reckless’ finance and unrestrained greed had led to economic Armageddon (c.f. Morgenson and Rosner 2011, Phillips 2008; Tett 2009), questioned the ‘social value of the financial sector’ (Acharya et al. 2014; Zingales 2015) or even saw finance as a ‘curse’ ‘causing widespread damage to democracy and society’ (Christensen et al. 2016; Shaxson 2018) resulting in proposals for ‘embedding the international financial system’ (Abdelal and Ruggie 2009), to close the casino (Sauer et al. 2009) and return to ‘boring banking’ (Krugman 2009), also described as ‘relationship banking’ in which trust plays a crucial role and banks fulfil the traditional role as intermediary bridging savings and investments in the real economy. More recent research has confirmed that relationship banking gives small banks ‘a comparative advantage in using soft information since such information is easier to be conveyed within a less complex organization’ (Berger and Roman 2018: 272). A systemic crisis of that magnitude would necessarily justify a radical change and some now hoped that the crisis might result in taming finance, re-embedding finance into the wider economy and that a more active form of state interventionism could enable a transition towards a more ethical “decent capitalism” (c.f. Dullien et  al. 2011). Zingales (2012) asked how ‘crony capitalism’ and ‘crony finance’ could be transformed back into ‘a capitalism for the people’. Even further went critical theorists who demanded a democratization of finance and a radical transformation of finance into more local and regional structures and of investment that it becomes socially beneficial (Block 2014; Huffschmid 2009). For the establishment in finance, many of these ideas were ‘horrifying solutions’ (Blodget 2009); financial industry intensified lobbying with

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vast amounts of money and other resources, and business associations and leading academics warned about potential unintended consequences of fast overreaction to public pressure. Goodhart (2010: 162) warned ‘any fool can make banks safer’ but it would not be wise to take simple measures without careful consideration of the ‘cost to regulation’. Many experts and regulators have described the post-GFC regulatory environment as too burdensome and in need for scaling back that would even increase financial stability (Ricks 2016). In the meantime, a new wave of deregulation has started, and European financial markets integration policies have become part of that movement with the aim to systematically identify and remove obstacles to deeper financial integration. Although justified in some areas and resulting in useful harmonization, it boosts in other areas highly problematic market developments and will therefore increase financial instability (see Chaps. 5 and 6). Three key former American regulators just warned that the United States (U.S.) has mistakenly introduced a dangerous ‘mix of constraints on the emergency policy arsenal’ of financial regulators and supervisors that are ‘dangerous for the world’ (Bernanke et al. 2019: 129). Over recent years, several rising risks in financial markets have been identified including market developments in the U.S. and in emerging markets, China’s growth of private and commercial debt, its banking system and its rising shadow banking system, and the various ongoing problems in the European economic and financial system. Whether finance has become too dominant and whether it enjoys the right level of regulation or is overregulated or underregulated has been a heated debate within the broader globalization discourse. Susan Strange (1986, 1998) was an early voice warning about how markets outgrew governments and how casino capitalism with excessive speculation and an explosion in new and highly toxic financial products undermines stability; Bourdieu et al. (2001) described the new system as “terror of the economy” resulting in more social injustice and inequality; Ann Pettifor (2006) lamented about “lawless finance” in her warning about “the coming first world debt crisis”. There are numerous examples of regulators and lawmaker before the GFC arguing for deregulation and against regulation to protect their country’s financial industry’s global competitiveness. There are even examples of regulators trying to intervene into markets such as OTC derivatives that were then stopped by new legislation to do so. Despite such a clear trend towards deregulation, liberalization, and business-­friendly light-touch regulation and soft law, finance in many areas

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faced ‘strong regulation’ with an ever-increasing mix of private and public regulation (c.f. Picciotto 2011). Since the GFC the regulatory burden clearly increased. In the U.S. the Dodd-Frank Wall street Reform and Consumer Protection Act of 2010 passed during the Obama administration is 848 pages long has led since then to the release of numerous rules, guidance and exemptive orders by the regulatory authorities, running into 1000s of pages. Dodd-Frank has therefore been called a ‘full employment act’ for lawyers, corporate accountants, financial consultants, risk management advisers, and regulators (Dash 2011). Critics of this new complexity of financial regulation pointed how Dodd-Frank compares with older financial legislation: The Federal Reserve Act 1913 had 31 pages, the Glass-Steagall Act 1933 37 pages, the Interstate Banking Efficiency Act 1994 61 pages, the Sarbanes-Oxley Act 2002 66 pages and Gramm-­ Leach-­Bliley Act 1999 145 pages. The EU proposed more than 50 legislative and non-legislative measures over the past decade. For the UK, Lord Mervyn King (2016: 260) summarized that ‘the Prudential Regulation Authority and the Financial Conduct Authority have combined Rulebooks exceeding ten thousand pages.’ The compliance costs such complex legislation requires has been criticized by many, including King (ibid.) who described it as ‘a large ‘dead-weight’ cost to society’ and foremost burdensome to small firms and potential new market entrants. Yet many have insisted that more deregulation and light-touch and industry self-­ regulation would be necessary to keep national or regional financial systems competitive in an ever deeper integrated global market and to avoid ‘market distortions’ (c.f. Friedman 2011). A key feature of post-GFC financial regulation are macroprudential policies aiming at preventing the excessive build-up of risk by countercyclical interventions, making the financial sector more resilient and reduce contagion effects within the financial system, and encouraging a system-­ wide perspective in financial regulation with the right incentives for financial institutions. Claudio Borio (2003), chief economist from the Bank for International Settlements’ Monetary and Economic Department, had already earlier proposed to address financial instability with a new macroprudential orientation in financial supervision and regulation, justifying this approach with the potentially high costs of financial instability and the nature of financial instability and systemic risk. His third reason reflects a particular dilemma: Borio argued that microprudential regulation can become ‘overly protective’ as regulators would seek to avoid any reputational damage from bank failures. In such a situation an ‘overly generous

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safety net’ could create a ‘moral hazard problem’ (ibid.: 5). In his view and in contradiction to what for example the Turner Review (FSA 2009) showed for the UK, bank regulators had already become ‘macroprudentialists’ and the trend would continue (Borio 2003: 1). Yet since the GFC significant work has been produced to rebalance and finetune micro- and macroprudential regulation. The International Monetary Fund IMF (2013) has highlighted that macroprudential policies require ‘strong ­institutional and governance frameworks’ and coordination across countries to ‘contain systemic vulnerabilities’. However, the macroprudential policy frameworks have still gaps and need to be monitored how they develop and that they become effective. The IMF has repositioned itself as ‘a global macroprudential facilitator’ (ibid.: 37) and has taken over a surveillance role and provided guidelines for a common understanding of this new approach, its relationship to related policy areas, its operationalization, institutional arrangements, and multilateral issues. The IMF has recognized some of the core problems for macroprudential policies that arise in related policy areas. Standard responses in monetary policy have been identified, that can increase instability; in fiscal and structural policy the IMF listed among other issues that corporate tax systems have a ‘debt-­ bias’ by encouraging the use of debt over equity finance—an issue that has been raised by critics for years. The IMF (ibid.: 11) acknowledged the existence of a large empirical literature and ‘the evidence that this effect matters for leverage choices of non-financial companies, as well as financial institutions.’ In a paper for the G20, the IMF had already in 2010 demanded that states should take actions to reduce ‘tax distortions that run counter to regulatory and stability objectives’ and recommended a ‘Financial Stability Contribution’ (FSC) that should be ‘linked to a credible and effective resolution mechanism’ and a Financial Activities Tax (FAT) (IMF 2010). The latter was a direct response to the popularity of the Tobin Tax—Financial Transaction Tax (FTT). Unlike the FTT that was specifically proposed to disincentivize extreme speculation and short-­ term transactions over long-term investment, the FAT was a rather neutral tax levied on the sum of a financial firm’s profits and remuneration, without any direct effect on financial activities or products (Pesendorfer 2013b). The IMF (2013) is still not addressing extreme speculation, HFT, and short-termism. With regard to competition policy, the IMF acknowledges incentives for excessive risk-taking that can create tensions between competition and financial stability and that modern banks in advanced economies are insufficiently regulated with traditional competition laws

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focussing on market structure. The IMF proposed a reorientation toward the TBTF problem and on ‘the permissible scope of activities rather than on market structure of banks’. Competition policy should be used to restrict the size of large banks and address market distortions created by TBTF institutions to create a level playing field. In times of banking crises, governments should temporarily permit higher concentration and government control of banks (IMF 2013; Ratnovski 2013). While the IMF now realizes that larger banks have become riskier despite diversification and that they create higher operational risk, it also warns against too little competition in the banking sector that could also lead to a TBTF problem (Ratnovski 2013: 4f). Macroprudential policies also need to be aligned with microprudential policies and with crises management and resolution policies (IMF 2013). Overall, the TBTF problem has not been solved and banking structures have even become more concentrated since the GFC. Several regulators and central bankers, including the governor of the Bank of England Mark Carney, have concluded that the right reforms here adopted since the GFC and that the financial system has therefore become sufficiently resilient. This resilience to hypothetical adverse scenarios has been explored by regulators with stress tests for banks and insurance companies, which have become more prominent and common and have become an ‘established … key part of the bank regulation toolkit’ (Dent et al. 2016). The tool as such already exists since the 1980s and was widely used by large financial institutions themselves; in 1999 the IMF introduced stress testing as part of its Financial Sector Assessment Program. However, the models used remained rather simplistic and they failed to predict major disasters. The experiences with post-GFC stress tests have been mixed as the tests immediately after the GFC had to calm markets and rebuild trust into the banks. After the first stress tests in Europe banks failed and needed bailouts after they had just passed stress tests. Later well-­ known banks such as Santander and Deutsche Bank failed tests and had to reassure the public to take measures. The Bank for International Settlement (BIS 2018) developed ‘stress testing principles’ and central banks including the Federal Reserve in the U.S., the Bank of England in the UK, and the European Central Bank (ECB) have established and refined their stress testing over recent years. The practices so far differ widely and some focus on microprudential risks of individual financial institutions, while others explore the macroprudential system-wide risks. Overall there is still need for harmonization of the stress test design to address the risks of large financial institutions and their cross-border activities (Baudino et  al.

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2018). Stress testing has also been criticized that it allows manipulation by the banks, that certain risks might be ignored or played down in the scenarios, and that it depends on regulatory accounting methods that cannot adequately reflect economic realities (Vickers 2019). For the UK, Carney has repeatedly stated over recent years, that the British financial industry could withhold a repeat of the stress it had during the GFC and that banks would also be prepared for a disorderly Brexit (see also BoE 2018). A recovery to strength is also frequently acknowledged for U.S. banks. The latest stress test results from the EU and Eurozone (EBA 2018; ECB 2019) showed an improvement since 2016 but the test did not report pass and fail and also did not include all banks. The British banks Barclays and Lloyds were the laggards in this health check evaluation. However, it was already back then widely acknowledged that many EU Eurozone banks continue to struggle with bad loans on their books. Interestingly the ECB (2019) did not state that Eurozone banks were resilient but only that they were ‘more resilient’ and the EBA was carful in comparing data between the recent and previous stress tests. In July 2019, the European Court of Auditors (2019) released a report criticizing the latest round of EU stress tests as too soft and that the scenarios used were too weak and even milder for countries with weaker economies despite their more vulnerable financial systems. The scenarios failed to take systemic risks sufficiently into account. Future stress tests should focus more on EU-wide systemic risks. Whatever the shortcomings of existing stress testing might be, the background to the debate is the realization that banks have been extremely leveraged and undercapitalized, that their ‘equity base had been allowed to become paper-thin’ (Tucker 2019: 2), and that higher capital puffers, including countercyclical capital requirements, increase their resilience in times of crisis. Yet in the immediate aftermath of the GFC, many warned that rising capital buffers at the time of economic meltdown would make recovery more difficult as banks would not be able to finance the real economy and therefore undermine growth and employment (de Boissieu 2017: 102). As a result, higher capital requirements adopted with the Basel III Accord and implemented in the EU with a revision of the capital requirement directive (CRD IV) and regulation (CRR) were designed to kick in gradually with full implementation only in 2019. However, the assumption that these new higher capital requirements would be enough has remained contested. King (2016: 259) rather vaguely states that none of the changes was ‘a mistake’ but ‘nothing fundamental has changed’

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(ibid.: 261).2 Admati and Hellwig (2013) made the convincing argument that banks would need much more equity and that it would not be ­difficult to get there without any delay and without harming economic recovery. ‘The easiest way to’ do so, they recommended, ‘is to ban banks from ­making cash payouts to shareholders and to require banks to retain their earnings until they have significantly more equity’ (ibid.: 172). Alan Greenspan is now also making the case for much higher capital requirements, even proposing that they are needed for both banks and shadow banks. In his book with Woolridge (Greenspan and Woolridge 2018: 445– 447) he argues that significantly higher capital buffers could be easily phased in over a number of years without having any negative impacts on earnings or lending. The resulting reduction of risk could then be used to cut back on the too burdensome supervision and regulation of financial institutions. Currently only banks that fail stress tests must cut their dividend payouts and share buybacks to preserve or build up their capital puffers. Dempster (2018: 13) came also to the conclusion that capital requirements remain insufficient. Moreover, he concluded that the rules for systemically important banks in the EU and in particular the contingent collateralized debt obligations (CoCos) have ‘contagion implications for the next crisis’ that ‘are frightening’. CoCos are high-risk, high-yield products that are designed as hybrid debt securities to help the issuing financial institutions, in particular undercapitalized banks, to absorb capital loss. They emerged as an innovation in banking, first issued by the Lloyds Banking Group in December 2009, and were incorporated into the new CRR/CRD IV in 2014 to help European banks meeting the Basel III capital requirements. The European Commission sees them as ‘promising instruments which would reduce the overall risk and recapitalize the bank without having recourse to taxpayers’ (Di Girolamo et  al. 2017). Tucker (2019) criticized Basel III as an improvement over Basel II but by far not achieving the resilience in the system policymakers frequently claim. In his view, the capital requirements fail to take into account the macroeconomic shifts that have taken place; banks would fail to update ‘their estimates of expected loss, probability of default and loss-given2  King (2016) suggested ‘radical reforms’ on the basis of his critique of financial alchemy, sympathizing with the Chicago Plan of 1933 and newer contributions to ‘narrow banking’ and ‘limited purpose banking. Such ideas have been criticized for several reasons (Bolton et al. 2019; Dempster 2018; Pesendorfer 2013a). Additionally, King suggested the central bank’s role as the Lender of Last Resort should be replaced by the ‘pawnbroker for all seasons’.

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default for the prospect of risk of a world characterised by low growth and weaker macroeconomic stabilization policy’ (ibid.: 5). Another issue that has been raised is that stress testing and capital requirements insufficiently reflect the risks emerging from the interconnections between the banking and the shadow banking systems. A key challenge for macroprudential policies is how to address problems and financial instability arising from outside the regulated sectors and cross-border spillovers. The shadow banking system remains largely unregulated ‘with many regulatory blind spots that should be addressed’ (Lagarde 2019: 10) while it returned to fast growth over recent years and could easily be affected by sharp adjustments in asset prices. Instead of regulating these institutions only the managers of funds have become subject to some reporting obligations to increase transparency over this market. To improve their image and get rid of the shadow banking terminology that became a point of reference in many policy documents and legislative texts post-crisis, the industry pushed for avoiding the term and naming the sector ‘alternative investment funds’. Securitization suffered during the crisis but did not disappear and regulators have been working over recent years to revive this market. OTC derivatives were also kept alive. For this toxic market central clearing houses have taken over a good part of the market that is now under their control. Clearing houses fulfil a number of important functions in systemic risk management; however, they also have the disadvantage of risk concentration and becoming an oligopolistic market which puts a small number of very large clearing houses center stage to regulating systemic risk and instability. Competition between clearing houses can further undermine financial stability (Dell’Erba 2017). Legislation for the orderly resolution of failing central clearing houses is still outstanding. The IMF suggested that ‘underwriting standards in high-risk debt markets, including leveraged loans’ should be a priority for regulation (Lagarde 2019: 10). Overall, securitization and derivatives are making a strong comeback since these markets collapsed during the GFC. They are still far above the level in the 1980s, when Susan Strange (1986) identified them as a main feature of casino capitalism that could undermine financial stability. Many other questions about the future of finance remain controversial and unsolved. Most would agree that finance needs to be redirected to take a long-term over the current short-term perspective and away from extreme speculation to productive investment in the real economy (see Chaps. 3 and 5). Proposals for downsizing finance and for a more

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­ recautionary approach in financial regulation have largely been ignored p in reforms over the last decade, while proposals for structural reforms have either been moderate like in the U.S. or in the UK or been dropped altogether like in the EU (see Chap. 6). Instead of radical change, reforms secured at least for now finance-led capitalism as will be argued throughout this book. European financial integration has been framed by these discourses over the past decades and remains deeply linked with the current system of financialization and finance-led capitalism. Many of the negative consequences of financialization and neoliberal globalization have widely been acknowledged. According to Hopkin and Shaw (2016), for example, financialization has led to increased inequality described as a ‘winner-take-all political economy’. Shaxson (2018) argues that countries with a too big financial structure would suffer under a ‘finance course’, describing the wealth extraction finance produces over other industry sectors and the entire real economy. Since 2008, mainstream scholars and key regulators have accepted a connection between financial globalization and systemic risk (c.f. Evanoff et al. 2009) and have started to question the evidence that modern finance increased growth and stability. Anand et  al. (2016: 2) argued that the traditional understanding of systemic risk has to be extended to include the macroprudential risk implications and the complexities of the financial system with all its parts, including shadow banking and the cross-border implications. For this new understanding they suggest relabeling it ‘new systemic risk’. Before the GFC, these debates had relatively little impact on policy responses to neoliberal financial globalization (Lane 2013). Acharya et al. (2014), Lord Turner (2010), Haldane (2012), and Cecchetti (2012) represent key scholars and regulators that have put forward the argument that beyond its ‘optimum size’ a country’s financial sector becomes socially harmful by generating ‘lower economic growth, steeper inequality, inefficient markets, damage to public services, worse corruption, the hollowing-­ out of alternative economic sectors, and widespread damage to democracy and to society’ (Shaxson 2018: 4). A volume edited by Acharya et  al. (2014) on ‘The Social Value of the Financial Sector’ discusses key areas such as extreme leverage, banking structures, financial innovation, supervision and provides an excellent overview of the thinking within key regulatory authorities. While leading scholars such as Shiller (2012) put forward ideas for ‘finance and the good society’ which still reflects a strong belief in leaving financial regulation largely to the market and trusts in financial innovation and international institutions such as the OECD, the

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IMF and WTO now advocating ‘inclusive capitalism’, ‘financial inclusion’, and ‘inclusive growth’ with more distributional policy interventions. Others have argued for a much more precautionary and interventionist approach (Epstein and Crotty 2009; Pesendorfer 2012, 2014; Picciotto 2011). Precaution has especially been advocated for downsizing finance, including winding up shadow banking system and controlling financial innovation. Neoliberal globalization has massively increased financial innovation and its diffusion across borders, largely designed to circumvent regulation and outside any regulatory oversight within the regulated and shadow banking systems. Lane and Milesi-Ferretti (2008) argued that compared to earlier waves of financial integration financial innovation has become a dominant driver in recent decades. The explosion of securitization and shadow banking supported a rising interest in financial innovation as they are in themselves a reflection of financial engineering designed to exploit regulatory loopholes and regulatory arbitrage. Attracted by profit expectations related to new asset classes foreign investors have created the demand and speculators specialized on gaining profits from arbitration resulting from asset price, tax and other regulatory cost differences. Financial innovation became a major cause of financial instability in finance-led capitalism. In any case ‘transformative strategies’ to overcome financialization and finance-dominated capitalism are facing serious challenges (Pesendorfer 2014). Regulating finance with transformative strategies is moreover only realistic within a wider program for an alternative globalization that needs to become based on a fair trading system and an acknowledgment of the limits of globalization, reconceptionalizes the role and functions of the state, and radically transforms the corporate structures behind the current inherently instable and unsustainable capitalist system.

2.5   From Finance-Led Capitalism to Inclusive Capitalism with Resilient and Sustainable Finance Throughout its history capitalism has proven to be a highly adaptive system, with markets driving as a powerful engine economic and social change. Marx and Engels (1848) and Schumpeter (1942) praised how capitalism replaced the old feudal structures and has since its victory p ­ ermanently revolutionized the economic and social structures, yet both doubted the system could survive. While Marx regarded capitalism as unable to evolve

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without rising destructive forces and predicted the end of capitalism, possible once the productive forces are fully developed, would require revolutionary action by the working class, Schumpeter anticipated a more evolutionary transition based on various trends, especially the trend towards  self-destruction in capitalism that led to demands for security, equality, and control of the economy. Polanyi (1944) described the emergence and expansion of capitalism as ‘the great transformation’. The free market, which could only emerge ‘planned’ and created by state intervention, begun working like a ‘satanic mill’, destabilizing society and disembedding the social fabric that holds society together, yet it would create a countermovement resulting in regulatory intervention to re-embed markets. This Countermovement took different forms over the past centuries, most prominently with the rise and fall of the organized working class. During the end of the gold standard period the working class became highly organized in trade unions and socialist parties that threatened the system, in the Bretton Woods years trade unions and social democratic parties in the West became highly integrated in the operation of state policies based on a social compromise between labor and employers, in various countries this was institutionalized in social partnership arrangements, and Stalinist parties in Eastern Europe had impact on economic integration policies in east and west; then in the neoliberal period trade unions and social democratic parties became much less influential. Weakened by failed ‘Keynesian’ policies and neoliberal reforms, they were also unable to adopt to new social issues such as environmental protection emerging as new policy domains in the 1970s and to changes in the labor markets following flexibilization and new wage bargaining practices. A wide range of NGOs emerged that filled some of the gaps but could only achieve marginal influence. Neoliberal policymaking became strongly influenced by think tanks, especially the ones with major industry funding and pushing for an industry-­friendly agenda. This was part of the ‘neoliberal counterrevolution’ against the dominance of Keynesianism. With the fall of the Berlin Wall the argument was frequently made throughout the 1990s that without any real-existing system alternative, even with the low attractiveness it had gained during most of its existence, capitalism would become more aggressive again. Social partnership then also lost much of its previous influence on economic policy making as employers and labor representatives found it increasingly difficult to agree on joint economic policies in the age of globalization and the national competition state. The new (anti-) ther-globalization movement of the 1990s became a rather mixed

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and loose coalition that failed to organize anything close in terms of masses to the working class movement a century ago. It remains contested whether a plurality of social movements can form a powerful coalition against wellorganised private interests in finance-led capitalism. The other factor driving the great transformation beside countermovement in Polanyi’s analysis is the process of disembedding and ­reembedding. The classical justification for regulatory intervention into markets has been market failure. Usury, speculation, fraud and market manipulation led early in the history of capitalism to interventions. Information asymmetry in financial markets became at the next stage of capitalist development a classical market failure identified as justification for financial regulation to protect investors and other consumers of financial services. However, capitalism has not always been able to tame markets and the system’s destructive forces continue to affect societies and the environment. Finance literature has described the Bretton Woods years as a form of reembedded markets that stabilized societies especially at the national level upwards and finance-led capitalism as a disembedded form destabilizing societies from the global markets level downwards. The rich data on financial crisis throughout history presented in Reinhart and Rogoff’s (2009) famous study of ‘eight centuries of financial folly’ became an influential point of reference in post-GFC debates. However, the international financial regime up to nowadays only provided a temporal fix, be it under the gold standard, the Bretton Woods or the liberal system replacing it and evolving since then into finance-led capitalism. It would also be difficult to distinguish what exactly allowed this temporal stability to occur as it might not necessarily have been a result of the interventions. One could be happy enough with such temporal fixes if they not only assured periods of prosperity but if there has been no alternative. This is basically the argument of the dominant view, expressed by Greenspan, that if we want no more busts, we would also have to give up booms based on the assumption that regulators could never know what the right moment for diffusing a speculative boom would be. One could also make the argument that it seems the current system survived the GFC remarkably well. Drezner (2014: 1) did exactly that by countering the broad consensus that the system of global economic governance failed in 2008–2009 with the observation that it ‘responded in an effective and nimble fashion. In short, the system worked’. However, the transitions from one international trading regime to another and from one financial system to the next were not only driven by market forces and political interventions and regulatory reforms, but

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there were always alternatives possible, if rarely feasible given the strengths of the dominant economic paradigms and the weaknesses of the alternative ideas, the countermovement, at the times of crises when the system was most open for alternative ideas. Keynes’ plan fully implemented would have led to other results; the different models within the varieties of capitalism clearly show countries that were much less affected by the GFC because they had kept stricter banking regulation, restricted innovation and allowed banks to make profits through traditional lending practices (Bell and Hindmoor 2015). If ‘the system worked’ means only that it survived, then it is a valid observation, if it becomes an excuse for excesses in finance and intolerable costs to society and to not take more radical reforms, this observation becomes deeply problematic and dangerous. In fairness to Drezner (2014: 185), he acknowledged to have presented a rather ‘rosy picture’ and remained ‘concerned about the future’ since ‘considerable amounts of fragility remain in the global economy’ and ‘neoliberal ideas remain privileged’ despite a short Keynesian intervention in 2008–2009. Critical about the institutional changes in global economic governance, Drezner (ibid.: 188) warned about a possible rise in forum-­ shopping. This practice has been a problem in several commercial law areas and it was also a major issue in the U.S. regulatory supervision system before the GFC with financial firms having the option to pick the softest regulator and regulators being dependent on financial firms for their funding. Climate change and increasing inequality were other challenges that made Drezner more skeptical about the future as ‘neither national governments nor global institutions will necessarily be well equipped to cope with the policy externalities and political resentments of that future’ (ibid.: 189). Yet he does not address the core issues related to contemporary finance-led capitalism and its challenges and his ‘rosy picture’ fails to clearly criticize—as the Stiglitz Report by the UN Commission of Financial Experts (2010: 1) did—that the international institutions and arrangements that were created to protect financial stability failed to do so, their responses were slow, and ‘some policies recommended by these institutions have facilitated the spread of the crisis around the world’. It might be difficult to identify when a boom turns into a toxic bubble; however, it is much less difficult to put strict rules, including product standards and other precautionary measures, in place that would necessarily downsize or even ban some currently highly profitable sectors, products, and activities.

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Like the transition in the global trade system from laissez-faire to protectionism to GATT/WTO/WTO+, each of the past international financial systems only generated resilience to a certain degree within their own antagonisms that led to crises and occasionally their evolution or replacement. Moreover, capitalism as a system has remained unsustainable and unstable not just because of reoccurring financial crises but also because of other deep-rooted contradictions. Despite creating historically unique prosperity for an increased number of people and providing us with goods and services we never knew we needed before sometimes getting totally dependent on them, capitalist societies have not been able to generate sustained growth without major economic crises or increasing destructive forces creating enormous losses to societies and businesses and high levels of involuntary unemployment and environmental degradation. Yet finance-led capitalism even increased poverty and inequality in periods of growth. This is where the distinction between different accumulation regimes and their minor and major crises, between crises that can be solved within the system and crises that require system transformation to be solved, becomes important. The more moderate ups and downs of business cycles, which have become manageable thanks to the invention of countercyclical measures and the invention of social welfare systems, led to the view that such crises are necessary for a dynamic innovative economy and have a healing character. Schumpeter (1942) coined the term ‘creative destruction’ as ‘the essential fact about capitalism’. He argued that the business cycle reflects product and process innovation in the economy and that failing firms should not be rescued but sent into bankruptcy as this would in a competitive market allow the surviving firms to return to profits. Destruction of capital and firms during such economic downturns would therefore not be something to worry about, but a creative process building the foundation for the next growth phase. Policy intervention should therefore not focus on the failing but on the surviving firms and foremost on supporting structural changes required for the next boom. The idea that rescuing failing firms via bailouts is dangerous and even a counterproductive market distortion, gained widespread attention in the aftermath of the GFC when many firms were rescued as too-big-to fail institutions and Schumpeter provided the arguments for bailout critics. Yet, Schumpeter’s hope in free markets was limited as he also doubted that capitalism could survive and predicted its end, although not in the way Marx had anticipated. He claimed that not capitalism’s breakdown but its ‘very success undermines

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the social institutions which protect it, and ‘inevitably’ creates conditions in which it will not be able to live and which strongly point to socialism as the heir apparent’. Classical Marxism expected that capitalism’s crises are the result of antagonisms in the capitalist mode of production and its accumulation regime that would ultimately lead to the working class revolting and overthrowing the capitalist system in a revolutionary act. Karl Kautsky (1927) then reinterpreted Marx’ crisis theory claiming that the revolution could not come before capitalism is ripe for it in its final crisis and that the working class should in the meantime fight for improving their living conditions via social policies and legislative change, leading to Marxists’ critique that Social Democracy had turned into the ‘doctor on the sickbed of capitalism’. Since then, various theories have been developed to argue that capitalism changed its nature and became more stable or even that crises other than business cycles would have become a thing of the past. In the postwar period, ‘managed capitalism’, ‘social market economy’, and the invention of the Keynesian welfare state promised solutions based on underconsumption theories explaining why crises would occur. These demand-side theories advocated state intervention to counter crises caused in the private sector and to protect full employment. With monetarism and neoliberalism rising, these explanations were replaced by supply-side theories (Sherman 1991). Instead of full employment price stability became the central aim of fiscal intervention. Monetarist and neoliberal policies were based on the observation that most economic cycles were no longer driven by waves of innovation, but by failures of monetary policies. Since the 1970s, recessions were seen as necessary market corrections to bring down and control inflation around the artificially set magical 2% inflation target. The European Central Bank set the target at ‘below, but close to, 2%’. There was never a convincing argument why 2% would be superior maybe higher number or generally some more flexibility taking into account context; nevertheless, it became the dogma in central banking from which central bankers are reluctant to move away as such a move would raise questions about their policies’ legitimacy. As national markets have increasingly become open and exposed firms to more international and global competition this was seen as positive effect on structural changes in the economy, increasing the benefits from creative destruction. Under these conditions, it was claimed that the old Keynesian forms of state interventionism would no longer work. Increased global competition in open, increasingly integrated market economies was expected to spur productivity growth. Instead of

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achieving full employment it became more important to make labor markets flexible. Macroeconomic stability and robust economic growth could be assured by controlling the interest rates. None of the interventions into markets transformed capitalism into a stable system with sustained growth or wider systemic sustainability. According to the theory of ‘long waves’, the best thing we can get is long periods of growth, driven by the invention and spreading of key technologies such as steam, railways, electricity, fossil fuels, or new information and communication technologies that not just create a boom in a single sector but transform the entire economy. Nikolai Kondratieff (1926) invented the basic theory by studying the nineteenth and early twentieth century development by describing that capitalist development evolved not linear and not only in seven to eleven year business cycles but in long wave-like movements. He discovered one wave of 60 years with a 25 year upswing and a 35 year decline, a second wave of 47 years, with 24 years upswing and 23 years decline, and a third wave with an upward movement lasting 24 years before decline started in 1920. The theory that long periods of economic expansion depend on key technologies was also supported by Schumpeter (1942) as part of his understanding of capitalism as a deeply evolutionary system. Over the decades the theory remained convincing and growth and investment policies have frequently tried to identify such new technological developments that could transform the entire economy and its production system. In more recent years several innovations raised such hopes ranging from biotechnology, to nanotechnology, to artificial intelligence, or in finance fintech. Securing the financing and regulatory support for these technologies has played a key role in policy interventions. The invention of new technologies has of course not always been smoothly. Already in the nineteenth century, the Luddites formed as a group of radical and violent protesters against the use of machinery in the textile industry, fearing that machines might replace workers entirely and undermine labor standards. This movement had to be suppressed with legal and military force. New technologies have always created new markets with plenty of opportunities for the winners while putting pressures on markets and workers in industries using the old technologies that were to become redundant. Some new technologies such as intelligent machines with a potential to radically transform the capitalist system and drive all kind of new innovations are nowadays often described as ‘creative disruption’ creating opportunities and serious threats which require regulatory intervention to deal with both and to manage the transition in a way that

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stabilizes the unstable system. Mark Carney (2019), governor of the Bank of England, has interpreted the changes coming with the Fourth Industrial Revolution as a ‘new economy’ that will also require a ‘new finance’ to serve the digital economy and support this major transition. But without strict regulation and a strong focus on what innovation finance pushes and how harmful they can be to society, it is unlikely this ‘new finance’ will operate so much differently to the previous ‘new finance’ that has been driving the finance-led accumulation regime. A trust in morality and ethics of those involved in financial engineering seems naïve and idealistic in the light of past experiences as the incentive structure in finance-dominated capitalism supports profit-driven behavior. A theory that has shown how capitalism can become stable for a longer period is the French Régulation School, first developed by Michel Aglietta (2000) in his study on U.S. capitalism first published in 1976. Régulation theory describes capitalism as a complex accumulation regime, with a mode of regulation of the wages and the labour process, the production process, the consumption, capital concentration, and a money and credit system, in short, a system of regulation allowing the overall reproduction of the system that influences the short-, medium-, and long-term dynamics of the economy. Crises are necessary in capitalism and ‘part of the laws of its regulation’ (ibid.: 384). All accumulation regimes and modes of regulation generate internal contradictions, conflicts, and disequilibria that destabilize them over time (Boyer 2000). Régulation theory distinguishes four different types of crises: the first type consists of extended perturbations, the second affects the workings of the mode of regulation that can lead to minor crises. But then there are also episodes during which the reproduction of the economy is challenged by the various contradictions created by the accumulation regime and mode of regulation. The third type of crises is a crisis of the mode of regulation and the fourth type is one of the regime of accumulation and mode of regulation (Boyer 1990). Financial crises are necessary and arise from antagonisms in the economy whenever the conditions for expanded reproduction of the relations of production are no longer sufficient. Aglietta (2000: 19) understands crises as ‘ruptures in the continuous reproduction of social relations’ and a financial crisis as ‘a rupture in the process of accumulation’ resulting from over-accumulation of capital (ibid.: 353). This is a situation in which newly created value can no longer be realized because of a macroeconomic imbalance between the production and circulation spheres. Resolution of a crisis requires ‘an irreversible transformation of the mode of production’

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that leads to a new accumulation regime. The transformation he described for the twentieth century was one towards post-war Fordism, a new accumulation regime that introduced a regime for the entire economy including a system that aligned profits with wages via collective and connected bargaining and provided the regulation of production, consumption, and finance. Fordism peaked in the 1960s before starting to decline throughout the 1970s, leading régulation scholars to introduce the term ­Post-­Fordism that would later become finance-led capitalism with the system of market finance replacing ‘the financial system administered by the banking oligopolies’ (ibid.: 420). The emergence of the institutional investor in this new accumulation regime, changes in capital markets, and financial innovation led to short-termism as firms now actively seek to maximize their equity value in response to hostile takeover risks. As Aglietta emphasizes, this new ‘form of company management breeds an obsession with cutting wage costs and shedding jobs to boost share prices without much thought for future development’ (ibid.). Another significant transformation from Fordism to finance-led capitalism is the explosion in security trading and the extraordinary boom in synthetic derivative products that were invented to manage risks and removed barriers between banking and non-banking activities. Because of these transformations, ‘a complex web of financial interdependence is being woven between countries through the arbitrage of interest rates, through currency speculation and international creditor and debtor positions’, now spreading globally and establishing a new growth regime (ibid.: 421). The transition from Fordism to finance-led capitalism removed various rules that guaranteed more equality and stability in society and weakened collective bargaining as the globalization of corporations increased competitive pressures and undermined the stability of wage structures by decoupling and detaching multinational corporations from their country of origin. In short, the transition to finance-led capitalism came out of a crisis of capitalism that allowed a new expansive growth period, creating new instabilities and rising inequality that at some point must be replaced with different accumulation and growth regime. The fordist and post-fordist, finance-led periods of capitalism were based on a system largely dependent on the existence of cheap fossil fuels with its wide-ranging environmental impacts related to exponential economic growth. The focus on growth has been a key concern from an environmental perspective since at least the first Club of Rome ‘limits to growth’ report (Meadows et al. 1972). Capitalisms inherent ‘growth obsession’ (Altvater

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2004) has been criticized and challenged especially since the 1970s with demands for a change towards qualitative instead of quantitative growth, a steady-state economy, living on terms with nature, or changing from unsustainability to sustainable development and more recently ‘green growth’ and inclusive growth’ but also degrowth. These debates led to demands to replace GDP with measuring ‘wellbeing’ as the ultimate indicator for growth; the more moderate debates made it into the mainstream and have also shaped policies for ‘sustainable finance’. Whether green capitalism is a possibility or not has been subject of many and ongoing controversies. In the late 1960s, early 1970s, when environmental policy emerged in the advanced economies as a new policy domain, there was still widespread perception that growth and development would require a certain level of environmental pollution and that economic development would provide the wealth necessary to afford clean-up measures. At that time, widespread concern existed about the costs of environmental measures and how too ambitious policies could result in a loss in competitiveness. However, studies showed quickly that stricter environmental standards can also lead to first mover advantages, creating competitive advantages for green pioneer countries (Porter 1990). Throughout the 1980s, an increasing number of countries started to believe in this option when ‘ecological modernization’ suggested that there are not hard choices to be made, when it comes to environmental protection, but win-win-­ strategies. After the fall of the Iron Curtain symbolized in the Berlin Wall, the end of the cold war and with the transformation of the Eastern European economies from formerly centrally planned economies to capitalist money and market economies an optimistic scenario emerged with hopes that the world could now benefit from a “peace dividend” allowing investment in infrastructure beneficial to growth and development and wealth distribution leading to a fairer society. In that optimistic climate, the United Nations (UN) Conference on Environment and Development, held in Rio de Janeiro in June 1992, propagated sustainable development as a global paradigm promising radical transformation that would allow capitalism to solve all the big problems arising from globalization such as human made climate change, reduced biodiversity, environmental pollution with toxics, and poverty. Sustainability has its origin in forestry and became increasingly popular with its incorporation into the Brundtland Report (1987) by the World Commission on Environment and Development that defined it as ‘the ability to meet the needs of the present without compromising the ability of future generations to meet their

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own needs’. Seemingly the old conflict between environment and growth was overcome. The Brundtland Report foremost raised the need for external financing for developing countries and identified the Latin American debt crisis as a serious ‘threat to international financial stability’. It supported the ‘fundamental changes in international economic arrangements’ demanded for decades by developing countries and advocated an increase of external finance, a focus of lending on sustainable development, solving the conflicts between trade, environment, and development, addressing unfairness in international commodity trading, protectionism in international trade, issues around ‘pollution-intensive’ goods, and ensuring responsibility in transnational investment. Overall, nothing less than a transition to a sustainable world economy was demanded. Without the old East/West conflict blocking progress and with the narrative that the concept of sustainability could help overcoming the different goals of the most developed and the developing countries and the conflicts related to them, optimism rose even higher after Rio. However, this mood did not last and already the Rio+5 UN conference in 1997 showed that the major powers had another agenda, largely reflecting the neoliberal globalization agenda of the IFIs and the WTO (Baumann 2001). Capitalism has failed to become ‘green’ beyond some niche markets. Yet today’s more urgent question than radical system transformation has become the challenge that finance needs to provide the resources to cope with climate change disasters and adaptation measures. The OECD calculated that the world would need about $6.9 trillion of investment a year up to 2030 to meet the commitment under the Paris Agreement to limit global warming below 2 degrees (OECD, World Bank & UN Environment 2018). This necessary transition is most ambitiously addressed in calls for a Green New Deal and sustainable finance. At times haunted by the ‘spectre of communism’—to put it in the famous opening words of Marx and Engels’ Communist Manifesto (1848)—and challenged during the Cold War by the Eastern European Stalinist centrally planned economies with at least in their first phase fast quantitative growth, capitalism survived and seemingly even came out of crises stronger than before. After the collapse of the Eastern European competitor system and these countries’ inclusion into the capitalist world system, Francis Fukuyama (1989, 1992) famously declared the ‘end of history’ with the ‘unabashed victory of economic and political liberalism’ that would now allow the only conclusion that we would face the ‘prospect of centuries of boredom’ in a world that no longer needed any ­‘system

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alternative’. Important events would still happen and provide material for news, however, ‘there would be no further progress in the underlying principles and institutions because all of the big questions had been settled’ (Fukuyama 1992: xii). Many shared the euphoria about the superiority of the Western model of democracy and capitalist money and market economies and the spirit of optimism was also reflected in Rio and the emerging sustainability discourse. Žižek (2009: 3) called Fukuyama’s ­thesis a perfect ‘Hollywood-style ending’. However, the emerging globalization discourse radically shifted the mood towards more pessimism while sustainability remained on topical. Following the cycle of international environmental conferences, states produced first environmental plans and then sustainability strategies to outline their transition towards a more sustainable pathway. However, critics of neoliberal globalization saw chances for a more sustainable development undermined by the emergence of finance-led capitalism, crony capitalism, and predator capitalism and pushed at the margins of society for an ‘alternative globalization’. Altvater (2005) was one of the critical scholars frequently reminding that there cannot be a capitalism without an end or alternative and now he predicted ‘the end of capitalism as we know it’ while expecting that radical change would not come without a fundamental shock to the system and the existence of a veritable and credible alternative. Capitalism would increasingly get under pressure by rising geopolitical tensions, financial repression and more financial crises, including currency wars, and the end of the age of fossil fuels with peak oil, while at the same time credible alternatives are emerging around various social movements. Yet this alternative did not translate into radical change when the GFC hit. However, the GFC led to a renewed questioning whether capitalism—at least in its current form—can survive that even occupied the minds of pundits in the leading global financial institutions now acknowledging that financial globalization might have gone too far and that a change to ‘inclusive capitalism’ would be necessary (see below). In the academic discourse the question about the future of capitalism and finance-led capitalism has remained controversial. With ‘capitalism at risk’, rising income inequality, resource depletion, climate change and other pressing problems, the ‘role of business’ attracted not only the attention of critics of big business but also of those who thought that business should ‘lead the way’ out of these systemic crises. According to Bower et al. (2011), this would require measures to prevent ‘regulatory capture’, which has led so frequently to private interest regulation doing more harm than good, and to build on

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examples of a past interventions when business supported a broader planned approach such as policies to return to full employment after WWII. Litan and Schramm (2012) called for ‘better capitalism’ based on a more entrepreneurial economy with ‘sustainable growth’ that could avert future crises. Markets and competition would be best suited to lead the transition from fossil fuels to renewable energy sources. Businesses would just require the right ‘rules and incentives’. Warning against more deficit spending and recommending a combination of tax rises and welfare cuts beside their market solutions with strong, yet reformed capital markets, they used the famous study by Reinhart and Rogoff (2009) that had shown that rising levels of government debt are associated with lower economic growth and that debt above 90% of GDP would be dangerously unsustainable. Many government officials, including then incoming Chancellor of the Exchequer George Osborne in the UK and the EU Commissioner for Economic and Monetary Affairs Olli Rehn, used this warning against calls to increase government spending and to justify austerity, although an economics student had proven that the Reinhart-­Rogoff claim was fundamentally flawed as it was based on wrong data weighting methods and elementary coding errors. Amherst economists then reworked the calculations considering the errors and data omissions and showed that countries with a debt-to-GDP ratio of 90+% had still a positive growth rate of 2.2% on average. In short, their conclusion meant that public debt levels exceeding 90% of GDP ‘are not dramatically different from when the public debt/GDP ratios are lower’ (Herndon et al. 2014). If the state fails to provide the investment needed for transforming the system into a more sustainable system, it has to come from the private sector. The leading role of business in the transition to sustainability was already present at Rio. In preparation for the Rio conference, the Swiss entrepreneur and philanthropist Stephan Schmidheiny had founded the World Business Council for Sustainable Development (WBCSD) that has since then advocated business solutions to the global sustainability challenges, including measures for effective corporate governance practices and for a green circular economy and long-term value creation. Such business transformation strategies have nicely fitted into the neoliberal paradigm as they generally advocate voluntary measures and broad principles that would guide entrepreneurs and businesses without requiring specific action. The 1990s had led to much broader controversies about the unsustainability of neoliberal globalization and demands for an alternative global-

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ization, with the latter usually criticized by supporters of the first as anti-globalization movement. Yet neoliberal globalization critique was translated into a program under the slogan ‘another world is possible’. Within these broad demands for fundamental societal change, the developments in finance resulting from financial market integration and the transition to finance-led capitalism led to more radical proposals to ­re-­embed finance into society. These have included calls to tame finance, predator and crony capitalism, to establish a fair trade regime, to reintroduce capital controls, a financial transaction tax against speculative transactions, to take measures against money laundering, tax havens, tax avoidance and evasion, and stricter regulation of finance. Since the GFC, these demands have been pushed as part of a Green New Deal, aiming towards a more sustainable financial system. Some of these proposals have been incorporated into reforms as we will see later in more detail. However, the language of sustainability that made it into finance and financial regulation comes from the moderate interpretations. Like all big corporations, large financial firms quickly adopted this language and win-­ win-­philosophy and many of them became leaders in sustainability rankings in the years before the GFC, notwithstanding their contribution to unsustainable economic structures and their own contribution to increasing instability. Their involvement in financing fossil fuels only led in the last couple of years to pressures from civil society and non-governmental organizations (NGOs) on corporations including financial firms and their investors to divest from those investments. Emerging on U.S. campuses in 2010, these campaigns quickly spread across the Atlantic and now exist in a number of European countries too. The background of this global movement is dissatisfaction with businesses’ and governmental action to tackle human made climate change and the goal to reduce carbon emissions faster. Governments have throughout the 1990s and into the 2000s incorporated the language of sustainability foremost in its neoliberal version. Environmental policy was pushed towards ‘policy integration’, meaning a stronger justification for environmental measures to take their economic and social impacts into account by incorporating benefit-cost analysis and regulatory impact assessment. Measures had to become cost-­ effective with regulatory techniques that minimize foremost the short-­ term costs of meeting regulatory goals. Neoliberalism changed environmental policies also with the strong focus on markets, that either supported the creation of new markets such as emission trading or advocated voluntary business self-regulation over state intervention based on

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the critique that classical command and control regulation would be highly inadequate for a highly diverse business world and softer instruments would put firms into the position to respond in the most flexible way. For the economic sector, the language of sustaining growth via the creation of more competitive markets became prominent and fiscal discipline meant fiscal sustainability. The EU’s Lisbon Strategy is a typical example of this approach that was also presented under the slogans of better regulation and better lawmaking (see Chap. 3). Acknowledging that the financial system is unsustainable and short-­ term oriented and an increased interest from investors for integrating Environmental, Social, and Governance (ESG) criteria into investment decisions, the UN developed with inputs from private investors six Principles for Responsible Investment (UN PRI) in support of more sustainable long-term value creation as a voluntary framework for private investors. Since the principles were adopted in 2006, the number of signatories has grown from 100 to over 2300 in 2019 (www.unpri.org). This UN initiative has been linked to the OECD Guidelines for Multinational Enterprises as a complementary but distinctive contribution. The UN as well as the OECD approaches reflect a failure to introduce strict regulation for big firms and global finance and to trust in voluntary self-­regulation of firms and investors. However, some even in the NGO world have become more optimistic in recent years. Various industries have seen major scandals and lawsuits that turned out extremely costly for investors and created an interest in long-term orientation. Bayer’s takeover of Monsanto in 2018 is an example from the chemical and biotechnology sectors in that regard. This multibillion-dollar takeover became questioned after the new company lost a lawsuit in the U.S. over its popular glyphosate weedkiller Roundup, with 11,200 more lawsuits against the company pending. Of course, investors could have anticipated this development, given that glyphosate was a highly controversial regulatory debate over recent years since the World Health Organization identified the substance as ‘probably carcinogenic’ in 2015 and the following approval decisions by the European Food Safety Authority and the European Chemicals Agency were highly criticized. Now, Bayer’s stock lost almost 40% of its previous value. The International Chemical Secretariat, a leading NGO focussing on chemicals, saw a bigger trend in the sector with an increasing number of companies declaring that they would phase-out all chemicals of high concern (Bäcker 2019). Such hopes rely on transparency for investors and

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on the existence of an overall incentive structure that supports long-term value creation much more than currently existing. In 2015, the Financial Stability Board, created by the G20 from the previous more informal Financial Stability Forum, established a Task Force on Climate-related Financial Disclosures (TCFD) in recognition of a relationship between climate change and financial stability. Tasked with a mandate to develop principles and recommendations for voluntary climate-­related financial disclosures the TCFD added an industry-led process to the previous NGO work on sustainable finance. Again, the focus is on voluntary and transparency in markets that would then lead to better markets based on the assumption that investors lack information about the environmental and climate-change risks. The TCFD (2017) released its final recommendations after a consultation process together with an annex on implementation and a technical supplement on how to use scenario analysis, followed by annual status reports since 2018. Its 2009 status report concludes that disclosure of climate-related financial information increased since 2016 ‘but is still insufficient for investors’, that more clarity would be needed on the potential financial impacts, that companies using scenarios ‘do not disclose information on the resilience of their strategies’ (TCFD 2019: iv). Inspired by this work, the City of London Corporation, the body running London’s financial sector square mile, launched in 2016 a Green Finance Initiative aiming at providing leadership in this area, influence regulatory and policy change, and promote London as leading global financial center for the provision of green financial services (greenfinanceinitiative.org). In the aftermath of the GFC, key global institutions such as the IMF, the World Bank or the OECD have also picked up on the ‘capitalism at risk’ discussion and discovered ‘inclusive capitalism’ as a new concept. Supported by a broad coalition including Prince Charles, Pope Francis, Bill Clinton, and some of the world’s richest industrialists, inclusive capitalism calls on firms to act responsibly in line with their broader environmental, social, and governance (ESG) sustainability metrix to restore trust in capitalism. Inclusive capitalism merges the old ideas of corporate social responsibility and sustainability with ‘inclusive (green) growth’. The World Bank (2012: 4), for example, argued that greening growth would be ‘necessary, efficient, and affordable’. While acknowledging rising inequality and the existence of massive fraud and market manipulations in existing capitalism, proponents of this concept highlight the wealth ­generation that capitalism has produced and remember that Adam Smith,

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‘the father of capitalism’, was not just an advocate of free markets and free trade but also a moral philosopher. The inclusive capitalism movement has acknowledged a lack of ethical behavior and short-termism as serious problems in current markets (c.f. Henry Jackson Initiative 2012). Mark Carney (2014a), governor of the Bank of England, described inclusive capitalism as ‘fundamentally about delivering a basic social contract comprised of relative equality of outcomes, equality of opportunity, and ­fairness across generations’ and as a term that will be interpreted differently across societies. Carney outlined what the concept means for central banking, namely maintaining monetary and financial stability as ‘cornerstones of strong, sustainable and balanced growth’. He then described the BoE’s work over the last decade as contribution to inclusive capitalism with the central bank’s macroeconomic promotion of social welfare and its encouragement of financial market participants ‘to think of their roles as part of a broader system’, and its extraordinary monetary stimulus and other measures to support economic recovery. Carney outlined the major challenges for a more inclusive capitalism: ending too-big-to-fail, creating fair and effective markets, reforming compensation, and building a sense of vocation and responsibility. Carney, who has also been the chairman of the Financial Stability Board created in the aftermath of the GFC to coordinate the global regulatory responses to the crisis, has over the past years frequently stated that the financial reforms led to a safer, simpler, and fairer system and that the focus should shift towards implementation and consolidation. His ideas for future reforms included a commitment to a diverse system based on bank-based and financial markets-based finance and an open system that avoids ‘Balkanised finance’ (c.f. Carney 2014b). For derivatives Carney has called for greater transparency and more robust trading and settlement infrastructure, including better collateral management as ‘a cornerstone to resilient markets’ (Carney 2013). The Bank of England remained a strong supporter of financial innovation and pusher for FinTech as part of a new finance which should ‘more cost effective, better tailored, and more inclusive’ financial products (Carney 2019). To boost innovation and market leadership in this area, the UK and some other countries have invented ‘regulatory sandboxes’ with less regulation for FinTech in exchange for commitments to consumer protection. Cournède et al. (2015) went further in their OECD paper on ‘finance and inclusive growth’ acknowledging that there can be too much finance. After a period of rapid growth of finance, additional financial expansion would be more ‘likely to slow rather than boost growth’. According to

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OECD data, financial expansion has increased income inequality. Their conclusion is that a healthy financial system that can contribute to inclusive growth would require strong capital requirements, measures targeting implicit and explicit subsidies to too-big-to-fail institutions, and tax reforms to promote neutrality between debt and equity financing. The list falls clearly short of addressing the most problematic issues in contemporary financial markets. Overall, the agenda brought forward by inclusive capitalism advocates has remained rather limited, with introducing little to the old sustainability demands from the Rio conference or the much older discussions about corporate social responsibility and business ethics and only some moderate adjustments to finance-led capitalism. Reforms for the financial sector remain limited and based on the assumption that the right measures have already been taken and are partly still to be implemented but are already transforming finance. A closer look at Europe’s financial markets will show that this is by far not the case. Resilience has separately become a key term in finance and financial regulation debates for some decades. As a key concept in discussions about financial stability, it was also used in debates about redesigning financial markets via market forces as well as financial regulation and supervision (BIS 2016), acknowledging in stark contrast to pre-2007 mainstream thinking and more in agreement with Hyman Minsky’s (1975, 1986) theory of financial instability that the financial system is inherently prone to crises which are inevitable but if regulated adequately at least manageable. The basic meaning of resilient finance is to create a system that can withhold and cope with stress. However, its meaning remains probably as unclear, vague and contested as the concept of sustainable finance that is mostly not applied to finance in general but only to the niche market dealing with financing projects that support or lead to a more sustainable development and now also with regard to climate finance. Yet, it might be less ambitious as it does not necessarily refer to the concept of policy integration or the precautionary principle usually linked to sustainability in its more radical versions used in environmental debates. The concept of resilience acknowledges that future crises are unavoidable and aims at improving the system and all its key elements to withhold anticipated stress levels. Capacities to survive extraordinary stress and shocks in times of crises are therefore incorporated into the system and measures aim at risk and crises management and prevention. Future strategies for deeper financial integration therefore need to incorporate the concept of resilience, while I would argue that the concept of sustainability goes even further and

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actively addresses issues such as short-termism in financial markets and the wider economic system, unsustainable structures, products and activities, and how the overall system and especially the dominance of finance affects (in)equality. The EU has as we will see in more detail later put both concepts onto its financial integration agenda. Together with the various challenges of overcoming fragmentation and disintegrative tendencies and deepening integration, important questions arise about the progress achieved so far and the need for further reforms. The main point is, as Tucker (2019) emphasized, that it is a political and societal question to define what level of (in)stability is tolerable and to decide what is ‘resilience’ in finance. This is very much in accordance to the broader societal question about what constitutes (systemic) risk and how much risk a society is willing to life with, whether risk regulation and risk management should be risk-averse or risk-friendly. Schwarcz (2016: 59) suggested to apply chaos theory to macroprudential regulation and supervision. As ‘systemic shocks are unavoidable’, given the complexity of the financial system, chaos theory could help to create a more successful system by limiting the consequences of failures. This would require creating more robust markets and firms. One key element would be to address ‘the incentives of corporate managers to engage their firms in excessive risk-taking.’ Again, a key insight is that the more complex a system is, the more likely it is that failures happen. But also much more ambitious reforms were suggested to transform finance-led capitalism, including calls to ‘close the casino’. Wray (2013: 697) called for ‘a more sensible model’ that would be characterized by ‘enhanced oversight of financial institutions and with a financial structure that promotes stability rather than speculation.’ In particular a shift from finance-led capitalism would require ‘rising wages for the bottom half so that borrowing is less necessary to achieve middle-class living standards’, employment instead of transfer payments, monetary policy that targets ‘runaway speculation’ and more government spending on infrastructure and job creation. Following Minsky Wray demanded that wages need to grow ‘at a pace consistent with productivity growth’. This would allow consumption without debt. Another key point are proposals to deal with financial innovation in a much more precautionary way. Current debates are largely praising financial innovation, without a closer look at what kind of innovations occur and drive the evolution of finance-led capitalism. Robert Shiller is one of

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the most prominent scholars advocating not to throw out the baby with the bath: It seems a paradox that the very financial system that is the facilitator of some of our greatest achievements can also implode and create such as disaster. Yet the best way for society to proceed is not to restrain financial innovation but instead to release it. Such an approach can reduce the impact of such disasters and at the same time democratize finance. […] financial innovation has to be accomplished in a way that supports the stewardship of society’s assets. And the best way to do this is to build good moral behaviour into the culture of Wall Street through the creation and observance of best practices in its various professions (Shiller 2012: xi)

Shiller also emphasizes the need of ‘socially productive innovations’ (ibid.: xii). However, he very much leaves this to the financial sector. Applying the precautionary principle based on clear rules to financial innovation and combining this with strict product regulation would make much more sense (Crotty and Epstein 2009; Pesendorfer 2014). Another key discussion in the globalization debate relates to short-­ termism created by finance-led capitalism. In the 1980s, corporate governance discovered shareholder value maximization as a powerful doctrine to reconceptualize the ‘nature’ of the firm from the previous managerial view. The idea that managers would be solely accountable to their company’s shareholder interests and should only act in their economic interest was declared as so powerful that it would lead to ‘the end of history for corporate law’, meaning that all countries should adopt this superior doctrine and incorporate it into their corporate laws (Hansmann and Kraakman 2001). This new idea advocated the introduction of an incentive structures within businesses that largely supported short-term goals and benefits over the long-term value creation. These new perverse incentives have undermined public companies and capital markets and increased financial instability (Rappaport 2011). Aglietta and Rebérioux (2005) described this as a major shift towards the new finance-led capitalism but challenged the assumption that this would lead to convergence towards the U.S. model. While they observed significant convergence in the area of financial market law, they described the picture with regard to corporate law as more nuanced, in the area of workers involvement the European model remained different, ‘putting a brake on the process of convergence of the European model towards the US model’ (ibid.: 62), and in the regulation

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of takeover bids at the intersection of these three areas of law as ‘contradictory evolutions’ (ibid.: 73), leading to an overall picture of convergence, resistance or divergence. However, the ‘ideological domination of the Anglo-American world’ would destabilize the European model with the liberalization of European capital markets and the power of U.S. and British investment funds as key drivers (ibid.: 71). Yet, those changes have led to a crisis of financial capitalism, reflecting ‘in an unprecedented series of bankruptcies and scandals’ (ibid.: 249). In response to these developments, the U.S. introduced the Sarbanes-Oxley Act of 2002, discussed by Aglietta and Rebérioux as a measure to restore trust in U.S. security markets while at the same time strengthening shareholder power without addressing the root of the problem, but criticized by others as foremost being too costly, while only adding marginal protection for investors and having created disadvantages for U.S. capital markets from which London and Hong Kong benefited (Leon 2007). The shift towards short-termism had wider effects on the corporate world. One is the massive boom in mergers and acquisitions that led to capital concentration and less competition across a number of markets. In finance, it contributed to ever larger financial institutions, becoming too-­ big-­to-fail, too-big-to-jail, and too-big-to-govern. Calls for breaking up these mega-firms have been ignored, the crisis itself led to further capital concentration and survival of even larger financial institutions, and the European financial market is by many seen as in need of further consolidation via mergers (see Chap. 6). At the time of the April 2009 London Summit of the Group of 20 (G20), that had since its first meeting in Washington in November 2008 in direct response to the GFC emerged as the most important international forum for discussing global financial markets and the world economy, it seemed to many observers and pundits that the world had not just escaped a repetition of the 1930s national economic disasters following the Wall Street Crash of 1929. In the mainstream discourse, the G20 was now expected to set the right measures for a strong recovery and to establish a new regulatory framework for financial stability without falling into the trap of a dangerous downward spiral of regulatory competition among the most important economies and their financial centres. The challenge was to curb long-term growth with expansive investment strategies. In the 1930s, protectionist measures led not to recovery but to mass unemployment, the rise of fascism in Europe and to WWII. Bretton Woods creating ‘embedded liberalism’ seemed now again superior to neoliberalism.

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Besides the strong commitment in London against protectionist measures and other mistakes of that tragic historic lesson in economic and political failures, the financial commitments of this group of 20 leading economies promised a response to market developments that was seen to significantly improve economic and financial stability and recovery. Then UK Prime Minister Gordon Brown, who hosted the event and called for nothing less than a New Bretton Woods, was celebrated as saviour of the world ­economy at a moment no other country was able to take leadership (Dixon 2010) and claims were widespread that ‘all are Keynesians now’ (Wolf 2008). Keynesianism meant a return of more policy intervention into financial markets and a return of embedded liberalism but various related proposals such as for an international financial transaction tax found support among various government actors. Calls for a renewal of Bretton Woods existed already in the years before in different interpretations, now they had merged with ideas for greening the economy and emphasized especially the importance of investment in infrastructure and other areas that result in structural changes that support long-term growth and jobs. Robert Zoellick (2010), World Bank president from 2007 to 2012, called for looking beyond the Bretton Woods II system and global leaders should employ ‘gold as an international reference point of market expectations about inflation, deflation and future currency values’. Demands for such a (Green) New Deal, however, received only moderate popularity in Obama’s 2008 presidential election campaign and even less in Europe where the Green parties used this slogan in their European Parliament election campaigns of 2009. Since then, the idea of a Green New Deal remained foremost an academic debate before returning on the political agenda again in 2019 election campaigns on both sides of the Atlantic. However, neither the economic recovery in the U.S.A. nor in the EU fulfilled the hopes of those believing in a quick recovery based on a redirection of resources into greening the economy. Both jurisdictions were at the centre of the financial meltdown and severely affected by the financial and economic crisis and have ever since been facing problems of returning to a sustained economic recovery. Until 2016, the US development was characterised by a stop-go recovery resulting from a continued threat to reverse policies including post-crisis financial reforms and of government shutdowns, risks of deflation and weak consumers and business confidence but nevertheless with a better result concerning unemployment, profitability of banks, and returning to pre-crisis economic output. Since then, the U.S. turned under President Donald Trump to economic

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nationalism which also includes hostility against environmental protection measures as part of a massive deregulatory agenda of ‘deconstructing the regulatory state’, reversing financial reforms, and trade wars even with the closest economic partners with possible impacts on regulatory cooperation in the area of finance. The EU, however, has continued to face multiple, partly unique crises largely linked to the poorly designed currency union resulting in the Eurozone/European (sovereign) debt crisis starting in 2009 and action limited by legal restrictions in the EU Treaties with a potential to seriously threat achievements of political, social, and economic integration. However, the EU has also adopted the language of ‘sustainable finance’, although in a limited way with the goal that finance needs to provide the financing for the transition to a low carbon economy (see Chaps. 3 and 5). In a situation of multiple crises and instabilities the U.S. as well as the EU and its member states are in dire straits to securing significant investments in long-due renewed infrastructure to remain competitive in the long-run among themselves as well as with other economic competitors, while also meeting the challenges of transforming the financial system into a more resilient, more sustainable financial system. The EU, which is the focus of the following chapters, finds itself in a situation in which most of its citizens now think that the entire integration project could collapse and fail in the next 10 to 20 years although the European Union is a good thing and more needed than ever (Dennison et al. 2019) given the numerous global challenges such as security, climate change, or the fourth industrial revolution.

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Sutherland, P., Bhagwati, J., Botchwey, K., FitzGerald, N., Hamada, K., Jackson, J., Lafer, C. & de Montbrial, T. 2004, The Future of the WTO: Addressing Institutional Challenges in the New Millennium, WTO, Geneva, https://www. wto.org/english/thewto_e/10anniv_e/future_wto_e.pdf. Strange, S. 1986, Casino Capitalism, Blackwell, Oxford. Strange, S. 1998, Mad Money: When Markets Outgrow Governments, University of Michigan Press, Ann Arbor. Streeck, W. 2015, ‘The Rise of the European Consolidation State’, MPIfG Discussion Paper 15/1, Max Planck Institute for the Study of Societies, Cologne. TCFD 2017, Recommendations of the Task Force on Climate-related Financial Disclosures: Final Report, 29 June 2017, https://www.fsb-tcfd.org/wp-content/uploads/2017/06/FINAL-TCFD-Report-062817.pdf. TCFD 2019, Status Report 2019, Task Force on Climate-related Financial Disclosures, https://www.fsb.org/wp-content/uploads/P050619.pdf. Tett, G. 2009, Fool’s Gold, Little Brown, London. Tinbergen, J. 1965, International Economic Integration, 2nd ed., Elsevier, Amsterdam. Toporowski, J. 2005, Theories of Financial Disturbance, Edward Elgar, Cheltenham. Toporowski, J. 2018, ‘Marx, Finance and Political Economy’, Review of Political Economy, vol. 30, no. 3, 416–427. Tucker, P. 2018, Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State, Princeton University Press, Princeton. Tucker, P. 2019, ‘Is the Financial System Sufficiently Resilient: A Research Programme and Policy Agenda’, BIS Working Paper no. 792, BIS, Basel, https://www.bis.org/publ/work792.pdf. Turner, A. 2010, ‘What Do Banks Do? Why Do Credit Booms and Busts Occur? What Can Public Policy Do About It?’, in A.  Turner et  al., The Future of Finance: The LSE Report, LSE, London, 3–63. Turner, A. 2012, Economics after the Crisis: Objectives and Means, MIT Press, Cambridge, M.A. Turner, D. & Ollivaud, P. 2018, ‘The Output Cost of the Global Financial Crisis’, OECD Ecoscope Blog, https://oecdecoscope.blog/2018/12/07/ the-output-cost-of-the-global-financial-crisis-2/. UNCTAD 2016, ‘Sovereign Debt Restructurings: Lessons Learned from Legislative Steps Taken by Certain Countries and other Appropriate Action to Reduce the Vulnerability of Sovereigns to Holdout Creditors’, UNCTAD, New York, https://www.un.org/en/ga/second/71/se2610bn.pdf. Vickers, J. 2019, ‘The Case for Market-based Stress Tests’, VOX CEPR Policy Portal, 14 June 2019, https://voxeu.org/article/case-market-based-stress-tests. Vogel, S.K. 1996, Freer Markets, More Rules: Regulatory Reform in Advanced Industrial Countries, Ithaca, Cornell University Press.

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Weiss, L. 1998, The Myth of the Powerless State, Cornell University Press, Ithaca, N.Y. White, H.D. 1942, ‘Preliminary Draft Proposal for a United Nations Stabilization Fund and a Bank for Reconstruction and Development of the United and Associated Nations’, in J.K. Horsefield (ed.) 1969, The International Monetary Fund 1945–1965: Twenty Years of International Monetary Cooperation, Volume III: Documents, International Monetary Fund, Washington, D.C., 37–82. White, H.D. 1943, ‘Preliminary Draft Outline of a Proposal for an International Stabilization Fund of the United and Associated Nations’, in J.K. Horsefield (ed.) 1969, The International Monetary Fund 1945–1965: Twenty Years of International Monetary Cooperation, Volume III: Documents, International Monetary Fund, Washington, D.C., 83–96. Williamson, J. 1990, ‘What Washington Means by Policy Reform’, in J. Williamson (ed.), Latin American Adjustment: How Much has Happened?, Institute for International Economics, Washington, D.C. Wolf, M. 2008, ‘Keynes offers us the best way to think about the financial crisis’, Financial Times, 23 December 2008. Woods, N. 2006, The Globalizers: The IMF, the World Bank, and Their Borrowers, Cornell University Press, Ithaca, NY. World Bank 2012, Inclusive Green Growth: The Pathway to Sustainable Development, The World Bank, Washington, D.C. WTO 1997, ‘Successful Conclusion of the WTO’s Financial Services Negotiations’, World Trade Organization, WTO Press Release, Press/86, 15 December 1997. Wray, L.R. 1998, Understanding Modern Money: The Key to Full Employment and Price Stability, Edward Elgar, Cheltenham. Wray, L.R. 2011, ‘Keynes after 75 Years: Rethinking Money as a Public Monopoly’, Working Paper no. 658, Levy Economics Institute of Bard College, Annadale-­ on-­Hudson, N.Y., http://www.levyinstitute.org/pubs/wp_658.pdf. Wray, L.R. 2013, ‘A Minskyan Road to Financial Reform’, in M.H. Wolfson & G.A.  Epstein (eds.), The Handbook of the Political economy of Financial Crises, Oxford University Press, Oxford, 696–710. Wray, L.R. 2018, ‘Functional Finance: A Comparison of the Evolution of the Positions of Hyman Minsky and Abba Lerner’, Working Paper no. 900, Levy Economics Institute of Bard College, Annadale-on-Hudson, N.Y., http:// www.levyinstitute.org/pubs/wp_900.pdf. Zingales, L. 2012, A Capitalism for the People: Recapturing the Lost Genius of American Prosperity, Basic Books, New York. Zingales, L. 2015, ‘Does Finance Benefit Society?’, NBER Working Paper 20894, National Bureau of Economic Research, Cambridge, MA, http://nber.org/ papers/w20894. Žižek, S. 2009, First as Tragedy, Then as Farce, Verso, London. Zoellick, R. 2010, ‘The G20 Must Look Beyond Bretton Woods II’, Financial Times, 7 November 2010.

CHAPTER 3

Finance-Led Capitalism and Neoliberal Financial Market Integration in Europe

Since European integration started it has created political and economic dynamics that often resulted in antagonistic goals and tensions with potential to undermine or even undo the progress made. Fundamental transformations of capitalism and European societies have also transformed the expectations European citizens have from European integration. In response to new social movements, nation states moved in the 1960s, early 1970s from predominantly economic regulation to wide-ranging social regulation, and the same trend occurred at the European level resulting in the emergence of the European Union as a modern regulatory state (Majone 1996) with its today’s wide range of integration objectives. European integration is often presented as a peace project built on solidarity, compromise, and cooperation that allow deeper economic, social, and political integration based on European values such as human dignity, freedom, democracy, equality, rule of law, and human rights. Yet economic integration and trade policies are primarily based on strong pro-market and free(r) trade beliefs that have not become market fundamentalist in a pure form as economic integration requires a ‘social dimension’ to be acceptable to European citizens and at the international level protecting the EU’s economic model including the European values as part of its trade and investment policies is moreover a competitive advantage as it is linked to a large high quality consumer market. The commitment to free trade leads in practice to a policy that aims to guarantee fair competition on a level playing field while at the same time opening formerly protected © The Author(s) 2020 D. Pesendorfer, Financial Markets (Dis)Integration in a Post-Brexit EU, https://doi.org/10.1007/978-3-030-36052-8_3

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markets to wider competition and protecting investment inside and outside of the EU with strong investor protection rights. This creates necessarily conflicting goals that have resulted in critics seeing the EU’s model of capitalism as deeply protectionist or as neoliberal which makes financial integration in Europe either repressed by safeguards protecting domestic markets and private interests and not global or European enough or the destructive force it has been described in the alternative globalization literature. In abstract terms, the European model, based on European varieties of capitalism and liberal democracies, would according to its supporters ensure friendly and healthy rivalry between member states that would result in a high quality of life based on increasing prosperity and some fairness in distribution, a high level of employment, environmental protection and public health, and competitiveness in the world economy. The sui generis international organization that the EU has become would protect Europeans from market failures including negative consequences from economic and financial globalization. Since the 1990s, the EU is also trying to achieve sustainability and has presented itself as an environmental pioneer at the international level. More recently the Union even aims for improving its current and future generations’ happiness and well-­ being. This aim goes back to the emergence and rise of postmaterialist values in societies, first described by Ronald Inglehart (1977) as a ‘silent revolution’, and to a broader debate about how to incorporate environmental degradation and citizens’ well-being into national statistics. This led then in the post-GFC climate French President Nicolas Sarkozy to appoint in early 2008 a ‘Commission on the Measurement of Economic Performance and Social Progress’ that should investigate the concerns about the measures of economic performance with their focus on GDP and make recommendations for better informed economic policy decision-­ making. Joseph Stiglitz, Amartya Sen and Jean-Paul Fitoussi were chosen for that task and produced their report (Stiglitz et  al. 2010) that influenced new indicators in European statistics. However, like other advanced economies the EU and its member states faced too increasing challenges from neoliberal globalization which they had actively helped creating over the past decades. Since the 1990s, the EU was described by its critics as a major global force for financial globalization and neoliberalism contributing to hyper-globalization that has increased the power of finance and markets over states, transformed capitalism into a finance-led system, and created structures, activities and products in markets that caused the GFC (see Chap. 2). An ‘alternative globalization’ would necessarily require an

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alternative European Union with alternative setups for European economic and monetary integration and for financial globalization and integration in this region. Euroskeptics with a clear deregulatory agenda on the opposite side of the argument have claimed that European regulation has become rather intrusive, constituting lots of ‘red tape’ with costly and burdensome overregulation in business regulation and would also be much too risk-averse and precautionary than for example U.S. regulation (c.f. Mason 2008). The latter led to a high-level transatlantic dialog in the 1990s aiming at finding a long-term solution for increasing dissimilarity in U.S. and European standards for various industry sectors. Euroskeptics argue, the EU would not be a liberal and open market and definitely not neoliberal but a ‘Fortress Europe’ with protectionism for agricultural goods, too strict and too burdensome regulation for all businesses, not supportive enough for the integration and expansion of trade in services, with an increasing tendency towards ‘nanny state’ regulation, and an overly bureaucratic environment that is anything but business- and innovation-­ friendly. Interestingly, the Nanny State Indicator produced annually by neoliberal think tanks shows that among the most intrusive countries in that area in Europe are the most liberal market economies, UK and Ireland (nannystateindex.org). Overall, these features of the European regulatory state would constitute a rather bureaucratic interventionist regulatory regime which does not reflect the radical neoliberal call for a minimum state and deregulated and liberalized free markets. Yet the European Economic Community had an economic focus in the name and integrated other policies only when they were affecting economic integration and the four freedoms of movement enshrined already in the founding Treaty were in their very nature economic too (Dorn 2015). Although the EU invented in the 1990s, the principle of environmental policy integration and adopted agendas for a ‘Social Europe’, these measures were systematically undermined by the neoliberal economic agenda. With the Single Market and EMU, the EU has incorporated ‘neoliberal principles of competition, price arbitrage, and public policies that favour background economic stability over active intervention in markets’ (Parsons 2007: 160). At the center of integration debates is the distinction between positive (market-correcting) and negative (removal of barriers) integration. Negative integration in the EU can be understood as market-driven neoliberal process that has pushed the liberalization and deregulation agenda including capital market liberalization, while redistributive policies became

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more difficult under financial constraints (Altvater and Mahnkopf 2007: 63–71). The Commission (EC 2018a: 1) itself has stated that integration in the areas affecting ‘increasingly sensitive economic and social issues […] is proving difficult’ and that citizens would not ‘fully’ benefit from integration. However, even more important for the ‘normalization of transnational neoliberal hegemony in Europe’ was the rise of finance-led capitalism as financial, monetary, and exchange rate policy moved to ‘the very core of this project’ (Talani 2003: 123). Especially the financial centers, including the European ones in London, Frankfurt, Paris, Zürich or Geneva, have been steering the neoliberal world economy (Altvater and Mahnkopf 2007: 267). Given that neoliberalism has remained a highly political and contested term used by opponents of a range of theories that advocate free(r) markets and business-friendly regulation it is not surprising that the EU has been described as not neoliberal on one end of the spectrum and as neoliberal to its core and deeply captured by corporate interests on the opposite end of the spectrum. Warlouzet (2019) argues that European integration has been based on an ‘evolving compromise between French dirigisme and German ordoliberalism’ although other member states have played important roles in certain areas. Especially since the Eurozone was created, differentiated integration expanded. The idea of the two biggest continental European economies driving integration is not new; Andrews (1993) explained from an intergovernmentalist perspective the Maastricht Treaty as a result of French and German confluence. The creation of the EMU based on the Maastricht convergence criteria was a major step towards institutionalizing neoliberal governance in the EU and the global economy (Gill 1998). Brunnermeier et al. (2016) described the ‘battles of ideas’ and power shifts, especially between France and Germany and how the ideas, including French dirigisme and German ordoliberalism, evolved in response to new challenges and have influenced economic and monetary integration policies. In financial markets integration literature Story and Walter’s (1997) analysis described the processes in Europe as ‘the battle of the systems’ with the UK ‘as instigator of EU financial market reforms’, the German authorities often ‘eager to extend regulations internationally’ and the French insisting on protecting the Single Market against ‘third countries’ and France and Germany forming continental alliances against but also with the Anglo-Saxons. Quaglia’s (2010) more recent analysis studying banking, securities and post-trading regulatory governance in the EU has shown that power is more diffuse, often resulting ‘(at times rather odd) compromises’ but also in some areas ‘in an

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incoherent set of rules’ which would have resulted in fragmentation and has undermined adequate EU crisis responses. Financial regulatory reform debates after the GFC included issues where the UK opposed proposals or lobbied to water them down, while Germany and France were in some cases pushing for relatively stricter regulation. The responses to the Eurozone crisis have been widely seen as neoliberal and ordoliberal Germanic variant of neoliberal economic thinking (c.f. Papadopoulos and Roumpakis 2018). Bob Jessop (2018) argues that ‘global pressures and crisis management in Europe tend to reinforce neoliberalization’. Yet with Brexit looming many politicians and pundits have expressed fears that the less interventionist, more pro-free market member states such as the Baltic countries or the Netherlands as well as free market advocates in the other member states might very soon miss the UK as an important coalition partner in pushing against overregulation and for more liberalization. The distinction between different systems and their influence on integration policies reflects the different interests among the varieties of capitalisms in Europe (Hall and Soskice 2001) that have played an important role in European economic and financial markets integration. However, member states not only came under more pressure from the design of EMU but also as a result of major changes in lawmaking. The EU adopted the Better Regulation Agenda in 2002 to become more responsive to business demands, to address overregulation and to optimize the costs of regulatory interventions, a development that is even positively acknowledged by neoliberal critics. Since then regulatory change is based on obligatory impact assessments and stakeholder consultations for all new legislative initiatives proposed by the Commission. This practice is also followed by the independent EU agencies. The idea for this fundamental change in European law- and policymaking came from the UK as one of the liberal market economies in Europe that pioneered the shift towards monetarism and neoliberalism under Margaret Thatcher’s ‘There Is No Alternative’ (TINA) battle call and ever since. In the UK Better Regulation had emerged after the privatization, liberalization and deregulation policies of the 1980s had shown that freer markets need even more rules (Vogel 1996) and the focus shifted towards the ‘quality of regulation’. The EU describes the change towards Better Regulation as a rational approach to find the middle ground between protecting the public interest and improving the business environment and Europe’s competitiveness. The Commission (EC 2012b) introduced in a Communication the idea of ‘regulatory fitness’, presented as ‘smart regulation’ that

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responds ‘to the economic imperative’ accompanied by an Action Programme for reducing administrative burdens (EC 2012b). Under the Commission’s ‘regulatory fitness and performance’ (REFIT) programme, introduced in 2015 and enhanced in 2017, the aim is to assure that regulation is as simple, effective and efficient as possible at minimum cost for businesses. REFIT requires the Commission to ensure that all its evaluations and revisions of existing legislation are considering simplification and burden reduction. However, for critics this Better Regulation agenda has become a key feature of European neoliberalism as it is one of the significant changes in capitalism that made global and transnational corporations ‘shadow sovereigns’ (George 2015) by providing another route to influence decision-making beyond traditional lobbying activities. Corporate Europe Observatory (2019), a European NGO watchdog of corporate lobbying activities in the EU, regards the EU as a neoliberal bloc in which decisions are ‘framed by the EU’s systemic neoliberal bias’ and governments are hold captive by corporate power. In short, like in other advanced economies around the world the EU has experienced too a clear trend over the past decades that increased the power of business and finance. This chapter will provide first a short history of European financial integration, then an overview of financialization in Europe and link the relative success in financial integration with the critique of neoliberal globalization and finance capitalism in Europe. The chapter will then engage with the EU’s experience of financial fragmentation and disintegration. It finally addresses key challenges for deeper integration and a more resilient and sustainable finance arising from the theoretical concepts of resilience and sustainability. This will result in a framework that distinguishes between the pre-crisis and the post-crisis financial regulatory environment with regard to the incorporation of measures aiming at resilience and sustainability and a more ambitious or truly resilient, precautionary, and sustainable financial system.

3.1   History of European Financial Integration and the Challenges Ahead European (financial) markets integration is a special case in the overall trend towards regionalization, deeper market integration and globalization. Financial integration has been deeper than in other regions yet is still incomplete. A fully integrated European financial market would mean that

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‘every cross-border business in Europe needs to become truly domestic’ in ‘a genuine single market in which financial services are offered on the same conditions within and across borders’ (Tumpel-Gugerell 2008). Despite numerous flaws, current challenges, risks, and uncertainties European integration still is the most successful regional integration project. Historically Europe played a key role in the two waves of financial globalization and the transition to finance-led capitalism. It seems likely that Europe would also play a significant role in transforming finance-led capitalism into a new accumulation regime. The size of its market makes Europe definitely a major battleground for the future of finance. Capitalism itself has its origin in European countries, dating back to the sixteenth century, when it was spearheaded by the British textile industry over the next decades and supported by developments around the commercial centers in other European countries that led to the rise of merchant capitalism. The Industrial Revolution, starting in the eighteenth century and transforming the previous agrarian and handicraft economies and merchant capitalism into industrial capitalism and societies with machine manufacturing and wage labor, quickly spread from Britain to other countries. Accumulation of capital and its use for expanding the production capacities became the new powerful driver, destabilizing the old feudal systems and transforming societies in Europe and throughout the rest of the world. Yet this globalization also led to an unequal development and rivalry between countries took the form of imperialism. In Europe faster development occurred in the north and west, while Southern and especially Eastern European countries fell back. This gave rise to protectionist theories in the lesser developed countries such as in the German countries where Friedrich List (1841) countered Adam Smith’s free market ideas with the argument that the interest of merchants would not necessarily reflect the national interest in the development of a country’s powers of production and that national security and independence would require protectionism to allow capital accumulation and a greater division of labor to develop. Especially infant industries are necessary for developing a strong competitive domestic market and would require protection, but agricultural products and raw materials should always be traded freely. On this basis, List suggested a gradual approach to industrialization and trade liberalization. This gradual approach towards more liberalization became an influential strategy, although protectionism in practice has also covered the agricultural sector until nowadays. The German Countries also formed a customs union, allowing free internal trade and setting a common tariff

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for imports from other countries before the German Empire was founded in 1871. Belgium and Luxemburg later formed a customs union at the end of the First World War. The Russian Revolution in October 1917 was another key result from economic and financial integration and in this case of uneven and combined development, meaning a largely agrarian society in the fast countryside represented still the feudalistic past, while the big cities were already massively transformed thanks to foreign investment bringing in the modern technology of the time from the most developed Western European countries. In that period, capitalism had created sharp tensions and social conflicts resulting in a highly organized working class inspired by socialist, communist, and anarchist ideologies that spread quickly across Europe and beyond and organized across national borders. But only in underdeveloped Russia revolution overthrew its half-capitalist, half-feudalist system, put industry and finance under workers control and started transforming from ‘war communism’ to the New Economic Policy adopted in 1921 into a post-capitalist society that promised temporary concessions to market principles but put large companies under state ownership, before degenerating into a centrally planned economy under the control of the ‘communist’ party under Stalin, now declaring ‘socialism in one country’. Until then, socialists and communists since Marx had called for a ‘permanent revolution’ that would spread from the most developed to the other countries and should have led to an alternative form of globalization and economic integration. Leon Trotsky (1923), for example, called for the ‘United States of Europe’ with a ‘Workers’ and Peasants’ Government’ for ‘pacification and reconstruction’, arguing ‘that only the closest economic co-operation of the peoples of Europe’ could protect the ‘continent from economic decay and from enslavement to mighty American capitalism’. The more advanced capitalist countries in Western Europe, however, survived various revolutionary upheavals after the First World War (WWI) and entered after the Second World War (WWII) and a short reconstruction phase a period of fast economic growth based on a number of national economic ‘miracles’ and in friendly but competitive rivalry with America and among each other. This phase of globalization became known as ‘the golden age of capitalism’ created under the postwar international economic order that established the United States of America (U.S.A.) as new hegemonic power, providing the political and financial support for postwar reconstruction and economic integration in Europe (see Chap. 2). The European Recovery Program or Marshall Plan laid the foundations for economic recovery. This U.S.-sponsored program

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­ rovided between 1948–1951 economic support on the basis that the 17 p western and southern European countries that had signed up to it would create stable conditions for economic growth and agreed to economic integration. This included the commitment to establish financial stability and expand trade. To coordinate the European countries participation and to distribute Marshall Plan dollar allocations, a Committee of European Economic Cooperation was created that became in 1948 the Organisation for European Economic Co-operation (OEEC) and later in 1961 the Organisation for Economic Co-operation and Development (OECD). The OECD extended membership to the U.S. and Canada and later also to other countries in the ‘western bloc’. Today, the OECD represents 37 member countries that ‘represent about 80% of global trade and investment’ (www.oecd.org/about/members-and-partners). Russia, then the Soviet Union, emerged as the second super power controlling the Eastern bloc, with the Baltic nations part of the Soviet Union, and Poland, East Germany, Czechoslovakia, Hungary, Romania, and Bulgaria as satellite states. They formed in 1949 Comecon or the Council for Mutual Economic Assistance (CMEA). Albania and Yugoslavia belonged too to the Eastern bloc. But Albania split from Russian influence in 1961 when it decided to support China in the Sino-Soviet dispute. Yugoslavia remained a slightly more open system since it developed in 1950 ‘self-management’. Over the next decades until the end of the 1980s, their economic integration was much less ambitious and successful with the Comecon and their integration into the global economy remained restricted until the system collapse in the late 1989 (Lavigne 1999). However, several Eastern European countries got increasingly dependent from international financial markets and western banks throughout the 1970s. Romania had already joined the IMF in 1972 and over the next decade the country’s indebtedness to the IMF rose significantly. In the late 1970s, early 1980s Poland engaged in confidential and secret membership talks with the IMF after it had become increasingly dependent from external debt in convertible currencies, mostly owned to Western governments. Hungary had also applied for IMF membership. Its more open economic system had become more reliant on western loans too. Hungary was seeking support from the BIS to meet its payment obligations to international creditors. These countries were forced into negotiations with western banks to restructure their debts and to agree on reforms in line with IMF adjustment policies (Boughton 2001: 320–325). In the early 1990s, all eastern European countries were quickly reintegrated into

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global financial markets and especially Austrian, French, German and Italian banks got highly involved in those countries and secured a dominant market position. The postwar period in Europe was also the starting point for western European integration. Based on lessons drawn from the horrors of two world wars, the instable interwar period and the threat from the system conflict and Cold War between East and West, deeper economic, financial, and political integration were now seen as means to secure peace and prosperity in Europe. Belgium, Netherlands, and Luxembourg signed in 1944 a customs agreement that formed the Benelux Union. The next step of integration happened when six founding states—Belgium, France, Germany, Italy, Luxembourg, and the Netherlands –integrated their coal and steel industries in 1950. The same countries expanded integration with the Treaty of Rome in 1957 creating the ‘common market’ within the European Economic Community (EEC) which became ‘the nucleus of integration efforts in Europe’ (Balassa 1961: 175). Other European countries established the ‘outer seven’ in 1960 with the creation of the European Free Trade Area. After a boom in the 1950s and 1960s driven by economic reconstruction, catching-up with the American best-practice technologies and economic integration, a decade of economic difficulties with slow growth and high unemployment followed in the 1970s that was labeled ‘Eurosclerosis’ (Giersch 1985) and reduced the progress in deepening economic integration, while the first enlargement took place in 1973 with Denmark, Ireland, and the United Kingdom (UK) joining. In that period the EEC developed its regional policy to allow wealth transfers from richer to poorer regions, but it failed to achieve the goal set out in the Werner Report (1970) to establish an Economic and Monetary Union (EMU) by 1980. In the 1980s, Greece, Spain, and Portugal joined the EEC as three less developed countries that had just overcome military dictatorships. Their integration did not slow down harmonization efforts as their support for stricter standards in areas such as environmental policy was usually compensated with longer implementation periods for them or with financial compensation via the regional and structural funds. However, because of structural problems in the core countries the EEC was now seen as falling behind the U.S. and Japan in economic growth and technological development, and European economies came under pressure from increasing competition from newly industrialized countries. The disappointing economic performance led to new calls for more integration and harmonization but also for more deregulation, labor market

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flexibility, and tax reforms. To make Europe more competitive the Council of the European Community decided in late 1982 to create a fully unified internal market by 1992. The Commission worked out the details for that plan and released in 1985 a White Paper ‘Completing the Internal Market’, listing a timetable and 300 measures with 25 of them aiming at free movement of capital and creation of a single financial market. The 1986 Single European Act was then adopted to create the Single Market by 1992 that should boost economic growth and protect jobs and the member states’ social welfare nets in a global economy that was increasingly characterized by competition between the U.S., Europe, and Japan. This fundamental treaty change should create a new momentum for European integration via the removal of internal borders and the free movement of goods, persons, services, and capital. Especially the latter three are key to deeper financial integration and supportive for market concentration in the financial centers. The Cecchini Report (1988: 37) promised ‘substantial economic gains […] from real integration of European financial services markets.’ The process was accompanied by the adaptation of more than 200 European laws that harmonized national regulations and removed further barriers for more integrated markets. As such they resulted in deregulation at the national and reregulation at the European level but also in establishing new barriers between the European and ‘third country’ markets. The Acquis Communautaire, the accumulated body of EU law and obligations, grew significantly and soon became the target of critique about overregulation and that it would need to become simplified, less complex, and less burdensome for businesses. As a next major step in financial integration, the Delors Report (1989) set out a new three-stage preparatory period for finally creating an EMU in 1999. In 1992, the European Union (EU) was officially created with the Treaty on European Union signed in Maastricht. This was also the official launch of the EMU that was ‘the most daring move towards fully-­ fledged integration’ (Majone 2014: 20). Yet it also created a split in the membership between all becoming part of the economic union but not all countries joining the monetary union. The monetary union boosted financial markets integration by reducing transaction costs including the elimination of exchange rate risks. The creation of the Schengen Area in 1995 gave another boost to transnational transactions and other cross-­ border activities. In this climate of fundamental change since the mid-­ 1980s and even more throughout the 1990s, deeper economic and political integration in Europe was presented as a requirement to respond

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actively to the increased vulnerabilities of national economies resulting from hyper-globalization. More economic coordination and a common currency—the euro—should transform the EU into a world power but— most importantly—without creating a political union first. Austria, Finland, and Sweden joined the EU in 1995 as a group of high-income countries that had done comparatively well outside the EEC but now wanted to enjoy the benefits of having a say in rule-making too. This enlargement was followed by the accession of 10 mostly much less developed Eastern European countries in the 2004 ‘Big Bang enlargement’, of Bulgaria and Romania in 2007, and of Croatia in 2013. Their transition from centrally planned economies into capitalist money and market economies gave another boost to economic and financial integration as it opened a huge new market for financial expansion. These enlargements, however, also showed the complexity and state capacities that were necessary to adjust new member states to EU law. The Acquis Communautaire had grown to about 80,000 pages. The Commission in line with business demands stressed the need for better law-making and better regulation to improve the quality of business regulation which has become seen as crucial for increased competitiveness in the global economy. The enlarged EU turned into an economic bloc with 28 member states and a distinct growth regime as one of the world’s largest economies with over 500 million consumers. In terms of global exports and imports the EU emerged as one of the world’s biggest trade players alongside the declining U.S.A. and fast rising China. And the euro has become the world’s second most important currency in the international monetary system. Yet the European sovereign debt crisis following the GFC led to serious questions about the stability and sustainability of this integration project, the design flaws in the EU’s financial regulation and supervision frameworks and the EMU governance, their needs for reform, and their future. One particular challenge is the UK’s decision to leave the bloc. Only Greenland had left the EEC after a membership referendum in 1982. The small and poorly populated country had originally joined the EEC as part of the Danish Kingdom but had then gained independence granted by Denmark. While Greenland’s leave was inconsequential for European integration, the UK’s possible withdrawal from the EU is highly significant not just because of the size and economic power of the UK but also because the much deeper European integration and the overall changes in the global economy with increased importance of trading blocs and production chains.

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The UK has been a very particular member state of the EU with a special role in financial integration but with a dislike of ‘ever deeper integration’, making the member state ‘an awkward partner’ (George 1998). As the world’s fifth largest economy and the EU’s second largest economy in the EU with a population of 66 million people, it remained mostly dependent on intra-EU trade. In 2017, 44.5% of its goods and services exports went into other EU countries, while it imported 53.1% from other EU countries, resulting in a trade deficit with the EU of £67  billion. With non-EU countries the UK had a trade surplus of £41 billion. Its largest trading partner outside the EU was the U.S.A. with 18% exports and 11% imports. While the UK had a trade deficit in goods with the EU and with non-EU countries, it had a trade surplus in services with both country groups. The EU market for service exports is 40% and 49% for imported services. UK financial services accounted for 23.6% of exports and 6.4% of imports. The longer-term trend over the period 1999–2017 shows that the share of imports has only fallen moderately from 56% to 53% but the value of imports in goods and services increased from £145.2 billion to £341 billion, while exports dropped from 54.6% to 44.5% while the value of exports increased from £133.3 billion to £274 billion (Ward 2019). In political terms the UK has a durable tradition of Euroskepticism, that led to a strong public perception that the UK did not benefit from the Single Market, that the EU would hinder the UK of becoming more competitive, and that the EU is a failing continent, too protectionist to compete with the rising powers. Hit particularly hard by the GFC and the following recession that resulted in a UK record peacetime budget deficit, the Conservative and Liberal Democrat coalition government adopted an austerity program in 2010 that has since then continued. A study by the New Economics Foundation (2018) called this decade of austerity ‘the worst economic policy error in a generation’. Stirling (2019) estimated that austerity had left the UK economy £100 billion smaller than it would otherwise have been. As the country with the most developed financial system and capital markets, the UK has a rather mixed performance. The country’s financial service industry generates a significant contribution to growth, jobs, and tax revenue. However, like the other EU member states the UK has failed to invest in infrastructure and key public sectors as a result of the country’s neoliberalization. Compared to other EU countries labor productivity was lower since the GFC and for one of the richest countries most jobs created have been low wage jobs with high insecurity. Several industry sectors increasingly use zero-hours contracts, leading to

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low-paid insecure work for more than 5 million people in the UK. Regional inequality has increased because of deindustrialization in the North of England since the 1980s. British conservatives had praised the loss of manufacturing industries since the Thatcher years as a necessary price of modernization and for the transition to a modern service economy. Decades later after continued neoliberal reforms under New Labour and then Conservatives, Theresa May spoke in her first speech as Prime Minister in 2016 of ‘burning injustices’ dividing people across the UK’s unequal society. According to Eurostat data, income inequality in the UK is among the highest in the EU (with only Bulgaria, Lithuania, Latvia, Spain, Portugal and Greece having higher income inequality), but lower than in the U.S. OECD data shows Lithuania as only EU member state with higher income inequality (McGuinness and Harari 2019). Low incomes and the failure of welfare benefits to cover basic living costs have resulted in an explosion of people using food banks. The Trussell Trust’s food bank network registered a 73% increase of food banks use over the last five years (trusseltrust.org 2019). The fallout of the GFC, domestic austerity, the prolonged Eurozone crisis, and the refugee crisis in Europe created the perfect climate for British Euroskeptics that resulted in the EU Referendum on 23 June 2016 in a majority voting to leave the EU and to become an independent country again. 57.9% or 17.4 million people had voted to leave, and 48.1% or 16.1 million people voted to remain in the EU, with a turnout of 72.2%. The UK’s EU withdrawal process known as Brexit started officially when Prime Minister Theresa May invoked the procedure in Article 50 of the Treaty on European Union (TEU) with a withdrawal notification letter to European Council President Donald Tusk on 29 March 2017. Many in the UK have argued that sovereignty has to be regained, that the EU does not provide protection against the globalization pressures and would be too protectionist and not respond fast enough to global challenges and opportunities. An independent UK as the fifth largest economy in the world with the world leading financial center in London could negotiate more suitable trading arrangements with the world, especially with the more dynamic, faster growing emerging market economies in Asia, while at the same time keeping the access to the EU market as open and frictionless as possible. However, since the Leave Referendum Brexit has turned out not to be ‘one of the easiest [free trade agreements] in human history’, as International Trade Secretary Liam Fox famously assumed it to be. It became clear that ‘beginning with zero tariffs’ and ‘beginning at the point of maximal regulatory equivalence’ (Liam

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Fox cited in Weaver 2017) is no longer the situation for a former member state once it leaves not just the EU but also the Single Market and turns into a ‘third country’ outside the Single Market. Because of this basic truth, Brexit could only become a significant challenge for the UK but also for the EU in terms of future European (financial) markets integration. The UK not only provides the key financial services for the Single Market, the UK is moreover the second largest economy in the EU. Over half of the EU’s GDP is generated by three member states: In 2018, Germany contributed 21.1%, the UK 16.1%, and France 14.9%. Italy with 11.3% and Spain with 7.5% were the only two other member states contributing more than 5% to the EU’s total GDP.  The GDP of the EU amounted to € 15,884 bn, the GDP of the 19 member states in the euro area had a cumulated GDP of 11,581 bn or 72.9% of the EU GDP, with Germany and France making up half of the euro area’s contribution (Eurostat 2019). Any disintegration of these markets would result in a loss of wealth in the UK as well as in the EU-27 of the remaining member states. Many in the UK have hoped that the country’s powerful financial sector or its trading deficit with the other EU member states would help to keep privileged access to the EU market, but the developments so far show into another direction (see Chap. 4). Brexit is not the only concern about more market fragmentation. Together with the election of Donald Trump as President of the U.S.A. in November 2016 these two events have been interpreted by many as first and strong signs of a new phase of deglobalization or at least a crisis of globalization that has increased the divide between winners and losers (Lamy 2018). Under President Trump the U.S. paused negotiations with the EU on the Transatlantic Trade and Investment Partnership (TTIP). Plurilateral negotiations on a Trade in Services Agreement (TiSA) came too to a halt. Both trade deals were expected to deepen transatlantic and global financial integration. Dani Rodrik (2018: 13) has argued that the backslash against hyper-globalization reflects that the current levels of financial and economic integration have made it almost impossible ‘to achieve legitimate economic and social objectives’ centering around economic prosperity, financial stability, and equity. The challenge now would be to find the right level of globalization in trade and finance and for Europe to find the right balance between more or less integration in a situation in which the level of economic integration is no longer in line with democracy. Both countries, the U.S. and the UK, have still the most developed financial systems in the world with the two leading global financial

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centers in New  York and London and their repositioning in the global economy can only have significant consequences for the rest of the world. The EU-27 must reposition itself in an increasingly competitive global environment, and this necessarily includes a strategy to build its own global financial center that provides the economic advantages of a highly integrated and advanced financial hub without creating dependency from an offshore financial center that would result from continued dependency on London. Other challenges to European financial integration are increasingly coming from emerging market economies. The comparative capitalisms study has for a long time focussed on the most advanced economies and the interest in the periphery was largely looking at their integration into the global economic system. However, more recently this research has discovered that capitalism in the twenty-first century is ever more influenced by countries such as China and India and to a lesser degree by other large emerging economies (Kristensen and Morgan 2012: 13). For European financial integration China’s activities have raised concerns. China got involved in investment especially in the Eastern European member states and Greece over recent years. In 2019 Italy signed up to China’s global investment New Silk Route project—the Belt and Road Initiative (BRI) as the first G7 country, causing further concerns among other EU countries and the U.S. about the long-term consequences of China’s growing influence. The EC had developed its own ‘Connectivity Strategy’ in 2018 to connect Europe and Asia with an emphasis on sustainability, sustainable finance, protection of labor rights in investment and fair competition, and formulating measures to avoid political or financial dependencies. The underlying problem is that European financial markets integration has failed to generate the long-term investments in major infrastructure projects. In this climate of uncertainty and transformation financial globalization and the future of (European) financial markets integration raise important questions about these powerful trends that have so uniquely transformed the global and European economies over the past decades. A decade after the GFC many reforms are still unfinished, and many problems and questions remain unresolved, while the world obviously turns towards a more conflict-laden, polarized system with rising competitive pressures. In short, interesting times are ahead for financial markets (dis)integration and urgent answers and actions are needed to stabilize an inherently instable financial system.

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3.2   European Integration and the Rise of Finance-­ Led Capitalism Economic and financial integration have been central to ‘an ever closer union’, enshrined already in the 1957 Treaty Establishing the European Community signed in Rome. Progress in economic integration should translate into the necessary political support for political integration and as long as the latter was incomplete and identified with a democratic deficit successful economic integration was necessary to provide output legitimacy (Scharpf 1999). European countries had laid the foundations for European integration immediately after WWII, and the European Payments Union, operational between 1950 and 1958, had replaced bilateral with plurilateral cooperation that laid the foundation for trade recovery and European financial integration (see previous section). This had an immediate effect on exports and with deeper economic integration the financial sector had to play a central role. The Treaty of Rome provided the rules for the creation of a customs union and a common market. It also established rules and a dynamic for capital markets liberalization; yet monetary integration was still limited at that stage of integration and the Treaty did not call for an economic and monetary union. Ever deeper economic integration had, however, to lead to economic and monetary union in the long-run following the logic of integration theory (see Sect. 1.1). Deeper economic and financial integration has also moved from the areas easy to achieve with simply extending markets to the more complex issues around how to perfectionate and optimize markets. The Treaty of Rome dealt in Chap. 4 with ‘Capital’. Article 67 called on member states to ‘progressively abolish between themselves all restrictions on the movement of capital belonging to persons resident in Member States and any discrimination based on the nationality or ca the place of residence of the parties or on the place where such capital is invested’. It also called for the removal of payment restrictions ‘connected with the movement of capital’. In rather abstract language Article 68 called on member states to ‘be as liberal as possible’ and that they should use ‘domestic rules governing the capital market and the credit system […] in a non-discriminatory manner’. Article 105 established a Monetary Committee and Article 69 specified that the Council should consult with it when developing ‘directives for the progressive implementation of the provisions of Article 67’. The Commission was tasked to propose measures to improve the coordination of exchange policies for the free

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­ ovement of capital. Member states were also given some protection in m cases of rule evasion in Article 70(2). Article 71 called on member states not to introduce ‘any new exchange restrictions on the movement of capital and current payments connected to such movements’ and none of the existing rules should become ‘more restrictive’. Member states were allowed to go ‘beyond the degree of liberalisation of capital movement’ taking into account ‘their economic situation’ and the Commission got a right to intervene with recommendations. Further protectionist measures were set out in Article 73, applying to situations when ‘movements of capital lead to disturbances in the functioning of the capital market in any Member State’. Article 104 then called on member states to ‘pursue the economic policy needed to ensure the equilibrium of its overall balance of payments and to maintain confidence in its currency, while taking care to ensure a high level of employment and a stable level of prices.’ This monetary policy legislation therefore did not incorporate the Keynesian aim of full employment. German ordoliberals were opposed to the idea of full employment (c.f. Eucken 1959) and for Europe they insisted that ‘stability begins at home’ and as this was missing in Europe domestic reforms would have to transform the national economies prepare them for integration (Erhard 1957). Given West Germany’s central role to European integration it is not surprising that some early integration steps have been described as guided by (German) ordoliberal ideas of a ‘social market economy’ that advocated re-establishing free markets within clear rules and regulations that provide a level playing field for fair competition first at national level and then via liberalization and market integration at the European and international levels. Whether Ordoliberals belong to neoliberal theories has remained contested as they do not constitute the most radical free market versions such as in the Chicago School that includes the most prominent neoliberals such as Friedman, Hayek, Stigler, Posner, Fama, or Becker and are therefore sometimes described as belonging to a distinct variant of social liberalism. Developed by economists and lawyers from the Freiburg School of economic thought in the 1930s in Germany, they were aiming at developing a ‘positive’ theory in response to capitalism’s discreditation that had led to the emergence of Keynesian policies that promised full employment and investment stability and the Soviet Union that threatened to put an end to private property of the means of production. Ordoliberalism criticized laissez-fair capitalism for its failure to stop the emergence of monopolistic and oligopolistic markets that would not just

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destabilize economies but also would have led to these demands for centrally administered or planned economies. Rules for the market seemed therefore a solution to reembed capitalism and to protect freedom and private property rights. They criticized Keynesian ideas as part of the economic trend towards more state interventionism and advocated their neoliberal regulated market ideology based on basic principles of an economic constitution aiming at perfect competition and free price formation in markets (Erhard 1957; Eucken 1959; Müller-Armack 1981). European competition law and policy is an example often referred to as originating from German ordoliberalism (c.f. Gerber 1998); however, that view has been challenged (c.f. Akman and Kassim 2010), and European competition law and policy have been described as more reflecting post-Chicago school economics and becoming rather interventionist compared to more free market antitrust law in the U.S. of recent decades. Compared to more interventionist Keynesian economic policies in other European countries, economic policy in the Federal Republic of Germany practised an ‘underdeveloped Keynesianism’ with Keynesian ideas and policies only ‘used sparingly’ (Allen 1989). European competition policy is moreover distinct with its principle of European integration and its inclusion of state aid rules to avoid unfair competition between member states that could undermine market integration. To protect integration the Commission has a long tradition of tackling developments in markets or in member states that could disintegrate the Common and later the Single Market (Monti 2007: 39). Since the 1970s, ‘the prevailing economic policy perspective’ in Europe ‘shifted away from Keynes towards Schumpeter and Hayek. Entrepreneurs and innovators gained social prestige’, as Giersch (1989) highlighted in an internal paper for the European Commission that suggested various reforms including deregulation to match the wave of deregulation initiated earlier in the U.S. by President Carter’s Administration. Whatever the precise influence of ordoliberalism and other neoliberal ideas on EU integration might have been until the 1970s, ordoliberalism had definitely influenced West German economic policy and its approach towards integration in significant ways, however, just like Keynesianism was only a superficial practice of Keynesian ideas, many of the ordoliberal ideas had little impact such as their loathing of any forms of government bailouts and subsidies or their ideas to limit the influence of big business to create and protect highly competitive markets. Because of those ideas, ordoliberalism became advocated as a solution to financial globalization after the

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GFC (c.f. Straubhaar et al. 2009) and the regulatory swing towards more market regulation was also described as a swing to a more moderate ordoliberal neoliberalism in the EU (Pesendorfer 2012). However, ordoliberalism in the years before the GFC was a theory that uncritically supported the liberalization and deregulation of financial markets and pushed structural reforms based on very similar ideas as those in the most neoliberal economies. Yet European integration, until the 1980s partly driven by conservative and interventionist ideas, was very much an economic project first focusing on establishing a customs union and a common market for goods until the 1980s. Already at the beginning of the 1980s, the Commission (CEC 1983) lamented about the ‘deadlock in the process of financial integration’ and ‘the sluggishness of European progress in the area of finance’ that left financial integration in the Community ‘far from an optimal situation’ and far behind other areas of economic integration. The Single Market programme was designed to overcome the stagnation of integration efforts and to push also the integration of service sectors. European economies were going through the transition from the Keynesian demand management towards more free market ideologies such as monetarism spreading from the UK since the late 1970s to other member states. The Economist called the Single European Act and its Project 1992 ‘an adventure in deregulation’ (Erdilek 1990: 246). While keeping the slogan of a social market economy, free(r) markets were increasingly presented as solutions to all economic problems, including in areas where the founders of ordoliberalism had in the aftermath of WWII argued that free market principles would not apply such as to public sectors like electricity production and distribution given the sector’s overall importance for economic development. Since the early 1980s, the European reform agenda was driven by the European Roundtable of Industrialists that aimed at addressing ‘Eurosclerosis’ (Giersch 1985) by pushing for deeper economic integration to boost competitiveness within the European markets but also to strengthen Europe’s declined position in the global economy. The White Paper on ‘completing the Internal Market’ (CEC 1985) advocated market-­ oriented reforms to achieve integration goals. The German Bundesbank took the leading role in fighting inflation and wage moderation made Europe more competitive under a supportive global environment (Giersch 1989: 5). This also led to a wave of mergers that were supported by the Commission and national competition authorities to develop larger European companies, first as national then as European

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champions that could later become global players. Not surprisingly, European merger control in that phase became accused of being protectionist (Aktas et al. 2007) but not neoliberal. However, the dominance of big business in Europe was no majority programme and the Single Market agenda had to incorporate also environmental and social policies to get sufficient support. The adaptation of the Single European Act in 1986 as a fundamental revision of the Treaty of Rome led to significant reforms aiming to create the Single Market by 1992. The 1985 Commission White Paper ‘Completing the Internal Market’ had listed 300 measures with 25 of them aiming at free movement of capital and creation of a single financial market that were now implemented. Given the harmonization aspect in the Single Market agenda, it was a process of deregulation at the member states level and reregulation at the EEC/EU level that gave a significant boost to cross-border trading. In the 1990s, the EU presented itself as a project to compete successfully in the global economy but also as an alternative ‘soft power’ and creator of a distinct European Social Model. Yet at the end of the 1990s the role of ‘European integration in shaping and protecting’ the member states’ welfare systems changed ‘from cautiously optimistic to bleak’ as the EU seemed increasingly unable to defend them ‘against global or domestic forces’ as integration policies had increasingly become ‘market driven’ (Rhodes 1998: 36). However, the creation of a large amount of harmonized law replacing the variety of national laws also led to very complex and detailed legislation, resulting in demands to simplify and deregulate further to reduce ‘red tape’ that had also shifted from the member states to the European level and to end ‘overregulation’. Especially the UK was a strong supporter of this idea and pushed first for deregulation, liberalization, and privatization measures and then under Tony Blair’s New Labour government for Better Regulation, realizing the need for re-regulation. At the EU-level it also became apparent ‘that European market building followed the pattern of deregulation and re-­ regulation, which led to a modernization of Europe’s interventionist traditions and a true renaissance of regulatory politics’ (Joerges 2002: 15). With the change to ‘Good Governance’ the EU became more concerned about regulatory performance. Yet while corporate and financial market law made quite some progress towards harmonization over the years, the focus shifted increasingly towards more flexibility and especially towards more self-regulation. This new approach was reflected in the multi-layer framework which was based on the idea that directives and regulations establish only principles and general rules and the Commission then

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f­ollows up with the development of more detailed implementation rules. In this work special committees with representatives from member states and industries played an important role (Doralt and Kalss 2004: 255). Article 126 of the Treaty on the Functioning of the EU states that ‘Member States shall avoid excessive government deficits’ and provides powers to the Commission to monitor and to adopt recommendations and enforcement powers to the Council, including the powers to introduce fines (Article 126(11) TFEU). This is the link between the Treaty and the Stability and Growth Pact (SGP), proposed by Germany in 1995 as a cornerstone of the neoliberal design of the EMU based on monetarist ideas to enforce strict budgetary discipline among member states, which was adopted in 1997. Although the SGP had to be suspended in 2003, when France and Germany violated its rules to address domestic economic developments, it survived with its ‘excessive deficit procedure’ and reforms in 2005. However, the GFC then revealed again significant flaws in the EU’s economic governance system and an overall failure to achieve convergence and growth and to protect jobs. Towards the end of the GFC, some scholars expected that the emergency interventions and bailouts and the modifications to the Stability and Growth Pact had undermined the EU’s strict rules and there would now be a permanent risk of shifting towards ‘loose fiscal policies’ that make it much harder ‘to regain a discourse of consolidation’ after the crisis. Heipertz and Verdun (2010: 195) warned, ‘the Commission is at some risk of harming its role as guardian of the Treaty by exaggerating its ambition to be a ‘policy entrepreneur’ in times of crisis.’ Yet the SGP survived also the GFC and Eurozone crisis by adopting further reforms. In the absence of political consensus and political support for treaty change, an inter-governmental treaty, the Treaty on Stability, Coordination and Governance (TSCG) filled the gap. The ‘Six Pack’, introduced in 2011, strengthened monitoring rules and a Code of Conduct was adopted, followed by two new laws (Regulation 472/2013 and 473/2013) known as ‘Two Pack’ aiming at stricter economic coordination rules. Additionally, the Fiscal Compact, part of the TSCG, was reformed to incorporate modifications for budgetary targets as part of the ‘preventive arm’ of the SGP. According to Streeck (2015) the enhanced SPG has turned member states from debt states into ‘consolidation states’ turning the EMU into ‘an asymmetric fiscal stabilization regime’. In 2015 the Commission issued an interpretative Communication that linked flexibility to meet the existing SGP rules with requirements to apply structural reforms for jobs and growth. The only member states that did not go

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through an excessive deficit procedure (EDP), forcing them to agree on structural reforms and budgetary measures, were Estonia and Sweden. In 2011, 24 member states were under surveillance for violations against the corrective arm of the SGP.  In 2019, the Commission ended the EDP against Spain as the last country that was still under the measure since the crisis. But new EDPs were opened. Hungary and Romania were subject to the Significant Deviation Procedure; Belgium, France, Italy, and Cyprus were under review for compliance with the deficit and debt criteria. Especially with Italy strong political pressure from the Commission and other member states was necessary to avoid the country’s populist government to provoke an EDP procedure and to force it into more fiscal discipline. The most significant problem with this economic governance regime remains that it imposes costly requirements on its member states without redistribution of wealth necessary in a currency union to counter uneven development. Critics demanded for years that it would be necessary to distinguish debt from investment for the future and criticized that the EU’s fiscal rules cause political controversies and lack transparency, are procyclical and have moreover not been successful in reducing sovereign debts. Dullien et al. (2011: 110), for example, called for splitting public budgets into a consumption budget that should be balanced in the medium term and financed by taxes and contributions and a ‘capital budget’ financing public investment. For the latter public debt should be justified as long as long-term revenues from the investments can be expected. In their plan the state should take on a much more active role again and especially invest in infrastructure and education and also in a Green New Deal. It has also been suggested to introduce a regime for orderly sovereign-­debt restructuring to allow such processes under a clear legal system and without states getting into legal disputes with holdout creditors. A further proposal is the creation of ‘a euro area fund, financed by national contributions, that helps participating member countries absorb large economic disruptions’ Bénassy-Quéré et  al. (2018: 13), who suggested this fund, designed it in a way that it avoids the creation of a transfer union by ‘countries that are more likely to draw on the fund’ making higher contributions with frequent revisions. However, it seems a weak solution for the continued problem that a functioning monetary union needs to be a transfer union. Instead of a fundamental overhaul of the governance mechanisms of the currency union and a shift towards an approach based on heterodox economics, the EU has started to plan its next multiannual financial

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f­ ramework for the period 2021–2027 which should include three funds to contribute to a more ‘social Europe’. The Social Fund Plus (ESF+) is an update of the existing European Social Fund and should commit to spending €101.2 billion; the European Globalization Adjustment Fund (EGF) should provide €1.6 billion; and the Justice, Rights and Values Fund will be worth €947 million (EC 2018d). The EGF was already created in 2006 by Regulation (EC) No 1927/2006 to support active labor market policies to compensate for jobs lost as a result of trade agreements. In 2009, it was upgraded with Regulation (EC) No 546/2009 to cover also major structural adjustment costs resulting from the economic fallout from the financial crisis. Now it should become a fund for the losers from globalization and digitalization. In global trade debates it was until recently ignored that freer trade creates significant adjustment costs. Neoliberal supporters of trade deals used economic models that did not take into account such problems. More recent trade negotiations, such as TTIP or CETA, were supported by the EC with exactly such studies. In both cases, researchers from Tufts University using the more complex UN Global Policy Model showed significant unemployment, inequality and welfare losses and that these trade deals undermine stability and could even lead to European disintegration (Capaldo 2014; Kohler and Storm 2016). Financial integration was a goal already set out in the 1957 Treaty of Rome’s single market objective but its realisation occurred much slower than in other areas. Just like in international trade liberalisation debates, markets proved much easier to be opened for goods than for services. For goods the main traditional trade barrier of tariffs became less and less important throughout the successful trade negotiation rounds under the General Agreement on Trade and Tariffs (GATT). This success shifted the focus to regulatory standards for products and production processes as real or potential non-tariff trade barriers. ‘Negative integration’ became a powerful dynamic thanks to international standard setting at the global level and mutual recognition of regulatory standards between and within trading blocs such as the EU. However, for financial services market integration remained hindered by various aspects. Within the GATT financial services were not covered and under the World Trade Organization (WTO) emerging out of the GATT, an agreement on financial services remained rather limited in its scope. Within the European Union, a major push towards a transformation of national financial systems into an EU-wide system did not start before the 1980s. At that time, the capital and banking markets in Europe were

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‘highly fragmented’ (Fonteyne 2007: 1). The overall development over the past decades can simply be summarized as fragmented financial markets becoming less fragmented and increasingly more integrated, especially in the period between 1990 and 2007 which includes the liberalisation of capital movements and the creation of the internal market and the Monetary Union. At the end of that period, the IMF’s First Deputy Managing Director John Lipsky (2007: xi) described ‘the European Union’s financial integration policies’ simply as ‘a success story’. The GFC and the Eurozone crisis, however, led to new disintegration and since then the EU adopted various new policies for deeper integration. Leading experts have for a long time agreed that Europe’s strategic and economic long-term interests have been hindered by weaknesses in its financial structures and lacking financial integration. Globalization led to a triadization with fierce competition between the three power blocs of the U.S., Europe, and Japan/Asia as Kenichi Ohmae (1985) asserted in his analysis of the world economy. Since then, regionalization has become a major feature in the global economy, leading to new emerging powers and a rising importance of global and regional value chains in production processes based on optimization of just-in-time production processes thanks to relatively low transaction costs, resulting from low transportation costs, increased monetary cooperation, and abolition of integration barriers via the creation of customs unions or free trade areas. In the 1980s, Europe invented the Single Market programme with a completion date in 1992 as a strategic response to this increased competition, followed by the introduction of EMU and a reform agenda to boost economic and financial integration, making the EU seemingly the most successful regional financial integration project. Other regions took European integration as a best practice model to learn from. However, already before the global crisis European economic integration led only to underperformance and failure to achieve the set goals of the Lisbon Agenda. Launched in 2000 by the EU heads of state and government, this neoliberal strategy had promised to make Europe ‘the most competitive and dynamic knowledge-based economy in the world, capable of sustainable growth with more and better jobs and greater social cohesion’ (European Council 2000). Following critique of the neoliberal growth and competition orientation, the Gothenburg Summit added the following year an environmental dimension without changing the overall direction and its underlying neoliberal paradigm centered around the core idea of states as national competition states and the EU as a supranational

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c­ ompetition regime. The main aim was the reduction of costs for doing business in Europe and to boost economic growth to 3% annually thanks to structural reforms and more innovation. The target date for meeting these ambitious goals was 2010. The design of the Lisbon Strategy was based on the idea that member states and not just the European institutions had to play a major role in this process and the Open Method of Coordination was expected to create enough competition and peer-pressure between member states to achieve the goals. With this new more flexible form of integration, the limitations of the time-consuming Community Method of integration should have been overcome. European guidelines with goals and corresponding deadlines, benchmarking, National Action Plans, and multilateral surveillance were the new instruments for flexible integration (Schelke 2005). However, already the midterm evaluation (Kok 2004) showed damning signs of failure leading to a ‘relaunch’ in 2005 with a revised strategy based on priority actions. The relaunch was focused on flexible labor markets, an industrial policy that strengthens the competitiveness of European multinational corporations in key sectors, completing the internal market for (financial) services and deepening liberalization, and supporting international trade liberalization in the WTO, including trade in (financial) services. The relaunch had also a strong geopolitical dimension with China now recognized as a rising global player and rival. The focus of the relaunch was even more on ‘growth and jobs’ and the social and environmental dimensions lost even more relevance for the implementation of the strategy (Dräger 2006). With the Euro crisis the supposed miracle turned ultimately into a debacle and a mirage. In December 2008, the EC (2008) was forced to adopt a European Economic Recovery Plan (EERP), followed in 2010 by ‘Europe 2020: A strategy for smart, sustainable and inclusive growth’ (EC 2010). In the meantime, new emerging powers have led to additional competitive pressures and tensions and various countries rediscovered protectionist policies and economic nationalism in reaction to the fallout of the global economic crisis and the changing global environment. With European integration coming to the brink of collapse with the global and European financial crises escalating and the EU pushing towards more open market access and more effective international regulatory cooperation, including deeper financial integration, while various fault lines and flaws in the regulatory frameworks are still unprepared, fundamental questions about European financial markets integration arise that are deeply rooted in financial globalization history and the European policy responses to the

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ever-changing challenges. These questions have not gone away with European financial markets entering a calmer, less tumultuous time as future crises remain possible because of internal and external pressures. Regional integration projects drove the developments towards globalized financial markets and financial integration and were most successful in overcoming fragmentation. The European Union (EU) and its predecessor, the European Economic Communities (EEC), were at the forefront of that trend (Enoch et al. 2014) which was also understood as a ‘natural extension of the economic integration’ required for efficient markets (Giovannini & Mayer 1991: 1)—although one with ‘more radical implications for the autonomy of the member states than any other aspects of economic integration’ (Francis 1993: 211), resulting in conflicts and ‘battles’ between different national systems (Story and Walter 1997). The EU’s approach to financial integration has also been described as ‘a project of market-building’ (Mügge 2006), often leading to ‘rather odd’ compromises, incoherent rules and fragmented institutional arrangements with a potential to undermine financial stability (Quaglia 2010). Quaglia (ibid.: 28) described European financial market integration as ‘piecemeal, ­incremental and politically controversial’. It has also been analyzed as a European version of financialization and neoliberal globalization (Pesendorfer 2012, 2014). According to Berend (2016: 201), financial integration in Europe has its origin in the 1960s, when the financial sector pioneered ‘the transformation from national to pan-European company structures’. Deutsche Bank became the first European bank that changed its business model from a domestic market to a European market. The European Commission commissioned an expert report on the development of a European capital market (Segré 1966) that outlined the starting position for deeper financial integration as rather disappointing (Berend 2016: 202). In the 1970s, the European market provided the European multinational banks more safety and stability than investment opportunities in less developed countries that were then struggling to cope with the fallout of the first oil shock (ibid.). According to Bello et al. (2000: 3), the oil price increases in the 1970s led to OPEC money massively increasing eurocurrency liquidity boosting cross-border lending. However, progress in financial integration remained slow and markets fragmented as numerous national differences and restrictions persisted until more progress was envisaged with the Single Market programme that included an ambitious agenda for the creation of Single Market in financial services. The passporting idea, mutual

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recognition, the so-called Lamfallussy architecture providing a framework for financial regulation and supervision, and finally the introduction of the Euro were decisive steps in deepening financial integration in Europe promising a strong foundation for economic prosperity, deeper integration, and the Euro as a new global reserve currency (Berend 2016; Decressin et  al. 2007; Enoch et  al. 2014; Quaglia 2010; Story and Walter 1997). The reforms of the architecture for financial stability before the GFC led to a decentralized and segmented system that was reliant on voluntary cooperation between the various authorities in the member states. Banking supervision was decentralized along national responsibilities, in some countries the national central bank or another independent sector supervisor (like the UK’s Financial Services Authority) and treasuries had responsibilities and also the deposit insurance schemes were split along national borders with different levels of protection. Supervision of banks and financial conglomerates was conducted separately. The ‘considerable progress in integrating its financial markets’ (Fonteyne 2007: 1) and the progress ‘from fragmentation to financial integration in Europe’ with some parts still fragmented (Enoch et  al. 2014) was challenged when the GFC of 2007–2009 destabilized European financial markets and released disintegrative tendencies that led to the sovereign debt crisis. The functioning of the single financial market was suddenly in question and pressures increased when member states took unilateral emergency action in their national interest, ignoring the wider cross-border implications before a more coordinated approach emerged to restore public and market confidence (Teixeira 2011). Teixera (ibid.: 10) described the situation as clear evidence of the unsustainability of the European regulatory system and institutional arrangements. When the crisis hit, the EU was ill prepared in terms of a robust crisis management system and the lacking resilience and sustainability of European financial integration was widely acknowledged. While a collapse of the financial system was avoided, and the Eurozone has returned to moderate and maybe steady growth, it is highly contested what has been achieved and what still needs to be done to create a system better prepared for future crises. Representatives of key institutions such as the Commission, the ECB, Eurozone central banks, or the Bank of England assert that financial integration is already overcoming the setback from the crisis and that the banking system has become more resilient and regulators more preventive and precautionary. Others emphasize that the increasing importance of

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finance of the past decades has generated highly problematic developments in contemporary financial markets that continue to pose financial instability in a still highly opaque and fragile system (Pesendorfer 2015, 2016) or that risks will emerge in new, unexpected areas. After turbulent years in which it was repeatedly highlighted that a good crisis should not be allowed to go to waste by inaction, Daniel Gros warns that in a situation with ‘little sign that [the banking system] has become resilient to future shocks’ the calmer period ahead has to be used for the necessary reforms despite the lack of urgency (Gros 2017: 47). In the meantime, Brexit has become interpreted as a potential cause for financial instability if the withdrawal agreement will not be ratified and the UK leaves without a deal.

3.3   Europe’s Financial Markets Fragmentation and (Dis)Integration Based on the costly experiences of floating exchange rates in the 1920s and competitive currency devaluations in the 1930s and framed by the key international developments that created the post-war conditions for the globalization of trade and finance, Europe’s financial integration moved after the post-war transition in which currency convertibility had to be restored from a system of fixed yet adjustable currencies, to free floating, pegged to neighbour states (e.g. Ireland to United Kingdom, Austria and Benelux countries to Germany, Scandinavian countries) but with some coordination within the European Payments Union existing between 1950–1958, then becoming fixed for European Community member states in the European Monetary System (EMS) created in 1979 with the European Currency Unit (ECU) as an artificial currency created from a basket of member states’ currencies to stabilise and narrow currency fluctuations and counter inflation via closer monetary policy cooperation, before moving to an Economic and Monetary Union (EMU) with the introduction of the Euro in 1999 as single currency within the Eurozone countries and with the creation of the European Central Bank (ECB) as new European institution that should as independent central bank not just protect the Euro as a credible, stable currency but transform it into a global currency, maybe one day even replacing the declining U.S. Dollar as global reserve currency. EMU was moreover created with the intention to boost economic and social convergence between member states by

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increasing price stability, reducing transaction costs for cross-border trade, removing the uncertainties related to trading across different currency areas, and enforcing fiscal discipline across member states. The ECB provided with its collateral policy a large pool of substitutable assets available for refinancing operations in the markets. In its first ten years of existence, the Euro thrived and “provided price stability to previously inflation-­ prone countries”, “a shelter against currency crisis”, and was applauded for being “conductive to budgetary discipline”, while it welcomed new members and “many countries in Europe wish to adopt it” as “a strong regional currency” (Pisani-Ferry and Posen 2009). However, the Euro introduction was criticised from the outset, partly because of theoretical concerns, partly out of fears that a common currency would ultimately lead to much deeper integration resulting in the United States of Europe or to integration failure and high social costs. Based on Mundell’s (1961) theory of ‘optimum currency areas’ (OCA) leading economists were highly sceptical about the prospects of this new currency. Milton Friedman (1997 and 2000) as leading neoliberal thinker anticipated that it could break down once the ‘honeymoon phase’ following its creation would be over and the differences among its member states would then hinder the possibility to respond to future shocks. Other scholars criticized EMU from a left or Keynesian perspective. Karl Rothschild (1999), for example, criticized the primacy given to markets and the limited remaining scope of action for member states’ redistributive measures. Mundell assumed that a geographical region could maximise economic efficiency by sharing a common currency and that this would be the final step of economic integration. However, the European Union did not introduce the Euro as final step but as a stepping stone towards deeper economic integration, to a good part for political reasons in awareness of its shortcomings and to address fears that a unified Germany could become economically and politically too powerful within Europe. Mundell had also assumed that an OCA would lead to convergence and similar responses to macroeconomic policy changes and economic shocks and that a well-functioning OCA would require and allow flexibility in markets to respond to changes and shocks. EMU supporters had hoped that a strong and stable common currency and the four freedoms of goods, services, capital, and persons would lead to increasing similarity in living standards between the different national economies and that this would ultimately make further reforms and deeper economic and financial integration easier. Yet, the EMU was criticized from the left and the right, from Eurosceptics and from

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e­ nthusiastic supporters of deeper integration alike, that its design would hinder convergence and the infamous Maastricht criteria, invented to enforce strict fiscal discipline on member states and based on the simplistic idea that price stability would be “sufficient to ensure financial stability and that fiscal policy had no role to play in the provision of price stability” (Brunnermeier et al. 2016: 7), would undermine and endanger convergence by punishing states in crises instead of providing them a pathway to economic recovery. The eurozone governance was criticized as “profoundly undemocratic” given the independence and powers of the ECB, largely designed from the German Bundesbank as model, and as misguided by putting price stability ahead and ignoring jobs and the growth of output in monetary policy (c.f. Thirlwall 2002: 26). The ECB expanded its powers with a ‘technocratic’ and often ad-hoc governance approach. Scicluna (2018) labeled this approach ‘integration through the disintegration of law’ which risks in the long run to undermine integration. Moreover, the history of currency unions has shown that successful currency unions require significant fiscal transfers from the richer to the poorer regions. The EU’s fiscal transfers in form of regional and structural funds were largely seen as not adequate to guarantee success and convergence of regions over time. Some have therefore argued that only the countries already highly integrated should become members of EMU and countries not already converged sufficiently should be kept outside (c.f. Minford 1996: 165). Such proposals were always seen skeptical by integration supporters worried about the damaging effects that could have (Hirst and Thompson 1996: 161). For political reasons the European Commission allowed countries into EMU that were far less integrated and ignoring warning signs that they could not have met the entry conditions. Only after the Eurozone crisis had started, it became public that international investment banks such as Goldman Sachs had helped member states to mask the true scale of their sovereign debt to circumvent the deficit rules by using unregulated swaps and other techniques. The neoliberal design of the currency union was accomplished by a neoliberal design for social integration. While the EU praised and pushed economic integration establishing monetary and fiscal pressures on member states, progress towards a Social Europe was not really proceeding based on the belief that the reality of European social models would require ‘unity in diversity’. The Commission defined the EU’s role in addressing the rising social tensions in a neoliberal agenda pushing for ‘modernization’ including demands for more flexibilization in labor markets and completion of the

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internal market including deeper financial integration (EC 2005a). These policies were very much derived from the neoliberal design of the monetary union. Member states gave up their responsibility and powers over key economic variables that have been crucial for labor market interventions at the national level. Before the EMU, national governments had used the interest and foreign exchange rates to steer labor demand. With those powers now centralized at the European level for the Eurozone member states and restricted by the rules of the Stability Pact, member states have only limited possibilities within the fiscal constraints making traditional Keynesian interventions impossible. In this new environment, ‘economic success becomes increasingly dependent on reducing labor costs and greater employee flexibility’ (Whittall 2007: 29). Work in deregulated and less regulated labor markets became precarious with additional pressures in recent years from the rise of the platform economy disrupting the employment relationship. Another consequence of EMU was that the role of finance ministers was significantly strengthened in the general ‘structural reform’ of the Welfare State (Fitoussi and Le Cacheux 2007). Health, social protection, education, labor, retirement—all social policies came increasingly under pressure from the neoliberal agenda as the social norms changed ‘concerning the degree of inequality desirable or tolerable in European societies (ibid.: 14). Fitoussi and Le Cacheaux (ibid.: 4) regarded the new ‘cure’ as ‘doomed to fail’ and as a wrong ‘defensive strategy’ that would result a ‘race to the bottom’ that again cannot succeed in an open world economy. With the introduction of the ‘golden rule’ and ‘deficit break’ in the Fiscal Compact the pressure on member states to aim for balanced budgets increased even further and while there has been recognition of the need to also create a strong fiscal capacity in form of a central budget for the EU or Eurozone this has not found sufficient political support yet (Fabbrini 2016). The race to the bottom was not just a feature of the transformation of labor regulations and social policies but also in taxation. Since the 1990s, tax competition between EU member states intensified. For quite some time tax competition and the creation of attractive tax policies for large corporations and rich individuals were justified as a remaining option for member states to regain competitiveness and to attract investment. Such policies would create a dynamic environment boosting investment that leads to more growth and jobs beneficial for the entire EU. However, with the fiscal crisis of the ‘depleted state’ (Lodge 2013) after the GFC and following several scandals concerning prominent large corporations with special tax deals and an increasing

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awareness about tax avoidance and tax evasion schemes of multinational corporations, the mood changed at least to some extend since the GFC. The EU adopted a number of policies to address the issues. In 2018, the Commission called on seven EU member states, Belgium, Cyprus, Hungary, Ireland, Luxembourg, Malta, and the Netherlands, to end ‘aggressive tax planning’. Their taxation policies were now regarded as ‘unbearable’ and ‘part of the imbalances that have to be reduced’ (Maurice 2018). Tax competition had created an environment for tax ‘base erosion and profit shifting’ (BEPS). Corporations could now use legal arrangements in different jurisdictions to make profits disappear for tax purposes; instead of moving activities to lower wage or lower regulatory standard jurisdictions, they could now simply move profits. Different rules for tax on intellectual property rights and other details allowed companies to artificially shift profits to low or no-tax locations. Unfair taxation practices were no longer just a problem with tax havens, but they moved ‘right at the centre’ (Shaxson 2011) of the global economy. With the digitalization of the economies, additional problems emerged as highly digitalized businesses are usually highly involved in the economy of a jurisdiction without any significant physical presence and rely moreover on intangible assets and data. Critics regarded these developments ‘as a crime of globalization’ (Evertsson 2016) with significant consequences for the global economy and for nation states. Left critics of financial globalization argued since the early 1990s, that a fair corporate taxation system would end the pressures on the Welfare State. ‘Tax regulations have been re-written by tax authorities, financial controls have been removed, and secrecy has been guaranteed to provide a favourable atmosphere for investors’ (ibid.: 199) making the tax system increasingly unfair and undermining its legitimacy. As tax avoidance and tax evasion schemes resulted in significant revenue losses in the countries were the real economic activities of those corporations took place, the OECD started to address the issues. The OECD then launched in 2013 together with the G20 their BEPS project trying to address corporate strategies to exploit tax law gaps and mismatches in tax rules to artificially shift profits. In 2018, the OECD’s Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting, called Multilateral Instrument (MLI) came into force as a flexible instrument. Both influenced by the OECD developments and influencing them, the EU put forward measures for implementing those reforms. In 2015, the Commission released a Communication on ‘A Fair and Efficient Corporate Tax System’ identifying ‘5 Key Areas for Action’.

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Most importantly the EU wanted to re-launch its Common Consolidated Corporate Tax Base (CCCTB) which was first proposed in 2011 as a ‘modern, business-friendly and fair corporate tax system for the entire EU’ (EC 2019a) but vetoed by the member states that were highly engaged in tax competition policies. The Commission also presented an Anti Tax Avoidance Package, including an Anti Tax Avoidance Directive (ATAD) laying out minimum standards for member states and has since then taken further measures. The Council adopted the ATAD in 2016 and then an amendment to tackle hybrid mismatches with tax systems outside the EU (ATAD II) in 2017. The member states have to implement ATAD I into their national law by 31 December 2019 and ATAD II by 1 January 2020. However, both the EU measures and the new OECD guidelines do not go far enough to close tax havens and end unfair taxation policies and practices and they still provide loopholes and do not address the incentives to relocate economic activities to low or no tax jurisdictions (Collier et al. 2018; Knobel 2018). The IMF (2019: 10f.) concluded that opportunities for profit shifting continue to exist especially with the allocation of risk, the valuation of intangibles, and the avoidance or limitation of physical presence. Overall the problem ‘remains substantial’ and tax competition not only continues but would even become ‘more intense’. The CCCTB as part of a reform agenda to create a ‘deeper and fairer internal market’ is still facing problems and a missing link in the overall tax regime for corporations in Europe. Trade unions welcomed the progress from the 2011 proposal which was ‘purely pro-market and pro-business’ to the more balanced 2016 version but still saw major flaws (Valenduc 2018). Following the OECD, the EU set the reporting requirements in the CCTB directive proposal Article 2  in a way that they only apply to corporations with a revenue of a minimum of €750 million, which excluded 85–90% of the world’s multinational corporations from reporting obligations. The EU also failed to address tax havens within the EU. The European Parliament Committee on Economic and Monetary Affairs proposed in 2018 in the Lamassoure Report to implement CCCTB by 2020 and to amend it by reducing the turnover threshold for mandatory inclusion in the CCCTB to €40 million to capture most of the companies with transnational commercial activities as the Commission’s proposal would not be fit for purpose. The Parliament also suggested to set the minimum corporate tax rate at 25% to re-establish more fairness between multinational corporations and SMEs. However, the main problem of the CCCTB remains that member states have to agree unanimously on the future of corporate

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t­axation. According to the EU Commission non-action in tax policy has significant consequences; reforming the VAT regime could end tax evasion and tax avoidance in the amount of €147 billion annually, the CCCTB could increase investment by up to 3.4% and growth by up to 1.2% corresponding to €180 billion; a financial transaction tax (FTT) could create annual revenue of €57  billion; and a Digital Services Tax, proposed in 2018, would raise another €5  billion in revenue. Overall, such reforms could provide resources urgently needed to ‘prevent the fragmentation of the Single Market’ (EC 2019a: 4). It is surprising that the Commission was in early 2019 still using the revenue calculation from its original 2011 FTT proposal. As the EU-wide Commission’s FTT proposal was blocked, a group of initially 11 member states continued to push for it via the ‘enhanced cooperation’ procedure and that version was expected to generate up to €35 billion. However, the latest version of the FTT (see Chap. 5), still supported by 10 EU member states, in a watered-down proposal by France and Germany would only generate a significantly lower revenue of €3.45 billion annually. This calculation was based on the already existing French financial tax (Valero 2019). EMU also increased the pressure on companies to shift towards the shareholder value principle as a result of deeper financial markets integration and in particular the increased role of capital markets that transformed corporate financing. ‘In resorting to capital markets for financial investment’, highlights Whittall (2007: 29), ‘an outside controlling influence (shareholder value) is introduced into corporate governance that throws into imbalance the amalgamation of insider interests (stakeholders).’ Employees, local and national governments come under an ‘exit’ threat from capital mobility and ‘become hostages to external investment decisions’. The shareholder interests come with the already discussed focus on short-term profit maximization. With the Eurozone crisis unfolding, skeptics were proven right with their fear that external shocks affect the member states rather differently and over recent years many became convinced that the EMU foremost works for Germany while the promise of a Social Europe became a disappointing failure. The main argument why the Euro cannot survive in its current design is that the Eurozone has no common fiscal policy, insufficient fiscal transfers, that member states are asymmetrically affected by its operation and by shocks, that labour mobility is still rather restricted and that the existing rules leave insufficient space for economic interventions to counter structural problems at the member state level. While it became

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widely acknowledged that EMU requires fundamental reforms to survive, some experts argue that the EMU is not so different from the U.S. as an OCA (Kouparitas 2001) or that the U.S. was neither an OCA when it created its currency union and that a fully functioning currency union needs time (Rockoff 2000). EMU supporters have become largely optimistic again that the Euro has survived a major stress test and returned to stability and its path to becoming a global currency. Moreover, they argue that a return to the previous system would not be sustainable as the EMS had numerous flaws and got into a serious crisis in 1992 when various European currencies including the British Pound were under massive speculative attacks and it took an expensive coordinated intervention by national central banks led by the German Bundesbank to respond. The EMS was also under critique for turning into a D-Mark club, polemically labeled ‘Tyranny of the Mark’ (Marsh 2011), meaning that the western European countries had basically to follow decisions made by the German Bundesbank, reflecting the dilemma that an integrated system requires an anchor currency which subsequently limits the scope of action for other central banks and nation states (Altvater and Mahnkopf 1993: 90). Yet the Eurozone also showed various strengths throughout the crisis. During the GFC, the ECB was one of the first central banks to respond in coordination with the U.S. Federal Reserve and the Bank of England (BoE). And ECB’s President Mario Draghi’s (2012) famous statement that “the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough” in July 2012 combined with non-standard monetary policy measures calmed markets and allowed the Euro’s survival by rebuilding trust in the common currency’s future. The EC (2012a) published in the same year “A Blueprint for a Deep and Genuine Economic and Monetary Union” with the intention of “launching European Debate” as the subtitle promised. The EU has since then pushed further action to address financial instability in the EMU with more coordination and improved governance. A new economic governance regime has emerged, consisting of the European Semester, a ‘Six Pack’, a ‘Two Pack’, the European Stability Mechanism1 (ESM), and the Treaty on Stability, Coordination 1  The ESM was established on 27 September 2012 as a special purpose vehicle under Luxemburg private law with a maximum lending capacity of 500 billion euros. It replaced the European Financial Stability Facility (EFSF) and the European Financial Stabilisation Mechanism (EFSM) that had provided temporarily funding for the bailout loans to Ireland, Portugal, and Greece.

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and Governance in the EMU (TSCG). Additional reforms, including a roadmap towards a complete economic and monetary union with the final stage achieved at the latest by 2025, were outlined in the 2015 Five Presidents’ Report by Jean-Claude Juncker, Donald Tusk, Jeroen Dijsselbloem, Mario Draghi and Martin Schultz and in a ‘Reflection Paper on the Deepening of the Economic and Monetary Union’ by the European Commission (EC 2017), leading to the current complex structure of EMU governance. In 2017, the EC also presented the ‘Completing EMU Policy Package’ consisting of a communication on further steps, on new budgetary instruments, and on a European Minister of Economy and Finance plus proposals for a European Monetary Fund (EMF), to be created under EU law by transforming the intergovernmental ESM, and other necessary changes. Despite the number of reforms and proposals, they came extremely slowly, reactively responding to increasing pressures as indicated in the Five Presidents Report’s Roadmap and remained rooted in the old logic of the Maastricht Treaty, its convergence criteria, and the ordoliberal school of thought. They also have been limited by what is possible within the existing treaty framework or agreeable as a supranational solution outside the treaty as an interim solution. The EMF proposal, for example, has been supported by the European Parliament but is strongly opposed by the Council where the majority prefers maintaining the ESM’s intergovernmental character (EPRS 2019). In short, major reforms remain outstanding and controversial with some calling for reforms that are politically doable and do not require treaty change and others proposing a radical overhaul such as Stiglitz’s (2016) “bold, new system dubbed the ‘flexible euro’”, while key actors and experts have continuously warned not to postpone these measures but to have them in place for the next crisis. In a wider sense, the debates are linked to philosophical controversies about the underlying economic thinking behind EMU and how to respond to economic crisis, including the key question whether the EU would need a massive economic stimulus or austerity measures for a sustainable economic recovery and a new boom phase (Brunnermeier et al. 2016). But not just the Euro and EMU pose a problem for European (financial) integration. Within a ‘risk-based’ and ‘light-touch’ regulatory system—most successfully advocated by the City of London as leading global and European financial centre, international or even globalised, highly interconnected financial markets have been at risk for a long time and more than a decade after the outbreak of the GFC of 2008–2009 they still

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have the potential to bring down entire economies and to spread throughout the world economy, potentially affecting other countries and markets even if they share little direct trading links. Before the GFC such international contagion was largely attributed to risks from Developing Countries and their Debt Crisis in the 1980s and Emerging Market Economies in the 1990s, where it was assumed that politics would continuously interfere with markets. According to the mainstream belief global financial markets were efficient and self-regulating and crisis would only occur “when governments depart from sensible rules and fall into error” (Kindleberger and Laffargue 1982: 1). This belief was still dominant when the East Asian financial crisis started in 1997. However, the global contagion risk at that time led temporarily to some radical proposals to reregulate global finance. Yet, the biggest and most expensive crisis of the liberalised and deregulated financial system of the past 30 or so years, the 2008–2009 financial meltdown, started in the very centres of global capitalism, in the most advanced economies of the United States of America (U.S.A.) and the European Union (EU) that until then were praised for their most sophisticated and sound risk management, regulation, and supervision. Neoliberal financial integration policies have led to a system of financialisation or finance-dominated capitalism that has now been in demise for a decade without showing signs of disappearance (Hein et al. 2015). It is little surprising that, after a wave of fundamental regulatory financial reforms in the U.S. and the EU in the aftermaths of the financial meltdown in 2008–2009 aiming at increasing the resilience of the financial system, at both sides of the Atlantic various actors have started to push for a redesign of capital markets to boost economic recovery and to find new ways to finance infrastructure projects and other economic activities. Capital markets are the part of financial markets guaranteeing the medium and long-term financing needs of governments, businesses, and individuals. Their general role and design have a significant impact on particular forms of growth and innovation and how investments are pooled and risks distributed throughout a financial system. Since the GFC started, investor trust in markets suffered enormously and many features of capital markets and developments over the past decades have become highly criticized and continue to undermine trust in the system and to pose serious risks to financial stability. For now, however, it seems that the financial system has been stabilized, but many banks especially in continental Europe remain weak and are still

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fighting to develop a new business strategy. At the start of the GFC politicians and pundits thought that this crisis would be one of Anglo-Saxon capitalism, that continental European countries would not be affected due to their more solid bank capitalisation and behaviour and still stricter regulatory oversight. However, the Eurozone crisis quickly emerged as a special feature of the GFC.  Paul Krugman (2009) assumed that, beside Iceland and Ireland, Austria would pose the highest risk among the advanced economies given the country’s banks’ exposure in Eastern European markets—Austria is just one of several countries that developed in recent decades a largely oversized financial sector in relation to domestic GDP. Worries then shifted to Portugal, Ireland, Italy, Greece, and Spain, impolitely labeled the PIIGS countries. Since then the southern EU member states, including Italy but also France have raised ongoing concerns about major features of European economic and financial integration. The banking system of Greece and individual banks in other member states such as Spain, Italy, but even Germany remain problematic. In 2016 the IMF identified Deutsche Bank as the most dangerous bank in the world that could bring down the entire world economy. Involved in almost every major financial scandal of recent years from money laundering, Libor manipulation, sale of toxic securities to violation of U.S. economic sanctions, this bank suffered from significant fines and restructuring turned out more painful and time consuming than for other large banks. In 2019, merger talks between Deutsche Bank and Germany’s second largest bank—Commerzbank—failed and many experts had already before argued that Deutsche Bank would not need at least a merger with another large EU bank to survive. A few months later, Deutsche Bank announced its biggest restructuring ever, cutting some 18,000 jobs and focusing now on wealth management in key European countries and markets. The sheer amount of bad loans in European banking still holds down economic recovery and reproduces financial instability and cleaning them up is already high on the EU’s agenda at least since 2017. More recently, the EU Commission has emphasised the need for more bank mergers and generally more integration to prepare Europe for the next financial crash (see Chaps. 5 and 6). However, mergers and acquisitions (M&A) have driven a highly problematic development in the past decades leading to ever larger financial institutions that led to the notorious too-big-to-­ fail problem. Banks and other financial institutions play a key role in capitalist market and money economies and despite globalized financial markets global or

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even European financial integration is still incomplete. Moreover, within the global trading regime direct access and control of a global financial center is strategically of utmost importance for regional economic powers to secure financial stability and to exploit competitive advantages foremost for their own economic development. The British financial services industry has been providing such a function for the European Union (EU) since it secured its role as a global financial center with radical measures domestically in the mid-1980s and in exchange it benefited from a privileged access to power and decision-making within the EU. The United Kingdom’s (UK) global financial center—also branded as the City of London—has an impressive history of successfully reacting to global challenges. In the period of EU membership London has largely been supported by the EU’s agenda for financial market integration, a project that remained fragmented and experienced serious setbacks during and after the GFC but nevertheless continuously generated advantages for the City by setting strong incentives to financial firms within and outside the EU to establish substantial subsidiaries in London. The benefits of the UK’s EU membership for its financial industry were assumed to increase even further with the creation of a complete, ‘true’ and ‘deep’ Capital Markets Union (CMU), which became a key project under the Juncker Commission to mobilize capital for growth and employment in Europe, and the UK got assurances that the City’s role would not be undermined by deeper integration of the Eurozone area with the creation of the Banking Union, which the UK decided not to join. Now, the UK’s vote to leave the EU of 23 June 2016 poses at least significant challenges to financial services firms and to those who have been committed to protecting the UK’s global and European market position throughout the Leave negotiations and by achieving a future ‘bold and special relationship’ between the EU and UK that aims at securing Single Market access for UK finance that no other third country has ever been granted in trade in services negotiations. Financial integration theory accepts the possibility of continued market fragmentation and imperfect integration but also the possibility of disintegration. There is firstly the warning from history that deglobalization can reverse progress. In Oxelheim’s (1996: 47) neoliberal understanding of perfect integration resulting from a wave of deregulation and liberalization he also anticipates that once minimum regulation for this globally integrated market is set in place, there would still be ‘a risk of policymakers starting to compete in attracting investments in the financial industry, by adopting a ‘looser’ interpretation of the content of this set of regulations

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in the national regulatory body’, ‘potentially triggering a wave of re-­ regulation.’ Yet in the real world of incomplete integration and from an abstract level the question of direction of change towards more or less financial integration and financial globalization would be easy to answer. Liberalization, the removal of barriers and harmonization lead to more integrated markets; while remaining barriers constitute fragmentation, and the adaptation of new barriers would constitute financial disintegration that could theoretically range from partial to full disintegration. Looking at the evolution of European financial markets we see generally a clear trend in Europe towards more financial integration, with a slow start and then increasing speed especially in the mid-1980s and late 1990s although with remaining fragmentation in various areas (see Chaps. 5 and 6). The effects of the financial crisis would be a rise of market fragmentation, but not necessarily a move towards disintegration. Clear instances of financial disintegration were Iceland’s introduction of capital controls in November 2008 after the central bank of Iceland had already temporarily restricted foreign currency outflows as a result of the country’s severe banking crisis in October 2008. Even the IMF, for years arguing that capital controls would be the worst choice in any situation, unexpectedly supported this emergency measure as necessary in the county’s circumstances to prevent massive capital flight and a total collapse of the country’s economy and currency. Iceland had become the first victim of the GFC that needed financial support from the IMF and the fund made the capital controls now even a condition for its assistance package. As an EEA member state Iceland was acting in accordance with the EEA Agreement which incorporates the free movement of capital in Articles 40 and 41 but also allows emergency action in the provisions of Article 43 in order to avoid significant disturbances of a member state’s financial markets. The EFTA Court ruled in 2011 that the capital controls were justified under Article 43 of the EEA Agreement and that Iceland had met the substantive conditions set out in the article for its preventive measures (Case no. E-3/11). The restrictions were lifted in stages based on the central bank’s capital controls liberalization strategy but remained largely in place until March 2017. Since then the country fully re-integrated in global and European capital markets. An episode of financial disintegration in the EU then followed with the Greek crisis. When the Governing Council of the ECB expected in February 2015 that Greece would not successfully conclude the review of the EU/IMF financial assistance program, the ECB regarded Greece no longer compliant with this program and therefore withdrew the

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acceptance of marketable debt instruments issued or fully guaranteed by Greece (Decision (EU) 2015/300 ECB/2015/6). The decision was repealed in 2016 (Decision (EU) 2016/1041 of the ECB). With losing the access to ECB emergency liquidity assistance, Greece had to announce a bank holiday lasting 20 days and to introduce capital controls on bank transfers and limits on bank withdrawals. In mid-2019, capital controls were still in place in Greece. Another case of disintegration is the EU’s decision to end on 30 June 2019 the stock exchange equivalence recognition for Switzerland in response to the Swiss failure to ratify modifications to the complex EU-Swiss bilateral trade arrangements that would have secured Switzerland continued privileged access to the Single Market. In response and to protect Swiss exchanges, Switzerland withdrew its recognition under which EU trading venues were permitted trading in around 250 Swiss companies (Smith 2019). If this will be a temporal disintegration or a longer conflict has to be seen. Switzerland offered in early July to pay more into the Single Market budget for poorer member states to settle the conflict and regain market access. Beside these examples of clear de jure and de facto financial disintegration there has not been an active decision to reverse European financial integration more broadly, meaning there has not been any other de jure disintegration but some more de facto disintegration. New legislation necessary to avoid a collapse of the Eurozone and interpretation of existing rules to address urgent problems were directed towards protecting integration and minimizing market fragmentation as much as possible under the current political constraints. Various proposals for disintegration based on the assumption that integration has gone too far or that monetary integration would not work for all member states found not sufficient support to change direction of financial integration. The 2015 Greek bailout referendum, in which a clear majority voted not to accept the bailout conditions, was ignored by the government as the costs of such a dramatic financial disintegration, that could have resulted in temporarily or permanent withdrawal from the Eurozone, were unacceptable as they would not have solved the country’s debt problem. Other political parties in Europe that have in the past advocated leaving the Eurozone or splitting it up have shifted their positions for now towards reforming the system from within. However, financial markets and their regulation and supervision have remained fragmented to a certain degree. Fragmentation has been a result of market developments, the corresponding evolving interests of financial

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firms, and a reluctance from member states to centralize powers for joint supervision or to agree on more consistent supervision and more harmonization of rules and practices. But political interventions clearly played a role in the development of fragmentation and disintegration. Macchiarelli and Koutroumpis (2016) have measured market disintegration or a rise in fragmentation in a number of areas after the GFC and the Eurozone ­crisis. They found that the announcements of unconventional monetary policies by the ECB and of creating a Banking Union led to resumed financial integration albeit still on a well below pre-crisis level. Not surprisingly, the study showed a significant ‘core-periphery’ divide. Since then financial integration was also boosted by the Capital Markets Union agenda. Those two major deeper integration projects will be discussed later in Chaps. 5 and 6. Yet Brexit and the UK’s decision to leave not just the EU but also the Single Market is the clearest example of posing a threat of financial disintegration in Europe in the form of disintegrating to a currently still uncertain extend the UK’s financial markets from the EU-27 and other Single Market member states’ markets (see Chap. 4). Whether this disintegration results in deeper integration in the EU-27 is not just a question of measures that have already been taken and are now implemented and how the EU-27 will adopt its regulatory regime post-Brexit; it will also depend on the destabilizing factors coming from Brexit and from the negative consequences the boost of finance-led capitalism could have (see Chap. 5).

3.4   Reforming the Economic and Monetary Union Towards More Resilience and Sustainability As capitalism in its current stage is deeply unsustainable any progress towards more sustainability in the EU is relative moderate compared to the overall societal challenge. Since the EU first adopted the language of sustainable development it has been continuously extended from environmental policy into other policy domains. But only recently it entered a dominant role in regulatory debates about finance and in only a few years sustainable finance emerged from being only a small niche market to ‘becoming a transformational force’ (Dombrovskis 2019). The Commission stated in 2016 that sustainable finance is necessary ‘to meet climate and environment objectives and international commitments under the Paris Agreement on climate change’ and announced to ‘establish an

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expert group to develop a comprehensive European strategy on green finance’ (EC 2016: 5). The EU’s High-Level Expert Group on Sustainable Finance (HLEG), established in December 2016, presented its final report two years later in which a renewal of ‘the purpose of finance’ was demanded and recommendations were put forward to create in Europe ‘the world’s most sustainable financial system’ (HLEG 2018: 9). Already in the interim report, the chair of the HLEG, Christian Thimann, stated that ‘[r]epositioning financial regulation towards sustainability’ does not ‘require rewriting the whole system of financial regulation’ and that it would be sufficient to make gradual adjustments in ‘key areas’ based on ‘targeted proposals for change’ (HLEG 2017: 3). The HLEG (ibid.: 12) presented ‘three definitions of sustainable finance’ ranging from the ‘narrow definition’ as integration of ESG factors in financial decisions, to a broader definition according to which finance is ‘fostering sustainable economic, social and environmental development’ to the ‘broadest definition’ which would require a ‘financial system that is stable and tackles long-term education, economic, social, environmental issues, including sustainable employment, retirement financing, technological innovation, infrastructure construction and climate change mitigation’. Another definition can be found in the vision which the HLEG (ibid.: 16) described as ‘a financial system that is promoting sustainable economic development rather than boom and bust; sustainable social development rather than inequality and exclusion; and sustainable environmental development rather than damaging the endowments of nature.’ None of these definitions are particularly strong or radical and the overall approach of the HLEG has not been based on a systematic analysis of what makes the current system inherently instable and unsustainable. The final report set out two imperatives: improving the contribution of finance to sustainable and inclusive growth by funding society’s long-term needs and strengthening financial stability by incorporating ESG factors into investment decision-making. As already discussed earlier, the concept of ‘inclusive growth’ is a moderate post-crisis adaptation of the inequality discourse but not taking into account the wider lessons from the financial globalization and integration and their contribution to increased instability in the financial system. The idea of simply incorporating ESG factors does not reflect lessons from the failure to transform deeply unsustainable societies towards more sustainability over the past decades and the ‘broadest definition’ is too abstract too result in specific action that would transform the system fundamentally

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and the entire approach is based on strong market beliefs and an ignorance towards the power of markets over politics in finance-led capitalism. Mostly based on the HLEG recommendations the Commission published its Sustainable Finance Action Plan on 8 March 2018 presenting 10 action points as a strategy for a more sustainable financial sector. The Action Plan outlines three aims: ‘(1) reorient capital flows towards sustainable investment in order to achieve sustainable and inclusive growth; (2) manage financial risks stemming from climate change, resource depletion, environmental degradation and social issues; and (3) foster transparency and long-termism in financial and economic activity’ (EC 2018b: 2). The Commission then put forth three legislative proposals of which two have been quickly agreed at the EU level: one is disclosure obligations for investment managers and financial advisors, the other on low-carbon investment benchmarks. The more controversial classification system for green economic economies—also known as taxonomy—is still under discussion. The Commission planned to base the definitions for green investment on scientific evidence, but then there also needs to be a clarification of the social and governance aspects. The Technical Expert Group (TEG) on sustainable finance was tasked to prepare guidance on the EU Climate Change taxonomy, a report on the EU green bond standard and advice for the methodologies of low-carbon benchmarks and metrics for climate-­ related disclosure. The taxonomy—defined by the HLEG (2018) as ‘a technically robust classification system to establish market clarity on what is ‘sustainable”—is designed as ‘an implementation tool that can enable capital markets to identify and respond to investment opportunities that contribute to environmental policy objectives’ (TEG 2019: 10). The Commission also announced revised guidelines for companies to disclose non-financial and climate risks based on previous recommendations from the TEG (Dombrovskis 2019). The European Parliament adopted in March 2019 amendments to the proposed regulation on the establishment of a framework to facilitate sustainable investment proposing various improvements including incorporating a reference to a ‘holistic and ambitious approach and the application of a stringent precautionary principle’ (Amendment to 6b). The WWF, represented in the HLEG, welcomed the Action Plan stating that if the proposals are translated into law, the EU would become ‘a global trailblazer on sustainable finance’. However, support from member states and implementation would be important. The WWF nevertheless regarded the Action Plan as falling short of what meeting the Paris

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Agreement commitments would require and missed in particular that mainstream benchmarks such as FTSE 100 and retail funds do not have to disclose their climate impacts (WWF 2018a). The WWF’s demands were relatively narrowly focused on mandatory climate disclosure, integration of sustainability into EU investor duties, integration of sustainability into ESAs mandates and their guidance to financial institutions, EU standards for green bonds and labels based on a clear sustainability taxonomy, and a requirement for investment advisors to ask about and respond to sustainability preferences of retail clients (WWF 2018b). The WWF was also involved in putting forward ‘NGO recommendations for the EU Sustainable Finance Action Plan, supported by 12 NGOs (Finance Watch et  al. 2018). Finance Watch was more critical than the WWF. This NGO, created with EU funding after the GFC as a countervailing power to strong business interests dominating financial reform debates, welcomed the Action Plan but predicted that the EU would ‘fail to deliver on its core objective of “reorienting capital flows towards a more sustainable economy” as it fall short of confronting the key drivers of capital allocation in our financial system’ and the EU fails to recognize ‘financialization of our economy’ (Geiger 2018). Finance Watch (2018a) had quite correctly already criticized the HLEG report for failing to urge ‘policy makers to enforce the adequate pricing of negative externalities’ as a ‘top recommendation’ as a precondition for sustainable finance and that financial instability is insufficiently addressed. Finance Watch (2018b) outlined a very short ‘blueprint’ for ‘building a financial system for a sustainable future’ suggesting six areas to think differently by starting from acknowledging the financialization of the economy. Firstly, ‘society’s needs must be defined’ based on a clear ‘roadmap for action’ and detailed national plans for transition. Secondly, economic regulation needs to change direction and needs to be ‘hard-wiring sustainability in the economy, by changing the nature of economic incentives’. Here the pricing of negative environmental externalities come into play. Thirdly, financial instability needs to be addressed with ‘structural reform and an ambitious and binding cap on leverage’. Fourthly, the direction and flow of capital to markets needs to be guided. Fifthly, financial markets need to serve society which requires regulation of private financial institutions and the restauration of ‘some degree of democratic oversight of credit and capital creation and allocation, standards, data, investment labels and legal duties of investors to comply with ‘sustainable investment objectives, defined not by

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themselves but with reference to suitable external standards’. Finally and sixth, individual investors and financial sector workers need to be engaged. Resilience and sustainability in the EMU are not just about sustainable finance as addressed by the HLEG and the Commission in its sustainable finance agenda but also about the resilience and sustainability of the financial sector in the EU and within each individual member state and the resilience and sustainability of the European and each national economy. As we have seen in Sect. 2.1, economic imbalances resulting from freer trade have not been addressed and only Keynes made unsuccessfully a proposal at the time of its negotiation. EMU established a neoliberal adjustment to economic pressures. Not just the financial sector but all economies must be able to withstand and adjust to shocks. The term sustainable finance has been slightly redefined in recent years. The European Commission regards it as ‘the provision of finance to investments taking into account environmental, social and governance considerations’ and a process has started to translate what that means for creating sustainable financial markets. Following a weak definition of sustainable development, sustainable finance should support economic growth but consider the pressures on the environment, greenhouse gas emissions and pollution, waste, and the use of natural resources. Based on a commitment to a transition to a low-carbon, more resource-efficient and sustainable economy, the Commission and central bankers have recently started to warn financial institutions that they need to think about risk exposure from unsustainability and potential climate change impacts and to think about risk mitigation. Mark Carney (2019) suggested that supervisors should assess strategic resilience with climate-related stress testing to measure the exposure of banks and other financial institutions in different climate-change scenarios. This should also include checking whether the financial system ‘would be resilient to shorter-term shocks—including a climate ‘Minsky moment’ when climate risks materialise suddenly.’ The Paris Climate Agreement, finalized in 2015 and to be implemented from 2020, requires signatories to commit to align financial flows ‘with a pathway towards low-­ carbon and climate-resilient development’ (UN 2015, Article 2.1.c). Article 9 of the agreement calls for the mobilization of climate finance and calls on countries to develop strategies that use public funds; overall financial resources should be scaled-up ‘to achieve a balance between adaptation and mitigation’. Tackling climate change is also included in the UN 2015 Sustainable Development Goals. These international commitments by the EU and its member states have been incorporated into the Capital

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Markets Union agenda. The Commission even claims that the CMU project (see Chap. 5) is not just aiming towards more transparency in financial markets, allowing investors to consider and balance environmental and other risks in their decision-making, but also a strategy towards long-­ termism in the wider economy. The Commission presents its approach in the tradition of the moderate sustainability discourse as a win-win strategy by claiming that ‘taking longer-term sustainability interests into account makes economic sense and does not necessarily lead to lower returns for investors’ (EC 2018b). Central for resilience and sustainability is to reduce system risk. The EU defined systemic risk as ‘a risk of disruption in the financial system with the potential to have serious negative consequences for the internal market and the real economy’ (Article 2(c) of Regulation (EU) No 1092/2010) and financial system as comprising ‘all financial institutions, markets, products and market infrastructures’ (ibid. Article 2(b)). Among the various changes adopted in recent years, the new arrangements for the supervision of financial markets, market participants, instruments, and infrastructures play a significant role in transforming finance into a more sustainable and resilient system. The idea of separating supervision and monetary policy had already influenced supervision reforms in European countries since the 1980s, before it became a wider trend in the 1990s (Masciandaro and Quintyn 2011). In 2008 the financial crisis laid bare the weaknesses of the supervision architecture and European supervisory reform was put on the agenda with the Commission establishing the de Larosière expert group that was given the task to come up with recommendations for reforms (Masciandaro et al. 2011: 487). At the center of these reforms is the shift towards macroprudential regulation to allow for early interventions and finding the optimum level of deeper European integration to improve the Single Market based on the principle of ‘same risks—comparable/same rules’ to create a level playing field in the European market (Lautenschläger 2013). Following recommendations by de Larosière’s (2009) High-level Group on Financial Supervision, the new European System of Financial Supervision (ESFS) was created by replacing the committee structure that had been established under the Lamfalussy architecture for governing the securities sector, banking, insurance, occupational pensions, and asset management. The ESFS were created by legislation, not by treaty change, and entered into force in 2011 as a network consisting of three new European Supervisory Authorities (ESAs), the European Systemic Risk Board (ESRB), and national

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s­upervisors. The ESAs are the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA), and the European Securities and Markets Authority (ESMA). These three new specialized authorities work on harmonizing supervision in their respective areas and on harmonizing regulation in a single rulebook to support financial integration and assure a level-playing field in the areas of banking, insurance and pensions, non-banks, and financial markets infrastructures and instruments. The ESAs have a joint Board of Appeals and a Joint Committee to ensure cross-sectoral consistency of rulemaking and implementation. The ESFS has become responsible for micro- and macroprudential supervision to incorporate the lessons of the GFC and move from a focus on individual financial institutions to a systemic approach in supervision. Since the ESRB and the ESAs started their work, they have been reviewed in accordance with the review provisions in the regulations that had established them. Based on a public consultation in 2013, the Commission published its reviews in 2014, followed by further consultations in 2016 and 2017 before the Commission adopted a package of proposals to improve the ESAs and the ESRB. The proposed new regulation to reform the ESAs aims to improve regulation and supervision to be more supportive for financial markets integration. The EBA was created as an independent EU authority with responsibility for the prudential regulation and supervision of the banking sector, taking over the responsibilities and tasks of the Committee of European Banking Supervisors that had been created in 2004 as an independent body compromised of representatives of bank supervisory authorities and central banks. The EBA was originally located in London but, because of the UK’s decision to leave the EU, it was gradually relocated to Paris and closed its London offices on 31 May 2019. The EBAs overall objective is to maintain financial stability and to protect the integrity, efficiency, and orderly functioning of the EU’s banks. It was created to boost financial integration by achieving ‘a more integrated approach to banking supervision across the EU’ by assuring harmonized and consistent rules and supervisory practices are applied ‘to all banking institutions in the EU in the same manner’ (EBA 2016: 1). Concerning resilience, it has the important task to assure that the quality and consistency of supervision is protected, that cross-border banking regulation and supervision is improved, and that standards will not be watered-down once the lessons of the GFC are forgotten. The EBA regards itself as acting ‘as a cornerstone of a consistent and transparent single market for EU banking that is beneficial to

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all: businesses, consumers and the broader EU’. The EBA is publishing annually a ‘report on convergence of supervisory practices’ and a ‘report on supervisory colleges’ as part of its monitoring role. These reports play an important role as competent authorities in the EEA member states have a number of options and national discretions that can be applied when justified on the basis of national circumstances. The ESMA is the independent authority responsible to protect investors and to promote stable and orderly financial markets that replaced the Committee of European Securities Regulators. But compared to its predecessor, it was designed to have ‘real teeth’ (Schammo 2011). Its mission includes the assessment of risks to investors, financial markets and financial stability; completing a single rulebook for EU financial markets to improve the Single Market and ensure a level playing field for investors and issuers; promoting harmonization of supervisory practices in the EU to reduce the risks of regulatory arbitrage or a race to the bottom in regulatory or supervisory standards; and supervise credit rating agencies, trade repositories, and since 2017 also securitization repositories directly. The ESMA has soft law powers and can produce guidelines and recommendations and it has preparatory rule-making powers (Schammo 2011: 1881f.). The EIOPA, the third independent agency tasked to improve the working of the Single Market, has responsibilities for financial stability in relation to the insurance industry and their products and the institutions for occupational retirement provision. It has also responsibility to prevent regulatory arbitrage and fair competition in the Single Market and to ensure that risks related to insurance, reinsurance and occupational pensions are appropriately regulated and supervised and consumers are protected (Article 1 of Regulation (EU) No 1093/2010). The ESRB, located in Frankfurt, was already established in late 2010 as a new oversight body focusing on macroprudential risks and financial (in) stability in the financial sector. Compared to the ESAs it does not have any legal personality or powers of intervention (Lautenschläger 2013: 461). It covers all sectors and areas including banking, insurance, asset funds and managers, shadow banks, financial infrastructure and instruments. Its particular monitoring and reporting obligations make it an institution that is responsible for early warning of any build-up of financial instability and systemic risk in the financial system. The ESRB Regulation (Regulation (EU) No 1092/2010) defined the ESRB’s task ‘to monitor and assess systemic risk in normal times for the purpose of mitigating the exposure of

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the system to the risk of failure of systemic components and enhancing the financial system’s resilience to shocks.’ All three new ESAs are committed to enhance financial stability and prevent crises by trying to identify at an early stage potential risks and vulnerabilities building up in the financial system, largely building on tools and approaches that have been developed already before the GFC and were now given to these new authorities to harmonize approaches within the Single Market. However, instead of just focusing on the soundness of individual financial institutions, market infrastructures, or products, they now have all a clear mandate to also consider macroprudential risks. None of them, however, constitutes a radical shift in moving away from the key assumptions on which finance-led capitalism is based. Instead of downsizing finance, they try to regulate the complexities and opaqueness in the system. The European supervisory authorities have also been criticized as “‘the biggest sell-off’ in terms of regulatory and legislative sovereignty since World War II” (Engelen 2012: 31) and as a radical change towards more centralization that would not have been possible without a deep existential crisis (Howarth and Quaglia 2016). In terms of achieving deeper financial integration, the creation of the ESAs and the ESRB have clearly been progress as the varieties of national regimes for regulation and supervision were no longer adequate for more integrated financial markets. The optimum level of harmonizing supervisory rules and practices has remained difficult to find. Lautenschläger (2013: 464) emphasized that harmonization has its benefits, but European market regulation and supervision also has to take into consideration the ‘historically grown market structures and business models’ and varieties in customer preferences. A certain level of competition between different banking services and products across jurisdictions would be beneficial and counter too much concentration in the markets and undermining this with too much harmonization would even increase financial instability. According to Lautenschläger (ibid.: 473) the post-crisis supervisory system is ‘a workable political compromise’ offering a sound ‘balance between harmonisation and the required flexibility’. Experience with their operation over recent years has shown that national competent authorities still often tend to privilege the domestic market in their practices and that there are considerable differences in the implementation of EU legislation in the member states. Full harmonization of regulatory and supervisory practices is often not achieved and a risk of regulatory arbitrage remains

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that can be exploited by market participants (ESMA, EBA, EIOPA, Joint Committee 2019). An area of clear failure is fight against tax avoidance, financial crimes, and money laundering. After years of piecemeal reforms, the Panama Papers revealed in 2016 that the regulatory framework in these areas is deeply flawed and that there is a fundamental lack of transparency in financial markets. This came as little surprise as critics including the European Parliament’s Committee on Financial Crimes, Tax Evasion and Tax Avoidance and the Committee on Economic and Monetary Affairs have warned for some time that the EU’s framework was inadequate. In September 2018 the Commission had to announce in a Communication another revision of powers for the EBA because of serious money-­ laundering cases in the EU that went on undetected by regulators and supervisors and proposed to introduce a regulation amending existing legislation to concentrate and strengthen anti-money laundering powers into the EBA in a further move towards deeper integration of supervision practices. The scandals involved Cyprus, Denmark, Estonia, Latvia, Malta, the Netherlands, and the United Kingdom, and various credit institutions within the EU Single Market. The Commission’s review of some of these cases ‘revealed substantial incidents of failures by credit institutions’ and the supervisors’ failure to intervene before significant risks had already materialized; ‘repeated compliance and governance failures’ went undetected and ‘regulatory and supervisory fragmentation’ caused further problems and delays in acting (EC 2019b: 4). The cases also revealed a deeply inadequate risk management and compliance and a failure of internal auditing within the credit institutions. The practices were moreover linked to high risk appetite created under the banks’ business models and insufficient funding for competent authorities. In short, there is a low detection rate that makes it attractive for the industry to engage in such activities and punishment is moderate. Confidentiality constraints make it moreover difficult to investigate the actions of prudential authorities (EC 2019c). Kirschenbaum and Véron (2018) proposed a new European Anti-­ money Laundering Authority should be created with strong supervisory powers, including the power ‘to impose sufficiently large fines to deter malpractice’. The Commission followed up with another Communication on implementing the new anti-money laundering framework which included the proposal to strengthen the EBA’s role (EC 2019b). In total these changes signify a gradual and often responsive change. Sustainable finance has become an additional element to boost certain

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markets and foremost to secure investment in areas where the EU and its member states have made international commitments to address human made climate change. The institutions for regulating finance have adopted the new post-GFC mainstream thinking about what is necessary for a more resilient financial system. However, these new institutions have not taken on a radical new perspective and have not become institutions pushing for a systematic downsizing of finance. Macroprudential regulation has led to the new ideology that it is possible to monitor the evolution of risk in a highly opaque and complex financial system and to take early interventions if necessary; yet as the areas of tax havens and money laundering have demonstrated in recent years, regulation and supervision are both lacking in powers and strength. However, if it is not acknowledged that finance has already grown beyond the size where it is socially beneficial and that strategies of winding down certain markets systematically are not even considered as realistic options, regulatory interventions will necessarily come at a stage where social costs are already high. The EU has not adopted sustainability or the precautionary principle in finance as a radical concept to transform unsustainable elements in the system into more sustainable structures. European regulators have not become ‘Financial Stability and Product Safety Administrations’ with a clear mandate ‘to test and approve (or deny) the marketing of new financial products’ (Crotty and Epstein 2009: 5). The literature on a precautionary principle in finance has made suggestions how to incorporate such a system based on shifting the burden of proof to financial institutions in a regime of strict product regulation based on strong interpretations of the precautionary principle (Pesendorfer 2014). European financial regulation has not adopted such an approach and remains based on trust in finance to innovate in an ethical and responsible way. Regulators focus on transparency requirement and monitoring of structures, activities, and products that have been identifies as potential causes of financial instability. Given the complexity and opaqueness of modern financial markets such an approach has often been criticized as a ‘catch me if you can’ situation, where finance introduces new innovations to circumvent regulation, and regulators do not have the knowledge and resources to intervene at an early stage. Risk monitoring is limited moreover by a continued acceptance of highly problematic activities and products that have developed before the GFC, contributed to the crash, and now reemerge or are even revived with the support of financial regulators (see Chap. 5).

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CHAPTER 4

Brexit and Financial (Dis)Integration: Between Cakeism, Project Fear, and Reality

Compared to the relatively high regulatory barriers for trade in financial services under WTO rules and in RTAs and FTAs (see Sect. 2.1, Lang 2018), the European Single Market for financial services is despite its imperfections the gold standard in providing open market cross-border access for financial services from firms that are incorporated in member states. European financial integration has therefore worked very well for the UK’s financial industry over the past decades since the UK joined the EEC.  The City of London—the brand under which the UK’s financial industry operates—has been one of the most powerful and influential industries in the EU and financial regulation and market integration were largely along the lines London desired and needed to expand its position in the global economy. Although at times challenged by the EU’s financial integration agenda, the post-GFC regulatory reforms and in the long-­ term by rising emerging market financial centers outside of Europe, the City of London successfully protected its position as leading global and European financial hub until 2018. Staying permanently outside the currency union was part of the UK’s strategy of European financial markets integration and limiting centralization of powers within the EU served the UK’s interest to guarantee flexibility in adjusting the City’s regulatory environment in response to new challenges. Despite complains about the EU’s post-GFC reforms from many within the industry including the frequent threat to relocate out of the EU if reforms go ahead unchanged, the City was largely happy with how it shaped them and was already working © The Author(s) 2020 D. Pesendorfer, Financial Markets (Dis)Integration in a Post-Brexit EU, https://doi.org/10.1007/978-3-030-36052-8_4

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with high energy towards removing overregulation and boosting business by creating new markets. With its economically powerful and politically influential financial center the UK had no interest in ever joining the Banking Union but was the main driver behind concessions in its design to protect the interests of non-Eurozone member states (see Chap. 6) and the country was expected to gain most from deeper integrated capital markets, making the UK part of the Financial Union agenda (see Chap. 5). London ruled undisputed as number one global financial center while other EU financial centers such as Paris and Frankfurt fell back over the last decade until recently (Cassis and Wójcik 2018). Yet following the UK’s referendum vote of 23 June 2016 to Leave the EU, the long struggle and failure of the new UK’s government under Prime Minister Theresa May to agree a joint negotiation position and the UK’s parliament’s refusal to ratify the negotiated ‘Agreement on the withdrawal of the United Kingdom of Great Britain and Northern Ireland from the European Union’ from 25 November 2018 have created a prolonged uncertainty about the future relationship between the EU and the UK.  No matter whether the UK will exit from the EU with or without an orderly withdrawal agreement and a transition period the result will ultimately be some form of disintegration between the EU-27 financial markets and the EU’s then former financial center. Discussions over recent years since the Referendum campaigns were highly controversial, largely reflecting the overall extremely polarizing Brexit debate in the UK with claims ranging from nothing would change to disaster and economic downfall. For Brexiteers the City was a key asset that should provide the UK government an even stronger hand in negotiations it already had as fifth largest economy in the world as European markets would require continued unrestricted access to London’s financial services. For Remainers the country’s most important export industry was under threat by giving up the privileged access to European markets only full membership can provide. The Brexit impact on trade in services could be more serious than for the UK’s manufacturing exports given international trade rules. The ‘preparedness notices’ to stakeholders published by the European Commission since 2018 and the political declaration on the future relationship agreed with the withdrawal agreement in November 2018 show that there will be significant ‘friction’ between the markets after Brexit especially under a no-deal exit. Yet the long-term consequences for the City of London and other European financial centers remain uncertain and again highly contested.

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Brexit could result in a period of deglobalization and financial disintegration at least for the UK as market turbulences are a possibility when the country’s economic relationship to its biggest and geographically closest trading partner changes, especially abruptly with a no-deal Brexit and a phase of non-cooperation or even economic war between the UK and EU. Such a worst-case scenario could reduce the attractiveness of the UK for foreign investment. EU-27 countries, foremost Ireland, would also take a hit but could at the same time benefit from businesses relocating into their markets. As a result of the uncertainty about London’s future access to the European Single Market for finance, the City lost its top global position in 2018 to New York while other European financial centers have already taken some business from London. For the financial sector the EU adopted contingency plans to avoid the most serious market disruptions in the financial services sector. For the UK the Bank of England declared that the country’s financial sector would be strong enough to cope with a no-deal Brexit and that it is ready to intervene as necessary. Some in the UK suggested to keep the country competitive by adopting an aggressive strategy based on regulatory divergence from EU rules, adopting various tax advantages, and creating free ports. Such a strategy would raise questions about unfair competition and most certainly cause countermeasures from the EU. With the increased possibility of the no-­ deal scenario, UK industry representatives suggested a temporary VAT holiday to businesses and that ‘the government should work with banks to temporarily relax loan repayment terms’ (Jolly 2019). Continued privileged access to the Single Market is at risk for the UK and the consequences could be rather significant for the UK and the EU. If Brexit goes ahead under the ‘do or die’ and ‘no ifs and buts’ commitment to leave on 31 October 2019 with no deal adopted by Prime Minister Alexander Boris Johnson’s cabinet end of July 2019, the next phase of European financial integration will include rather significant and abrupt elements of economic and financial markets disintegration that will bring various technical, economic, political and legal challenges for unwinding some markets with regard to access to the City and for deepening financial integration in the remaining member states of the EU and Single Market. This chapter will firstly discuss the general role of financial centers in Europe and the UK’s financial industry’s unique role. This will include looking at the fluctuating fortunes throughout the history of the City of London as a global and European financial center, before discussing the City’s challenges during the GFC and the post-crisis regulatory reforms.

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It then continues with what London could loose and gain after Brexit outside of the Single Market and how that might impact its role as European financial center. It is then concluded that the UK’s financial system faces significant challenges that have the potential to undermine London’s role as leading global and European financial center and that both, the UK and the EU, would need different policies for a more decentralized, sustainable and resilient financial system.

4.1   Financial Centers in Europe and the City of London [Financial] Integration is good in good times; in bad times, it is good if you have the trouble and the rest of the world helps, bad if the trouble originates outside and is communicated inwards. Charles P. Kindleberger (1974: 15)

A key feature of financial globalization and financial market integration is capital concentration in global and regional financial centers. They are located in urban spaces where major infrastructure and expertise are provided for financial institutions to ‘coordinate financial transactions and arrange for payments to be settled’ (Cassis 2018: 2). Such a concentration leads to higher efficiency in markets and requires liquidity in markets; ‘the diversity and complementarity of financial activities; the availability of professional services, technological expertise, and a skilled workforce; and access to high-quality information’ (ibid.). Global financial hubs, most notably nowadays in London and New York, have been respected as the ‘truly sophisticated’ financial systems, providing ‘a full and ever-changing range of products and services’ (Arner 2007: 46). They exist in a hierarchy to each other that includes complementary, cooperative, and competitive aspects between them and only a small number can have ‘a truly global role […] as the nerve centres of international financial activities’ (Cassis 2018: 2). Within the global trading regime direct access and control of a global financial center is strategically of utmost importance for regional economic powers to secure financial stability and to exploit competitive advantages foremost for their own economic development. Financial centers have naturally been the strongest supporters of neoliberal financial globalization and deeper financial integration and play a key role in the operation of finance-driven capitalism. International and domestic financial regulation, deregulation and liberalization as well as regional integration policies

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have supported their growth as heavily concentrated markets in a business-­ friendly regulatory environment. The lessons from the GFC, however, have undermined the claims of more efficiency and higher financial stability and resilience of the most globalized and integrated financial markets with the two leading global financial centers turning into the epicenters of the financial meltdown. Like other financial crises before (Kindleberger 1974), the GFC demonstrated that oversized financial centers create significant advantages for their host country in good times when they enjoy all the benefits of financial integration, but in bad times they might require massive state intervention and taxpayer bailouts that almost entirely rest with the responsibility of the host country. Some from within the financial services industry have argued, however, that everyone in the UK benefited from the strong Pound Sterling, rising house prices, cheap credit, consumer durables and cheap holidays during the boom years and that ‘[t]he boom was a collective delusion’ (c.f. Freedman 2009: xxv). The GFC raised nevertheless concerns about the social impacts of financial centers on the rest of the country and whether they are a blessing or a curse (Christensen et al. 2016; Shaxson 2018). For many British leave voters the threat of financial firms and assets relocating out of the UK made little impression as finance is perceived by many as the source of the UK’s inequality problem and London-centered development. Yet from the perspective of European financial market integration the future of European financial centers is of key importance as it relates to market infrastructures, economic advantages of having highly attractive and competitive financial centers, and the powers to intervene if things go wrong. In short, the control of financial centers is essential for financial stability and resilience. Financial centers have also become key locations for developing new technologies for the future of finance and for driving ‘sustainable finance’. The strong tendencies towards centralization of capital resulted also in rising competition between different trading blocs within the wider world economy in which the competition between financial centers plays an outstanding role (Kindleberger 1974). From a strategic point of view, access and control of a financial center is of utmost importance for a region’s success in global competition as they provide the maximum benefit of financial integration. London has for a long time played a core function in the globalization of finance and in European financial markets integration but with leaving the Single Market, the EU has to draw some lessons from the history of the rise and fall and reemergence of financial centers. For the UK different but equally important questions arise about whether a role as

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European financial center can be protected without close regulatory alignment to EU regulation and whether staying a European financial center long-term would be compatible with a reorientation in regulatory standards towards the U.S. as some Brexiteers aim for. Charles Kindleberger (1974: 8) described the evolution of financial centers as ‘partly Darwinian and partly the result of deliberate action by government or private individuals’. In his short history of the ‘formation of financial centers’ he shows how London provided not only ‘an ancient banking tradition’ and the perfect location, supported by the creation of infrastructure assuring easy accessibility, but was also well connected with the Irish and Scottish banking systems (ibid.: 16). An optimum combination of political, legal, and market forces drove a centralization process and while ‘granting credit’ remained decentralized, deposits ‘gravitate[d] to London, the center of commercial activity’ (ibid.: 18). ‘The same concentration that produces a single dominant financial center within a country’, Kindleberger (ibid.: 57) ascertains, ‘tends to result in the emergence of a single worldwide center with the highly specialized functions of lending abroad and serving as a clearinghouse for payments among countries.’ Yet the concentration process is largely a market process that is held up by continued market fragmentations within the global economy and geographical barriers but also by political interventions and financial integration strategies in regional blocs that lead to continued competition between different regional financial centers and the small number of truly global centers. London achieved in the nineteenth century its status as world financial center, overtaking Amsterdam as ‘trend-setter for financial innovation’ thanks to various factors including strong political support and oversea trade driven by the colonial expansion of the British Empire (Bindemann 1999: 13). Throughout a good part of the nineteenth century London and Paris competed for dominance as the world’s two leading financial centers, and while Paris declined into the ‘second division’, falling behind Frankfurt and Zurich in Europe, London became the leading European financial center (Cassis 2005). Kindleberger (1974) described London as the first real global financial center, which ‘emerged as the undisputed leader in international finance after 1873’ and ended the competition with Paris, which had stopped to ‘contest British financial leadership’ in 1870 (ibid.: 59). However, with the entry into World War I, the Great Depression and Britain forced to give up the gold standard in 1931, Wall Street in New  York, already challenging London since 1900, rose as the new

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i­nternational financial center but only taking on ‘world financial leadership’ from 1936 onwards and only really becoming ‘the world financial center from the early 1950s until the end of the decade’ (ibid.: 61). According to Bindemann (1999), London kept some relevance in insurance and shipping after World War II, before it regained importance with the emergence of the Eurodollar market. US banks increasingly followed US companies to Europe, using London as a hub to access the European markets. The City became the key player in Eurodollar and eurocurrency markets (ibid.). For regulatory arbitrage reasons, an increasing number of US banks and security dealers opened branches in London in the 1960s (Kindleberger 1974: 62). Across the world, the financial services industry operates in a highly dynamic environment. Maybe ‘the only constant’, as Swary and Topf (1992: vii) put it, ‘is the steady acceleration in the pace of transformation.’ Their study on ‘global financial deregulation’ was focusing on a global trend in banking and capital markets regulation increasing speed in the 1980s, which was successfully shaped and exploited by the City, going through a ‘radical shake-up’ during the ‘City Revolution’ that had started with the ‘Big Bang’ sudden deregulation under Margaret Thatcher (Reid 1988). Since this spectacular overnight ‘Big Bang’ introduced on 27 October 1986 as a package of liberalization, deregulation, and reregulation of the British financial markets life in the City of London was revolutionized and the rapid growth of banks and other financial institutions made the City the leading global as well as the European Union’s (then European Economic Community) financial center (Vogel 1996). In the following ‘thirty years, the City has been changed beyond recognition’ (Coggan 2002: 1) and it became one of the global financial centers that made ‘Governments round the world […] constrained in their economic policies for fear of offending the markets’ (ibid.). It was no longer characterized by ‘thousands of small or medium-sized firms’ but became home for mega-large conglomerates, already with its new architecture reflecting the ‘masters-of-the-universe syndrome’ (Kynaston 2011: viii). Light-­ touch regulation, a high degree of banking confidentiality, and a business-­ friendly climate and legislative environment combined with the existence of supporting professional services and high-quality infrastructure as well as the introduction of new technologies boosted London’s position ‘resulting in self-sustaining growth by attracting ever more business’ (Bindemann 1999: 15). With the introduction of ‘American-style annual bonus rounds’ and the increased role of the ‘quants’—the specialists in the

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application of mathematical and statistical methods utilized to create ever more complex financial products—came a significant cultural change, supportive for ever more risk-taking, but highly rewarding activities supported by financial institutions that have become too-big-to-fail and could therefore expect taxpayer bailouts if something goes wrong (Kynaston 2011: ix). The Big Bang secured London’s historical position as a global financial center in competition with New  York and then also Tokyo and other emerging financial centers in the radically dynamic environment created by the second wave of globalization that led in all these jurisdictions to deregulation resulting in increasing downwards regulatory competition between the top financial centers and their potential rivals. However, London’s role as the main European financial center was challenging to achieve. According to Bindemann (1999: 1) ‘[f]actors like its peripheral location, the Euro-phobic attitudes of policy makers, the refusal to join the Economic Monetary Union (EMU) and adopt the single currency, as well as the intercontinental orientation of London’ would have made it more likely for Frankfurt, ‘its main continental rival’ to become Europe’s financial center. Kindleberger (1974: 63) already speculated that a European currency might be created out of an existing currency such as the Deutsche Mark. Such a creation would generate a competitive advantage for the financial center of that very country—namely Frankfurt. ‘An attempt to create an entirely new currency’, he thought, ‘would presumably not affect the ultimate choice of a particular financial center’ but the creation of a European central bank, especially when its location would be merged with the administrative capital with a historical tradition in finance, would in the long-run certainly have an effect (ibid.: 64). However, although the Euro currency was created with the features of the D-Mark in mind but as a new creation and Frankfurt became the seat of the ECB, the City successfully used the Single Market to keep any rivals in Europe at a distance and secured the European Banking Authority for London. The City successfully used ‘Europe as its hinterland’ as the Inter-Bank Research Organisation suggested in its 1973 study of the future of London as an international financial center (see Kindleberger 1974: 65). Globalization with its unleashed market powers as well as European financial integration policies supported centralization and economic efficiency, culminating in an ever more powerful London, although smart regulatory competition allowed some countries to attract a significant amount of business and some niche markets to their financial hubs. Paris had its own Big Bang in the 1980s, expanded its capital market continuously, and

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­ enefitted from the Euro introduction. Overall its comeback into the ‘race b for European leadership […] suffered from decades of financial protectionism and state intervention’ but with mergers and other policies, including a more business-friendly orientation under the current government, France starts from a strong position to benefit from Brexit (Quennouëlle-Corre 2018). Frankfurt proved over the last few decades rather resilient as a continental financial center, benefitting foremost from Germany’s exporting strength and the close relationship between German banks and companies. According to Schamp (2018: 100), ‘Frankfurt has become China’s first choice on the continent for trade finance’ and the leading Chinese banks are present with offices. Overall, Frankfurt was also seen to have good opportunities to improve its position after Brexit (ibid.: 102), especially since the German government committed to Frankfurt more actively in the last years. Beside the three historical continental rivals Frankfurt, Paris, and Amsterdam, Ireland with its Celtic Tiger boom before the GFC and Luxemburg attracted financial firms thanks to their tax and Foreign Direct Investment-friendly policies. Besides the UK, especially the Netherlands and Ireland have attracted a significant amount of hedge funds and other parts of the ever larger and highly opaque ‘shadow banking’ world that evolved largely unregulated as a major driver of finance-led capitalism. All three countries also feature prominently in the game of tax avoidance and tax evasion for the rich and multinational corporations that have become features of global and regional financial centers. The history of financial centers in Europe shows that the hierarchy among them has always been contested and that political support plays an important role in protecting and expanding their relative positions. For political and economic reasons, the EU will have to develop a strategy to develop its own global financial center instead of relying on a ‘third country’ for providing major tasks that impact financial stability. From history and the literature on the rise and decline of international financial centers one could assume that this will require the EU and key member states such as France and Germany to adopt ‘firm but not too intrusive state supervision’ combined with various incentives for finance (Cassis 2018: 9). If designed in that way, this would become another heightening for finance-driven capitalism in the EU and the EU and UK could easily end up in a race to the bottom to make their financial centers most attractive in the region. However, there is also an alternative possibility to adopt stricter regulation for finance within the EU and use the opportunity to downsize certain markets and transform banks back into intermediaries.

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4.2   British Finance and the GFC Finance is the UK’s most important and most dynamic industry sector, generating significant revenue for the Treasury and lucrative remuneration for many employed in the booming industry and its related legal and accounting services. In the years before the GFC, the majority in the country arrived at the conclusion that the sheer size of the sector and its many activities secured wealth for all and many of the brightest university graduates aimed for a lucrative career in finance, while the size of the market also required attracting talent from all over the world. That the British manufacturing sector had shrunk for three decades like in no other major economy was presented as economic modernization in a society that has realized that the future is in the most profitable service sectors. Business-­ friendly light-touch financial regulation was broadly accepted as ‘essential to London’s continuing pre-eminence as an international financial centre’ and there were constant worries about possible overregulation related to the US Sarbanes-Oxley rules adopted in the aftermaths of the big Enron corporate governance scandal, ‘growing US ownership of the London Stock Exchange, or the European Commission’s desire to increase EU competence in this area, leading to a single EU regulator’ (Lawson 2006: iv). Although the GFC then revealed the disastrous effects of poor supervision based on a ‘light-touch’ risk-based regulatory approach and of extreme leverage and extreme speculation that had become core elements of the business model in the sector and despite public anger against greedy and maybe even criminal ‘Bangsters’, costly bailouts and impertinent banker bonuses, UK governments have rather successfully continued protecting the sector from various attempts to downsize finance and against ‘over-regulation’ that would negatively affect the future of the City by putting it into a less competitive position to other existing or potentially future financial centers. However, given the public anger with finance and lessons from the financial crisis, the powerful but in its reputation damaged UK financial sector had to accept a special one-off tax on banker bonuses paid by the banks in 2010 and then a banking levy as a financial activity tax that has since its introduction already been reduced, with plans for further reduction already in place since before the EU Referendum. The largest banks also could not escape stricter capital requirements, which made in 2011 J.P.  Morgan, for example, investigate whether it would be worth relocating to another EU member state. Back then such a move was financially not viable (Glazer 2016). Especially the Bank of

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England, taking over banking supervision from the discredited Financial Services Authority, has since then argued that a global financial center needs stricter standards to assure investors and to protect taxpayers—a position that has for now been accepted by banks. But the financial sector has also started to call for addressing overlapping regulatory requirements that would cause unnecessary compliance costs and reduce what can be spent on new innovation and investment. The sector has also pushed for an even closer relationship with the government and regulators. Providing key functions as European financial center, the City received in exchange for its contribution to economic development and financial integration a privileged access to power and decision-making within the EU.  British finance has largely been supported by the EU’s agenda for financial markets integration especially since the creation of the Single Market and the EMU. Although European financial integration remained fragmented and experienced serious setbacks during and after the GFC it continuously generated advantages for the City by setting strong incentives to financial firms within and outside the EU to establish substantial subsidiaries in London, from where they could operate across the Single Market in the increasing areas where markets have become more or even fully integrated and centralized. Yet in the aftermaths of the GFC of 2008–2009 various British actors and industry representatives became concerned about the politization of financial regulation and bad and overregulation, which was perceived as strongly supported by Germany and France and therefore finding its way into the EU’s institutions. Given the increased importance of European regulation and supervision Brussels, driven foremost by pressure from these two large continental countries with their more interventionist approaches and strong domestic public pressures for more ambitious financial regulation, became an enemy for the UK in key regulatory reform debates such as regulating ‘shadow banking’, short selling, structural reforms of banks, ending short-termism and supporting long-termism in finance and the wider real economy. In these battles the UK also used the European Court of Justice (ECJ) with a mixed result. In 2012, the UK suit against the EU’s regulation of short selling arguing that this regulation is based on the ESMA given the power ‘to adopt quasi-legislative measures of general application’ which would be in violation of principles established in previous case law; a general legislative measure is beyond the powers granted to the ESMA under the EU Treaty; and the Council has no authority to delegate such powers to an EU agency (Case C-270/12). However, the ECJ Grand Chamber ruled

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in 2014 that the ESMA has the powers to regulate or prohibit short selling and rejected the UK’s challenge in its entirety. The UK also challenged the capping of bankers’ bonuses (C-507/13), following amendments by the European Parliament to the CRD IV Package. The Chancellor then decided to withdraw the case after the Advocate General suggested in his report in 2014 that the ECJ should reject the UK government’s pleas and dismiss the action. One of the most controversial topics has been the debate about a Financial Transaction Tax (FTT). Proposals for such a tax on the global and on the EU level were successfully blocked by the UK and a proposal for enhanced cooperation in this area by a coalition of supportive EU member states was challenged in the ECJ by the UK government (Case C-209/13). The Court’s Second Chamber dismissed the UK’s claim in its judgment of 30 April 2014 but left it open for the UK to challenge the FTT with regard to its effects on non-participating member states once its technicalities are specified and it would be implemented. For London that was a symbolic success. The UK was more successful in blocking the ECB’s attempt to move euro clearing into the Eurozone. The ECB had tried to shift a large bulk of this business, currently still in London, into the Eurozone to allow in a crisis supervision and intervention within the Eurozone under its own competence. This policy was first announced by the ECB in its Eurosystem Oversight Policy Framework in 2011 which stated that ‘infrastructures that settle euro-denominated payment transactions should settle these transactions in central bank money and be legally incorporated in the euro area with full managerial and operational control and responsibility over all core functions for processing euro denominated transactions, exercised from within the euro area’ (ECB 2011: 10). The UK challenged this policy announcement in 2011 and launched then two further challenges at the ECJ where the UK successfully defended its industry in 2015. However, although the General Court annulled the ECB’s 2011 Policy Framework for lack of competence, its ruling was based on the UK’s membership in the EU and moreover stated that the ECB could request a change to its Statute which would then be decided in accordance with the ordinary legislative procedure (Case T-496/11), meaning even as an EU member state, the UK could not block such a decision. So at least in this business area withdrawal from the EU was expected to repeat the discussion under new circumstances (Edwards 2016; see below). When Michel Barnier was Commissioner for Internal Market and Services between 2010–2014, he was frequently attacked by London as

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trying to overregulate finance in a typical French statist approach. His Irish predecessor Charlie McCreevy had been a strong supporter of financial market liberalization, industry self-regulation and ‘light-touch’ principle-­based regulation, and much more to the liking of the City he had only reluctantly adopted stricter regulation during and after the GFC. Barnier (2010) was critical of ‘failed’ self-regulation, the ‘race to the bottom’ in financial regulation, and ‘regulatory gaps’ that were ‘exploited’ and created systemic risk. He declared it no longer acceptable to leave ‘large parts of the market unregulated and unsupervised’ but he also showed concern about overregulation, advocating ‘appropriate and efficient regulation’ and definitely did not adopt a radical transformative strategy to overcome finance-led capitalism. The Commission largely followed the policy design that had been adopted by the G20 and finetuned by the BIS, FSB, and IMF and their guidelines and recommendations. In that situation the British government had to take a stronger stand to remind the EU of not going beyond the international reform agenda. The two Cameron Governments between 2010 and 2016 defended their enthusiastic engagement for the financial sector against too ambitious reforms generally as acting in the public interest of the entire UK and its citizens whose pensions would depend on the success and very survival of the City. In key areas, the UK adopted regulation before the EU to shape the debates and reforms there into a direction supported by the UK’s financial industry (e.g. structural reforms of banks, capital requirements for SIBs). According to the Corporate Europe Observatory—an NGO watchdog over big business lobbying activities in the EU—the British financial industry strategically used the Brexit threat, that was lingering since Prime Minister David Cameron promised a In/Out EU Referendum, to push for deregulatory reforms at the EU level, signaling that overregulation might endanger competitive advantages and might make a future outside the EU unavoidable. The country’s and industry’s concerns were taken seriously in Brussels and directly addressed by the European Commission that shifted its focus to growth and jobs and increasingly linked the financial sector’s services to their positive contribution and potential to achieve ambitious societal goals such as addressing environmental and climate change commitments and financing infrastructure (see Chap. 5). The Juncker Commission taking office in November 2014 gave the powerful Commissioner for Financial Markets to the UK and Lord Jonathan Hill in this position then successfully pushed for a Capital Markets Union, a project foremost in the interest of the British financial

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industry and demonstrating that despite deeper financial integration with the emerging Banking Union the EU also puts forward projects for all and not just for Eurozone member states. Under Commissioner Hill the EU intensified a debate about the ‘cumulative effect’ and possible negative unintended consequences of regulatory reforms of previous years and launched a review of the EU’s regulatory framework in 2015. This constituted a reframing of financial reform debates away from stricter regulation, harmonization and centralization of powers towards deregulation, reducing compliance costs, and removing barriers in the Single Market to boost financial integration. The idea of a negative ‘cumulative effect’ of reforms was originally launched by the International Institute of Finance (IIF 2010, 2011), the global association of the financial industry, and already debated in the European Parliament (Schröder et al. 2011) and by the UK House of Lords (2015). One of the few successes, David Cameron as Prime Minister could show when he returned from renegotiating the British EU membership with Brussels, was a promise not to overregulate finance and a formal recognition to respect the rights on non-euro member states in the Internal Market and to guarantee that countries outside the Eurozone will not have to contribute to Euro bailouts. The UK did not get any carve-out from EU banking regulation as the EU insisted on keeping a level playing field in terms of same rules between the City and other European financial centers. The benefits of the UK’s EU membership for its financial industry were assumed to increase further with the creation of a complete, ‘true’ and ‘deep’ Capital Markets Union, and the UK got assurances that the City’s role would not be undermined by deeper integration of the Eurozone area with the creation of the Banking Union, which the UK decided not to join in order to protect the City’s regulatory oversight. In light of these overall developments, the City— despite all its concerns about the post-crisis ‘regulatory tsunami’ (Roberts 2018: 48)—was in support of continued EU membership although in a reformed EU. The Commission had also renewed its commitment to the Better Regulation Agenda in line with British demands for assuring a focus on competition and growth across all its policy measures. These changes— actively supported by the British financial industry (IRSG 2016)—accompanied with the existing advantages of the Single Market led TheCityUK (2016c)—the UK financial sector’s lobbying group—to support Remain during the Referendum campaign, notwithstanding suggestions for future reforms for European financial markets. However, financial industry was on the losing side in this battle as it suffered from reputational damage

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after the GFC and the public discourse about its contribution to high inequality within the UK society and its regions. Threats to relocate such as from J.P.  Morgan were more counterproductive than helpful for the Remain campaign in this climate. The official position of finance was also undermined by various bankers and fund managers openly supporting Brexit and hoping for undoing post-GFC reforms they did not like. Brexit has moreover been a highly political topic with huge public engagement compared to the highly technical, opaque and complex issues of ‘quiet politics’ where a unified industry is normally seen as shielded from the public and most successful (Culpepper 2011). These factors explain why such a powerful industry as finance lost the battle to remain in the EU and fight from the inside for reforms. However, many still expected that the sector would play a key role in shaping the UK’s negotiation position and the future relationship between the EU and UK. Douglas Flint, the chairman of HSBC, suggested that the best strategy for financial services lobbying in this climate would be to ‘refrain from lobbying for the industry’s sectional interests; be very discreet; and be seen to be batting for Britain, not the City’. Moreover, ‘bankers should welcome the stringent regulations of the post-crash world, drop their objections and accept it as the price of stability and citizen consent.’ (Inman 2016).

4.3   The Brexiteers’ Plan for Finance: Opportunities and Challenges During the Leave campaign and since then hard Brexiteers have argued that in an independent post-Brexit UK even outside the EU Single Market the financial industry would have a great future and that the City’s role as the leading global financial center would be secure. Given how the City mastered challenges in the past, the inductive argument goes, anything else would just be unthinkable or political punishment against any economic logic to which the UK could easily respond with a more competitive regulatory framework for finance. Besides the general ‘cakeism’ Brexiteers’ claim that the UK could keep its privileged access to the Single Market under any Brexit scenario because of the sheer importance of British finance for Europe and the potential self-harm to the EU-27 resulting from any future trade in service barriers, their claim has been based on three assumptions: (1) the City has a unique collection of knowledge and skills that exist nowhere else in the world; (2) the EU Single Market does

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not matter for finance in the contemporary trading world; and (3) regulation nowadays comes from the global level at which the UK is well positioned and has—and will keep—a strong voice that can be used to drive harmonization in line with British interests. With the start of the Article 50 withdrawal process, the argument has been further developed by proposing that the UK’s financial sector would need a unique bespoke deal based on mutual recognition and an extended equivalence regime or else the UK could take deregulatory measures to protect the City’s interests and transform it into an offshore Super-Singapore. One of the main problems created by the UK’s Leave Referendum was that the Leave campaign deliberately decided to leave open what the future relationship with the EU would be in order to avoid splitting into different groups and creating controversy and uncertainty among voters. This allowed some Leave supporters to advocate continued EEA membership and others to talk vaguely about a more ambitious future free trade deal while all stayed united behind one key message although split into a cross-party and a UKIP campaign. The general message was that the UK holds all the cards in the future negotiations and can even get a better deal than other countries have with the EU, while also profiting from trade deals with the faster growing economies in Asia because of the UK’s economic importance as Michael Gove, Dominic Raab, and other leading Leave campaigners claimed. The Economist (July 2nd, 2016) summed up the situation with stating: ‘Brexit comes in 57 varieties.’ Some commentators have argued that for the financial sector ‘only the Norway model’ would be ‘appealing’ (ibid.). Especially firms exporting financial services were expected to lobby in that direction while at the same time also making contingency plans. Yet, during the Leave campaign there was a rather limited discussion about the future of the City outside the EU.  Then energy minister and former banker Andrea Leadsom claimed that BRIC countries would offer a new business opportunity for UK-based firms. Brexit campaign star Boris Johnson in his evidence to the House of Commons Treasury Committee on 22 March 2016 showed little knowledge of the industry’s own studies and positions, while trusting anecdotal evidence from friends in finance who assured him that the sector would be fine outside the EU.  After the Referendum, however, Johnson talked more vaguely about a future ‘close relationship’. Michael Gove, in his speech on 1 July 2016 launching his unsuccessful Tory leadership bid, criticized the remuneration of CEOs and finance and called for ‘reform capitalism’ with the ‘right sort of corporate behaviour’ and more control

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for shareholders. As the second most prominent Tory Brexiteer, he also never outlined a detailed plan what Brexit would mean for the financial services. The ‘Change Britain’ coalition’s minimalistic website (www. changebritain.org) needed until September 2016 to come up with a few points explaining what ‘Brexit means Brexit’ means. ‘Getting British businesses the best possible deal to sell goods and services into the Single Market’ was not much of a clarification. However, given the strong statement that ‘free movement ends’ the coalition was described as ‘hard brexiteers’ (Williams-Grut 2016). Alexander Boris Johnson’s then popularized the proverb ‘we can have our cake and eat it’ after it reportedly first occurred in November 2016 on ‘a page of notes scribbled by an aide to Conservative MP Mark Field’ (Horobin 2018). However, there have also been Brexiteers who thought that the EU is close to collapse anyway and that even if costly leaving the sinking ship first can only be an advantage. At least a clearer idea about what Brexit should mean for finance came from Blake and Reynolds who will be discussed further below and from economists who campaigned for Brexit and a Brexit campaign networks outside the political parties. ‘Economists for Brexit’ (after the Referendum relabeled ‘Economists for Free Trade’) is chaired by Gerard Lyons and Patrick Minford and based on a neoliberal free trade paradigm. This small but influential group with connections to the right-wing think tank Institute of Economic Affairs and the Conservative Party has been on the ‘hard landing’ side, arguing against keeping Single Market access and against any ‘EU lite’ version outcome (EEA/Norway). Lyons, who was economic advisor to Boris Johnson when he was Major of London, outlined the impact for the City for the group in a short section in ‘The Economy after Brexit’. According to Lyons (2016 and 2017), Cameron’s renegotiation of the British EU membership had failed to secure the City’s future from overregulation and negative effects of deeper financial integration of the Eurozone countries. The UK’s ‘ability to influence the regulatory environment for the financial sector’ would have been ‘declining’ for some years. As examples he mentions the bank bonus tax, the ban on short selling, and the financial transaction tax (which might never see the day of light anyway). Lyons disputed that there was any progress under Commissioner Hill and doubted that the EU would have the necessary reform will to ever address the demands put forward by TheCityUK. For whatever reason, he finds it ‘hard to imagine London not being the financial centre in Europe, regardless of whether the UK is in or out of the EU’ (Lyons 2016: 21). Today’s rivals would only be New York, Singapore, or

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Hong Kong, but not Frankfurt, Amsterdam, or Paris. The latter were in some forecasts during the Sterling/Euro debate seen as potential winners if Britain stayed outside the Eurozone. Warnings of business shifting activities to the continent because of Brexit would turn out to be equally wrong. Single Market access and passporting would be negligible as ‘the single market in financial services did not work particularly well’. A revision of the euro clearing decision of 4 March 2015 by the ECJ (Case T-496/11) would, however, be possible but its ‘overall impact may be marginal’ (ibid.: 22). He then stressed, what was repeatedly stated during the Leave campaign, London’s unique concentration of skills, knowledge, and expertise. After a Brexit, the UK could regain a stronger role in international regulation and global regulation would be a ‘growth area’ for the City. Especially the EU’s plan to deepen capital markets would ‘play into London’s hands’ (ibid.: 23) and that advantage should be strategically exploited in the Leave negotiations. However, no plan has been presented how this could be done. The Leave Alliance’s (2016a) plan—a liberal network around the Euroskeptics Richard North and Christopher Booker that insisted already before the referendum that a strategic exit plan is necessary to make Brexit a success and were the only ones offering one—suggested for the ‘short to medium term’ a ‘continued participation in the EU’s Single Market’. If the UK government would have taken up their proposal, not much would have changed for the City for several years. However, their work, although widely read, has remained marginalized and excluded from the mainstream public media discourse and hard Brexiteers in the Conservative Party ignored their approach as unimaginative and too soft. Their 406 pages ‘Flexcit’ Plan for Leaving the EU provided some engagement with the financial services sector and the Leave Alliance published further work, including a Monograph on finance and Brexit (Leave Alliance 2016b) and frequent blogging covering ongoing developments in much more depth than provided by other Brexit supporters. The argument brought forward by the Leave Alliance and North is that the EU is more of a rule taker at the global level than a rule maker and that EU financial regulation is increasingly influenced by global standards. In the long-term British finance is facing a challenge much more serious than leaving the EU coming from the European global decline and the rise of the BRICS countries in global banking assets. In the short term, Britain would need either EEA membership or sectoral agreements. The loss of direct influence on EU

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regulation from such a transition period would be overrated as the UK is ‘adequately represented’ at the more important global level (2016b: 10). This closes one of the circles promised by Brexit. In the long-run, there would be the ‘golden opportunity of new trade deals with the rest of the world’. For financial services this means competing with other financial centers such as Singapore or Hong Kong (Inman 2016) which are geographically closer to some of the growth markets the Brexiteers target with their Global Britain vision. Geography and cultural similarities might be important factors in succeeding in those markets and global firms generally well understand them when they make location decisions. In short, the pool of talent, skills and knowledge the Brexiteers praise in the City might not be that unique or immobile as they would like to think. The UK would lose business to other financial centers and to the remaining EU member states. The City had good reason to remain worried and to lobby for Single Market access. For a number of policy areas including finance Brexiteers have been arguing that standard setting moved a long time ago from the national to a regional and global level and increasingly to private standard setting bodies or international committees of regulators such as the Basel Committee on Banking Supervision or the Committee on the Global Financial System and the Committee on Payments and Market Infrastructures, all hosted by the Bank for International Settlements (BIS). Without any doubt the UK has been a key player in those standard-setting bodies. Although centering their campaign on sovereignty and parliamentary powers, Brexiteers had no problem with this shift of power. In his book on international standard setting for finance, Singer (2007: 121) showed that this ‘growing prominence of international committees of regulators […] has prompted some elected leaders to balk at the idea of international regulatory “treaties” negotiated outside the normal legislative process.’ In the US the autonomy of the Fed and other regulatory bodies has been repeatedly criticized for ‘making important public policy decisions outside the political process’ (ibid.). Brexit advocates might be satisfied with the oversight and accountability of regulators in parliamentary committee hearings. However, the fact remains that international standards are set in a way that limits sovereignty. Without any doubt, neoliberal Brexiteers are more interested in an ‘independent regulator’ or private regulation, despite their concerns about the ‘independence’ of the Bank of England and its Governor since before the Referendum.

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The Basel Committee shows other possible problems for increasing harmonization and regulatory competition. Firstly, the Basel Accords are soft law that still needs to be implemented in a harmonized way by states. In the past, Basel capital requirements have been adopted even by other states than just those represented in the Basel Committee. Europeans were rather skeptical whether the US would adopt and implement Basel III, which was only adopted in the political climate of aftershocks to the GFC and banking scandals. Especially the ‘London Whale’ dealer Bruno Iksil, that took J.P. Morgan by surprise in 2012, provided a strong argument for stricter regulation. Yet capital requirements got softened under President Trump, who promised deregulation to the financial industry and reforms of the Dodd-Frank Financial Reform Act of 2010. Howard Davies (2016) expected a ‘threat to global banking standards’ and that ‘harmonization of financial regulation is beginning to wane’ because of developments in the US and in Europe. In short, international banking standards do not necessarily provide long-term stability and harmonization efforts may become undermined by increasing regulatory competition. Overall, international standards have some limitations as they ‘are of viable quality and many are not capable of functioning as the anchor point for the rigorous checks that should precede the granting of market access (because this is not what they were designed to do), so this could be only a partial solution’ (Ferran 2018: 35). Brexiteers have tried to make an argument working around such limitations by insisting that global standards should be designed in a way that they allow countries to achieve the same outcomes in different ways. However this outcome-oriented approach would quickly become highly contested and would not provide any certainty about market access under existing rules for cross-border financial services. TheCityUK (2016c), in its first response to the Referendum result, demanded ‘securing continuing access to the Single Market.’ This demand has been shared by other industries with strong EU exports such as the automobile industry. But as the Single Market Access comes with Free Movement of People and contradicted the immigration promises of the Leave campaign. J.P.  Morgan demanded that whatever the outcome of withdrawal negotiations would be, the government should assure that there is a long transition period allowing businesses adaptation (Glazer 2016). Among the various consequences of Brexit, the most significant ones are loss of passporting rights and a significant amount of the Euro clearing

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business, legal uncertainties about cross-border financial contracts, to what extend the UK will be able to diverge from EU financial regulation without losing market access to the important Single Market, how the UK could remain a rule-maker with a global reach, and how British finance might be affected by a possible reduced access to talent once free movement of people no longer applies to the UK. While the latter could most certainly be resolved to some extend with incentives around a new immigration policy, the more serious threat here is the perception of foreigners coming to and living in the UK in recent times as anything but a ‘Global Britain’. Racism, Anti-Semitism, and hate crimes have risen significantly since the Brexit Referendum. All these threats have been widely reported and discussed since the Referendum and can therefore be quickly summarized here with only focusing on the most important aspects. The Commission made the consequences of a no deal scenario for finance clear in its Notices to Stakeholders, which have received little attention in the UK’s public. The UK government has published its own no deal guidance documents to citizens and businesses, including guidance for finance. Former Prime Minister Theresa May has originally argued that because the UK starts from a unique position of full harmonization with EU law, it should be allowed to keep the same level of access to the Single Market as enjoyed as member state. Moreover, the UK and the EU should allow for mutual recognition once the UK diverges based on the promise that the UK would remain committed to internationally agreed standards which it will continue to shape and the overarching objective of financial stability but might want to achieve the same goal with a different, diverging regulatory approach. Mutual recognition and regulatory cooperation were also demanded by the City, insisting that British finance could not accept becoming a rule-taker (TheCityUK & PWC Strategy& 2017: 40). However, this idea of shared international commitments, abstract objectives and different regulatory standards and practices failed to fly given that mutual recognition would have put the UK in a better position than the remaining EU-27 member states. Mutual recognition in the EU is limited to areas where there is no harmonization and such areas hardly exist anymore in the domain of financial regulation. With the Chequers Plan the UK government has accepted that there will be less access to the EU market for finance and the new line has become to secure ‘a meaningful cross-border market access in financial services’ (Sabbagh 2018). However, if ‘meaningful’ access is in the interest of both sides of the negotiations was contested.

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Most prominently in public debates among potential threats are the passporting rights for financial institutions which allow firms, established in one member state of the EU, to provide their services in all member states without any significant additional financial or administrative burdens. Passporting is currently enshrined in a number of areas but not in all. As a third country the UK would automatically give up passporting on Brexit day and financial firms would no longer be in the position to provide their cross-border transactions in the same way as before. While some Brexiteers have seen this as ‘punishment for leaving’ enforced by the political bureaucrats in Brussels against the economic self-interest of member states, the Commission emphasized that this is simply the default option for third countries and the UK’s withdrawal puts it automatically and by choice into that position. At least additional costs would occur, with requirements to establish adequately resourced subsidiaries in member states. Once the UK leaves the EU and becomes a third country it would move into a position where the current EU’s Third Country Regimes (TCRs) for financial services become the new rule of the game.1 The equivalence regime covers the access to the capital market in the Single Market and the export to third countries; however, it lacks transparency and legal certainty and equivalence can easily be withdrawn (Moloney 2018). TRCs are rather burdensome and require a high degree of equivalence’ of financial regulation and supervision which make it more likely that third countries’ financial institutions set up subsidiaries within the Single Market, which are then supervised by the host state. This regime creates significant set-up costs for third country financial institutions. As an EU member state, the UK profited from these TCRs as they provided strong incentives for foreign financial institutions to locate in London. Most commentators agree that the current EU regime for equivalence is insufficient for the UK’s needs. Before the Referendum the Remain campaign including the financial industry’s lobbying groups made clear that if the UK would leave the EU’s Single Market the TCRs would require UK banks and other financial institutions to create costly subsidiaries within the Single Market and that this would result in a significant loss of tax

1  For an overview of equivalence see: https://ec.europa.eu/info/business-economyeuro/banking-and-finance/international-relations/recognition-non-eufinancial-frameworks-equivalence-decisions_en.

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revenue, jobs, and wealth. The Leave campaigners swept away such concerns by insisting that the City of London had a unique position. Barnabas Reynolds, who prepared in 2016 the ‘Blueprint for Brexit’ for the financial sector, argued that ‘certain aspects to equivalence, as now constituted, must be addressed if the model is to work successfully for future UK-EU relations in the sector’ (Reynolds 2017a). In the Blueprint, Reynolds describes passporting as ‘unattractive post-Brexit solution’ and equivalence-based access to the Single Market as most ‘desirable, achievable and realistic’ (Reynolds 2016). He suggested that measures for which equivalence is required should be limited to areas where systemic risk is the justification. The UK should not accept ‘EU-specific requirements, such as social policy, competition measures and rules designed to further the EU’s ‘single market’ as they would ‘have nothing to do with financial services equivalence’ (Reynolds 2017a). In short, the UK should aim for a position that allows divergence in certain areas and gives the country an equal voice to the EU’s about future changes. Here the argument comes back to the claim that all regulation is based on global standards and Reynolds adds that ‘reasonable compromises … should be achievable’. The UK should also aim for flexibility by allowing that equivalence in certain areas would not affect ‘equivalence in place on other topics’ and discussions over conflicts should generally ‘be de-politicised as to maximize the technocratic nature of the decisions’ (ibid.). To simplify the current complex TCRs, Reynolds (ibid., 2017c) suggests that the EU should ‘adopt an Equivalence Regulation to provide for a single mechanism for equivalence, with full coverage’, which should be quickly voted on before the UK leaves the EU. However, the EU Commission only released a staff working paper on the EU equivalence decisions in financial services which evaluates the post-crisis experience without any consideration of Brexit (European Commission, EC 2017a). There is no sign to modify the existing TCRs. Blake (2017) argued that as it had become clear the UK would lose passporting rights after Brexit, the UK should either opt for third-­ party expanded equivalence or alternatively develop a ‘World Financial Centre model’ ‘where the City ‘goes it alone”. Blake also argued that a transition agreement is not necessary as both sides would adopt transitional arrangements, which are in ‘everybody’s interest’. The City should also be protected by supporting more global regulation and the government should provide support that financial services can expand overseas. Reynolds (2017d, 2018) and other UK actors imagined a system largely protecting the current status of the UK’s financial sector claiming that this

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would be to the benefit of all parties and help avoid fragmentation. TheCityUK (2017a) and Brexiteers have advocated that approach claiming that any change from the current access would be more painful for the continent than for the UK. Reynolds (2017b, d) also proposed that in the case the EU would not accept enhanced equivalence, the UK should adopt a ‘financial centre model’ based on removing burdensome regulation, take measures to avoid any significant relocations and provide tax incentives and other measures supportive to finance. A further challenge are cross-border financial contracts, including among other contracts medium and long-dated derivatives contracts, revolving credit facilities, general insurance, and long-term life insurance. Many of these contracts run far beyond the envisaged transition period. Theoretically, the UK and EU could have agreed that any such contracts outstanding on and after Brexit day could be ‘grandfathered’ to avoid legal uncertainty and disruption of financial arrangements. The Bank of England proposed provision for the continuity of cross-border financial contracts, and this would most certainly be covered in the withdrawal agreement. The Commission, however, made clear that under a no deal scenario UK based entities will no longer be able to perform certain obligations and activities and service continuity will be at risk. The EU rules on conflicts of laws and jurisdictions will cease in the UK and parties to contract were asked to ‘carefully assess the impact of the withdrawal of the United Kingdom on the validity and enforceability of those contracts and mitigate any risks, including any risks to their clients’ (EC 2018a). The UK has repeatedly complained about the legal uncertainty and UK financial regulators have unsuccessfully proposed that the EU and UK regulators should come to an agreement independently from the withdrawal agreement negotiations to protect financial stability. Besides contracts signed before the UK’s withdrawal, there is also a question about the future of contracts under English law. Such contracts have become highly popular given the business-friendly design of English business law. The UK reformed its Commercial Court by creating new Business and Property Courts of England and Wales that should help to protect London as ‘the largest specialist centre for the resolution of financial, business and property litigation anywhere in the world’ in an increasingly competitive legal service area (Campkin 2017). However, in recent years various jurisdictions on the continent have started to establish courts operating in English and applying English commercial law. A good amount of UK business lawyers has already secured continued access to EU business by registering

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in Dublin. In short, uncertainties around contracts could undermine the importance of legal services currently supporting London’s unique environment for finance. With the increase in transnational commercial transactions and the internationalization of commercial law over the past decades, another factor that contributed to London’s dominance in the past, could now turn against its fortunes. The EU Commission left the uncertainty about contracts unaddressed, increasing pressure on businesses to take contingency measures. Much less discussion has yet happened about any long-term effects of regulatory divergence and the UK’s future impact on European regulation. Brexiteers have insisted that the UK must make its own rules for finance and that the UK plays a key role in the G20, Basel Committee and other international standard setting bodies. The City’s representatives have made clear that finance would not accept to become a simple rule-­ taker, having to incorporate any future EU regulatory change without any meaningful say or veto power. Already the Brexit Vote made them less influential in Brussels. The EEA option has been rejected by the government as well as by finance as not allowing sufficient input to Single Market decisions, ignoring the argument that EU/Single Market regulation would anyway derive from global regulation as well as the existing routes for EEA countries to influence EU/Single Market law. On the domestic level, it has been suggested that the relationship between the regulators and finance have to become even closer to support the City as global financial center, which most certainly should raise concerns about even more regulatory capture in the future. In debates about the ‘bonfire of regulation’ promised by some brexiteers the Treasury has foremost rejected the argument for deregulation and has instead emphasized that a global financial center needs strict regulation to assure and attract international investors. Chancellor Hammond nevertheless also threatened that the UK would do what it takes to remain competitive and if market access would be reduced. Deregulatory strategies feature prominently in hard brexiteer plans such as in Reynold’s (2017b, d) no deal ‘financial centre model’. From the general comments by the Commission on unfair regulatory competition from a post-Brexit UK one can assume that the EU would take countermeasures to any lowering of standards in the UK that might lead to further market disintegration between the then two diverging jurisdictions. But given global dynamics with the US entering a drive for deregulation and the EU pushing for deregulation too, a ‘race to the bottom’ becomes a possibility. For securing the City’s global position the

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UK would need to gain whatever is lost in European markets in other markets and despite the hopes in BRICS countries or African countries where FinTech promises wide access to people that had until recently no access to banks it is questionable how much market loss can be compensated there. Among the BRICS countries, China has established the world biggest banks with protectionist measures, India has in the past constantly refused to open up its market for services, if its own developing needs are not met first, and Russia and the UK have entered a more confrontational phase resulting in more trade sanctions. The City’s commissioned study on the future ‘architecture for regulating finance after Brexit’ by the International Regulatory Strategy Group and Linklaters (IRSG & Linklaters 2017) proposed a number of institutional and policy changes that can be summarized as allowing for a dynamic and business-friendly regulatory environment but largely remaining focused towards broadly equivalent regulatory outcomes to the EU.  The City’s ‘vision for a transformed, world-leading industry’ is based on the idea that the UK’s financial industry would become more decentralized across various cities and regions in the UK. It also makes the case for a strong regulatory regime while at the same time arguing that going beyond international standards like in recent years might not always be ‘appropriate’ and needs to ‘be balanced with the need to retain the UK’s global competitiveness’. Regulation should be agile and responsive to a fast-changing environment with low administrative burden and cost. The vision then justifies lowering regulatory standards in response to recent and future changes to the US regulatory system und proposes lower taxes and other incentives to realize its ambition. With regard to Brexit the vision states that ‘Brexit poses a significant longer-term risk of eroding the ‘cluster effect’ … Firms will start small, with the ability to scale their European presence up or down’. However, the City does not anticipate any serious rivalry from Europe (TheCityUK & PWC Strategy& 2017). Given that the vision bought into the unsuccessful mutual recognition and regulatory cooperation idea, it does not consider how the UK should affect EU regulation in the future as a third country. There is nevertheless an acknowledgment that ‘in the longer term, some firms may relocate to the EU to increase proximity to the EU market and its institutions’ and that ‘bigger location decisions’ might happen in the future. However, the risk would be higher that other international financial centers outside Europe would benefit from any relocations (ibid.: 40). However, the possibility of more significant business shifting to Europe and the need to have privileged access to European

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regulators as well as the political need for the European Union to have its own financial center in the long term might undermine the City’s vision for 2025.

4.4   The UK Government’s Struggle to Negotiate a Brexit Deal It came to be a big disbelief for many commentators and experts that the Leave campaign appeared rather surprised about their victory and without a plan what to do next, proclaiming they had expected that the government had made detailed preparations. However, with Prime Minister David Cameron’s resignation it became clear that his Cabinet had not made any contingency plan and developed no strategy for a Brexit scenario, should the Leave side win. The parliament’s Foreign Affairs Select Committee criticized this as a gross negligence in a report released on 20 July 2016. The Remainers in the government were worried that such a plan would leak and damage their campaign. They also thought it would be the Leave supporters’ task to have a plan—a view not accepted as an excuse by the Select Committee. Anyway, this situation meant a prolonged period of uncertainty for the biggest challenge the UK had faced probably since the WWII that took its next stage with Theresa May as a former Remainer winning the trust of Brexiteers and becoming Prime Minister on 13 July 2016. Prime Minister May then appointed three leading Leave campaigners into her Cabinet for negotiating Brexit: Alexander Boris Johnson as new Foreign Secretary, David Davis as Secretary of State for Exiting the EU and Brexit negotiator, and Liam Fox as new Trade Secretary. The first major milestone for the new Cabinet was to agree on what the government wants to achieve, develop a Brexit negotiation strategy, and then to trigger Article 50 TEU to start the formal withdrawal process (see Sect. 3.1). Some had expected that because of the close result in the Referendum and the fact that there was no majority for Brexit in Scotland and Northern Ireland the government would aim for a ‘soft Brexit’ to unite the country. However, May did not address Brexit in her first speech at all and in the following months the government kept vague what kind of Brexit it was aiming for and massages were highly contradictory. In November 2016, Jeroen Dijsselbloem, the Dutch finance minister, responded in a BBC Newsnight interview to Johnson’s claim that the UK could continue trading freely in the Internal Market after Brexit but

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be outside the Customs Union and Single Market as ‘intellectually impossible’ and ‘politically unavailable’. May’s first Brexit speech, delivered on 17 January 2017 in Lancaster House set out her ‘Plan for Britain’ consisting of ‘12 objectives that amount to one big goal: a new, positive and constructive partnership between Britain and the European Union’, and called for ‘a bold and ambitious Free Trade Agreement’ allowing ‘for the freest possible trade in goods and services’. This speech was a clear rejection of soft Brexit and continued membership in the Single Market, however, still hoping to protect certain aspects of the Single Market such as ‘the freedom to provide financial services across national borders’. Instead of ‘frictionless’ trade with the EU, the UK was now aiming for ‘the greatest possible access to the Single Market’. The UK’s government’s position was not too well perceived by the EU and many commentators pointed out the contradictions within this position. Donnelly (2017) summarized it as follows: ‘The British government knows exactly what it wants, which is systematic “cherry-picking” of the perceived advantages of membership of the European Union combined with the systematic unpicking of the obligations of such membership.’ The UK Government under David Cameron anticipated in its outline of the withdrawing process (published in February 2016): ‘Uncertainty during the negotiating period could have an impact on financial markets, investment and the value of the pound, and as a consequence on the wider economy and jobs.’ Further uncertainty arises from negotiating the future relationship. The UK Government stated: ‘Any sort of detailed relationship would have to be put in a separate agreement [to the withdrawal agreement] that would have to be negotiated alongside the withdrawal agreement using the detailed processes set out in the EU Treaties. Article 50 does not specify whether these negotiations should be simultaneous or consecutive. This would be a matter for negotiations.’ (p. 9, 2.15). The Cameron government back then also warned that the negotiation process could go well beyond the two years set out by Article 50 and that the process could create significant uncertainty for a decade or more. The EU Commission and the Trade Commissioner have early positioned their opinion that the negotiations on the separate agreement can only begin once the withdrawal is completed before adopting a more moderate view. The Brexit campaigners disputed this as part of project fear. The May government then triggered Article 50 by submitting the Prime Minister’s letter to European Council President Donald Tusk on 29 March 2017. The first setback for the British government came with the

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EU-27’s decision to negotiate Article 50 in two steps, first negotiation on the withdrawal agreement has to settle all outstanding issues to terminate membership in an orderly way before in a second separated negotiation the terms of the future relationship can be clarified. The EU also clarified that a future trade deal can only be completed once the UK has officially become a third country, pulling cold water over the UK government’s claim that ‘nothing is agreed, until everything is agreed’ would include the future trade deal. The consequences of that structure and the problem issues around the UK border in Northern Ireland and the uncertainties about the future trade deal are well known and will not be discussed here. What is important is the continued uncertainty for business and the questions about what that has meant for financial services and what future for finance might emerge out of Brexit. While the government had argued that its negotiation strategy is based on a careful evaluation of the impacts on a large number of industry sections, industry representatives frequently complained about a lack of transparency and influence. When the government finally published in July its Chequers deal in form of a Government White Paper on ‘The Future Relationship Between the United Kingdom and the European Union’ it called for ‘new economic and regulatory arrangements for financial services’ based on ‘mutual benefits of integrated markets and protecting financial stability while respecting the right of the UK and the EU to control access to their own markets’ (HM Government 2018: 8). This plan was also based on the idea of giving the UK privileged access to the Single Market for trade in goods by creating a ‘common rulebook’ that should only cover ‘rules necessary to provide for frictionless trade at the border’, a ‘backstop’ solution for Northern Ireland that ‘will not have to be used’, and a new ‘facilitated customs arrangement’ (ibid.). This plan led to resignations from leading Brexiteers including David Davies and Alexander Boris Johnson. It was also not acceptable to the EU as the split between trade in goods and services would have given the UK an unfair advantage not least because the trade in many modern goods is deeply related to connected service provision. The Chequers Plan of the UK government incorporated the enhanced equivalence idea, although accepting that this could only amount to less than the EU’s passporting regime. Dropping the idea of mutual recognition, the UK government has accepted ‘the principle of autonomy for each party over decisions regarding access to its market’ but suggested that a regime for consultation and collaboration should be established and

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then necessary for future regulatory changes (HM Government 2018). The Commission argued that the EU would not change its existing rules for third countries to accommodate the British proposal and that any such change would trigger most-favoured nation rules in trade agreements with other countries. Indeed, the EU would be badly advised to accept this idea. While British actors argued that their proposal would make economic sense and avoid market fragmentation and financial instability, it is likely that in the long run enhanced equivalence would increase financial instability and reduce the EU’s regulators direct interventionist powers over financial institutions. For political reasons the EU could not accept to strengthen an offshore financial center that would continually weaken the EU’s own financial centers. If a great power such as the EU would not need its own financial center it could simply increase competition between global financial centers around the world for economically more efficient finance instead of supporting a special deal with the UK. In short, there was not just a political argument to oppose the British push for enhanced equivalence but an economic. The UK government continued to push for financial services for a solution that would go beyond the existing EU equivalence regimes and for a new economic and regulatory partnership for financial services. The final withdrawal agreement agreed between the UK government and the EU in November 2018 set out a different scenario in the political declaration on the future relationship. The political declaration stated under ‘III.  Services and Investment’ first the objectives: 29. The Parties should conclude ambitious, comprehensive and balances arrangements on trade in services and investment in services and non-­ services sectors, respecting each Party’s right to regulate. The Parties should aim to deliver a level of liberalisation in trade in services well beyond the Parties’ World Trade Organization (WTO) commitments and building on recent Union Free Trade Agreements (FTAs). 30. In line with Article V of the General Agreement on Trade in Services, the Parties should aim at substantial sectoral coverage, covering all modes of supply and providing for the absence of substantially all discrimination in the covered sectors, with exceptions and limitations as appropriate. The arrangements should therefore cover sectors including

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professional and business, services, telecommunications services, ­courier and postal services, distribution services, environmental services, financial services, transport services and other services of mutual interest. These objectives are the translation of what is required for an FTA in services under WTO rules, namely that it covers substantially all service sectors and not just financial services like some in the UK had hoped for. Section B then set out the rules for market access and non-discrimination putting the provisions ‘under host state rules’ and providing for ‘temporary entry and stay of natural persons for business purposes in defined areas’. Putting financial services under ‘host state rules’ means that financial services will need to establish subsidiaries in the EU and cannot continue trading as under current EU membership. Under ‘C.  Regulatory aspects’ the political declaration acknowledges the ‘regulatory autonomy’ of both Parties and calls for the promotion of ‘regulatory approaches that are transparent, efficient, compatible to the extent possible, and which promote avoidance of unnecessary regulatory requirements’. Domestic regulation should ‘reflect good regulatory practices’ and ‘the Parties should establish a framework for voluntary cooperation in areas of mutual interest, including exchange of information and sharing of best practice.’ Specifically for ‘IV. Financial Services’ the declaration acknowledges that both ‘Parties are committed to preserving financial stability, market integrity, investor and consumer protection and fair competition, while respecting the Parties’ regulatory and decision-making autonomy.’ This includes that both sides have the right to ‘take equivalence decisions in their own interest’, while preserving the prudential ‘carve-out’ provision. The declaration also states that equivalence assessment should start as soon as possible after the UK has become a third country. Equivalence frameworks will be kept under review by each Party. The Parties also agree on ‘close and structure cooperation on regulatory and supervisory matters’. The language in the political declaration is in line with other EU FTAs and not the special ‘bespoke’ trade deal the UK and its financial industry wanted. The UK government failed to secure ‘enhanced equivalence’ or ‘mutual recognition’. The price for ‘regulatory autonomy’ and the ‘right to regulate’ is that market access will no longer be frictionless and that providing financial services to the EU-27 will become more expensive for financial firms currently incorporated in the UK.

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4.5   The Brexit Threat of Disintegration to the City It was the task for Mark Carney, Governor of the Bank of England, to calm down markets with a speech on 24 June 2016. The Bank of England, in expectation of ‘a period of uncertainty and adjustment’, put in place a backstop of £250bn to avoid a market meltdown. The Bank had already instructed banks to raise over £130bn of capital, bringing their high quality liquid assets up to £600bn (Carney 2016). According to Carney (House of Commons Treasury Committee hearing), at least two banks would not have survived without the central bank’s emergency measures. Yet immediate market impacts remained moderate. On 4 July 2016, the property insurer Standard Life and a day later Aviva suspended trading, reflecting business concerns about London becoming less attractive and therefore being overpriced. The Russian investment bank VTB was the only bank announcing immediately after the Leave decision to downscale in London and shift activities to continental Europe. The European Banking Authority as EU regulatory body announced in early August 2016 that it would move from its London headquarters within the next two years to one of the remaining EU member states (EU-27). Since then, numerous banks have announced to shift activities to Frankfurt, Paris, or Dublin and speculation and uncertainty continued since then how much damage Brexit could cause to the City of London and its position as global and European financial center. Since the UK had to realize that it does not hold all the cards in the negotiations with Brussels and the EU-27, the deregulation agenda found some resonance. Reynolds updated his Brexit Blueprint with a Brexit no-­ deal scenario calling for deregulation to protect the City’s role (Reynolds 2017). Then Chancellor Philip Hammond, a Remainer turned soft Brexiteer in May’s government, told in January 2017 a German newspaper that if Britain would be closed off from markets it could abandon the European-style social model und adopt aggressive tax changes (Oltermann 2017). During the Referendum campaign the right-wing neoliberal leave supporting Brexiteers promised that Brexit could bring ‘a bonfire of bureaucracy’ and ‘a bonfire of regulation’ with the UK ‘embracing deregulation’ and creating a business-friendly environment, including the lowest corporation tax and making the UK ‘Global Britain’ as a ‘free trade champion UK’. The idea of creating ‘free ports’ was also frequently mentioned without providing further details than speculating that entire

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regions could be transformed into tax free import-export zones to revive manufacturing in a post-Brexit UK. Combined this was a ‘neoliberal wet dream’ coming true (Wren-Lewis 2016). Yet Brexiteers also frequently denied such a strategy. Stephen Barclay, then economic secretary to HM Treasury with responsibilities for the City of London and since 2018 Secretary of State for Exiting the EU, stated that there would not be ‘heavy deregulation’ in the UK’s financial services sector even under a no-­ deal scenario and the industry is also not pushing ‘to significantly loosen regulation’. The existing regulatory environment for finance would not undermine the industry’s competitiveness and the U.S. would even have stricter regulation, he asserted. Key standards would moreover come from international institutions such as the BIS (Thorpe 2017). David Davis, another leading Brexiteer and former Brexit Secretary, claimed in a speech in Vienna in February 2018 that Brexit would not result in a ‘Mad Max dystopia’ or a ‘bonfire of regulation’. The Confederation of Industry (CBI) as well as City lobbying groups spoke out against deregulation, while hard Brexiteers, such as Richard Tice, then co-chair of Leave Means Leave and now in the Brexit Party, criticized that business lobby groups would want ‘to keep a load of unnecessary EU regulations that stifle growth and innovation’ (cited in Dorman 2018). However, David Davis, one of the ‘Brexit ultras’, also claimed repeatedly that the UK would have the possibility to divert from EU rules and simply rely on trading with the EU after Brexit on the basis of ‘mutual recognition’. However, that famous principle applies in EU law only for the EU member states and only for around 20% of intra-EU trade which is not regulated under harmonized rules. For member states this highly effective tool of ‘negative integration’ works because the entire market falls under jurisdiction of the ECJ. Allowing mutual recognition for the UK even beyond the areas where it is possible for member states would give a non-member more rights than the member states. Moreover, the EU has identified various weaknesses in its mutual regulation system and put forward in 2017 a proposal to regulate ‘the mutual recognition on goods lawfully marketed in another Member State’ that became law in 2019 and will apply from 19 April 2020 (Regulation (EU) 2019/515). Key regulators from the Bank of England have frequently stated that there would be ‘no desire whatsoever to weaken’ the post-GFC regulatory framework but that the Bank ‘will be flexible in responding to new risks, and opportunities and make adjustments when the evidence warrants it’ (Saporta 2019). Woods (2019: 4) argued, however, that maintaining the

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current EU-inherited regulatory framework ‘would be undesirable if it came with the prospect of becoming a rule-taker in financial services with all the risks—both prudential, and as a matter of industrial policy—that entails’ (Woods 2019). Saporta (2019: 5) suggested the future regulatory framework would need to be ‘dynamic and responsive’ and UK regulators must be able ‘to make necessary adjustments to that framework to reflect technological, economic and social change’. In Woods’ (2019: 4) view the EU system worked well for the UK because regulators had it well adopted to the country’s needs. For the future he proposed to base regulation on 6 Principles: robust prudential standards, responsible openness based on international collaboration and standards, proportionality and sensitivity to business models and promoting competition, dynamism and responsiveness, consistency, accountability. The UK and the EU had in the past some key differences: The EU approach tends to be very technical and detailed already in legislation, while the UK parliament usually deals with ‘overarching changes to the institutional framework and the details are then delegated to the regulators, who are vigorously held to account for their activities to Parliament’ (Woods 2019: 7). This would open various possibilities after Brexit: ‘imagine a ‘design vs calibration’ split (design in legislation, calibration in rules), or a wholesale/retail split with more of the wholesale framework in legislation in order to keep closer to the EU’. The UK parliament has already started an investigation into the future of UK financial regulation. Brexiteers and supporters from finance frequently named in the past EU overregulation of shadow banking and CEO renumeration as concerns, areas taming financialization at least a bit. The consequences of Brexit for the financial sector depend largely on whether there will be an orderly or disorderly withdrawal from the EU and what the future long-term relationship will be. The political declaration on the future relationship agreed in November 2018 and not ratified gives only a vague idea about the potential direction. It is widely known that the international trading rules for trade in services are much less developed than those for the trade in goods and that this is true under WTO rules as well as under RTAs and FTAs (see Sect. 2.1). Since it had become clear that Brexit is a rather difficult negotiation process of first agreeing a withdrawal agreement before talking about the future trade relationship and that there is a risk to end up with a no-deal scenario, those who had originally claimed that negotiating the future would be particularly easy because you start off with the same rules and practices, learnt (or continued to

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ignore) the reality. Some Brexiteers have claimed already before the Referendum that the Single Market does not really exist for financial services and that leaving the EU would therefore not put the City into a worse situation; with increasing likelihood of a no-deal Brexit, most Brexiteers repeated the mantra that the UK could perfectly cope with a ‘clean Brexit’ based on WTO rules. However, falling back from full EU membership to the protection and market access under the WTO GATS is highly disadvantageous for the post-Brexit UK as the UK is as EU member state highly reliant on cross-border supply from its own territory into the EU-27 markets, while outside the Single Market the UK would have to establish offices in the other countries to continue selling their services; financial services as well as related business services including law, accountancy and professional services would all contribute much less to the UK’s trade balance (Dhingra and Sampson 2017; Lowe 2018). Despite strong ideological support under the neoliberal paradigm and the trend to globalized financial markets, incomplete global and European financial integration is a result of jurisdictions keeping protectionist measures in place to assure financial stability. This includes powers for domestic regulators in regulatory oversight and other host country rules and in the post-crisis years those powers have become even more important after a short experience with more open equivalence regimes. In the academic literature, Switzerland has been discussed as operating under the GATS as legal basis for the free movement of financial services. Switzerland and the EU have made commitments under the GATS to liberalize certain sectors of their financial services industry as basis for cross-border trading. But Swiss financial institutions need to open subsidiaries in an EU member state, meeting the capital and other regulatory requirements in all member states where these subsidiaries operate making it therefore a costly alternative to full membership. Access to the market is moreover restricted by the prudential ‘carve-out’ provision in the GATS (Alexander 2018: 130). As a result, the global trading rules for financial services remain rather basic and only more recently the big powers started engaging in negotiations on further liberalization, most notably with the TiSA negotiations (see Sect. 2.1). The City was among the strongest supporters for liberalizing finance as a strategy to increase its global reach. TheCityUK was in 2016 a co-signatory along with 11 other services industry associations from various countries to a Joint Statement by the Global Services Coalition advocating ‘a high ambition agreement, to be finalised as rapidly as possible.’ The Coalition emphasized: ‘For much too long, services in

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multilateral negotiations have been hostage to other negotiating topics. The TiSA offers the best opportunity to overcome that impasse and establish a template for twenty first century services trade, for the benefit of the world economy’. However, TiSA would not have been a solution for banks’ market access to the EU post-Brexit as the EU had put forward a no more ambitious approach than also incorporated into its comprehensive FTAs (Adams 2016). Unfortunately for Brexiteers negotiations came to a hold in 2016 and a restart is increasingly unlikely in the current international climate of trade war threats and financial disintegration tendencies. These very serious threats as well as little appetite in the developing countries to open their markets to service imports before their core demands are met might even have buried the entire enterprise. In any case it is no fallback option for the post-Brexit British financial industry. During the Referendum campaigns and in the first stage after the Referendum until Prime Minister May stated otherwise it was still open whether the UK would stay in the Single Market as an EEA member or try to negotiate an ambitious FTA. Continued EEA membership would not have changed much for the UK’s financial services in operational terms but the political impact was criticized as significant as the UK would have become what Brexiteers and also some Remainers discredited as a ‘rule taker’. Relying on the existing EU ‘third country’ regime for accessing the Single Market from outside seemed also little attractive, compared to agreeing a bespoken trade deal covering financial services in a unique, unprecedented way. While the UK government has pushed in that direction, the EU side made clear that any such change in its third country regime would trigger most-favoured nation rules in existing trade agreements with other third countries and therefore be unacceptable besides allowing the UK to hold on to rights only existing for member states and therefore constituting cherry-picking. Some Brexiteers, including the new Prime Minister Johnson, have since then reinvented Article 24 of the GATT to claim that the EU and UK could continue trading under entirely unchanged conditions until they finally agree in the following years on a trade deal and then implement it. Despite Article 24 GATT not allowing for such an exemption and the claim being corrected by numerous experts, including from the WTO, the claim resurfaced again and again. Anyway, for trade in services GATT would not provide any solution as also all trade experts emphasized. At the stage of writing this chapter, the UK finds itself in the position of either revoking Article 50 and staying in the EU, give the final decision back to the people in another referendum, or (going for an election to change the

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arithmetic in parliament) leaving the EU either with or without a withdrawal agreement and transition period. Leaving the UK without a deal is a strategy by some Brexiteers linked with a radical break away from Europe and signing a comprehensive trade deal with the U.S. instead. Beside all kind of difficulties with this strategy, including likely opposition in the U.S. against any trade deal that could undermine the Good Friday Belfast Agreement and peace in Northern Ireland, it is difficult to see how trade deals with the U.S. or other countries could compensate for loss in market access to the EU. This is at least the clear result of the majority of trade impact studies and in line with theories of trade (dis)integration. Only a small number of economists for free trade are outliers (c.f. Lawlor et  al. 2018; Minford 2016, 2019; Minford and Shackleton 2016). The UK has started closer cooperation in financial services with China. But again it seems unlikely that China would open its market more generously than other countries given its not too open approach towards foreign companies in the past. Many in the UK hope for a Canada+ trade deal with the EU. Michel Barnier, the EU Commission’s chief Brexit negotiator, clearly stated that the preferred British option is not on the table and it could not be achieved, given the most-favoured nation principle enshrined in various EU free trade agreements and the best the UK could hope for is a Canada-type agreement, given Prime Minister Theresa May’s ‘red lines’. The only improvement from there is a closer EEA relationship that neither May nor Johnson found attractive. Some commentators have argued that there would be no reason why an FTA could not become the ‘basis for facilitating the cross-border flow of financial services with third countries.’ The UK hoped to expand on what the EU agreed in its FTA with Japan which incorporated ‘a more structured cooperation process on financial regulation’. As Schammo (2019: 102) points out, that agreement ‘does not commit parties to the type of broad and stable cross-border market access that the UK favours.’ FTAs are still based on accepting consequences for keeping the ‘right to regulate’.

4.6   Equivalence and Mutual Recognition: Securing ‘Deep Market Access’ Via a ‘Bespoke’ UK-EU Deal The complex EU legislation covering financial services and adopted since the GFC includes some 15 acts containing so-called ‘third-country provisions’ that give power to the Commission to engage with relevant other

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European institutions to take decisions whether certain third country rules on financial regulation and supervision are ‘equivalent’ to EU rules and procedures. The focus in such decisions is whether other jurisdictions achieve with different rules and practices the same outcomes. The EU has now several years of experience with this equivalence regime and has already reflected on its success and issues arising from it, resulting in a new framework in July 2019. Equivalence is a relatively new approach which has been part of global efforts coordinated by the G20 to fill regulatory gaps and inconsistencies and to avoid uncertainty in markets by reducing regulatory overlaps. The International Organization of Securities Commissions (IOSCO) as the international body of the world’s securities regulators and global standard setter for the securities sector reported in 2015 that jurisdictions have significantly increased their cross-border engagement with recognition and equivalence regimes on the rise (IOSCO 2015). This 2015 report recommended a toolkit consisting of national treatment, recognition, and passporting. IOSCO provided in 2010 a Multilateral Memorandum of Understanding (MMoU) for supervisory purposes. IOSCO’s latest report on market fragmentation and cross-­ border regulation stated that there are now ‘signs of fragmentation in certain parts of the financial markets, which may undermine the effectiveness of the G20 reforms’; however, there would still be a further increase in bilateral arrangements especially concerning information exchanges (IOSCO 2019: 1). IOSCO recommended to ‘deepen existing regulatory and supervisory cooperation’ (ibid.: 2). IOSCO regards mutual recognition as a regulatory action that is designed to address or prevent market fragmentation under which authorities ‘ensure that their regulatory objectives are met whilst enabling a more streamlined process for market participants to operate in the different jurisdiction’ (ibid.: 49). Equivalence regimes are in particular of importance in regulated markets that are systematic, regular, and frequent. They provide incentives for foreign regulators to engage in supervisory cooperation and to bring rules and practices closer together and keep them aligned in the future. Regulators in major markets such as the EU keep the power to withdraw equivalence decisions on short notice if the third country changes its regulation or supervisory practices and is no longer regarded as achieving the same outcomes or if there is a market change that is seen as a concern for financial stability. The European Commission provided in a staff working document an assessment of the use of equivalence in financial services policy (EC 2017b). The Commission describes equivalence as a balancing exercise between

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‘the needs of financial stability and investor protection in the EU on the one hand with the benefits of maintaining an open and globally integrated EU financial markets on the other’ and as a way of promoting regulatory convergence (ibid.: 5). Equivalence is in its very nature a deregulatory measure that reduces the regulatory burden on financial market participants without removing regulation altogether. But it can only work if there are similar although not identical rules and practices as well as trust between the jurisdictions in place. The concept cannot work for areas where regulatory arbitrage and regulatory competition are at play. As the Commission states, equivalence is most relevant in areas where countries already comply with international standards but it is not ‘fit for every purpose’ (ibid.: 6f). The EU’s approach to equivalence is ‘tailored’, meaning adjusted to the specifics of the areas to which it is applied. However, equivalence has to be based on comparable requirements that are legally binding, subject to effective supervision, and achieve the same results. Additionally data protection, anti-money laundering issues and a third country’s tax rules might also be of relevance in certain areas (ibid.: 7). This is of crucial importance given that Brexiteers have frequently considered tax cuts for improving the UK’s post-Brexit competitiveness and that the City has also identified tax as an important area where action might be required to compensate for losses in EU market access. It is also important to recognize that there is a wide range of EU financial legislation in place that does not provide for equivalence. An important area are product rules under UCITS or the payments area. In short, the existing equivalence provisions provide only for limited compensation of membership in the EU and they provide weak legal certainty as many provisions include reviews either on a planned schedule or even just ad hoc. Once the UK leaves the EU and (with or without transition period) becomes a ‘third country’ it would move into a position where the current EU’s Third Country Regimes (TCRs) for financial services becomes the new rule of the game. TRCs are rather burdensome and require a high degree of equivalence’ of financial regulation and supervision which make it more likely that third countries’ financial institutions set up subsidiaries within the Single Market, which are then supervised by the host state. This regime creates significant set-up costs for third country financial institutions. As an EU member state, the UK profited from these TCRs as they provided strong incentives for foreign financial institutions to locate in London. Most commentators agree that the current EU regime for equiv-

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alence is insufficient for the UK’s needs. Before the Referendum the Remain campaign including the financial industry’s lobbying groups made clear that if the UK would leave the EU’s Single Market the TCRs would require UK banks and other financial institutions to create subsidiaries within the Single Market. The Leave campaigners swept away such concerns by insisting that the City of London would have a unique position. The UK has tried unsuccessfully to put forward a number of proposals for enhanced equivalence in the negotiations and linked them also with proposals for ‘outcome-based mutual recognition’, linked with new governance structures and a dispute resolution mechanism (Schammo 2019: 103). The EU-27 side saw this as an attempt to change the rules of the club the UK wanted to leave, ignoring that the UK should well understand these rules as it helped designing them and benefitted from them as member state. Overall, accepting these proposals would have undermined the EU’s right to regulate and put the UK into a better position than member states. The EU has started to tighten up its equivalence rules for third countries ahead of Brexit and announced for ‘high impact’ third countries ‘more detailed and granular assessments’. The Commission also decided that credit ratings from Argentina, Australia, Brazil, Canada, and Singapore can no longer be used as these countries weakened their regulations and are no longer equivalent (Jones 2019c; Tan 2019), proofing the legal uncertainty of relying on equivalence and the less privileged market access of countries with FTAs with the EU. The Commission indicated that the future policy might provide for a transition period ahead of repeals of equivalence, but it would not consider any more substantial change to its equivalence regime (Jones 2019c), pulling cold water over the UK’s hope for ‘enhanced equivalence’. The new approach to ‘equivalence in the area of financial services’ has been published by the Commission in a Communication (EC 2019). It sets out that the approach has to be based on being able to dynamically respond to external regulatory and supervisory developments that could impact on market participants active in the EU. This approach should be reflected in ‘a resilient and effective prudential framework’ and the EU aims to not just take into consideration effects on financial stability, but also ‘market integrity, investor protection and the level-playing field in the internal market’ in order to ‘avoid conflicting requirements and reducing opportunities for regulatory arbitrage’ (ibid.: 1). The EU regards the equivalence regime as ‘a flexible regulatory instrument capable of building bridges across jurisdictional fault-lines’ (ibid.:

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12), useful when it contributes ‘to foster cross-border business’ but calls for a ‘risk-sensitive’ assessment and checks on compliance ‘on an ongoing basis’ (ibid.: 2). As expected, there is no indication in the new policy framework to move towards UK demands for ‘enhanced equivalence’; instead the EU is moving towards higher quality requirements for continued equivalence which would reduce the UK’s options to move away from EU regulatory and supervision standards post-Brexit.

4.7   Euro denominated Clearing and Passporting Rights As expected after the Court ruling on euro clearing, several EU politicians announced immediately after the UK Referendum of 23 June 2016 that this business activity would now have to move into the Euro area. Then French President Holland was among the first to make a strong statement on Euro clearing, hoping to win this huge business entirely for Paris. Since then various EU member states signalled to London’s financial industry their interest in good parts of its activities. The € 660  trillion clearing market is dominated by three London-based companies: LCH, ICE Clear Europe, and LME Clear. LCH—London Clearing House Clearnet created in 1888—is part of the London Stock Exchange (LSE) Group and the world’s largest clearing house handling the vast majority of dollar and euro-denominated swaps. LCH has a subsidiary in Paris that processes credit swaps. The LSE has since then opened an EU base in Amsterdam for its pan-European share trading platform Turquoise and then lobbied to obtain a permanent EU authorization for its clearing house LCH in London as part of its Brexit preparations (Jones 2019a). To protect its clearing of euro-denominated transactions, the LSE lobbied for U.S. support, after Brussels proposed legislative changes to secure joint supervision over LCH in London or if that proves insufficient, to shift euro clearing to the EU-27. The Commission argued that its clearing proposals had no impact on the operation of U.S. clearing houses, which have a much less significant share in overall euro clearing. From the City’s perspective, this move constituted a major attack on London’s role as the regional financial center raising worries that other activities could follow; the LSE Group offered some minor concessions by conceding that ‘London may not be the ‘optimal’ place for clearing some euro products’ in order to protect more significant business (Jones and Price 2017).

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Another serious threat to London is the potential loss of significant Euro derivatives clearing business. The European Market Infrastructure Regulation (EMIR), adopted and in force since 2012 to regulate OTC derivatives established an obligation to centrally clear certain classes of OTC derivative contracts through Central Counterparty Clearing (CCPs) or apply risk mitigation techniques. Most of this clearing has become centralized in London, where the two largest clearing houses are located: LCH-Swapclear and Intercontinental exchange. The ECB failed attempt in 2011 to move Euro denominated clearing into the Eurozone came as expected back on the agenda. With Brexit the ECB and leading EU-27 politicians have renewed their interest to bring this business into the Eurozone as ‘this very important activity should not take place in financial institutions over which it has no control and which are not subject to EU rules’ (Wymeersch 2018: 90). The UK’s position is that any such move would create market fragmentation, inefficiencies and financial instability. TheCityUK (2017b) made its position clear: Clearing is a central part of the infrastructure that makes London the leading international financial centre. It happens here because that is the most efficient and effective way to serve customers in Europe and the wider world. While these proposals appear to fall short of the worst-case scenario, the European Commission is holding back any real detail on when or how it might pull the trigger on a location policy. Despite the Commission recognizing the costs that a clearing location policy would pass on to European savers and businesses, it appears politically committed to exploring this further. This kind of currency nationalism is likely to lead to less competition, higher costs and market fragmentation. These are dangers that the US watchdogs and international bodies have also underlined and they should not be ignored.

In the meantime, the Commission, little impressed by the British position, proposed to bring all third country Euro clearing under ESMA supervision in a push to drive third country clearing houses to establish in the EU, while the ECB proposed the necessary statutes change to gain regulatory authority over clearing houses. Such a change is possible without UK veto under simple majority rule. Political commentators and academics too have expressed concerns about shifting ‘dramatic proportions’ of derivatives clearing. Lannoo (2018) warned, for example, that the Commission ‘fails to appreciate the huge volume of business that will be disrupted’. Roberts (2018: 57)

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expects changes would at best come gradually, highlighting London’s widely overlooked competitive advantage as ‘a hub to the world’s submarine communications cable network’. The US, clearing a smaller share of Euro derivative contracts, also raised concerns about any change in the EU’s policy (ibid., Wymeersch 2018). However, without a withdrawal agreement and with the UK possibly refusing to honor its financial commitments to the EU budget after a disorderly Brexit, it is likely that the EU would adopt emergency measures and then transfer clearing as quickly as possible to existing infrastructure in EU member states if not already insisting that these changes are in place on Brexit day. In July 2018, Deutsche Bank shifted half of its Euro clearing to Frankfurt, giving a boost to Deutsche Börse and demonstrating that the warnings that any bigger moves would disrupt markets were unfounded. Given the market size of the business, knock-on effects could quickly lead to further and bigger losses for the City of London. Deutsche Börse’s clearing division Eurex launched a program to attract clearing in interest rate swaps from London. German finance minister Olaf Scholz expected that large parts of euro clearing would move to EU-27 clearing houses after Brexit arguing that clearing of financial derivatives is too important for the EU economy to have it located outside the EU’s jurisdiction as clearing has to be protected by a LOLR and emergency intervention has to be possible during crises (Storbeck 2018). The French central bank wanted to see clearing of euro repo trades centralized in Paris and France also provided incentives to shift interest rate swaps clearing to Paris. LCH has already applied for EU approval to continue serving the EU-27s markets after Brexit (Jones 2019b), however, EU authorization cannot be granted before the UK has formally become a third country. The EZB has argued that central clearing has become systemically important and that the clearing of interest rate derivatives contracts had risen since 2009 from just 40% to 83% in 2017. UK-based CCPs had a market share of 95% of euro-denominated interest rate derivatives and 30% of euro-dominated repos. The ECB assumed therefore that ‘a significant disturbance i­ nvolving a major UK CCP could affect financial stability and market functioning in the EU. On top of this, most of the liquidity provided by central banks tends to be channelled through the repo market’ (Mersch 2018). In short, euro clearing is not just about the derivatives market but also highly relevant for the ECB’s monetary policy and responsibility for currency stability. The ECB has also argued that it ‘needs broad discretion to take the necessary measures and address risks to monetary policy and the smooth

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operation of payment systems’ and to have flexibility in responding to extreme market events. The ECB has moreover to take into account the principle of proportionality (ibid.). The ESMA signalled that authorization might nevertheless be necessary to avoid market disruption. The Chief Executive Officer of the UK’s Financial Conduct Authority, Andrew Bailey, attacked the EU for sacrificing ‘the principles of open markets’ and behaving in a mercantilist way by trying to dictate to market participants and companies where they can or cannot do business (Keown 2018). The ESMA started in November 2018 to implement contingency plans for the cross-border derivatives transactions and announced to recognize clearing houses in the UK on a temporary basis to allow them continued clearing derivatives trades for EU customers in case the UK leaves the EU without a transition period. EU actors, including the French central bank have insisted that any temporary solution can only be for a maximum of one year. In December 2018, the Commission presented the implementation of the ‘no-deal’ Contingency Action Plan and argued that for the financial sector ‘only a limited number of contingency measures is necessary’. The Commission adopted acts in that regard: ‘A temporary and conditional equivalence decision for a fixed, limited period of 12  months to ensure that that there will be no immediate disruption in the central clearing of derivatives’; a ‘temporary and conditional equivalence decision for a fixed, limited period of 24 months to ensure there will be no disruption in central depositaries services for EU operators currently using UK operators’; and two ‘Delegated Regulations facilitating novation, for a fixed period of 12 months, of certain over-the-counter derivatives contracts, where a contract is transferred from a UK to an EU27 counterparty’ (EC 2018b). London kept its leading position in euro clearing in the first half of 2019 (and maybe beyond) because of the Brexit delay, the ESMA policy and the Commission’s acts. Yet this does not guarantee that clearing stays after Brexit. In 2018, the LSE Group ‘has warned that as many as 100,000 jobs could leave the City if London loses its status as the euro clearing hub’ (Storbeck 2018). In early 2019, the ECB’s announcement to move the euro dominated clearing business to the Eurozone led to protest by the Bank of England insisting that this would constitute a form of protectionism and that the Bank of England wants to keep regulatory primacy. A no-deal Brexit and the possibility of a ‘cold trade war’ between the EU and the UK would make any form of regulatory coordination and cooperation difficult. In March 2019, the EU agreed on new rules on foreign clearing houses with strict relocation provisions for large amounts of euro-­

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dominated derivatives clearing, originally proposed by the Commission in 2017 and requiring foreign systemic clearing houses that offer services to EU clients to be subject to EU supervision. ESMA was given the power to decide whether CCPs pose a risk to financial stability and any such decision would then allow the Commission to require CCPs to shift their activities into the EU to keep regulatory permissions. EU Commission Vice-President Dombrovskis justified the new rules as logical consequence of ‘the departure of the largest EU financial centre’ and necessary to protect financial stability. Moreover, he declared: ‘The EU is protecting financial stability while remaining very open to international integration’ (cited in Brunsden and Stafford 2019). Given the fierce competition about future market shares in euro clearing it seems unlikely that the UK will be able to protect its dominant position and the main uncertainty at this stage is whether the EU will opt for ending the transition period after one year or whether regulators will allow keeping old contracts in London and only requiring new contracts to move into the Eurozone. If the Deutsche Bank decision in 2018 showed that a move of business from one financial center into another one does not cause any disruption, another proof was the EU’s decision to ban using Swiss Exchanges for trading after Switzerland failed to ratify the EU-Swiss trade deal update (Smith 2019, see Sect. 3.3 above).

4.8   What Could London Lose? The Costs of Brexit and Relocations Brexiteers and supporters of the City have frequently praised the exclusive combination of factors that make London unique and the resilience the City had throughout history to cope with all kind of challenges. Interestingly, it was a key argument for continued business-friendly regulation and under-taxation of finance to point towards the features of a global economy that make it ‘easy for financial services firms to relocate’ (Snyder 2006: 3). With the basic Brexit strategic decisions delayed by the UK government, markets started operating under the uncertainties any Leave option might encompass. The Bank of England as well as the ECB immediately required banks and other financial institutions to prepare for the worst-case scenario and called on them not to delay this planning. The ECB has continuously warned banks that they ‘should not count on transition periods’ and that they need to prepare for ‘far-reaching’ changes

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that would result from the UK becoming a third country. The ECB also insists on not treating the UK different to other third countries to assure ‘a level playing field’ and ‘not enter any race to the bottom’ (Nouy 2017). The ECB, as well as EU-27 central banks such as the German Bundesbank, made clear early in the debate that they will ‘not accept shell companies in the euro area’ (ibid.). Nouy criticized that banks which are directly supervised by the ECB and had ‘to share their Brexit strategies with’ the ECB, ‘are not where they should be’. Since then, this stance has not been relaxed. The UK has put forward a legislative proposal for a temporary permissions regime that will allow EU-27 financial firms continued, although temporary only access to the UK financial markets. The regime would make EU-27 firms subject to UK supervisory oversight and offer a mechanism to transfer those firms to full UK authorization. Broker-dealers could rely on the overseas persons exclusions. This has been presented as a generous offer by the UK that should be followed by the EU. However, it is foremost a clear indicator of the UK’s financial center under threat and in need to set incentives for firms to minimize any relocation activities before it is too late. Once established, it is unlikely that this approach would change, given that it was also part of Reynold’s no deal strategy. In July 2017 the ESMA released guidance on relocations from the UK to the EU-27 in form of Opinions in the areas of investment firms, investment management, and secondary markets ‘to avoid the development of regulatory and supervisory arbitrage risks’, emphasizing that ‘firms need to be subject to the same standards of authorization and ongoing supervision across the EU27  in order to avoid competition on regulatory and supervisory practices between Member States’ and ‘to support the Capital Markets Union’ (ESMA 2017). Like national regulators before, ESMA made clear that ‘letterbox’ companies will not be acceptable, and a presence of substance is required once the UK becomes a Third Country. Andrew Bailey, chief executive of the UK Financial Conduct Authority, opposed the need for ESMA’s approach and especially the plan to ‘curb long-standing “delegation”, where asset managers based in Britain manage several funds listed elsewhere in the EU’ (Euractiv with Reuters 2017). The European Commission has laid out the consequences of no-deal for finance in ‘Notices to Stakeholders’ released in February 2018 (for statutory audit, credit rating agencies, asset management, post-trade financial services, financial instruments, banking services, insurance, and occupational retirement institutions). The UK government followed later with own guidance for financial institutions published in August and September 2018.

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Relocations are expected to result in job losses, whereby the estimations vary between 65,000–75,000 by Oliver Wyman (2016), 70,000 by PwC (2016), and 83,000 by EY (Butcher 2016). A lower estimate of around 30,000 by Bruegel (Batsaikhan et  al. 2017) reflected the possibility of a bespoke trade agreement, and more recently in 2018 optimistic scenarios saw a much lower job loss in the short term if a transition period is secured. The most recent data on relocations is from Wright et al. (2019) and shows that more than 250 firms in banking and finance have already moved or are moving business, staff, assets or legal entities into the EU-27 markets. As the authors of the study emphasize this is above previous estimates but still ‘underestimates the real picture’. An increase can be expected once the temporary transition measures expire. Banks have already moved around £800bn in assets to the EU-27, additionally ‘insurance companies are moving tens of billions of assets, and asset managers have transferred more than £65bn in funds.’ They conclude ‘the damage is done’ and that ‘Brexit effectively happened some time last year’. Dublin is ‘the clear winner’ having attracted around 100 firms or 30% of all the moves identified; most asset management firms have chosen Dublin. Luxembourg attracted 60 firms, Paris 41 firms, Frankfurt 40 (90% banks), and Amsterdam 32 (mostly trading platforms, exchanges or broking firms). Again, the authors expect numbers to rise significantly soon. They also state that many firms had taken a deliberate decision to ‘split their business and [have] chosen separate cities as hubs for different divisions’. More than 40 firms are moreover already ‘expanding in other EU cities in addition to whichever centre they have chosen as their main post-Brexit hub’. Firms have still tried to move as little staff as possible and concrete numbers are currently hard to calculate. They also highlight that the £800bn in moved bank assets are ‘nearly 10% of the UK banking system’, which should make a significant impact on the UK’s tax base. Their overall conclusion is that ‘there is no question that London will remain the d ­ ominant financial centre in Europe for the foreseeable future. Firms are keen to keep as much of their business in London as possible […]. However, over time other European cities will chip away at London’s lead’ (Wright et al. 2019: 3). For entertainment reasons it is also worth noting that Jacob ‘Rees-Mogg’s firm Somerset Capital has set up two funds in Dublin’ and Gina ‘Miller’s firm SCM has opted for Luxembourg’ (ibid.: 13). In current debates the focus is on job losses and there was surprisingly little attention given in the UK media and political landscape that the City lost already its leading position. Brexiteers would most certainly explain

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this with unnecessary uncertainty created by the previous May government and that growth would return once business gets the clarity needed to make investment decisions. They would also point towards the inward investment and firms that still locate in the City. However, the numbers above should raise serious concerns as they reflect how relatively large markets can easily move if the regulatory environment becomes unfavorable. Another area of potential more radical change over time is related to the broader services provided in key financial centers. Not just banking and insurance but also dispute resolution is an important feature of the business-friendly UK regulatory landscape. The UK reformed its Commercial Court by creating new Business and Property Courts of England and Wales that were seen to help protecting London as ‘the largest specialist centre for the resolution of financial, business and property litigation anywhere in the world’ in an increasingly competitive legal service area (Campkin 2017). However, continental countries such as the Netherlands and Germany have started to expand courts that can hear business cases under English law in the hope to also take a chunk of that market from London. If Brexit causes a huge decline in manufacturing industries, London could find itself under more pressure than anticipated in studies on potential economic fallouts from a chaotic no-deal Brexit. Much will depend on economic emergency measures needed to stabilize markets but it can be doubted if the dominant neoliberal ideology of Brexiteers would take the right measures or just inflict more pain onto the British society after a decade of misguided austerity that is no longer justifiable in the light of the ‘money tree’ that has been shaken over recent years to pay for Brexit preparedness. If a badly managed Brexit goes even more wrong than it already has and if it creates massive job losses across the country, the social costs will be much higher than the potential permanent loss of the global financial center.

4.9   Brexit and the Future of European Financial Centers What none of the economic impact studies incorporate is the possibility of a deep economic shock and chaos in the UK resulting from a no deal and the emergence of a much more aggressive strategy by the European Union which has so far not put forward any vision for a post-Brexit financial centre in Europe. As a result of Brexit, the future of the financial industry in

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the UK and its roles as a global and European financial center and not just its role in Euro clearing have become uncertain. Brexit is a significant game changer for European’s financial markets that does not fit into the long-term historical development pattern of global financial centres (Cassis and Wójcik 2018). Not just that there is the possibility of a chaotic split between two highly interconnected markets but even under an orderly and gradual withdrawal with a relatively short transition period the magnitude of problems for both the UK and the EU can result in catastrophe, which in the area of finance automatically translates into financial instability. There is no historical precedence for a regional financial center disintegrating significantly from its core region or at least none that would be of any relevance in today’s complex and interlinked markets. For Brexiteers the power and importance of the City was always a guarantor for continued privileged access to the EU-27 financial markets criticized by others as cakeism and denial of economic reality. Financial integration theory would suggest advantages from continued integration levels while at the same time also pointing towards the regional disintegrative effects generated from political and economic pressures. From history one could draw the conclusion that even less dramatic shifts caused serious harm. Kindleberger (1974: 61) argued, for example, that ‘the 1929 Depression was the consequence of an ineffective transition of the financial center from London to New York’. He also showed that in the 1960s, American banks moved to London ‘not so much to earn profits as to avoid losing clients’ (ibid.: 62). Tokio’s fall as a global financial center shows how economic turmoil can affect negatively on a regional financial center. London’s own history shows that a global financial center can grow by exploiting the opportunities of a growing world market, including exploiting developing countries. Success in the past depended on deregulated markets that encouraged ‘innovation’ and London was a master in exploiting this with the Euromarkets, the markets for derivatives, and international securitized loans. But the success of a global financial center also depends on ‘the ­relative conditions between centers’ and ‘a political, fiscal, regulatory and institutional environment in which international financial business can thrive almost regardless of the fortunes of the home country.’ Such a model is however one of a typical offshore financial center that has ‘developed financial business on a scale disproportionate to the rest of their economic activities’ (Bindemann 1999: 18). The UK run such a model successfully over the past decades and was the center of global finance-­ driven capitalism. But if the global trading environment becomes less open

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and more confrontational and countries have to pick sides in such confrontations, the model is significantly challenged. Despite financial globalization and financial markets integration, countries still have the possibility to protect themselves from offshore finance, if they chose to do so. UK financial institutions have been warned by EU regulators repeatedly that they will have to be able to serve their clients and in exactly that spirit banks and other financial institutions have started contingency planning that at some stage will lead to a point of no return given the difficulties discussed above that the UK could escape the EU’s third country regimes. The UK’s financial institutions strategic game has been to delay costly decisions that cannot be undone easily as far as possible into the future. After the release of a first bunch of notices for a no deal Brexit by the UK government in August 2018, TheCityUk hoped the EU would follow suit to also put in place provisional transition arrangements. That the EU-27 has not done so first, is one of several indicators to pull as much business as possible towards its members, undermining the Brexiteers’ argument that the EU-27 would be more harmed from a no deal. The history of finance in various countries reflects, according to Kindleberger (ibid.: 31), periods of decentralization for political reasons and market forces powerfully working towards ‘the direction of a single financial center”. However, he also predicted that ‘modern communication’ since the late 1950s would reduce ‘the economies of centralization’ and there are indeed other factors in contemporary finance that might support a more decentralized structure. Across Europe we have seen strong centralization pressures as well as decentralization along regional or specialized market segments. In the UK decentralization is also a requirement of the sheer size of finance. High living costs in London and limited space for endless expansion led to relocations of some activities to other cities. As a result, UK’s financial services and related professions are nowadays widely spread across the UK and this trend is prognosed to go even further. The EU might equally be transformed into a highly decentralized financial structure, less focused on London and more building on the existing regional financial centers, most prominently, Paris and Frankfurt. Banks were in their relocation decisions more guided by where they already had a relatively strong presence instead of, for example, closeness to the ECB or EBA. With deeper integration of supervision and modern communication and transport technology, distance to the regulator becomes more relative. However, financial markets might have more decentralized financial structures nowadays but only in terms of firms;

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specific markets such as for example OTC derivatives trading and CCP clearing remain highly concentrated with enormous market and political power for a relatively small number of mega-firms. One could also argue that more decentralization is no problem as long as capital markets are more integrated, and that modern finance is moving away from location boundaries towards higher mobility anyway, making the market more competitive. The relocation of a large number of financial institutions and the centralization of activities and markets in some locations will require regulators and supervisors to expand their experiences and to secure additional resources to be able to cope with the higher workload. For the UK, Wright et al. (2019) mentioned a risk that supervisory experience could get lost if fewer financial institutions will be regulated and supervised in London in the near future. Brexit will lead to a significantly stronger financial sector within the Eurozone countries and this will without any doubt transform European economies. In that sense relocations are ‘a mixed blessing’ (Schelke 2018) as they might just shift the problems of having on oversized financial sector into other countries that then have the ‘finance curse’ (Shaxson 2018). The current financial markets integration and CMU policies are inadequate for a number of reasons to reduce financial risk and instability (see Chap. 5). Measures for increased resilience have insufficiently addressed what reproduces financialization with all its negative consequences for economic growth and societal well-being and sustainability has mostly been reduced to an effort to finance the low carbon transition. For a future EU financial markets integration strategy, it will be key to decide whether the trend towards financialization should be continued or whether the future system should become much more resilient and sustainable across all financial structures, activities, and products. Measures to radically downsize and transform finance into more resilient structures, more socially beneficial activities instead of extreme speculation, and safer products that are closely monitored and strictly regulated will be necessary for reembedding finance into society. The deepening financial market integration agenda and Brexit have so far weakened such a strategy, in the weak forms it was present, and a new deregulatory trend was already on its way before Brexit. There is good reason to build an EU financial center for long-term economic interests, however, deregulation is the wrong answer to the challenges ahead. The involuntary downsizing of finance in the UK has also not been linked with a strategy to overcome finance-led capitalism. The UK is cur-

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rently experiencing a revival of much more market fundamentalist ideas. Under Prime Minister Johnson ideas like radical tax cuts for businesses and creating free ports are now pushed that would put the UK into a direction of more financialization. The EU has already responded to this threat by including free ports in its latest policy framework to address tax evasion and money laundering. The signs are currently more pointing in a direction of conflicts at the start of whatever will become the future long-­ term relationship. The UK is moreover focusing on global expansion strategies outside of Europe. FinTech and FinReg are promising to revolutionize finance in the next years. Several EU-27 member states have also started to invest in those areas opening another area of regulatory and market competition to intensify over the next period of financial markets integration. FinTech is broadly acknowledged to be one of the big disruptive technologies, and the City itself has acknowledged it as such in its strategy (TheCityUK & PWC Strategy& 2017). Yet disruptive technologies can also have rather unexpected consequences and dynamics in markets. A change to a Labour-led coalition government in the UK could lead to more radical change as Labour is now proposing to push in its next election manifesto for tackling climate change with a much more interventionist strategy and putting forward a spending program based on a Green New Deal. As we will see in the next chapter, green and sustainable finance has become a topic in capital markets regulation with certain investors looking for changes to make their investments future-proof to climate change and overall more sustainable. A post-Brexit Europe in the EU and beyond will have to push this agenda further and any post-Brexit EU or UK strategy would be well advised to move further in that direction and beyond the current reformist approach. Unfortunately for the UK there are a good number of leading Brexiteers who have joined the ranks of client change deniers and environmental and climate change regulation has been highlighted in Brexiteer literature as an area of EU overregulation, fitting with the demands for financial deregulation and offshore strategies. With a reorientation of the UK towards the U.S. and adaptation of wide ranging deregulating the UK would risk a massive step back. Asian economies which are seen by Brexiteers as the trading partners of the future have taken steps too towards sustainable finance. There might be more synergies there for a struggling post-Brexit City of London that has to keep losses in business at a minimum before it might make another one of its big historical returns to the leading position among financial centers. However, this time might be different if the break from EU-27 markets becomes deeper over time or with a big bang.

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Reynolds, B. 2017d, A Template for Enhanced Equivalence: Creating a Lasting Relationship in Financial Services between the EU and the UK, Politeia, London, http://www.politeia.co.uk/wp-content/Politeia%20Documents/ Unpublished/A%20Template%20for%20Enhanced%20Equivalence%20-%20 Reynolds%20-%20July%202017.pdf. Reynolds, B. 2018, EU-UK Financial Services after Brexit: Enhanced Equivalence – A Win-Win Proposition, Politeia, London, http://europeanreform.org/files/ EU_UK_Financial_Services.pdf. Roberts, R. 2018, ‘London: Downturn, Recovery and New Challenges – But Still Pre-eminent’, in Y. Cassis & D. Wójcik (eds.), International Financial Centres after the Global Financial Crisis and Brexit, Oxford University Press, Oxford, 37–60. Sabbagh, D. 2018, ‘Liam Fox to offer UK firms help to export more after Brexit’, The Guardian, 21 August 2018. Saporta, V. 2019, ‘Bank Regulation: On the Benefits of Flexibility’, speech by Victoria Saporta, Executive Director of Prudential Policy, Bank of England, at Liquidity & Funding Risk Summit, London, 26 June 2019, Schammo, P. 2019, ‘Banking Union and Brexit: The Challenge of Geography’, in G.  Lo Schiavo (ed.), The European Banking Union and the Role of Law, Edward Elgar, Cheltenham, 87–106. Schamp, E.W. 2018, ‘Frankfurt: A Tale of Resilience in the Crises’, in Y. Cassis & D.  Wójcik (eds.), International Financial Centres after the Global Financial Crisis and Brexit, Oxford University Press, Oxford, 83–105. Schelkle, W. 2018, ‘What Impact will Brexit Have on the Euro Area?’, in B. Martill & U. Staiger (eds.), Brexit and Beyond: Rethinking the Futures of Europe, UCL Press, London, 124–131. Schröder, M, Riedler, J., Jaroszek, L. & Lang, G. 2011, Assessment of the Cumulative Impact of Various Regulatory Initiatives on the European Banking Sector, Study commissioned by the European Parliament, Directorate General for Internal Policies, Policy Department A: Economic and Scientific Policy, Economic and Monetary Affairs, IP/A/ECON/ST/2010-21, PE 464.439, Revised Version, August 20aa, http://ftp.zew.de/pub/zew-docs/gutachten/ StudyBankingSector2011.pdf. Shaxson, N. 2018, The Finance Curse, The Bodley Head, London. Singer, David Andrew 2007, Regulating Capital: Setting Standards for the International Financial System, Cornell University Press, Ithaca and London. Smith, E. 2019, ‘The EU may be overplaying its hand in Swiss stock exchange standoff, experts say’, CNBC, https://www.cnbc.com/2019/07/10/the-eumay-be-overplaying-its-hand-in-swiss-stock-echchange-standof fexperts-say.html.

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Snyder, M. 2006, ‘The Challenges Ahead’, in Big Bang 20 Years On: New Challenges Facing the Financial Services Sector, ed. Centre for Policy Studies, London, 1–10. Storbeck, O. 2018, ‘Deutsche Börse cools post-Brexit euro clearing ambitions’, Financial Times, 30 August 2018. Swary, I. & Topf, B. 1992, Global Financial Deregulation: Commercial Banking at the Crossroads, Blackwell Publishers, Cambridge, MA, and London, UK. Tan, H. 2019, ‘The EU is reportedly stripping 5 countries of some market access rights’, CNBC, 29 July 2019. The Leave Alliance 2016a, Flexcit: A Plan for Leaving the European Union, 13 July 2016 v. 08, http://www.eureferendum.com/documents/flexcit.pdf. The Leave Alliance 2016b, Financial Services and Brexit, Brexit Monograph 14, 4 October 2016, http://www.eureferendum.com/documents/BrexitMonograph 014.pdf. TheCityUK 2016a, UK Financial and Related Professional Services: Meeting the Challenges and Delivering Opportunities, August 2016, TheCityUK, London, https://www.thecityuk.com/assets/2016/Reports-PDF/UK-financial-andrelated-professional-services-meeting-the-challenges-and-delivering-opportunities.pdf. TheCityUK 2016b, A Practitioner’s Guide to BREXIT: Exploring its Consequences and Alternatives to EU Membership, TheCityUK, London, https://www.thecityuk.com/assets/2016/Reports-PDF/A-practitioners-guide-to-Brexit.pdf. TheCityUK 2016c, ‘TheCityUK responds to the UK’s vote to leave the EU’, Press Release, 24 June 2016, https://www.thecityuk.com/news/thecityukresponds-to-the-uks-vote-to-leave-the-eu/. TheCityUK 2017a, ‘A Forced Re-location of Euro Clearing is in No One’s Interests’, Press Release, 4 May 2017, TheCityUK, London, https://www. thecityuk.com/news/thecityuk-a-forced-re-location-of-euroclearing-is-in-no-ones-interests/. TheCityUK 2017b, ‘Comment on Euro Clearing Location Policy’, 9 June 2017, https://www.thecityuk.com/news/thecityuk-comment-on-eur oclearing-location-policy/ TheCityUK in association with PWC Strategy& 2017, A Vision for a Transformed, World-Leading Industry: UK-based financial and related professional services, July 2017, TheCityUK, London, https://www.thecityuk.com/assets/2017/ Reports-PDF/A-vision-for-a-transformed-world-leading-industry.pdf. Thorpe, D. 2017, ‘City minister rules out Brexit bonfire of regulation’, FT Adviser, 5 December 2017. Vogel, S.K. 1996, Freer Markets, More Rules: Regulatory Reform in Advanced Industrial Countries, Ithaca, Cornell University Press. Williams-Grut, O. 2016, ‘Boris Johnson is taking on Theresa May with a new ‘hard Brexit’ campaign group’, Business Insider UK, 11 September 2016,

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http://uk.businessinsider.com/boris-johnson-hard-brexit-change-britain2016-9?r=US&IR=T. Woods, S. 2019, ‘Stylish Regulation’, speech by Sam Woods, Deputy Governor for Prudential Regulation and Chief Executive Officer, Prudential Regulation Authority, at the UBS Financial Institutions Conference, Lausanne, 16 May 2019, https://www.bankofengland.co.uk/-/media/boe/files/speech/2019/ stylish-regulation-speech-by-sam-woods.pdf. Wren-Lewis 2016, ‘Brexit and Neoliberalism’, https://mainlymacro.blogspot. com/2016/10/brexit-and-neoliberalism.html. Wright, W., Benson, C. & Hamre, E.F. 2019, ‘The New Financial Brexitometer: Analysis of how the banking & finance industry has responded to Brexit – and who is moving what to where’, New Financial, March 2019, https://newfinancial.org/wp-content/uploads/2019/03/2019.03-New-Financial-Brexitometer-EXT-HIGH-RES.pdf. Wyman 2016, The Impact of the UK’s Exit from the EU on the UK-based Financial Services Sector, Oliver Wyman, http://www.oliverwyman.com/content/dam/ oliver-wyman/global/en/2016/oct/Brexit_POV.PDF. Wymeersch, E. 2018, ‘Some Aspects of the Impact of Brexit in the Field of Financial Services’, in D. Busch, E. Avgouleas & G. Ferrarini (eds.), Capital Markets Union in Europe, Oxford University Press, Oxford, 81–96.

CHAPTER 5

Finishing Capital Markets Union

‘By tearing down the remaining barriers to free capital flows and investment we can strengthen financial integration, leverage our common market and reap a double dividend of higher growth and stronger resilience. This will ultimately benefit EU citizens. […] there is no reform so broadly agreed on as the capital markets union. […] The capital markets union can promote growth and stability for the EU as a whole. Together with the banking union, the capital markets union would establish a genuine “Financing Union for investment and innovation”. Such a Financing Union would be a decisive and feasible step to complete our Economic and Monetary Union.’ F. Villeroy de Galhau and J. Weidmann (2019)

While still struggling with the fallout of the GFC and the Eurozone crisis the Commission was not just busy with crisis management and the enormous amount of regulatory reforms for finance agreed at the international level that had to be drafted, adopted, and implemented. The Commission also launched various ambitious initiatives to counter market fragmentation partly resulting from these two intertwined crises, partly already existing before, and to deepen financial integration in line with the general reform goals for capital markets developed over the past decades. As part of the post-GFC regulatory reforms, the EU adopted measures affecting the future regulation and supervision of capital markets aiming at re-­ stabilizing finance-led capitalism with moderate refinements but not © The Author(s) 2020 D. Pesendorfer, Financial Markets (Dis)Integration in a Post-Brexit EU, https://doi.org/10.1007/978-3-030-36052-8_5

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replacing this system. Yet it became also necessary to respond to the extraordinary decline in investment across European markets resulting from the GFC and the Eurozone crisis and rising fears that Europe could enter a decade of economic decline with sluggish growth. Capital markets, broadly defined as markets for buying and selling equity and debt instruments and as markets for medium and long-term financing for governments, businesses, and individuals, provide a central function in capitalist money and market economies. If well-designed, equity markets can provide the necessary investment ranging from venture capital to growth capital to listed equity; and debt can become cheaper and less risky if optimally distributed and well regulated. However, this abstraction immediately raises the question of which firms, products, activities, and market infrastructures should belong to a well-designed and stable capital market and which are parts of casino capitalism and socially harmful. The evolution of capital markets in Europe is very much linked to the general pattern of financial integration and the transition to finance-led capitalism that led to massive flaws and even fraud in these under regulated and often overly complex and opaque markets (see Chap. 3). European capital markets have grown significantly since 1992 but were still rather fragmented when the global financial meltdown started and during the crisis tumult various areas became even more fragmented (see Sect. 3.3). Like in so many other areas of financial integration, the crises had exposed significant design flaws and problems in global and European capital markets. The general fall in investment was hardest felt in the countries that came closest to a collapse of their financial systems and while large firms tried to build up cash reserves, SMEs and infrastructure projects struggled to find financing. Beside the overhaul of European financial regulation since the GFC and measures to safe the Euro the Commission launched two highly significant proposals: one on the establishment of a European Banking Union (EBU) that should stabilize the banking sector and one on the creation of a Capital Markets Union (CMU) that should shift the dependency on bank funding towards more capital market-based funding. Both projects are not separate from each other but related and expected to create certain synergies by significantly transforming European economies and their funding and to contribute to more resilience in financial markets (de Guindos 2019; EC 2018a). The Five Presidents Report on Completing Europe’s EMU (Juncker et  al. 2015) and the Commission’s Reflection Paper on Deepening the EMU (EC 2017c) have called for a full Financial Union with the EBU and the CMU as central elements to protect the

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integrity of the common currency and to improve the functioning of the Single Market, the Eurozone, and the entire European economy. The Five Presidents stated that ‘a well-functioning Capital Markets Union’ should result in ‘truly integrated capital markets’ that would increase private sector risk-sharing and reduce public risk-sharing. Full integration would ultimately need ‘a single European capital markets supervisor’ (Juncker et al. 2015: 12). The CMU became a central element in the work programme of the incoming Juncker Commission in 2014 and its focus on ‘growth, jobs and investment’ that was designed to tackle the economic fallout of the crises and the problems in securing long-term investment finance. As such it was, as Nicholas Dorn (2015) described it, ‘a “post crisis” return to the politically normalised agenda of the EU single market: completing free movement for capital’. Not too much financial integration and financial globalization were identified as problem, but too little because of the absence of a fully functional internal market for capital markets. Very much in tradition of the classical studies used in the 1980s to justify economic integration by raising the ‘costs of non-Europe’ (Cecchini 1988), Lannoo (2016) called to eliminate ‘the cost of non-Europe in capital markets’ and to ‘undertake a radical upgrade of the Capital Markets Union’. The CMU in that context had to become translated into a huge agenda for legislative review and reform based on the Better Regulation agenda that has been used systematically to revise existing legislation to remove remaining barriers to deeper capital markets. The CMU has been presented by the Commission as ‘a plan to unlock funding for Europe’s growth’ and has been promoted with a corresponding slogan. The banking sector in Europe has become seen as unable to allocate resources efficiently across national and regional economies and the various industry sectors and dependence on it more as a burden to economic recovery than a solution while capital markets became presented as more flexible and dynamic. European regulators have since then highlighted that CMU is a project of utmost importance for the future of the EU and it will contribute significantly to macroeconomic adjustment within EMU, the energy transition, innovation in the digital age, and SME growth. The overall aim is to make the European capital markets more competitive in the global economy by increasing similarity to the most developed U.S. capital markets which is expected to result in more investment from within and outside the EU and much deeper European financial markets integration with improved risk sharing and economic convergence in form of the poorer countries

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catching up with the richer member states. The Commission (EC 2015a) has started to implement a CMU Action Plan launched in 2015 and designed CMU as a program that would contribute to economic recovery and long-term growth perspectives, and especially to help the many small and medium-sized enterprises (SMEs) that constitute the majority of European companies with the largest contribution to growth and jobs in European economies. The EC has also emphasized the CMU’s importance for facilitating cross-border investment, driving innovation and simplifying access to capital markets while at the same time contributing to sustainable finance and financial stability based on a more resilient and sustainable financial system. To make the project more appealing it was also linked to Juncker’s investment plan (EC 2014) that was aiming at an investment target of €315 billion and was based on three objectives: the removal of remaining obstacles to investment, visibility and technical assistance to investment projects across Europe, and to make ‘smarter use’ of financial resources limited in the post-crises environment. The Juncker investment plan was not a massive Keynesian investment program, but a moderate pooling of resources that was then leveraged with private resources to generate its full amount for investment. For generating a more investment-friendly environment, completing CMU was the main Commission goal. This investment plan should be continued under the InvestEU Programme in the period 2021–2027, expected to provide mobilize at least €650 billion in investment in the next multi-year budget. CMU has been presented as the ‘third pillar’ of the Investment Plan for Europe that will benefit the entire Single Market and all member states and improve EMU ‘by supporting economic and social convergence and helping absorb economic shocks in the euro area’ (EC 2017a: 2; see also Juncker et  al. 2015). In short, it is a strategy that fits into the ‘unique convergence machine’ narrative of the World Bank, emphatically shared by the Commission (c.f. Dombrovskis 2018). However, the realization of a true CMU is already facing various challenges. Most importantly, the goals behind the CMU are deeply flawed and contradictory. Financial markets integration is not just creating advantages but also significant risks and that not just from a critical perspective but based on mainstream financial integration theory (see Chap. 1). In its contemporary form in finance-led capitalism financial integration has substantial consequences for states’ macroeconomic behavior and firms’ orientation and performance and that is also true for capital markets and therefore matters for their deeper integration. Because of delays in various

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areas, the Commission called for a ‘renewed political commitment’ to the Single Market which was presented as ‘a unique asset’ ‘in a changing world’ (EC 2018a) and completing CMU is a central element in this renewal strategy aiming at creating competitive advantages in the global economy and improving the attractiveness of the European market domestically and internationally. Yet despite rising tensions and antagonistic goals the plan for a CMU has remained ‘a relatively uncontroversial idea’ (Thomsen 2019) with little public awareness and ‘only financial market participants, lobbyists and EU legal specialists […] engaged with CMU— between whom it is most commonly discussed in terms of its technicalities’ (Dorn 2015). After playing a rather marginal role in stakeholder consultation processes over the past years, Green and finance NGOs got engaged in the technical debates and invited by the Commission to become members of expert groups working on sustainable finance, but they have been unable to generate any broader public discourse, while industry was from the outset highly organized in lobbying towards removing barriers and avoiding overregulation. The EC successfully presented the project of deepening capital markets integration as beneficial and in the wider public interest and got support from member states and other major stakeholders in a highly technical discourse isolated from the broader public. Critique expressed in stakeholder consultations was marginalized and side-lined, while many problematic demands from industry were wilfully incorporated into the CMU agenda that was explicitly based on a call on industry to help identify barriers to integration and a commitment to their fast removal (Pesendorfer 2015). New and more ambitious proposals such as those for sustainable finance should build on business experiences and leave a high degree of flexibility to market actors. In the academic debate CMU was largely welcome as a positive step forward and expert advice was given on specific details and how to improve the CMU agenda; there was only little but fundamental critique so far with no impact on the EU’s legislators (see Sects. 5.2 and 5.3). More consideration was given to another key problem, namely the question how Brexit will affect the development of a CMU and the uncertainties Brexit created, given that the UK is the (still at the time of writing) member state with the most advanced capital markets in the EU, providing important, currently frictionless, cross-border services to other member states. This chapter will first discuss the evolution of capital markets integration and supportive policies in Europe as a background to the recent developments and then summarize the CMU progress so far. The chapter will then explore the

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flaws and contradictions, the benefits and dangers of the Commission’s CMU agenda and argue how this program will contribute to a boost for finance-led capitalism. This will require exploring in detail the areas where integration is beneficial and where integration is highly problematic and most likely contributing to more fragility and financial instability. This will be followed by a discussion of Brexit and its possible effects on the future capital markets integration in Europe, before concluding the chapter with the question of what would be a resilient and more sustainable approach to CMU.

5.1   Background and Evolution of Europe’s Capital Market Integration Based on the Treaty of Rome provisions on gradually liberalizing capital movements while allowing member states to take protectionist measures (see Sect. 3.1) the EEC Council adopted two directives, the first in 1960 and the second in 1962, liberalizing certain transactions and eliminating exchange restrictions. With economic integration developing quickly there was soon a need for further measures to develop a European capital market to support further economic integration. However, in this early phase member states remained ‘reluctant to give up financial sovereignty and permit foreign market participants access to their markets’ (Doralt and Kalss 2004: 256). In that climate, an ‘independent group of experts’, mostly composed of bankers and supported by the OECD, was installed by the Commission to investigate ‘what needs to be done to develop a European capital market’. The Segré Report (1966) by that group under the chairmanship of Professor Claudio Segré, a representative of the Commission, then set out proposals based on the assumption that member states would increasingly depend on capital markets for financing economic growth. Additional cross-border funding would be needed that firms could grow to a size necessary ‘for efficient operation in the common market’ (ibid.: 15). A European capital market would not just come into existence as a result of spontaneous market developments, but active intervention with integration policies would be necessary (ibid.: 16). The report also assumed that pressure for harmonization would arise once large capital markets emerge on a European scale (ibid.: 95). In the meantime regulations should be revised that ‘entail, hamper or distort capital movements’ with the aim of giving ‘firms the greater independence in the

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choice of finance as a result of the improved scope for recourse to capital markets in the other member countries whenever domestic sources of finance prove either insufficient or comparatively more costly’ (ibid.: 97). The report then set out policies for stimulation of saving and direction of capital investment, finance policies of public authorities and enterprises, proposals for widening credit channels, the integration of securities markets, the removal of obstacles preventing equal access to the European capital markets, and tax obstacles. Yet progress remained slow and only in the 1980s a new dynamic started, following the adaptation of the Listing Directive (Council Directive 80/290/EEC) and other directives. The Investment Services Directive introduced a European passport to investment firms and other requirements for market participants. Based on the various integration policies and remaining fragmentation, the sizes and features of capital markets developed rather unevenly across countries and regions throughout the evolution towards finance-led capitalism with the most developed capital markets booming around the global financial centers and in the Anglo-Saxon liberal market economies. Because of the rapid development and expansion of capital markets, capital markets law was introduced in all European countries, some following the U.S. model and their securities regulation, while other European countries remained more cautious. This trend and market pressures, especially the rising pressure from international securities markets on corporate governance, increased competition between different regulations and their relevance for corporate transactions. This led the European Commission to push for further harmonization resulting in an increasing body of harmonized European company and capital market law. The background to this development was the rising cross-border investment, which was expected to speed up with the Euro introduction (Hopt and Wymeersch 2003: v) and result in more integrated economies and financial markets based on integration policies following the market developments. However, in the early 2000s, EU member states were still highly reluctant to give up their own regulations trying ‘to fence off their markets under the cloak of investor protection’ (ibid.: vi). The traditional investor protection rational had come under pressure with the rise of foreign and large institutional investors. In the late 1990s into the early 2000s, European capital markets law was ‘widely regarded to be outdated and inadequate for coping with the emerging pan-European market’ (Doralt and Kalss 2004: 269) because of the creation of the EMU and wide-ranging changes in the markets including the rise of shadow banking, securitization, and

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over-the-counter derivatives. According to Mügge (2010: 93), the regulatory and supervisory system of the 1990s was ‘full of loopholes that fell far short of its original ambitions’ but industry preferences quickly shifted towards deeper integration resulting in broader and more ambitious lobbying activities in Brussels. The EU had only begun to respond to some of the more traditional changes with the Financial Services Action Plan (FSAP) released by the Commission in 1999 (EC 1999) with a new Investment Services Directive, a Directive on Investment Services and Regulated Markets, a new Prospectus Directive, a new Market Abuse Directive, and other measures. The FSAP aimed to establish deep and liquid capital markets within the Single Market and the Council agreed on fully implementing this plan by 2005. The FSAP was described as ‘a milestone in the history of European financial market integration’ as it ‘marked the beginning of the transition towards harmonised European rules’ and moreover ‘the first transnational public-private alliance in EU financial markets’ based on ‘a coalition of firms with international ambitions and the European Commission’ (Mügge 2010: 93). A ‘committee of wise men’, chaired by Baron Alexandre Lamfalussy, was established that produced a report on the regulation of European securities markets identifying priorities for action and setting out a new governance structure for financial markets regulation and supervision, the so-called Lamfalussy architecture (Lamfalussy 2001; Doralt and Kalss 2004: 273; Quaglia 2010: 35). The FSAP was part of the neoliberal Lisbon Agenda and it also set out the goal to establish ‘a common legal framework for integrated securities and derivatives markets’ and ‘removing the outstanding barriers to raising capital on an EU-wide basis’ hoping to raise more capital for Europe’s drive towards more competitiveness in the global economy. After this overhaul of capital markets regulation and supervision the Commission paused reforms to allow markets to adjust to the new regulatory practices. In 2005, the Commission released a White Paper setting out the next steps for capital markets integration for the period 2005–2010 (EC 2005). The White Paper was based on a consultation on a Green Paper and built also on a report on financial integration by the Financial Services Committee, Ecofin conclusions, and a report by the Economic and Monetary Affairs Committee of the European Parliament. It called for a ‘dynamic consolidation’ of financial services ‘towards an integrated, open, inclusive, competitive, and economically efficient EU financial market’, removing economically significant barriers, implementing and enforcing

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existing legislation and ‘to apply rigorously the better regulation agenda’, making sure the Lamfalussy process will work by improving supervisory cooperation and convergence, and outlined ongoing and future legislative activities. Overall this program should ‘strengthen European influence globally’ (ibid.). As part of the new agenda the Investment Services Directive was replaced in 2007 by the Market in Financial Instruments Directive (MiFID) as a ‘new centrepiece of financial market reform in Europe’ (Mügge 2010: 93). As Mügge (ibid.) highlights: ‘No directive has been more important for the organisation of capital markets, for the future of European financial centres and for the prospects of the financial industry’s different branches. And no other directive has attracted more attention from bank lobbyists.’ Mügge (2010: 8) highlights another important aspect behind the increased regulatory activity in the 1990s: many large banks had no longer a domestic market focus as they had discovered that they can make much higher profits in the global and European capital markets. Therefore, they started lobbying for more European harmonization and supranational governance structures to reduce costs for cross-­ border transactions. Considerable progress towards deeper integration was made in several areas, including wholesale financial services. As Fonteyne (2007: 7) highlights, the ‘[m]arkets for unsecured interbank lending, government bonds, investment banking and several categories of derivative financial instruments have become essentially integrated’ and markets had moved towards increased competition and innovation, which the IMF praised as beneficial for European economies and societies just before the crisis (ibid.). Eichacker (2017) has shown how this market transformation led to a rise in securitization and consumption of exotic financial derivatives. European banks got highly engaged in U.S.-originated asset-backed securities which increased risk exposures especially in some member states, including Germany, the Netherlands, Spain, and Ireland. The Single Market passport made it easier for financial institutions in EU member states to engage in exotic financial products that were neither properly understood by these firms nor by their regulators. The regulation of securitization in the member states had led to a degree of divergence with some member states introducing laxer laws for structured investment and special purpose vehicles, which made member states like Ireland or Belgium especially attractive locations for exploitation of this regulatory arbitrage (ibid.: 36).

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For cash settlements the ECB established in November 2007 its TARGET2 system, going live in a first wave for eight Eurozone member states. To overcome the fragmented post-trade infrastructure for securities the ECB introduced a settlement service for all domestic and cross-border securities transactions—so-called TARGET2-Securities (T2S)—settlement in central bank money building on the new TARGET2 system. The aim of this measure was to reduce the transaction costs for T2S to the same level as domestic settlement transactions and to create a similar centralized post-trade environment as the U.S. operates. This should increase the volume of transactions, reduce their costs significantly, harmonize the European securities industry, ‘speed up market integration and foster competition […] by allowing market participants to select and choose post-trade partners irrespective of their location within the single market’ (Tumpel-Gugerell 2007). T2S ended the previous complex cross-border securities settlement procedures that caused problems and uncertainties for users because of different practices across member states. Some member states such as Austria or Germany did not have any central bank involvement in settlement in place. In the new system banks pay for securities on the platform using their central bank account which reduced the transaction risk significantly. As a result, it became easier, cheaper, and less risky for investors to purchase securities in other EU countries and competition between clearing and settlement service providers increased. Overall these developments before the GFC can be split into ‘two main waves of financial markets development in the EU: the period from the mid-1980s to 1992, which was driven by the Single Market programme, and the period from the late 1990s onwards, which was driven by the effects of EMU and the FSAP’ (Quaglia 2010: 31). One could now add an end to the second phase with the GFC and the start of a new ‘third wave’ (Valiante 2016) starting with the post-crisis reforms re-regulating capital markets and their supervision and since 2014 the CMU agenda and continuing with its ongoing implementation. In 2016, the Commission consulted stakeholders on the future design of a CMU and took various steps to develop an action plan later that year to put in place ‘the building blocks for an integrated, well, regulated, transparent and liquid Capital Markets Union for all 28 Member States’ (EC 2015b: 28). These building blocks were scheduled to be in place by 2019 and after taking first measures outlined in the Action Plan (EC 2015a) progress was monitored in a Communication (EC 2016a), in which the Commission announced to accelerate the reform speed to meet

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the deadline, and then presented further steps the mid-term review in 2017 to ensure success. With the international environmental and climate change protection commitment the EU now also incorporated the ‘sustainable finance’ concept into the mix of measures to transform European capital markets. Despite the pressure to achieve quick results and market developments, Brexit and other problems have slowed progress at least in some areas. In 2018, the Commission had to delay legislation, including a proposal to simplify bankruptcy proceedings, the development of pan-­ European pension funds, and the cross-border market for covered bonds. European Commission Vice-President and Commissioner for CMU, Valdis Dombrovskis, confessed in August 2018 that the 2019 goal for putting in place all the building blocs for a true CMU might have become unreachable because of member states lagging behind in approving the necessary legislative agenda. Before looking closer on the progress achieved in finishing capital markets union, we first look into the theoretical justification for this significant strategy to transform the European economy.

5.2   The Flawed Rationale for a CMU The EU set out three main objectives for the CMU: ‘(i) development of a more diversified financial system complementing bank finance with capital markets instruments; (ii) unclocking the capacity of capital markets to support growth, giving savers and investors more investment choices; and (iii) establishment of a genuine single capital market in the EU by removing barriers to cross-border investment and capital raising’. The underlying idea is that European economies can only develop their full potential if capital markets are deep integrated and all cross-border barriers removed and capital markets fully developed. The Green Paper (EC 2015b) as well as the Action Plan on Building a CMU (EC 2015a) claimed significant benefits for the EU economies and especially for SMEs within the European market based on a comparison with U.S. capital markets and with what could be achieved if the capital markets size in Europe before the GFC would be revived (EC 2015a: 4). With the experience of the Eurozone crisis, the Commission got wide support for its claim that a key lesson from the crisis would be the need to overcome the ‘overreliance’ on banks (Papadia 2016) to make the financial system more stable. The Commission set out the assumption that integrated financial and capital markets result in better risk sharing and allows European financial markets to become more resilient to shocks. Member states, citizens and ­companies

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would become less vulnerable to banking contractions; and more developed and integrated capital markets would generate more investment. Deeper integration would also make the European market more attractive to outside investment from the rest of the world, better connect financing across borders to investment projects which would make the European economies more efficient and also more competitive. ‘Put simply’, the Commission (2015a: 3) summarized the advantages, ‘Capital Markets Union will strengthen the link between savings and growth. It will provide more options and better returns for savers and investors. It will offer businesses more choices of funding at different stages of their development.’ In theory fully integrated, deep capital markets should allow significant welfare gains like the benefits linked to financial integration (see Sect. 1.1); consequently, fragmentation of capital markets along national borders and less developed capital markets within a nation or a region are expected to generate welfare losses because of inefficiency including imperfect risk sharing. However, global, U.S. or European capital markets before the GFC did not work efficiently, risks were massively mispriced, large-scale fraud occurred, and overall the system created highly problematic incentives for businesses increasingly focussed on short-term profit maximizing strategies. Because of their massive involvement in capital markets too many financial institutions became too large and interconnected and raised the TBTF and too-interconnected-to-fail problems onto a new level. Shadow banking activities, very much a key element of the most developed capital markets, developed outside regulatory oversight and control as another key driver of finance-led capitalism. In Europe, the member states with the most developed capital markets have built up an extreme high amount of systemic risk within their large shadow banking systems before the financial crisis and have led to rather specific post-crisis policies of ‘privatizing gains, socializing losses’ (c.f. Engelen 2017). Yet CMU advocates drew another lesson from the GFC and Eurozone crisis. Sapir et al. (2018: 2), for example, see them as ‘wake-up call that the EU economy had been too dependent on bank lending and needed a more diversified funding system in which non-bank finance would play a significant role.’ According to Langfield and Pagano (2015, 2016) Europe’s financial structure is much more bank-based than in other economies and the ‘bank bias’ is moreover reflected in ‘regulatory favouritism towards banks’ that would need to be reduced, especially by ‘supporting the development of securities markets’. The CMU debate is essentially ‘a controversy about the relative merits of market- vs. bank-based systems’ (Kotz and Schäfer

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2017: 6) and as such of key importance for the future design of financial markets and the entire economy with significant consequences for society. Despite the enormous costs of the GFC, proponents of capital markets-­ based systems still claim that systems with ‘underdeveloped capital markets’ that remain mostly bank-based in their funding suffer from significant welfare losses. They also advocate capital markets as superior dynamic systems that respond quickly to any changes in the economy which allows them to rise quickly from economic shocks just like ‘phoenixes’, while banks remain stuck with slow restructuring to return to profitability making them in comparison look like ‘the lame ducks’ (Allard and Blavy 2011). Yet the two systems are highly interlinked, and banks have been using capital markets in good and in bad times for profit maximizing and the shift towards capital markets-based finance creates not just additional funding and benefits but is related to a fundamental transformation of the economy that causes economic and social costs. The relative size, structure, and power of banks and capital markets, including the shadow banking system, have significant consequences on equity and debt finance. The transition from bank-based to capital markets-based financing affects household and company finance, transforms their behavior, and has become a powerful element in the transition towards finance-led capitalism and financialization. The background to the CMU agenda is the evolution of’ bank-based’ and ‘markets-based’ systems and a rather ideological interpretation of their performances over the past decades, highlighting the theoretical benefits and ignoring the real-world impacts. ‘Markets-based’ systems are actually ‘capital market-based finance’ and I will refer to them as such as banks operate also in the capitalist market. Yet in the regulatory and academic literature the more common language might create more support for the idea behind as it also fits with the radical market fundamentalist narrative that banks are no longer operating in a market when they can assume bailouts for reckless behavior, while capital markets would present more competitive markets. Supporters of capital markets-based systems also emphasize that bank-based systems are more risk-averse as the banks’ funding comes from depositors, while capital markets would be driven by risk-takers in form of yield-seeking investors, resulting in a more risk- and innovation-friendly funding environment (c.f. Thomsen 2019). Banks are also criticized for their special status with deposit insurance creating moral hazard and their need for prudential regulation. There is no counterargument in the discussion that shadow banks enjoy a competitive advantage

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by not being regulated like banks but performing similar functions and creating instability that can lead too to bailouts by taxpayers or that the shift to capital markets-based financing has caused ‘rising profit claims by the rentiers’ resulting in ‘rising interest and dividend payments of the corporate sector’ and higher inequality in society (Hein 2012: 179). According to the dominant view risk taking in capital markets would be controlled by market forces in an efficient, effective and sufficient way and regulatory oversight could mostly be limited to transparency rules necessary for market participants and for monitoring. Banks would require a less efficient collection of information from borrowers that they then do not share with others; while capital markets often use publicly available information (Thomsen 2019). Yet such information has also its downsides and costs. No surprise that a capital markets-based system fits perfectly into the finance-led capitalism ideology of less or light-touch regulation and oversight for highly dynamic, self-adjusting and efficient financial markets. The size of capital markets in the EU increased significantly since 1999 (Trichet 2007). According to Trichet (2007), the capital market size between 1995–1999 was 177% of GDP in the euro area, in 2005–2006 it had increased to 256% of GDP.  The U.S. had in the same periods an increase from 279% to 353%. For Trichet, this showed a clear ‘potential to grow even further’ and to catch up with the capital markets size in the U.S. Comparisons with the U.S. capital markets usually do not reflect on the problematic developments over the past decades within U.S. capital markets or American society. Valiante (2018), for example, largely describes capital markets integration in the U.S. since the creation of the monetary union in 1788 and 1929 but hardly mentions more recent developments and only to highlight their positive effects but presents ‘key lessons for Europe’ (ibid.: 28f.) that then lead him to highlight the importance of competition law enforcement and ‘stronger supranational tools to enforce EU rules’ without considering any problematic developments in capital markets yet suggesting ‘the development of a sustainable financial integration process’. The capital markets-based structure emerged in the U.S. in the 1980s, when a significant part of the savings and loan industry collapsed. This led to a ‘financial revolution’ (Litan 1991) that resulted in new ‘financial intermediaries’ belonging to what later became termed shadow banks starting to compete with banks. Individuals put money into pension and mutual funds instead of bank deposits and companies turned increasingly to finance companies, securitization, and financial derivatives. The changes

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included the erosion of the banks’ special status and their monopoly on delivering payments services. Money market mutual funds (MMFs) were already rapidly growing since the 1970s enjoying an advantage over banks whose interest rates were regulated at a maximum level, limiting returns for investors. Thanks to new technologies the MMFs were able to enter the payments sector. MMFs were designed to offer alternative investment to bank deposits by investing in low-risk securities. Yet their investments are riskier than deposits and investors can face losses. Only with the GFC, awareness has risen that MMFs are significantly exposed to risks and a short discussion started whether they should be treated just like banks as they are too engaged in maturity mismatch or differently without deposit insurance (Kacperczyk and Schnabl 2011). On the asset side banks came even more under competition with the explosion of securitization markets. However, banks themselves were involved in creating these markets and expanding them to increase their liquidity and short-term profits, making the banking sector extremely leveraged and dependent on short-­ term financing. Loans became pooled into collateralized securities and into more and more synthetic derivative products that were then sold on to nonbank financial institutions. The U.S. government was also involved in the expansion of these new markets by using the housing sector and the government housing finance entities. Mortgage-backed securities (MBS) were seen as a radical transformation in mortgage finance, contributing to rising home ownership. The entire financial system became more and more build on debt and rising inequality. ‘The mass production of credit’, as Litan (1991: 15) concluded, ‘has become the Trojan horse of the American banking system.’ Banks moved in the direction of extreme leverage and liquidity but by doing so they also undermined their traditional business model. The new finance required a fast growth in the shadow banking system and banks had to become more involved in the new, riskier activities to counter falling profitability in their traditional business areas. Stiglitz (2019: 105) describes how in the U.S. banks developed a strong interest in credit card lending ‘because it was so easy to take advantage of consumers, charging them usurious interest rates, late fees (even when they weren’t late), overdraft fees, and a host of other charges’, while pushing the corporate sector into the more profitable capital markets financing. Especially for the SMEs it became much harder to secure financing in this new environment. Basel I, for example, was widely criticized for designing capital requirements in a way that large corporations were treated less risky than SMEs, which made it much more complicate for the latter to secure loans.

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The rationale for a CMU comes from comparison of market structures for risk sharing in the U.S. and Europe and the claim that ‘greater private cross border risk-sharing through deeper integration of banking systems and capital markets could certainly help increase the euro area’s stability in the face of country-specific shocks that cannot be addressed by a response from the common monetary policy’ (Thomsen 2019). According to IMF data, the euro area’s ‘listed equity amounts to about 68 percent of GDP— in the United States, the ration is closer to 170 percent. In the euro area, private sector debt securities stand at an equivalent of about 85 percent of GDP, in the United States the figure is 100 percent. This means that less than one-third of nonfinancial firms’ liabilities in the euro area are tradable instruments, compared to more than two-thirds in the United States. […] Total banking sector assets amount to about 300 percent of GDP in the euro area, dwarfing the U.S. ratio of about 85 percent of GDP’ (Thomsen 2019). This ‘underdevelopment’ is also reflected in a much higher level of household savings in Europe held as bank deposits and since years European politicians and experts have tried to convince citizens that traditional saving accounts in banks or building societies are a comparatively poor form of investment and steer them towards investment options with higher returns. The ‘underdeveloped market’ hypothesis is the justification for deepening capital markets. The hypothesis is that systems with a large capital market are superior to the more traditional bank-based funding systems. An IMF study, studying the effects of financial systems on economic growth and stability, concluded that there is no strong evidence for the superiority of bank or capital markets-based systems (Sahay et al. 2015). There is also evidence that capital market-based financing increases procyclicality (Dombret 2015) and that it undermines the traditional funding in coordinated market economies that made them successful models in global competition (Pesendorfer 2016). Aldasoro and Unger (2017: 20) showed that increasing the supply of non-bank financing provides only a limited stimulus for the economy and conclude that the hopes in CMU would be too high. Bank funding would have the advantage of increasing ‘the nominal purchasing power of the economy when they create additional deposits in the act of lending.’ Compared to non-bank financing, bank lending ‘has a strong and persistent impact on economic activity and prices.’ Overall the evidence is contested and the political agenda behind CMU largely ignores any counterarguments against its preferred option and the harmful effects of contemporary capital markets, its connection to

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a large shadow banking system, toxic securitization and derivatives trading, high-frequency trading and dark pools remain ignored. The claim that CMU would foremost be in the interest of SMEs was pure propaganda. Lord Hill, then Commissioner for financial stability, financial services and CMU, confessed openly at an event in the U.S. at the Brookings Institution that the SMEs rhetoric was just to sell the idea as ‘people want to rally around ideas that will enable [SMEs] to be strengthened’ (Hill 2015a) when confronted with the fact that the U.S. capital markets are not of any big use to these companies. SMEs have experienced difficulties to access funding as a consequence of the credit crunch. SME bank lending had peaked in mid-2008 when it reached € 95 billion; then it fell to about € 54 billion in 2013/2014, and while SME lending remained below pre-crisis levels, the bank lending for large corporations quickly recovered with variations across countries and banks. Better capitalized banks were generally lending more, including to SMEs while banks with large amounts of non-performing loans lent less to SMEs. Overall, ‘access to finance has remained of greater concern to SMEs than to large enterprises’ (EBA 2016: 8). U.S. data also showed that capital markets were less suitable for SMEs; moreover, the post-crisis economic recovery was not driven by SMEs despite the more developed capital markets (Brookings Institution 2015a). According to a Eurofound (2016: 49) study, SMEs have faced unfavourable conditions (high interest rates, larger collateral required) or were not being granted credit due to a poor lending history or high indebtedness. The study clearly showed that the funding problems are similar in countries with more developed capital markets such as the UK.  Other research showed that German SMEs performed as amongst the most innovative ones in Europe. In short, the majority of European companies will not benefit from the CMU. The EU has in the meantime replaced the SME claim with highlighting that the CMU will especially boost capital market-based funding for innovation and start-ups (c.f. EC 2019b: 6) that often find it difficult to secure bank funding. Moreover, the Commission adopted a stronger focus on ‘growth and jobs’, which also meant dropping the support for a European Financial Transaction Tax (Brookings Institution 2015b). For what it is worth to have the most developed capital markets, the U.S. has not been very successful in securing finance for major infrastructure. Public investment in infrastructure declined significantly over the past decades and infrastructure including airports, bridges, dams, electric transformers, roads are in a miserable condition. Moreover, the economy

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has become much more concentrated and the rate of company creation has been in decline. According to Greenspan and Wooldridge (2018: 396) there were 6797 listed companies in 1997 and this number dropped to 3485  in 2013. This increased capital concentration is a result of capital markets financing reflected in what Greenspan and Wooldridge have described as companies no longer dreaming ‘of taking their companies public and becoming the next Bill Gates’ but ‘selling their companies—or at least their bright ideas—to one of the established tech giants’ which made them ‘supplicants to the established order rather than radical disrupters’ (ibid.). Greenspan and Wooldridge do not link these developments to capital markets. Instead they come up with various other reasons for the American decline, including blaming ‘the growth of regulation, which acts as a tax on entrepreneurs’ two most valuable resources, their time and their ability to try new things’ (ibid.: 411). For Joseph Stiglitz (2019: 105) it is clear that a highly ‘dysfunctional financial sector’ and ‘shortsighted financial markets’ are to blame for ‘a dysfunctional economy’ in the U.S. where the last decades since the 1980s saw a major decline in economic growth (ibid.: 35), a massive distortion of the market system that led to a much less efficient economy (ibid.: 62). Finance fundamentally transformed and is now providing less traditional intermediation, while gambling activities have risen dramatically. As a result, ‘growth slowed and the economy became more unstable—culminating in the worst crisis in seventy-five years’ (ibid.: 109). Like Paul Krugman and others, Stiglitz laments the loss of ‘boring banking’ with the invention of the ‘originate-to-distribute’ model dominating twenty first century banking. Overall the financial sector is too big and ‘doing too much of what it shouldn’t be doing and too little of what it should be doing’ and it ‘used its power not so much to serve society but to extract profits for itself’ (ibid. 114). Mitchell (2011: 42) went even further and argued that ‘financialism’ has so significantly transformed the U.S. economy that it is no longer a capitalist ‘system in which wealth is created and sustained by the production of goods and services determined through market supply and demand.’ Instead, financial markets now ‘exist primarily to serve themselves’ by ‘creating, selling and trading securities and derivative securities that do not finance industry but rather trade within markets that exist as an economy unto themselves.’. These very markets undermine the functioning of the real economy as already discussed earlier in Chap. 2. Gorton, Llewellyn and Metrick (2012) and Gorton (2019) have shown how the rise in shadow banking correlated with a significant

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fall of privately-produced safe debt and how the shadow banking system became larger than the regulated banking sector in the U.S. The Financial Stability Board (FSB 2018 and 2019) has started to monitor the developments in shadow banking over recent years. Total financial assets increased from $340 trillion at the end of 2016 to $382 trillion at the end of 2017. This makes the size of financial assets about 4.5 times the global GDP. ‘Other financial intermediaries’ (OFI) (excluding central banks, banks, insurance corporations, pension funds, public financial institutions or financial auxiliaries) grew by 7.6% in 2017, exceeding the growth of banks, insurance corporations and pension funds, and gaining their largest share on record, then holding 30.5% of total global financial assets. Structured Finance Vehicles returned to growth for the first time since the GFC. The ‘narrow measure’ of non-bank financial institutions, which the FSB labeled in 2018 ‘narrow measure of shadow banking’, consisting of securitisation, market intermediation dependent on short-term funding, lending dependent on short-term funding, unallocated shadow banking and facilitation of credit creation, grew from $45  trillion in 2016 to $51.6  trillion in 2017. Overall non-bank financial intermediation grew from $160 trillion at the end of 2016 to $184 trillion at the end of 2017. The OFI share was 348 times GDP in Luxembourg, 14 times GDP in Ireland, and 8 times GDP in the Netherlands with all these countries having a very large share of investment funds and CFIMLs with limited linkages to their real economies. Loans by banks grew globally and the Euro area, where banks still play a significant role for lending, contributed to this trend. According to the FSB, the EU has also a stronger interconnectedness between banks and OFIs than between OFIs and pension funds and insurance companies. In the core shadow banking the U.S. had the largest share with $14.9 trillion, followed by eight eurozone jurisdictions with a combined $11.8 trillion, followed by China with $8.2  trillion and the Cayman Islands, a British Oversea Territory and one of the best known tax havens, with $5.4 trillion. According to the Federal Reserve (2019: 21) Report on the Economic Well-Being of U.S. Households, four in ten adults would face difficulties in paying for an unexpected, small expense of $400 and twelve percent ‘would be unable to pay the expense by any means’ in 2018. For the months of the survey, ‘17 percent of adults expected to forgo payment on some of their bills’ and seven percent were unable to pay their rent, ­mortgage, or utility bills entirely. ‘3 in 10 adults are either unable to pay their bills or are one modest financial setback away from hardship’. A large

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number of U.S. households are also unable to cope with unexpected health care expenses. The rise of finance-led capitalism and financialization has led to increase indebtedness and inequality. The OECD (2019) reports how the middle class has become squeezed over the last 30 years and how middle incomes are being ‘hollowed out’. A negative side effect of financialization and the securitization of bank loans is also a sharp increase of debt-buying companies in the U.S. that use collectors often ignoring the law. According to Human Rights Watch (2016), debt buyers, companies specialized in buying non-performing loans, make massive use of lawsuits. These companies also specialize in buying ‘out of statute debt’ that is so old that in can no longer be collected. Another trend is the buying of peoples’ medical debt. One could question how this is related to capital markets as it is banks, debt buyers and courts involved in such processes. However, the underlying problem comes from the competition between banks and capital markets, from the growth dynamics in lending that are based on securitization and the interlinkages to the shadow banking system. While the Commission frequently points towards lost growth caused by less developed capital markets, other EU actors have highlighted that the EU is superior to the U.S. when performance is not just measured by growth but by wellbeing. Janse (2015), Secretary General and member of the management board of the ESM, acknowledged that the U.S. comes ahead of the EU when GDP per capita is compared, however, Europe would make a better use of the wealth resulting in a higher wealth-to-­ wellbeing coefficient. Already earlier, data was presented that the UK with the most developed capital markets in the EU is also the most unequal society. The role and size of finance is certainly a factor that led to increasing inequality. However, central bankers and regulators have become highly supportive of the transition towards more capital markets-based financing. Carney (2015: 2) argued ‘The debt tail is wagging the market dog’ and lamented that in Europe, ‘[s]avings aren’t flowing freely to the areas that need them the most. This is certainly true for the euro area, where many savings are trapped and much of finance remains fragmented’. In his view, the UK escaped the debt trap thanks to its ‘integrated financial system which channels savings from one part of the economy to investment in others’, its fiscal policy framework designed to insure against severe systemic shocks, an open and flexible economy, and a credible monetary policy framework (Carney 2015: 3f). Viñals (2015) states that in ‘the United States, where capital markets are both deep and fully integrated, nearly 40 percent of

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shocks to states within the country are smoothed through capital markets, three times more than what is smoothed through the Federal Budget’ and concludes that capital markets in Europe would provide a ‘substantial potential’ for enhanced risk-sharing in the region. However, the risk of cross-border transmission of shocks would require ‘adequate regulatory and supervisory frameworks to safeguard financial stability’. This data was from a study by Asdrubali et al. (1996) covering the period 1963–1990; another study covering the years between 1991 and 1998 calculated, capital markets smoothed out 55%, and the federal budget 13% (Kalemli-­ Ozcan et al. 2004). These results led the former President of the ECB, Jean-Claude Trichet, to conclude ‘that the financial channel can be much more important than the fiscal channel’ (Trichet 2007). However, Duwicquet and Farvaque (2018) argued that those studies’ conclusions are methodologically problematic as the necessary data would not be available for several U.S. states. Their conclusion is that the existing literature probably overestimates the degree of income smoothing offered by capital markets. If capital markets have clear risks and downsides, the main question becomes how to find the right balance between bank-based and capital market-based financing. Thomsen (2019) at least acknowledged that one could discuss whether the U.S. capital markets are over-sized, without giving an answer to the rhetorical question; however, for Europe he stressed the IMF’s position that the region would ‘remain in the throes of very strong bank-dependence’ and capital markets remain too fragmented reducing financial stability. This view is summarized in his conclusion that ‘Europe is a long way from having a single financial market—and the implications are costly.’ In estimating these costs, the IMF studied the financing costs for firms in different member states, the restraints on innovation and growth potential, capacity to shock absorption, and cross-­ border risk-sharing through fiscal transfers, concluding that more financial integration ‘offers the prospect of powerful macroeconomic benefits.’ The aim of reducing dependency on bank funding and increasing capital markets-based financing was supported by market developments. Since the GFC and Eurozone crises, finance raised by companies shifted already mostly to capital markets-based finance. According to van Steenis (2018), ‘more than €500bn of corporate funding has transferred from eurozone banks to bond markets’, although this option has only been available to the largest companies. CMU supporters called for a fast transition to a capital-markets based system to create a more resilient, more diversified

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system. Van Steenis (ibid.) argued that thanks to the more developed U.S. capital markets, banks had only to suffer 40% of the losses from the credit crunch, while bondholders took a 60% hit; yet in Europe 90% of the losses had to be taken by the banking sector, resulting in a huge amount of bad loans that have slowed down progress towards a Banking Union (see Chap. 6). The EU would need stronger and deeper capital markets to be prepared for the ECB’s return to conventional monetary policy. The Commission (2018a: 37) reported that the capital markets expanded ‘to more than twice the size of the Union economy in 2015.’ The growth transformed the funding of companies. Debt securities and non-bank loans increased in the last decade from 24% to 36%; ‘listed equity issued by non-financial companies increased from 36% of GDP in 2014 to 41% in 2018’ bringing the ‘total market capitalisation of listed companies […] above pre-crisis level’. However, ‘a ‘CMU effect’ on the cross-border integration of capital markets is yet to be seen’ as the removal of ‘core barriers to further integration has been too slow’ (de Guindos 2019). There would also be alternative explanations for slow recovery and moderate growth, which have characterized both the U.S. and the EU post-crisis recoveries. El-Erian (2017) argues that policymakers had misunderstood the nature of the crisis and the policy window for ‘bold action’ had closed as explanation for prolonged crisis and slow recovery: ‘Indeed, advanced-country politicians today still seem to be ignoring the limitations of an economic model that relies excessively on finance to create sustainable, inclusive growth. Though those limitations have been laid bare over the last ten years, policymakers did not strengthen adequately the growth model on which their economies depend. Instead, they often acted as if the crisis was merely a cyclical—albeit dramatic—shock, and assumed that the economy would bounce back in a V-like fashion, as it had typically done after a recession. […] A decade after the start of the crisis, advanced economies still have not decisively pivoted away from a growth model that is overly reliant on liquidity and leverage—first from private financial institutions, and then from central banks. They have yet to make sufficient investments in infrastructure, education, and human capital more generally. They have not addressed anti-growth distortions that undermine the efficacy of tax systems, financial intermediation, and trade. And they have failed to keep up with technology, taking advantage of the potential benefits of big data, machine learning, artificial ­intelligence, and new forms of mobility, while managing effectively the related risks.’

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Not just that the shift from a bank-based to a capital markets-based system increases all the negative tendencies inherent to finance-led capitalism, it also increases the costs of future crises. Dombret (2015) suggested that capital markets increase the procyclicality and a Bank of England study (Anderson et al. 2015) concluded that a more capital markets-based system could fail to deal with a large shock; financial instability would then result from higher contagion risk. Moreover, CMU was from the outset designed as an agenda for liberalization, deregulation, and harmonization that should remove not just national barriers but also make sure that the post-GFC regulatory environment becomes business- and financial innovation-­friendly and that all proposals are subject to better regulation and achieving more growth and jobs above competing goals (Pesendorfer 2015, 2016).

5.3   CMU—Progress and Obstacles The CMU is a wide-ranging agenda building on legislative frameworks at the national and European levels that pre-date the CMU Action Plan and came under review to modify them for contributing to a deeper capital market plus a wide range of new measures that have been identified as priorities to remove remaining barriers to deeper financial integration combined with an agenda for sustainable finance aiming at expanding the existing niche markets for green financial products. As such, CMU is a large-scale market making and market redesigning exercise that is aiming at deepening and widening the existing capital markets based on expectations derived from the ‘underdeveloped financial markets’ hypothesis and a soft interpretation of the sustainable development concept. It was little surprise that the original agenda of changing towards a capital markets-­ based financing system was most reassuring to industry after the years of far-ranging regulatory change and highly applauded by industry associations and think tanks as it nicely merged concerns about unintended consequences of the post-crisis regulatory reforms with demands for a new wave of deregulation as major strategy for deeper financial integration and market expansion. The Association for Financial Markets in Europe (AFME 2014), for example, proposed that CMU should have a focus on the supply and demand sides of capital markets and improve regulation for infrastructure for capital markets issuance and trading. Most of the ­academic literature has welcomed the CMU agenda as a necessary change to deepen capital markets integration in Europe and to catch up to the

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leading U.S. markets with a general perception that the agenda is highly ambitious but worth completing (c.f. Moloney 2016a, b; Ringe 2015; Sapir et al. 2018; Schammo 2017; Schoenmaker 2015; Véron and Wolff 2015). Valiante (2018: 27) praised CMU as an ‘opportunity to achieve that level of risk sharing among Member States that stabilizes Europe’s financial system’ and suggested that the EU could do even ‘more to improve cross-­border price discovery (information flows) and enforcement of common rules and principles to promote intra-EU trade and, with it, capital mobility.’ Others were more critical in their overall support. Acharya and Steffen (2016) argued that CMU cannot be successful if the EU does not first address the government bond markets that cause highly fragmented bond and equity markets in the Eurozone. First sovereign bonds need to be restored as risk-free assets to stabilize the markets. Rather skeptical, they conclude that CMU ‘solely rests with the European Central Bank in the near to medium term’. The sustainable finance agenda was also welcomed by industry and experts, although with some concerns about too much ambition and potential overregulation, but overall certainly with merits to establish a fairer and competitive market for climate change investment for firms and investors with climate risk exposures. The Commission started out with acknowledging that creating a CMU would require a wide range of measures to achieve the intended impact on the entire economy and that ‘closer integration of capital markets and gradual removal of remaining national barriers could create new risks to financial stability’ which would need to be addressed with increased ‘supervisory convergence’ (EC 2015a: 4). Since 2015 the Commission put forward 71 actions, 33 incorporated in the Action Plan of 2015 and 38 further actions announced in the mid-term review of 2017, with the aim of implementing them by mid-2019. Until 2018, the Commission’s proposals have only partly been adopted by the co-legislators. Legislation adopted included the new Prospectus Regulation repealing a 2003 directive (Regulation (EU) 2017/1129), a new framework regulation for securitization (Regulation (EU) 2017/2402), and a new regulation for venture capital funds and social entrepreneurship funds (Regulation (EU) 2017/1191). In 2017, the Commission was still optimistic to have all building blocks for a CMU in place by 2019 (EC 2017d: 3). However, a year later the Commission urged quick action as ‘a matter of urgency’ (EC 2018b) to adopt further legislation. Regulators have also lamented that progress has been ‘proving difficult and slow’ (Villeroy de Galhau and Weidmann 2019) and think tanks have recommended to focus on clear

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priorities with political support. Sapir et  al. (2018) suggested that the ESMA should be such a priority and should get additional powers to become a key driver for the agenda. A stronger ESMA would put an effective check on the potential financial stability and business conduct challenges that might arise from cross-border markets integration.’ However, in mid-2019 the Commission reported that 11 out of 13 CMU legislative initiatives have been agreed on by the EP and the member states and out of three sustainable finance legislative proposals two have been agreed on by the EP and Council. The Commission lamented that ‘concrete support on specific legislative files has sometimes been lacking’ and insolvency regimes and cross-border taxation still need to be addressed ‘to ensure a better integration of capital markets in Europe’ (EC 2019a: 2). Moloney (2018: 92) has argued that ‘[t]he EU financial system has reached an inflection point where capital market growth and financial stability may be coming into conflict’ and that ‘governance changes may follow’ from this. She identified instability arising especially from ‘the new MiFIR trading transparency rules and CRD IV/CRR’s new capital charges for securities dealing business’ and from the recent growth in capital markets-­based funding (ibid.: 93). However, there are much more fundamental problems with the CMU agenda. This agenda includes highly problematic aspects including debates about the need for deeper capital markets, more integration vs more competition, the illusion of ‘sound securitisation’ and the growth of shadow banking, increasing reliance on central clearing, abandoning the Financial Transaction Tax, the ‘cumulative effect of regulatory reforms’ and deregulation. CMU is a project that clearly continues the financialization trend from the period before the GFC and as project that will significantly increase fragility. The regulatory oversight over derivative markets was improved with the European Market Infrastructure Regulation (EMIR, Regulation (EU) No 648/2012), which provides the legal basis for data collection and central clearing of derivatives (amended by EMIR Refit, Regulation (EU) 2019/834). Mutual funds are regulated under the Undertakings for Collective Investment in Transferable Securities (UCITS) directive (Directive 2009/65/EC). In the European derivative market the share of centrally-cleared transactions has risen in recent years. The Commission claimed in its CMU Action Plan (EC 2015a: 26) that EMIR, which is based on G20 commitments, would have made the derivative markets ‘more transparent, well regulated and robust’. However, there was no significant downsizing of this toxic market and the regulatory solution has

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only shifted the problem to central counterparties (CCPs) which are put between the two counterparties to a transaction, acting as buyer to the seller and seller to the buyer in order to manage the risk involved (Article 2(1) of EMIR). By April 2019, 16 CCPs were authorized by ESMA (2019a) in accordance with the EMIR Regulation on OTC derivatives, central counterparties and trade repositories. The Commission started a review of EMIR in 2015 with a public consultation and then published in 2016 a report to the European Parliament and Council (EC 2016b) and an ‘inception impact assessment’ (EC 2016c) that outlined scope for simplification and reduced administrative burden for further consultation with stakeholders. The Commission (EC 2016d) released a proposal for a regulation on the recovery and resolution of CCPs to allow orderly resolution of CCPs as they have taken on enormous risk in the new system that is still not adopted. In 2017, the Commission presented the results of the EMIR review in a Communication (2017i) and published its reform proposal (EC 2017j). The Communication stated that further reforms of derivatives clearing are necessary to support deepening CMU and to reflect the ‘growing systemic importance of CCPs’. As clearing services are highly centralized, the Commission proposed ‘enhanced supervision’ to overcome the current fragmentation and to achieve ‘supervisory convergence’ in the Single Market. The European credit default swaps (CDS) market is dominated by ‘alternative investment funds’ with the largest exposures and UCITS funds play a smaller role. According to the FSB (2019: 88f.), this ‘market resembles a bow-tie network structure, with a high degree of intra-dealer gross exposures at the centre of the network’. The alternative investment funds have not directly been regulated after the GFC; only managers of funds above a certain threshold have reporting obligations under the Alternative Investment Fund Managers Directive (AIFMD, Directive 2011/61/EU). The AIFMD covers managers of hedge funds, private equity, venture capital, professional investors, real estate, and other ‘alternative investment funds’ (AIFs) that are not already covered under the UCITS Directive. The directive ‘aims at establishing common requirements of governing the authorisation and supervision of AIFMs in order to provide a coherent approach to the related risks and their impact on investors and markets in the Union’. This directive was criticized by the shadow banks regulated under it since it came on the agenda. They failed with their original ­argument that they should not be regulated after a crisis, in which they had played no part in its making. However, regulators and lawmakers had

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already acknowledged that AIFs can amplify and spread risks through the financial system, and in some situations they can even be of systemic relevance similar to TBTF banks. Since then AIFs have shifted to lobbying against too burdensome requirements. However, instead of regulating the AIFs directly and putting them under strict regulation and supervision, this industry sector got away with authorization rules and reporting obligations for managers, including non-EU AIFMs in form of minimum harmonized conditions. AIFs under €100  million or unleveraged AIFs fall under a lighter regime and managers of those funds did not become subject to full authorization but to registration in their home member state (Article 17 AIFMD). The directive required a review 4  years after the deadline for transposition and the directive specified that the review has to consider the aim and assess ‘whether or not this Directive functions effectively in light of the principles of the internal market and of a level playing field’ (Article 5 AIFMD). As basis for its own report, the Commission released a background report on the operation of the AIFMD produced by KPMG in January 2019 which studied the impact of the directive in 15 member states. It found that the directive had a clear and positive impact on creating an internal market for AIFs by providing ‘a harmonized and stringent regulatory and supervisory framework for AIFMs’ although the study also criticized some concerns about effectiveness and efficiency and identified ‘a small number of areas’ that would require ‘further harmonisation’ (KPMG 2018: 20f.). In short, it contributed to the CMU’s completing the Single Market agenda. The AIFM data collected by national competent authorities is not publicly available and only limited data is currently shared across member states at the EU level. The CMU Action Plan called for the removal of barriers for AIFs that they can fully exploit the benefits of a fully integrated market. The plan identified that a number of member states had set out conditions under which AIFs can originate loans under national laws that create cross-­ border barriers for the funds (EC 2015a: 10). Luis de Guindos (2019), Vice-President of the ECB, argued that the overall ‘CMU effect’ will be mixed based on some flaws in regulatory frameworks such as in the area of insolvency or taxation where further harmonization and a single rulebook would be required. Major reforms need still full implementation to take effect or are even pending in the legislative process, while other reforms would not ‘deliver their full ­potential’. In particular, he lamented about a ‘lack of ambition’ in areas such as the creation of a pan-European personal pension product or the

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cross-­border mobilization of savings. Especially, insolvency regimes, taxation and supervision of non-banks need to be reformed to create a level-­ playing field in the markets and to increase financial stability. He argues that ‘strong cross-border banks and cross-border ownership of assets would reduce the risk of disruptive capital flight in crisis times, while also reducing the bank-sovereign nexus’. The latter is a central concern that led to the creation of the Banking Union (see Sect. 6.2) and the call for creating a European safe asset is one of its ongoing controversial debates (see Chap. 6) where synergies between CMU and Banking Union are expected. Insolvency regimes and personal pension products have also by others been suggested as priorities for the next phase (Sapir et al. 2018). Another key area for a CMU is an effective insolvency regime. Insolvency has been addressed by a Commission proposal for a Directive on restructuring, insolvency and discharge procedures (COM(2016) 723). The legislative process has been completed for this directive in June 2019 and the Directive on Restructuring and Insolvency (Directive (EU) 2019/1023) has then been adopted in June 2019. One of the major aims of this directive is to reduce the build-up of non-performing loans by adopting preventive restructuring frameworks for enterprises. Member states have to transpose the directive by 17 July 2021 into national laws, regulations, and administrative provisions (Article 34) with some exemptions concerning the use of electronic means of communication (Article 28) that should come into force in 2024 and 2026. The pan-European personal pension product was suggested in the Commission’s 2017 mid-term CMU review and then led to the proposal for a regulation on a pan-European Personal Pension Product (PEPP) (COM(2017) 343). Pension funds have played a key role in the financialization of society. The Commission’s aim was to overcome market fragmentation that currently ‘prevents personal pension providers from maximising risk diversification, innovation and economies of scale’ (ibid.: 2). The PEPP should become an attractive, safe, cheap and simple financial product especially for young citizens that use their right to live and work across the EU.  The idea is that pooled savings for retirement are used for long-term investment in an integrated European financial market; however, in the past, pension funds were also influenced by short-termism in finance which makes this reform necessarily linked to measures to improve the incentives for long-term over short-term investments. Their investments were also not safe from massive losses. According to the OECD pension fund assets dropped by over $5 trillion from $27 trillion

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during the GFC and they also often invested in companies that were not the most sustainable ones linking their reform to the agenda for sustainable finance. In Europe, Ireland’s pension funds lost nearly 38% and were the worst performing funds in 2008. Belgium, Hungary and Iceland were in the country group facing more than 20% losses; Germany, Slovakia, Norway, Spain, Switzerland and the Czech Republic had around 10% losses. Some countries’ funds, including Austria, Hungary, Iceland, Norway and Poland, recovered quickly from the losses (Keeley and Love 2010: 71). Changes to future pension contributions and working longer were the consequences of private pension systems based on speculation. After years of advertising private pension funds as safe and smart investment, the GFC led to questions about possible bailouts for such funds and about investment risk and longevity risk. The OECD, since years a strong supporter, called for stronger pension fund governance and updated its guidelines and suggested the bigger pension funds are the better, advocating mergers. The OECD continued defending private pension as important and ‘necessary to diversify the sources of income at retirement’ and complementing public pensions (ibid.: 83f.). UK funds lost 19.7% in value in 2008, 4.6% in 2011 and 6.2% in 2018. Only 9% of UK pension funds reported positive investment returns in 2018 (Seekings 2019). The EIOPA reported in its 2019 Financial Stability Report that the economic environment has worsened over the previous year with increasing uncertainty in the global economy and with Brexit and that these factors as well as low interest rates have been challenging for insurance firms and pension funds. A new period of economic slowdown or even a new crisis would therefore destabilize these industries. The PEPP has also to be seen critical in light of the financialization literature criticizing channelling pensions into the financial system and allowing ‘large corporations to enrich themselves by managing ‘other people’s money” (Picciotto 2011: 122). The pressure towards public pension systems was not just a result of an aging society in most European countries but also a consequence of increasing fiscal pressures resulting from large corporations’ tax avoidance and evasion practices and an ideological shift towards private pensions. Calls for returning to public pensions have not found much support so far; a more moderate approach has been to suggest that if private pensions have become a fact, they should be regulated in ways that minimize their risk exposure and are properly regulated and supervised (Hassel et al. 2019). Interesting is also the regulatory response to dark pools and algorithmic and high frequency trading (HFT), which has been included in MiFID

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II and MiFIR.  A revision of the Markets and Financial Instruments Directive (MiFID Directive 2004/39/EC) was proposed by the Commission in 2011 which resulted in the revised directive (Directive 2014/65/EU) and a corresponding regulation (Regulation (EU) No 600/2014). The Market Abuse Regulation (Regulation (EU) No 596/2014) repealed the Market Abuse Directive and the Short Selling Regulation (Regulation (EU) No 236/2012) are also of relevance for HFT. HFT has become highly significant in equity trading and has become even dominant in various markets (ESMA 2016; Kern and Loiacono 2019: 311). MiFID II introduced a new regime for HFT that entered into force on 3 January 2018. According to ESMA (undated), the ‘new legislative framework will strengthen investor protection and improve the functioning of financial markets making them more efficient, resilient and transparent.’ The rules apply to HFT firms and proprietary traders who engage in algorithmic trading techniques, which includes HFT and banks with a proprietary algorithmic trading desk. The rules do not ban dark pools or HFT but aim to limit their use. HFT firms and traders must have a license and comply with reporting obligations and investment firms and trading venues have to comply with organisational requirements. Additionally, measures to increase competition have been introduced. Marcus and Kellerman (2019: 83) have argued that ‘the efforts of legislators and regulators are undermined by a lack of empirical research’. Currently many questions about costs and benefits of HFT would still be unknown, including the costs of abusive strategies and ‘mini flash crashes’ and the overall welfare implications. Focusing on spot foreign exchange markets, they also hope for market ‘self-healing’ and ‘industry-led solutions’ given a ‘widespread recognition within the industry that changes are needed’ to restore fair and effective markets. The regulation of HFT has also introduced a circuit-breaker to assure trading systems are resilient in situations of severe market stress (Article 48 of MiFID II) and ESMA is monitoring its use. Circuit-breakers must enable a regulated market ‘to temporarily halt or constrain trading if there is a significant price movement in a financial instrument on that market or a related market during a short period and, in exceptional cases, to be able to cancel, vary or correct any transaction’ (Article 48(5) of MiFID II). ESMA (2017a) provided as mandated by Article 48(13) guidelines for member states to calibrate circuit breakers in order to develop common standards and assure consistent application of Article 48(5) and called on competent authorities to incorporate them into their supervisory practice. ESMA (2017b) went beyond

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this requirement and also published a report to expand the guidelines to other mechanisms to manage excessive volatility which was based on a stakeholder consultation that took place in 2016. Dark pools were created for large institutional investors to escape HFT in trading venues for equities without pre-trade transparency (see Sect. 1.2). MiFID introduced in 2007 four types of waivers that allowed for the establishment of dark pools, making it the responsibility of national competent authorities to grant waivers. However, inconsistent implementation raised concerns about possible effects on price discovery. MiFIR harmonized the waivers and mandated ESMA to develop technical standards for harmonized implementation (Article 4 of MiFIR). MiFID was also the reason behind growth in dark trading as the directive introduced uniform pre-trade transparency requirements and market participants started to worry about the possible use of this data by HFT firms. According to the ECB, dark pools had grown continuously since their emergence in 2009 to almost 10% of market share in trading in European stocks in 2015 (Petrescu and Wedow 2017). The ECB expected no dramatic change for dark pools under MiFID II (ibid.: 52). Kern and Loiacono (2019: 309) noted that dark pools are still rather underdeveloped in the EU and only accounted for 2% of trading just before MiFID II came into force in 2018 and aimed at a reduction that should be achieved by disincentives for equity and equity-like instruments in dark trading. They expected this share to decrease because of the double volume cap mechanism (DVCM) introduced by the MiFIR (Article 5 of MiFIR). This DVCM limits the amounts of transactions in dark pools to protect the price discovery process in equity markets. Article 5.1(a) limits the percentage of trading in a financial instrument carried out on a trading venue under an Article 4 waiver to 4% of the total volume of trading in that instrument on all EU trading venues over the previous 12  months. Article 5.1(b) limits the overall EU trading in a financial instrument to 8% of the total trading volume over the previous year. ESMA has to provide regularly information about the DVCM on its website in the DVC Register. According to the chair of the ESMA, Steven Maijoor (2018b), this system has led to a significant decrease in number and volume of dark trading. ESMA (2019a) reported that the overall share of equity trading on dark pools has fallen to 1.9%. But for equities banned by the DVCM in March 2018, trading in dark pools dropped from 7% to less than 1% in August before increasing again above 5% in September 2018, when a number of restrictions ended. In liquid shares dark pools trading stayed at 9.6% of the total trading. In

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April 2019, trading on dark pools was back at 9.1% on all on-exchange activity (Basar 2019). A relatively new development in casino capitalism has been the boom in Exchange Traded Products (ETPs) or Funds (ETFs) since 2009. These products are typically index-tracking investment products sold on secondary markets and based on a pool of securities or other assets. They are continuously traded on liquid markets. The IMF raised concerns about ETFs in its 2018 Global Financial Stability Report stating that this passive investment vehicle, ‘in less liquid underlying markets, could amplify the impact of asset price moves on the financial system’ and it could constitute an ‘overreach in risky assets’. The 2019 IMF report noted that increasing use of ETFs has changed the current corporate credit cycle stating that this could result in higher refinancing costs for borrowers. According to the IMF (2019a: 31), ‘investors have been increasingly attracted by the low cost, high liquidity, and growing availability of such funds for a range of asset markets.’ The IMF (ibid.: 50) was concerned that this trend could affect demand for liquidity and as a consequence also ‘herding behaviour by market participants’ resulting in ‘adverse implications for market liquidity’. Over the past decade, ETFs in European markets increased from €160  billion to about €760  billion of assets under management with a prediction to reach €1 trillion by 2020 and €2 trillion by 2024 (Lamont 2019). Because of MiFID II rules, the fragmented market is reshaping and increasingly moving from stock exchanges to electronic venues that trade over-the-counter products. In the U.S., this market is more developed with the biggest ETFs already traded as actively as stocks and increasingly attractive for retail investors. Trades increasingly move to automated algorithms (Stafford 2019). The ESRB (2018: 4) highlighted the risks related to the rise of ETFs in its 2018 Shadow Banking Monitoring Report and came to the conclusion that risks are still small but because of the rapid growth further monitoring would be necessary. The ESRB then published in June 2019 a study that identified how ETFs contribute to systemic risk (Pagano et al. 2019). The report highlights ‘four main reasons why ETFs could pose systemic risk’: ‘In normal times, the high liquidity of ETFs encourages investors to place large short-term directional bets on entire asset classes, which affect the prices of the underlying securities, increasing their volatility and their co-­ movement.’ This can cause liquidity problems that are magnified by the ‘built-in procyclical trading strategies’ in leveraged ETFs. During market stress, ETF price movements can destabilize financial institutions with

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large exposures. Contagion may further increase systemic risk. A large event could trigger massive fire sales that could result in large price movements of securities or ETFs (ibid.: 32). However, the report failed to make any proposals how to intervene into this market and only suggested further research. It also did not reflect on the more recent change to algorithmic trading and possible consequences for financial stability and systemic risk. The IMF provided in 2019 ideas and recommendations for the CMU based on the assumption that financial integration in the EU is still rather incomplete with the currency union ‘still far away from being’ a political union. The proposal is therefore ‘a medium-term action plan’ and ‘not a plan for how to soon get to a U.S.-style European CMU’. The IMF recommends that the EU should focus on increasing transparency in capital markets, ‘reducing variability in investor protection regulations; and improving insolvency regimes, both to improve recovery values and to facilitate smooth market exit.’ Most importantly the EU should ‘facilitate market discipline, which requires an approach that is distinct from explicitly seeking to reduce the likelihood of failure through intrusive prudential supervision’ (Thomsen 2019). The IMF is supportive of the Commission’s Action Plan but especially suggested to focus on key initiatives with sufficient political support. The IMF stressed the idea that the Prospectus Directive and Regulation should be supplemented by ‘instituting centralized, standardized, and compulsory electronic reporting for all issuers on an ongoing basis’ making the system more similar to the U.S. Securities and Exchange Commission database and the Canadian system (ibid.). The background to this is the current fragmentation of information in the member states that has not been standardized. Another recommendation is ‘to streamline procedures for cross border refunds of withholding taxes on dividend and interest income’. In the area of insolvency laws the IMF anticipates complications and most likely only gradual reforms in overcoming national legal traditions that have led to the current dissimilarity of laws. The IMF therefore only recommended that the Commission should collect data and ‘develop a code of good standards for core features of corporate insolvency and debt enforcement processes’ and monitor developments and progress. Regulatory oversight should be based on the principle of proportionality and avoid ‘intrusive prudential supervision’ of ‘nonbank financial intermediaries’. Here the IMF’s warning was that the U.S. Federal Reserve’s experience would have shown that ‘excessive prudential oversight’ could lead to ‘bailout expectations and moral hazard

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simply by being seen to be talking to certain nonbank financial actors’. That sounds unconvincing. Maybe in a regulatory environment where shadow banking is largely unregulated such limited contact can be interpreted as excessive; if there is regulation in place requiring strict prudential oversight, the situation would be different. Thomsen (2019) also claims that there would only be ‘a few capital market entities’ posing systemic risk requiring and justifying strict oversight. Beside large investment firms this would foremost include clearing counterparties which require strict and ‘deeply intrusive’ prudential oversight given their importance in derivative and repo market clearing. Dorn (2015) and Pesendorfer (2015, 2016) have criticized that CMU is used to roll back ‘burdensome’ regulation offering tranquillity to financial market firms. Dorn (2015) argues that CMU is to a large extend a return to pre-crisis thinking without considering the fundamental alternatives that would have been possible to create ‘safer’ products, governance and market architectures. CMU is ‘a proactive, wide, collaborative programme’ that the Commission has presented to the industry to widen regulation-industry relations and wide-ranging ‘public-private cooperation in rewriting the rulebook’ for finance (ibid.). Ertürk (2015) criticized that the CMU agenda is trying to copy the U.S. market structure and capital market governance in a too simplistic way, but it would be much preferable to learn lessons from the U.S. experience. Capital markets would need to be designed differently to favor sustainable growth and employment over managerial enrichment and market bubbles. Stiglitz et al. (2019: 88) also described the CMU as ‘a move in the wrong direction’. The flawed system of securitization is still reliant on rating agencies being paid by the issuer instead of the buyer of securities which creates ‘an incentive to provide a good rating’. They also oppose the idea to increase lending to small businesses by promoting securitization as ‘securitization of small business loans is even more difficult than securitization of mortgages’. Here they identify a lack of ‘incentives to assess who is a good borrower, and a strong incentive to pass bad loans onto others.’ Traditional banking is better suited to understand the localized information from SMEs and it would therefore be much better ‘to strengthen well-regulated local banks, with assistance possibly provided through partial loan guarantees’. A public new development bank could provide additional funding. The IMF, in the past decades always supportive of deeper capital markets integration in Europe (c.f. Decressin et al. 2007; Enoch et al. 2014), also commented on the progress: ‘Capital markets in Europe remain frag-

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mented, impeding cross-border private sector risk sharing. Relatively technical actions would advance the CMU. For example, centralized reporting requirements for companies would improve transparency, while minimum standards on insolvency regimes and simplified procedures for reclaiming withholding taxes would reduce cross-border investments’ costs’. The IMF also called on the new Commission to remain committed to a deep CMU (IMF 2019b).

5.4   The Limits of Sound Securitization in Finance-­ Driven Capitalism The packaging of loans into securities and their sale to investors is known as securitization. It goes back to the 1970s when the secondary market for home mortgages was developed to free up the savings and loan industry in the U.S. from regulatory constraints. Designed to allow banks to transfer risk related to their traditional banking activities to investors, including other banks, insurance companies, or asset managers from hedge funds and the like, this practice allowed financial institutions to become extremely leveraged and financial market participants to engage in excessive speculation. Securitization has risen dramatically into a key capital market financing in the past decades until the GFC. Since then, it became widely known that regulated financial institutions used extensively ‘off balance sheet’ vehicles to finance debt and widespread abuse became evident. With increasing market demand securitization no longer just included well diversified risk based on first class securitized asset quality, but fraudulent practices led to the famous NINJA (no income—no job—no assets) loans that became securitized and then ‘diversified’ in highly opaque synthetic financial products created by financial engineering. With the endorsement from rating agencies paid by the issuer of those products the market flourished and supported reckless behavior. Abbreviations such as ABS for asset-backed securities or MBS for mortgage-backed securities became familiar terms even for non-experts that stood for internationally issued and traded debt securities. Structured-investment vehicles, also called special purpose vehicles or entities, were another underregulated innovation compared to other investment pools that became abused by financial ­institutions aiming to maximize their profits at the expense of financial stability. The underlying problems are linked to the opaqueness created with an ever-larger shadow banking system and an accounting practice in the

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regulated sector that has become wide open for manipulation. The impact of securitization on financial instability leading to the crash has been acknowledged by regulators. In Europe as well as in the U.S., the market for these toxic products as well as their reputation collapsed and securitization markets remained subdued, showing only slow recovery in a new regulatory environment in which securitization became linked with capital requirement standards. Investor confidence not only shrunk because of the losses during the crisis years; a high number of lawsuits and regulatory changes also had an impact. In 2007, the European securitization market had a volume of about €595 billion, that shrank to €214 billion in 2015 (Schwarcz 2018: 485). At its peak in 2008, securitization stood at about €813 billion before dropping to €177 billion which was the lowest point in a decade in 2013. In 2018, securitization was up and reached €269 billion, which would already be above the pre-crisis average for the period 1996–2007 (Teffer 2019). The effects of the shrinking after the GFC on European markets were uneven with stronger effects on the less developed markets (Bavoso 2017). Andenas and Deipenbrock (2016: 1) stated that there would be rising ‘doubt whether market players, regulators and supervisors have sustainably learned their lessons from recent crisis scenarios’ and mention explicitly securitization as an example where those actors failed to fully understand the underlying financial stability risks. Financial industry lamented that European securitization had a ‘historically strong performance’ and that ‘the sector’s public reputation’ would be rather unfair and that somehow caused the European securitization market to dry up after 2008 (Hopkin 2019). The Commission announced in 2015 an initiative to revive securitization by introducing a framework for trusted securitization. ‘Sound’ or as it became termed ‘simple, transparent, and standardized’ (STS) securitization has become a centrepiece of CMU. Calls for ‘sound securitization’ had already earlier been made after the Enron collapse. The new idea does not replace securitization with only STS securitization but tries to create an additional market via incentives in form of lower preferential capital requirements. The Bank of England and European Central Bank had pushed to invigorate the EU securitization market and published a short joint paper on the impact of the securitization market in Europe (BoE & ECB 2014a), followed by a more detailed ‘discussion paper’ (BoE & ECB 2014b) ­presented to stakeholders for feedback and then the responses (BoE & ECB 2014c) and a ‘synthesis of responses’ (ECB 2014). Central banks gave moreover a boost to securitization with their QE measures (Héant

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et al. 2017: 406). The European Commission released in the following year its own consultation on ‘an EU framework for simple, transparent and standardised securitisation’ (EC 2015c). The Commission regards the revival of high-quality securitization as key to transform Europe’s financial system towards the desired capital-markets orientation and has praised securitization for its benefits for the entire economy including SMEs. The SME claim has been widely dissented by CMU supporters and critics (c.f. Héant et al. 2017; Pesendorfer 2015, 2016; Schwarcz 2018). Héant et al. (2017: 417) conclude: ‘For very small companies, proximity with a banker and exchange of information on an ongoing basis have advantages that securitization cannot provide. Furthermore, middle market loans are quasi-­illiquid, meaning that they can rarely be sold on a secondary market.’ According to Schwarcz (2018: 489), the EU regulatory responses are largely identical to the U.S. reforms and can be distinguished along ‘five categories: increasing disclosure, requiring risk retention, reforming rating agencies, imposing capital requirements, and requiring certain due diligence’. Remaining problems concerning the regulation of rating agencies and capital requirements were already discussed earlier in Chap. 2. Within the core CMU agenda, the Commission followed up on its public consultation with a revision of the Capital Requirement and Regulation 2017/2402 on Securitisation, in force since January 2018 and rules applying since January 2019, and adopted in 2019 two implementing and delegated acts on Regulation 2017/2402. The Securitisation Regulation, aiming at deeper integration via harmonization and consolidation and updating of the previous patchwork of legislation governing the EU’s securitization, mandated the EBA to develop in close cooperation with ESMA and EIOPA guidelines and recommendations on the harmonized interpretation and application of the criteria related to STS securitization. Following public consultations with limited contributions from industry, EBA published the final guidelines in December 2018 and these guidelines entered into force in 2019. In March 2019, a first securitization product meeting the new STS criteria was submitted to ESMA for notification, raising concerns whether ‘the Commission overestimated the market demand for STS securitization’; however, the Commission explained the slow start with markets awaiting implementation rules (Teffer 2019). Securitization has become a major strategy to restore bank profitability as it has been advocated as ‘the most effective way for banks to sell the bulk of their’ non-performing loans and exposures (Bruno et al. 2018: 157). It is also one of the areas where industry and academics have repeatedly

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warned that the post-crisis framework constitutes overregulation and that capital requirements should be relaxed for STS securitizations (c.f. Kastelein 2018: 483). Hopkin (2019), from the Association for Financial Markets in Europe, reminded ‘Europe’s policymakers’ to ‘renew their vows’ by adopting further reforms for a thriving future of securitization.

5.5   Short-Termism and CMU The original plan for a CMU outlined in 2015 was not very ambitious with regard to long-termism and sustainable finance, although Commissioner Hill presented CMU early ‘as an instrument of sustainable growth’ (Hill 2015b) and a program that would make ‘finance serving the economy’ (Hill 2014). The Action Plan (EC 2015a) only listed two areas of action. One was a revision of Solvency II ‘to better reflect the true risk of infrastructure investment’ combined with reviewing the treatment of such investment under the CRR and a commitment to ‘assess the cumulative impact of previous regulatory reforms to ensure coherence and consistency’ in line with the better regulation guidelines. The 2015 Action Plan lacked an acknowledgment that contemporary finance is a major factor for short-termism and the idea to use ‘finance to deliver environmental sustainability’ reflected a strong trust in voluntary guidelines from industry and aimed only for some monitoring activities. Sustainability language was more used in meaningless references to a commitment to ‘sustainable growth. Since then, sustainable finance got much more attention in the EU’s agenda for a CMU in line with the broader work by the European institutions in this area (see Sect. 3.4). The EU has taken various measures over recent years to address the problems related to short-termism in financial markets and it affects the short-term orientation of firms. A revised Shareholder Rights Directive (SRD II) (Directive (EU) 2017/828) aimed to encourage shareholder engagement in EU listed companies in order to influence decisions in a way that they protect the long-term stability of the company. For a more sustainable finance the incorporation of ESG principles (see Sects. 2.4 and 3.4) is considered through an amendment or a delegated act in a number of directives (UCITS, Solvency II, AIFMD, MiFID II, Insurance Distribution) to provide a coherent framework for sustainable investment. The Commission has started a process to develop a taxonomy to define ESG in a process that is still ongoing and expected to last a couple of years.

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The Commission’s ‘Action Plan: Financing Sustainable Growth’ (EC 2018c: 3) acknowledged that financial markets are still reproducing pressures on financial market participants to take measures that maximize profits in a short-term period and that these pressures conflict with long-term orientation required to meet environmental and social goals. The Commission (ibid.: 4) indicated that ‘increased transparency’ would be the desired regulatory response, expecting this would result in ‘better informed and more responsible investment decisions’ by corporations and investors. The Commission also accepted that corporate governance has become focused on short-term financial performance and that the ‘interactions between capital market pressures and corporate initiatives may lead to unnecessary exposure in the long-term to sustainability risks.’ The Commission announced consultations ‘to analyse this issue more closely’ (ibid.: 10). It mandated the ESAs to collect evidence of ‘undue short-term pressure from capital markets on corporations’ and to consider measures on the basis of the evidence collected. As part of this mandate and its work on sustainable finance, ESMA launched in June 2019 a five-weeks public consultation on short-termism in financial markets to gain evidence from market participants on potential short-term pressures on firms. ESMA will produce its report on the results of this consultation by December 2019. For the consultation, ESMA suggested six areas for feedback, including investment strategy and investment horizon, disclosure of ESG factors (based on the Non-Financial Reporting Directive that requires large EU companies to disclose information on matters such as environment, social and employee issues, human rights, anti-corruption, bribery), the role of fair value in better investment decision-making compared to ‘mark-to-­ market’ valuation, institutional investors’ engagement and how they monitor long-term value maximization, remuneration of fund managers and corporate executives, and use of CDS by investment funds. ESMA (2019b) emphasized in its ‘explanatory note’ that ‘ESMA is not claiming there is a causal relationship between the abovementioned areas and short-termism; it is rather seeking the views of stakeholders on these areas in order to better understand their interaction with short-termism.’ In an earlier ESMA consultation on integrating sustainability risks and factors in MiFID II (ESMA 2019c), the WWF (2019) criticized that ESMA is advocating a ‘principle-base approach’ and reluctant to use a more prescriptive approach and suggested that ESMA should develop much clearer and stronger guidelines setting out clear steps how to incorporate ESG and reduce risks of non-compliance. The WWF was also criti-

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cal about the market practices in designing ESG metrics and applying them as they would not properly integrate impacts. Finance Watch (2019) criticized that the EU’s approach only focuses on ESG and sustainability risks for finance but not on risks related to unsustainable economic activities and that absence of risks for an investment can still transfer into risks for society. A better approach would be ‘to classify all economic activities as green or non-green’. Finance Watch also criticized that asking the private sector about their compliance costs is misguided in that area where it is clear that a stronger incorporation of sustainability into investment decisions would be highly beneficial to society. The NGO highlighted that such benefits cannot and should not be monetized and that the improvement in the net societal welfare would be clear. Industry associations were warning against ‘narrow and prescriptive requirements’ to allow for different business practices to continue evolving and to avoid negative impacts on innovation (c.f. AFME 2019). AFME also warned that a too rigid definition of ESG principles would limit sustainable investment to a rather small number of ‘pure products that fall under the label ‘green’ or ‘sustainable’. Any definition of ESG should take into account current business practices and ‘not constitute an exhaustive and exclusive classification system for sustainable development’. Any regulatory change in MiFID II should be proportionate and not give ESG factors higher weight than other factors and risks such as liquidity, credit and market. Compliance costs need to be seriously considered and to keep them reasonable change should be introduced gradually (ibid.). The alternative investment management association (AIMA 2019) warned also about ‘radical change’ and an imposition of ‘an artificial or inefficient regulatory framework’ but welcomed ESMA’s ‘proportional approach’. AIMA also warned about any negative consequences for innovation or of creating ‘regulatory inconsistencies’. There would also be limitations for including ESG because of data limitations and a ‘flexible definition of sustainability’ would be key. The German Banking Association (Bankenverband 2019) was concerned about the lack of legal definitions of sustainability risks and factors and the existing fragmented legal framework that would raise issues from ‘a “better regulation” and implementation perspective’. Any amendments to MiFID II should be linked to the scheduled review and any requirements should not ‘bee too detailed at this stage’. The French Bank Federation (Fédération Bancaire Française 2019) saw ‘a risk of green washing in ­marketing ESG products’ but welcomed ESMA’s approach. The federation emphasized that the industry has been highly challenged by the over-

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all requirements to implement MiFID II and there are still many issues that need to be resolved to improve interpretation or implementation. ‘Any additional new obligations—which the industry could not have anticipated—may impair the implementation work already completed’, the federation warned. The process of defining ESG in Europe would not be finalized before the end of 2022 at the earliest. The ESMA (2019d) consultation on integrating sustainability risks and factors in the UCITS Directive and AIFMD raised similar arguments and issues. Out of 66 contributions to the MiFID consultation, only two came from NGOs, one specialized on environment, the other on finance; one contribution came from an individual highly opposed to incorporating ESG, the rest of the contributions came from industry. The UCITS and AIFMD consultation had one NGO contribution (Finance Watch), one trade union, one individual, and 51 responses from business sector representatives. Overall the consultations gave industry an opportunity to raise concerns about a number of technical details and to highlight the main concerns about too intrusive regulation that would change already existing business practices and negatively affect innovation, too much priority to ESG compared to other risks and significant costs for implementation. The issues raised are ongoing issues in the sustainable finance debate and there has been little coming forward so far from the European Commission or the ESAs that would indicate any radical shift in approaching unsustainability in finance and society in a more ambitious way. The core of the approach is to leave developments to markets and only change information available for market participants that can or cannot then take the more ethical decisions.

5.6   Capital Markets Union and Brexit: Are There Only Lose-Lose Solutions and What Is at Stake for the EU’s Financial System? It goes without saying that uncertainty and times of crises and fundamental change pose not only risks but also enormous opportunities to economies and their societies. Economic actors and foremost financial institutions specialize on their exploitation. Markets like in any other situation produce winners and losers, although maybe many more losers in turbulent times. After the UK government submitted officially its Article 50 withdrawal notification to the European Commission on 29 March 2017, it

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emphasized repeatedly that it could walk away from a bad deal and that the UK would prosper under any scenario, while European Council President Donald Tusk (2017) stated clearly for the EU-27 that there is no winner in the UK leaving the EU and that the process would be about damage control, expressing the broadly shared view among experts on financial and economic integration that disintegration must necessarily result in loss of wealth. One could argue that the Commission held on to its agenda on creating a deeper CMU in the spirit of minimizing economic costs despite some early concerns by commentators that Brexit might have killed or at least delayed CMU, while others suggested that Brexit would require CMU to go global and not just rely on London but also on New York, Singapore and other financial centers outside Europe (Bowman 2016). Some have even argued that CMU could benefit from Brexit (Price 2016), while others in the UK described CMU without the UK’s strong involvement as doomed (James 2018). Moloney (2018: 86) doubted that the CMU agenda would ‘lose significant traction’ given that it ‘has not experienced significant political contestation.’ The CMU Action Plan was very much based on the idea that European companies could easily ‘tap a ready capital market at their doorstep: the City of London’ (Reza 2017). The CMU agenda was expected to be foremost beneficial to the UK with its most developed capital markets while also providing all other member states economic advantages from cost reductions and efficiency gains. Especially, the UK had pushed for such a reform agenda and it was not just highly symbolic when a UK representative, Lord Jonathan Hill, got in the Juncker Commission the responsibility for financial markets and his title was extended to ‘Commissioner for Financial Stability, Financial Services and Capital Markets Union’. This reflected the ambitious brand new portfolio for completing the Single Market for financial services and the promise to address post-crisis overregulation either directly or via compensating higher costs for compliance by the creation of attractive new markets. British finance, the UK’s government and parliament welcomed the announcement of CMU and great benefits were expected for the country’s financial center. British actors emphasized that success would require strong input from the UK government and industry to drive this new deregulation and harmonization agenda and to give political support to industry-led priorities (House of Lords 2015). Now London and its capital market were suddenly removed ‘from the equation’ (Reza 2017) with Prime Minister Theresa May announcing in her Lancaster House speech that the UK would not just

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leave the EU but also the Single Market based on her claim that ‘both sides in the referendum campaign made it clear that a vote to leave the EU would be a vote to leave the single market’ (May 2017). The Commission responded since the UK’s Leave Referendum with clear indication that CMU has become even a higher priority and now even wanted to fast-­ track its CMU program. In the 2017 CMU mid-term review the Commission stated: ‘The departure of the United Kingdom from the Single Market reinforces the urgent need to further strengthen and integrate the EU capital market framework’ and ‘the need for further integration of supervision at EU level’ (EC 2017a: 8). To speed up progress, the Commission (EC 2018a: 13) called on EU-27 member states that ‘further development and deeper integration’ are necessary and that the legislative process needs to proceed quickly. Much of the academic literature on CMU and Brexit focuses on the legal and economic consequences, uncertainties, and challenges resulting from the British decision to leave the Single Market. Busch et al. (2018: 3) raised concern that recent political developments, including Brexit, could potentially rise to ‘an existential threat to the EU’ but the pressures could also ‘spark a new wave of European integration and reform within the EU27’. According to Ständer (2016), Brexit has raised three core questions: firstly, about ‘the future financial ties between the UK and the EU’; secondly, how ‘the UK’s exit process may affect the political support for the CMU’; and thirdly, what kind of institutional setup is best for financial markets integration. He asserted that Brexit constitutes ‘a lose-­ lose situation’ for the EU and the UK and ‘a huge setback for the objectives of the CMU’. Brexit consequences for Europe’s capital markets would ‘vary across different market segments’ but generally costs for trading would increase and efficiency would decrease (ibid.: 7). Moloney (2018: 94) also assumed that if the post-Brexit UK-EU trade in services relationship would reduce the level of access for EU-27 markets to UK finance, there would be a risk to lose access to the ‘UK’s risk-management capacity’ which would increase ‘EU liquidity risks’. Moloney (2018: 86) moreover expected that some member states in particular have an interest in keeping UK funding undisrupted and that it would moreover be important ‘to signal the openness of the EU-27 financial system’. Some commentators have argued that the EU would not be able to complete CMU without a special deal with the UK for financial services. For the IMF, Thomsen (2019) expects the emergence of ‘a multi-hub CMU inside the EU-27, with some activities concentrated in Frankfurt, others in Paris,

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and yet others in Dublin or Luxemburg’ and fears that this could lead to fragmentation with reduced market liquidity and higher transaction costs. Brexit could result in disruption in various network linkages. The EU-27 would have to upgrade its ‘capital market oversight capacities and infrastructure, to cope with a large-scale migration of activity out of London’. The EU-27 should encourage ‘diversification outside the EU’ and supervisory cooperation will be necessary between the EU-27 and the UK as a third country. De Guindos (2019), Vice-President of the ECB, expects that Brexit could lead to the emergence of ‘one or more financial centres’ in the EU-27, ‘possibly in competition with each other, or perhaps each specialising in certain areas’. CMU should support this process ‘by creating a framework that supports the emergence of an integrated financial market and avoids a return to a fragmentation of activities’. De Guindos calls ‘to develop macroprudential policies for the non-bank sector’ to counter the tendency of capital markets to undermine resilience and to create financial instability. In his view, this would necessarily require ‘more centralised supervision of financial markets’, something that was not achieved with recent reforms. Central bankers are obviously aware of the risks of rising importance and size of capital markets and their inadequate regulation and supervision. The possibility of Brexit might change the approach towards the institutional setup for the CMU. The UK as a member state was opposed to centralization of risk surveillance and market supervision or too much harmonization of regulation and centralization of enforcement powers. The Five Presidents’ Report (Juncker et al. 2015) had originally argued that a ‘single European capital market supervisor’ would be necessary for a true Single Market for capital. Increasing the powers of the ESMA was the logical consequence (see Ständer 2016: 11). Although the Commission has insisted that CMU would be even more important with more friction between the EU-27 and British financial markets but has not provided any public analysis on how Brexit would affect the future of European financial markets integration and CMU. Of course, this was a logical consequence of the EU-27 negotiation strategy dealing first with the withdrawal agreement, including a framework for the future relationship, and only allowing detailed trade negotiations about the future relationship (including trade in financial services) for once the UK is no longer an EU member state. Most certainly the Commission has a much more detailed analysis and strategy as part of the EU-27 preparations for no-deal Brexit as indicated by the transition periods for certain

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market activities. However, the EU-27 strategy so far is reflecting a calm agenda of attracting as much business as possible from London based on the general logic that a third country cannot enjoy the same benefits in terms of access as a member state. The ESMA has warned that the potentially ‘significant shift of entities and activities from the UK to the EU27’ has ‘triggered concerns about the risk of regulatory arbitrage between the EU27 Member States seeking to attract this business’ but supported competition between financial centers as long as the EU rulebook would ‘be consistently applied’ (Maijoor 2018a). The Bank of France and the French Financial Markets Authority (AMF) quickly created in September 2016 a one-stop shop allowing fast and simplified procedures for firms willing to relocate, while the government became more skeptical towards the idea of a financial transaction tax and promised labor market and other reforms to signal openness for business. In Germany proposals were made to relax strict labor laws suggesting that highly paid bankers would require less protection and financial firms would regard the existing laws as too inflexible. While France presented itself as the only EU-27 member state with a financial center in a city, namely in Paris, of similar attractiveness to London, Frankfurt highlighted to be home to the ECB, and both quickly provided information about local international schools, accommodation and other facilities for a comfortable life. Smaller financial centers such as Dublin or Amsterdam made their case with regulatory similarity and cultural and geographical closeness. Denmark and Sweden are two other countries beside Ireland and the Netherlands that have already a capital market above EU-28 average (New Financial 2016). Paris as the new home for the European Banking Authority gained an important boost and hosts a subsidiary of London’s major clearing house LCH. Germany was not just successful in attracting various UK-based banks to move business to Frankfurt but also created in recent years a successful hub for FinTech investment. In 2016, it was expected that Deutsche Börse could benefit from a merger with the London Stock Exchange (LSE) that was initiated before the Brexit vote (Ständer 2016: 10). Merger negotiations between these two important European stock exchanges occurred twice over the years before and had failed; the most recent third merger attempt collapsed in 2017, partly due to opposition in Germany. Some German politicians declared the merger immediately after the Brexit vote dead; German politicians and regulators then argued that if the merger goes ahead the company should not be based in London (Davies 2016). LSE Chief Executive David Schwimmer lamented about a ‘nationalistic focus on

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exchanges’ that has made mergers between major stock exchanges impossible. Relocations have been significant so far (see Sect. 4.6 and Wright et al. 2019) Overall, the result of relocations could lead to an emerging EU financial center that is not concentrated in one city but largely decentralized and compromised of Paris, Frankfurt and other cities, just like the City aims for a more decentralized financial structure within the UK. This could moreover be supported by the trend described by Wright et  al. (2019) that financial firms that already relocated have spread various activities across a number of EU-27 member states. Although UK financial firms have tried to delay relocations for as long as possible and the UK government has been downplaying the risk, the relocation drive has been supported by the strict stance of the ECB and member state central banks insisting on contingency plans and with regard to capital markets by ESMA decisions. In 2018, the British Chancellor tried to suggest that the possibility of a transition period would have stopped the need for immediate relocations, the ECB clearly stated that it is ‘not in a position to assume that such a transition period will be agreed upon’.1 British financial institutions have criticized the uncertainty caused by the delayed agreement on a withdrawal agreement and have in turn been criticized by EU regulators for not preparing enough for the worst-case scenario. Financial firms stated that the first quarter of 2018 would be the point of no return when contingency plans would have to be activated. However, in Spring 2019 financial firms stated that relocations will go ahead and even if Brexit would not happen, decisions would not be reversed at this late stage of planning. Yet it is still unclear how much jobs will shift from the UK to EU-27 financial centers. With the failure to agree on a withdrawal agreement and transition period quickly and the risen possibility of a disorderly chaotic withdrawal, more significant relocations have become more likely. Whatever the Brexit outcome, the UK-based financial industry had passed the point of securing its former position and damage is already done. Even with a withdrawal agreement and a transition period or in the case of a last minute Remain decision, uncertainty about the future relationship of the UK with the EU or just political instability would endure that could lead to relocations into countries least likely to leave the EU. The IMF (2019c) has warned that relocations of financial firms could lead to a sharp increase 1  See the ECB’s relocation guidance, https://www.bankingsupervision.europa.eu/banking/relocating/html/index.en.html.

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in demands on supervisory authorities in EU member states such as France and that they would need the resources to be able to fulfil their tasks and not to increase risks to the financial sector. The EU institutions or any of the remaining EU-27 member states have not used Brexit or CMU to push for more ambitious financial reforms aiming at downsizing finance and especially its highly problematic areas in contemporary capital markets. Quite contrary, EU-27 member states have either started a competitive game about winning the biggest share of business or stayed neutral, while the UK’s strategy to mobilize or split them to protect a ‘shared interest’ of avoiding more fragmentation and higher costs for finance post-Brexit failed miserably. However, at some point in the future relocations will be settled and one can expect that in the future Germany and France will become strong supporters of the industry’s special interests. It will then be crucial whether they push for more centralization or develop along a joint strategy in order to establish a truly global EU financial center. The existence of such a political long-term goal cannot be neglected given the relevance of regional financial centers for prosperity and the risks of reliance on an offshore financial center that insists on regulatory autonomy and to which regulators have no direct access to intervene if things go wrong. Once the UK has left the EU and the future relationship becomes clear, the EU will have to develop a much clearer strategy and would not be wise after the GFC and Eurozone crisis to forget the lessons of financial crises. The EU should then develop a more radical, ambitious financial sector model that systematically identifies socially harmful structures, products, and activities and then addresses them accordingly. The current CMU agenda is not just ignoring serious problems but also includes an agenda to push deregulation that can only result in increased financial instability. Measures that have been perceived as key in transforming and reembeddying finance into the real economy, such as structural reforms of banking, a Financial Transaction Tax and a role for the Precautionary Principle in finance, should be revived (Pesendorfer 2014). A future EU financial center should be operating on a solid, resilient and sustainable basis. CMU including its latest Action Plan on Financing Sustainable Growth are insufficiently oriented towards such an agenda and need reform. Signs for such a change are hard to see anywhere today. The CMU agenda also includes a strong commitment to financial innovation. The Commission has repeatedly stated its expectation that FinTech would offer enormous opportunities (c.f. EC 2017d) and released in

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March 2018 its FinTech Action Plan (EC 2018h). It is very likely if Brexit goes ahead, that this will become a major area of regulatory competition between the UK and the EU. The Commission has raised concerns about cybersecurity in relation to FinTech too.

5.7   What Would Be a Resilient and Sustainable CMU? As Busch et al. (2018: 4) have highlighted, ‘financial stability is not the primary driver’ for CMU; its major focus is on redesigning the role of finance for the entire European economy and it is ‘part of a broader long-­ term agenda for structural change in Europe’. Unfortunately, it is not just an agenda for structural change; it is also an agenda that enhances financial instability. Braun and Hübner (2018: 130) have described CMU as ‘a financial fix for the fiscal fault of the European regulatory state’ and as an expansion of the European regulatory state ‘into the field of macroeconomic stabilization’ which results from preferences of financial market actors and the constraints of European institutions ‘which put a grand fiscal bargain well out of reach’. CMU, they argue, is moreover a clear case of ‘state-led financialization’ and the alternative to it is clear: ‘a stronger fiscal capacity for macroeconomic stabilization at the supranational level’. The alternative would also include less reliance on ‘risk-averse, short term-­ oriented private investors to allocate capital’ and more use of public development banks and public wealth funds (ibid.: 132). This chapter has shown that the CMU—despite its merits and potential benefits—is foremost a failure to seize the opportunity to transform finance into a more resilient and more sustainable system. There is nothing wrong with the goal of European capital markets integration as such as European integration will need deeper capital markets for medium and long-term financing. There is little support that an entirely decentralized, fragmented system would be superior regarding resilience and sustainability and especially in a currency union more integration of sound market structures and activities is necessary. There is also little that speaks against the idea of sharing risk across the continent if the EU should be based on solidarity. However, CMU goes in a wrong direction by pushing towards much more capital markets-based funding for European companies instead of improving relationship banking. A push in that direction further undermines more traditional banking models and drives banks towards more concentration and

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more engagement in capital markets. The overall market structure becomes more centralized and concentrated with the CMU agenda. The recent developments towards a more decentralized financial structure resulting from Brexit-related relocations of financial firms (see above Sect. 4.6) should not just be used to create a highly competitive network of European financial center that compete for more concentration in particular markets, instead of developing a more cooperative mode of operation. The opportunity would be there to intervene more actively into market structures and aim for smaller firms with sound and sustainable business models that are not TBTF and easier to cope with if they fail. Policies that encourage cross-border activities would foremost be important for Europe of the Regions. The development and underdevelopment of regions should however not be left to capital markets and investor decisions but needs to be addressed within a Transfer Union. Investment for addressing economic imbalances would need to be radically transformed to allow real cohesion throughout the EU.  The approach to CMU has to take into account the consequences of certain market structures and activities on the varieties of capitalism in Europe, on companies and their short- and long-term behavior based on the overall incentives, and their consequences on unsustainable economic and social structures. The EU’s adaptation of sustainability language into its CMU agenda reflects a limited and inadequate approach that does not address the problematic issues in contemporary capital markets as identified in the earlier section on the flawed arguments behind and negative aspects of CMU.  The Commission has linked its CMU agenda with the long-term investment, sustainable finance, measures against short-termism and claimed that it would facilitate ‘the transition to a low-carbon, more resource-efficient economy’ (EC 2017d: 2). However, short-termism and unsustainability are enshrined deeply in the current finance-led capitalist system with its oversized shadow banking system and breaking it up requires a much more interventionist strategy than providing some soft incentives for market actors to redirect their behavior in a more ethical way. Giandomenico Majone (2009) has described the functioning of the EU ‘on the basis of a few operational principles’ with the most important of these principles providing integration ‘priority over other competing values, including democracy’. In the case of finance, one could argue that under a neoliberal paradigm financial integration and increasing the power of finance has taken priority over democracy and financial stability. Since the 1980s, the power of finance in Europe increased signifi-

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cantly and this was largely due to the increased role of capital markets. The CMU agenda is now aiming for much larger capital markets but the agenda also includes sustainable finance with various ideas to shift the focus of market participants from short-termism towards long-term orientation. Kalypso Nicolaïdis (2018) made the case to replace the EU’s typical response to challenges including in the area of EMU with ‘sustainable integration’. ‘If in Europe and beyond’, she writes (ibid.: 213), ‘we are plagued by short-­termism—governments acting under emergency powers, markets wedded to short-term returns—what better way to justify anew the process of European integration than to proclaim loud and clear the EU’s commitment to long-term goals irrespective of short-term expediency.’ The EU would be perfectly suited to replace short-termism for long-term goals as this is more compatible with its role as a peace project. The EU should become ‘the guardian for the long term’. Instead of aiming for faster or deeper integration, the EU should aim for fairer integration (ibid.). Such a vision would be more based on heterogeneity of national political arrangements than on ‘ever more centralisation’ (ibid.: 214). She states that financial integration would still be ‘desirable in the long term to share risks and spread resources across Europe’, however, ‘this does not mean that the EU needs to radically centralise its fiscal, regulatory and supervisory functions.’ For the foreseeable future, ‘minimum integration’ would be sufficient to stabilize the common currency (ibid.: 218). For the CMU that would mean in first instance a much more ambitious orientation towards sustainable finance with much less securitization, derivatives, and shadow banking. However, current financial markets integration policies of the EU drive exactly those markets to return to pre-crisis levels and maybe beyond. Sustainable finance needs to become the core not the expanded niche market and states would have to take again a more active role in steering investment not via limited public resources that are enhanced with capital from the markets. Capital markets need to be limited to certain provisions of funding, they should not replace a bank-based system that has already been transformed way too far towards capital markets and shadow banking. It is time to start addressing the unfair ­competition between banks and shadow banking; however, as the next chapter will discuss, the European Banking Union goes into the opposite direction.

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CHAPTER 6

Finishing the Banking Union

‘At present, Europe is the “low pressure” zone in the world economy, posting low growth and high global and youth unemployment. By itself BU will not solve the challenges of the real economy; but it is an opportunity not only to improve the resilience of European finance but also to think and to act together for the long term, in a period of quasi-general myopia. BU is much more than a purely technical project, much more than the addition of integrated supervision, resolution and deposit insurance. It is one of the few political economy perspectives that we have in common today.’ Christian de Boissieu (2017: 102f.)

A Banking Union (BU) consisting of common regulation and supervision of the European banking sector was a centerpiece of the EMU that was missing in its original design, although proposed by the Delors Commission in 1989, due to resistance from member states to give up control over banks operating in their jurisdiction and advantages that system still provided at that time (James 2012; Gren et al. 2015). According to Barrett (2019: 11f.) it was in particular ‘the rock-solid opposition from then Bundesbank President Hans Tietmeyer’ that mattered most. Tietmeyer feared that regulatory and supervisory powers for the ECB would signal to banks that they could expect bailouts. Potential bank solvency problems were therefore left to national treasuries. It was also reasoned that such centralization would not be essential as long as the ECB does not have © The Author(s) 2020 D. Pesendorfer, Financial Markets (Dis)Integration in a Post-Brexit EU, https://doi.org/10.1007/978-3-030-36052-8_6

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lender-of-last-resort powers requiring it to provide emergency liquidity to stabilize financial markets but as soon as it would take on such a role, regulation and supervision could no longer be left to national central banks and competent authorities. Folkerts-Landau and Garber (1992: 103) argued that the ‘narrow ECB’ design forming ‘the centrepiece of EMU’ could only be sustained if the EU keeps a ‘predominately bank-­ intermediated financial system avoiding any significant degree of liquid, securitized markets, including markets for short-term corporate obligations, bank liabilities, repurchase agreements, derivative instruments, and equity products’. If, however, markets would develop in that direction (as they clearly did), the ECB would need a LOLR function with broad supervisory and regulatory responsibilities. Financial globalization and market integration have increased the costs of ‘banking nationalism’ that had dominated until recently in Europe while the costs of international economic exchange fell (Epstein and Rhodes 2016). One could argue that it was only a matter of time before the increase in cross-border activities would lead to problems that force countries to create new institutions and adopt new rules to address the issues around Single Market-wide supervision and regulation. There was a ‘logic behind a move to supranational supervision’, as Howarth and Quaglia (2016: 113) put it, as ‘national control of large (‘systemically important’) cross-border banks was bound to be sub-optimal’, yet there were also ‘significant differences in internationalization patterns in national banking systems’ and national banking systems were still very much dominated by national banks that captured their national regulators and supervisors. Because of these structural reasons, politicians put the topics into the long-term future before the GFC, while regulators pretended to have everything under control (Castañeda et al. 2016: xv). It took an existential crisis of the EMU to introduce more ambitious reforms. The GFC sparked fears about capital flight from countries such as Ireland that would have put banks in various other member states under severe stress with the possibility of bank runs quickly spreading and affecting the entire European banking system. The EU responded to that threat by amending in 2009 the deposit guarantee schemes (DGS) directive (DGSD) (Directive 2009/14/EC amending Directive 94/19/ EC) and increased the protection level of deposits first to a minimum of €50,000, before introducing a uniform level of €100,000 by the end of 2010. Forced to further action by the escalating Eurozone crisis including costly bank bailouts, the European Council (2012) described the problem of reinforcing crises in the areas of sovereign debt and banking (­ economists

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added macroeconomic imbalances) as a ‘vicious circle’ that must be broken by establishing ‘an effective single supervisory mechanism’ and allowing the European Stability Mechanism (ESM) ‘to recapitalize banks directly’ in order not just to survive but to allow the EU as a whole to emerge even stronger from the currency crisis. The Council agreed on 28 June 2012 to create a ‘genuine’ EMU based on an integrated financial framework. In December 2012, the President of the European Council together with the presidents of the European Commission, the ECB and the Eurogroup presented a ‘roadmap’ for a genuine EMU which included the creation of an integrated financial framework that became the European Banking Union (EBU). While southern member states, foremost Spain back then awaiting financial support to recapitalize its banking sector, unsuccessfully advocated the immediate introduction of Euro bonds to reduce pressures on their economies straightaway, several northern member states, led by Germany, pushed for the centralisation of European supervision and for stricter economic governance control mechanisms. German conservatives insisted that Euro bonds could only be introduced at the end of a longer reform towards a real banking union. It is the success of such demands that led to a dominant narrative that the EBU reflects foremost German design proposals (Donnelly 2018a, see also Howarth and Quaglia 2016 on different national positions to different elements of the EBU throughout the negotiating phase). The idea of a banking union had already been discussed among economists before the crisis and with the emerging Eurozone crisis eminent economists demanded a banking union as an adequate response that would take off the market pressures from the most troubled member states (Beck 2012). However, only the threat of a collapsing currency union, or at least a dangerously escalating fiscal crisis, gave broad political support to this step of further integration, since it had become clear that any piecemeal approach such as centralising supervision only and leaving bank resolution and recapitalisation to the member states would not provide a solution but create new, possibly even more serious problems (ibid.). In this situation, ‘the merits of a banking union’, as then German Finance Minister Wolfgang Schäuble (2013) put it, were ‘rarely disputed’ and appeared as the logical and next step forward. The Banking Union among the Eurozone member states—and open to the other Union member states who would like to join—is yet beside the CMU agenda the most significant change in capital and financial markets integration in the European Union since the introduction of the currency union. Véron

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(2018) describes the EBU ‘as the most structurally significant policy initiative of the whole decade of crisis’. The EBU has been affecting the entire Union as it had a relative positive and stabilising effect on Europe’s banking sector and the wider financial markets creating synergies between EMU, EBU, and CMU at a time in which the financial sector is inherently instable and many European banks continue struggling with low profitability and non-performing loans. Lessons from the GFC, the Eurozone crisis and the excesses and resource misallocation before the crisis have led to the identification of regulatory shortcomings, including too low capital requirements and off-­ balance sheet speculation, procyclicality in regulation, insufficient and poor supervision of banks, and weaknesses in national insolvency laws. In 2010, the decision was taken to improve the EU’s cross-border crisis-­ management framework by creating an EU financial stability fund and a resolution unit for failing banks. The Banking Union was then created with a Single Supervisory Mechanism (SSM) based on the SSM Framework Regulation (Regulation (EU) No 468/2014) as its first pillar and a Single Resolution Mechanism (SRM) run by a Single Resolution Board (SRB) adopted with the SRM Regulation (SRMR) (Regulation (EU) No. 806/2014) as its second pillar at its core and the Bank Recovery and Resolution Directive (BRRD) (Directive 2014/59/EU) that requires EU but also EEA member states to put in place regimes that allow early interventions for restructuring or orderly resolution of failing banks. The third pillar of the EBU is the European Deposit Insurance Scheme (EDIS), proposed by the Commission in 2015 but still not adopted. Lastra (2016: 109) stated that also a ‘fourth pillar’ was ‘missing, namely lender of last resort (LOLR) or emergency liquidity assistance (ELA)’. Although an Agreement on Emergency Liquidity Assistance was signed in June 2017, it has the features and weaknesses of the previous system criticized by Lastra. In a broader understanding the Banking Union also includes measures to strengthened bank capital and liquidity, to end too-big-to-fail, to make financial markets safer and more transparent, to reduce the reliance on credit ratings, to address the risks posed by shadow banking, and to prevent and punish market abuse. Solutions to these broader problems are much more controversial than common rules for bank supervision or bank resolution although the latter is always ‘a thorny issue’ as bailouts frequently require taxpayers’ money (Howarth and Quaglia 2016: 135). Within the Banking Union banks should finally ‘become European in life

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and death’ by changing the institutional structures of supervision and the incentives for member states, authorities and banks for risk taking. The ‘life and death’ metaphor goes back to Charles Goodhart’s (2010: 172) observation that systemically important financial institutions have become ‘international in life’ but ‘national in death’ and that bankruptcies of international financial institutions have resulted in the ‘worst complications and outcomes’. This has then led to the slogan to make European banks ‘European in life and death’ and later also to make ‘global banks global in life and death’ (Enria 2019). In short, the emergence of transnational bank structures has led to the need for deeper European financial market integration with more centralized supervision and regulation and also more international coordination with jurisdictions in which global systemically important banks (G-SIBs) and institutions (G-SIIs) are active and affect European markets (FSB 2018). This chapter starts with a discussion of why a Banking Union with common supervision and regulation and an orderly resolution regime for failing banks was needed before analyzing in more detail the design of the still unfinished EBU, its performance and contribution to deeper financial integration, and some ongoing reform issues and how they affect finance-­ led capitalism, before drawing an overall conclusion on the EBU’s contribution to stabilizing an unstable financial system.

6.1   The Need for a Banking Union and Orderly Resolution of Failing Banks European banks have for a long time been national banks protected within their nation states by their national regulators and supervisors who had a strong home bias. With financial globalization and financial integration especially since the 1990s European banks became highly active in global capital markets and within the Single Market cross-border mergers and acquisitions increased. Europe financial markets integration necessarily requires the development of a banking sector that no longer operates within national boundaries, be it in capital markets or in the more traditional banking activities. Complete European financial integration moreover requires common regulation and supervision for all banks in the Single Market including common resolution rules and practices for failing banks and burden-sharing in form of a common financial safety net to create a fair and competitive market. In short, an EBU requires common

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macro- and microprudential regulation and supervision in all times and effective, efficient, and fair crisis-management tools for bad times when things go wrong. In the U.S. a national banking system was created in 1863 and it took various banking crises and interventions to develop the regulatory and supervisory frameworks at the federal level. Even with this long history, a more ‘seamlessly integrated banking market’ only emerged after ‘the deregulation and reforms of the 1980s and 1990s’ (Schnabel and Véron 2018) and this integration did not make the U.S. banking sector more stable but more concentrated. At times the rules for banking were stricter: after the Wall Street Crash 1929 the famous Glass-Steagall Banking Act of 1933 separated commercial and investment banking which many have seen as reason for a period of stability in the U.S. banking sector. With the emergence of finance-led capitalism banking became riskier and the separation was already watered-down soon after its adaptation and then over the following decades before it was finally repealed with the passing of the Gramm-Leach-Bliley Act of 1999 that was designed to protect and increase U.S. banks’ leading global position and their competitiveness. As the U.S. developed a banking sector that became composed of numerous smaller banks, often operating at local or regional levels and causing little disturbance when going into bankruptcy, and a smaller number of very powerful world-leading banks that are country-wide as well as globally active, U.S. regulators experienced increasingly problems with too-big-to-fail (TBTF) banks. This new threat of moral hazard and instability caused questions about reorganizing orderly resolution and bankruptcy over the past decades and with the GFC those questions came high on the agenda, with the FSB and BIS since then discussing G-SIBs and G-SIIs and developing guidelines for their regulation. European countries have developed different banking structures and cultures over the past decades that persisted despite financial integration policies aiming at creating a Single Market for banking. Some countries were much less prepared for the liberalization and deregulation of their banking sector. For these and other reasons, a complete European-wide banking system has not emerged yet; most significantly retail banking has largely remained national and therefore fragmented, and the regulatory and supervisory structures have only recently been ‘Europeanized’ with the creation of an EBU. The ECB has not been designed as a lender-of-last-resort (Wyplosz 2012) and member states had rather different national regimes for banking supervision and regulation. When the EMU was created, regulators and other experts had expected that the combined forces of Single Market and

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c­ urrency union would unleash market forces for deeper economic integration in the banking industry and weaken banking nationalism that would then allow deeper financial integration. Since then a key hope was that market pressures would result in a high number of cross-country mergers to restructure the European banking industry. Many countries were simply too small markets and troubled with ‘overbanking’, meaning burdened by too many small banks with too many branches across the country to survive in a more competitive environment. National regulators remained protective of their banks and were supportive of financial innovation and the new business models banks had adopted with the ‘new finance’ and moved them from relationship banking to stronger involvement with the shadow banking system. Their prudential approach was blind towards the off-balance sheet activities banks had invented to circumvent rules. These new activities transformed banks into ‘flow monsters’ more engaged with betting than investing with increasing interconnectedness of the banking system with the shadow banking system (Lindo and Hanula-Bobbitt 2013). European banking became driven by the ideology that banks can permanently achieve returns on equity of 25% as Josef Ackermann, Deutsche Bank’s former chief executive, former chairman of the Institute of international Finance, and member of the influential Group of Thirty, propagated. Since the EMU was launched in 1992, a significant increase in mergers and acquisitions led to a reduction in the number of banks, resulting in much higher concentration and soft touch regulators believed in the claim that larger banks would become safer. New technologies, globalization, and deregulation forced European banks to restructure and consolidate and merger activities increasingly shifted from national towards a cross-border consolidation resulting in deeper financial integration in the European banking industry (Epstein and Rhodes 2016). Financial conglomeration was another industry trend. Increasingly different types of financial institutions such as banks, securities firms, and insurance companies merged into ‘large, and increasingly complex, financial institutions’ that raised questions about market transparency and how best to supervise these new mega-institutions (Faruqee 2007: 35f). These trends were similar in the U.S., in the UK as Europe’s leading financial center, and in the Eurozone and led to discussions whether more market concentration will create more stability or more instability in financial markets. The BIS (2001), the IMF (IMF 2001; Decressin et al. 2007), and the Group of Ten (2001) investigated the effects of bank concentration on financial (in) stability. The results of these reports were mixed. On the one hand there

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were concerns about a decrease in competition in a more concentrated market, an increase in market power of the largest financial institutions, less transparency, and more difficulties in disciplining mega-institutions. Concerns about TBTF remained controversial among experts. There was foremost an expectation of efficiency gains and enhanced stability resulting from diversification and better risk management in line with the dominant view of banking experts. The ‘concentration-stability theory’ showed ‘that banking systems characterized by a few large banks are more stable than less concentrated banking markets’, that larger banks are more diversified and that there would not be any ‘evidence that banking system concentration increases banking sector fragility’ (Beck et al. 2006: 213, see also Faruqee 2007). National regulators and politicians were moreover hopeful to create national champions that could in a next step become European champions that could gain a global position. There was little concern about the banking practices related to extreme speculation that came with Ackermann’s 25% return on equity business model that he championed with Deutsche Bank and which resulted in all the legal problems and scandals that bank has been facing over the last decade. In this climate of highly problematic market changes pressures for more financial integration policies increased. The Commission had raised concerns about the DGS directive in a review that than led to a stakeholder consultation resulting in a Communication in 2006. The review investigated whether the Directive was ‘still fit for purpose in light of the continuing trend towards financial integration and cross-border mergers between credit institutions’ (EC 2006: 2). The consultation identified obstacles for cross-border consolidation and competition concerns. The DGS varied significantly across member states with guarantee levels ‘ranging from just €14,481  in Latvia to €103,291  in Italy’ and the schemes were designed as ex post funded schemes, so not really designed as insurance against bank failures but more as levy on surviving firms to be collected after the event. Overall the DGS raised concerns how that system could work under crisis conditions, how the market is distorted by unfair advantages of banks operating under the schemes with lowest costs, and how consolidation under the European Company Statute might be affected. The Commission feared that this system ‘could ultimately prove very costly […] in a cross-border crisis situation’ (EC 2006: 3). The Commission therefore considered pragmatic steps that could be implemented in the short term without changing the DGS Directive but also legislative change as a way forward to catch up with financial market

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i­ntegration. However, the overall conclusion back than was that the more fundamental change would be rather costly ‘for a number of Member States’ banking sectors but with few apparent immediate benefits’ (ibid.: 11). The GFC and the start of the Eurozone crisis provided the shock and the cross-border crisis necessary to speed up the process and go directly to the legislative change option. However, the crisis also proved how costly this delayed action had become and that the earlier assumption about few immediate benefits was entirely wrong. The Eurozone and EMU simplified and accelerated financial transactions across the member states’ banking systems and reduced the costs for banks and customers. However, changes in European banking now also meant that ‘money could easily and quickly flow out of the banking system of a country in trouble’ making it harder for such countries’ banks to provide finance to businesses and households and therefore deepening and prolonging the economic downturn (Stiglitz et al. 2019: 88). The economic imbalances within the Eurozone led to a split between member states into those with a current account deficit and those with a surplus which resulted in the ‘deadly sovereign-bank embrace’ (ibid.: 89, Macchiarelli and Koutroumpis 2016) as banks from the surplus countries bought sovereign debt from the deficit countries. Moreover, such debt has been insured with credit default swaps (CDS) as an instrument that is designed to spread the risk of a sovereign bankruptcy. During the Eurozone crisis this problem became highly visible in the bailout discussions for the member states in trouble and how their failure to repay debt could affect big banks in France and Germany and the CDS markets which could then undermine financial stability in entire Europe causing enormous economic fallout. As an ECB working paper highlighted, a ‘credit-risk transfer’ from the private banking sector to the government had occurred as a result of the financial rescue packages for the banks with a ‘decrease in risk spreads for banks at the expense of a marked increase in risk spreads for governments’ (Ejsing and Lemke 2009). The authors of the paper called the rescue packages therefore the ‘Janus-headed salvation’. The European Commission started talking about the ‘vicious circle’ in 2012 after the Eurozone leaders highlighted in their Euro Area Summit Statement from 29 June 2012 the aim ‘to break the vicious circle between banks and sovereigns’, describing the dangerous problem of reinforcing crises resulting from the connection between sovereign debt and private debt of the banking sector. This circle starts with banks needing financial support by their national government after their engagement in extreme speculation or

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reckless lending had collapsed and left them with a huge amount of bad assets, which then weakens the fiscal position of the member state’s government and the country’s refinancing costs rise. Unsustainable sovereign debt levels then further weaken bank balance sheets as most of the sovereign debt is now held by national banks and the crisis deepens, with the circle starting again with banks needing additional support. Sovereign debt was largely seen as risk-free for the calculation of capital requirements before the GFC and Eurozone crisis; now it turned into a major source of financial instability. The vicious circle or bank-sovereign negative feedback loops identified by the Commission becomes even more complicated with the economic imbalances in the currency union and the limited economic policy measures member states can take. Member states in crisis can no longer devalue their currencies to regain competitiveness and are forced to consolidate their unsustainable budgets while finding ways to kick start an economic recovery. Instead of printing money or deficit spending to boost economic growth in a situation where the private sector is also highly indebted, states have to adopt structural reforms such as labor market flexibilization and austerity measures such as welfare spending cuts that impact negatively on private sector investment and reduce tax revenue while the state has to identify public assets for quick privatization. While the countries in crisis got stuck in this neoliberal austerity and structural adjustment program, the stronger member states such as Austria, France, Germany, and the Netherlands suddenly found themselves in the comfortable position to issue government bonds with negative interest rates, meaning investors pay these stronger states for the privilege of owning their sovereign debt as a relatively safe asset in an increasingly risky investment environment. A Fiscal Union creating a real Transfer Union would be necessary to counter these economic and social imbalances that undermine financial stability. It has also become clear with the Eurozone crisis that the EU had failed to provide a regulatory and supervisory system that would have been equipped with powers for early intervention and emergency action at a European level. National authorities were more interested in national financial stability than in cross-border consequences. What was now needed was a combination of market solutions and state interventions. The first consisted of banks trying to raise new capital in markets to recapitalize, bank restructuring, and burden sharing with creditors in form of bail-in. Market solutions are difficult during a financial crisis as the GFC when interbank lending collapsed because of a lack of trust caused by

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opaqueness and uncertainties about financial institutions’ risk exposures. During recovery, market solutions remain also constrained by uncertainties related to non-performing assets. States needed to provide support to the banking sector, to make fiscal adjustments to keep the trust of financial markets, to deal with failing and ailing banks and support bank restructuring, and to provide supranational support to member states in funding difficulties (Enoch et al. 2014: 16f.). That was the emergency agenda necessary to avoid a system collapse. Beyond these interventions there were two alternative options available: Member states could have remained in charge and bear themselves all the consequences of their actions under a modified Maastricht framework or alternatively member states would give up substantial national sovereignty and transfer powers to the EU level which would ultimately result in a Fiscal Union (Weidmann 2013). However, the first option only really works if banks are downsized and transformed back into their traditional role of intermediaries with a strong focus on the local and regional levels based on relationship banking as business model. Fiscal Union, Financial Union with EBU and CMU are now all on the agenda with each having their own obstacles to overcome in the complex European multi-level governance system and based on the different financial market structures and cultures across member states. When the European Monetary Union (EMU) was created, it was clear that most economists would have suggested a different approach of first creating a political union and then a monetary union which would have avoided the problems with decentralized regulation and supervision. However, in order to seize the historical opportunity then German Chancellor Helmut Kohl ignored warnings from the German central bank (Bundesbank) about the possible risks. With the Treaty of Maastricht criteria were formulated that should lead to fiscal discipline in the Eurozone countries without centralization of fiscal policies. Germany, representing the interests of the net-payer member states, then also took the leadership in incorporating a ‘no bailout clause’ into the Maastricht Treaty (now Article 125 of the TFEU). Since the Pringle case (Case C-370/12 Pringle) was decided by the ECJ in 2012, this clause lost whatever might have been the good intentions of its creators as the court ruled that member states could voluntarily agree on financial support for member states in need of financial assistance and this is exactly what member states did by using an intergovernmental agreement outside the Treaty for their action. This led to ongoing debates about how to guarantee sound government budgets and what would be necessary in the long term to enforce conditionality on

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countries receiving a bailout without the need to rely on the IMF’s expertise and funding. Since then various crisis interventions such as the ECB’s Outright Monetary Transactions program have led to legal controversy and led to cases in the German Federal Constitutional Court and the ECJ (Chiti 2019). Controversies about Italy’s budget in 2018–2019 showed difficulties in pressuring a large founding member state that is by many perceived as a sovereign TBTF. Overall, the need for a deepening the regulatory framework for banking supervision and regulation in Europe is a direct result of transformations in the banking industry, including a weakness of the insurance system within the banking industry based on securitization and diversification that has led to large off-balance sheet risk exposures. The literature in this field has highlighted the problems related to moral hazard and legacy problems, weaknesses in insolvency laws, no or limited ‘creative destruction’ (Schumpeter 1942) and the TBTF problem (Stern and Feldman 2004; Sorkin 2009). The TBTF literature identified in particular three problematic areas: firstly, these institutions receive quite significant subsidies simply because investors perceive them as TBTF and in case of failure these systemically important institutions are expected to receive taxpayer bailouts which incentivizes them to take on extreme risks; secondly, so-­ called ‘zombie banks’ might survive for a longer time and contribute to enormous social damage by increasing the fallout of a financial crisis; and thirdly, some countries’ financial sectors have become so large that they might be too-big-to-safe. Overall TBTF institutions would be too big to safe and too big to be resolved in an orderly fashion if things go wrong. In Europe a challenge emerged regarding questions about cross-border effects of failing banks and national versus European supervision and resolution powers. Overall the crises showed that Europe not just needs a BU that provides European-wide banking regulation and supervision and an integrated well-financed system of orderly resolution for failing banks but also measures to address the excesses of finance-led capitalism in the banking sector, the unfair competition with the non-bank financial institutions and the interlinkages between banks and the shadow banking system. This context raises issues about structural reforms of banks and the wider financial sector, financial innovation, and financial product regulation. The EBU does not go that far and has especially in combination with the CMU agenda led to a survival and strengthening of finance-led capitalism in its evolving European version.

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6.2   The Design of the European Banking Union Gregorio-Marino (2019) described the EBU as ‘a creature of the Euro area crisis’ and as ‘a two-sided construction, with a foot in the internal market and another one in the EMU.’ Given the EBU’s constitutional design Grundmann and Micklitz (2019: 2) argued that ‘the name of a ‘European Banking Union’ to some extend is preposterous’ as it ‘is only an increased ‘Eurozone’ integration of banking supervision, namely at the administrative level.’ Castañeda et al. (2016: 6) also doubted whether a common regulatory framework and a common regulator make a BU and found this definition ‘troublingly incomplete’ when compared to the ‘genuine’ BU within the UK where individuals have the ability ‘to borrow and lend where they wish and for banks to lend and borrow in any part of the UK they wish, without regulatory impediment or barriers to entry in any part of the country […] supply and demand can move freely across the nation’ (ibid.). A better description would be to see the EBU as ‘a device for simplifying and sharing the burden of the resolution of large banks’ or as ‘a step towards fiscal union, starting with the banking sector’ (ibid.: 7). Yet the EBU includes an agenda to achieve such a deeper BU via regulatory and supervisory interventions into markets. EMU has maybe therefore been described as the most significant change in financial markets integration in the European Union since the introduction of the currency union. Grundmann and Micklitz (2019: 1) have acknowledged that the EBU is now one of the few areas of full integration beside competition law and monetary policy but compared to these other two areas, which are enshrined in Treaty rules, the EBU ‘is ‘merely’ an EU secondary law construct’. There have been serious doubts among policymakers and observers about the possibility of creating a BU without time-consuming Treaty changes at the outset and its imperfections have largely been accredited to political compromises, including between Eurozone members and non-­ members, and Treaty constraints (Castañeda et al. 2016; Donnelly 2018a; Ferran 2015, Howarth and Quaglia 2016). With the escalation of the Euro crisis in 2012, mounting pressures on Spain and Italy and debates about a ‘Grexit’, the creation of a northern and a southern Euro or even the end of the currency union the deeper integration of financial markets and supervision became a solution to some and another threat in crises-­ driven Europe to others. Dangers of a ‘partial monetary union’ have already been discussed when the Euro was planned and critics of splitting member states along different economic performance always feared that

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this would permanently undermine convergence needed for successful financial integration (c.f. Hirst and Thompson 1996: 161). However, in April 2014, Michel Barnier, then Commissioner for Internal Market and Services, announced proudly: ‘We set up the banking union in record time. […] in less than two years we revolutionised the banking sector. We can now prevent, supervise and deal with crises together. We broke the vicious circle between sovereignty and banks, and now have banks that live and eventually die at a European level’ (Euractiv 2014). However, the EBU is still incomplete and the vicious circle has not yet been broken. In April 2012, then Commission President Barroso had proposed advancing financial and banking integration to overcome the crisis and prepare for the next. The presidents of the Council, the Commission, the Eurogroup and the ECB followed up with a short report ‘Towards a Genuine Economic and Monetary Union’ in which ‘an integrated financial framework’ with ‘two central elements’ was proposed: ‘single European banking supervision and a common deposit insurance and resolution framework’ (Van Rompuy et  al. 2012: 4). This new framework should allow for differentiated integration between euro and non-euro area member states in order to protect the functioning of the monetary union and the stability of the Eurozone. The Commission then in September 2012 put forth a proposal on regulatory changes for the supervisory architecture which was adopted in March 2013. The IMF (2012: 21) supported the development and stated in its World Economic Outlook that ‘[a]n integrated regulatory and supervisory structure—a banking union—is indispensable for the smooth functioning of integrated financial markets in the EMU’ and suggested ‘four pillars’ for this BU: ‘common supervision, harmonized regulation, a pan-European deposit guarantee scheme, and a pan-European resolution mechanism with common backstops’, highlighting that especially the last two ‘building blocks’ would be ‘critical’. The Single Supervisory Mechanism (SSM), operational since November 2014, was since then described as the ‘first leg’ of the Banking Union. The ‘second leg’ of the reform, the Single Resolution Mechanism (SRM), was put forth in July 2013 and agreed on in March 2014. In November 2015, the Commission presented with the proposal for a European Deposit Insurance Scheme (EDIS) the third leg of the EBU. While the SSM has been established, the SRM is still incomplete and the European Deposit Insurance Scheme (EDIS), by many seen as ‘the cornerstone of any “real” banking union’ (Epstein and Rhodes 2016: 213)—has not yet been

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adopted and some doubt if it will ever be adopted (Grundmann and Micklitz 2019: 4). The EBU is widely acknowledged as enormous progress but with significant imperfections and as incomplete but a starting point that can potentially work (c.f. Busch and Ferrarini 2015; Castañeda et  al. 2016; Ferran 2015). There have also been warnings about shortcomings that could undermine the EBU and also ‘the ECB as the world’s first supranational bank supervisor’ (Gren et al. 2015: 197). It is therefore not surprising that the Commission, lawmakers, regulators, and scholars have put forward a range of reform proposals since the EBU came into existence to improve the unfinished project. EBU has also been described as ‘tremendous achievement’ born ‘under a more favourable constellation’ than CMU (Busch et al. 2018: 4). Firstly, there was higher pressure to introduce the EBU to counter the market pressures on the most exposed member states that had come close to collapse; secondly, EBU is affecting only one sector and banks were highly supportive of the project, although with some concerns about how risk sharing would affect different banks and how they would be able to avoid any unfair contributions. There was also more public pressure to make quick progress at least with the SSM and SRM as ailing and failing banks and bailout negotiations with member states made it into the headlines compared to the highly technical expert discourse on the CMU. The legislative framework of the SSM consists of Council Regulation (EU) No 1024/2013 conferring specific tasks on the ECB concerning policies relating to the prudential supervision of credit institutions and the SSM Framework Regulation (Regulation (EU) No 468/2014 of the ECB). As the IMF highlighted, this design largely follows the Basel ‘Core Principles for Effective Banking Supervision’ (BIS 2012) which recommends 13 principles that the IMF summarized: ‘(1) operational independence; (2) clarity of objectives and mandates; (3) legal protection of supervisors; (4) transparent processes, sound governance, and adequate resources; and (5) accountability’ (Enoch et al. 2014: 18). Under the SSM the ECB and the national supervisory authorities of the participating countries aim to guarantee and protect financial stability in the banking sector from a micro- and macroprudential perspective, to have a consistent approach to supervision among all jurisdictions participating, and to increase financial integration. The ECB is directly supervising 114 significant banks which account for about 82% of banking assets in the eurozone, ‘making the ECB one of the biggest banking supervisors in the

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world’ (Dombret 2015). All other credit institutions remain supervised by national supervisors and it is the ECBs role to assure a harmonized supervisory approach to all banks. This means, as Dombret (ibid.) emphasizes, that ‘national supervisors will have to take a more European perspective in supervising those banks which remain within their direct sphere of responsibility’. The ‘significant banks’ directly supervised by the ECB must meet certain criteria such as total assets value above €30  billion, economic importance, cross-border activities, or if a bank has requested or received funding from the European Stability Mechanism or the European Financial stability Facility. As the ECB would not have the staff and other resources for supervising all these banks, it is supported by Joint Supervisory Teams. Each team has a coordinator at the ECB, national sub-coordinators, and a team of experts. Each significant bank is supervised by such a team of staff from the ECB and national supervisors from several countries. These teams should over time establish a joint supervisory practice and allow learning across national borders without falling victim to banking nationalism or regulatory capture. It is therefore based on regular rotation and the various rules that should guarantee independence and no weakening of practices over time. This arrangement is the result of political resistance to give up supervisory powers to an EU institution entirely and fears that such an approach could have weakened supervision in countries with stricter rules and practices before EBU came into existence. Less significant banks are still supervised by their own national supervisors. However, in emergency situations the ECB can take over the supervision of banks in that category. The status of banks and whether they fall under the ‘significant’ or ‘less significant’ status is frequently reviewed. The SSM can also be joined by non-Eurozone EU member states under a ‘close cooperation’ arrangement with the ECB, if they meet the conditions laid out in Council Regulation (EU) No 1024/2013. However, close cooperation gives them only consultation and not voting rights in decision-making. The ECB (2014) laid out the procedures for entering and terminating ‘close cooperation’. This design feature has raised questions about the long-term effect on European financial integration as there is a risk of countries ‘outside of EBU becoming increasingly marginalized within the EU’ which might also have negative effects on the Single Market (Ferran 2014). Yet Ferran (ibid.) remained ‘cautiously optimistic’ that the EBU provides strong ‘procedures and safeguards to encourage participation in EBU and to protect the integrity of the Single Market’. The UK, worried about the emergence of a strong Euro block in the

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Single Market for finance and without any intention of ever joining the SSM, secured its interests with a reform of voting rights in the EBA (Howarth and Quaglia 2016: 106). The overall supervisory structure and decision-making in the EBU became complex as it is based on the ‘separation principle’ to keep monetary policy and banking supervision apart that banking supervisors do not have access to central bank liquidity. Such a separation is also called Chinese walls if it is as in the ECB’s case within one institution (Ioannidou 2012) and its main purpose is avoiding any conflicts of interest that can arise from different goals arising from protecting either monetary or financial stability. It is also complex because it involves 26 authorities from 19 countries and the ECB, the ECB’s Supervisory Board and the ECB’s Governing Council. As decision-making has also to take into account the interests of non-EBU-members it can even become more complex. Both the engagement with national central banks (NCBs) and with national competent authorities (NCAs) can lead to further conflicts (Rodriguez 2018: 80). Not surprisingly, it has been questioned whether this structure is too complex (Lautenschläger 2018), especially in situations where fast emergency action needs to be taken, and whether conflicts of interests within the ECB are unavoidable despite Chinese walls and what the long-­ term consequences would be (Ioannidou 2012). Needless to say that systems where central banks have been responsible for bank supervision and systems that provided supervision in separate authorities have failed to achieve sound supervision without getting captured by industry interests that led to ‘light touch’ supervision over time and unable to anticipate raising instability and major bank crises. Lautenschläger (2018) stays neutral on the question which system is preferable: ‘Time will tell whether this structure truly helps to avoid conflicts of interest between monetary policy and banking supervision or whether it might have been better to create an independent banking supervisor.’ The German Bundesbank had previously criticized the supervisory role of the ECB for ideological concerns about the purity of the central bank that should solely be responsible for price stability and demanded a clear separation of supervision and monetary policy, which would, however, have required corresponding changes in the EU Treaty. This plan has not been given up (interview Andreas Dombret, Bundesbank, in the Börsen-Zeitung, 28 January 2015; see also Howarth and Quaglia 2016: 98f.). Whatever the institutional design for supervision the main problem remains that sound supervision is rather impossible in an overly opaque and complex financial system.

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Although supervision has been harmonized for the largest banks in the EU, regulatory frameworks are still fragmented. According to Sabine Lautenschläger (2018) the remaining issues are in conflict to the Single Market idea and allow regulatory arbitrage, violating ‘the principle of same business, same risk, same rules’. ‘Every day’, she stresses from her experience within the ECB, ‘we supervisors struggle to maintain the equal treatment of banks that have to comply with different rules even though these differences are not justified by national specificities with regard to risk.’ European banking supervisors work around these problems by using the powers they have under discretion rules but this practice has limitations that need to be addressed by legislative reforms. Lautenschläger suggested the need for harmonization in areas such as ‘the fit and proper assessments of banks’ board members, the liquidation of banks, large exposures and the supervision of branches of non-EU banks’ (ibid.). In order to improve and harmonize how national authorities deal with banks that are either failing or under severe stress and likely to fail the BRRD set a minimum harmonized legal framework complemented by the SRMR.  The main purpose of the SRMR is the centralization of certain resolution functions and decisions for the members of the EBU. This new EU resolution framework is based on the idea that in certain cases of bank failures national insolvency law is insufficient and for public interest reasons resolution authorities can take action on the basis of the BRRD and SRMR to protect financial stability or negative impacts on the real economy. Without such a public interest and in the absence of a private sector rescue solution, failing banks must be wound up in accordance with national insolvency laws and procedures. Only two member states had transposed the BRRD within the December 2014 deadline, but it is now fully transposed in all EU member states and implementation is ongoing (EC 2019c: 2). The BRRD aims at establishing common rules in the EU for national authorities to manage bank failures in an orderly manner. It provides authorities with comprehensive resolution arrangements and sets out cooperation arrangements for dealing with cross-border banking failures. One of the central ideas in this new resolution regime is that banks must prepare recovery plans, also called living wills, National authorities received under the BRRD stronger powers aiming at lowest possible costs for taxpayers from any future bank resolution. Member states must set up a national resolution fund to which all banks have to contribute based on their size and risk profile. Another key change incorporated into the BRRD is the ‘bail-in’ mechanism that requires shareholders and creditors

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to pay a share of the recovery or resolution costs. Living wills were also adopted by the U.S. Dodd-Frank Act and must be periodically submitted with one public and one confidential version for regulators’ eyes only. U.S. regulators have over recent years frequently commented on the progress and that in their opinion the submitted living wills were still underdeveloped. In Europe, there has been no real public discussion yet and regulators prepared the frameworks for living wills as banks have to have workable resolution schemes in place by 2022. Publication of evaluations of such submissions are important for investors and for the broader public especially if they become linked to some of the ideas presented by Gerding (2014) to address the Regulatory Instability Hypothesis and in literature on how to minimize regulatory capture. The new resolution framework also allows for early intervention under certain circumstances. In exceptional cases banks can receive public support in form of precautionary recapitalization or state guarantees without being declared failing or likely to fail. Overall, the framework allows for quite some discretion and flexibility depending on case specific issues. Additional harmonization on technical standards should come from EBA guidelines and Commission Delegated Acts building on these guidelines. Together with the DGSs these rules form a single rulebook that should lead to deeper financial integration, although again in differentiation between EBU members and non-members. To coordinate recovery and resolution interventions for banks that are operating in Europe and in the U.S. market, officials of both sides have held coordination exercises. For the Eurozone/EBU member states the SRMR established a Single Resolution Board (SRB) that manages the Single Resolution Fund (SRF) and takes responsibility for preparing resolution plans and the necessary measures for recovery or orderly resolution. The idea behind the SRMR was that a common currency requires supervision by a single supervisory system (SSM) and that decision-making can only be strong and efficient when centralized and independent. The SRB published in 2016 an ‘introduction to resolution planning’ which presented the SRM as ‘a European solution for ending ‘too big to fail’ and ‘the undesirable feedback loop between banks and governments’ (SRB 2016: 7). The SRB also provides guidance on critical functions such as the operation of the bail-in mechanism. A more detailed resolution planning manual should also be published (EC 2019c: 3). In 2016, the Commission presented a legislative package to revise the BRRD, the SRMR, and the CRR/CRD IV in order to further decrease

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risks in the banking sector. Some elements of the framework were revised with the adopted Banking Package in April 2019 that included revised rules concerning the Minimum Requirement for own funds and eligible Liabilities (MREL). The MREL is designed to allow banks to absorb losses and restore their capital buffers in a way that they can continue providing critical economic functions during and after a crisis. The ‘critical functions’ have been defined by the SRB (2017). Since 2017, these MREL have been binding for the largest and most complex banks and the SRB can request bank-specific adjustments concerning the quality and quantity of the MREL.  The SRB provides guidance that is frequently updated. According to the Commission (2019c: 3), ‘while some banks at present still face MREL shortfalls, they are on their path towards fulfilling the objectives within the timeframes specified by SRB.’ The 2019 revision aligns the MREL with the international standard by the FSB on the Total Loss Absorbing Capacity (TLAC) and includes some other refinements (ibid.). The determination of the MREL is part of the resolution planning. The SRB has split the resolution planning in two cycles, a first one started in January 2018 and a second wave of resolution plans in 2019. For the common backstop to the SRF an Intergovernmental Agreement was signed by 26 participating member states (Sweden and the UK excluded) in May 20141 in order to enhance the SRM’s credibility. The participating countries committed to establishing the common backstop by the end of a transitional period for the mutualization of the means in the SRF. According to Article 4 of the agreement, the contributions collected during the transitional period ‘shall be transferred to the Fund in such a manner that they are allocated to compartments corresponding to each Contracting Party.’ Article 5 then set out that any costs should be covered first within the corresponding compartments depending on where the parent undertaking and subsidiaries are established. The agreement then sets out the details for gradual mutualization. While the Commission pushed for faster implementation of mutualization, the Euro Summit agreed only on making the introduction dependent on progress in risk reduction as key member states were concerned about taking over responsibilities for past reckless behaviour in other member states. Progress should be assessed in 2020 or by 2023 at the latest. The Commission suggested ‘the mutualisation of ex-post and ex-ante contributions, starting 1  Council of the European Union, Agreement on the transfer and mutualisation of contributions to the Single Resolution fund, ECOFIN 342, Brussels, 14 May 2014.

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from 2021 in order to deliver a common backstop of a credible size and increase the Banking Union resilience’ (EC 2019c: 7). The common backstop is designed as a last resort in bank crises management within the SRM and can be accessed via an emergency voting procedure. The SRF, which has been designed to be built up over a period of eight years with a target size of around €60 billion or at least 1% of the covered deposits by the end of 2023, had reached the amount of about €33 billion in July 2019. So it still would not have the capacity to provide liquidity on a large scale. The SRF is financed by banks and credit institutions from the 19 participating member states (SRB 2019a). In 2019, 3186 institutions made contributions to the SRF, 49% made as mall institutions only lump-­ sum contributions; 29% made contributions as medium-sized institutions; and 22% came from the largest institutions that paid in 97% of the total 2019 ex-ante contributions. Similar to previous years, the 20 largest banking groups contributed 67% to the annual contributions (SRB 2019b). The SRF has been criticized from the outset that it will not be sufficiently resourced to eliminate implicit government guarantees for TBTF financial institutions. According to de Boissieu (2017: 97), the SRF in 2024 could cope with bailing out a significant bank but it would still not be ‘not enough to face a big systemic crisis’ unless it gets a common backstop of around € 500 billion. Rodriguez (2018: 76) states, the SRF ‘does not fully eliminate the connection between sovereigns and the banking sector’ and it consequently still provides an incentive for banks to take on excessive risks. Adequate funding would, however, put further stress on the banking sector that is still struggling to find business models that allow them to return to sustainable profitability. In the early discussion on the size of the SRF, regulators also speculated that the resources might be leveraged if need be. The European Deposit Insurance Scheme (EDIS), the third pillar of the EBU, should be based on a new Deposit Insurance Fund (DIF) with a target size of 0.8% of covered deposits in Eurozone banks which the Commission suggested to be created by 2024. According to ECB research a DIF of that size would provide insurance cover for even a severe banking crisis (Carmassi et al. 2018). The Five Presidents’ Report (Juncker et al. 2015: 11) had anticipated that it would take time to create a ‘fully-fledged EDIS’ but that it must be a priority to take concrete steps immediately under the existing legal constraints. They suggested ‘to devise the EDIS as a re-insurance system at the European level for the national deposit guarantee schemes’ and follow the SRF example and design the common EDIS

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as ‘privately funded through ex ante risk-based fees paid by all the participating banks in the Member States and devised in a way that it would prevent moral hazard.’ However, progress on EDIS remains slow as some key member states including Germany have insisted that risk reduction must come first in order to avoid having to pay for other countries’ regulators lax supervision in the past. End of June 2018, the Council agreed on work to begin on a roadmap for political negotiations once risk reduction measures are adopted (Gortsos 2019: 22). The Commission (EC 2019c: 11) lamented that the ‘impasse’ is regrettable but ‘certain stakeholders remain firmly opposed to the pooling of resources and risk-sharing at this point’ and called on the Council to start political negotiations on the EDIS. Gros and Schoenmaker (2014: 537) had early criticized that the European discussion focuses on two separate functions for resolution and deposit insurance, although these two functions are related. They suggested to combine the two functions in a European equivalent of the U.S. FDIC as a superior, more efficient and swift solution. They argued that ‘a myriad of national funds is difficult to activate during a crisis and may give rise to conflicts’, including ‘inter-agency conflicts’. Copying the design of the FDIC was also supported by ECB President Draghi (2018). Brescia Morra (2019) explained ‘the obstacles for establishing a fully-­ fledged EDIS’ with the different banking systems in Europe and with controversies about the legal basis and supported too an ‘integration of the SRF with the EDIS’. The missing fourth pillar of the EBU is the LOLR function for the ECB, which would constitute ‘the first line of defence in a crisis’ (Lastra 2016). Lastra criticized that the interpretation of treaty constraints and the ECB statute had led to LOLR becoming a task for the national central banks (NCBs) who also have to cover the costs. With EDIS and common backstop missing, there remains a possible liquidity gap for bank that are failing or likely to fail or under resolution, for which central banks would normally provide emergency liquidity under certain circumstances. The ECB has developed a clear and constant ‘position on that matter’, as Mersch (2018) stated: ‘the provision of central bank liquidity—be it through monetary policy credit operations or emergency liquidity assistance, should not be automatically assumed in resolution planning. Resolution measures should be financed by contributions from shareholders and creditors of the bank, or by the State or at Union level, but not by central banks.’ In short, the ECB’s interpretation of the monetary financing prohibition in the Treaty (Article 123 of the TFEU) is that it cannot

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provide liquidity to insolvent credit and/or other financial institutions and that this would be a task for governments. ELA can only be provided by NCBs if it is necessary to preserve financial stability when a solvent entity is facing temporary liquidity issues and the entity is able to provide sufficient collateral. The ECB Governing Council has a veto right and NCBs must respect the prohibition of monetary financing. The ECB Agreement on ELA from 17 May 2017 sets out: ‘2.1 The main responsibility for the provision of ELA lies at the national level, with the NCBs concerned’ and under 2.2. that ‘any costs and risks arising from the provision of ELA are incurred by the NCB concerned (or by a third party acting as a guarantor). There is, however, legal uncertainty about the supervisory liability (Rodriguez 2018: 80). The discussion whether the ECB should become a LOLR has remained an academic one. Lastra (2016) argued that the ECB could have become LOLR on the basis of Article 127 TFEU and a reinterpretation of Article 14.4 of the ESCB Statute. Goodhart and Schoenmaker (2014) have argued that the LOLR function should at least for the significant banks move to the ECB, while NCBs could remain responsible for local banks. The resistance of the ECB to go into these directions, which provide it with a different design the U.S.  Federal Reserve Board has and that allowed a massive market intervention with its Term Asset-Backed Securities Loan Facility, backed-up by the U.S.  Treasury, might also be explained by the limited legal mandate given to the ECB and by the absence of a Fiscal Union and a European finance minister. As Lastra (2016) highlighted, this ‘fiscal constraint’ and the various legal restrictions did not stop the ECB to respond to the crisis with significant unconventional measures.

6.3   The Banking Union at Work: Progress and Obstacles As the aim of the EBU is a deeper financial integration in form of establishing a single banking market in Europe with single supervision practices and common regulatory standards that create a level playing field for the sector, the biggest risk is that the process could be disrupted either by economic and financial crises or that design flaws within the supervisory and regulatory frameworks established with the EBU could lead to a ‘resurgence of a national bias and the fragmentation of financial markets

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across the EU’ (Rodriguez 2018: 81). Acknowledging many of the outstanding issues in finishing the EBU, the European Commission has been highlighting over recent years that banks have become much safer thanks to wide-ranging reforms and the EBU. Since 2014, significant European banks have increased their capital by €234 billion (EC 2019b). However, the overall picture is not that great as there are still a high degree of fragility and fragmentation in the markets and serious concerns about European banking. Bank profitability fell in recent years to relatively low levels as banks have struggled to increase profits in the low interest environment and because of legacy issues. Since the GFC, European banks had three years with negative return on equity (2008, 2011 and 2012). According to the European Banking Federation (2018), return on equity of all EU banks fell from 10.6% in 2007 to 5.6% in 2017 and was in Cyprus, Greece and Portugal still negative. German (2.9%) and UK banks (4.3%) were below 5%, while Bulgaria, the Czech Republic, Denmark, Hungary (highest), Romania and Sweden had banks with return on equity above 10%. The ESA’s 2019 risk and vulnerability report expected for banks large refinancing needs that must be addressed with appropriate strategies and careful management ‘to avoid a cliff-edge effect at a later stage’. The report also called on supervisors to assure that banks address the issues, increase their ‘bail-in-able capacity’, and find business models that allow them to become more profitable again. With increasing bank lending regulators should assure that lending standards remain high. Particular care should be given to banks’ sovereign exposures (EIOPA et  al. 2019: 2). The banking sector had an exposure to sovereign bonds of €3 trillion or 10% of total assets by June 2018, with especially high-risk exposure among Italian banks. Any value adjustments of sovereign bonds would have direct effects on banks’ capital (ibid.: 7). The data shows that the bank-sovereign vicious circle has not been broken. Véron (2018), who sees the vicious circle as ‘the central driver of financial deterioration and fragmentation in the euro area’, suggested to introduce of legally binding rules in form of ‘sovereign concentration charges to reduce home bias in banks’ sovereign exposures’. Home bias means that domestic banks hold a large share of their governments’ debt which is not just a problem because of the doom loop but it also undermines the economic model of sovereign borrowing that is based on the assumption that states borrow from international investors and have a strong incentive to repay debt because they would otherwise be locked out from international financial markets for a longer period. If states can circumvent that pressure by relying on domestic banks

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and bailouts, the model no longer works. In short, the idea is to use a market mechanism in form of charges to make another market mechanism work. However, as long as the holdout problem is unresolved, this only would lead to other problems and could make sovereign debt restructuring even more problematic. Another major issue related to the ‘doom loop’ that has not been solved yet is economic imbalances in the EU that are the cause behind asymmetric effects on member states from shocks and that need to be addressed by reforms of the EMU. Structural change enforced via the ‘consolidation state’ (Streeck 2015) has limits that need to be acknowledged and addressed with a Fiscal Union and a more interventionist economic policy in the EU (see Chap. 3). The EU has not found a way forward to address the macroeconomic imbalances within the Eurozone. As a European Parliament Resolution of 16 February 2017 stated, ‘the currency area is not yet endowed with the instruments necessary to cope with another crisis of the same extend as the previous one’. It has been suggested that a European Monetary Fund could be designed along the lines Keynes had in mind with his idea for an International Clearing Union (Amato et al. 2016; Hess 2012; Whyman 2015). However, it would be highly unlikely that such a proposal finds any broader support. Over recent years, Germany was the main target for critique and especially American commentators suggested that Germany should rebalance its economy by increasing domestic demand and reducing its export surplus which would allow the weaker economies in Europe to recover. German politicians usually responded by defending the country’s export strength and comparing it to the position of the strongest exporting states within the U.S. However, the logical consequence of this argument is also to accept the need for a transfer union. More progress has been made in the core areas of EBU. The ‘independent’ institutions have worked for a short number of years and had their positive and negative feedback as already discussed to some extend in the previous section. In its review of the BRRD and the SRMR the Commission (EC 2019d) was highly positive about the institutional and regulatory changes adopted and made various smaller reform proposals for improvement. As one of the more important areas for reforms, the Commission identified the existing national variation in insolvency regimes as a potential ‘source of challenges and complexity for the resolution authority’, especially for cross-border banks in resolution, and announced a study on options for harmonization. The Commission (ibid.: 9) also commented

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on the limited experience on the application of the resolution framework so far. In 2015, when Italian authorities had to manage the recovery of four banks the bail-in provisions were not applicable and only state aid rules had to be applied. The Case of Banco Popular in June 2017 was ‘the only resolution carried out after entry into force of all the provisions of the SRMR’. However, as there was a private solution available, with Banco Santander taking over the failing bank, no further intervention was necessary that could have tested the new framework’s effectiveness, efficiency, and fairness. The Commission also summarized the cases where either precautionary liquidity support or precautionary recapitalizations were provided and three cases of bank failures in which the SRB found no public interest justification for intervention and therefore the institutions were liquidated under national law. Based on these limited experiences and ‘legacy issues’ the Commission has developed best practice guidance for member states and considered further harmonization to minimize the risk of diverging national transposition measures under the BRRD (ibid.: 4f.). The academic literature on these cases and most of the commentary in newspapers have been much more critical with many seeing a divergence of practice from the new rules. The bail-in tool in the BRRD has been criticized as ‘too complex to work’ (Tröger 2018). Ventoruzzo and Sandrelli (2019) argued that there is still ‘an attitude to bail-out rescues’ and non-harmonized insolvency rules complicate the situation. They conclude that while shareholders and subordinated creditors of failed banks have become involved as a rule, ‘the involvement of senior creditors remains exceptional and, de facto, almost never takes place if the failed institution raised capital on the international debt markets’ (ibid.: 76). The public interest test as required by Article 32.5 BRRD has been influenced by the consideration of state aid availability, which ‘is subject to a milder burden sharing’ making it ‘the preferable option for governments driven by the desire to minimize creditors’ write-down’ (ibid.). The problem for bail-ins is moreover a high litigation risk and a contagion risk if institutional investors sell in anticipation of bail-ins, which would make bail-ins ‘theoretically applicable, but practically unviable’ (ibid.: 77). Donnelly (2018b) criticized national authorities for continued protection and support of insolvent banks ‘despite Banking Union rules on resolution designed to facilitate their closure at the cost of private investors.” The Commission and the Single Resolution Board would support this ‘liberal economic nationalism’ (ibid.: 159). Far from more resilience and sustainability, Donnelly (2018b) expects ‘an accelerated balkanization’

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across the EU market if a systemically important bank in the EU fails. Like many other scholars and commentators Donnelly analyses the progress and shortcomings of Banking Union with a strong German influence, resulting in a ‘German Europe’. Chang (2017) also pointed towards Germany’s reluctance to support more risk-sharing. Other member states with similar interests have often hidden behind German demands instead of publicly supporting them. In April 2019, the Italian government put forward a plan, agreed with investors’ associations, to compensate retail shareholders and bondholders of six small banks that had to be wound down under Italian insolvency law. Investors with assets above €100,000 or annual income above €35,000 would have to prove that they fell victims of mis-selling; for the majority of 90% of investors falling below these thresholds it was simply assumed that they were such victims and that they should therefore be compensated automatically. Members of the European Parliament urged the Commission to block Italy’s plan as it would undermine the SRMR and BRRD and result in moral hazard. However, the plan had already been formally agreed by the Commission. The Italian case is a rather specific case of mis-selling, as ‘Italian savers were forced to buy bank shares in exchange for mortgages, while many others were given false information about the risks of their investors’ (Guarascio 2019a). However, it is also a broader issue as such mis-selling was widely practice in several Southern European member states and comes with high litigation risks making state intervention inevitable (Ventoruzzo and Sandrelli 2019: 77). Italy then put forward an even more generous plan just before the European Parliament election that raised again protest from Members of the European Parliament who now called for the Competition Commissioner to start an investigation (Guarascio 2019b). However, Commissioner Vestager had just to acknowledge the judgment of the EU’s General Court from 19 March 2019 (Joint Cases T-98/16, T-196/16, and T-198/16) that the Commission Decision of 23 December 2015 against rescuing a failing local bank in Italy was no violation of state aid rules. Italy had planned in 2014 to rescue the bank, which had already been under special administration since 2012, with a banking industry fund with the approval of Italy’s central bank. The Commission had incorrectly decided that the government is in control of this fund and that the measures granted entailed the use of state resources and were imputable to the state. Therefore, state aid rules would apply. The Commission decided end of May 2019 to appeal the General Court’s ruling to clarify the application

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of EU state aid rules in banking rescues. Because of that decision Italy did not use that option for the other four failed regional banks for which it now seeks to compensate investors (Sciorilli Borrelli 2019). Micossi (2019) argues that, ‘if resulting in blanket compensation for losses to bondholders (95%) and even to shareholders (30%)’, the generous plan by the Italian populist government ‘would be in clear violation of EU rules’. Neoliberal finance has been inventive in finding ways to maximize profits in good times and to socialize losses in bad times. This has been achieved by convincing regulators and policymakers that there are limited ways to allow banks to return to profitability after a financial crash and when they are systemically too important to fail. During the GFC bank bailouts and state subsidies for financial firms in the EU raised concerns by the Commission about long-term market distortions and the Commission insisted on member states respecting state aid provisions and to seek Commission approval for state aid provided. Nationalization has been the strongest form of socializing losses in the private sector, especially as governments such as in the UK tried to sell their shares again as quickly as possible instead of using the nationalized banks for a radical transformation of banking or selling only when the costs for taxpayers have been more than fully recovered. A preferred but difficult solution during market stress was restructuring via mergers and acquisitions. Cross-border mergers might need approval by the ECB banking supervision if a transaction between banks creates a new bank or if a significant bank is involved and the member state’s national law under which the merging banks operate provides for supervisor approval of mergers. Restructuring banks requires that bank’s balance sheets are freed up from toxic assets and one way of doing that is by transferring those assets into so-called ‘bad banks’. These bad banks are publicly sponsored financial institutions specifically created to collect the toxic assets from the banking sector at their market value at the time they are transferred, which is difficult to estimate when markets collapsed, and take in exchange an equity stake in them as a measure of recapitalization. The government then takes on the responsibility for the management of these assets in the hope that they can be resold. The bad bank therefore becomes an asset management company or a special purpose entity (Bruno et al. 2018: 161). In theory and if well designed, a bad bank approach would avoid any costs for the taxpayer; however, in practice the experience with bad banks was more often otherwise (Altvater 2010: 214). The EU post-GFC bad bank supporters especially pointed towards positive experiences in Sweden and their banking crisis in the

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1990s. The main idea is to win time, allow fast bank restructuring, and leave it to the state to either make a profit or a loss from the bad assets after several years. In some countries, including the U.S., profits have been reported for taxpayers, in Germany it is still unknown what the costs will be, while the bad banks had in the meantime negative consequences for public finances. Banks also used internal ‘bad banks’ after the GFC and combined assets into ‘non-core assets’ or into a ‘non-core operation unit’ to wind them down quickly. Deutsche Bank, having used this measure in the past, was in June 2019 again planning to put up to €50 billion of high-risk assets into an internal bad bank. Progress in completing the EBU has been influenced by the bad assets and bad banks in the member states as they have affected the strength and resilience of banks and their ability to provide funding undermining trust in the stability of the banking sector. Since the GFC and Eurozone crisis, many European banks have struggled to return to profitability and to meet higher capital requirements. The process of cleaning up banks from bad assets and non-performing loans (NPLs) remains an ongoing issue in the EU.  While NPLs fell in the EU significantly since Q4-2014, they remained on a high level in some member states, including Cyprus, Spain, Greece, Ireland, Italy, Portugal, and Slovenia. In 2017 NPLs reached more than a trillion euros. However, the EU total NPLs are returning almost to pre-crisis levels and they fell in nearly all member states. The total volume of NPLs across the EU fell to €786 billion. At the end of the third quarter 2018, 14 member states had low NPL ratios below 3%; while three member states (Greece 43.5%, Cyprus 21.8%, and Portugal 11.3%) had still ratios above 10%; some were still close to 10% (Bulgaria 8.6%, Ireland 7.8%, Croatia 7.9%, Italy 9.5%); and overall NPLs remain a risk ‘to the viability of the most affected banks and to economic growth and financial stability in some Member States’ (EC 2019a: 4f.). The size of NPLs in European banking reflected a fragility of the banks holding them on their balance sheets that can easily translate into financial instability. It also reduced bank lending and therefore the contribution of the banking sector to economic recovery. Moreover, NPLs were a major cause for increased financial fragmentation in European markets as their existence reduces cross-border risk sharing while at the same time increasing contagion risk in the monetary union (Bruno et al. 2018: 158f.; Montanaro 2019). Given the continued high level of bad loans in the European banking system, the idea of shifting them into a bad bank was repeatedly brought

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on the agenda. Bad banks have been used in various EU member states over the recent years. Now with regard to the EU level, EBA chairman Andrea Enria (2019) suggested that an EU-wide institution should collect the ‘non-performing loans’ and sell them on to private investors, favouring a solution that would work without any collective guarantees by EU member states. Bad banks were the solution during the GFC used widely by EU member states including Austria, Belgium, Denmark, France, Germany, Greece, Ireland, Latvia, Netherlands, Portugal, Slovenia, Spain, Sweden, and United Kingdom (Gandrud and Hallerberg 2014). Since then the focus at the European level shifted towards revitalizing securitization and using that market then also for restructuring banks. Bruno et al. (2018: 161) described the difference between bad bank and securitization; while the first ‘creates only a market for distressed loans, securitization also creates a market for structured securities guaranteed by the pool of distressed loans.’ This makes securitization attractive to a wider range of investors. Selling privately non-performing loans has also led to controversies over recent years in a number of member states. In Ireland, banks have been selling NPLs, in this case mortgages, to investment funds such as the U.S. company Cerberus over recent years. Most of the loans in arrears from the boom years have gone to ‘vulture funds’ that do not offer mortgage holders any debt restructuring but push through repossession. As a result, thousands of people are expected to lose their homes and these vulture funds as well as the banks that were not just reckless before the crisis but also have continuously overcharged their clients came under attack. In Germany, the large-scale sale of houses and apartments to investment funds led exploding rents and to a broad movement that calls for banning investment firms from ownership and for nationalizing those homes to reintroduce affordable housing. The EU has argued that NPLs are not only an issue for private banks and their prudential regulators but that in a monetary union there is also an EU interest to avoid any cross-border spillover effects. The ECOFIN Council adopted in July 2017 an Action Plan to tackle NPLs and the Commission followed up with measures to reduce the level of NPLs. The European Council’s (2017) conclusion expressed concern that ‘the high NPL rations in some Member States may not decline at a satisfactory pace’ and called for ‘incentives for all EU credit institutions to deal with NPLs pro-actively’. Any measures should avoid causing fire sales that could lead to disruptive effects in the markets. Measures also need to be consistent

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with the new Banking Union rules and the EU’s state aid requirements. The Council’s Action Plan put forward the idea to combine: ‘(1) supervision, (2) structural reforms of insolvency and debt recovery frameworks, (3) development of secondary markets for distressed assets, and (4) fostering restructuring of the banking system’ (ibid.). The Council invited the Commission to put forward legislative change as part of reviewing the CRR/CRD IV, the ECB to produce a guidance to banks on NPLs and the EBA to produce guidelines on NPL management and on loan origination and monitoring. The ESRB was tasked to develop ‘macro-prudential approaches to prevent the emergence of system-wide NPL problems’ and the Commission should also develop a ‘blueprint’ for national asset management companies (AMCs) for a harmonized approach in the member states and ‘a European approach to foster the development of secondary markets for NPLs’ to shift NPLs to the shadow banking sector ‘while safeguarding consumers’ rights’. Pressures on member states should be increased with benchmarking exercises and peer-reviewing (ibid.). Montanaro (2019: 239) argues that the EBA’s contribution to harmonize criteria for classifying loans as non-performing or forborne was highly relevant for addressing regulatory gaps that hindered effective prudential control of NPLs. However, this guidance would risk misrepresenting the underlying problems in different countries and ‘the system promotes solutions which are inappropriate to what really ought to be the main purpose in dealing with the NPL legacy, that is, maximising the number of the amount of problem loans returned to the performing status.’ In response to the Action Plan the Commission presented a ‘package’ of reforms in March 2018, including a proposal for a directive on credit servicers, credit purchasers and the recovery of collateral that aims to create the secondary markets for NPLs by introducing passporting to transfer bank loans to shadow banks across the EU; a proposal for a regulation amending the CRR as a preventive measure introducing for newly originated loans the requirement for banks to set aside funds to cover NPL risks, and a blueprint on the set-up of national AMCs. The reforms also led to a new regulation on non-performing loans (Regulation (EU) 2019/630) that is addressing the Union dimension of NPLs/NPEs introduced minimum levels of loan loss coverage for new NPLs as a statutory ‘prudential backstop’ with the aim to prevent the risk of future NPLs building up that could result in cross-border spillover effects and financial instability. NCAs can still go beyond the minimum requirements on the basis of their supervisory powers provided for in Directive 2013/36/EU.

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In its fourth progress report on the reduction of NPLs, the Commission (EC 2019a: 5) stated that the secondary markets for NPLs have already shown a sustained growth and an overall progress in implementing the Action Plan with 11 out of 14 actions accomplished, the development of new guidelines on banks’ loan origination, monitoring and internal governance imminent, and benchmarking of national loan enforcement and insolvency frameworks as well as insolvency issues in the European Semester ongoing (ibid.: 6). Another big issue of significance for finishing CMU but also EBU is the creation of a shared safe financial asset for the Euro area as a major contribution to break the doom loom between sovereign debt of the weakest member states and banks. The Commission presented safe asset as an issue ‘beyond Banking Union and Capital Markets Union’ that would contribute to the diversification of bank balance sheets’ (EC 2017a: 21). The idea as such ‘is as old as the currency itself and was seen by some as a necessary, but missing, step in the process of monetary, banking, and capital markets union’ (Hill 2019). Economists have argued over recent years for its introduction to release the weaker economies from market pressures. Under the term ‘Eurobonds’ various proposals emerged and were discussed (Brunnermeier et al. 2016: 111–114; Brunnermeier et al. 2017) and in early 2018 the idea got boosted by a joint paper by 14 leading German and French economists proposing ‘how to reconcile risk sharing and market discipline in the euro area’ and including ‘a synthetic euro safe asset’ as ‘an alternative to national sovereign bonds’ (Bénassy-Quéré et al. 2018). The Eurozone’s current financial system is dependent on German government bonds which are broadly acknowledged as benchmark and a destabilizing factor reproducing the existing asymmetries of supply in the sovereign debt markets and financial instability. All other government bonds relate to this benchmark as only ‘semi-safe’ and while this can attract investors during quiet periods, adverse shocks can trigger ‘flight-to-­ quality’ resulting in ‘destabilising capital flows that risk tearing EMU apart’ (van Riet 2017: 4). A more traditional response would be to rely on central bank intervention under its financial stability mandate (Gabor 2018). However, this has been criticized as old-fashioned monetary policy that would undermine the ECB’s independence. This gave credit to the safe asset idea that should lead to a design that avoids mutualization of debt or risk-transfer across member states. As various member states have insisted that each country has to keep full responsibility for their own debt, proposals had to work within these parameters. The Commission

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has started to push for the creation of a synthetic euro-area-wide safe asset designed as sovereign bond-backed securities (SBBS). The issue was also investigated by a High-Level Task Force of the ESRB, established in 2016 and chaired by Philip R.  Lane, the Governor of the Central Bank of Ireland, that presented its finding in January 2018 (ESRB High-Level Task Force on Safe Assets 2018a, b). The Task Force recommended a gradual development of a demand-led market for SBBS. The Commission had already raised the option of introducing SBBS in its Reflection Paper on the deepening of the EMU, praising their ‘innovative nature’ and anticipating ‘that issuance would develop only gradually’ (EC 2017a: 21). In May 2018, the Commission presented its proposal for SBBS which ‘would take the form of low-risk liquid assets backed by a pre-defined pool of euro-area central government bonds’. The Commission presented SBBS as ‘a market-led solution to promote financial integration, reduce the ‘home bias’ in investors’ portfolios and facilitate the diversification of their sovereign exposures’ (EC 2018). Lane and Langfield (2019: 60) argue that ‘SBBS are a promising tool’ but regulatory changes would be necessary to make it attractive for banks ‘to hold these low-risk securities.’ If properly designed, ‘SBBS could contribute to enhancing financial stability and the completion of monetary union.’ Critics have argued that the success of the safe asset will depend on sound fiscal and structural policy and that there are risks as the ‘SBBS idea remains untested and politically controversial’ and its implementation could lead to unintended consequences for the eurozone’s sovereign bond markets (Claeys 2018). Claeys (2019: 96) suggested that ‘an improved euro area architecture—with a completed Banking Union, effective macroprudential policies, improved fiscal rules, a euro area stabilisation instrument, and a reformed ESM/ OMT framework—would, in the long run, make all euro area sovereign bonds safer’ and ‘SBBS unnecessary’. A European safe asset still faces significant opposition. De Guindos (2019) emphasized: ‘There is no other currency union in existence in which regional debt is considered to be the safe asset’, but this is what the current situation in the Eurozone is. This has led to some countries operating as ‘cross-border safe-haven’ and getting paid by investors for their safe assets over the past years. De Guindos (2019) proposes that this European safe asset needs to be ‘a homogeneous product of a high quality and significant size that could become a benchmark for investors’. Special care needs to be taken to avoid any negative impacts on sound national fiscal policies. If properly designed, a European safe asset would ‘improve financial integration’, improve the effectiveness

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of the ECB’s monetary policy and make European capital markets more attractive, which would overall increase ‘the international role of the euro’ (ibid.). The Commission is also considering to revise the regulatory treatment of sovereign exposures to incentivise banks to hold less sovereign debt from their host countries and to phase-in such a fundamental change gradually ‘to ensure a smooth transition’ (EC 2019c: 13). A rather alternative view has been put forth by Gabor and Vestergaard (2018: 142) who argue that the ECB already engineered before 2008 ‘a single safe asset via repo markets’ that was largely based on using the shadow banking system for creating ‘shadow euros’. The ‘market-driven integration of government bond markets’ constituted ‘a way of arriving to a ‘single’ safe asset without having to go through the politics of agreeing to one’ (ibid.: 150). This was then the start of short-term government finance and debt, following the U.S. sovereign debt market model, that quickly led to ‘an increasing level of competition between sovereign issuers and between leading financial centers in Europe for the favour of international investors’ (Euromoney 1997, cited in Gabor and Vestergaard 2018: 150). The plans now for the revival of securitization and SBBS, designed to allow banks to return to higher profitability, again use shadow banking. In their view, this strategy fails to ‘solve the enduring predicament of the EMU bond markets architecture’ (ibid.: 142) and SBBS can only work with a market-maker of last resort function for the ECB (ibid.: 159). The discussions about progress and obstacles to finishing EBU reflects the underlying controversies about economic ideas and how they affect the design of EMU, EBU, and CMU with the broad issues behind how EU member states should share risks emerging from a common currency and a single financial market. It also reflects how the current discussion is very much shaped by worries to not create a Fiscal Union and a Transfer Union of any sort and to keep the pressure from financial markets on member states to transform their economies into directions that are supported by the markets, meaning opening them up for further financial integration especially into capital market-based finance.

6.4   Banking Union and Finance-Led Capitalism EU representatives and politicians from member states pushed since 2018 towards completing EBU. That raised the question of what constitutes an incomplete EMU and what needs to be achieved for completeness.

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Schnabel and Véron (2018) explored that question: ‘A narrow interpretation, based on euro area leaders’ past commitments, equates it with breaking the bank-sovereign vicious circle; a more ambitious long-term vision for complete Banking Union implies the removal of all cross-border distortions within the euro area banking market.’ All versions would require additional reforms to those already adopted and proposed, they concluded. It is clear from the discussion above that the EBU is still far away from creating a truly borderless banking market in Europe. The Commission (2019c: 11) stated that the EBU is incomplete without ‘a robust system for dealing with ailing banks’ which ‘requires having an effective mechanism to provide sufficient liquid assets to banks in resolution to withstand short term deposit outflows’. The Commission (ibid.: 13) moreover aims at removing ‘unnecessary obstacles to the cross-border integration of the banking system’ and has taken various measures that support the shift from bank-based to capital markets-based financing. While the EBU had been widely praised as huge progress and as an essential step forward in stabilizing the EMU in a moment of deep and existential crisis, there have also been early warnings about long-term consequences of a badly designed or unfinished EBU. Wyplosz (2012) argued that ‘a partial banking union is no better than no banking union at all, and possibly worse.’ Alexander (2015) saw a risk that some of the EBU’s features might ‘worsen moral hazard conditions and legal uncertainty with the effect of increasing financial instability.’ Various authors have raised questions about the effects of the EBU on non-member states and more broadly on European integration or disintegration. Chiti and Santoro (2019: vii) claimed that the ‘the EBU is irreversible’ and that ‘[t]he process can only go in the direction of further integration.’ However, if the financial system remains inherently instable, the Eurozone and its banks fragile, and capitalism continues to be finance-led, the process is anything but irreversible. In short, an unfinished EBU creates its own risks to financial stability and even a completed Banking Union in the current design makes serious banking crises possible and if the Financial Union, of which the EBU is a part, does not solve the broader problems in finance-led capitalism, including how the European banking sector might become more instable as a result of the creation of the CMU that has already boosted the growth of shadow banking and therefore also the interlinkages with banks, the existing measures for prevention and precaution will proof insufficient. The important question in the overall analysis of European capitalism after

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the GFC and Eurozone crisis is whether the creation of the EBU has contributed to a transformation of finance-led capitalism. Overall, the EU’s approach towards the banking crisis remains within the boundaries of the finance-led system of capitalism. Calls for alternatives for breaking the ‘vicious circle’ such as a European debt conference were ignored. The idea was originally advocated by various prominent economists including Hans-Werner Sinn, particularly obsessed with ‘moral hazard’ and a self-declared ‘classical economist’ by some labeled an ordoliberal (Brunnermeier et al. 2016: 63) as well as an outspoken critic of the ECB’s handling of the Eurozone crisis, who suggested in 2013 a European Debt Conference that should restructure debt in various European countries at the cost of creditors (Armbruster 2013). In 2015 the Greek Syriza Party took up the idea and proposed a European-wide event similar to the conference that led to the London ‘Agreement on German External Debts’ of 1953 that settled Germany’s foreign public and private debt. Syriza’s idea was that the conference should deal with all the unsustainable sovereign debt levels of EU member states. However, Sinn now suggested an international debt conference for Greece only and combined with the country temporarily leaving the Eurozone (Focus 2015). In any case, the idea found not enough political support and even the IMF waived its own funding rules including the principle not to fund unsustainable debt and went beyond the normal maximum IMF lending limit when becoming part of the Troika together with the Commission and the ECB for the Greek bailout. The rise of finance-led capitalism has been very much driven by the emergence of megabanks as it has generally increased pressures for capital concentration. Larger organizations are generally allowing for economies of scale and therefore increase efficiency in an economy. Bank restructuring and increasing the size of European banks was an important strategy in the past to boost European financial integration and to make this industry sector more efficient. Moreover, consolidation and concentration were seen as necessary for a single financial market. Before the GFC, some European banks had expanded their business not just across European markets, but they also tried to become bigger players in the U.S. market. Deutsche Bank, relatively successful for some time based on a strategy of rapid expansion of their investment banking division and in 2018 still trying to expand its U.S. wealth management division, had to pull out of the U.S. in mid-2019 as part of its radical restructuring plan to focus on its core wealth management business in European markets. The bank’s failed

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attempt to merge with another German bank was already widely criticized as not creating a big enough European champion. Across European banking industry there is return to pre-crisis expansionist plans and push for ‘European champions’. U.S. banks recovered much better since the GFC and returned to profits much faster. In comparison the European banks have become much smaller than the largest U.S. megabanks. For investment banks, Goodhart and Schoenmaker (2016) described the clear trend towards U.S. dominance in European investment banking and the rise of Chinese investment banks now dominating the Asia-Pacific market and asked whether these developments matter for Europe. Their recommendation is that the EU should regard its ‘declining’ ‘banking industry as a strategic sector’. They also highlight that investment banking has major functions and dependency can have negative consequences. As a warning, they note: ‘we have seen episodes in which US banks and corporates were acting on stringent orders from Washington (such as over SWIFT, Cuba, Iran). What if these orders turn against Europe?’ (ibid.: 3). Iran sanctions have already affected European businesses and undermined foreign policy goals. In short, the EU needs a strategy to protect its economy from ‘complete dependence on US investment banks’. Such a strategy becomes even more important after a possible (no-deal) Brexit also in the light that the UK has already a cooperation agreement with China. However, many European banks are still large enough to be TBTF, a problem EBU wanted to solve. Italy’s Unicredit is half the size of the country’s GDP and if it would merge with the French Société Générale ‘the resulting group’s balance sheet would be bigger than the GDP of Italy and similar to that of France—leaving Italian or French taxpayers squarely on the hook’ (Samuels 2019). Supporters of megabanks and European champions emphasize that banks have become much better capitalized and repeat the pre-crisis arguments of better risk diversification and risk management, not taking into account any of the concerns raised in the too-big-to-manage literature (Kress 2019) or research from Federal Reserve economists finding that bigger banks are worse for customers (Curti et al. 2019). In the meantime, banks get positive encouragement from the European Commission and the ECB and EBU was setting ‘the scene for banks to merge across borders’ (ECB’s former Chair of the Supervisory Board, Danièle Nouy, cited in Samuels 2019). The IMF (2019) also recommends addressing the problem of low bank profitability by ‘pushing for greater revenue diversification and cost efficiency, including through cross-border

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mergers and acquisitions.’ The strategy to deal with NPLs encourages too mergers and acquisitions (M&A). Needless to say that the support of regulators for M&A and European champions goes against all calls to downsize banks to smaller banks and to create a more competitive market or to keep banking systems more within the boundaries of member states or regions to allow for a stronger focus on ‘relationship banking’, not to mention the calls for nationalizing banking altogether and putting the sector under democratic control as, for example, Huffschmid (2009) outlined as part of a broader new framework for an ‘alternative Europe’ or ideas such broad use of public and cooperative banks, non-profit investment banks, and non-profit innovation stock markets to democratize finance (Block 2014). In more mainstream thinking, Samuels (2019) warned in the Financial Times that M&A remain at least a risky strategy as the Eurozone does not have the EDIS in place as banks are still TBTF. Since the GFC, structural reforms of banks have been discussed and the EU reacted with the Liikanen High-level Expert Group on reforming the structure of the EU banking sector which presented its report in 2012. Among the member states the UK, Germany, and France introduced structural reforms (Alexander 2015) in anticipation of the European reforms and to make sure to have created change that would be incorporated in any new European framework. The Commission proposal for a regulation on structural measures improving the resilience of EU credit institutions (COM/2014/043 final), released in January 2014, has since then been blocked before the Commission included it in July 2018 into a list of pending legislative proposals to be permanently withdrawn. In the Annex to the its 2018 Work Programme, the Commission stated that there had not been any progress since 2015 on the proposal and agreement would not be expected anymore. As justification the Commission claimed that ‘the main financial stability rationale of the proposal has in the meantime been addressed by other regulatory measures in the banking sector’ mentioning explicitly ‘the Banking Union’s supervisory and resolution arms’ (EC 2017b: 2). The European policy on bank concentration and the largest banks is largely in line with international policies agreed among the G20 members and based on frameworks prepared by the FSB and the Basel Committee. It includes the identification of G-SIBs and GSIIs for the purpose of stricter regulatory supervision and additional capital requirements. The EBA distinguishes G-SIBs and G-SIIs which have a leverage ratio exposure measure above € 200  billion at the end of each year and ‘other

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s­ystemically important institutions’ (O-SIIs) based on Article 131(3) of the CRD IV (Directive 2013/36/EU). However, the EU does not use regulation to create disincentives for banks to reach a certain size and to downsize if they have grown beyond a certain size to avoid costs. Various member states still have banking systems that are ‘large enough to threaten government solvency’, ‘EMU’s financial markets are still more debt-based and less equity-based than other currency areas’, and the fiscal backstop to deal with large scale banking and financial crises is not in place (Berger et al. 2018: 4). The reforms have not ended TBTF or sufficiently created disincentives against moral hazard. EBU has clear limits of what it can achieve with prudential regulation and capital requirements incentivizing banks to hold sovereign bonds. Finance-led capitalism is stabilized and revived with the focus on bank consolidation and pushing cross-border portfolio diversification in order to break the links between banks and national economies. The idea to create a truly European banking sector has been justified with the needs of a monetary union in which nation states have no longer the possibility to use traditional monetary policy measures to respond to economic pressures and crises. The ‘consolidation state’ created and reinforced with the fiscal rules in the EMU and the incomplete Fiscal Union have led to a situation where the EU or its member states cannot respond to crises with Keynesian policies, that would initiate economic growth and allow banks to return to growth in their traditional business areas. Instead the pressure increases for banks to adopt riskier business strategies that involve more interlinkages with the shadow banking system and undermine financial stability further instead of creating a more resilient financial system.

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Guarascio, F. 2019b, ‘Lawmakers urge EU’s Vestager to halt Italy scheme for bank shareholders bailout’, Reuters, 26 April 2019. Hess, A. 2012, ‘Proposals for a European Clearing Union: An Application of Keynes to Regional Monetary Systems’, http://www.wpsanet.org/papers/ docs/7%2020%20%Hess%Proposals%20for%20an%20ECU.pdf. Hill, A. 2019, ‘The Search for a Euro Safe Asset’, Quarterly Reports, ICMA. Hirst, P. & Thompson, G. 1996, Globalization in Question, Polity, Cambridge. Howarth, D. & Quaglia, L 2016, The Political Economy of European Banking Union, Oxford University Press, Oxford. Huffschmid, J. 2009, ‘Europäische Perspektiven im Kampf gegen die Wirtschaftsund Finanzkrise’, in E. Altvater et al., Krisen Analysen, VSA, Hamburg, 105–118. IMF 2001, Financial Sector Consolidation in Emerging Markets, Chapter 5, International Capital Market Report, IMF, Washington, D.C. IMF 2012, World Economic Outlook: Coping with High Dept and Sluggish Growth, October 2012, IMF, Washington, D.C. IMF 2019, ‘Euro Area – IMF Staff Concluding Statement of the 2019 Article IV Mission, 13 June 2019. Ioannidou, V. 2012, ‘A First Step Towards a Banking Union’, in T. Beck (ed.), Banking Union for Europe: Risks and Challenges, Centre for Economic Policy Research, London, 87–96. James, H. 2012, Making the European Monetary Union, Harvard University Press, Cambridge, M.A. Juncker, J.-C., Tusk, D., Dijsselbloem, J., Draghi, M. & Schulz, M. 2015, Completing Europe’s Economic and Monetary Union, The Five Presidents’ Report, European Commission, Brussels, http://ec.europa.eu/priorities/ economic-monetary-union/docs/5-presidents-report_en.pdf. Kress, J.C. 2019, ‘Solving Banking’s ‘Too Big to Manage’ Problem’, Minnesota Law Review, vol. 104. Lane, P. & Langfield, S. 2019, ‘The Feasibility of Sovereign Bond-Backed Securities for the Euro Area’, in J. Pisani-Ferry & J. Zettelmeyer (eds.), Risk Sharing Plus Market Discipline: A New Paradigm for Euro Area Reform? A Debate, CEPR Press, London, 51–61. Lastra, R.M. 2016, ‘Lender of Last Resort and Banking Union’, in J.E. Castañeda, D.G.  Mayes & G.  Wood (eds.), European Banking Union: Prospects and Challenges, Routledge, Abingdon, 109–128. Lautenschläger, S. 2018, ‘European Banking Union – The Place to Be?’, speech by Sabine Lautenschläger, Member of the Executive Board of the ECB and Vice-Chair of the Supervisory Board of the ECB, Biannual high-level ­networking seminar on economic and financial issues organised by Danmarks Nationalbank, Copenhagen, 14 May 2018, https://www.ecb.europa.eu/ press/key/date/2018/html/ecb.sp180514_3.en.html.

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Lindo, D. & Hanula-Bobbitt, K. 2013, Europe’s Banking Trilemma: Why Banking Reform is Essential for a Successful Banking Union, Finance Watch, September 2013. Macchiarelli, C. & Koutroumpis, P. 2016, ‘The Current State of Financial (Dis) Integration in the Euro Area: In-dept Analysis’, IP/A/ECON/2016-03, PE 587.314, European Parliament, Policy Department A: Economic and Scientific Policy, Brussels, Belgium. Mersch, Y. 2018, ‘The limits of central bank financing in resolution’, speech by Yves Mersch, Member of the Executive Board of the ECB, IMFS Distinguished Lecture Series Goethe Universität Frankfurt, 20 January 2018, https://www. ecb.europa.eu/press/key/date/2018/html/ecb.sp180130.en.html. Micossi, S. 2019, ‘Testing the EU Framework for the Recovery and Resolution of Banks: the Italian Experience’, Policy Brief, LUISS School of European Political Economy. Montanaro, E. 2019, ‘Non-Performing Loans and the European Union Legal Framework’, in M.P.  Chiti & V.  Santoro (eds.), The Palgrave Handbook of European Banking Union Law, Palgrave Macmillan, Cham, 213–246. Rodriguez, H. 2018, ‘Banking Union and the ECB’, in R. Marimon & T. Cooley (eds.), The EMU after the Crisis: Lessons and Possibilities, CEPR Press, London, 75–83. Samuels, S. 2019, ‘Europe Should be Wary of the Lure of Bigger Banks’, Financial Times, 30 January 2019. Schäuble, W. 2013, Banking Union must be built on firm foundations, Financial Times, 13 May 2013. Schnabel, I. & Véron, N. 2018, ‘Completing Europe’s Banking Union means breaking the bank-sovereign vicious circle’, 16 May 2018, https://voxeu.org/article/ completing-europe-s-banking-union-means-breaking-bank-sovereignvicious-circle. Schumpeter, J.A. 1942, Capitalism, Socialism and Democracy, Routledge, London [1992]. Sciorilli Borrelli, S. 2019, ‘Vestager’s Italian banking fight plays into Euroskeptics’ hands’, Politico, 8 April 2019. Sorkin, A.R. 2009, Too Big to Fail: Inside the Battle to Save Wall Street, Allen Lane, London and New York. SRB. 2016, The Single Resolution Mechanism: Introduction to Resolution Planning, Publication Office of the EU, Luxembourg, https://srb.europa.eu/ sites/srbsite/files/intro_resplanning.pdf.pdf. SRB. 2017, Critical Functions: SRB Approach, https://srb.europa.eu/sites/srbsite/files/critical_functions_final.pdf. SRB 2019a, ‘SRF grows to €33 billion after latest round of transfers’, 17 July 2019, https://srb.europa.eu/en/node/804.

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SRB 2019b, ‘2019 ex-ante contributions’, https://srb.europa.eu/en/ content/2019-ex-ante-contributions. Stern, G.H. & Feldman, R.J. 2004, Too Big To Fail: The Hazards of Bank Bailouts, Brookings Institution Press, Washington, DC. Stiglitz, J.E., Capaldo, J., Stetter, E., Dougherty, C., Griffith-Jones, S., Ortiz, I, Gabor, D. & Schratzenstaller-Altzinger, M. 2019, Rewriting the Rules of the European Economy, Foundation For European Progressive Studies, https:// www.feps-europa.eu/attachments/publications/book_stiglitz-rewriting_ rules.pdf. Streeck, W. 2015, ‘The Rise of the European Consolidation State’, MPIfG Discussion Paper 15/1, Max Planck Institute for the Study of Societies, Cologne. Tröger, T.H. 2018, ‘Too Complex to Work: A Critical Assessment of the Bail-in Tool under the European Bank Recovery and Resolution Regime’, Journal of Financial Regulation, vol. 4, no. 1, 35–72. Van Riet, A. 2017, ‘Addressing the Safety Trilemma: A Safe Sovereign Asset for the Eurozone’, Working Paper Series no. 35, ESRB, https://www.esrb.europa. eu/pub/pdf/wp/esrbwp35.en.pdf. Van Rompuy, H., Barroso, J.M., Juncker, J.C. & Draghi, M. 2012 ‘Towards a Genuine Economic and Monetary Union’, Brussels, 5 December 2012, http://www.consilium.europa.eu/uedocs/cms_Data/docs/pressdata/en/ ec/134069.pdf. Ventoruzzo, M. & Sandrelli, G. 2019, ‘O Tell Me the Truth About Bail-In: Theory and Practice’, Law Working Paper no. 442, European Corporate Governance Institute. Véron, N. 2018, ‘EU Financial Services Policy Since 2007: Crisis, Responses and Prospects’, Working Paper issue 06, 21 June 2018, Bruegel, https://bruegel. org/wp-content/uploads/2018/06/WP06_2018_Final2.pdf. Weidmann, J. 2013, ‘Banking Union, Properly Structured’, The International Economy, Winter 2013, 42–78. Whyman, P.B. 2015, ‘Keynes and the International Clearing Union: A Possible Model for Eurozone Reform?’, Journal of Common Market Studies, vol. 53, no. 2, 399–415. Wyplosz, C. 2012, “Banking Union as a Crisis-management Tool” in T.  Beck (ed.), Banking Union for Europe: Risks and Challenges, Centre for Economic Policy Research, London, 19–23.

CHAPTER 7

Conclusion: The Future of Financial Markets (Dis)Integration

‘The crisis consists precisely in the fact that the old is dying and the new cannot be born; in this interregnum a great variety of morbid symptoms appear.’ Antonio Gramsci (1971: 275–276). ‘Unimpeded liberalization and financialization in the heartlands of finance have led to massive structural change, supercharging markets and creating a financial order that now appears as a new kind of financial Frankenstein—one that is too big to fail, too complex to manage, too embedded in the wider economy, yet extremely fragile and crisis-prone.’ Stephen Bell and Andrew Hindmoor (2015: 336f.)

The history of financial crises, financial globalization and financial markets integration has shown that periods of rapid expansion can abruptly end and lead to deglobalization and market fragmentation when accumulation regimes fail to deliver, and states turn towards protectionism and economic and financial nationalism. The major crisis in today’s global and European financial markets is related to the design flaws in the post-war Bretton Woods system and its evolutionary change over the past decades that led to the creation of a deeply flawed system for international trade and finance. This international economic legal and political system enabled the second wave of globalization with unprecedented wealth creation;

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however, it is also responsible for a high degree of financial instability by allowing and actively supporting markets to develop since the 1970s into an opaque and overly complex financial system. With rising inequality and continued economic pressures on societies a backlash on globalization was expected in various forms: ‘protectionist trade policies, financial protectionism, with restrictions on foreign direct investment; capital controls; and a broader rejection of any policies that promote free markets’ (Roubini and Mihm 2010: 300). Indeed, protectionist measures and economic nationalism have made a return in various countries that see no longer globalization as a win-win but as a win-lose situation in which countries need to foremost protect their self-interest against other states. This has already led to a degree of deglobalization and more market fragmentation that is also reflecting financial markets disintegration. In the current crisis of multilateralism, the IMF has just celebrated the anniversary of Bretton Woods at 75—the post-WW II economic and financial order that was the institutional foundation for the second wave of financial globalization. At this occasion the IMF called for a rethinking of international cooperation. In the aftermaths of the GFC and the Great Recession global financial markets became more fragmented. Moreover, a return to protectionism occurred, most visible in the area of trade in goods. But the liberalization agenda of trade in services took too a hit in recent years and after a post-­ GFC period of regulatory harmonization under the direction of the G20, FSB, IMF, and BIS, countries have returned to looking for deregulatory and re-regulatory measures that gives them an economic advantage in the global market. The more radical demands made since years to establish an ‘alternative globalization’ remain topical as ever to address the problems related to oversized and opaque financial markets and to provide a global institutional structure for trade, finance, and development that can deal with the global challenges in a fair and democratic way. The contemporary crisis of capitalism is much deeper than acknowledged with the adaptation of the modern concepts of ‘inclusive capitalism’ based on ‘inclusive economies’ with ‘inclusive growth’ and ‘sustainable finance’ that have been pushed by international organizations such as the IMF, OECD, and the EU since they emerged in the aftermath of the GFC as attractive solutions to problems created by finance-led capitalism. The lessons drawn from that major systemic crisis stayed within the neoliberal paradigm and key features of finance-led capitalism remain in place and continue to constitute systemic risk and vulnerabilities in the global economy. This systemic risk is much wider than just financial instability that can lead to a crash, as

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the system permanently reproduces a deeply unsustainable mode of ­production and redistribution based on short-termism, extreme leverage, extreme speculation, and profit-maximization while creating substantial externalities. Tax havens within and outside the most developed economies and sophisticated tax avoidance and evasion schemes remain major features of finance-led capitalism and have contributed to the transformation of the fiscal and welfare state into a consolidation state. Macroprudential regulation and supervision—the big paradigmatic change in financial regulation and supervision that should shift the focus from individual financial firms to the systemic risks created by finance with all its complexities and interlinkages—necessarily has to fail, if the current financial structures, products, and activities are not radically questioned. After the GFC expectations for more radical change were high and the G20 took more ambitious measures with some calling for a New Bretton Woods and a (Green) New Deal. A decade later, the achievements are moderate while the challenges have risen. Critics have continually doubted that the G20 would be the best forum to achieve change. Tensions in the G20 have always existed but now they are undermining a stronger orientation towards protecting the stricter post-crisis financial regulation and to agree on a clear agenda to move forward towards sustainable finance and more resilient financial markets. The G20 Osaka Leaders’ Declaration, adopted at the Osaka meeting in Japan on 28–29 June 2019, only noted ‘the importance of maximizing the positive impact of infrastructure to achieve sustainable growth and development while preserving the sustainability of public finances, raising economic efficiency in view of life-cycle cost, integrating environmental and social considerations, including women’s empowerment, building resilience against natural disasters and other risks, and strengthening infrastructure governance.’ In rather abstract language and without agreeing on any measures while praising ‘private sector participation and transparency’, the G20 emphasized: ‘Mobilizing sustainable finance and strengthening financial inclusion are important for global growth.’ The declaration also stated: ‘An open and resilient financial system, grounded in agreed international standards, is crucial to support sustainable growth.’ But the G20 did not set out any new reforms and only agreed on continued implementation of already agreed financial reforms and continue evaluating their effects. This can be read as reference to the deregulation agenda behind the demand to address unintended consequences of adopted reforms in the aftermath of the GFC and under high public pressure. Shadow banking now labeled more neutral language as

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‘non-bank financing’ is praised for its positive contribution, although monitoring it should continue. The G20 welcomed ‘pro-growth tax policies’ and confirmed the importance of the G20/OECD BEPS package; however, the G20 was also unable to agree on how to address the key issues in tax avoidance and evasion. Technological innovations in finance such as crypto-assets were not seen as a ‘threat to global financial stability at this point’, but they are closely monitored. The G20 acknowledged financial markets fragmentation as a concern stating without any details that this would also be a result of ‘unintended negative effects, including through regulatory and supervisory cooperation’. The FSB and IOSCO are studying this issue. Overall this most recent political declaration of the leading economies shows a lack of political will to tackle the most serious challenges of our times. The EU Commission stated in its summary of the meeting that the U.S. and Saudi Arabia opposed any international work in the area of sustainable finance (EC 2019). In line with theories of financial regulation, the GFC led to a rather typical cycle in financial regulation that is a key part in itself in undermining financial stability. Proposals to reinvent financial regulation such as for example to rebuild a new framework based on lessons from the Regulatory Instability Hypothesis (Gerding 2014) or to develop ‘transformative strategies’ to systematically address the main features of finance-led capitalism with a more precautionary approach (Crotty and Epstein 2009; Pesendorfer 2014) have not been followed, not to speak about radical ideas such as democratizing finance and developing non-profit banking (Block 2014; Huffschmid 2009). Shaxson (2018: 272) called for ‘a huge clean-up, to drive out the bad and preserve the good’ in finance. The focus of this book has been on financial globalization and financial markets integration (policies) in Europe. It was argued that European development cannot be understood without the broader global context and the historical evolution of financial globalization and market integration. Europe has made huge progress in financial integration and has managed to position itself as a leading trading bloc in the global economy. In the current climate of economic nationalism the EU positioned itself as a globalizer trying to rescue to multilateral system for international trade and finance. However, European integration has not become the powerful ‘convergence machine’ (Gill and Raiser 2012; Ridao-Cano and Bodewig 2018) its advocates claim it would already be, and multiple disintegrative tendencies have emerged from within. Over the past decades the European strategy followed the path of neoliberal financial globalization in its unique

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European style. This has caused significant problems of a deeply flawed EMU with underregulated financial markets as described in detail in Chap. 3. The instability of the European monetary and financial system requires just like the global financial system more radical answers for ‘taming’, ‘reembeddying’, deleveraging and downsizing finance to make finance safer by using a more precautionary and more interventionist approach. Since the GFC the EU has without doubt gone through its most severe crises and adopted fundamental reforms covering all aspects of financial markets. However, many areas remain underregulated and the EU has not used the crisis as an opportunity to reform finance more radically. As a result of a largely reformist re-regulatory agenda many of the underlying flaws in European economies and societies are still not resolved. The Euro introduction was deeply flawed in its original design and although that was well known, reforms were postponed in a reckless way and left to be addressed in a future financial crisis that then came sooner than expected. However, the design flaws of the EMU are much deeper than identified by the European political elite. The neoliberal design of the EMU was from the outset doomed to create social tensions and conflicts that could bring European integration to the brink of collapse. The massive regulatory response to the GFC and Euro area crises is still unfinished, in many ways again problematic and moreover under threat from global and European developments. In some ways the EU is better equipped for the next crisis, however in various areas problems have not been addressed at all and can easily culminate in a systemic crisis of similar proportions than the GFC.  The EMU with its latest additions in form of a Financial Union consisting of an EBU and CMU remains work in progress as discussed in detail in Chaps. 5 and 6. As Berger et al. (2018) argued in an IMF paper on a Fiscal Union in the Euro area this incomplete EMU architecture is a result of ‘more Europe’ facing political constraints. In their view it would be a mistake for European policymakers to accept these ‘political constraints as unchangeable’ as the current ‘favorable economic circumstances will not last forever, and the chance to strengthen the euro area should not be missed.’ Being prepared for the next crisis is not just the key lesson from the GFC and Eurozone crisis but the basic idea behind monetary policy and financial regulation (see Chap. 2). As this book has shown, there are plenty of vulnerabilities in contemporary global and European financial markets that reflect significant fragility that can easily transform into financial instability and crises. Additionally to the large amount of financial reforms over the past decade the EU has put forward new proj-

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ects with ambitious but highly problematic goals. Numerous measures have been taken for deeper financial integration and ‘more Europe’ in financial regulation and supervision. The Commission has argued that continued financial integration would be ‘essential for strengthening the Economic and Monetary Union’ and that ‘deep and liquid markets increase the resilience towards adverse shocks and substantially facilitate private risk-sharing across borders, while at the same time reducing the need for public risk-sharing’ (EC 2017: 2). Deepening financial markets integration in the EU has been a major aim of strengthening the Single Market and featured prominently in EU strategies for a more competitive region within the global economy. It was the response to the GFC and the Euro area crisis but also to changes in the global economy and in global financial markets. This agenda has been a central point of controversy about the neoliberal character of EU economic policy, how it generates an increasing importance of finance in the wider economic and political systems with significant effects on growth, investment, (in)equality, and financial (in)stability that has been captured by the concepts of financialization and finance-led capitalism. The ongoing debate about the social value and costs of modern finance reflects what a destructive force finance-dominated capitalism has become. The EU frameworks have massively limited what member states can do in their economic policies to address economic imbalances or respond to the uneven effects of economic crises and pressures, while the EU remains under-resourced to tackle the problems in a more interventionist way. Both the EU and its member states remain under pressure from financial markets to continue reforms and consolidation in directions rewarded by markets but undermining democracy. The fallout of the GFC as well as the Eurozone crisis brought various disintegrative tendencies and setbacks to the attention of lawmakers, regulators, and markets. These two interlinked crises also provided ample evidence of the unsustainability and poor resilience of the European financial system. Disintegration was not just a process resulting from market participants becoming more risk-averse after the crash but also a result of various features of incomplete financial integration and national bias in financial regulation and supervision. The failed neoliberal integration model has undermined social peace and stability in Europe and led to mass protests and other forms of deep frustration with the EU. However, public protest was successfully redirected from finance to other issues. Neither ‘left’ political parties nor protest movements or NGOs were able to sustain pressure on decisionmakers. Neither the sov-

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ereign debt crises in various EU member states nor Brexit have led to a radical overhaul of the European financial integration agenda. The Better Regulation agenda with its Better Lawmaking procedures and public stakeholder consultations has not made financial reforms more democratic in terms of wider participation. Even popular demands such as for structural reforms of banks or introducing a Financial Transaction Tax at the European level via enhanced cooperation were killed in delayed processes of detailed legal and political debates until the circumstances allowed to drop them from the agenda (Kalaitzake 2017). However, the FTT has not entirely disappeared from the agenda and might still become reality if public pressure can be reorganized. The EU itself should have a strong motivation to introduce such a tax, given that it still is listed in some policy documents as a possible source of revenue. However, moderate FTTs in the meantime introduced in some EU member states were quickly criticized for their design flaws and reducing ‘liquidity in markets’ without discussing the overall societal impacts of particular activities that such a tax tries to address. The FTT as well as policies to close loopholes and flaws in anti-tax avoidance and evasion policies face strong resistance that have led to damaging and costly delays. More radical calls for strict financial product regulation, much higher capital requirements for banks, banning certain legal constructs and activities, radical overhaul of corporate tax rules, and an overall much more active and interventionist state were entirely ignored. Unfortunately, the sad truth is that they will not come back on the agenda before the next crisis. However, this should not be a reason to stop recalling their importance for more stable and more resilient financial markets. This book has argued in previous chapters that EBU and CMU will have substantial consequences for finance and the ‘real economy’ of non-­ financial firms as well as for individuals in Europe. The overall goals of improving risk sharing across Europe’s Single Market and achieving more growth, innovation, jobs and financial inclusion are noble; yet the details of those policies remain deeply flawed and concerning. It is not surprising that this agenda has not resulted in much wider opposition as the post-­ crises regulatory reform debates have become much less attractive for the wider population and became again highly technical discussions among experts who mostly share the belief that capital market-based is superior to a bank-based financing system and that a well-developed flourishing capital market needs much less intervention, regulation and supervision than a bank-based system. This deeply flawed economic rational behind current

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changes in financial regulation and financial markets integration policies is an indication of the survival of finance-driven capitalism that will make it much more difficult for banks to fulfil their more traditional functions and force more of their activities into the capital markets, increasing their already highly problematic interlinkages with the shadow banks. The development moreover links states and their subunits more into the shadow banking system and expands financialization in various areas and making savings useful for speculation in capital markets. The frequency of financial scandals emerging from contemporary business practices demonstrate that a decade after the GFC finance is still not serving society and that we are still far away from an ethical, sustainable and resilient financial system. EU financial markets integration and the UK’s post-Brexit approach are currently not going into a direction of change that would undo financialization and transform finance-led capitalism into a more embedded and sustainable financial system. Brexit has been discussed in Chap. 4 as a major challenge for European markets integration as it ultimately leads to financial markets disintegration. Among the EU-27 Brexit a group of countries has started a race of attracting financial services into their jurisdictions. This included an update of their business-friendly regulatory environment to signal that they have understood that a financial sector requires highly responsive states that respect their business demands and needs. The City and its political supporters have already demanded that any market loss in Europe should be compensated by tax cuts and other measures and a much closer relationship to regulators than before. UK supporters of the City have unsuccessfully warned that if London does not get privileged market access to the EU, firms would not relocate into EU-27 markets but to the U.S. or Asian financial centers and Europe as a whole would lose from such a scenario. Over recent years several studies showed how Europe is falling back in competition with U.S. finance. Davies and Oran (2016) stated that the EU could be left without its own ‘global champion’ in investment banking. They argued that European banks are generally in a competitive disadvantage to the U.S. banks whose post-crisis ‘structural overhauls’ would be ‘largely completed’. Moreover, they stated ‘Europe’s banks were already on the back foot before the [Brexit] vote, focused on cost-cutting and shoring up capital while more strongly-capitalised U.S. banks have been able to go out to win new business.’ If London-based businesses would relocate to the remaining EU-27 additional costs for relocating would reduce the EU’s banks’ competitive position further. This could

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lead to new regulatory barriers to protect and support EU banks and some recent developments such as the revision of the EU’s third country equivalence regime for financial services might indicate already such a direction. A more competitive approach to finance is also what some actors already push for: ‘Some senior executives [of EU banks], worried about the risks of Wall Street dominating the region, argue that Europe needs its own investment banks to service companies at home and abroad and help to spur economic growth’ (Davies and Oran 2016). However, it is not clear whether such pressure would result in more European banking nationalism or whether European accept the dominance of U.S. investment banks. The CMU among various reasons also been advocated as a solution to this U.S. dominance. Pushing capital-market based finance has even been seen as a necessary response to the rising dominance of U.S. and decline of European investment banks in Europe (Goodhart and Schoenmaker 2016). Moloney (2018: 87) suggested that this should give the CMU agenda a further boost. Again, such a strategy would go into the wrong direction and not strengthen European relationship banking that generally is more supportive for smaller banks than for the largest ones but lead again to strengthening shadow banking. As discussed in Chap. 5, the choice between different funding options is not neutral and has a significant impact on how corporations are incentivized to behave and operate. Pushing corporations and savings towards deeper and more developed capital markets has a significant impact on society. This is what needs to be discussed in much more detail. Instead the Commission has presented the CMU agenda as a neutral policy change that allows more financing for growth and jobs throughout economic cycles. Moreover, it would allow to secure funding during crises when banks are restricted in their lending. Yet the reality of contemporary capital markets is much more problematic. Capital markets are not just providing additional finance as discussed in Chap. 4. It would be necessary to have a more detailed discussion about what the purpose and benefit of specific shadow banks is and to what extent they are socially beneficial. Shadow banking, tax havens, financial innovation, and generally financial markets integration are all topics that would deserve to be discussed in the context of the alternative globalization debate and the integration promise of Europe being large enough to do things differently and to take more control over financial markets and regulate them in a way that they serve society and help achieving sustainable development. In the next phase of financial markets (dis)integration in Europe post-Brexit a new situation is emerging in which the UK hopes

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to become an offshore provider of finance for the rest of Europe while the EU is trying to bring finance onshore. As argued in Chap. 4, controlling an own financial center is of crucial importance for regional integration projects and it is not something a region could outsource without creating economic disadvantages and financial risk. Both, the UK post-Brexit and the EU’s CMU project aim for more outside investment and it will be difficult to navigate around conflicts this future relationship will necessarily create. The UK might opt for more openness while the EU for more protectionism to protect their financial centers from each other. This book also gave ample evidence that financial markets integration is not automatically beneficial and that justifying policies on the grounds that they would result in deeper integration and generally be justified by financial integration theory is pure ideology, similar to the claim that globalization is beneficial for all. Financial globalization and integration can have their benefits but they also can have highly disrupting and destructive elements. Critical integration theory has identified the shortcomings and flaws of contemporary financial markets for decades and also identified highly problematic developments in those markets that need to be addressed with strong state interventions. The critique of financial markets integration in Europe is not a call against financial or monetary integration, but similar to alternative globalization nothing more or less than a clear call for an alternative financial and economic and monetary integration based on heterodox and not neoliberal theory. In the globalization debate, supporters of neoliberal globalization were quick in discrediting opponents as ‘anti-globalizers’. Yet as the history of financial globalization and integration shows neoliberalism was a policy choice that would never have become a reality if political alternatives would have been chosen. In the words of the alternative globalization movements: ‘A Better World Is Possible’ and that requires to recognize casino capitalism and finance-­ driven capitalism as what it really is and close once and for all the casino.

References Bell, S. & Hindmoor, A. 2015, Masters of the Universe, Slaves of the Market, Harvard University Press, Cambridge, MA. Berger, H., Dell’Ariccia, G. & Obstfeld, M. 2018, Revisiting the Economic Case for Fiscal Union in the Euro Area, IMF, Washington, DC. Block, F. 2014, ‘Democratizing Finance’, Politics & Society, vol. 42, no. 1, 3–28.

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Crotty, J. & Epstein, G. 2009, ‘A Financial Precautionary Principle: New Rules for Financial Product Safety’, Wall Street Watch Working Paper, no. 1, Consumer Education Foundation. Davies, A. & Oran, O. 2016, ‘Brexit widens chasm between Wall Street and Europe’s investment banks’, Reuters, 18 July 2016, http://uk.reuters.com/ article/uk-britain-eu-investment-banking-idUKKCN0ZY1KF. EC 2017, Reinforcing integrated supervision to strengthen Capital Markets Union and financial integration in a changing environment, Communication from the Commission to the European Parliament, the Council, the European Central Bank, the European Economic and Social Committee and the Committee of the Regions, Brussels, 20.9.2017, COM(2017) 542 final. EC 2019, ‘G20 Summit’, Banking and Finance Newsletter, issue 07/2019. G20 2019, ‘Osaka Leaders Declaration, Osaka, Japan, https://g20.org/en/documents/final_g20_osaka_leaders_declaration.html. Gerding, E.F. 2014, Law, Bubbles, and Financial Regulation, Routledge, London. Gill, I.S. & Raiser, M. et  al. 2012, Golden Growth: Restoring the Lustre of the European Economic Model, World Bank, Washington, DC. Goodhart, C. & Schoenmaker, D. 2016, ‘The United States Dominates Global Investment Banking: Does it Matter for Europe?’, Bruegel Policy Contribution, Issue 2016/06, March 2016, Bruegel, Brussels, bruegel.org/wp-content/ uploads/2016/03/pc_2016_06-1.pdf. Gramsci, A. 1971, Selections from the Prison Notebooks, Lawrence and Wishart, London. Huffschmid, J. 2009, ‘Europäische Perspektiven im Kampf gegen die Wirtschaftsund Finanzkrise’, in E. Altvater et al., Krisen Analysen, VSA, Hamburg, 105–118. Kalaitzake, M. 2017, ‘Death by a Thousand Cuts? Financial Political Power and the Case of the European Financial Transaction Tax’, New Political Economy, vol. 22, no. 6, 709–726. Moloney, N. 2018, ‘EU Financial Governance after Brexit: The Rise of Technocracy and the Absorption of the UK’s Withdrawal’, in K.  Alexander, C.  Bernard, E. Ferran, A. Lang & N. Moloney 2018, Brexit and Financial Services: Law and Policy, Hart, Oxford, 61–113. Pesendorfer, D. 2014, ‘Beyond Financialisation? Transformative Strategies for More Sustainable Financial Markets in the European Union’, European Journal of Law Reform, vol. 16, no. 4, 692–712. Ridao-Cano & Bodewig 2018, Growing United: Upgrading Europe’s Convergence Machine, World Bank Report on the European Union, World Bank, Washington, D.C. Roubini, N. & Mihm, S. 2010, Crisis Economics: A Crash Course in the Future of Finance, Allen Lane, London. Shaxson, N. 2018, The Finance Curse, The Bodley Head, London.

Index1

B Bank for International Settlement (BIS), 18, 39, 40, 82, 84, 86, 137, 205, 211, 225, 320, 321, 329, 364 Bank of England (BoE), 4, 39, 61, 62, 86, 87, 98, 107, 156, 164, 195, 203, 211, 216, 224, 225, 236, 237, 275, 288 Bank Recovery and Resolution Directive (BRRD), 318, 332, 333, 339–341 Bretton Woods, 12, 38–54, 73, 74, 92, 93, 111, 112, 363–365 C Central clearing houses, 89 Central Counterparty Clearing (CCPs), 234, 235, 237, 243, 278

D Derivatives/OTC derivatives, 15, 18–20, 22–24, 55, 56, 62, 65, 83, 89, 99, 107, 216, 234–237, 241, 243, 260, 261, 266, 267, 269, 270, 277, 278, 286, 302, 316 Disintegration, 5, 7, 26, 36, 38, 71, 134, 143, 152, 153, 159, 168–171, 194, 195, 217, 224–229, 294, 349, 364, 368, 370 E Economic and Monetary Union (EMU), 4, 25, 28, 54, 131–133, 138–140, 145, 150, 153, 157–160, 163–165, 171–181, 200, 203, 254–256, 259, 262, 302, 315–318, 320, 321, 323, 325, 327, 328, 339, 346–349, 353, 367, 368

 Note: Page numbers followed by ‘n’ refer to notes.

1

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INDEX

Equivalence, 142, 170, 208, 214–216, 221–223, 227, 229–233, 236, 371 European Court of Justice (ECJ), 203, 204, 210, 225, 325, 326 European Deposit Insurance Scheme (EDIS), 318, 328, 335, 336, 352 European Monetary Fund (EMF), 165, 339 European Parliament (EP), 112, 165, 173, 204, 206, 277, 341 European Securities and Markets Authority (ESMA), 177, 178, 180, 203, 204, 234, 236–238, 277, 278, 282, 283, 289, 291–293, 296–298 European Stability Mechanism (ESM), 164, 164n1, 165, 272, 317, 330, 347 European Supervisory Authorities (ESAs), 5, 174, 176–179, 291, 293, 338 European Systemic Risk Board (ESRB), 176–179, 284, 345, 347 Exchange Traded Funds (ETFs), 284, 285 F Financialization, 12, 21, 23, 25, 26, 52, 67, 73, 76, 90, 91, 134, 155, 166, 174, 226, 243, 244, 265, 272, 277, 280, 281, 300, 368, 370 Financial Stability Board (FSB), 106, 107, 205, 271, 278, 319, 320, 334, 352, 364, 366 Financial Transaction Tax (FTT), 17, 53, 85, 104, 112, 163, 204, 209, 269, 277, 297, 299, 369 Financial Union, 4, 5, 25, 28, 194, 254, 325, 349, 367

Fiscal Union, 4, 324, 325, 327, 337, 339, 348, 353, 367 G Green New Deal, 101, 104, 112, 151, 244, 365 Group of 20 (G20), 44, 50, 79, 85, 106, 111, 112, 161, 205, 217, 230, 277, 352, 364–366 H Hedge funds, 19–21, 56, 201, 278, 287 High-frequency trading (HFT), 19, 21, 22, 85, 269, 281–283 I International Monetary Fund (IMF), 5, 9–12, 43–45, 53, 54, 56, 65, 68, 71, 77, 78, 85, 86, 89, 91, 106, 137, 153, 162, 167, 169, 205, 261, 268, 273, 284–287, 295, 298, 321, 326, 328, 329, 350, 351, 364 Investment plan, 256 L Lender of Last Resort (LOLR), 39, 44, 57, 88n2, 235, 316, 318, 320, 336, 337 M Mergers/mergers & acquisitions, 70, 75, 111, 148, 149, 167, 201, 281, 297, 298, 319, 321, 322, 342, 352 Monetarism, 17, 60, 73–74, 96, 133, 148

 INDEX 

Monetary policy, 2, 15, 39, 42, 52, 55, 58, 61, 63, 64, 67, 75, 85, 96, 109, 146, 157, 159, 164, 171, 176, 235, 268, 272, 274, 327, 331, 336, 346, 348, 353, 367 Money laundering, 104, 167, 180, 181, 244 Mutual recognition, 152, 155–156, 208, 213, 218, 221, 223, 225, 229–233 N Neoliberalism, 23, 45, 72, 74–76, 81, 96, 104, 111, 130, 132–134, 148, 372 Non-performing loans (NPLs)/ Non-performing exposures (NPEs), 269, 272, 280, 289, 318, 343–346, 352 P Passport(ing), 155, 210, 212, 214, 215, 221, 230, 233–237, 259, 261, 345 R Regulatory competition, 14, 26, 50, 52, 66, 79, 111, 200, 212, 217, 231, 300 S Securitization/simple, transparent and securitized (STS), 15, 19–21, 23, 24, 56, 65, 89, 91, 178, 259, 261, 266, 267, 269, 271, 272, 276, 286–290, 302, 326, 344, 348 Shadow banking, 19, 20, 50, 83, 89–91, 201, 203, 226, 259, 264, 265, 267, 269–272, 277, 286, 287, 301, 302, 318, 321, 326, 345, 348, 349, 353, 365, 370, 371

377

Single Resolution Board (SRB), 318, 333–335, 340 Single Resolution Fund (SRF), 333–336, 334n1 Single rulebook, 177, 178, 279, 333 Single Supervisory Mechanism (SSM), 317, 318, 328–331 Special purpose vehicle (SPV), 164n1, 261, 287 Stress tests, 86–89, 164, 175 Sustainability/sustainable development, 11, 58, 97, 100–106, 108, 130, 134, 140, 144, 156, 171–181, 243, 275, 290–293, 300, 301, 340, 365, 371 Sustainable finance, 4, 5, 91–113, 134, 144, 171–175, 180, 197, 244, 256, 257, 263, 275–277, 281, 290, 291, 293, 301, 302, 364–366 T Tax avoidance, 104, 161, 163, 180, 201, 281, 365, 366 Tax evasion, 22, 104, 161, 163, 201, 244, 281, 365, 366 Tax haven, 70, 71, 104, 161, 162, 181, 271, 365, 371 Too-big-to-fail (TBTF), 19, 24, 70, 86, 107, 108, 167, 200, 264, 279, 301, 318, 320, 322, 326, 335, 351–353 U United Nations (UN), 43, 45, 56, 94, 100, 101, 105, 152, 175 W World Trade Organization (WTO), 7, 46–50, 68, 91, 95, 101, 152, 154, 193, 222, 223, 226–228