# EUR-Lex - 52013DC0150 - EN

*|*

# 52013DC0150

**GREEN PAPER LONG-TERM FINANCING OF THE EUROPEAN ECONOMY /* COM/2013/0150 final */**

			*

			*

1.           Introduction

Europe’s pressing
challenge is to put the EU back on the path of smart, sustainable and
inclusive growth, creating jobs, building on its areas of competitive advantage
and, thereby, enhancing
its competitiveness in the global market place.

In
responding to this task, Europe faces large-scale, long-term investment needs, in line with
the priorities of the Europe 2020 strategy,[1]
the 2012 industrial policy update[2],
the Innovation Union initiative[3]
and the Connecting Europe Facility.[4]
Long-term investment is the formation of long-lived capital, covering tangible
assets (such as energy, transport and communication infrastructures, industrial
and service facilities, housing and climate change and eco-innovation
technologies) and intangible assets (such as education and research and
development) that boost innovation and competitiveness. Many of these
investments have wider public benefits, since they generate greater returns for
society as a whole by supporting essential services and improving living
standards. Their impact can also begin to be felt in the short term. They
enable companies and governments to produce more with fewer resources,
responding to new economic, social[5]
and environmental challenges, facilitating the transition to a more sustainable
economy and raising the productive and industrial capacity of the economy. Trends
in climate change and the depletion of natural resources further underline the sustainable
growth challenge, as they call for more long-term investment in low-carbon
energy, energy and resource efficiency and infrastructure, consistent with the
political objective of limiting climate change below two degrees and decoupling
economic growth from resource use.

To
fund these long-term investments, governments and businesses of all sizes need
access to predictable, long-term financing. The capacity of the
economy to make such long-term financing available depends on the ability of
the financial system to channel the savings of governments, corporates and
households effectively and efficiently to the right users and uses through open
and competitive markets. This can be carried out by various intermediaries
(e.g. banks, insurers and pension funds) and by direct access to capital
markets. This Green Paper focuses on how this process operates. As a
prerequisite to channelling long-term financing at reasonable cost, the economy
needs to generate and attract savings. Government policies can support this
through sound fiscal policies, efficient tax systems and a business-friendly
environment that fosters the attractiveness of the economy for investment,
including from abroad.

Getting
the long-term financing process right is central to supporting structural
economic reform and returning to the long-run trend of economic growth. Long-term
financing is also needed throughout the whole lifecycle of a company, helping
to start a business, allowing it to grow and then sustaining its growth.
Long-term financing supports the transition of companies as they progress
through this lifecycle. This requires the knowledge and availability of
different financial instruments and processes. Long-term financing also helps
in the financing of exports and thus contributes to improving external
competitiveness. The importance of long-term financing for growth and job
creation has been recognized at international level by the G20.[6]

The
financial crisis has affected the ability of the financial sector in Europe to channel savings to long-term investment needs. Above all, the financial
crisis and the current weak macroeconomic situation have created a climate of
uncertainty and risk aversion, particularly in those Member States under
financial pressure and for SMEs. The financial crisis has impaired banks' ability
to lend at long maturities, as they need to deleverage, correcting the excesses
of the past. At the same time, the crisis has had a negative impact on the
confidence and risk appetite of borrowers and institutional investors.

One main
lesson of the crisis is that appropriate regulation and supervision of the
financial sector is necessary to restore financial stability and confidence in
the markets. As part of a broader policy response, it is appropriate to ensure
that the detailed calibration of the new regulatory and supervisory framework
most effectively enables the financial sector to support the real economy,
without jeopardising financial stability.

Looking
beyond the financial crisis, an important question is whether Europe's
historically heavy dependence on bank intermediation in financing long-term
investment will give way to a more diversified system with significantly higher
shares of direct capital market financing and greater involvement of
institutional investors and alternative financial markets. There is no doubt
that, given
their risk management skills and local knowledge of and relationships with
enterprises,
banks
will continue to be important players in channelling long-term investment.
However, it is uncertain whether commercial banks will resume their practice of
holding long-term assets to maturity at previous levels.

The diminished
role of banks in long-term lending opens up new needs and opportunities for
other financial institutions and market-based intermediation to channel
financing to long-term investments. However, the ability of institutional
investors and markets to fill this gap depends on a number of conditions. Alongside the
right calibration of the prudential regulatory framework, many claim that
accounting principles, valuation measurements and the behaviour of asset
managers create extra costs and misaligned incentives. In addition, corporate
bond, equity and securitisation markets in Europe remain relatively
underdeveloped compared to other economies, and non-bank financing remains
largely inaccessible to SMEs.

Ensuring
effective and efficient intermediation channels for long-term financing is a
complex and multi-dimensional task. The purpose of this Green Paper is to
initiate a broad debate about how to foster the supply of long-term financing
and how to improve and diversify the system of financial intermediation for
long-term investment in Europe. As can be seen from the consultation questions,
this debate should take into account the specificities of different financial
market actors and also address questions related to a diverse set of enabling
conditions. Responses to consultation questions will contribute to further
assessment by the Commission of the barriers to long-term financing, with a
view to identifying possible policy actions to overcome them. Possible follow-up
could take several forms: in some areas new or adapted regulation may be
needed, while in others the role of the EU level could be in
encouraging stronger coordination and the promotion of best practices, or in
the form of specific follow-up with individual Member States in the context of
the European semester. This Green Paper is accompanied by a Commission Staff
Working Paper, setting out the underpinning analysis in more detail.

2.           The Supply of long-term financing and
characteristics of long-term investment

The capacity
of the economy to provide the financing for long-term investment depends on its
ability to generate savings and attract and retain foreign direct investments
(FDI).

Various
providers can act as the sources of long-term financing, including governments,
corporates and households. Governments and corporates also create demand for
long-term financing. In Europe, the ratios of investment or savings to GDP are
both around 20%. This is favourable compared to other regions. However, this
overall picture hides the fact that private investments in 2011 were well
below their 2007 level and this drop was four times more than the drop in real
GDP over the same period.[7] Both savers
and investors
are currently experiencing high degrees of uncertainty, risk aversion and lack
of confidence as a result of the weak macroeconomic situation and outlook. This
may have lasting effects, creating more permanent barriers to the supply
long-term financing, as well as affecting demand:

·
Governments: public
resources, coming from taxation and public debt, play a key role in financing
long-term investments given the positive externalities often associated with government
investment and its complementarities with private investment. While governments
will always play a key role in the provision of public goods and public
infrastructure, greater spending efficiency through more systematic
cost-benefit analysis and careful project screening has been a long-standing
challenge. In addition, public resources in the form of grants or loans are
used to support private-sector long-term investment in areas where market
failures lead to sub-optimal levels of private funding and/or investment. In
these areas, public resources should not replace private financing, but can
catalyse it and help manage the associated risks.;

·
Corporates: Corporates
finance investment either from their own resources or by accessing the
financial system. Subdued demand and market uncertainties have affected
corporate earnings. At the same time, corporate investment has been even
weaker, resulting in an increase, in some Member States, in the stock of
internal savings, especially of large corporates – cash and equivalent
positions of large firms are estimated to have increased by around four percentage
points from 2009 to 2011.[8]
However, many SMEs also suffer from a continual lack of liquidity;

·
Households: Households are
the main source of funds to finance investment. However, short-term savings are
their most preferred instrument. For example, over the period 2000-2010,
households reduced their equity holdings by eight percentage points as a
proportion of financial assets.[9]
Households generally prefer liquidity and easy redemption. Stability is
preferred and risk-aversion is now widespread. There is therefore a
need to mobilise more long-term savings; and

·
External
financing:
FDI
remains another traditionally-important source of financing long-term
projects. Despite the crisis, FDI flows into the EU made a recovery in 2011,
after the steep decline of the most recent years. EU inward FDI flows reached
€242 billion in 2011, thus growing by 13% relative to 2010 levels. Within the
EU, there are substantial cross-country disparities.

The long-term
growth prospects of any economy depend inter alia on the financial sector's
ability to channel the above-mentioned sources of savings into productive
investment. This Green Paper is concerned with long-term investment in the
sense of the formation of long-lived tangible and intangible capital. The focus is thus on
productive (as opposed to financial) capital similar to the concept of the
national accounts in which investment is specified as gross fixed capital
formation. The formation of productive capital was deeply hit during the
financial crisis, and investment levels are still below their pre-crisis levels
in many EU countries. Investment in tangible and intangible productive capital
is essential in order to turn the EU economy around and will be a corner stone
of any long-term growth strategy.

The focus is
put on long-lived capital goods (such as economic and social infrastructure, buildings
and R&D, education and innovation), not because they are more important for
growth than shorter-lived capital goods (such as computers, mobile phones and
vehicles). Rather, investment volumes for short-lived capital goods are
strongly pro-cyclical. These volumes are currently down because of the weak
macroeconomic outlook in Europe, but they are expected to recover as soon as
the economy picks up. The same is true for other expenses of productive firms
such as staff costs (hiring) and purchases of intermediate inputs.

The situation
is very different for long-term capital goods, which are characterised by long
investment/construction periods and require long-term financing given
that the cash flows generating the return on investment only start after a
considerable period of time. Since a significant share of the stock of
long-term productive capital consists of public infrastructure, this type of
capital has traditionally played a stabilising role for the economy – this
depends on governments being able to provide public investment in an
anti-cyclical manner; and the financial sector, when providing funds for
investment, being reasonably confident that the economy will be in full swing
once construction periods are completed.

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 the funding to pay for investments that stretch
over an extended time period.  This definition focuses on the range of
features associated with long-term finance.[10]
Alternatively, on-going international work under the auspices of the G20 on
long-term investment defines long-term finance more narrowly, focusing on maturities
of financing in excess of five years, including sources of financing that have
no specific maturity (e.g. equities).

Questions: 1) Do you agree with the analysis out above regarding the supply and characteristics of long-term financing? 2) Do you have a view on the most appropriate definition of long-term financing?

3.           Enhancing the long-term financing of the
European economy

As for all
types of financing, the capacity of the economy to finance long-term investment
depends on the ability of the financial system to effectively and efficiently
channel these funds to the right users and investments through open and
competitive markets. This process can be carried out by various intermediaries –
including banks, insurers and pension funds –and by direct access to financial
markets. However,
a range of factors restrains them from playing a fully effective long-term
financing role. Some of these factors will take longer to address than others.

One main
lesson of the crisis is that appropriate regulation and supervision of the
financial sector is necessary to restore financial stability and confidence in
the markets. The EU has been pursuing a comprehensive programme of financial reform
in this context, complementing broader fiscal and economic reform. Financial
stability is essential, but alone is insufficient. As part of a broader policy
response, the detailed calibration of the new regulatory and supervisory
framework must effectively enable and incentivise the financial sector to
support the real economy, including in the area of taxation, without
jeopardising financial stability.

Both public
authorities and market participants share responsibility for creating this
environment, re-embedding confidence and certainty, and enhancing Europe’s overall attractiveness as an investment destination. Building on this, action
to enhance the long-term financing of the European economy should address a
broad range of interconnected factors:

·
The capacity of financial institutions to
channel long-term finance;

·
The efficiency and effectiveness of financial
markets to offer long-term financing instruments;

·
Cross-cutting factors enabling long-term
saving and financing; and

·
The ease of SMEs to access bank and non-bank
financing.

3.1.        The capacity of financial
institutions to channel long-term finance

Commercial banks

Banks have
traditionally been the most important financial intermediaries in Europe. The share of the banking sector in the EU is large by international comparison,
especially compared to the US, reflecting Europe's greater dependency on bank
intermediation.
Going forward, this creates challenges for long-term financing.

The crisis
highlighted the risks associated with making excessive use of leverage and maturity
transformation. Along with weakening demand in some countries
in recession, this has led to deleveraging by many banks, contributing in
particular to the current scarcity of long-term financing.[11] Even once
this deleveraging process finishes, the re-pricing of risk following the crisis
will raise the cost of capital. The costs associated with bank crisis
management tools may also raise the cost of capital, although the positive
effects of establishing a more resolvable banking sector will be extremely beneficial
for society and the economy. The interconnections between banks and sovereigns and
tighter regulation have also amplified the concentration of bank activities in
home markets, leading to reductions in cross-border financing and fragmentation
of the Single Market, which further reduces the availability of funding and drives
up the cost of capital, in particular in countries currently under stress.

Going
forward, common European prudential rules for banks aim at preventing
the excesses of the past, increasing the resilience of banks to risk and
instilling confidence, and building a single rule book to protect the integrity
of the Single Market. From a long-term financing perspective, prudential
regulation must address the risks faced by banks when using short-term deposits
to fund long-term lending. It does not follow per se that rules that limit the
ability of banks to use short-term funding in this way translate into reduced
lending for the real economy. However, the potential trade-off between restricting
liquidity creation to ensure stability and providing long-term financing for
the real economy explains the need for appropriate calibration and progressive
implementation of the rules. Recent proposals from the
Basel Committee for liquidity requirements aim at
increasing banks' resilience, while ensuring that restrictions on maturity
transformation do not have unintended consequences. The Commission has proposed
a monitoring period, as well as a review of the calibration of the parameters
for liquidity requirements.[12]

Another
consequence of the crisis which may affect the ability of banks to channel
long-term financing is the growing debate on whether additional reforms
directly targeted at the their structure would further reduce the probability
and impact of failure, better ensure the continuation of vital economic
functions and better protect vulnerable retail clients. The recent report of
the High-level Expert Group on reforming the structure of the EU banking
sector documents how bank behaviour in recent decades has led to a
disproportional increase in intra-financial business, rather than
customer-facing activities, including long-term financing for companies. The
Group recommended restricting and separating out risky trading practices. The
Commission is currently reflecting on how to follow up on the Group’s report.

Banks
will, of course, not disappear from the intermediation chain in Europe. Their credit risk assessment skills and local knowledge of and relationships with
enterprises mean they will continue to and need to be important players. But
against the background of developments since the crisis in the banking sector,
there are new needs and opportunities for other intermediaries to complement
the role of banks by channelling financing to long-term investments in a more
balanced way.

Question: 3) Given the evolving nature of the banking sector, going forward, what role do you see for banks in the channelling of financing to long-term investments?

National
and multilateral development banks and financial incentives

Development
banks active both internationally and nationally should play a role in helping
to catalyse long-term financing and enhance the efficiency and effectiveness of
financial markets and instruments. Despite the positive net contributions of
certain investments to economic welfare, market failures can prevent investors
from taking certain risks and/or making certain investment decisions. In these
instances, national and multilateral development banks can be useful in
stimulating private financing given their specific public policy objectives
related to broader economic, social and environmental (as opposed to purely
financial) value added. Provided they focus on proven market failures, their
involvement can fulfil an important countercyclical role, including by reducing
the volatility of funding costs for certain categories of investors and
mitigating the short-termism of private actors. Importantly, the governance of development
banks should ensure that they do not use their funding-cost advantage to crowd
out private financing. Rather, they should strive to catalyse private financing
in areas where it is slow to come forward.

Public
intervention can be achieved, either directly or indirectly, by offering or
contributing to a range of financing products, including sharing and/or
guaranteeing risks,[13]
and bringing together financial intermediaries in appropriate networks.[14]
Under the current EU budget a number of the EU-level financial instruments,[15] several run
jointly by the Commission, the European Investment Bank (EIB) and the European
Investment Fund (EIF), as well as in partnership with Member States, aim at
addressing specific market gaps and facilitating access to finance, including
longer-term finance.[16]
Going forward, the EU multiannual financial framework (MFF) will make
increasing use of financial instruments, which can play an important role in increasing
the impact of EU spending, by further leveraging and catalysing private
long-term financing. In particular, most of the MFF, including all EU
Structural Instruments, will be eligible for use in financial instruments.
Their effectiveness will depend on close networking and cooperation between the
Commission, the EIB Group and Member States.

It is also
important that public intervention does not contribute to the fragmentation of
the Single Market. Coordination, assessment and accountability between national
and EU-level action can help prevent this, enhancing the value added of a
European approach. Closer cooperation between national and multilateral
development banks, under the aegis of Commission and EIB, could provide a
vehicle for such coordination, including by supporting the creation of European
economic interest groupings for the financing of cross-border projects. The impact
of foreign sovereign funds, and the opportunity to strengthen or create
European ones, could also be considered.

Questions: 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? 5) Are there other public policy tools and frameworks that can support the financing of long-term investment?

Institutional
investors

Given the longer time horizons of their business models, institutional
investors – such as (life) insurance companies, pension funds, mutual funds and
endowments – represent suitable providers of long-term financing. Together,
they hold an estimated total of €13.8tn of assets, equating to more than 100%
of EU GDP.[17] Other
institutional investors – such as sovereign wealth funds, dedicated
infrastructure funds and, to some extent, private equity – have also emerged as
providers of long-term capital. Venture capital can also provide long-term
finance.

The
long duration of their liabilities allows institutional investors, at least in
principle, to make buy-and-hold investments in long-dated productive assets,
achieving higher yields to offset longer-term risks and lower liquidity
inherent in many of these assets. Their longer time horizons enable
institutional investors to behave in a patient, counter-cyclical manner,
restraining “short-termism” and reducing the need for maturity transformation.
The need for diversification and the search for yield given the low interest
rate environment have been driving their expansion into long-term financing,
allocating substantial shares of their portfolios into long-term instruments
such as equity, private equity and other illiquid assets (e.g. some pension
funds have invested directly in large-scale renewable energy projects in recent
years).

Against this
background, as for banks, institutional investors are obliged to meet a variety
of prudential regulations and to comply with accounting standards. The new
prudential rules for insurance undertakings (the Solvency II Directive)[18] require them
to hold assets to cover the nature and duration of their liabilities; holding
long-term investments is aligned with the social functions of these
undertakings.
Solvency II aims at introducing a harmonised economic risk-based regime and values
assets at market-consistent economic value. The impact of new prudential rules
on insurers’ long-term financing ability will depend in part on their
individual starting point and on the exact fine-tuning of how longer-term
assets are treated. Discussion has focused on how to ensure that
regulatory asset risk capital charges do not weigh overly on the
holding of long-term
assets; and, that there is no reduction in the positive incentives of the
Solvency II framework on rewarding long-term liabilities duration-matching
through long-term investments.

In this
context, the Commission services have 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. The Commission, Council and Parliament have also discussed measures to
facilitate the provision of insurance products with long-term guarantees and
long-term investments under Solvency II. EIOPA will assess these measures by
June 2013. Based on these technical findings, the Commission will report on appropriate
measures that could be included in the Solvency II Directive or in the related
Delegated Acts.

Pension funds
need to manage their risks in order to generate the required level of annual
returns for their beneficiaries. Pension fund capital rules differ across
Member States and differ from those for insurers to take into account the different
risks associated with occupational pension funds and the funding resources they
may access. The Commission plans to review the Institutions for Occupational
Retirement Provision (IORPs) Directive.[19] The review
aims inter alia to strengthen the protection of scheme members and facilitate
cross-border activity in this field. It will be important to ensure that new
prudential rules for occupational pension schemes do not discourage sustainable
long-term financing. The review of the IORPs Directive will therefore need to
take into account the potential impacts on long-term financing and economic
growth.

However, beyond
prudential rules, a number of other structural factors affect the ability of
institutional investors to play a long-term financing role. The economic
downturn is likely to have a lasting impact on long-term asset allocation
strategies of institutional investors by promoting more conservative investment
strategies. For
example, the average exposure to infrastructure assets of institutional
investors remains low compared to their allocation to real estate and to actual
infrastructure investment needs. In terms of risk management and diversification,
institutional investors may have concerns around the large scale of long-term
investment projects. The asset management functions of non-bank institutional
investors may also be unaccustomed to dealing with more illiquid assets, tasks
which were previously often carried out by monoline insurers which guaranteed
such assets. Over time, this means that some investors may need to extend their
existing skills to support their investment decisions.

There may therefore
be scope to consider initiatives designed to pool financial resources[20]
and to structure financing packages according to different phases of risk. Dialogue
between investors and non-financial corporates, as well as through the
dissemination of good practices and case studies could help here.[21]
The Commission has also already committed[22] to make proposals on
possible forms of long-term investment funds (LTIF). Early indications
from stakeholders suggest that a new LTIF vehicle could facilitate the raising
of capital across the Union. It might help large and mid-range institutional
investors to invest, for example, in a range of infrastructure projects. The
LTIF will help institutional investors with diversification and risk spreading.
In addition, LTIF managers may bring additional expertise in how to look at the
underlying transactions, or in how to select and manage long-term
infrastructure projects.

Questions: 6) To what extent and how can institutional investors play a greater role in the changing landscape of long-term financing? 7) How can prudential objectives and the desire to support long-term financing best be balanced in the design and implementation of the respective prudential rules for insurers, reinsurers and pension funds, such as IORPs? 8) What are the barriers to creating pooled investment vehicles? Could platforms be developed at the EU level? 9) What other options and instruments could be considered to enhance the capacity of banks and institutional investors to channel long-term finance?

The
combined effects of regulatory reform on financial institutions

The EU has been pursuing
a comprehensive programme of financial reform. When taking stock of all enacted
and planned future changes to prudential regulations addressing the various
financial actors (banks, insurers, pension providers etc.), 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 reform taken
in isolation. For example, if banks reduce their exposure to long-term real
assets as a consequence of increasing liquidity requirements, institutional
investors with long-term liabilities could fill the gap as long as the
regulatory framework avoids an excessive focus on short-term volatility. However,
the simultaneous introduction of liquidity requirements for different financial
market players may discourage investments in less liquid assets and hence block
several possible financing channels for long-term investment at the same time.

This calls for a close
monitoring of any cumulative effects of prudential reforms. International regulatory
bodies such as the Financial Stability Board and the G20 Group of Finance
Ministers and Central Banks are already looking into this. The challenge
consists in achieving 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.

Question: 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?

3.2.        The efficiency and
effectiveness of financial markets to offer long-term financing instruments

Alongside
institutional investors, well-functioning and deep capital markets and infrastructures
are needed to offer a wider range of instruments to channel long-term finance.

European bond
markets have developed remarkably strongly over the last few decades.[23] However,
non-financial corporate bonds in Europe account still for only 15% of corporate
debt compared to other economies. In practice only large corporates have an
access to European bond markets, whereas most mid-caps and SMEs are barely able
to tap the bond markets. European securitisation markets are also
under-developed compared to other parts of the world, further limiting the
range of long-term financing instruments available.

The
Commission has proposed reforms to improve market structure through the
creation of new trading venues; enhance transparency and information efficiency;
enhance requirements to reduce short-term and speculative trading activities;
and, improve investor protection.[24]
The extent to which these reforms succeed in ensuring that capital markets
channel long-term financing as effectively as possible will need to be
monitored. Further efforts may be needed.

Covered
bond[25]
markets have proved relatively resilient during the
crisis. However, markets are fragmented along national lines and further
analysis is required to explore whether and to what extent greater
harmonisation could spur the use of covered bonds, in line with recent
market-led initiatives while taking due account of the concerns linked to
potential increased asset encumbrance of banks’ balance sheets.

Reshaping
securitisation markets could also help unlock additional sources of
long-term finance. Subject to appropriate oversight and data transparency, they
can help financial institutions free capital, which can then be mobilised for
additional lending, and manage risk. Market-based initiatives to stimulate
securitisation markets include emerging labels for high-quality, transparent
and standardised securitisations. There is scope to develop simple
securitisation products based clear and unleveraged structures, using
well-selected, diversified and low-risk underlying assets. Dedicated markets
especially for SMEs and adequate prudential rules and supervision systems are
important topics to consider. Further consideration could be given to products
linked to specific sectors.

The
EU as a whole has never had a true European project bond[26] market.
The Commission, together with the EIB, has begun to address this issue by
implementing the Project Bond initiative, a financial market solution to
address market imperfections and creditworthiness. The initiative seeks to
demonstrate the feasibility of bond financing for infrastructure projects and
ultimately aim to develop a liquid project bond market. Although still at a
small scale, market participants are also developing various investment
platforms, products and tools to stimulate project bond markets. There is merit
in reflecting on how to promote the use of project bonds further, also taking
into account the planned interim evaluation of the initiative.[27]

Many also claim
that the economy, businesses and investment projects need more equity, rather
than more debt. Equity can be a better financing instrument for long-term,
high-risk investments, as well as for investments with significant information
asymmetries and moral hazard. Since the crisis, macroeconomic uncertainty and
the low interest rate environment may have affected companies’ demand and risk
appetite for long-term equity capital. Investors have instead sought refuge in government
debt instruments with strong creditworthiness. In parallel, market windows for
IPOs have become smaller than ever, limiting companies’ access to capital and European
stock exchanges increasingly play a role as providers of liquidity, rather than
fresh capital. Overall, the cost of equity capital has remained high, while the
cost of debt finance has fallen. This highlights the equity gap in Europe, which is likely to take time to address. These developments appear to have had a
bigger impact on mid-caps. Government policies and regulations need to be as
neutral as possible with respect to private agents' choices between equity and
debt financing (for example, see below on corporate taxation).

Questions: 11) How could capital market financing of long-term investment be improved in Europe? 12) How can capital markets help fill the equity gap in Europe? What should change in the way market-based intermediation operates to ensure that the financing can better flow to long-term investments, better support the financing of long-term investment in economically-, socially- and environmentally-sustainable growth and ensuring adequate protection for investors and consumers? 13) What are the pros and cons of developing a more harmonised framework for covered bonds? What elements could compose this framework? 14) How could the securitisation market in the EU be revived in order to achieve the right balance between financial stability and the need to improve maturity transformation by the financial system?

3.3       Cross-cutting factors enabling long-term
saving and financing

There are a
number of more cross-cutting factors relevant to long-term investment that
should also be considered given the impact they can have on both the supply and
intermediation of long-term financing.

The actions
of public authorities, including taxation regimes, have an important role in inducing
long-term investments projects, build incentives and capacity for households to
save over the long term and for market participants to channel long-term
finance to productive investments. Long-term policy frameworks set by public
authorities support the development of strategic investment agendas beyond the
political cycle, providing greater transparency and increased certainty for
investors and corporates. It is important that state intervention in this
context does not distort competition, crowd our private investors or destroy
the level playing field in the Single Market.

Some Member States have also
taken action to promote long-term saving and investment decisions by
households. Auto-enrolment retirement schemes have been adopted in some
countries. Others have introduced targeted savings accounts[28] to support the financing of long-term investment projects,
providing a (government) guaranteed fixed return and in some cases with certain
tax concessions. The funds in these accounts are then invested in public goods
such as hospitals, social housing and universities. In the longer term, it may
be worth considering whether the availability of specific vehicles at the EU
level could help mobilise greater longer-term savings, more directly linked
to wider societal objectives. This model would need adapting to be applicable
at the EU level.

Valuation
measurements, accounting principles and the strategies deployed by asset
managers are also cited by many commentators as factors that complicate the
intermediation chain, increase the costs of intermediation and create
misaligned incentives, such as those arising from the bias towards speculation
and short-termism, which are also due to perceived higher risks and delayed
returns linked to long-term investment.

Question:

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?

Taxation

The structure
and level of taxation can have an impact on investment and savings decisions
and therefore on growth. Generally, tax systems should be designed in such a
way as to distort as little as possible the economic decisions of citizens and
companies, unless the taxes intend to correct externalities arising from
specific and well-defined market failures:

·
Tax and investment: Corporate income taxation (CIT) is one of many factors influencing
decisions over levels of investment, as well as how it is financed. In
particular, CIT systems in most Member States tend to favour debt over equity,
creating incentives for higher leverage for firms, because interest payments
are deductible, while there is generally no such relief for the return on
capital. A well-designed tax base that reduces the leverage distortion could also
make companies less vulnerable to a short-term reduction in credit. Reforms
that try to eliminate this distortion are, however, found in very few Member
States. Further discussions on the design of corporate tax bases with respect
to their financing neutrality could therefore be useful across the EU;

·
Tax and savings:
The taxation of savings has a number of important economic implications,
including by affecting the total amount of savings in the economy and thereby
influencing capital allocation and investment. Given these effects, tax
policies in this area have to be designed carefully. Many Member States have
already put in place a number of incentives to increase (long-term) savings,
notably with respect to pension-related savings. In addition, many Member
States apply dual income tax systems, where capital income is generally taxed
separately at a lower rate than other sources of income; and

·
Tax incentives:
Tax incentives are often considered as instruments to encourage certain types
of investment; a tax subsidy might be justified when the social return to an
investment is higher than the private return of the investor and therefore
investment levels are below the social optimum (e.g.  R&D and environmental
concerns). While there are cases for using tax incentives, they can also create
administrative burdens by increasing the number of exemptions or additional
rules to be applied. Also, in some cases, the multitude of different national
rules may create arbitrage possibilities.

Questions: 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?

Accounting
principles

Accounting is
not neutral, it shapes economic decisions: accounting standards and measures (such
as the IFRS) help provide a common language between entrepreneurs, investors
and public authorities, supporting confidence and safety. This means they have
to reconcile different points of view: an economic interest and a
financial/investor interest. Fair value accounting principles can
enhance the transparency and consistency of the financial information since they show the
market value of assets and liabilities and provide information
on the
relative financial condition of different institutions. But it may
also be detrimental to stability and long-term financing horizon. For
example, some research highlights a reduction by institutional investors in
equity allocations in investment portfolios, since equity is considered more
volatile and risky than bonds. Other research argues that market-consistent
valuation may encourage long-term investors to increase their risk exposure, if
the volatility is recognised outside their profit and loss accounts. There is
merit in examining further whether these standards are fit for purpose when it
comes to long-term investment. In this context, it would be useful to identify
ways to balance the accuracy of the information given to investors with
sufficient incentives to hold and manage very long-term assets.

Question: 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?

Corporate governance arrangements

The
way in which assets are managed can play an important role in long-term
financing in terms of aligning the incentives of asset managers, investors and
companies on long-term strategies, mitigating concerns around short-termism,
speculation and agency relationships. Rules are already in place as regards
fiduciary duties, conflicts of interest, remuneration, the exercise of voting
rights and cost disclosures, and the provision of investment advice and
portfolio management.[29]
Further action is also described in the Action Plan on European company law
and corporate governance,[30]
including through possible modifications to the shareholders’ rights Directive.
Additional steps could be envisaged, including further assessing the way asset
managers' incentives are structured to take better account of long-term
considerations and requiring more transparency from asset managers on the
fulfilment of their fiduciary duties. Ideas have also been advanced to
encourage greater long-term shareholder engagement, which could be subject to
further consideration, such as analysing the possibility of options around
granting increased voting rights or dividends to long-term investors.

Questions: 21) What kind of incentives could help promote better long-term shareholder engagement? 22) How can the mandates and incentives given to asset managers be developed to support long-term investment strategies and relationships? 23) Is there a need to revisit the definition of fiduciary duty in the context of long-term financing?

Information and reporting

Recent
analyses highlight a growing demand for disclosure of non-financial
information by companies. Research suggests that companies which
pro-actively manage sustainability aspects of their operations consistently
have a lower cost of capital and tend to outperform their competitors over the
long term. Generic requirements for disclosure
might not be enough to stimulate decisions on long-term investments, so the
Commission is working on developing a more robust non-financial reporting
framework. Non-financial disclosure by asset managers and owners may also merit
further reflection, including on how to reflect the specific risks and impacts
linked to sustainability in portfolio management. Many commentators also consider
that quarterly reporting creates the wrong incentives, pushing market
participants to focus on very short-term results. In the review of the
Transparency Directive,[31]
the Commission has proposed lifting the obligation for quarterly reporting.

Benchmarks and credit
ratings may focus also on annual or short horizons. The Commission has proposed
tightening the rules to reduce reliance on traditional ratings and political
agreement was reached on several legislative reforms in November 2012.[32] The
development of metrics and ratings that balance fostering a long-term
perspective with short-term accountability could provide a useful tool to
assist long-term investors.

Questions: 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?

3.4       The
ease of SMEs to access bank and non-bank financing

The small and
medium-sized companies (SMEs) of today have the potential to underpin the long-term
growth of the future. They have historically faced significant difficulties in
accessing funding to grow. Given their reliance on bank financing, these
difficulties are reinforced given bank deleveraging. In addition, they are now
faced with fragmented financial markets in the EU, as access to finance
conditions vary considerably from country to country.

The reduced
availability of bank finance has already spurred policy action to promote the
development of alternative, non-bank channels for SME lending. In 2011, the
Commission adopted an action plan to address the financing problems faced by
SMEs.[33]
Certain initiatives have already been agreed, including new EU frameworks
for investment in venture capital and in social entrepreneurship funds. Some policy
initiatives are also underway to facilitate SMEs’ access to equity markets. However,
other legislative proposals linked to the action plan have yet to be adopted. Proposals have
also been presented to allow the operators of multilateral trading platforms to
be registered also under the label of "SME growth market"; and, for a
proportionate regime that will decrease administration costs and burdens for
SME's accessing markets for funding.[34]
In parallel, there has been growth in long-standing markets, such as asset finance
and supply-chain finance, as well as financial innovations making use of
technology and the internet, for example through crowd-funding.

But these
measures may not be sufficient to address the difficulties of SMEs to access  finance.
Further steps could be considered, including:

·
Developing venture capital.  The venture capital sector suffers from lack of resources and is
influenced by bank and insurance prudential regulation. Funds-of-funds could be
efficient instruments to increase the volume of venture capital. A fund of
guarantees for institutional investors could further reduce the constraints in
this market;

·
Developing dedicated markets and networks for
SMEs. Venture capital funds are also dependant on
well-performing SME-oriented stock exchanges to turn their investments into
initial public offerings. Measures could include creating a distinct approach
for SMEs, going further than the current MiFID II proposal, and include the
development of specific accounting rules for listed SMEs and new trading
platforms. Dedicated SME markets could help raise their visibility, attract new
investors and support the development of new SME securitisation instruments. Developing
frameworks for business networks could favour SME pooling, risk sharing,
mutualisation and diversification and thus improve their access to finance;

·
Developing new securitisation instruments for
SMEs. The Commission already has a SME securitisation
instrument in place and has proposed to continue offering support for securitisation
through the COSME programme. In addition, under EU criteria for SMEs’
industrial investments of European interest, vehicles for structured credits
could receive European labels. In view of the wide differences between
industrial sectors and between investment cycles, these instruments should be
differentiated;

·
Developing standards for credit scoring assessments
of SMEs could help address the lack of reliable
information about SMEs and the related difficulty for potential investors in
evaluating their credit worthiness. Developing common minimum quality standards
on external evaluation of mid-caps and SMEs could further facilitate their
access to finance, including across borders, and deepen market integration; and

·
Developing or promoting other "non-traditional"
sources of finance, such as leasing; supply chain
finance; internet-based sources of funding like crowd-funding, etc. Further
reflection is needed about how to ensure these markets grow on a sustainable
basis and are properly supported within a regulatory framework.

Questions: 26) What further steps could be envisaged, in terms of EU regulation or other reforms,  to facilitate SME access to alternative sources of finance? 27) How could securitisation instruments for SMEs be designed? What are the best ways to use securitisation in order to mobilise financial intermediaries' capital for additional lending/investments to SMEs? 28) Would there be merit in creating a fully separate and distinct approach for SME markets? How and by whom could a market be developed for SMEs, including for securitised products specifically designed for SMEs’ financing needs? 29) Would an EU regulatory framework help or hinder the development of this alternative non-bank sources of finance for SMEs? What reforms could help support their continued growth?

Question: 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?

4.           Next steps

On
the basis of the outcome of this consultation, the Commission will consider the
appropriate actions to pursue further. The responses received will be available
on the Commission website unless confidentiality is specifically requested, and
the Commission will publish a summary of the results of the consultation.

Stakeholders
are invited to send their comments by 25 June 2013 to the following email address: markt-consultation-long-term-financing@ec.europa.eu

[1]              See http://ec.europa.eu/europe2020/index_en.htm

[2]               See http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2012:0582:FIN:EN:PDF

[3]               See http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2010:0546:FIN:EN:PDF

[4]               See http://ec.europa.eu/bepa/pdf/cef_brochure.pdf

[5]               The Commission Communication “Towards Social
investment for Growth and Cohesion” (COM(2013)83) underlines the need for
Member States to make more use of innovative approaches to financing in the
social area, including by using participation of the private sector.

[6]              See http://www.g20.org/news/20130216/781212902.html

[7]              See McKinsey Global Institute (2012).

[8]               Based on a survey of changes in cash and cash
equivalents of 170 large European non-financial corporates rated by Fitch.

[9]               See McKinsey Global Institute (2011).

[10]             These features include the characteristics of the
investor, the nature of the asset, the type of financial intermediation, and
the valuation and pricing of the asset. For further details, see the Staff
Working Paper accompanying this Green Paper.

[11]             For example, the ECB bank lending survey October 2012
reports that net tightening of credit standards by euro area banks for loans or
credit lines to enterprises increased 15% in net terms, compared to 10% in the
second quarter of 2012. Equally, the volume of new long-term loans declined
markedly in the first half of 2012 and their stock shows a significant downward
trend at the very short end.

[12]             See http://ec.europa.eu/internal_market/bank/regcapital/new_proposals_en.htm.

[13]             For example, ‘bridging products’ are instruments that
can ease investors’ or financial institutions' risk aversion. They can include
first-loss credit or mezzanine credit enhancement; vehicles specializing in
early-stage and large-scale demonstration projects with public sector financing
alongside private sector

[14]             For example, through the Long-Term Investors Club. See
http://www.ltic.org/.

[15]             Equity or risk-capital, guarantees or other
risk-sharing instruments supported by the central EU budget or the Structural
Funds budget. For further details see the Commission Communication “A framework
for the next generation of innovative financial instruments - the EU equity and
debt platforms” (COM(2011)662).

[16]             For example, the Project Bond
Initiative and instruments using resources from
Structural and Investment Funds providing debt, mezzanine and equity financing
to SMEs, municipalities and infrastructure projects. In 2011 the Commission
proposed an infrastructure package, composed of a new budgetary instrument, the
Connecting Europe Facility, as well as revised guidelines for transport, energy
and ICT and a Programme for the Competitiveness of Enterprises and SMEs
(COSME). The Commission and the EIB have developed two risk-sharing
finance facilities, including the Risk-Sharing Finance
Facility (RSFF) for research
intensive and innovative companies and the Loan
Guarantee Instrument for TEN-Transport (LGTT) for transport projects.  Under
the Structural Funds for the period 2007-2013, at least €10.7bn of EU money has
been invested so far in financial engineering instruments, mainly by the ERDF
for SME access to finance. This money will be re invested in the long term for
the benefit of the European economy.

[17]             See Fitch 2011 and EFAMA (2012).

[18]             See http://ec.europa.eu/internal_market/insurance/solvency/future/index_en.htm.

[19]             See http://ec.europa.eu/internal_market/pensions/directive/index_en.htm.

[20]             Existing examples include the proposed Pension
Infrastructure Platform in the UK and the ideas for a common private equity and
infrastructure fund between some regionally-based pension funds.

[21]             For example, a finance roundtable has been established
to identify opportunities to develop adapted finance and innovative financial
instruments for supporting resource-efficiency actions

[22]             See http://ec.europa.eu/internal_market/smact/index_en.htm.

[23]             For example, aggregate outstanding amounts of debt
securities issued by non-financial corporations in the euro area totalled
€940bn in July 2012, having risen from about €652bn at the beginning of 2008
(Source: ECB).

[24]                    See http://ec.europa.eu/internal_market/securities/isd/mifid_en.htm.

[25]             Covered Bonds are bonds backed by pools of mortgages
that remain on the issuer’s balance sheet, as opposed to mortgage-backed
securities, where the assets are taken off the balance sheet.

[26]             Project bonds are private debt issued by a project
company to finance a specific off-balance-sheet project.

[27]             This could include: a) standardisation and labelling of
project bonds issued by project companies in the EU; b) whether a specific
regulatory framework is needed; and c) analysing the need and merit for working
on the development of a project bonds market (e.g. through a trading platform).
Similarly, Project Bonds could be extended to Green Bonds and dedicated
industrial Demonstration Project Bonds, including for first-of-a-kind,
commercial-scale industrial demonstration projects.

[28]             For example, the Livret A in France; the libretti postali in Italy; and the Bausparvertrag (contractual savings for
housing finance) in Germany.

[29]             See http://ec.europa.eu/internal_market/investment/ucits_directive_en.htm
and http://ec.europa.eu/internal_market/investment/alternative_investments_en.htm.

[30]             See
http://ec.europa.eu/internal_market/company/docs/modern/121212_company-law-corporate-governance-action-plan_en.pdf.

[31]             See http://ec.europa.eu/internal_market/securities/docs/transparency/modifying-proposal/20111025-provisional-proposal_en.pdf.

[32]             See http://ec.europa.eu/internal_market/securities/agencies/index_en.htm.

[33]             See http://ec.europa.eu/enterprise/policies/finance/files/com-2011-870_en.pdf.

[34]             See http://ec.europa.eu/internal_market/securities/prospectus/index_en.htm.