Department of Finance Response to the European Commission s Green Paper Long-term Financing of the European Economy

Transcription

1 Department of Finance Response to the European Commission s Green Paper Long-term Financing of the European Economy

2 Response to the European Commission s Green Paper Long-term Financing of the European Economy 1) Do you agree with the analysis set out above regarding the supply and characteristics of long-term financing? We would broadly agree with the analysis set out in the Green Paper regarding the supply and characteristics of long-term financing. For Europe, securing an appropriate level of finance for long-term investment in SMEs, infrastructure and other long-lived capital goods (e.g. social infrastructure, R&D, education and innovation), is critical in terms of driving economic growth and generating much needed employment opportunities. The Commission s Green Paper on Long Term Financing of the European Economy is an important development as it provides a clear signal that this is a key policy issue for Europe and that it is linked to priorities of the Europe 2020 Strategy, the 2012 Industrial Policy update, the Innovation Union initiative and the Connecting Europe Facility. It is important to stress that given the limited availability of public resources and the constraints on bank lending as a result of post-crisis deleveraging, it is now essential for policy makers and other relevant stakeholders to proactively explore how the effectiveness of the financial system markets, institutions and financial instruments can be improved to channel available savings towards the financing of necessary infrastructure projects and enterprises, especially SMEs. In particular, there is a need to ensure that Europe develops an appropriate suite of policy measures and initiatives that will facilitate a more diversified financial system with increased direct capital market financing and a greater involvement by institutional investors and alternative financial markets. Given the longer time horizons of their business models, institutional investors such as insurance companies, pension funds, mutual funds and endowments represent suitable providers of long-term financing. Ensuring an effective and efficient intermediation channels for long-term financing is a complex and multidimensional task that will need to embrace both a diverse set of enabling conditions the regulatory environment, accounting rules, corporate governance, taxation and State supports regimes as well as the specificities of different financial actors. It is recognised that new instruments, products and initiatives may also have to be developed to attract the supply of funding for long-term investment. Ultimately the aim is to create a more balanced financial system that is capable of providing a sustainable supply of finance for long-term investment in growth and jobs within Europe. Although this is a long-term goal it is important to start taking action now in order to ensure that Europe effectively harnesses the 2

3 potential of both a broader range of institutional investors and direct capital market financing. Achieving this more balanced and effective financial system will also require the development of more robust relationships and partnerships between bank and non-bank institutions within the intermediation channels for long-term financing. 2) Do you have a view on the most appropriate definitions of long-term financing? As the Green Paper notes there is no single universally accepted definition of long-term financing. In broad terms long-term financing can be considered as the process by which the financial system provides funding to pay for investments that stretch over an extended time period while the G20 contends that the focus should be on maturities in excess of five years (including sources of financing that have no specific maturity). Evidently in practice what constitutes long-term investment will vary between asset classes i.e. infrastructure compared to SMEs. Similarly what constitutes a long-term maturity will vary according to the investor for example banks compared to insurers. Furthermore long-term financing can incorporate the financing of both tangible assets (such as energy, transport and communication infrastructures, industrial and service facilities, housing and climate change and innovation technologies) and intangible assets (such as education and R&D) that boost innovation and competitiveness. In some respects trying to establish the most appropriate definition may be less important that forging a more robust shared understanding of the objectives of long-term financing namely to provide stable, patient and intelligent capital for productive investment that will support economic, social and environmental development. The work being undertaken by the OECD to define the principles of long-term investment (in relation to infrastructure) is an important development and there may be merit in exploring if similar principles could be devised for SMEs for example. 3) Given the evolving nature of the banking sectors, going forward, what role do you see for the banks in the channelling of financing to long-term investments? Notwithstanding the necessary process of deleveraging that is taking place within the European Banking system, the key intermediary and transmission roles undertaken by banks, in conjunction with their distribution networks, ensures that banks will remain key players in the European financial system. This is particularly the case in relation to the financing of SMEs especially micro and small firms. This highlights the importance of building a stable and successful banking sector that channel the funds of savers to 3

4 investment opportunities, transform bank deposits into loans and help businesses and individuals manage risk appropriately. There is a real need to reaffirm the core intermediary and transmission functions performed by banks credit analysis, pricing and managing risk, maturity transformation etc., and to encourage activities that strengthen their core capacities and functions. The opportunities for increased co-operation between banks, institutional investors and, where appropriate, public authorities in financing long-term investment in both infrastructure and SMEs also need to be fully explored. This will facilitate banks financing productive activities that correlate more strongly with their core competencies and respective risk appetite. It is also important to ensure that any real or perceived barriers to banks providing specialised finance products such as trade finance to SMEs across national borders are removed. 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? The European Investment Bank (EIB) has a pivotal role to play in terms of stimulating investment in the European economy particularly with regards to both infrastructure projects and SMEs. The approval of a 10 billion capital increase in 2012 by all member states will allow Europe s long-term lending institution under the umbrella of the Growth and Employment facility to provide up to 60 billion, over a three year period, in additional lending for economically viable projects across the EU. The EU-EIB Project Bond Initiative is an important and innovative development for European infrastructure projects in the fields of transport, energy and information technology. The EU-EIB Project Bond has demonstrated its capacity to unlock capital market investment in key infrastructure projects by means of enhancing the credit quality of project bonds (senior debt) issued by private companies. It will be critical, however, to ensure that the benefits of the capital increase, coupled with the funding package which emerges from the EU multiannual financial framework (MFF), impacts across the EU and especially in those Member States striving to stimulate economic and employment growth in the face of prolonged economic and fiscal challenges. There may, therefore, be an opportunity for the consideration by both the EIB and the EU of what more could be done by adopting a more tailored and flexible approach to providing assistance to Member States with projects seeking funding which may not have previously met their requirements in terms of project type and/or credit issues. 4

5 The lack of a robust aggregation or securitisation market that is capable of both channeling investor interest to enterprises and/or enabling the recycling of loan assets by banks is clearly a key constraint on credit flows to SMEs within Europe. Currently the EIB, EIF, together with the Commission and ECB are considering to how to best revitalize the securitisation market as a channel to mobilise more resources and redistribute risks across the economy in a sustainable way. Given constrained investor appetite it would appear that some form of short-term but effective EIB-ECB initiative to develop a market for SME-backed Asset Backed Securities (ABS) may be necessary to revitalize this market and stimulate actual credit flows to SMEs. The proposal under the new Multiannual Framework to allow Members States to voluntarily allocate part of their structural funds to joint Commission/EIB risk-sharing mechanisms to stimulate lending to SMEs is a positive and innovative measure that should be progressed by the respective organisations. In this regard there is certainly a good case for some form of pan-european support scheme under which the ECB could provide targeted funding to SMEs and the EIB/EIF provides credit enhancement via a first loss guarantee. Of particular importance is the opportunity to pool funding to create more standardised, EU wide credit enhancement or state guarantee scheme for SMEs that would operate on the same basis in each state. A pooling of structural funds into a pan-european SME loan portfolio would diversify risks, reduce budgetary, limit policy fragmentation and importantly create greater leverage capacity in participating states. Given the scale of unemployment across Europe and in particular the high levels of youth unemployment in the periphery it may now be time for both the ECB and EIB to develop a well-designed and targeted programme of sufficient scale that could facilitate new lending to sustainable SMEs in weak economics by in effect partially removing any country risk differentials from business rates. While the maintenance of triple A ratings are critical, it may be the time for Europe s multilateral banks to incorporate a greater degree of flexibility and innovation into their risk management strategies. The importance of SMEs to the European economy, both in terms of gross added value and total employment, ensures that there is scope for greater co-ordination between national and multilateral development banks in the pursuit of EU policy goals. The co-operation agreement between the EIB and BPI (Banque Publique d Investissment) which leverages the combined forces of national and Europeans support for SMEs, and channels it through an extensive localised bank network to SMEs, is indicative of the potential of enhanced coordination between EU and national level institutions. Equally, the recent agreement 5

6 between KfW and ICCO, under which the former will provide funding of approximately 800m to Spanish SMEs (at rates close to those enjoyed by German SMEs), highlights the potential for increased bilateral co-operation and co-ordination of effort. In this regards the EIB-EIF and the Commission and ECB could play a key intermediary role in fostering and facilitating such cross national initiatives especially where the benefits generated support not only national economic objectives but also the achievement of broader EU policy goals. 5) Are there other public policy tools and frameworks that can support the financing of long-term investment? What other options and instruments could be considered to enhance the capacity of banks and institutional investors to channel long-term finance? (Questions 5 and 9 answered together) Supporting the Financing of Infrastructure Regulatory, Fiscal and Legal Framework: Encouraging long-term institutional investment requires a consistent and coherent regulatory, fiscal and legal framework. Uncertainty as to future policy direction can both generate a higher required risk premia and undermine investor appetite. There is also a need to ensure that the regulatory, legal and fiscal regimes at both the national and supranational level adopt coherent and considered policies that are designed to facilitate increased institutional and capital market financing of the type of long-term investment that is necessary to achieve economic and employment growth. Project Pipelines: In order to build investor confidence in transaction flow by encouraging greater transparency in the pipeline of national and pan-european projects and ensuring that this pipeline is not determined by shorter term political horizons. Procurement Rules: National, regional and local authorities need to focus on ensuring a simpler, more efficient and standardised bidding process for infrastructure projects. Procurement processes should be adapted to take advantage of instruments such as bond solutions and variable credit spread pricing. In particular bonds have to be allowed to compete with bank debt by taking into account the specific process by which bonds are committed. Documentation also needs to become more standardised and in some instances simpler. Finally Public policy and the regulatory framework could also consider new financing models that allow a split of financing between construction and operation phases. This would facilitate banks and other institutional investors financing those phases which correlate more strongly with their core competencies and respective risk appetite. 6

7 Targeting Investors: There is a need for public authorities to proactively develop strategies and actions that are customized and tailored to the needs of both fixed income investors and public/private pension funds. Such authorities may also need to improve their marketing capabilities in terms of matching their infrastructural demands to a broader range of potential investors. Given the importance of scale in attracting institutional investors, public bodies (particularly at the local and regional level) will also in many instances have to collaborate to create a portfolio of infrastructure assets that will attract investment from pension funds, insurers or sovereign wealth funds. Capabilities and Quality Data: Building a more robust capital markets industry for project finance will necessitate considerable investment in building the requisite competencies and skills across the entire financial system including in banks, institutional investors and asset managers. There is also a need to ensure that there is sufficient quality data on the return and performance from long-term investment in infrastructure. New EU Financial Instruments: There is an opportunity under the new MFF for the EU to place a greater emphasis on the pooling of resources to create fewer, simpler and more demand driven risk sharing instruments at supra-national level (see question 4). EU-EIB Project Bond Initiative The EU-EIB Project Bond Initiative is an important and innovative development that has demonstrated its capacity to unlock capital market investment in key infrastructure projects by means of enhancing the credit quality of project bonds (senior debt) issued by private companies. This project however now has to be scaled up to ensure that its benefits are shared across all Member States (see question 4). Pan-European Municipal Bonds Market Policy makers and industry could collaboratively explore the possibilities of establishing a pan-european municipal bonds market so as to facilitate increased retail and institutional investment in infrastructure development. Stimulating such a pan-european municipal bonds market may require the use of standby facilities from institutional investors and multilateral banks i.e. the EIB to facilitate credit enhancement and/or risk sharing instruments. Alternatively it may require a public infrastructure bonds agency which could intermediate for private investors and/or facilitate liquidity. 7

8 Infrastructure Debt Funds There may be potential in initiating European scaled infrastructure debt funds with the capacity to deal simultaneously with greenfield and brownfield as well as primary and secondary projects. Securitisation While there has been increased debate regarding the role of securitisation in enhancing credit flows to corporates and SMES, securitisation technology can also be successfully be applied to the infrastructure sector through the utilisation of whole business securitisations. REIT Framework Harnessing the potential of REITS in attracting increased levels of institutional investment in real estate, including social housing would be, greatly enhance by ensuring the development of a consistent REIT framework across the EU. Long Term Investment Vehicles or Funds This is discussed in relation to questions 8 and 11. Supporting the Financing of SMEs Regulatory Framework As is the case with institutional and capital market funding of infrastructure there is a clear need to develop a consistent and co-ordinated regulatory framework that facilitates SMEs accessing equity and debt funding. There is a clear need to carefully monitor the manner in which the regulatory regime is evolving and quickly address any potential market obstacles to enhanced non-bank financing of the SME sector. Securitisation and Aggregation The potential of securitisation in enhancing credit flows to SMEs is discussed more fully under questions 14 and 27. One issue that may be worth exploring is how existing EU policy on securitisation could be reconfigured to allow regulatory treatment to differentiate between quality and performing products on one hand and more risky, speculative structured vehicles on the other. 8

9 Information and Data The costs and difficulties of accessing quality and standardised information on SMEs, creates problems in the pricing of risk of SMEs and is a major constraint in accessing capital market funding. This suggests the need to create a pan-european SME information and rating database (using pre-defined standards). This would allow firms to quickly analyse comparative risks and market sector trends across borders. Similarly, better and more standardised information on the SME loan performance is also required. Some member states have made efforts to improve the quality of SMEs financial information and there is nothing to prevent a number of states particularly those where SMES are significant providers of employment and added value seeking to develop agreed standards and providing the type of quality information that would support proper risk evaluation by marketbased investors. Member States, for example, could take action to ensure that any enterprise that avails of government backed financial supports would be statutorily required to provide annual business accounts including credit data to a government maintained database / website. This approach could moreover be replicated for pan-european supports to SMEs. Covered Bonds See answer to question 8 Fiscal and Legal Frameworks: As was the case in relation to infrastructure, the fiscal and legislative framework should incorporate a strong market orientation and in particular include measures that incentivize non-bank investment in SMEs and Venture Capital. Improving the quality and quantum of non-bank, direct market funding available to European companies, including SMEs, would benefit from greater consistency in the tax and legal regimes across member states. For example, moving towards the harmonisation of bankruptcy regimes would improve the environment for non-bank funding of SMEs. Although such a move would be highly ambitious, this should not prevent individual states actually exploring with others the potential for enhanced co-operation on such an issue. Initial Public Offerings (IPOs): Strategies to incentivise companies use of the IPO route are discussed under question 12. EU Financial Instruments The potential to develop more standardised pan-european supports for SME lending using EU financial instruments is discussed under question 4. 9

10 6) To what extent and how can institutional investors play a greater role in the changing landscape of long-term financing? Within the EU traditional bank lending loans and overdrafts accounts for on average 70 to 80 % of external SME financing, which contrasts sharply with the US where bank financing represents only 25% of the external financial resources of companies. This reflects the fact that in the US insurance companies, pension funds, securitisation vehicles and other non-bank financial institutions all play a stronger role in the financing of nonfinancial enterprises compared to Europe. Similarly in the US, Canada and Australia institutional investors such as insurance companies and pension funds are actively involved in providing finance for major economic and social infrastructure projects. While on average European Pension funds allocate 1-3% of their portfolio to infrastructure assets the average in Australia is 10-15%. Both Australian and Canadian Pension funds are also active investors in infrastructure within Europe. The longer time horizons of the business models for insurance companies, pension funds, mutual funds and endowments ensures that they are better equipped to match their longterm liabilities to investment in long-term assets. The trends in the US, Canada and Australia shows that there is considerable untapped potential in terms of encouraging increased levels of institutional investment in productive capital goods within Europe. Importantly there would appear to be a growing institutional appetite for investment in both infrastructure and corporate debt. The aftermath of the sovereign debt crisis combined with the emergence of a low yield environment (historically low interest rates) has encouraged institutional investors to diversify their portfolio and seek higher yielding corporate and infrastructure debt that is suitable to their business models. Such investments moreover can provide stable, more secure and long-term cash flows. Ensuring that institutional investors can play a more prominent role in the changing landscape of long-term financing, however will require both the development of an appropriate regulatory and legal framework across the EU and also the adoption of a broad suite of policy measures and initiatives, many of which are discussed in this paper. 10

11 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? In the wake of the Global financial crisis, the EU has been pursuing a necessary and comprehensive programme of financial reform that is designed to strengthen its regulatory and supervisory framework. While securing financial stability is a necessary precondition for growth in Europe it is not sufficient on its own to drive the much needed economic recovery that Europe and its citizens require. As the Green paper highlights policy makers and other stakeholders face the difficult challenge of balancing prudential objectives with the desire to support long-term financing, For example, the potential impact of new prudential rules (Solvency II) on insurers long-term financing ability is in part in dependent on their individual starting point and on the exact finetuning of how longer-term assets are treated. In this context it was significant that the Commission asked the European Insurance and Occupational Pensions Authority (EIOPA) to examine whether the detailed calibration of capital requirements for investments in certain assets under the Solvency II regime (including infrastructure financing and project bonds; SME financing; debt securitisation etc.) should be adjusted to ensure there are no obstacles to long-term financing, albeit without creating additional prudential risks. It is important that the findings from this recently published report are used to frame a pragmatic agreement on an appropriate regulatory framework which can balance prudential objectives with the desire to support the capacity of institutional investors in this instance insurance firms to provide long-term financing for the economy. This model of asking the appropriate regulatory body to examine the detailed calibration of capital requirements in targeted assets should be incorporated into the design of prudential rules. Given the importance of securing an appropriate supply of finance for long-term investment in economic growth and jobs the EU may have to consider if indeed the best way to make infrastructure, private equity and socially responsible investment attractive to insurers is to actually provide a clear derogation or exemption as opposed to focusing on technical adjustments of capital requirements. This would represent a major shift in policy and would clearly have to be underpinned by a strong economic and social rationale. The recent decision by the Commission not to proceed with the application of a Solvency IIstyle prudential rules to institutions for occupational retirement provisions (IORPS) would appear to be a positive development. 11

12 8) What are the barriers to creating pooled investment vehicles? Could platforms be developed at the EU level? The main barriers to the creation of pooled investment vehicles that would operate on a cross-border or pan-european basis are firstly national differences with regards to the tax, legal and regulatory frameworks. Secondly the development of pooled investment vehicles has also been constrained by a lack of both standardisation and visibility. Despite these barriers it is possible that such platforms could be developed at the EU level. The commitment by the Commission to develop proposals for new long-term investment funds (LTIF) could serve to harness the potential of EU-wide investment vehicles that are targeted at productive investments. In particular, if designed appropriately, such long-term investment funds could act as an effective mechanism for pooling institutional and retail investment and channeling it to alternative investments asset classes that fall outside the traditional definition of listed shares and bonds for example real estate, unlisted companies or infrastructure projects. To date, there has been considerable emphasis on passports on the liabilities side and as such the development of a long term investment fund could facilitate an equal focus on passporting on the assets side. There would certainly appear to be a number of advantages for a Long Term Investment Fund if it was afforded a passport that allowed it to access asset types across borders on a similar basis to banks. This would include access to both the corporate/sme loan market and also infrastructure assets. Harnessing the full potential of such vehicles however will require that the European Commission works with Member States to ensure that national tax, regulatory and legislative rules facilitate institutional investment in such vehicles. 9) What other options and instruments could be considered to enhance the capacity of banks and institutional investors to channel long-term finance? See Answer to Question 5 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 Green Paper highlights that when considering all enacted and planned future changes to prudential regulations addressing the various financial actors, an important question is whether their cumulative impact on long-term macroeconomic capital formation could be greater than the simple sum of effects of each prudential reform taken in isolation? 12

13 The international body the Financial Stability Board (FSB) has been exploring the potential impact on long-term financing of both internationally agreed reforms and other national/regional policy measures on financial institutions. The FSB recognise that there are certainly short-term transition costs associated with the adoption of new prudential and supervisory reforms and that this may have some impact on aggregate long-term investment. However, they contend that as these reforms are designed to promote a safer and more resilient financial sector and consequently they will in the long-term make a positive contribution to the provision of long-term finance. The FSB and other international bodies such as the OECD do agree that there is a need to monitor European and other international financial regulatory reforms on an on-going basis in order to identify any regulatory factors that may materially affect the provision of long-term finance so that they can be addressed. It is also accepted that there should be a greater emphasis on the phasing in of regulatory reforms so as to minimise the negative impact of regulatory change. More fundamentally if the EU is seeking to promote a more balanced financial system in which a wider set of institutional actors pension funds, insurers, sovereign wealth funds in conjunction with capital markets, complement the traditional role of banks in providing financing for long-term investment in the economy then the regulation of these former institutions and markets may need further study to ensure their effectiveness and efficiency in playing this role. Thus while investors need to respond to the new environment of falling yields and to restructure and diversify their portfolios to take advantage of alternative sources of income and capital growth (including infrastructure and corporate assets) policy makers need to create sufficient regulatory space to allow investors to make a longer-term assessment of the risks and volatility of the assets in which they invest. The concept contained in the Green paper for an integrated re-calibration of the regulatory framework would appear to represent a step in the right direction for revisiting the prudential regulation in a manner that both achieves financial stability and also provides incentives for long-term investment by institutions. EU and national level policy needs to adopt a coordinated and focused approach to framing a consistent and long-term orientated framework that while securing stability will also increase the ability and willingness of institutional investors to take long-term investment decisions to meet their long-term liabilities. 13

14 The challenge, as raised by the Green Paper, is to achieve the regulatory goals of greater macro-financial stability and global regulatory convergence in a way that minimises any negative incentives for financing productive long-term investment. Without underestimating the complexities of this challenge, there have been suggestions that this process could be assisted by rethinking the relationship between financial stability and growth. The overall objective of the evolving regulatory and supervisory framework in Europe is to secure greater stability within the financial sector. Ensuring a stable and steady flow of long-term investment will contribute to this objective. Similarly, building institutional investor s confidence to the extent that they are willing to make the types of long-term investment that will drive growth necessitates greater financial stability and less pro-cyclicality. Furthermore there is a need for intensive problem solving dialogue between policy makers and industry. This could serve to not only foster greater reciprocity amongst stakeholders but also to generate practical solutions to difficult problems. This dialogue moreover should be forward looking how to secure stability and growth going forward as opposed to being dominated by legacy issues associated with the crisis. 11) How could capital market financing of long-term investment be improved in Europe? What other options and instruments could be considered to enhance the capacity of banks and institutional investors to channel long-term finance? As was noted in relation to Question 8 the development of a European Long Term Investment Fund harbours considerable potential in terms of channeling institutional investment into productive assets such as infrastructure and corporates. The impact of such a pooled investment vehicle could be augmented considerably by standardizing the conditions for the provision of capital by non-bank lenders throughout Europe through the application of a European Asset Passport. Such an Asset Passport could be operationalized through a pan-european pooled investment fund solution and indeed the Commission is currently developing proposals for a European Long Term Investment Fund. Given that banks are continuing to deleverage there is a clear need to facilitate the establishment of direct lending funds targeting medium sized enterprises that are not distressed but are bank-lending constrained. These could include direct financing by distressed debt firms, private equity firms, and venture capital, hedge funds and business development corporations. Indeed there may be an opportunity for the proposed new European Long Term Investment Fund to function something like a Business Development 14

15 Corporation (BDC) does in the US as means of pooling investor capital (a BDC is a publicly listed vehicle designated to invest in lending to companies with certain pre-set criteria). 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 growth and ensuring adequate protection for investors and consumers? MIFID II The proposals under the MiFID II to create a new subcategory of markets known as SME growth markets are a positive initial step that should support growing companies to access capital markets by raising the profile and visibility of these markets within the investor community. There will however be a need to strike an appropriate balance between maintaining high levels of investor protection, which are essential to fostering investor confidence in issuers on these markets, while reducing unnecessary administrative burdens for issuers on those markets. IPOs Drawing on the example of the US, there is a need for co-ordinated and focused policies at the national and EU levels, that are designed to incentivise dynamic companies both SMEs and larger corporations to continue to grow and scale using the IPO route to raise development finance as opposed to a trade sale exit. Firstly the EU should consider the establishment or encouragement (through incentive, fiscal or otherwise) of collective investment vehicles for pan EU investment in quoted SME s, possibly through UCITs regulations. Secondly the development of a centralised EU information hub for EU SMEs, that would facilitate better and more centralised information on quoted SMEs in the EU. Thirdly there should be an increased focus on standardising investor information, accounting and otherwise, for SMEs, enabling easier analysis and cross sectoral comparison. Finally developing small and mid-cap financing through growth markets or private placement mechanisms requires the (re)building of an ecosystem comprised of dedicated analysts, brokers, market makers, ratings etc., in order to both advise and support issuers and investors and foster the liquidity of these markets. 15

16 Venture Capital Aside from the fact that the broader economic and financial environment is challenging, the development of the European Venture Capital industry also faces other longer standing barriers including: continued fragmentation along national borders with only very few pan-european VC funds; the small size of VC funds in Europe; and, the relatively low returns compared to other forms of private equity. In terms of practical steps to strengthen the European VC industry, the potential developments in relation to a European Marketing Passport is a positive initiative as allowing all managers of qualifying venture capital funds access to eligible investors across the EU should encourage the establishment of larger cross country funds. One specific approach to encourage Private Equity investing is the setting of European venture capital funds of funds to increase the depth and liquidity of the market and to promote cross-border activity in the funds being supported. These funds could operate on a sectoral basis and would be targeted at sectors across Europe with high growth potential. These funds of funds could build on national venture capital operators for their management either individually or gathered in a pool, and benefit from their knowledge of the markets to select the best venture capital funds In view of the disappointing performance of European risk capital over the last ten years, it is unlikely that private investors will be attracted to these funds of funds at inception and as such public investment/equity would be required to demonstrate that these vehicles can produce a worthwhile return, with the intention of attracting additional private capital subsequently. 13) What are the pros and cons of developing a more harmonised framework for covered bonds? What elements could compose such a framework? It is clearly important that financial institutions have access to a variety of funding sources that are robust under stress as this can contribute to this enhancing the stability of both individual institutions and the broader financial system. In the wake of the financial crisis covered bonds have played an increased role in providing a stable funding base for banks across Europe, which in combination with other financial tools has the potential to support more sustainable lending to the real economy. The development of a more harmonised framework for covered bonds within the EU could facilitate the emergence of a more robust, deep and liquid market for such financial tools. 16

17 The development of a more robust, deep and liquid market would serve to enhance investor confidence, enable access to a wider range of investors and also potentially increase the flow and scale of institutional investment in such products. An effective harmonised framework moreover would also contribute to the promotion of financial stability. Seeking to develop a more harmonised framework for covered bonds could however lead to lengthy and protracted negotiations and an increased degree of uncertainty as to what elements would compose such a framework. This consequently could serve to undermine institutional investor s confidence in the covered bonds market. A harmonised framework for covered bonds in the EU should establish a minimum, but high, set of regulatory standards on transparency and asset quality for covered bonds, on rules for collateralisation and asset encumbrance and systematic rules on capital requirements. These minimum standards should reflect, as far as possible, international best practice and would ensure that investors have access to all relevant information about covered bonds, including the data on the underlying loans in the cover pool. Finally the harmonised framework would also need to identify the agency/institution that would be responsible for overseeing this framework and outline the characteristics of such a body. Finally the minimum standards set out in the framework should ensure that investors have access to all relevant information about the covered bond (including data on the underlying loans in the cover pool) as it is this type of disclosure that promotes stability, reduces uncertainty and facilitates increased investment. 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? Reviving the securitization market in the EU to achieve the right balance between financial stability and the need to improve maturity transformation by the financial system will require a suite of initiatives and measures that are designed to (re)build trust in such structured financial instruments. As was noted in the answer to Question 4 there would appear to be a strong case for a short-term but targeted EIB-ECB initiative to develop a market for SMEbacked Asset Backed Securities (ABS) as means of stimulating actual credit flows to SMEs. Secondly the measures currently proposed by IOSCO to make securitisation safer and more transparent should contribute to a rebuilding trust in these instruments. In a similar context industry initiatives such as the Prime Collateralised Securities (PCS) which aims to establish a label or quality kite mark, which can be awarded to securitisation issuance that meets strict criteria in relation to transparency, simplicity, liquidity and quality, can also assist in 17

18 achieving the right balance between financial stability and improving maturity transformation within the financial system. Thirdly it has been suggested by industry analysts that boosting this market will necessitate making sure that loans are sold with sufficient margin (which will increase their price) and that this could involve temporarily increasing public support mechanisms i.e. guarantees provided by the EIF for example. If such a measure were adopted it would be essential that targets or benchmarks for additional lending to businesses especially SMEs were clearly set in order to avoid the benefits being captured solely by the financial institutions. Fourthly there may be merit in creating a specific asset class for SME and midcap securitised credits eligible for use as collateral in ECB refinancing operations. Fifthly developing a strong and robust securitised products requires an approach which facilitates co-operation between banks, institutional investors and where appropriate public institutions. Banks will continue to play a strong role in loan origination and credit risk analysis, with the institutional investors such as insurance companies providing the necessary liquidity. Furthermore, where appropriate public bodies may also be involved in terms of providing some form of credit enhancement or risk-sharing guarantee. Critically the structured vehicle must be designed to ensure both a fair share of risk and rewards between participants and appropriate levels of transparency and disclosure. Thus for example while banks will focus primarily on loan origination and credit risk analysis they should retain part of the risk to ensure they have skin in the game. Finally it is accepted that financial regulation can have a particular impact on the development of the securitisation market in Europe. In this context any potential unintended consequences of Solvency II requirements on the capacity of insurers to buy securitisation products will have to be addressed in a manner that does not undermine the objective of strengthening financial stability in that sector. 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? Existing nationally based savings accounts such as the UK s ISA or the French Livret A are designed around specific national tax benefits and incentives and as such it would not at the current juncture seem feasible to have an EU model without a common tax base. Furthermore there may be considerable opposition from Member States to an initiative that channeled domestic savings way from national schemes to a pan-european one. 18

19 16) What type of CIT reforms could improve investment conditions by removing distortions between debt and equity? 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? It seems clear that tax issues are not central to coordinated policy solutions to long-term financing issues. Nonetheless, the tax issues identified in the report are useful to consider in particular the distortions caused by the debt-equity bias. It is clear that tax systems generally perpetuate a debt bias because the tax treatment of debt and equity is not neutral. While Ireland has already partially addressed this issue in the income tax sphere by phasing out residential mortgage interest relief, addressing the corporate debt bias is potentially more difficult. This is because removing interest deductibility could reduce a country s competitiveness were it to act unilaterally and the alternative of allowing deductibility for returns on equity would be too costly in the current economic environment. We would therefore welcome further discussions at EU level on the design of corporate tax bases with respect to their financing neutrality. In terms of corporate taxation, Ireland has a relatively low rate of corporate taxation on a broad base with relatively few targeted incentives e.g. R&D tax credit. As noted, there needs to be strong evidence of market failure to justify policy intervention. In relation to reducing the risk of arbitrage, Ireland notes the positive work of both the EU Commission and the EU Code of Conduct in this regard. Recent progress in improving automatic exchange of tax information between national tax authorities should also assist in this regard. 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 use of fair value accounting principles can exert different negative effects on long-term investor behavior and in particular encourage short-termism and pro-cyclicality. The role of a long-term investor is to hold assets and projects on a long-term period, no matter the 19

20 volatility in the interim period. The underlying asset could be a non-liquid asset (tailored finance project) or a simple liquid equity or bond held on a long-term period. In the case of a security for example, it would appear that the fair value system incentivizes investors to sell it during a period of price increase thus undermining any specific long-term investment strategy. Addressing what could be considered an unintended consequence will require accounting standards both recognizing, and relying on, the long-term investor business model. It has been suggested that a third accounting portfolio could be created in addition to fair value through profit and loss and amortised cost. This category would be dedicated to long-term investments strategy and managed on the basis of a business model that does not involve either the realisation of short-term capital gains or the collection of cash flow. Another proposition would be to introduce a more simple Available for Sale (AFS) category (variation of fair value though OCI with recycling of gains and losses in profit and loss at the exit period). 21) What kind of incentives could help promote better long-term shareholder engagement? Investors could be encouraged to keep their assets for a longer-term by creative incentives such an additional voting rights, higher dividends or even additional incentives. Equally there may be a need to remove any perverse incentives that would encourage a more short-term and speculative approach by shareholders. 22) How can the mandates and incentives given to asset managers be developed to support long-term investment strategies and relationships? Firstly there is a need to move away from performance evaluations and mandates that are generally short-term based and which create both pressure and indeed incentives to take short term risks which may not be in the interests of either the institutional investors or the assets in question. Addressing this situation will necessitate a combination of measures. Firstly the performance measurement system for an asset manager should incorporate longer-term performance targets; the monitoring of the investment turnover ratio of a fund manager and an assessment of performance in different market conditions. Secondly asset managers should adopt good practice statements that promote stewardship and long-term decision making. Thirdly the mandate and its relationship with performance measurement needs to be closely supervised and monitored by investors. Finally there is need to enhance the relationship between asset managers and companies with in particular a more overt focus on identifying long-term goals and risks. 20

21 23) Is there a need to revisit the definition of fiduciary duty in the context of long-term financing? Rather than focusing on revisiting the definition of fiduciary duty in the context of long-term financing the emphasis should be on promoting a better understanding of its full scope. This discussion should highlight for investors and/or asset managers that looking after the interests of investor or client is actually complimentary to the engaging with companies to improve their performance over the medium to long-term. In particular this discussion should stress that an overt focus on the short term asset or share price is not in the longterm interests of any stakeholders and may actually serve to undermine the objectives and returns associated with 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? Ultimately it is important that companies provide appropriate information that will enable investors to make informed and qualified decisions regarding their long-term performance. Companies should focus on those matters, both financial and non-financial, that directly impact on their long-term success and which can assist in explaining their performance to date. Certainly following the financial crisis of 2008 relying purely on financial information may not be viewed as sufficient for investors to make an informed decision about the competitive strengths of a particular company. As it would difficult to develop a standardised list of financial and non-financial information that should be provided there may be scope to develop some form of corporate guidance that would assist companies in identifying the type of material they should seek to provide if they are seeking to attract non-bank funding. 25) Is there a need to develop specific long-term benchmarks? The lack of objective, high quality data for less liquid classes in particular infrastructure equity and debt in combination with the absence of agreed benchmarks makes it difficult to assess the risks of these investments and to compare correlations with the investment returns of other assets. Without such information institutional investors are more reluctant to make allocations to such long-term assets. As outlined above there is also a need to regulate and standardise SME information and data to allow the correct pricing of risk. 21