EVFIN Joint response to the Green Paper on Long Term Financing of the European Economy Brussels, June 12, 2013 Long Term financing supports in particular businesses with long-term financing needs from their early-growth stages to their late stage of development. It is a vital source of finance for companies, in particular for SMEs, which form the backbone of the European Union s economy. As national venture capital operators (mostly public funds of funds), the institutions gathered in the EU Venture Fund Investors Network (EVFIN)) 1 invest in venture capital funds so as to foster risk financing for SMEs in Europe. Most of its members also manage directly VC funds and thus, select, finance and coach companies with expected high growth opportunities and need long term financing. EVFIN members objectives are to ensure a healthy supply of and access to long term finance for SMEs. EVFIN members welcome the publication of the Green Paper on long term financing of the European economy and are convinced that Long Term Investment is essential in order to promote sustainable and smart growth in Europe. In view of the large scope of the Green Paper, EVFIN has preferred to address mainly the questions related to the supply of Long Term capital to SME and in particular the supply of Private Equity through Venture Capital. Other important aspects, such as the financing of Infrastructure or project bonds are addressed by other groups, such as the Long Term Investors Club in which some EVFIN members are also part of. It should be stressed that the opinion expressed in this document reflect the common view of EVFIN members, in particular in their Private Equity activity but does not necessarily reflect the position of their respective government. EVFIN members believe that the situation in Private Equity of most, if not all EU Member States as present the following challenges: the environment for VC in Europe as a whole has become exceptionally difficult since the financial crisis and therefore needs more attention; 1 EVFIN gathers 10 national and regional VC operators from 8 European countries and representing all EU s geographical regions: Caixa Capital (Portugal); Capital Dynamics (UK); Capital for Enterprise (UK); CDC Entreprises (France); Enterprise Ireland ; Finnish Industry Investment Ltd; Krajowy Fundusz Kapitałowy S.A (KFK - Poland); PMV (Belgium) ; Société régionale d investissement de Wallonie (SRIW - Belgium) ; New Economy Development Fund / TANEO (Greece).
VC funds, including publicly-backed funds, need to have sufficient critical mass and be sufficiently capitalised to ensure they are able to support firms through all stages at which there is a market failure; VC, rather than debt, is crucial for innovation and entrepreneurialism in Member States economies, which is essential for growth; a lack of VC slows the growth of businesses in the EU but can also lead them to seek finance elsewhere, for example the US, with the risk of losing IP from Member States and not benefiting from the commercial exploitation of our research and innovation; following the financial crisis of 2008, there is a big mismatch between what investors want, namely low risk and high liquidity and what VC funds are able to offer (long term investment with high risk and high potential returns); this has compounded the structural failure caused by information asymmetries and the cost of making equity investment. Providing long term financing for European venture capital funds is therefore essential to address those challenges. Answers to questions 1) Do you agree with the analysis out above regarding the supply and characteristics of long-term financing? The Green Paper provides a good analysis of long term investment and its role in the economy. It might be useful to add the key characteristics of various long term investments, in terms of risk and liquidity to address them as asset classes. The solutions to provide more long term financing are indeed different if we want to address the higher risk (that could be covered by guaranties or diversification) or the lack of liquidity (that could be addressed by securitization). 2) Do you have a view on the most appropriate definition of long-term financing? The main characteristic of long-term financing is the fact that such financing is made - with the expectation of keeping the asset for a long time - by an investor who also has long term stable liabilities - with the objective of generating a positive return. EVFIN members are long term investor alongside insurance companies, pension funds and national and multilateral development banks (such as EIB). Whatever their name, the long term investments can be split into three main categories: - The Medium term, up to 5 years, which corresponds to long term loans for SME and corporations and Private Equity investments in SMEs; - The Long term, above 5 years, which correspond to Private Equity Investment in funds (who have usually a 10 years life) and Corporate loans for real estate or investments in productive assets; - The Very Long term above 15 years which correspond to large infrastructure projects, usually financed by public entities or specialized funds 2
3) Given the evolving nature of the banking sector, going forward, what role do you see for banks in the channeling of financing to long-term investments? It is likely that in the future the commercial bank will focus more on short and medium term loans, in view of the new prudential regulation. For long term loans, banks will move to securitized loans both for corporate bonds and for infrastructure project. It is unlikely that bank will play a role as investors in Private Equity Funds who will have to rely on institutional investors, pension fund, national and multilateral development banks and national operators. 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? National and Multilateral Development Banks as well as national public operators such as EVFIN members play a important role in the long-term investment needs of the economy, at national or European level. The fact that they rely on long term liabilities and do not have a short term view on their return on investments enable them to keep their assets in periods of crisis and therefore play an important contra-cycling role. Their long term view allows them to invest in new economic sector, including high risk activities or sectors which are profitable only in the long term. When acting as prudent investors, they have a catalytic effect on the market by indirectly encouraging private investors to commit capital in the economy (through a signaling effect on the expected returns, on the governance and the terms and conditions of the funds when it comes down to private equity investment or on the volume effect). There is indeed room for greater coordination between national long terms investors, among themselves and with EU entities, in particular in cross-border investments. EVFIN has been set up as such a coordination platform between 10 European venture capital operators to exchange good practices, dialog with the EU institutions and set up some specific joint projects such as the Athena Innovation Fund of Funds project. The Athena Innovation Fund (AIF) is a joint initiative designed to pool capital and expertise of national operators in a common EU investment vehicle. It has been developed by 8 EVFIN members 2. It s an innovative project conceived as complementary to EIF fund of funds activity which aims to promote a bottom up development of the EU VC market. With a target size of 250m, AIF will select best European VC firms and increase their funding while helping them to operate cross-border. The fund s objective is to address the fragmentation of the EU VC market by increasing both the scale and scope of the European marketplace. Such a project, with a strong EU added value, could be usefully supported by the EU Cosme and Horizon 2020 programmes. 2 Caixa Capital (Portugal) ; Capital for Enterprise (UK); CDC Entreprises (France) ; Enterprise Ireland (Ireland) ; Finnish Industry Investment Ltd (Finland); Krajowy Fundusz Kapitałowy S.A (KFK - Poland); New Economy Development Fund / TANEO (Greece); PMV (Belgium) ; Société régionale d investissement de Wallonie (SRIW - Belgium). 3
The European Commission must make greater use of national public operators to manage financial instruments under the EU budget. Such cooperation could (i) benefit from these institutions in depth knowledge of the markets, (ii) improve synergies with existing public finance programmes and avoid duplication; (iii) result in a greater uptake of European financing mechanisms at national level, while also raising their profile. 5) Are there other public policy tools and frameworks that can support the financing of long-term investment? 6) To what extent and how can institutional investors play a greater role in the changing landscape of long-term financing? First of all, the relative withdrawal of some long-term institutional investors from long-term financing, such as insurance companies and pension funds can partly be explained by new regulatory requirements that would need some adjustments in particular to favor SME access to finance which does not represent any systemic risk. In the specific case of Private Equity, institutional investors could play a greater role in investing in well managed Private Equity Funds of Funds that offer both an appropriate risk diversification and a minimum size investment. 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? A well conceived set of prudential rules for long term investors in a broader sense should encourage them to avoid portfolio concentration in sector specific loans or complex financial instruments, to stay away from pro-cyclical investments and perform adequate due diligence for their investments. They should also be rewarded for investing in the long term. 8) What are the barriers to creating pooled investment vehicles? Could platforms be developed at the EU level? There are some barriers in terms of the wide disparity of tax rules and the lack of standardization and visibility of such investment vehicle. In the Private Equity sector, 8 EVFIN members have been working on such a joint investment vehicle (the Athena innovation Fund of Funds project, see question 4). Cofinancing such pilot project with the European budget (Horizon 2020 and Cosme Programmes) will be a significant encouragement to set up other similar 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 questions 5 and 6 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 concept contained in the Green Paper for an integrated re-calibration of the regulatory framework is the right approach for revisiting the prudential regulation to achieve stability and stronger incentives to invest in the long term. 4
11) How could capital market financing of long-term investment be improved in Europe? The transformation of the banking/financial sector due to strengthened regulatory requirements (Basel III/ CRD IV for banks and Solvency II for insurance companies) requires that EU Capital Markets play an increasing role in the long term financing needs of the European economy. It requires both a higher integration of financial markets in Europe and a unification of listing rules. New liquid financial instruments may also need to be created to promote long term assets. 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? 13) What are the pros and cons of developing a more harmonized framework for covered bonds? What elements could compose this framework? 14) How could the securitization 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? 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? 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? 20) To what extent do you consider that the use of fair value accounting principles has led to short-termism in investor behavior? What alternatives or other ways to compensate for such effects could be suggested? There is need to review the current regulatory and international accounting framework to take into account long-term investment specificities. In particular, fair value accounting and IFRS 9 discourage long terms investors to invest in Private Equity. 5
21) What kind of incentives could help promote better long-term shareholder engagement? Investors could be encouraged to keep their assets for a long term by creative incentives such as additional voting right, higher dividend or even additional shares. 22) How can the mandates and incentives given to asset managers be developed to support long-term investment strategies and relationships? 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? 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? 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 regionally (covering several European countries) to reflect varying levels of maturity in the markets, and to capitalise on regions existing complementary strengths and weaknesses. 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 (see question 4). 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. The initial objective should be to show that these vehicles can produce a worthwhile return, with the intention of attracting private capital subsequently. 27) How could securitization instruments for SMEs be designed? What are the best ways to use securitization in order to mobilize 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 securitized products specifically designed for SMEs financing needs? Yes, such a separate market would have simpler rules and administrative requirements to reduce the cost for SME. 29) Would an EU regulatory framework help or hinder the development of this alternative non-bank source of finance for SMEs? What reforms could help support their continued growth? It would indeed help the development of non-bank source of loans for SME 6
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? Eight EVFIN institutions have developed a venture capital fund of funds project designed as a prototype of financial instruments proposed in the Horizon 2020 and Cosme programs. They are ready to establish this vehicle at the very beginning of the next Multi annual Financial Framework with the EU leverage. ABOUT EVFIN EVFIN is a platform for dialogue launched in March 2011 by major national investors in venture capital (VC) in response to the continuing funding crisis in this sector across the EU. It gathers 10 national and regional venture capital operators, mostly public funds of funds, whose mission is to foster equity financing for SMEs. EVFIN objective is to enable sharing of best practices between national operators and to bring forward concrete measures at the EU level to create a self-sustained EU VC market, in cooperation with the EU institutions. Its members are: Caixa Capital (Portugal) ; Capital Dynamics (UK); Capital for Enterprise (UK); CDC Entreprises (France) ; Enterprise Ireland ; Finnish Industry Investment Ltd; Krajowy Fundusz Kapitałowy S.A (KFK - Poland); New Economy Development Fund / TANEO (Greece); PMV (Belgium) ; Société régionale d investissement de Wallonie (SRIW - Belgium). For more information, click here. 7