Response to consultation on the Green paper on the long-term financing of the European economy

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1 Brussels, 25 June 2013 Response to consultation on the Green paper on the long-term financing of the European economy 1) Do you agree with the analysis out above regarding the supply and characteristics of long-term financing? A focus on long-term financing is a reaction to an issue of short-termism in the existing financial markets. An availability and composition of long-term financing has been affected by a set of factors related to the financial crisis, cyclical weakness and structural factors. The presented characteristics mentioned in the European Commission Green paper on the long-term financing of the European economy are well presented. In the last few years, the main source/ supply of long term financing in the European Union has been coming from institutional investors (hedge funds, insurances companies, fund management companies, pension funds), corporates and private investors and to a lower extent from Member States Governments as most of them were involved in bank bailouts and implementing austerity measures to reduce their national deficits. The supply of long-term financing clearly depends on the return on investment with the associated risk profiling of the project involved. Within the euro area crisis, the amount of private and public sector capital investment has been reduced therefore the supply for long-term financing has declined as well. Furthermore, investors reduced their risk appetite and prefer investing in national government debt that has a lower risk profile whilst a good return on investment within the current market conditions. Furthermore, some investors prefer to move towards safe havens such as gold while others towards commodities. Characteristics of long-term financing Contribution to economic and productivity growth, as well as to better resource management at business and government levels; Requirement of involvement of investors willing take advantage of such at the time illiquid opportunities; Driver of innovation and competitiveness having a stabilizing, countercyclical influence on the financial system; Transparency Register ID

2 Focused on investment in infrastructure, both in tangible (such as roads, bridges, ports, machinery, factories, commercial buildings, hospitals, or housing) and intangible assets (such as education, research or development), many of which are public goods which increase quality of life of a society as a whole. Stakeholders involved in supply and demand side of long-term financing *Self-financing instruments, Capital markets and Long-term investment section has been arranged in a descending order from the biggest to the smallest share Source: McKinsey Global Institute 2) Do you have a view on the most appropriate definition of long-term financing? To the characteristics suggested in answer to question 1) one could add as well the following features characterising long-term financing: Investments of maturities exceeding five-year period, including sources of financing that have no specific maturity (e.g. equities) (as defined by the Financial Stability Board) The long-dated funds to pay for capital-intensive undertakings that have multiyear payback periods (defined by Group of Thirty). Going more into detail, the definition of long-term financing should strictly depend on the life span and its economic and social return, particularly, in the area of infrastructural projects or investment in IT systems. The economic return mainly applies to private sector oriented projects

3 whilst social return applies to public sector related projects that involve public goods. For example the investment in a hospital should be between twenty to thirty years so the related financing should be on the same time span (that is matching the life span usage of the infrastructure with its financing instrument be it a government bond or loan). If a government agency is going to finance an IT system that has a lifespan of ten years the related financing vehicle should be matched. Certainly, one would need to look at the financing of aggregate items which will make the related financing package more market oriented and viable. The financing of exports directly through long term financing is not economically viable. What can be financed is the capital nature of investment that can assist the creation of the export opportunity. From a financial and economic point of view, recurrent expenditure should clearly not be covered or mentioned in the area of long-term financing. Within the current economic climate, long-term financing needs to be also divided by time periods related to the life span of the asset being financed, basically, the creation of a classification, for example 1 to 10 years, 10 to 20 years and over 20 to 30 years. 3) Given the evolving nature of the banking sector, going forward, what role do you see for banks in the channelling of financing to long-term investments? Banks will remain the main financing partner for Small and Medium Sized Enterprises (SMEs) in Europe. Of course, the crisis has shown that the application of leverage poses risks when credit exposures are not adequately extended. However, a shift away from the bank financing also poses many risks, especially, if the bank loan is to be replaced by capital market instruments. It is important that the company opens itself to instruments such as bonds, promissory notes, etc. however, for most companies, it cannot be considered mainly due to their small size. Also of importance is the ability to increase the internal financing and associated with it an improved (tax) framework. The role played by banks in long-term investments varies from one EU Member State to another. Banks are very important in financing Small and Medium Sized Enterprises (SMEs), corporates and in investing in government and corporate bonds depending on the associated credit rating. Within the current economic climate and with the introduction of the Basel III Accord a significant amount of deleveraging is taking place as banks are conserving cash to boost up their capital and provide additional buffers for any potentially bad loans.

4 Until the European banks manage to write-off a significant amount of their bad loans the amount of access to finance for SMEs will be limited particularly for long-term investments. European banks are increasingly becoming more risk averse and would prefer to finance short term projects compared to long term projects. The longer the term of a project the higher would be the associated risk. The European Commission through its Multiannual Financial Framework can certainly assist the situation by providing additional financing to Financial Engineering Instruments through centralised and decentralised funding channels operated by the European Investment Fund as these would assist banks to leverage on these schemes to further improve the access to finance for SMEs. Due to the cost of raising funds on the market through debt and equity issues micro and small enterprises will always remain dependent on their local banks to raise capital. Role of banks in the channelling of financing to long-term investments Long-term investment depends on a mix of self-financing and capital raised through the financial system. The estimates indicate that government accounts for about 30% of long-term investment, 30% is self-financed by corporations and households, while 40% via bank lending and capital markets. These statistics suggest that banks have been one of the primary providers of long-term financing. On top of that, taking into account the importance of these financial intermediaries for businesses, it is hard to imagine them disappearing from the intermediation system. However, taking into account the latest developments in the banking sector, undermined trust and economic slowdown, there might be a room for creation of other intermediaries such as investment banks that could provide complementary instruments to the real economy. Such institutions resulting preferably from public-private cooperation can take a form of, for example, infrastructure banks, SMEs lending entities, or innovation funds 1 and target sectors characterized by potential market failures (such as infrastructure or green economy). Currently existing distortions prevent many investors from capturing the returns from efficient long-term investments that is why there is a market opportunity to establish new lending institutions or investment intermediaries with long-term mandates as it is happening lately in many EU member states. Examples Most of SME lending in Malta is carried out by the traditional banks as they are very liquid and have very healthy loans to deposit ratios of 70 to 100. The Maltese banks that are domestically oriented do not depend on the international markets or ECB LTRO to rise funding. They have a good supply of funding through local depositors. Only a small number of Maltese SMEs have tapped into the local stock exchange to issue debt or equity instruments. It tends to be mainly 1 E.g. Corporate Innovation Platform of the European Investment Fund

5 the large SMEs who do so. Maltese SMEs that raised funding through the local stock exchange have done it in the form of debt compared to equity because they are mainly family owned businesses and they do not want to lose control. One also needs to take into consideration that 95% of the Maltese government debt is financed locally. This is financing by local bonds and treasury bills purchased by local banks, insurance companies, fund management companies and general public. Every time, the Maltese government launched a bond issue it is oversubscribed within a couple of hours from issuing. 4) How could the role of national and multilateral development banks best support the financing of long-term investment? Is there scope for greater coordination between these banks in the pursuit of EU policy goals? How could financial instruments under the EU budget better support the financing of long-term investment in sustainable growth? Public sector institutions such as national and multilateral development banks are an option of re-launching of long-term financing to the real economy, especially where the market failures have limited the development of commercial sources for long-term finance. Such public sector institutions could provide project financing, or supply indirect financing via guarantees or counter-guarantees to the existing financial intermediaries or private sector. However, at national level such solutions should be rather applicable in case of countries where strong public balance sheets allow the public administrations for credible commitments. In countries where public administrations cannot take such a burden, their activity could be supported by multilateral development banks such as the European Investment Bank (EIB) or the European Investment Fund (EIF) e.g. via guarantee platforms, risk sharing financial facilities and risk sharing instruments. In any case, when creating new institutions dedicated to long-term investments the policy makers must not forget about potential risks such as market distortions or crowding out the private sector initiatives. The European Union already have a well-developed banking industry that operates on a local level and that has a very good understanding of its customer needs. That is why having national and multilateral development banks competing with each other is a non-starter. One needs to develop a strategy that complements each other similar to what the European Investment Bank and the European Investment Fund are currently doing through the CIP, JEREMIE, JESSICA and JASPER initiatives. Local bank and regional banks should be free to operate on the local territory whilst the role of national and multilateral development banks should provide financial engineering instruments to complement product and service portfolio of local banks.

6 Examples During the current programming period , financial engineering instruments such as JEREMIE and JESSICA have clearly proven how local banks can leverage on them and improve long-term investment both in the SME and urban regeneration area. One also needs to take into consideration that with the requirement of Member States to attain a balanced fiscal position in the short to medium period the amount of national funding that is going to be devoted to grant schemes and national incentives is going to be reduced radically. Therefore, the formation of public-private ventures through which financial engineering instruments is going to increase. What is important is that tax payer funds are carefully invested and the potential leverage is increased. National (e.g. KfW) and multi-national development banks (EIB) can play an important role as anchor investors by bringing markets back on track or establishing new products. Thus, for example, KfW is strongly involved in a hybrid of securitization / mortgage of SME loans of commercial banks (Structured Covered Bonds). The EIB invests in securitizations to revive this market as well. It is important, however, that as a result no private financing is displaced/crowded out. 5) Are there other public policy tools and frameworks that can support the financing of long-term investment? There is certainly scope for greater coordination between banks, the European Investment Bank, the European Investment Fund, European Commission Directorate General Enterprise and Industry, Directorate General Economic and Financial Affairs and national agencies. The following are some recommendations: - The EU sets up a permanent working group that generates new ideas and initiatives to improve the access to finance for SMEs and long-term financing; - The EU facilitates the exchange of best practices through internships between banks and EU institutions be it DG Enterprise and Industry, DG ECFIN, the EIF and the EIB; and - There can be the exchange of best practices between the financial institutions themselves. The European Commission can further expand on the positive experience registered under the JEREMIE, JESSICA and CIP financial instruments. The application of a one-size-fits-all methodology cannot be adopted but there needs to be a certain amount of local market customisation of schemes as the market maturity and reality in Member States differs. Certain amount of State Aid regulations need to be moved as they just are bureaucratic process that

7 hinder the access to finance and long-term financing process. The reporting requirements on financial institutions need to be reduced to make the process of using financial instruments more cost effective. Guarantees and counter-guarantees An access to finance is stimulated through various schemes at European, national and local levels. Loan guarantee schemes generate the highest stimulus as they reduce both default risk and capital absorption of lenders. Furthermore, there would be a lower cost of capital for SMEs. Current schemes have highly variable impacts on the loan made available e.g. to SMEs (1 EUR of stimulus can generate from less than 1 EUR to tens of euro of loan). The efficient existing regional and local programmes have to be continued. Where no local or regional supply exists, a European Guarantee Platform may fill in the gap. A coordinated and integrated approach at European level could improve effectiveness of guarantee schemes in Europe, reduce distortions among Member States and increase efficiency of access to finance. The successful implementation of a coordinated European approach would minimize short term impacts on Member States loan-guarantee value chains, while maximizing the benefits for SMEs in terms of access to loans. The establishment of a permanent European Guarantee Platform (EGP) managed by the EIF would help to align temporal frameworks between European and national schemes, thus increasing their overall effectiveness. Most guarantee schemes having a European focus (e.g. SME Guarantee Facility and CIP Competitiveness and Innovation framework Programme) have a limited temporal framework while national ones have a revolving nature. A permanent structure in form of European Guarantee Platform would assure continuity, thus facilitating and improving cooperation practices with financial intermediaries (e.g. for the development of guarantees or lending products based on European guarantees). The Platform would reduce bank capital requirements and risk exposure for financial intermediaries, thus easing SMEs access to finance. This is particularly important given the current risk aversion of financial institutions and taking into account forthcoming Basel III rules. The European Guarantee Platform could offer equity guarantees in addition to debt ones. This type of financial instruments would target mainly the companies with high growth potential, as well as other companies based on the needs of a member state. Through equity guarantees the EGP could join venture capital firms and other risk capital providers in supporting SMEs in risk-sharing processes. Potential within Horizon 2020 and COSME When it comes to other public policy instruments available, the importance of the programmes related to innovation and maximising coherence between the EU s strategy and its multiannual

8 financial framework is crucial. The Competitiveness of Enterprises and SMEs (COSME) and Horizon 2020 are two programmes with a high potential to generate growth in Europe. Savings there would deprive European companies from an important source of finance to innovate, reach foreign markets and invest in the future. COSME addresses the crucial ingredients for the creation and growth of European SMEs by providing financial support for several key measures to support SMEs access to markets and financing, to reduce regulatory burdens and to stimulate entrepreneurship. Horizon 2020 s SME Instrument can help innovators access tailored research and support and thus capitalise on market opportunities. Structural Funds EUROCHAMBRES is a proponent of the Structural Funds financial instruments. The returns from revolving funds, loans, etc. are more beneficial than grants. In addition, it has been proven that a higher leverage for private investors can be achieved and performance incentives are greater. EUROCHAMBRES also supports the EU factoring infrastructure (transport, energy, ICT) into its strategy for long-term financing of the economy. However, the path through project bonds must be reviewed. So far, there is no reliable estimate of the costs and risks of private or private/public financing in relation to the conventional public financing and there is a lack of practical experience with this type of financing. EUROCHAMBRES is concerned that, particularly in the transport sector, the higher capital costs associated with private financing will not compensate for the marginally more rapid start of construction and the principle decision to build. It is also unclear who will take on the maintenance costs (usually the public sector). This approach may also undermine strategic network planning according to macro (and not microeconomic) criteria. In short, EUROCHAMBRES fears that this private financing method may in fact result in postponing and even increasing the costs for the public sector (i.e. tax payers). A thorough evaluation of the EU s project bond initiative should be conducted. It should also be taken into account that the Connecting Europe Facility as a source of direct funding can offer positive incentives. However, only limited means are available for direct funding. 6) To what extent and how can institutional investors play a greater role in the changing landscape of long-term financing? This can be done through better consultation and planning between the different stakeholders. National governments should have their national capital investment projects planned over a three to five year period so that investors would have a clearer idea what type of financing is required by the government and its agencies. EU Member States would also need to be very careful not to create a crowding out effect on raising the cost of capital for the private sector.

9 7) How can prudential objectives and the desire to support long-term financing best be balanced in the design and implementation of the respective prudential rules for insurers, reinsurers and pension funds, such as IORPs? 8) What are the barriers to creating pooled investment vehicles? Could platforms be developed at the EU level? The main barriers to creating pooled investment vehicles are: - Information and communication flow of information on the different market opportunities; - Different taxation policy in different Member States; - Language and business culture understanding that is a different business culture; - No common safeguards the European Commission may consider creative an overarching regulatory pan-european framework. 9) What other options and instruments could be considered to enhance the capacity of banks and institutional investors to channel long-term finance? Taking into account soft-policy tools, a proposal of new best-practice guidelines to promote long-term horizons in the governance and portfolio management of public pension funds and sovereign wealth funds could be put into consideration. At the same time, use of performance and asset allocation models that rely excessively on performance relative to market benchmarks and are inherently pro-cyclical in principle should not be encouraged. A transparency of measures among funds managers should be promoted to make it consistent with long-term investment horizons. The governing bodies of sovereign wealth funds and public pension schemes could be strengthened and given the necessary independence in decision making, while the boards should have the right mix of skills to design and evaluate the long-term investment strategies. Bearing in mind the discussions over bonuses under CRDIV-CRR package, conditionality between managers bonuses and their performance over a longer period could also be ensured to guarantee a focus on long-term returns. 10) Are there any cumulative impacts of current and planned prudential reforms on the level and cyclicality of aggregate long-term investment and how significant are they? How could any impact be best addressed? The Basel III reform does not target long-term bank finance directly, however, it may affect it by an increasing cost of long-term bank lending or decreasing a supply of it. Since it targets highly risk-prone activities reducing lending for expansion and productive activities, it also raises the

10 cost for banks to issue long-term corporate and project finance loans making it more expensive than issuing mortgages and short-term loans. The European Commission's proposal to review exactly what impact under Basel III (CRD IV / CRR), the LCR and the net stable funding ratio have on the long-term lending is a correct step to developing appropriate improvements. Uniform supervisory and management rules create more stability in Europe and help to restore confidence. That is why the revision of Solvency II is important for insurers to continue to invest in securitizations and long-term bank financing. 11) How could capital market financing of long-term investment be improved in Europe? 12) How can capital markets help fill the equity gap in Europe? What should change in the way market-based intermediation operates to ensure that the financing can better flow to long-term investments, better support the financing of long-term investment in economically-, socially- and environmentally-sustainable growthand ensuring adequate protection for investors and consumers? 13) What are the pros and cons of developing a more harmonised framework for covered bonds? What elements could compose this framework? 14) How could the securitisation market in the EU be revived in order to achieve the right balance between financial stability and the need to improve maturity transformation by the financial system? There is a need for: - Further standardisation of regulations and the legislative framework between EU Member States; - Better interoperability between the different European capital markets in terms of IT platforms and access for the small investors; - The creation of further fiscal incentives; - Reduction of government involvement in market and increasing opportunities for the private sector. Fiscal incentives A reduction of tax biasness towards debt financing could be one of the points of overcoming the debt-culture of Europe. According to the IMF study (2011) most tax systems today contain a debt bias offering a tax advantage to finance investments by debt. In most European countries the taxation of income from equity is harsher than the taxation of income from debt. 2 The 2 IMF Study (Tax Biases to Debt Finance: Assessing the Problem, Finding Solutions, Ruud A. de Mooij, May 2011)

11 following calculation illustrates TETR 3 on equity and TETR on debt in a situation, where profit is distributed either as dividend or as interest: Source: GEEF Majority of SMEs focus on debt financing what is also visible in statistics. Depending on the stage and sector of activity the ratio might differ. The share of equities in financing SMEs is significantly lower as well due to long-anchored loan financing habits. Equity shares vary due to heterogeneous tax laws, encouraging to more pro-equity approach in some countries such as in Belgium and discouraging in others such as in Germany. Despite a general agreement on tax biasness against equity, very little has been done for the moment. There is a need for coordinated action at European level on how to target this problem. The double taxation of equity should be removed in countries where it exists. In economies with mature debt markets, policy makers could consider changing the tax treatment of debt and/or equity in order to remove the bias, while also ensuring that policy changes are revenue neutral. Equity gap When it comes to equity gap one should look at the global level and not only on the European level. According to McKinsey Global Institute (2011) the potential global equity gap in 2020 will reach EUR 10 trillion. By 2020 equities are expected to decline from 28% to 22% of financial assets due to emerging markets and changes taking place in mature economies (reduced 3 TETR = Tax on corporate profits payable by the corporation + tax on dividend payable by the recipient of the dividend distributed from the corporate profits

12 demand, ageing, regulation etc). 4 It is important to realize that in reality there is no one definition of equity gap and one way of measuring it. It depends on type and stage of the undertaking as well as the sector of activity. Taking into account that services are less capital intensive the equity gap is lower there (Audretsch et al. 1999; Teruel-Carrizosa 2010). 5 In case of Europe and some of its wealthier economies such as France, Germany, Italy, Spain and the UK, the equity gap is expected to increase to EUR 2.5 trillion by Economies with less developed financial markets usually suffer from even higher equity gap. Equity gap is typical for modest investments, as a result of asymmetry of information and the necessity of evaluation of the project (diligence costs are relatively fixed and amount to EUR 25,000-63,000). As a result the potential investors will be more willing to invest in bigger projects in order to mitigate the diligence costs, what implies that smaller projects might have problems with obtaining finance from this particular source. Submarkets within stock-exchange such as NewConnect in Poland, AIM in the UK or First North in Scandinavia are tools targeting the equity gap but due to unpredictability and riskiness might not be perceived as permanent solution among SMEs. Corporate bond markets and securitization of long-term debt While the development of such markets is likely to take considerable time, during which bank financing will continue to dominate, an important step would be to create incentives and a regulatory framework for the development of securitization markets for long-term debt. Improving the regulatory framework, strengthening financial supervision and promoting transparency in equity markets in countries where these reforms are needed to lengthen financing horizons and diversify sources of funding is one of the options. Legal and institutional issues to be addressed include establishing clear creditor rights, prudential regulations and insolvency regimes. Governance and information infrastructure issues include the development of credit information systems, accounting and disclosure rules, and internal and external auditing systems. There should be sufficient enforcement of rules to enable the capital markets to function efficiently and protect the rights of creditors and minority shareholders. The ability of households to place their savings in capital markets by promoting the use of mutual funds, exchange-traded funds, and retail brokerages should be increased. It could be partially targeted 4 The emerging equity gap: Growth and stability in the new investor landscape MGI December Audretsch et al AUDRETSCH, D. B., KLOMP, L. oraz THURIK, A. R Do Services Differ from Manufacturing? the Post-Entry Performance of Firms in Dutch Services. w: AUDRETSCH, D. B. oraz THURIK, A. R. (red.) Innovation, Industry Evolution, and Employment. Cambridge, U.K.; New York: Cambridge University Press, ; Teruel-Carrizosa 2010 TERUEL-CARRIZOSA, M Why Do SMEs Grow? a Rejection of Gibrat s Law for Spanish Firms ( ). w: LENIHAN, H., ANDRÉOSSO-O'CALLAGHAN, B. oraz HART, M. (red.) SMEs in a Globalised World: Survival and Growth Strategies on Europe's Geographical Periphery. Cheltenham: Edward Elgar,

13 by financial education initiatives explaining the benefits of diversified sources of saving and of compounded annual returns. One could also consider: regular issuance of long-term government debt; creation of the infrastructure for secondary market trading; strengthening market infrastructure (for example, trading, depository, and clearing and settlement systems); rationalization of tax impediments; promotion of other types of debt securities such as social venture bonds, infrastructure bonds, and covered bonds. Examples The measurement of equity gap is important because it defines the size of public intervention. For example, depending on study the size of equity gap in Poland varies between EUR 60 and 170 million per year (Marciniak 2011) or EUR 172 million to EUR 1.29 billion (Tamowicz 2007). The value of projects that mentioned equity gap is embracing differs from EUR to EUR When it comes to innovative SMEs the equity gap amounts to EUR 3-4 million (Tamowicz 2007, Klonowski 2009) for projects above EUR 2.000, and EUR for projects below EUR According to the Polish Academy of Science (Institute of Economics) the biggest challenge in obtaining financing face projects of EUR 240,000- EUR 2.44 million. 6 In comparison, in the UK, Harding and Cowling (2006) have estimated the equity gap bottom line for 190, EUR and upper line for million EUR. It clearly shows that there is a pattern in lack of access to equity for innovative SMEs within this value of projects. Moreover, according to the Department for Business, Innovation and Skills of the UK, projects between EUR 320,000 to EUR 6.35 million face the biggest challenge to receive equity funding (BIS Economic Paper January 2012). In case of highly R&D and capital intensive sectors the gap amounts even to EUR 19 million. 15) What are the merits of the various models for a specific savings account available within the EU level? Could an EU model be designed? 16) What type of CIT reforms could improve investment conditions by removing distortions between debt and equity? 6 MARCINIAK, D Luka kapitałowa w Polsce - jej znaczenie i skala. w: BACZKO, T. (red.) Raport o innowacyjności gospodarki Polski w 2010 roku. Warszawa: INE PAN, ; TAMOWICZ, P. 2007a. Zapotrzebowanie mikro- małych i średnich przedsiębiorstw (MŚP) na finansowanie kapitałem private equity/venture capital (PE/ C) Gdańsk, Departament Instrumentów Wsparcia Ministerstwa Gospodarki. KLONOWSKI, D Innowacyjność sektora MSP w Polsce Rządowe programy wsparcia a luka finansowa, Warszawa, Ernst & Young; HARDING, R. oraz COWLING, M POINTS of VIEW: Assessing the Scale of the Equity Gap. Journal of Small Business and Enterprise Development, 13, 1, ; BIS Economic Paper no.16, January

14 17) What considerations should be taken into account for setting the right incentives at national level for long-term saving? In particular, how should tax incentives be used to encourage long-term saving in a balanced way? 18) Which types of corporate tax incentives are beneficial? What measures could be used to deal with the risks of arbitrage when exemptions/incentives are granted for specific activities? 19) Would deeper tax coordination in the EU support the financing of long-term investment? The Green Paper aims at the question of what is the contribution of tax policy to fiscal consolidation and sustainable growth. The question is raised with regards to the taxation of real estate and capital gains and must be designed to create an incentive for long-term investments, also in the context of climate change. A Europe-wide debate should be launched on how the tax base of corporate taxes should be designed in order to advance the goal of financial neutrality. With a view to greater resilience of the company the incentives for high borrowing rates should be underlined as it is the case in some Member States. According to the Green Paper the proposal to introduce a financial transaction tax via enhanced cooperation seems to create incentives for longer-term investments. However, there is a likelihood that part of the business will simply move to other regions of the world, or other forms of investment. (see also pages 9-10) 20) To what extent do you consider that the use of fair value accounting principles has led to short-termism in investor behaviour? What alternatives or other ways to compensate for such effects could be suggested? The European Commission refers to the various discussions on the impact of fair value assessments. The Green Paper raises the question of whether fair-value ratings promote shortterm investment and what alternatives there are which could be considered. The discussion on the long term investment and the impact of fair value accounting needs a close examination of the pros and cons of the fair value accounting in the perspective of listed and non-listed companies. Changing the accounting rules under which actors operate could foster long-term financial flows. One of options suggested is the approach called target-date accounting, that focuses on accounting for equities held for long-term investment purposes. Equity is well suited to financing long term investments, and is an effective form of risk-absorbing capital. It not only supports productive investments in the real economy, but promotes financial stability. However, in the

15 context of mark-to-market accounting, the short- to medium-term volatility of stock prices may discourage investors from allocating a high proportion of their portfolios to this instrument. Target-date accounting would address this issue by placing a diversified portfolio of equities into a target-date fund with a binding commitment to hold them for a long horizon. The manager could switch in and out of individual stocks but would need to remain invested in equities as an asset class. The fund would then be valued at a time-weighted average of cost and market value, thus smoothing out short-term volatility early in the life of the fund, but allowing for progressively greater recognition of volatility as the investments approach their maturity dates. 7 21) What kind of incentives could help promote better long-term shareholder engagement? 22) How can the mandates and incentives given to asset managers be developed to support long-term investment strategies and relationships? In general the European Commission has to respect the equal treatment of all shareholders, as mentioned in the article 4, directive 2007/36/EG: The company shall ensure equal treatment for all shareholders who are in the same position with regard to participation and the exercise of voting rights in the general meeting. We doubt if incentives would be compatible with incentives mentioned in the Green Paper. In addition to the activities that are already being addressed in the Green Paper on Corporate Governance, the following could be discussed: structuring incentives for asset managers, more transparency with regard to the fulfillment of fiduciary asset managers, grant greater voting rights to long-term investors or higher dividends. Moreover, once the need for disclosure of nonfinancial information is emphasized, it should encourage long-term investment. 23) Is there a need to revisit the definition of fiduciary duty in the context of long-term financing? 24) To what extent can increased integration of financial and non-financial information help provide a clearer overview of a company s long-term performance, and contribute to better investment decision-making? Depending on a company, its products and branch non-financial information could be in the interest of its stakeholders, but it is a decision to be made on a case-by-case basis if and which non-financial information is in the interest of different stakeholders. Therefore companies should 7 Group of Thirty

16 be encouraged to examine if and which non-financial information could contribute to better investment decision-making. The proposal for a directive amending Council directives 78/660/EEC and 83/349/EEC as regards disclosure of non-financial and diversity information by certain large companies and groups, COM (2013) 207 final, broadens the disclosure of non-financial information. Article 1a of the proposal will require large companies to disclose a statement including material information relating at least to environmental, social, and employee-related matters, respect of human rights, anti-corruption and bribery aspects. The statement has to include a description of its policies, results and risk-related aspects even if these aspects are not relevant for the understanding of the company's development and position. This is not consistent with the objective of an annual financial report. Therefore the proposal for a mandatory disclosure of non-financial information has to be rejected. 25) Is there a need to develop specific long-term benchmarks? 26) What further steps could be envisaged, in terms of EU regulation or other reforms, to facilitate SME access to alternative sources of finance? Crowdfunding could become a new source of capital for SMEs so there is a demand for removing legal obstacles on the EU-level (e.g. review of Prospectus Directive). 27) How could securitisation instruments for SMEs be designed? What are the best ways to use securitisation in order to mobilise financial intermediaries' capital for additional lending/investments to SMEs? 28) Would there be merit in creating a fully separate and distinct approach for SME markets? How and by whom could a market be developed for SMEs, including for securitised products specifically designed for SMEs financing needs? 29) Would an EU regulatory framework help or hinder the development of this alternative non-bank sources of finance for SMEs? What reforms could help support their continued growth? Design of securitisation instruments for SMEs and their use In the context of bad reputation earned during the financial crisis, it is important to draw attention to the fact that securitisation is just one of the diversification tools, and if properly used, it can improve liquidity and financing opportunities for business. That is the reason why the revitalisation of SME securitisation is an important element for the future growth of SME

17 financing. According to the European Investment Fund, it will be particularly relevant in the leasing area. Despite the financial crisis, the European securitisation market in general performed so far relatively well showing low default rates in the SME segment. Nowadays, the SME securitisation market (excluding pure European Central Bank-related transactions) slowly restarts. Investors appetite for SME credit as an asset class is quite strong. The securitisation, used in the right way, could spread risk intelligently. The future of the market, however, is dependent on several factors such as transparency, standardisation and trust. The revival of securitization markets is important; especially to give the banks in the euro zone a new scope. Also improved conditions of venture capital can positively contribute to long-term financing. However, all this can only be complementary as a bank loan will remain the main financial instrument of the SMEs. 30) In addition to the analysis and potential measures set out in this Green Paper, what else could contribute to the long-term financing of the European economy? Further information: Ms Iwona Mertin, Tel , mertin@eurochambres.eu