ACTUALITE Livre vert de la Commission Européenne sur le financement à long terme de l économie européenne Lettre conjointe de Paris Europlace et La City of London à Michel barnier Commissioner Michel Barnier Member of the European Commission B-1049 Brussels Belgium (by email) Date 14 June 2013 Dear Commissioner, European Commission Green Paper on Long-Term Finance The Anglo-French Committee of the City of London and Paris Europlace welcomes the opportunity to respond to the European Commission s Green Paper on Long-term finance. As you know, the Anglo- French Committee brings together senior industry representatives from London and Paris with the aim ofshaping financial services regulation in areas of mutual interest. The Commission is right to prioritise largescale,long-term investment as a key driver for reviving growth and employment across the EU. We welcome the Green Paper and commend the EU Commission on initiating a debate about how to foster the supply of Long-Term Financing (LTF) and how to improve and diversify the system of financial intermediation for long-term investment in Europe. The many important issues raised in the Green Paper could, given the right conditions, contribute substantially to growth and employment prospects across Europe. Our response focuses on 7 priorities relating to the challenge of European growth and competitiveness: the role of wholesale financial markets in funding business, infrastructure, SMEs, securitisation, banks, insurance and taxation. The role of wholesale financial markets in funding business Financial services, and in particular the wholesale financial markets are an important source of funding for corporates throughout their development, from start-up right through to multinational. Although the majority of corporate financing in the EU continues to be provided by banks, as a result of new financial regulation and bank eleveraging, companies will need to diversify their funding sources in order to grow.
The IRSG, CBI, MEDEF and Paris Europlace have produced a suite of 5 papers that demonstrate the many ways in which firms in all sectors of a modern economy can use financial services to get off the ground, grow and develop. Taken together, the papers show the important role that the financial and related professional services industry plays in supporting the wider economy and facilitating the creation of new jobs and new businesses that will be essential in facilitation job creation and driving Europe s economic recovery. Copies of these papers are enclosed. In producing these papers, specific policy recommendations have arisen, which are set out in the Annex. Infrastructure The EU Commission rightly recognises the need for increased investment in infrastructure projects as they can boost employment, economic growth and potentially are sound assets to invest in. Infrastructure projects, when they give rise to stable and predictable cash flows may be suitable investments for insurers. There is also a role for development banks, which by supporting existing funding vehicles and through their own initiatives (such as project bonds), development banks are helping to build awareness of, and confidence in, a relatively new market and asset class. The EU and EIB should also be credited for the project bond initiative, and its aim to improve capital financing for infrastructure. At the European level, it is important to define the proper conditions that will allow project bonds, as a new asset class, to reach critical mass as soon as possible. In this regard, it will be important to examine regulatory and legal standards, risk profiles and market practices, including revisiting prudential rules for investors to be able to invest in these instruments. Political and regulatory risk is the key impediment to private infrastructure investment. This risk either inflates the cost of financing (at taxpayers expense) or makes investing in this sector almost impossible for certain participants. Due to their need for stability and predictability of returns, insurers are more likely not to invest than to take this risk. Because infrastructure investments seldom offer an upside, and the best that investors can hope for is stable cash flows, any risk to returns can make the investment unattractive compared to alternatives. Investors accept that regulatory frameworks will change. However, they require certainty about the legal arrangements governing returns. Investors need to be able to see a clear pipeline of infrastructure projects to enable them to plan and prioritise their potential deals. At a national and European level the visibility of the infrastructure pipeline seeking private finance could be made clearer, particularly for small and medium seized projects. One way to improve the visibility of the infrastructure pipeline would be for the Commission to collate details of available and upcoming infrastructure deals, perhaps in a website, and to standardise some key metrics e.g. nature of the asset, funding requirements. Separately, the Commission is right to consider that a new long-term investment funds (LTIF) could facilitate the raising of capital across the Union. Done carefully, rules on LTIFs could inspire the same confidence as UCITS. The key to the success of a proposal is to set out product regulation that adds real value and whose rules, such as diversification or redemption limits, are easily understood by investors and providers. If LTIFs widened the investor base / demand for infrastructure debt or equity then this could incentivize asset managers to build up their expertise in long term investment over time.
SMEs National and multi-national development banks (the EIB in particular) are doing a good job through their various interventions and programmes in supporting the financing of European SMEs in partnership with private investors, including the banking sector, and therefore helping the recovery of the economy. We support their participation in financing long-term investments under their current policy of terms and conditions. The term SME represents a diverse range of businesses, from micro businesses to medium-sized companies with a number of employees. As such, there is a range of financial support needed to such businesses from early stage equity investment (for example angel financiers) to long-term capital accessible through the capital markets. It is important to support these various businesses in their investment readiness capability, planning and knowledge of the right form of finance for the different stages of the business lifecycle. One key area which would help SMEs diversify their funding sources would be increasing their access to capital markets. For example, more could be done to facilitate the development of SME-driven Multilateral Trading Facilities (MTFs) and new fixed-income instruments (such as venture loans, collective bonds, private placement, etc) in order to provide SMEs with a diversity of secured and flexible funding sources. Forthcoming proposals on Shadow Banking, in particular, should be calibrated to ensure that such activities are not stifled. However, there are a number of barriers to SMEs accessing finance. First, information on SMEs and their projects often lacks transparency and/or is not always easily available. In this respect, it is important that accounting/reporting standards are reviewed to ensure that investors are informed about the actual performance of SMEs and thereby facilitate their investment decisions. Secondly, many SMEs tend to favour a close relationship with their lenders, similar to what is provided by a bank, rather than a system that disseminates risks through various investors. Lastly, it is generally acknowledged - by both market participants and regulators- that banks, thanks to their expertise and granular knowledge of their client base - remain best placed to assess and manage inherent risks related to SMEs. Their involvement in the funding process will therefore remain substantial, though their specific role in the value chain will evolve. Securitisation One very important area covered in the Green Paper is the securitisation markets. Access for issuers has become increasingly important to overcome the funding gap between lending to the real economy and money raised from depositors. It is, essentially, an enabler for growth of the real economy. Moreover, a number of years later, the vast majority of European securitisations have demonstrated high credit resilience and strong price performance. This segment has great potential, although the lack of market confidence as well as a lack of trust by public opinion and authorities has hampered smooth market functioning. It is encouraging that the ECB and EIB have recently launched a consultation on initiatives to promote a functioning market for asset-backed securities collateralised by loans to non-financial corporations. Development of a European SME securitisation market (with or without credit risk mitigation from EIF or other official bodies) could provide an attractive alternative for investors and a stable source of liquidity and capital for European SME s. Properly designed, such a system could significantly diversify sources of funding for SME s, lower funding costs and reduce the exposure of the sector to any future constraints within the banking sectors. The Commission should seek to build on the work undertaken by the Prime Collateralised Securitisation (PCS) initiative to give further impetus to the European securitisation market.
Insurance The Green Paper acknowledges that insurance companies, pension providers and other institutional investors are well suited for long-term financing and investment. These investors have substantial portfolios with longer-term horizons, and due to the low interest rate environment continue to seek out diversification and yield in areas like long-term financing. That said, there are elements in Solvency II, in its most recent draft proposal that will make it more difficult for insurance companies to hold such assets. Solvency II, for example, creates a misleading disconnection between assets and liabilities valuation movements. To smooth the effects of this volatility insurers have no option other than to de-risk their balance-sheets and reduce the horizon of both their liabilities and their investments, i.e. shorter liabilities matched by shorter investments. These issues need to be addressed. It is very important that effective counter-cyclical tools are added to the Solvency II framework. In parallel, the Solvency II capital charge on the holding of long-term assets should also be reviewed. More specifically, we would welcome the Solvency Capital Requirement (SCR) to be closer to the market reality; e.g. for infrastructure loans the default probability is lower after the construction phase than for similar rated corporate bonds. In fact, the insurance sector has been supporting the recommendation made by the Commission to EIOPA to review SCR for long-term assets such as private equity, infrastructure loans, real estate, asset based securities, loans and long-term dated corporate bonds. Life insurers and occupational pension funds are also major providers of funded complementary pensions in the EU. It is important that they can continue to play this role and be able to act long-term investors. For markets to deliver even over the long term, competition is necessary. The Green Paper refers to markets but it does not stress the need to ensure effective competition between different providers. Even if prudential frameworks for different providers might vary for good reasons, they still need to be consistent with each other. Furthermore, a strengthening of certainty for investors, from the smallest to the largest institutional investors, will also contribute to improved investor sentiment. Banks We consider that banks will continue to be an important intermediary, especially in financing SMEs, which usually experience more constraints than large corporates in accessing the capital market (due to the higher cost of listing and their size). Banks have a close relationship with SMEs and understand their needs. Accordingly, SMEs often require more flexibility when they ask for a credit line and banks represent the best compromise, as they offer i) a re-negotiable debt ii) and a less costly and favourable financing.nevertheless, both weakening demand and deleveraging by banks have contributed to the current scarcity of long-term financing. The Green Paper quite rightly highlights the fact that many of the currently proposed reforms could further hamper the ability of the banking sector to channel long-term investment in the future. It is therefore important to encourage the diversification of sources long-term finance. The recommendations of the High Level Expert Group for the separation of trading activity from deposit taking banks (the Liikanen report) would fundamentally undermine the universal bank model and would see an increase in funding costs for affected banks. This in turn would feed through into higher costs of credit and a reduction in market making capacity amongst EU banks. Both of these effects would undermine the ability of the banking sector to maintain lending levels and to channel capital into longterm investments in Europe. It will be necessary to revisit the calibration of prudential rules to rebalance the competing objectives of financial stability and growth.
Taxation The Green Paper states that tax systems should be designed in such a way to distort as little as possible the economic decisions of citizens and companies. Unfortunately this is precisely the effect that the proposals for a Financial Transaction Tax (FTT) currently being discussed by eleven member states would have. Not only would the FTT risk distorting cross border investment decisions across the EU by creating disincentives to interact with counterparties within the FTT zone, it would also have disruptive implications for government debt, corporate debt and equity with the cost of funding for EU corporate and governments likely to increase as a result. Furthermore, as financial transactions would be more expensive, net investment returns of retirement savings will be lower hence resulting in lower benefits for pensioners. Moreover, the FTT would be inconsistent with the aim of strengthening the capital markets and diversifying the funding sources of corporates by penalising this activity and decrease the efficiency of these markets. Conclusion We are a strong supporter of the EU and the Single Market and are ready to support the EU Commission in this important project and to help identify and support appropriate initiatives and measures that can increase long-term investment. A long-term investment strategy that is needed to reinforce European competitiveness will require not only new instruments and distribution channels but a pan-european savings policy to mobilise more savings and channel these savings towards long-term investment. A stable and proportionate regulatory system is an important building block towards a long-term investment strategy. Given the uncertainty of the collective impact of the many regulations currently being undertaken, the European Commission should consider conducting a thorough impact assessment of all the regulation introduced so far and what the impact will be on the broader economy. In the meantime there should be a regulatory pause until the recently adopted legislation can be properly assessed. We welcome further dialogue and the opportunity to exchange ideas on these important topics and specific initiatives. Yours sincerely, Mark Boleat Chairman of the Policy and Resources Committee, City of London Member of the Anglo-French Committee André Villenueve Co-chair, Anglo-French Committee Vivien Levy-Garboua Co-chair, Anglo-French Committee Paris Europlace
ANNEX Starting a Business The first paper, Starting a Business, looks at how new start-ups can get access to the finance they need to get off the ground. Banks have played an important role in this area but as they repair their balance sheets, bank financing is not as forthcoming as previously. Other sources such as 3F grants and Business Angels can also play a part. Recommendations: 1. Incentives for funding start-ups: The Commission and Member State governments should examine the scope for increasing incentives to those looking to fund start-up projects e.g. through the tax system. 2. New forms of funding: The scope to facilitate new ways of funding businesses such as crowd funding should be examined. 3. Development Banks: The Commission s Green Paper examines the role of national and multilateral development banks. Their role in funding new businesses should be examined. Growing a Business organically through long-term finance The paper, Growing a Business organically through long-term finance, looks at how businesses can finance long-term growth. In Europe banks have traditionally been the main source of funding for businesses. By contrast, in the USA other sources of capital market finance have played a greater role. But the role of banks is now under pressure as a result of the banking crisis and its aftermath and new sources are needed. The paper looks in particular at ways in which smaller and new companies could get earlier access to bonds, equities and private placement to raise funds especially for long-term financing needs. Recommendations: 3. Private Placement: Private placement plays an important part in fund-raising for many private firms, but some feel it necessary to use the better organised US market. A European equivalent should be developed. 4. From Start-up to IPO: Limitations to bank funding make it all the more important for policy and market mechanisms to be developed to make it easier for smaller and newly established firms to achieve earlier access to equity finance. 6. Developing equity and bond markets: The Commission s Green Paper opens a debate on how equity markets can be developed to ensure that finance can flow more efficiently and effectively to long-term investment. It also calls for examination of a greater role for covered bonds. Growing a Business through alternative finance The paper, Growing a Business through alternative finance, looks at ways in which companies can access finance for growth through means other than traditional banking such as hedge funds, commercial paper, securitisation and money market funds. Such sources of capital can serve a vital function by enhancing liquidity, increasing capital efficiency, distributing risk and thus encouraging growth.
Recommendations: 7. The need for options: Future regulation of alternative finance markets and options should prioritise the requirement to give firms across the economy as wide a range of financing options as possible. 8. The need for regulatory flexibility: The area of alternative finance is one in which new and innovative products can emerge rapidly. It is vital that the regulatory regime is not so rigid as to stifle innovation. 9. Securitisation: The Green Paper opens a debate about the feasibility of reviving the European securitisation market to improve maturity transformation while maintaining financial stability. Combining forces for growth: acquisitions, mergers and buy-outs The paper, Combining forces for growth: acquisitions, mergers and buy-outs, examines mergers & acquisitions, joint ventures, management buy-outs and other ways in which companies can grow by joining forces with other companies to facilitate market entry, achieve economies of scale and gain access to intellectual property or human capital. Day-to-day operations: laying foundations for sustaining growth The final paper in the series, Day-to-day operations: laying foundations for sustaining growth, looks at some of the ways in which firms can use financial services to assist with their day-to-day operations, managing cash flow efficiently and reducing risks from trading activities. Recommendations: 10. Supply chain finance: Supply chain finance has been growing fast in Europe. A major oil company told us, the impact [of the crisis] has fallen particularly on our customer base and supply chain. The Commission and regulators need to recognise the increasing importance of this market and consider policy measures to ensure it continues to operate efficiently. 11. Supporting trade finance: Trade is a key element in many firms long-term growth strategies and trade finance makes this possible. However, as banks continue to deleverage the availability of trade finance is declining due to its short-term and self-liquidating nature. Policy solutions need to be found to enable firms to continue trading. Other recommendations 12. A European JOBS Act: The JOBS Act has sent a clear message to international markets of the US Government s determination to make jobs and growth a priority. The Green Paper and the set of measures that will eventually emerge from it give the EU the opportunity to make a similar public commitment to the importance of jobs and growth as political objectives, essential to Europe s economic recovery. 13. The cumulative impact of regulation: The Commission s Green Paper asks for views on the cumulative impact of current and planned reforms. A number of contributors to these papers have raised concerns about the long-term impact on EU competitiveness of regulations that, in restricting the activities of the financial services industry, limit the industry s ability to fulfil its vital role in financing the wider economy and facilitating economic recovery and job creation.