Europe's capital conundrum: Can Luxembourg lead the way?

Europe faces a formidable financial challenge. To fund its green and digital ambitions, the continent needs to invest an estimated €700bn–€800bn extra each year until 2030. Traditional bank lending, long the mainstay of European corporate finance, is insufficient for this task.

The Capital Markets Union (CMU), a project launched in 2015 to create a single market for capital, has thus gained renewed urgency. Now subtly rebranded as the Savings and Investment Union (SIU), the initiative aims to mobilise Europe’s vast €9.5trn pool of private savings and channel it towards productive investments, offering citizens better returns and boosting economic dynamism.

The CMU's goals are multiple: to diversify funding for firms, especially for SMEs; to finance innovation, the twin transitions of climate and geopolitics; and to enhance private risk-sharing. The SIU sharpens this focus, emphasising the need to make capital markets more accessible and attractive to retail investors, who in Europe are warier of market-based investments than their American counterparts.

Progress, however, has been sluggish, stymied by the EU’s fragmented regulatory and legal landscapes and a lack of sustained political impetus.

A Lëtzebuerger speciality?

Enter Luxembourg. The Grand Duchy, despite its small geographic footprint, is a financial heavyweight. It is the EU’s undisputed leader in investment funds, hosting a significant share of European UCITS and alternative investment funds. Its financial centre thrives on cross-border activity, with deep expertise in international fund distribution, corporate banking, and wealth management.

Furthermore, Luxembourg has carved out a niche as a pioneer in sustainable finance, notably through the Luxembourg Green Exchange (LGX), the first platform dedicated to green bonds.

Crucially, the country’s national financial strategy, Ambitions 2030, aligns closely with the CMU's objectives. It prioritises enhancing Europe's competitiveness by acting as a bridge for global capital, fostering growth in areas like alternative assets and tokenised investments, and mobilising capital for sustainability.

This congruence suggests that for Luxembourg, championing the CMU is not merely an act of European goodwill, but a matter of strategic self-interest. Its expertise in navigating diverse legal and tax systems makes it well-suited to contribute to the CMU’s complex harmonisation agenda.

The familiar hurdles

The road to a fully-fledged CMU is paved with obstacles. Differing national insolvency laws, tax rules (particularly concerning withholding taxes), and supervisory practices create significant barriers to cross-border investment.

Political will among the 27 member states can be fickle, with national interests often trumping collective European goals. The departure of Britain, formerly the EU's largest capital market, has further complicated the picture, removing a key proponent of market-based finance and altering the EU's internal dynamics.

Moreover, European households remain cautious. Only a relatively small portion of their savings finds its way into capital markets, compared with other developed economies. Improving financial literacy and building trust in market-based investment products are therefore essential prerequisites for the SIU's success.

The Grand Duchy's potential gambit

Luxembourg is uniquely positioned to help tackle some of these challenges. Its dominance in the fund industry allows it to spearhead efforts to simplify cross-border fund distribution, a key SIU aim. It could champion initiatives like FASTER, designed to streamline withholding tax relief procedures. The country's experience in catering to an international clientele could also inform the design of pan-European savings products, such as the Pan-European Personal Pension Product (PEPP).

In sustainable finance, Luxembourg can leverage the LGX and its experience with the Sustainable Finance Disclosure Regulation (SFDR) to promote common standards and best practices across the EU. It also possesses significant expertise in securitisation, a market the CMU aims to revive to free up bank capital for lending to the real economy.

And its Ambitions 2030 focus on digitalisation and tokenisation aligns with the CMU's goal of modernising market infrastructures using new technologies like DLT. The IMF itself notes that progress towards CMU could boost Luxembourg's growth, provided it addresses certain domestic structural issues.

More than good Europeanism

For Luxembourg, taking a leading role in the CMU offers substantial rewards. It would further solidify its status as a premier European financial centre, attract more global capital, and stimulate innovation within its own ecosystem. For the EU, a more integrated capital market, nudged along by a proactive Luxembourg, would enhance its global competitiveness, help finance the costly green and digital transitions, and provide a more resilient financial system less dependent on bank credit.

This requires a concerted effort. The Luxembourg government, its financial regulator (the CSSF), and industry bodies such as Luxembourg for Finance (LFF), the Luxembourg Capital Markets Association (LuxCMA), and the Association of the Luxembourg Fund Industry (ALFI) would need to work in tandem. They could jointly develop policy recommendations, pilot innovative financial products, and actively promote the CMU internationally.

The Capital Markets Union is a prize worth striving for. While its full realisation remains a long-term endeavour, Luxembourg has both the capacity and the incentive to play a disproportionately influential role in its construction. Doing so would not only benefit the Grand Duchy itself but would also contribute to a more prosperous and economically sovereign Europe.

Armin Prljaca has over a decade of experience in asset and wealth management, focusing on client engagement, investor experience, and strategic management, holding an MBA in Leadership and Management from the University of York.