A shortage of risk capital and under-developed capital markets are holding back growth in Europe, according to a new study comparing financing for business in Europe with the US.

The report by the Association for Financial Markets in Europe (AFME), “Bridging the growth gap: Investor views on European and US capital markets and how they drive investment and economic growth,” co written with the Boston Consulting Group (BCG), shows that Europe has a significantly smaller pool of investable assets than the similar sized US economy. But the real problem is the fragmented nature of European markets and the lack of equity finance.

The AFME report draws on a survey of global investors holding around €9tn assets under management and provides a unique, in-depth analysis of how capital markets in Europe and the US compare, and how these differences may have contributed to the wide disparity in growth rates since the financial crisis.

Key findings on Europe’s capital markets compared to the US:

• Survey participants identified three factors that are holding back investments: 65% cited market fragmentation, i.e. lack of information and understanding of differences across markets, 60% cited discrepancies in rules and 40% cited the macro outlook.
• Europe has a smaller pot of funding with approximately €30tn available for investment compared with €49tn in the US even though GDP is roughly similar at €17tn each.
• Europe has significantly less listed equity capital, with €10tn invested in listed equities compared to €19tn in the US.
• Europe delivers a larger pot of financing to SMEs than the US, with approximately €2.0tn in outstanding stock compared to €1.2tn in the US. However, the majority of EU financing is bank lending (€1.4tn vs €0.5tn).
• Sources of equity funding for SMEs are underdeveloped in Europe. By comparison, small SMEs, start-ups and entrepreneurs in the US benefit from more diverse financing sources which provide a significantly larger proportion of funding than in Europe:

- US private equity and venture capital funds had €488bn to invest in 2013 vs only €245bn in Europe
- In the US 33% of SME financing is provided by private persons’ wealth vs 9% in Europe

• Europe’s savings market structures are less geared to equity investing. The US retirement system, which is largely funded by savings, provides €14.9tn in investible assets, compared to €4.3tn in Europe.
• Allocation of investments toward equities is also lower in Europe than in the US, with only 37% of funds managed by pension funds and fund managers invested in equities, compared to 53% in the US.
• In Europe the private sector is providing more infrastructure financing than governments (€260tn vs €159tn in 2013), compared to the US (€115tn vs €182tn), but there is still an overall infrastructure funding gap. To solve this, surveyed investors believe government support should be channelled towards greenfield and brownfield projects that would not be viable without it.

Simon Lewis, chief Executive of AFME, said: “Under-sized capital markets are limiting growth in Europe, but more important is the lack of risk capital. This is a particular problem for SMEs, where the lack of equity is preventing the development of the entrepreneurial ecosystems that nurture growth sectors such as technology, communications and energy.”

Philippe Morel, global leader of Capital Markets at the Boston Consulting Group, said: "There are two particularly interesting dynamics at play which became clear during our conversations with institutional investors. The fragmentation in Europe is off-putting: working with 28 individual countries is burdensome in comparison to investment in the United States where one legal and regulatory system applies. Secondly, there is a strong sense amongst the investor community that there is less of an appetite for risk in Europe, and as such, alternatives to bank lending are not as readily available for SMEs in Europe when compared to the US."

In the Financial Times today, Michael Sherwood and Richard Gnodde co-chief executives of Goldman Sachs International, write that a ‘big bang’ via a capital markets union is needed to expand Europe’s economy:

Europe needs a market-based financial system that allocates capital efficiently to households and businesses from Lisbon to Ljubljana — and that means it needs not just a banking union, but a capital markets union, too. [ ] Europe’s financial system has traditionally centred on banks, which provide about 70% of European firms’ external financing, with the remainder coming directly from securities markets.

In the US, these shares are reversed. Bank dependence is both a cause and a consequence of the structure of the European corporate sector, which is dominated by small and medium-sized enterprises that cannot access capital markets directly."