EU Green Paper: Building a Capital Markets Union (COM(2015) 63 final) aba response 12 May 2015

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1 aba Arbeitsgemeinschaft für EU Green Paper: Building a Capital Markets Union (COM(2015) 63 final) aba response 12 May 2015 About the aba: The aba - Arbeitsgemeinschaft für - is the German association representing all matters concerning occupational pensions in the private and public sector. The aba has 1,200 members including corporate sponsors of pension schemes, IORPs, actuaries and consulting firms, employer associations and unions, as well as insurance companies, banks and investment managers. According to our statutes, our mission is to represent existing schemes as well as to expand coverage of occupational pensions independent of vehicle. Further information:

2 aba Arbeitsgemeinschaft für Page 2 General remarks and summary As the specialist association for all questions regarding occupational pensions, we very much welcome the drive towards a capital markets union initiated by the European Commission. The current low interest rate environment is politically motivated and particularly difficult to deal with for Institutions of Occupational Retirement Provision (IORPs). Not only on this backdrop it is important to broaden the investment universe to avoid jeopardising the Commission s objective to improve funded retirement provision across the EU. In recent years IORPs have been subject to many regulatory activities, sometimes intentionally, sometimes as a consequence of regulation of other institutions. Often this has had significant consequences for IORPs, most importantly increasing the workload and the related costs. It is important to consider whether the intended regulatory objectives are met, e.g. regarding the regulation on derivatives EMIR or the requirement to conduct internal credit ratings as stipulated by the CRA III Regulation. We are very concerned by EIOPA s work fully on its own initiative on the Holistic Balance Sheet approach (HBS approach). The goal of this approach is to copy the Solvency II framework to IORPs, while inadequately taking into account isolated characteristics of occupational pensions. The introduction of Solvency-II-style capital requirements would hamper sensible and desirable long-term investment by IORPs, rather than supporting it. Because of the existing security mechanisms in Germany (responsibility of the employer to ensure that the pension promise given is met; legal insolvency protection through the Pensions Sicherungs Verein ag), such a regulation would not increase the security of occupational pensions, but rather decrease overall provision. This is neither in the interest of the employer nor the employee, and reduced occupational pension provision is unlikely to be any government s objective. The aba supports the further development of occupational pensions and is very much against the introduction of a standardised savings product. The framework for occupational pensions should be improved and developed further, so that in the future more EU citizens will have the opportunity to build up pension rights which will secure their standard of living in old age. Guaranteeing and safeguarding legal certainty is important for those seeking investment opportunities in the capital markets. Investments in infrastructure are often made in the context of state subsidies. Reducing these subsidies could significantly curtail the advantages of these types of investments. IORPs have a strong interest in strengthening the protection of institutional investors. However, it should be different from the protection of retail investors, and at the same time ensure that small and medium sized enterprises (SMEs) have better access to funding through the capital markets. A credit scoring system and a European data base with those SMEs seeking capital could improve the availability and increase the standardisation of SME credit information. From the German perspective, the documentation of private placements as promissory notes has established itself as a standard. In this context we support the Pan-European Corporate Private Placement Market Guide. Because of their long-term time horizons, IORPs are well placed for long-term investment. Any regulatory framework should take this into account stable regulation with a long-term focus should be the objective.

3 aba Arbeitsgemeinschaft für Page 3 The introduction of a financial transaction tax (FTT) by 11 Member States should be considered carefully. On the one hand it would work against the goal of a uniform and efficient European capital market. On the other hand, the new tax burden would do little to increase coverage of occupational pensions rather to the contrary. For further information please contact: Klaus Stiefermann (Secretary General / CEO) Tel.: klaus.stiefermann@aba-online.de Dr. Cornelia Schmid Tel.: cornelia.schmid@aba-online.de Verena Menne Tel.: verena.menne@aba-online.de Answers to the questions Section 3, question 1: Beyond the five priority areas identified for short term action, what other areas should be prioritised? From the perspective of IORPs, stability and the safeguarding of legal certainty are important, in particular for long-term cross-border investments. Investments in infrastructure are often made in the context of state subsidies. Reducing these subsidies could significantly curtail the advantages of these types of investments. Other surprises such as for example in the case of Hypo Alpe Adria diminish trust in the international legal system and can hinder the flow of capital between countries. Section 3, question 2: What further steps around the availability and standardisation of SME credit information could support a deeper market in SME and start-up finance and a wider investor base? From the perspective of IORPs, a credit scoring system would be a sensible initiative to broaden the funding basis for SMEs. A European data base of SME seeking funding, administered by a central institution such as the European Investment Bank (EIB) could also be helpful. IORPs have a strong interest in strengthening the protection of institutional investors, for example by improving standardisation and legal harmonisation as well as legal certainty. A higher degree of standardisation does not necessarily require higher standards in particular for institutional investors. From our perspective it is important to distinguish between the protection of qualified institutional investors and the protection of retail investors. We are in favour of improving access to funding for SMEs, even if it means a lower level of investor protection. In contrast to retail investors, institutional investors can benefit from the related reduced administration and lower costs. The standardisation of credit information can lead to better market access for SMEs. However, there is a risk that sector or company specific information is lost, lowering the performance indicators. It can also be expected that SMEs and in particular start-ups will have worse performance indicators relative to those of bigger established companies. In these cases, support by the EIB, the German KfW-bank s ERP starting funds or guarantees by the state are needed to ensure that investments are attractive for investors.

4 aba Arbeitsgemeinschaft für Page 4 Section 3, question 3: What support can be given to ELTIFs to encourage their take up? After the publication in the Official Journal, the regulation on European Long-term investment funds (EL- TIFs) has to be integrated in the German Investment Law (Kapitalanlagegesetzbuch - KAGB). From the perspective of the IORPs, they then have to be integrated in the relevant regulation (Anlageverordnung for Pensionskassen und Pensionsfonds-Anlageverordnung for Pensionsfonds). Currently we see no specific advantages of ELTIFs over other alternative investment funds (AIFs) which would make them particularly interesting for IORPs. To incentivise investment in infrastructure and other long-term projects, ELTIFs could be subject to tax advantages as stipulated in 1b Investmentsteuergesetz, even though ELTIFs are closed funds, which normally excludes funds from this particular tax advantage. In Germany, the use of ELTIFs by occupational pension institutions which fall under the Anlageverordnung could be facilitated by the introduction of a specific ELTIF quota, without recognising this item in the risk quota and without the necessity of securitisation (ABS quota). Currently the investment of IORPs in infrastructure debt instruments is limited as those instruments do not fully meet the requirements of current regulation. ELTIFs could be an instrument that helps to overcome such obstacles. Section 3, Question 4: Is any action by the EU needed to support the development of private placement markets other than supporting market-led efforts to agree common standards? The further development of the European legal framework creating comparable conditions and uniform standards would be sensible, in particular because the differences in national legislation in areas such as securities, tax and insolvency law can be relatively large. From the German perspective, the documentation of private placements as promissory notes has established itself as a standard. In this context we support the Pan-European Corporate Private Placement Market Guide. Section 4, Question 6: Should measures be taken to promote greater liquidity in corporate bond markets, such as standardisation? If so, which measures are needed and can these be achieved by the market, or is regulatory action required? We would welcome an even stronger standardisation and harmonisation of (minimum) requirements regarding information and transparency within the framework of issuance of corporate bonds, because this could support the development of a more liquid secondary market for corporate bonds. In addition, this would make market access both easier and cheaper for small and medium sized companies. Overall, a uniform basis should be established rather than creating additional hurdles. IORPs in Germany have had positive experiences with the covered bond legislation (Pfandbriefrecht, see Pfandbriefgesetz), it is a good example for legal certainty, standardisation and therefore cost efficiency. Section 4, question 8: Is there value in developing a common EU level accounting standard for small and medium-sized companies listed on MTFs? Should such a standard become a feature of SME Growth Markets? If so, under which conditions?

5 aba Arbeitsgemeinschaft für Page 5 International Financial Reporting Standards (IFRS) for SMEs already exist, reducing the complexity of the full IFRS and facilitating their application. However, the IFRS for SMEs were not received well in Germany and other EU countries. A special European accounting standard for SMEs based on multilateral trading systems would at least for German SMEs mean additional costs and increased complexity. The Bilanzrechtsmodernisierungsgesetz in Germany was the beginning of Germany s own way to develop the German accounting rules further, so that in particular SMEs do not have to rely on the complex IFRS regulation. An additional accounting standard would result in SMEs having to produce three balance sheets one according to EU standards, one according to the German HGB standards and one according to taxation standards. At least in Germany, there are a myriad of links between accounting, corporate and tax law, so that abolishing the HGB-balance seems unrealistic in the near future. The EU accounting standards Directives should therefore be developed further in their current form. Further harmonisation can be achieved by curtailing the options Member States have in these Directives without distinguishing between the use of different trading systems. If at all, the EU standard should only be applied on a voluntary basis. If this was the case, the publication of an additional IFRS financial statement (also using the IFRS for SMEs) for individual company and conglomerate statements could be voluntary as well (if the IFRS requirements for listed companies do not apply). This is already practice in Germany. Section 4, Question 10: What policy measures could incentivise institutional investors to raise and invest larger amounts and in a broader range of assets, in particular long-term projects, SMEs and innovative and high growth start-ups? Because of their long-term time horizons, IORPs are well placed for long-term investment. There are no other investors who regularly have longer time horizons. The main objective of an IORP is to secure the benefits of their members. Pensionskassen and Pensionsfonds in Germany generally provide lifelong benefits to their members. A cancellation of the policy with a pay-out of the surrender value is prohibited either in the pension plan itself or in legislation. Therefore the investment horizon of IORPs despite the possibility to transfer the capital to a new employer and pension sharing orders in case of divorce is much longer than for other institutional investors. The possibilities for IORPs to engage in long-term investment depend on the disposition and ability of employers and/or employees as well as the legal framework. Legal certainty and grandfathering play important roles in this regard. The objective should be that the supervisory and the tax framework are stable and oriented towards the long-term. Retroactive changes in particular should be ruled out. In Germany, prudential regulation, accounting standards and tax law are already today limiting the possibilities for IORPs to invest in the long-term. Together with other associations the aba has called for many years for investment conditions for long-term investors such as insurers and IORPs, in particular in small and medium sized enterprises and infrastructure projects. Unfortunately, the requirements for investors and investment processes have been intensified over the last years and in many cases are diametrically opposed to the goals set out in the Green Paper. For example under Solvency II as it currently stands, investments in private equity are subject to the maximum stress factor in the standard model, therefore requiring the highest possible level of own capital. Therefore, there is currently no incentive for those falling under Solvency II to invest in this type of asset.

6 aba Arbeitsgemeinschaft für Page 6 The same applies to outside capital investments in small and medium sized enterprises, which often do not have the official rating of a recognised credit rating agency. In this case, the stress factors in the standard model are significantly higher than in cases where an official rating is available. Another factor which has led to tighter regulation is the Credit Rating Agency Regulation 462/2013. Investors were partly held responsible for the financial crisis because they used credit ratings of official credit rating agencies as was stipulated in legislation. To reduce this dependency on credit rating agencies, institutional investors are now required to build up their own internal credit rating processes. In recent years IORPs have been subject to many regulatory activities, sometimes intentionally, sometimes as a consequence of regulation of other actors. Often this has had significant consequences for IORPs, most importantly increasing the workload and the related costs. It is important to consider whether the intended regulatory objectives are met, e.g. regarding the regulation on derivatives (EMIR) or the requirement to conduct internal credit ratings as stipulated by the CRA III Regulation mentioned above. We are very concerned by EIOPA s work fully on own initiative on the Holistic Balance Sheet approach (HBS approach). The goal of this approach is to copy the Solvency-II framework to IORPs, while inadequately taking into account isolated characteristics of occupational pensions. The EIOPA Consultation Further Work on Solvency of IORPs which included 111 questions regarding the further development of the HBS approach closed on 13 January From May 2015, IORPs face a new impact study (IORP QU) and the first EIOPA stress test. The introduction of Solvency-II-style capital requirements would hamper sensible and desirable long-term investment by IORPs, rather than supporting it. Because of the existing security mechanisms in Germany (responsibility of the employer to ensure that the pension promise given is met; legal insolvency protection through the Pensions Sicherungs Verein ag), such a regulation would not increase the security of occupational pensions, but rather decrease overall provision. This is neither in the interest of the employer nor the employee, and reduced occupational pension provision is unlikely to be any government s objective. Regarding their investment policy, IORPs would face similar effects as already described for those already regulated by Solvency II which are diametrically opposed to the objectives of the Green Paper. Section 4, question 12: Should work on the tailored treatment of infrastructure investments target certain clearly identifiable sub-classes of assets? If so, which of these should the Commission prioritise in future reviews of the prudential rules such as CRDIV/CRR and Solvency II? Yes, the introduction of sub-classes for investment in infrastructure with different risk features would be sensible from the perspective of IORPs. The risk structure varies with the demand risk, the project progress (greenfield, brownfield) and other operative risks, such as the necessary maintenance costs, which are difficult to quantify. Dividing products into financial and operative risks could lead to more flexibility and to a broadening of the involved investors. Depending on how the products are broken down into tranches, it is primarily the illiquidity premium which would be added as a component to the return. The possibility to participate in a fund using small investment tranches without incurring active management fees (but knowing that there will be a service charge) would also contribute to broadening the investor base. This way, the diversification of maturities, regions, segments and compensation models could lead to a reduction in risk. The EIB or a similar institution could play an important role collecting and mixing the different infrastructure investments such as e.g. in peripheral countries or in new technologies.

7 aba Arbeitsgemeinschaft für Page 7 Section, question 13: Would the introduction of a standardised product, or removing the existing obstacles to cross-border access, strengthen the single market in pension provision? As stressed in the aba response to the EU Green Paper on Long-term financing of the European Economy from June 2013, the aba supports the further development of occupational pensions and is very much against the introduction of a standardised savings product. Occupational pensions are the most efficient form of funded retirement provision for employees particularly if the social partners organise occupational pensions as a social benefit with little or no cost to the employees. In Germany, occupational pensions are defined as a benefit, which the employer grants the employee in the case of old age, invalidity or death (survivor s pension) on the occasion of an employment contract. Occupational pensions are therefore much more than an individual long-term savings product. We therefore doubt that a new EU-wide savings product is necessary or, in fact, feasible, considering that the Member States are responsible for pensions and taxation. In particular because of the diversity of the different pension systems within the EU and the complementary nature of funded pensions, it is right that the Member States are responsible for these areas. The introduction of an EU-wide savings product would unnecessarily increase complexity and potentially lead to a misallocation of public resources. Instead, the framework for occupational pensions should be improved and developed further, so that in the future more EU citizens will have the opportunity to build up pension rights which will secure their standard of living in old age. Section 4, question 15: How can the EU further develop private equity and venture capital as an alternative source of finance for the economy? In particular, what measures could boost the scale of venture capital funds and enhance the exit opportunities for venture capital investors? From the perspective of IORPs it would be helpful if there were supporting measures, such as e.g. in the EU project bond initiative through subordinate loans by the EIB or public guarantees (see also a German report on investment: Bericht der Expertenkommission im Auftrag des Bundesministers für Wirtschaft und Energie, an English summary is available). And as mentioned earlier, a short-term view with regards to regulation as in the Solvency II context does NOT foster investment in these asset classes. Especially for IORPs with their long dating liabilities and thus long-term investment horizon, the private equity as well as the infrastructure equity markets are able to build a significant part of an IORP s asset allocation. If, and only if, regulation does not penalize such investments. Section 4, question 16: Are there impediments to increasing both bank and non-bank direct lending safely to companies that need finance? Yes, there are impediments to increasing safe non-bank direct lending to companies that need finance. The obstacles are mainly of regulatory nature, such as supervisory requirements regarding the processes around asset allocation and asset monitoring, or in the case of Solvency II the requirements for own capital.

8 aba Arbeitsgemeinschaft für Page 8 Section 4, question 18: How can the ESAs further contribute to ensuring consumer and investor protection? IORPs have a strong interest in strengthening the protection of institutional investors, for example through higher standardisation and legal harmonisation as well as through legal certainty. However, we would like to point out that there is a trade-off between improving the investment opportunities for companies and increasing investor protection with a high level of standardisation. Any improvement for companies, including both those seeking funding (e.g. SMEs and start-ups) and those seeking investments (e.g. IORPs and insurance companies) collides with the improvements in investor and/or consumer protection initiated by the Commission over the last years. Strengthening investor protection works against the explicit goal of the Green Paper to make access to the capital markets easier for SMEs. To avoid this trade-off, the EU should distinguish between qualified (institutional) investors and retail investors. A lower level of consumer protection would lead to less effort and lower costs. In contrast to retail investors, institutional investors would be likely to benefit from these changes. For IORPs the creation of legal certainty is paramount. Section 4, question 23: Are there mechanisms to improve the functioning and efficiency of markets not covered in this paper, particularly in the areas of equity and bond market functioning and liquidity? The strengthening of the regulatory requirements regarding own funds and the risk requirements regarding own funds in the Directive 2013/36/EU and the Regulation 575/2013 have contributed to lowering the appetite of bank s for corporate finance. This also means that banks are not as active as they used to be in the markets. From our perspective, this negatively influences the functioning and efficiency of the markets, in particular the liquidity of the equity and bond markets. Therefore long-term investors such as IORPs play an ever more important role in stabilising the markets by providing liquidity. Chapter 4, Question 25: Do you think that the powers of the ESAs to ensure consistent supervision are sufficient? What additional measures relating to EU level supervision would materially contribute to developing a capital markets union? The review of the European System of Financial Supervision still needs to address the key questions for occupational pensions in relation to the European Supervisory Authority EIOPA. 1 Occupational pensions were only a side issue when the European System of Financial Supervision (ESFS) was introduced under time pressure following the financial crisis of 2007 and IORPs are not considered to be part of the group of institutions experiencing fundamental difficulties during the financial crisis, which led to the introduction of the new supervisory regime. Regarding occupational pensions it was not clarified and precisely defined which tasks and competences an EU supervisory authority should or could (considering the crucial role of national social and labour law for key questions regarding the design of occupational pensions) have. The EIOPA Regulation, which stipulates the competences of and the scope of action for EIOPA, only provides With regard to institutions for occupational retirement provision, the Authority shall act without prejudice to national social and labour law. 1 On 8 August 2014 the European Commission published two reports reviewing the functioning of the European System of Financial Supervision (ESFS).

9 aba Arbeitsgemeinschaft für Page 9 However, the occupational pensions strategy paper, which EIOPA published on 27 June 2014, simply ignores the existence of national social and labour law. It is obvious that such an approach is bound to lead to recommendations for a supervisory regime which is at most adequate for providers of third pillar retirement and savings products. The last HBS consultation even suggested that, if necessary, Member States should adjust their national social and labour law to fit EU supervisory law. 2 We are strictly against ignoring national social and labour law and against the desire to prioritise EU supervisory law over the former. The review of the European System of Financial Supervision which includes the EIOPA regulation should clarify the key questions for occupational pensions: i.a. equal procedural involvement of the ministers of social affairs, of the EP Committee EMPL, of DG Employment, Social Affairs and Inclusion as well as inclusion of the key occupational pension stakeholders, particularly the social partners. The provisions of national social and labour law fall firmly and exclusively within the remit of the Member States, they cannot be altered by EU supervisory law. Beyond this, EIOPA seems to be developing a life of its own. How else could it be possible that EIOPA requires IORPs to participate in a stress test using the models developed by EIOPA and based on the Solvency-II-style HBS methodology? From our perspective there is neither a political consensus nor a legal basis for these requirements. Section 4, question 27: What measures could be taken to improve the cross-border flow of collateral? Should work be undertaken to improve the legal enforceability of collateral and close-out netting arrangements cross-border? From the perspective of IORPs, legal certainty regarding the insolvency law of the investment is very important. We would welcome a European framework for legal enforceability of collateral and close-out netting arrangements cross-border. Section 4, question 28: What are the main obstacles to integrated capital markets arising from company law, including corporate governance? Are there targeted measures which could contribute to overcoming them? The review of the Shareholder Rights Directive is intended to strengthen the long-term engagement of shareholders. It is intended that IORPs as institutional investors are required to exercise their shareholder rights and publish information about their engagement policy and details regarding their investment strategy (in particular how it is geared to serve the long-term liabilities). We doubt that the reviewed Directive will encourage institutional investors and asset managers to provide more long term capital to companies. 3 The main repercussion of the reviewed Directive will be an increase in business for consultants in proxy voting to the detriment of occupational pensions. 2 If EU prudential requirements were amended, Member States may need to adjust their social and labour law in order to ensure that their overall framework continues to reflect the previously agreed objectives. (p. 114, EIOPA Consultation Paper on further work on solvency of IORPs) 3 Greepaper, p. 24

10 aba Arbeitsgemeinschaft für Page 10 Section 4, question 30: What barriers are there around taxation that should be looked at as a matter of priority to contribute to more integrated capital markets within the EU and a more robust funding structure at company level and through which instruments? The introduction of a financial transaction tax (FTT) by 11 Member States should be considered carefully. On the one hand it would work against the goal of a uniform and efficient European capital market. On the other hand, the new tax burden would do little to increase coverage of occupational pensions rather to the contrary. Since it is intended that any transaction incurs the FTT twice, occupational pensions would be hard hit for example regarding transactions restructuring the portfolio or when engaging in new investments. The often necessary involvement of financial intermediaries would lead to cascading effects. Section 4, question 32: Are there other issues, not identified in this Green Paper, which in your view require action to achieve a Capital Markets Union? If so, what are they and what form could such action take? From our perspective a closer analysis of the regulatory framework for institutional investors such as IORPs is necessary. The main objective of IORPs is to deliver the benefits promised by the employer.