pggm.nl Position Paper Capital Markets Union Introduction PGGM is a cooperative responsible for serving institutions for occupational retirement provision (IORP s). PGGM was founded by employers and employees in the different health care and social services sector. The cooperative board consists of paritarian representatives. Coming from this history PGGM s largest client is the Dutch Pension Fund for the Healthcare and Welfare sector (PFZW). As a pension services provider, PGGM is responsible for pension administration and asset management for 6 Dutch IORP s. In addition, PGGM provides managerial and policy support for Boards of Trustees of IORP s. On behalf of its clients PGGM takes care of the day-to-day affairs for the pensions of about 2.6 million people and has over 200 billion assets under management. As a cooperative PGGM is not for profit; the same characteristic counts for PFZW as a pension fund being a foundation. As a final characteristic, it should be added that PGGM and PFZW are of the opinion that financial return and responsibility towards society should go hand in hand. Corporate governance and sustainable investment are second nature to us. Therefore we invest in projects and assets in which environmental, social and governance standards are met. 1. Pension funds core objective is retirement provision. Our fiduciary duty to do so in the best interest of participants is aligned with the prudent person principle as laid out in the IORP Directive. We invest in the economy on behalf of our pension fund participants, their long term pension ambition comes first. Key is high quality investment opportunities and diversification of risk. 2. Combining fiduciary duty with responsible investing. PFZW and PGGM act as responsible investors and encourage other investors to do this as well. We do this by including non-financial factors like climate impact and investing in solutions for sustainable development into the investment process. 3. Strong EU home bias. Dutch pension funds act in accordance with the prudent person principle. Diversification of the portfolio by asset class as well as geography is the consequence. Close to half of Dutch pension assets under management is invested in Europe (ranging from government bonds to equity investments in companies). This is also the case for PFZW and PGGM. 4. Consistency in policy and reliable governments on all levels is crucial. European policy targeted on energy union, innovation and infrastructure is beneficial to the growth of the European economy and thus creating opportunities for global investors. Prudential regulation should encourage long term investing in the EU economy and avoid focus on short term liquidity only. 5. Role of EU should be targeted and pragmatic. Examples of European solutions could be creating a platform in order to explore and facilitate European, national and local initiatives for standardising and upscaling investment opportunities, standardising of contracts and other project documentation or harmonisation of VAT treatment on investments.
Background On 18 February, the European Commission published a Green Paper on Building a Capital Markets Union. In our view, the Green Paper marks the start of a dialogue between market agents and policy makers of how a balance can be struck between financial regulation and economic growth and financial stability. In this respect we 1 support the European Commission to call upon long term financiers to take up the challenge that in an environment of constrained public resources alternative resources should be unlocked. PGGM and PFZW are committed to play an active and constructive role in this discussion and our viewpoints are listed in this position paper. After all, future investments and consequently economic growth is influenced by the choices made by investors like us. Before going into detail on the issues raised by the green paper Building a Capital Market Union PGGM and PFZW would like to highlight the following key messages: European Union is our home market; what is the relevance of a Capital Market Union for PGGM? Pension Funds as Long term Investors: General Principles Pension funds are long-term investors. They seek assets with long and stable cash flows, ideally linked to inflation, that match well with their liabilities. A long investment horizon allows them to invest in asset classes that are not accessible to short-term investors, such as illiquid, private assets or asset classes with high start-up costs. Long-term investing thus brings financial benefits in terms of higher expected returns as well as potentially lower risks. Long term horizon and creation of long term value. Because of their long investment horizon, pension funds (and other long-term investors) need to consider and prepare for scenarios that may seem unlikely in the short run, but with a potentially huge impact in the long run, both for society and their portfolios. It is only good risk management to incorporate sustainability factors, such as ESG (environment, social and governance) into their investment decisions. Investment opportunities that address major challenges for society, such as climate change, are increasingly sought after. Moreover, as active owners, pension funds engage with their investee companies such that they will create long-term value. Generating social returns without compromising on financial returns. In many ways, pension funds are similar to commercial investors. They have a fiduciary duty to allocate their investments into asset classes that optimise (expected) risk/return, subject to internal and external constraints. Social returns are not a substitute for financial returns, but many funds express an ambition to generate social returns without compromising financial returns, as they realise that a pension is worth more in a pleasant and healthy environment. Banks will continue to play an important role in financing SMEs. Unlike banks, pension funds do not sell multiple products to their investee companies. Banks offer current and savings accounts, lines of credit, hedging facilities, among other things, which allow them to monitor clients on a continuous basis with little effort. Also, they can cross-subsidise products. This makes them more natural lenders to small and medium-sized enterprises (SMEs). Pension funds can only step in at higher costs or via risk-sharing transactions with banks. Upscaling reduces costs and can make investment opportunities more attractive. Expertise to manage illiquid assets such as infrastructure internally is concentrated in a few large pension service providers. The pension sector in the Netherlands is increasingly consolidated, as smaller funds disappear or merge with larger funds. The number of funds has halved from more than 800 in the early 2000s to less than 361 in 2014. Collectively, the three largest service providers manage approximately 60% of total pension savings. The largest funds and providers naturally seek large investment opportunities, as the fixed (due diligence and monitoring) costs for small projects are prohibitive. To make smaller projects more attractive and to help smaller funds access these markets, the Netherlands Investment Institution was recently established, which will, among other things, standardise and bundle investment opportunities. Strong EU home bias. With on average 14% invested in the Netherlands and 43% in the euro area (March 2013), pension funds have a significant home bias already. The shares in global GDP correspond to 1% and 23%, respectively. 1. We refers to both PGGM and PFZW, unless otherwise stated. 2 Position Paper Capital Markets Union
Diversification of risk globally and across asset classes based on prudent person principle. Diversification of risk remains important. Historically, accumulated investment returns comprise the bulk of pension savings at retirement. Generating a good pension at reasonable cost requires risk taking. To achieve this, it is necessary to diversify over asset classes and geographies, especially as beneficiaries are exposed to the domestic economy in other ways as well. The scope for further increasing the home bias in the investment portfolios is therefore limited. Pension funds are subject to strict prudential regulation. Like banks, pension funds in the Netherlands are subject to strict prudential regulation. The financial assessment framework ( financieel toetsingskader, FTK) imposes risk-based solvency requirements on investments, and thus restricts the allocation to investments considered risky. In current circumstances with low solvency rates, few pension funds are in a position to add risk to their portfolios in net terms. As pension fund and pension fund investor our fiduciary duty is our first and foremost objective. We are investing in the global economy on behalf of the pension fund participants, their pension ambition comes first. Dutch pension funds need to perform according to prudent person principle. Diversification of the portfolio as well as geography is the consequence. Still, close to half of investments are done within the EU. Pension funds are subject to strict prudential regulation. Ambition of a pension fund investor PFZW and PGGM are strongly committed to being responsible investors. As such we work to advance corporate governance standards because we recognise their rights and responsibilities as shareholders and (co-)owners of the companies they have invested in, as well as the impact of environmental, social and governance (ESG) factors on risk-adjusted returns. In addition, we believe that by including non-financial factors into the investment process, the risk and return profile of our investment portfolios can be improved, which will be to the benefit of the pension participants. A sustainable financial system is a necessary condition for a healthy investment climate in the long run. To be able to provide a good pension we need a sustainable financial system. This means that we need a financial sector which is healthy in the long run, has customer focus and contributes to the real economy. PGGM and PFZW are convinced that a sustainable financial system is a precondition for accomplishing the long term pension ambitions of our clients and investing in a sustainable financial system pays off in the long term. ESG integration. Because of their long investment horizon, pension funds (and other long-term investors) need to consider and prepare for scenarios that may seem unlikely in the short run, but with potentially dramatic consequences in the long run, both for society and their portfolios. It is only good risk management to incorporate sustainability factors, such as ESG (environment, social and governance) into their investment decisions. Investment opportunities that address major challenges for society, such as climate change, are increasingly sought after. Moreover, as active owners, we engage with their investee companies such that they will create long-term value. PFZW has set an ambitious target to substantially increase investments that directly contribute to sustainable development. The focus areas for this target are climate change, water availability, health(care) and food security. The billions of euro s that will be invested this way, will have to meet normal financial (risk return) criteria and social impact criteria. We will look for investment opportunities in all asset classes. However, we have particularly high expectations for our infrastructure investments. These investments potentially fit very well with Europe s climate change and energy ambitions for 2030. Governments must be reliable partners. Most infrastructure investment depends on government guarantees, regulated revenue streams and/or subsidies. As such, political and regulatory risk is critically important. Since infrastructure investment is of a very long duration it needs to be resilient to changes in government. Sudden changes in regulation reduce investors risk appetite and, hence, future supply of finance. Moreover, such changes increase the perceived regulatory risk for other sectors as well. Differences in asset allocation reflect also the credibility of individual countries. Retroactive changes for renewable energy have brought foreign direct investment to a standstill in some countries and have hugely damaged investor confidence. Infrastructure investment by international investors will only rebound in those countries if renegotiation risk is mitigated. 3 Position Paper Capital Markets Union
Intermezzo Three cases of long term ambitions of different asset classes. Growth perspective from PGGM and PFZW. Infrastructure: On behalf of PFZW, PGGM has invested 5 billion in infrastructure. Around 80% of this amount is invested in the EU. The growth ambition of PFZW is aiming at 14 billion in 2020. Large parts of the portfolio are invested in sustainable energy. Private Equity: Current size of this category is 9 billion with a growth ambition towards 13.5 billion in 2020. Non listed Real Estate: The PGGM Private Real Estate team currently manages 11bn of private real estate investments, on behalf of several clients. 9.3bn is invested through the Private Real Estate Fund, of which one third is invested in Europe. Over the period 2015 2017 another 1bn is expected to be invested in Europe. Over the period 2015-2020 we expect to invest 500m per year in so called investments in solutions for sustainable development. Acting as a responsible investor: PFZW has set an ambitious target to substantially increase investments that directly contribute to sustainable development. The focus areas for this target are climate change, water availability, health(care) and food security. The quality of investments is key; these should lead to a more sustainable society, innovation and the creation of an Energy Union. Steering on quantitative criteria only leads to short term behaviour. Impact of European Policy CMU is in itself a good objective when it comes to substitution of bank financing. However, there are areas where the EU can contribute positively or produce effects which we see as a pension investment opportunity to contribute to growth and a level playing field: 1. Macro-economic context: EU and ECB policy The (implicit) objective of encouraging pension funds to allocate more funds to long-term investments in Europe can only be realised if all conditions are met. The chain is as strong as its weakest link. Within their investment universe of eligible asset classes, pension funds look for opportunities with the best risk/return trade-off. The risks and expected returns are determined by markets and interventions by policy makers. The investment universe is constrained by resources, expertise, risk tolerance and regulation. Increasing the supply of long-term finance requires balanced and consistent policies in all areas. Barriers to long-term investing. The current policy mix includes several barriers to long-term investing and incentives to invest short term or even outside Europe. Ultra-low or even negative yields and low risk premia encourage long-term investors to shorten the duration of their portfolios and switch to risk-free assets until yield and spread levels have normalised. Likewise, investors may be tempted to invest outside the euro area if they expect the ECB to be successful in depreciating the euro exchange rate. Prudential regulation drives many investment decisions. Prudential regulation has responded to the crisis with a range of safety-first measures. Pension funds in the Netherlands are unable to increase the risk profile of their portfolios, even if they wanted to, unless they have excess buffers, which very few currently do. The regulatory framework forces pension funds into holding very substantial allocations to low-yielding government bonds. At current yield levels, the implication is that less certainty is exchanged for certainly less (return). A sustainable financial system is a necessary condition for a healthy investment climate in the long run. Investments leading to a moderate financial return but which do lead to a significant societal gain, are primarily the public sector s domain. Consistency in policy and reliable governments on all levels are crucial. 4 Position Paper Capital Markets Union
Subsidies and long-term investing do not match well. Pension funds commit long-term capital to highly-regulated industries and markets, such as (in particular) infrastructure. Government stimulate many markets with high social, but low or unknown financial returns e.g., off-shore wind via subsidies or guarantees. For long-term investments in particular, such schemes introduce significant political risk, i.e., the risk that support measures are scaled back prior to maturity if the scheme becomes too successful and, hence, too expensive for the government. We have seen several examples whereby investments are hurt by changes in subsidies or guarantees, in a few instances even retroactively. Although these risks can be mitigated to some extent, generally speaking, subsidies do not create healthy or sustainable investment environments in the long run. Long-term investors prefer to invest in projects that are bankable without government intervention. If, instead of subsidising green investments, brown investments are taxed more heavily (e.g., though a cap-and- trade CO 2 scheme), a more sustainable long-term investment climate may result. Quantative easing puts burden on pension savings. Artificially low interest rates, further depressed by quantitative easing (QE), place the burden for the crisis squarely on savers and long-term investors. A new search for yield has elevated asset prices and reduced risk premia to unsustainable levels. Low expected returns on investments threaten the financial ambition of pension funds and other long-term investors. Importantly, unattractive risk/return trade-offs discourage long-term investments in the real economy, and encourage investors to invest elsewhere. 2. Supervisory frameworks and Prudential Regulation Prudential regulation applying to pension funds should encourage long term investments. At the moment, there are too many examples of national prudential regulation which discourage long term investments. 1. Avoid focus on short-term liquidity. Supervisory frameworks place too many obstacles on the path of long-term investments, because they do not allow sufficient room for pension funds to make illiquid investments. Focusing on short-term liquidity and too strictly regulating ( punishing ) illiquid assets is not in accordance with the nature of the liabilities of pension funds and will excessively limiting asset allocation to long-term investment categories. 2. Aim for matching assets. Supervision of pension funds is predominantly short-term in outlook. Supervisory authorities do not pay sufficiently attention to returns and the long-term perspective of pension funds. Supervisors should not steer on the basis of short-term liquidity, as the maturity of pension liabilities is predominantly long-term. 3. One size fits all is not stimulating. Since much financial regulation is based on a one size fits all principle, pension funds are faced with financial regulations (EMIR, MiFID) that are not conducive to holding long-term assets (guarantees, maintaining liquidity and taxes on transactions). This stated, we do find it important that the regulatory landscape for the financial markets and the Capital Market Union create a level playing field for financial institutions. 4. Current IORP proposal makes a positive choice for long-term investing. We would like to underline that we are supportive to the current proposal of the IORP directive. This aims for maintaining a balance between both investment freedom and compliance with the prudent person principle. Furthermore we are underlining the importance of absence of capital requirements in the current IORP proposals. Capital requirements will limit the potential for long-term pension capital to be invested in the economy. Otherwise higher pension premiums will effect labour costs jeopardising global competiveness of the European economy. Furthermore, imposing inappropriate quantitative measures or capital requirements to pension funds (e.g. in the context of IORP or the Holistic Balance Sheet) will have negative effects on the investment capabilities of pension funds and could discourage the development of occupational pension schemes which are important channels of finance for the European economy. It is important that regulation (in the sphere of pensions as well as financial markets) facilitates long-term investments. The relevant perspectives are: 5 Position Paper Capital Markets Union
3. Stimulating Energy Union and other innovation policies The new European Commission presented late 2014 its ideas for investing in the EU by presenting an Investment Plan. As a global investor we see the relevance and importance of extra investments in order to make the European economy more competitive and maintain an open and expanding framework for global trade and investment. We underline that the focus of this additional investment through the EU Investment Plan should be on infrastructure, notably: broadband and energy networks; transport infrastructure in industrial centers; education, research and innovation; renewable energy and energy efficiency. Decarbonisation of the energy mix is one of the five dimensions of the Energy Union. Unfortunately, it seems to have moved down the agenda with security of supply becoming the top priority since the Russia/Ukraine dispute. We strongly believe that decarbonisation of the energy mix is vital for energy security in the long run and for meeting the EU climate change obligations for 2030. Competition regulation (e.g. the unbundling regulations in the Third Energy Directive) can act as barriers to infrastructure investment by financial investors. Coherence between the EU s infrastructure investment objectives and wider European regulation could make investment in infrastructure more accessible. We therefore urge you to consider the effect of unintended constraints from financial or competition regulations on investments in low carbon infrastructure and technologies and in climate resilience. Artificially low interest rates, further depressed by quantitative easing (QE), place the burden for the crisis squarely on savers and long-term investors. The regulatory landscape for the financial markets and the Capital Market Union should create a level playing field for financial institutions. Regulation should encourage long term investing in the EU economy: avoid focus on short-term liquidity; aim for matching assets; one size fits all is not stimulating and current IORP proposal makes a positive choice for long-term investing. The need for targeted and pragmatic European solutions. As stated before being a global investor we see the relevance and importance of extra investments in order to make the European economy more competitive and maintain an open and expanding framework for global trade and investment. The European Union should act as facilitator rather than regulator in this process. In this paragraph issues are listed where targeted and pragmatic European solutions are welcomed and needed. More standardisation could positively affect the demand for securitisations and bring synthetic securitisation in the scope of EU policy. Securitisation is an ineffective a complex instrument to increase the possibility for banks to underwrite new loans. Under AIFMD additional measures have been implemented to mitigate these risks. We choose to add additional requirements when investing in synthetic securitisations. Some additional requirements that we deem necessary are continuous loss sharing of the issuing institution ( skin in the game ) and transparency in the issuing party s credit review and monitoring process. When investing in securitisations we rely on the internal processes in place with the banks and their track record in relation to their loan portfolio. Through the use of synthetic securitisation PGGM create freefall of capital for the banks, scale of investment for its clients, and perhaps most important a simple investment product to understand by the pension fund boards. These synthetic securitization however are not in scope in the green paper, which only has true sale securitization in scope. Bring synthetic securitization in the scope of EU regulation. Insist in harmonizing VAT treatment and avoid the Financial Transaction Tax. Pension funds across Europe face different VAT treatments in relation to the returns on investments. At this moment these differences are mitigated by bilateral agreements between governments. Creating a further level playing field in Europe in relation to the VAT treatment of pension funds may contribute to a higher level of pension fund investments in Europe. In relation to the initiative for taxation of a financial transaction, we believe that this will result in a shift to other types of financial transactions that undermine the long-term investment horizon of pension funds and will reduce the ability of pension fund to take up their responsibilities as investors and (co)owners of companies. The mismatch with the long-term investment horizon will lead to higher premia for the participants of the pension funds which will reduce their economic perspective in the short-term. 6 Position Paper Capital Markets Union
The importance of upscaling investment proposition. In our Dutch home base a new intermediary that will contribute to increasing financing opportunities for (Dutch) enterprises in the long term has been established under the name NLII. Pooling illiquid assets will help to attract more potential investors and diversify risk across projects with different risk profiles. The easiest way to get these fund structures up and running is to start at a local level in multiple member states. Many European countries have their own examples how to improve the functioning of their capital markets. In the longer term these could be the building blocks of a pan-european direct financing market. Venture capital, although of immense importance in order to finance start-ups and SME s, is very often lacking scale as well. The creation of a sizeable European Venture Capital fund of funds with equal participation of public and private sector could be a practical solution. The importance of standardising project documentation and professional standards. Private equity, private real estate and infrastructure investments do benefit from certain forms of standardisation. More standardisation of contracts and other project documentation will cut costs as well as encourage the convergence of the regulatory environment. The same counts for professional standards and governance structures where EU recognition of industry standards would be an opportunity. European Union should act as facilitator rather than regulator. Securitisation is potentially a complex instrument. More standardisation can positively affect the demand for securitisations and bring synthetic securitisation under EU regulation. Standardisation of contracts and other project documentation is a way the EU can assist in creating a level playing field for long term investment categories like infrastructure, private real estate and private equity. Insist on harmonising VAT treatment and avoid the Financial Transaction Tax. Size matters: initiatives in Members States and across border in order to facilitate upscaling of investment opportunities are crucial. The EU can create a platform to explore and facilitate such initiatives. Private Real Estate investments can contribute to the objectives of the Energy Union. Green leasing and userowner issues need attention on EU level as these can interfere strongly in investors decision making processes. PGGM Corporate Communicatie Noordweg Noord 150 P.O. box 117, 3700 AC Zeist T +31 (0)30 277 99 11 www.pggm.nl 15-7178 mei 2015