Opinion of the European Economic and Social Committee on the Green Paper on the Enhancement of the EU Framework for Investment Funds  (COM(2005) 314 final)
Date: 2006-03-15
Institutions: European Economic and Social Committee
Subjects: financial market, investment, investment policy, investment protection, investment transaction, securities, tax system

9.5.2006

EN

Official Journal of the European Union

C 110/19

Opinion of

the European Economic and Social Committee on the Green Paper on the

Enhancement of the EU Framework for Investment Funds

(COM(2005) 314 final)

(2006/C 110/04)

On 12 July 2005 the European Commission decided to consult the European Economic and Social
Committee, under Article 262 of the Treaty establishing the European Community, on the Green paper on
the enhancement of the EU framework for investment funds.

The Section for the Single Market, Production and Consumption, which was responsible for preparing the
Committee's work on the subject, adopted its opinion on 21 February 2006. The rapporteur was Mr
Grasso.

At its 425th plenary session, held on 15 and 16 March 2006 (meeting of 15 March), the European
Economic and Social Committee adopted the following opinion by 138 votes to one with four abstentions.

1. Introduction

the EU has not yet completely removed the regulatory barriers
to cross-border localisation and product marketing, the UCITS
market operates in a harmonised regulatory context.

1.1
The Commission's green paper is an extremely impor-
tant strategy document in the quest to achieve full integration
of EU financial markets. It is well known that the economic
development and growth of European countries is closely
linked to the development and integration of financial markets,
the latter also representing the full achievement of the third
phase of European Union.

1.2
Leaving aside the academic debate as to whether finan-
cial development precedes or follows economic development, it
would seem important to emphasise that with regard to the
dualistic, bank- and financial market-oriented approach that
characterises the ‘Anglo-Saxon’ model (and that of the US in
particular) as compared to the ‘European model’, current legis-
lative trends and the direction of the Union seem to indi-
cate a desire to continue to work towards full integration
of the two approaches in our economic system.

2.2
The UCITS market appears to be growing at an unstop-
pable pace. In recent years, managed net assets have seen two
figure growth. According to figures from the ‘European Fund
and Asset Management Association, Investment Company Institute,
and other Mutual Fund Associations’, from 1996 to 2005 the
market that comprises the EU, the Czech Republic, Hungary,
Poland, Norway and Switzerland recorded a compound annual
rate of 14.5 %,
increasing from approximately EUR 1 450
billion to more than EUR 4 900 billion of net assets.

The publication (1) of the annual figures for the number
2.3
of funds and total fund capital globally shows that the phenom-
enon is clearly on the increase both in terms of numbers and
volumes managed.

1.3
Financial markets and institutions perform for society
task of bringing together units that are
the fundamental
running a deficit and those that are running a surplus,
complying with ground rules based on efficient allocation of
resources and rationality. Furthermore, it must be remembered
that fair competition — and competition between firms —
occurs in capital and credit markets before it does in the mate-
rial goods market.

2.4 Whilst it appreciates the difficulties, the EESC believes it
is very important to resolve the problem of fiscal convergence
in order to increase the growth potential of UCITS. The sector's
internationalisation strategies can be influenced by entrance
barriers and exit barriers. Exit barriers are created when non-
resident fund holders are taxed according to fund host country
legislation; entrance barriers are created by the legislation of
the fund holder's country of residence.

2. The UCITS market in the EU and the need for harmoni-

sation

2.1
European regulation of managed savings, in general, and
of UCITS (Undertakings for Collective Investment in Transfer-
able Securities) in particular, revolves around the core Directive
85/611/EEC, which in recent years has supplied the regulatory
framework within which the sector has developed. Although

2.5
In Europe UCITS fiscal discipline appears almost every-
where to be inspired by the principle of neutrality of invest-
ment in funds compared to direct investment; nearly all Euro-
pean countries operate — either formally or substantially
— the no-veil
in which
investor income is taxed directly. The transparency model
applies the principle of capital export neutrality and, where
income from funds has not been taxed at source, investors are
taxed based on the residence principle.

transparency) model,

(fiscal

(1) Source: European Fund and Asset Management Association, Invest-

ment Company Institute and other Mutual Fund Associations.

C 110/20

EN

Official Journal of the European Union

9.5.2006

3. Comments on the General assessment section

4. Responses to the green paper's questions

In the European financial

3.1
industry, UCITS are, on
average, less than one third of the size of their US counterparts;
as a result fund management does not fully benefit from econo-
mies of scale, reducing net returns to end-investors.

3.2
However, although the Commission's key objective is to
define a framework for product financing, the EESC feels that if
investors are to benefit, there must be full regulation of
the financial system (i.e. regulation of both products and
services).

3.3
The Green Paper highlights the increased operational
risk that the outsourcing of certain functions may entail, which
may possibly result in conflicts of interest: the EESC feels this
is a valid concern, which should be followed up with
appropriate legislation.

relations develops. Let us

3.4 Whenever a process is segmented and delegated to
different organisations, the problem is not so much to do with
the technical arrangements for making the subdivision than
with the balance with which the (new) market that regulates
buyer-vendor
take, by way of
example, the financial analysis industry. Under current practice,
financial analyses are not bought and sold independently;
instead, they are incorporated into other services, usually of an
operational nature. Thus, for example, a bonds broker tends to
distribute analyses of individual bonds in exchange for opera-
tional continuity based on commission levels that also include
the cost of the analysis.

to say the least: analysis is underpaid,

3.5
Information (analysis) is thus disseminated according to
a market logic that is typical of that for a ‘public good’: the
amount of information needed is provided and the price is the
sum of the prices paid by the various buyers; only a few of
these buyers, however, actually pay anything. The effect is
destabilising,
thus
providing an incentive to make economies of scale when
producing analyses, with an inevitable reduction in quality and
also an incentive to take advantage of cost benefits deriving
from conflicts of interest (see, for example, the British FSA's
intervention on ‘soft commission’ between brokers/dealers and
asset managers). The EESC considers that rules must be estab-
lished to avoid — as far as possible — confusing the price
setting mechanisms used in the financial capital risk interme-
diation industry with those used in the investment risk interme-
diation/transformation industry.

4.1 Question 1: Will

the above initiatives bring sufficient

legal

certainty to the implementation of the Directive?

A. Eliminate the uncertainty surrounding the recognition of

funds during the transition from UCITS I to UCITS III,

B. Simplify the notification procedure for passporting funds,

C. Promote implementation of Commission's Recommenda-
simplified

and the

tions on the use of derivatives
prospectus,

D. Clarify the definition of ‘assets’ which can be acquired by

UCITS.

4.1.1
To answer the question it is necessary to distinguish
between ‘product’ financing and ‘service’ financing. The
aim of the former is to establish the practical instruments for
bringing providers and receivers of financial capital together;
the latter aims to identify the instruments that are best suited
to the requirements of fund investors or providers, and indicate
the missing
— where no suitable product exists — what
features are.

The conversion of

financial systems from a ‘bank-
4.1.2
centred’ to a ‘market-centred’ approach changes the role of the
financial intermediary, who increasingly frequently has to inter-
mediate risk as well as financial capital. Risk intermediation is
profitable as long as the intermediary is able to handle the risk
at a lower cost then the investor. It is therefore legitimate to
wonder whether a legislative system that aims for total reduc-
tion of risk is more effective than one intended to provide
adequate levels of efficiency for risk intermediation.

4.1.3
It should be borne in mind that even in efficient finan-
cial market contexts, the overall risk of an investment would
ideally be split into two parts: ‘payoff risk’ and ‘informative
risk’. The former measures the effective volatility of an invest-
ment's payoff. The latter measures the difficulty of correctly
assessing the payoff risk (due mainly to a lack of information
on the part of the economic operator). It must be appreciated
that the risk premium calculated by the economic operator
derives from both types of risk and that the links between the
two types are not characterised by simple addition but by
correlations of varying degree.

4.1.4
In light of the above, the EESC would answer in the
affirmative, but only insofar as this applies to product financing.
With regard to service financing there is a need to allow
greater freedom in the provision of investment services, for
example, by removing the current restrictions on financial
promotion, which do not take full account of the principle of
home-country-control.

9.5.2006

EN

Official Journal of the European Union

C 110/21

4.1.5
There is a clear concern underlying this, i.e., the need
to prevent evasive behaviour on the part of those aiming to
set up promotional networks exploiting the more favourable
conditions pertaining in certain EU countries. The EESC
believes that this logic is fundamentally flawed: the fact that
evasion is possible means that the conditions have not been
effectively harmonised.

4.1.6
The EESC therefore feels that free movement should be
increased within the service financing industry as an incentive
towards the standardisation of the application by individual
countries of EU directives on investment and transferable secu-
rities (including UCITS III).

4.2 Question 2: Are there additional concerns relating to day-to-day
implementation of the Directive which need to be tackled as a
priority?

4.2.1
Regulatory convergence must, however, be accompa-
nied by measures to coordinate the fiscal rules that apply to the
sector. Different national systems still coexist in the European
market, as they do in all other areas of finance, and these are
compounded in some sectors by rules deriving from bilateral
agreements to avoid double taxation.

4.2.2
This patchwork of fiscal regulation leads to distortions
of competition, double taxation, and scope for arbitrage,
fraud and tax evasion. In this respect, the national regulatory
framework needs to be more efficient, given the growing inter-
nationalisation of the market.

Individual Member States possess a formidable promo-
4.2.3
tional and protectionist instrument: taxation. Given that the tax
implications of UCITS originating in other EU countries are
open to various interpretations,
less favourable tax arrange-
ments can be applied, thus creating a kind of entrance barrier.
The Committee is aware that tax harmonisation cannot be
considered an easily attainable objective in the short term,
partly due to the requirement for unanimity in this area. We
would therefore propose that consideration be given to
framing an EU taxation system for investment products in
terms of both levying and collecting.

eliminating the uncertainty surrounding the recognition of
funds launched during the transition from UCITS I to UCITS
III.

4.4 Question 4: Would the splitting of responsibility for the supervi-
sion of the management company and the fund across jurisdic-
tions give rise to additional operational risks or supervisory
concerns? Please describe sources of problem and steps that would
have to be taken to manage such risks effectively.

4.4.1
The EESC realises that within the EU there are two
financial models: that of the UK and that of continental Europe,
and it will be difficult to converge them in the short term.
However, the EESC hopes that the new rules will ensure that
the convergence process can be facilitated by having a
single regulator, since it believes that the introduction of legis-
from picking and
lative obstacles
choosing which regulatory system to avail of would only serve
to perpetuate the current imbalanced situation.

to prevent

institutions

4.4.2
The EESC is convinced that splitting responsibility for
supervision of the fund management company and of the fund
between two Member States increases supervisory concerns,
and risks reducing operational efficiency. The Committee
therefore recommends that responsibility towards the
investor should lie with the fund that is based in the
investor's home country, even when the management
company is based abroad.

4.5 Question 5: Will greater transparency, comparability and atten-
tion to investor needs in fund distribution materially enhance the
functioning of European investment fund markets and the level of
investor protection? Should this be a priority?

4.5.1
To enhance the functioning of fund markets and the
level of investor protection it is not enough to regulate only
the product side of financial instruments. The EESC suggests
that, if investors are to make informed choices, due attention
must be given to their needs in the fund distribution phase,
making it more transparent.

4.3 Question 3: Would an effective management company passport
deliver significant additional economic advantages as opposed to
delegation arrangements? Please indicate sources and likely scale
of expected benefit.

4.3.1
The passport and simplified prospectus seem suitable
measures for overcoming criticisms regarding market fragmen-
tation and barriers to full mobility of capital and market
completion and for beginning to establish sufficient legal
certainty; the EESC also believes it is essential to work towards

Information provided to investors must

4.5.2
take some
account of the home environment and culture in which the
investors are based. The enlargement of the European Union to
include countries which up until 15 years ago were not partici-
pating in the market economy raises the issue of whether there
should a uniform information requirement. The EESC believes
that consideration should be given to this, bearing in mind on
the one hand, the need for a regulatory framework which is as
simple and uniform as possible, and on the other, the different
economic and financial cultures that still exist between some
Member States.

C 110/22

EN

Official Journal of the European Union

9.5.2006

4.6 Question 6: Will clarification of
applying to firms which retail
significantly to this objective? Should other
disclosure) be considered?

‘conduct of business’

rules
funds to investors contribute
(enhanced

steps

The EESC believes that clarification of

4.6.1
‘conduct of
business’ rules for distributors can only be a good thing. We
must not underestimate, however, the problems arising from
the day-to-day implementation of the directive, with regard to
risk management and fee transparency, which are not always
easy to resolve.

Consider, for example, the technical

4.6.2
issue of bench-
mark accounting. This can take on totally different meanings
depending on whether the manager is aiming to beat the bench-
mark or meet the benchmark; the particular delegation process —
where the same technical
instruments are used — requires
exposure to different levels of risk, assuming that to beat the
benchmark it is necessary to allow managers to vary their allo-
cations, thereby assuming additional degrees of risk.

In this context, we would propose the introduction of
4.6.3
transparency to the
regulations aimed at bringing greater
process (rather than the quantity) of portfolio investment rota-
tion: gross performance being equal, high levels of rotation
bring higher transaction costs, reducing the net performance
for the client. This is a particularly pressing issue, especially if
part of the transaction costs are to be borne by the managers
themselves.

4.7 Question 7: Are there particular fund-specific issues that are not
covered by ongoing work on detailed implementation of MiFID
conduct of business rules?

4.7.1
The MiFID directive can provide an important regula-
tory basis, particularly in seeking to attain high transparency
standards in the distribution of UCITS.

4.7.2
The MiFID directive does not, however, lay down
transparency rules for the negotiation of bonds, which can
be far from transparent. The EESC therefore feels that the
MiFID Directive cannot be seen as the instrument that rounds
off the legislative framework governing UCITS by remedying all
of its shortcomings.

4.8 Question 8: Is there a commercial or economic logic (net bene-
fund mergers? Could those benefits be

fits)
largely achieved by rationalisation within national borders?

for cross-border

European funds are still relatively small-scale: in 2004
4.8.1
the average was USD 195 million, compared to the American
average of USD 628 million in the same year. This impacts on
the chances of achieving economies of scale, then on returns

and, last but not least, on the profitability of the company that
manages the fund.

4.8.2
It is widely known that one of the financial effects of
the process of economic globalisation is a reduction of the
absolute level of risk, which is associated with a readjustment
of the levels of systematic (increasing) and specific (decreasing)
risk. While admittedly cross-border mergers can increase
economies of scale they should only be implemented on a
limited basis, in the case of products where such mergers
can be a driver of success, or rather to all sectors of fund
management where efficiency is more important than effective-
ness.
In sectors where effectiveness is lacking, however, no
benefit can be derived from agglomeration.

4.9 Question 9: Could the desired benefits be achieved through

pooling?

4.9.1
Pooling asset management in the case of funds that
are very similar in nature clearly leads to economies of scale
and is an instrument already used by management companies
for improving fund management efficiency. With cross-border
pooling, however, investment funds run into the various tax
and legislative problems previously discussed. The EESC there-
fore considers that it cannot be an alternative means of circum-
venting the legislative and institutional difficulties impeding the
consolidation of the investment fund industry.

4.10 Question 10: Is competition at the level of fund management
investors will

to ensure that

and/or distribution sufficient
benefit from greater efficiency?

The answer to this is no, as the US experience has
4.10.1
revealed.
funds have existed on the American
Investment
market for the past sixty years: despite the spectacular increase
in the number and size of funds available, the costs borne by
the funds and by investors have, on the whole, almost
doubled (2). This has resulted in a distinctly unsatisfactory
performance when measured against
the benchmark: while
over
the period 1945-1965 the benchmark outperformed
funds by an average of 1.7 % annually, in the period 1983-
2003 this gap increased, reaching 2.7 % per annum.

4.11 Question 11: Which are the advantages and disadvantages
(supervisory or commercial risks) stemming from the possibility
to choose a depositary in another Member State? To what
extent does delegation or other arrangements obviate the need
for legislative action on these issues?

The option of choosing a depositary in a different
4.11.1
Member State from that
in which the fund management
company is based could increase competition among deposi-
taries, reducing the costs borne by the fund.

(2) Bogle J.C. (2005),

‘The Mutual Fund Industry 60 Years Later: For

Better or Worse?’, Financial Analysts Journal, January/February.

9.5.2006

EN

Official Journal of the European Union

C 110/23

4.11.2
This could also mean an increased supervisory risk if
there is not sufficient cooperation and convergence between
the regulatory authorities.

become less reactive, with an outcome that remains to be
established, but it would certainly be negative. On the other
hand, awareness of ‘real loss’ of capital could be the most
effective impetus to its protection.

Though they are considerable, depositary fees are
4.11.3
lower than other costs, such as,
for example, distribution
expenses. The EESC would suggest that the benefits and risks of
a legislative initiative in this regard should be weighed up care-
fully.

4.12 Question 12: Do you think that on-going industry-driven stan-
dardisation will deliver fruit within reasonable time-frames? Is
there any need for public sector involvement?

4.12.1
Standardisation, automation and the computerisation
of order-placing and fund liquidation are fundamental pre-
requisites if distributors are to expand their range of products
and increase competition.

This, however, would require significant changes to
4.12.2
be made to the rules and standards governing operating and IT
procedures, incurring significant costs for operators. It should
be remembered that in continental Europe fund management
companies and distributors are often part of the same group. In
a context such as this there is presumably little incentive for
operators to bear the costs involved in increasing competition
at the distribution level. It is possible, therefore, that public
sector involvement could accelerate this process.

4.13 Question 13: Does heavy reliance on formal investment limits
represent a sustainable approach to delivering high levels of
investor protection?

The effectiveness of strict codes of conduct regarding
4.13.1
risk management has always been a matter of intense debate in
the world of economics, especially in light of the varying bene-
fits deriving from past experience since the Bretton Woods
exchange-rate agreements. This results from the diverse nature
of economic risk in relation to time: in the short term, fluctua-
tion in the face of restriction creates risk, while conversely, in
the long term, risk is also created where something remains
rigid while the system evolves. As a result, introducing rigidity
in the short
by means of formal
term, but would create substantial risks in the long term.

limits would be beneficial

4.13.3
This development entails further distortion of the
markets: the creation of expectations that if the risk has a
favourable outcome,
it
produces negative results, this will be absorbed by the market.

the investor benefits, whereas

if

4.14 Question 14: Do you think that safeguards — at the level of
the management company and depositary — are sufficiently
robust to address emerging risks in UCITS management and
administration? What other measures for maintaining a high
level of investor protection would you consider appropriate?

4.14.1
The EESC would propose intervening in the short
term, possibly by means of formal and strict regulations, but
only with a view to breaking cartels; if this were to happen the
market would become more mature, and thus, would no longer
require tight restrictions. Accounting is one area of particular
interest: all too often the timeframes set by accounting obliga-
tions are completely inconsistent with those pertaining to
product financing (too short), so that the accounts show little
evidence of the temporal diversification pertaining to certain
investments.

In order to enhance investor protection, the EESC
4.14.2
suggests considering setting up a special guarantee fund, to
which fines imposed by the supervisory authorities could also
contribute. Clearly, this fund should not cover market risks
originating from UCITS investments; it should help to compen-
sate investors who have lost out when intermediaries have not
played according to the rules.

4.15 Question 15: Are there instances resulting in a distortion of
investor's choice that call for particular attention from European
and/or national policy-makers?

4.15.1
Investment funds compete against financial products
such as unit-linked policies, perceived as comparable by
investors, despite the fact that they are governed by a very
different legal framework.

A point should also be made in relation to recent
4.13.2
studies on the so-called behavioural finance sector: the actions
and decisions of individual economic agents tend to be strongly
influenced by the level of risk involved. As the level of risk
increases, behaviour becomes increasingly reactive and vice
versa; consequently, the EESC takes a negative view of any
legislation that introduces excessive rigidity and which could
have a twofold effect in the long term: the instruments would
pose a greater operational risk and economic operators would

This can distort

investors' choices with negative
4.15.2
repercussions on cost and risk levels in the investments
concerned. The EESC believes that this problem cannot be
addressed with reduced competition or by easing the restric-
tions and guarantees imposed on investment funds. We would
instead for an upward adjustment of standards so that
call
financial products that are perceived as being a direct alterna-
tive to investment funds are subject to regulatory requirements
that are comparable to those pertaining to such funds.

C 110/24

EN

Official Journal of the European Union

9.5.2006

4.16 Question 16: To what extent do problems of regulatory frag-
mentation give rise to market access problems which might call
for a common EU approach to a) private equity funds; b) hedge
funds and funds of hedge funds?

4.18 Question 18: To what extent could a common private place-
ment regime help to overcome barriers to cross-border offer of
alternative investments to qualified investors? Can this clarifica-
tion of marketing and sales process be implemented indepen-
dently of flanking measures at the level of fund manager etc.?

In order to clarify the terms of this question and the
4.16.1
issue raised in the previous question it is necessary to preface
our response as follows. The Commission needs to clarify its
definition of transferable securities. Clarification is needed
to dispel doubts as to whether or not this term implies a
liquid instrument. It seems that these two concepts are being
used interchangeably,
in an attempt to divest the concept of
transferable securities of any connotation of being an alterna-
tive investment or a UCITS-substitute. We believe that this
misunderstanding could have serious consequences, as it could
lead to the confusion of two quite different theories regarding
financial markets: efficiency and completion.

4.16.2
A financial market is efficient when investment trans-
action costs can be borne by it; a financial market is complete
when it comprises all possible investments.

4.16.3
Private equity and hedge funds must be judged
primarily in terms of their effectiveness (capacity to select the
best investments) before being considered in terms of efficiency
(capacity to achieve economies of scale regarding costs). For
this reason,
thus,
problems regarding effectiveness (capacity to move quickly on
the market without
influencing its performance) and the
containment of systemic risk (consider the rescue of the LTCM
fund in 1998) suggest that it would be preferable not to incen-
tivise excessive expansion in the size of funds.

fund size is less relevant:

the issue of

4.17 Question 17: Are there particular

risks (from an investor
protection or a market stability perspective) associated with the
activities of either private equity or hedge funds which might
warrant particular attention?

A feature of these investments,

4.17.1
in addition to the
payoff risk, is their major informative risk. It is right to regu-
late this risk, particularly in order to contain the risk of fraud,
but it would be a mistake to try to reduce it excessively.
Indeed, if these funds were to become fully transparent, there
would be a risk of invalidating manager skills, which in fact
underpin the production of returns that are only tenuously
linked with the market.

The Committee does not believe that

the way
4.17.2
to clarify a
forward should consist
complex process, but rather to inform the ‘average’
investor
that alternative investments require highly specialised knowl-
edge, without which expert advice should be sought.

in a utopian attempt

The establishment of a common private placement
4.18.1
regime for qualified investors could be a major fillip to the
development of private equity funds in the European Union.

Qualified investors must by definition be in posses-
4.18.2
sion of
the technical skills and assets management ability
required to make high risk investments such as in private
equity. It must therefore be assumed that they are able to assess
the ability and credibility of managers. Moreover, given that
private equity funds provide a de facto diversification of risk,
there should be no need for any flanking measures that might
lead to over-regulation of management company activity.

4.19 Question 19: Does

the

current product-based prescriptive
UCITS law represent a viable long-term basis for a well-super-
vised and integrated European investment fund market? Under
what conditions, or at what stage, should a move toward prin-
ciple-driven, risk-based regulation be contemplated?

There are several examples of

4.19.1
the shortcomings
inherent in the current approach. For example, ETF (Exchange
Traded Funds), which combine the positive features of a fund
(considerable diversification) with those of shares (can always
be traded on the market). The directive encourages use of this
instrument by allowing it — given its UCITS status — to
benefit from the passport. On the other hand, it poses restric-
tions on another UCITS holding it, as it would then be treated
as a stock certificate.

In the light of,

4.19.2
inter alia, alternative investment
thinking and given the importance of not focusing solely on
product finance but also on services finance, the Committee
considers that a move towards principles-based regulation
would be welcome. At the same time,
it believes that the
review of the regulatory framework should be done gradually
to strike the right balance between providing
and attempt
adequate
review
promptly.

consultation time

and completing

the

5. Future challenges

5.1
As has been shown, the European UCITS system still
appears to be fragmented, with relatively small businesses
compared to the U.S. and apparently still sluggish cross-border
collaboration and flows. This is not something that is likely to
enable any significant economies of scale or — consequently
— cost reductions to be made.

9.5.2006

EN

Official Journal of the European Union

C 110/25

5.2
Furthermore, the excessive concern, also voiced in the
green paper (3), regarding the definition of assets that can be
acquired by UCITS, obliging funds to invest in liquid financial
instruments in particular, would prevent participation in non-
regulated markets.

accounted for approximately 0.37 % of all assets managed by
European UCITS. A comparison with the American market,
where in the same period 11.3 % of all assets managed by
UCITS belonged to ethical funds, shows that socially respon-
sible finance still has very high growth potential in Europe.

5.3
It would therefore be advisable to consider making
private equity operations a possibility. This would be
consistent with the objective of opening SME capital up to risk
capital operations and therefore to private equity.

5.4
The European economic system is strongly characterised
by small and medium enterprise, which often appears
undercapitalised because it resorts mostly to banks.

5.5
This undercapitalisation is often accompanied by
excessive indebtedness — especially short-term debt –with
a large amount of commercial debt and credit, linked to the
fact that businesses from the same sector of industry are highly
interdependent. This is also the consequence of a type of
ownership that is typical of family capitalism in that the entre-
preneur's assets and the firm's capital are often combined.

These business problems and the need to achieve more
5.6
general
‘productive system’ objectives on a European scale
make it essential to find solutions to the financial problems
experienced by SMEs. These objectives are threefold, and can
be summarised as follows:

— encourage an enterprise culture that can open SME capital
up to risk capital from third parties and financial organisa-
tions;

— encourage innovation as an instrument of competitiveness

in globalised markets;

— provide support for business continuity (and inheritance),
understood as a process that must not cause any ‘disconti-
nuity’ that might compromise the life of the business.

The Committee hopes that, on the basis of the above
5.7
considerations, the European legislator will extend his attention
to the important field of private equity, while venture capital is
still underdeveloped in Europe.

The Committee believes, moreover,

the current
5.8
discussion of the regulatory framework for investment funds
must also provide the opportunity to take a closer look at
the development of socially responsible finance, which
does not sacrifice social development and environmental
protection issues to the profit motive. In 2003 ethical funds

that

In order to encourage faster development of socially
5.9
responsible finance,
the Member States might envisage tax
incentives involving partial de-taxation of earnings from these
investments following a practice — already provided for in
some Member States — that allows voluntary contributions to
socially useful organisations to be tax deductible. Furthermore,
tax concessions should be available to funds profits that are
reinvested in socially useful organisations.

Given the innovative nature of

5.10
the
Committee hopes it will be examined in further detail and a
feasibility study carried out in the light of current best practice.

this proposal,

5.11

The medium- and long-term challenges are essentially:

— to consider the new products that

innovation
inevitably ‘creates’, in particular the alternative investments
that are increasingly essential for ‘financing innovation’ for
SMEs;

financial

— to overcome, including by means of mergers, the problems
posed by European funds being too small, with uncompeti-
tive operating costs; at the same time, to help the informa-
tion and analysis market ‘break through’;

— to ‘complete’ the market, with ‘product finance’ and ‘service

finance’ being regulated.

Proper information on risks and related products and
5.12
manager credibility on transaction amounts and arrangements
are all factors which — above and beyond the necessary rules
— are able to endow the market with confidence, fairness and
behavioural rules. These are crucial factors for market efficiency
and for effectiveness in allocating resources.

funds

Consequently, harmonising tax rules,
enabling joint management of

encouraging
5.13
mergers,
(pooling),
encouraging competition in the management and distribution
of products and services, abolishing the need for the fund
manager and the depositor to belong to the same Member
States, avoiding high ‘transaction costs’ connected with frag-
mented subscription and reimbursement procedures, will
bestow on the market a greater degree of efficiency and effec-
tiveness.

Brussels, 15 March 2006.

The President

of the European Economic and Social Committee

Anne-Marie SIGMUND

(3) COM(2005) 314 final, p.5, point 4.