Derville Rowland: Private assets - a changing European landscape
Remarks by Ms Derville Rowland, Deputy Governor of the Central Bank of Ireland, at
the 10th Annual Irish Funds UK Symposium, London, 30 November 2023.
* * *
Introduction
Good morning.
th
Thank you to Irish Funds for the invitation to address this the 10 Annual Irish Funds
UK Symposium. It is a pleasure to be with you again today.
When preparing for this event, I found myself reflecting on all that has changed since
the first UK Symposium a decade ago in 2013. The ancient Greek philosopher
the only constant in life is change
Heraclitus is credited with the idea that . When a
simple maxim like that has survived for centuries, it probably holds some truth. I think it
has certainly been true over the last 10 years. The global economy has shifted
significantly, emerging from the financial crisis and entering a period of sustained
recovery. 'Low for long' interest rates seem like a distant memory, with one of the
fastest hiking cycles in history, and an uncertain monetary policy
outlook. Technological advancements have continued apace. With the emergence of
developments, such as artificial intelligence, which are likely to continue to transform
how we conduct business and go about our daily lives. And, of course, challenges such
as climate change remain an ever present but evolving risk as we look ahead. The
regulatory landscape has also changed dramatically over the last 10 years. Enormous
work was undertaken to address the fragilities associated with the global financial crisis
through initiatives at a domestic, European and international level. Indeed, in this new
environment of heightened risk we are benefitting from the resilience built up as a result
of these changes. In addition, significant steps have been taken in the advancement of
a true European Capital Markets Union. But opportunities remain for enhancing the
resilience of financial markets and further developing European capital markets. These
are complementary goals and will be the focus of my remarks.
Indeed, as we gather in London for this Irish Funds Symposium, it would be remiss not
to recognise how much has changed in the United Kingdom over the last 10
years. Once a driving force within the Europe Union, the UK is now charting a path
outside of the EU. That said, the UK and London in particular, remain a critical part of
the global and European financial system and as such a vital part of European capital
markets. No longer as a direct participant of that Union but instead, like other global
financial centres, as a link to external sources of capital for the EU. Integration with the
appropriate regulatory safeguards and cooperation, will increase European businesses'
access to international capital and further boost European growth. International
influence and co-operation is critical to well integrated financial markets. Particularly in
an increasingly complex, challenging and uncertain environment.
But first, it is important to recognise that continued change to EU capital markets is
required. Ensuring well-functioning European capital markets is key to unlocking the
European private capital necessary to fund Europe's major investment needs. It is
positive that the Eurogroup of Finance Ministers has prioritised this issue and is
currently undertaking an initiative to agree priorities for enhancing and deepening
Europe's capital and financial markets. The Eurogroup is aiming to identify areas of
political consensus for the next European Commission to take forward, while at the
same time adopting a more bottom-up approach and facilitating exchanges of best
practices. This work is taking place in 'inclusive format' meaning that all EU 27
Finance Ministers are participating. Other policy makers, including central banks and
securities regulators, also have a key role to play in this regard. Both in terms of
identifying and addressing impediments which hamper EU capital markets but also in
terms of building and maintaining an effective regulatory and supervisory framework
which supports confidence in the functioning of the financial system and
markets. Notwithstanding sustained progress since the Commission's first CMU action
plan in 2015, much more remains to be done to address market fragmentation, a lack of
1
retail participation and an overreliance on bank funding in Europe. For that reason,
change, for all of us, will remain a constant over the coming years.
One particular area of change I would like to focus on today is that of private
finance. The span of the term 'private finance' is necessarily broad and intended to
capture activities relating to capital raising and lending, generally to corporates, by the
non-bank investors. And while public markets will continue to be the core driver of
CMU activity, private finance has an important role to play. Private finance globally is
going through a period of rapid growth, with Assets under Management (AuM) reaching
approximately $12.8 trillion US dollars in June 2022, up from $3.5 trillion in 2012.2
However, in Europe, while European private equity and early-stage equity financing
have grown in recent years, the euro area continues to lag behind international
peers. The ECB's second edition of their biennial report on financial integration and
structure in the euro area outlined that total euro area early-stage equity financing
including business angel, venture capital and growth equity investments grew from
€10.7bn in 2016 to just under €14bn in 2020. Venture capital accounting for almost all
of the increase and nearly doubled over this period. Nevertheless, the gap with the US
widened. Euro-area activity was less than 5 percent of US venture capital.3
Globally, the scale of private financing activities varies considerably by jurisdiction.
According to one industry report, the US accounts for over 54% of the private market
assets under management. Asian markets account for 22% of AUM and Europe
4
accounts for only 20%. Clearly, more needs to be done to stimulate European capital
markets.
There are significant economic arguments which support the emergence of private
finance supporting the real economy. Firstly, publically listing a company is expensive
and as such generally not an available option for small or medium sized
enterprises. These costs range from the extensive public disclosure obligations on
5
issuers as part of the initial public offering process. But the costs also relate to the fees
associated with the participants involved, including analysts, advisors, and brokers. As
a result, private equity may offer a less expensive form of equity-based financing,
particularly for smaller companies. Secondly, reliance on bank funding imposes costs
in terms of the increased cost of finance, hampering innovation and reducing resilience
during periods of stress. Private finance, including direct lending activities by
investment funds, offers an alternative to bank funding which may address some of
these challenges. Reliance on bank funding in Europe has been an acute issue for
some time. But, remembering the theme of constant change I started with, who would
have predicted that the first failure since the global financial crisis of a systemically
important bank would have taken place earlier this year. That event and the other
recent challenges with US banks have pushed banking regulation back onto the
6
international regulatory agenda. But those issues also serve as an important reminder
to Europe to diversify funding sources and continue to address the prevailing bank
dominance.
In that regard, it is positive that AIFMD 2, on which the EU institutions reached a
provisional agreement in July. The proposed changes are quite targeted and that is
because since enacted following the financial crisis, the AIFMD has largely been
successful at increasing the transparency of the alternative investment fund sector in
Europe. Though it was not without its challenges when first introduced - the directive
imposed some 169 obligations on the alternative investment fund managers, which
previously had not been regulated at an EU level. However, there were significant
benefits. The EU passport - introduced under the directive - has supported the
distribution and management of alternative investment funds in the EU, fostering growth
in the sector. The changes agreed as part of the AIFMD Review are appropriately
targeted and it is positive that these include new rules to harmonise the rules for funds
which undertake lending activity. We were strongly supportive of developing a
panEuropean framework for loan origination by funds, having had a longstanding domestic
policy framework in Ireland for such activity. That domestic framework was a
considered attempt to explore solutions to meeting the credit needs of the real economy
whilst carefully addressing the issues of investor protection and financial stability. In
due course, given the proposed EU level framework incorporates many features of the
Central Bank's rules, the Central Bank will move to align the provisions of our domestic
framework with that of AIFMD 2.
Prior to that change taking place however, another development is underway which will
provide fund managers with an additional option in terms of product development and
support capital flows into long-term investments in the European real economy. I am of
course referring to the amended European Long Term Investment Fund (ELTIF)
regime. As was discussed earlier in the conference, these long awaited changes are
intended to address the relatively low take up under the original ELTIF framework. The
amended ELTIF Regulation will apply from 10 January 2024. There is significant work
underway at an ESMA level to develop the draft regulatory technical standards under
the revised ETLIF Regulation with the full package of measures expected in Q1,
2024. As you are aware, in Ireland, we are also taking steps to provide, for the first
time, for an ELTIF which will be authorised under domestic funds legislation. This fund
structure will have all of the benefits otherwise applicable to an authorised AIF in
Ireland. These steps, which will provide retail investors' greater access to alternate
investment strategies and assets, particularly in terms of long term, less liquid,
investments. If designed correctly, and sold appropriately, there are many benefits for
retail investors having access to such investments through diversified, pooled, collective
investment funds.
There is much more to do on the CMU agenda, including steps to further increase retail
participation and address the fragmentation which exists in EU markets. However,
regulators and policy makers must, in tandem, continue to strengthen resilience and
address any emerging vulnerabilities.
There are two areas I would identify in this regard. Firstly, as the Financial Stability
Board has signalled in their recent G20 letter, a major focus of the FSB's policy work
next year will be to address financial stability risks associated with non-bank
leverage. As you know, over the last 12 months, the focus of both the FSB and IOSCO
has been on investment fund liquidity, with both consulting on updates to the
international regulatory framework. That international liquidity work is reaching
conclusion. However, national policy makers will need to consider how to implement
the outputs from that work. Therefore, unsurprisingly, the topics of liquidity and leverage
will remain a focus in Europe and at the Central Bank of Ireland. In particular, there is
continued work underway looking at liability driven investment funds (LDI) funds with a
view to preventing a repeat of the issues we saw last year, one of the first times that
leverage played such a significant role in a market event. As part of our ongoing policy
work to safeguard resilience, last week we published a consultation paper on measures
to enhance the steady state resilience of Irish authorised sterling denominated LDI
funds. Given the cross-border nature of these funds, we have sought to ensure
international coordination in codifying these measures, as exemplified by the fact that
the Commission de Surveillance du Secteur Financier (CSSF) in Luxembourg is also
publishing a similar consultation paper on LDI funds in parallel to our work. This
coordination is important to ensure the effectiveness of these measures.
The second area I would highlight in terms of potential vulnerabilities, relates to
sustainable finance disclosures. Funds managers, and other participants in Europe
capital markets, have an important role to play in supporting the transition to a more
sustainable economy. The challenge climate change represents has become even
clearer over the last number of months. Financial markets have a critical role to play
and, in many ways, the financial sector is to the fore of the risks and opportunities these
changes present. As a result, an ambitious sustainable finance agenda has been
embarked on in the European Union. We have moved from a framework devoid of
sustainable disclosure requirements, to a rapidly advancing legislative and regulatory
landscape. As a result, this area is forming an increasingly large part of our current
work programme, both at ESMA and at the Central Bank of Ireland. At ESMA we are
actively taking steps to address a potential vulnerability, namely the disconnect
between a fund's name, a critical aspect for a retail investor when determining whether
or not to invest, and the disclosures required in the EU Sustainable Finance Disclosures
Regulation. In due course, the European Commission look likely to further consider the
introduction of a labelling regime for investment products in this area. That is
something which we would be supportive of. Closer to home, at the Central Bank, we
have also taken steps to provide clarity in terms of disclosure expectations. That
includes recently hosting a workshop with industry representatives where participants
were able to exchange views on the disclosures required under the SFDR and how
standards could be raised across the sector. In due course, following further
engagement with the sector, the Central Bank will provide further clarifications to
ensure these disclosures best serve the end investor.
Conclusion
As regulators, we serve the public interest by maintaining monetary and financial
stability while ensuring that the financial system operates in the best interests of
consumers and the wider economy. In order to achieve this mission, we must continue
to strengthen the resilience of financial markets and address areas of potential
vulnerability. However, we also support other policy makers in identifying and
addressing areas of fragmentation or other inhibitors which hamper the development of
deeper capital markets. That is because consumer participation in investment products
and financial markets can have a positive impact on the consumer's financial wellbeing,
and as a result, their overall wellbeing.
Thank you.
1
See IMF Background Note on CMU for Eurogroup, dated 15 June 2023.
2
See: Bain (2023) Global Private Equity Report 2023.
3
See Financial Integration and Structure in the Euro Area, April 2022 (ECB).
4
See McKinsey (2023) Private Markets Annual Review.
5
For example, this includes the Prospectus Regulation, Transparency Directive, Market
Abuse Directive and exchange listing rules
6
See FSB Chair's letter to G20 Leaders: September 2023.