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«Rome, 25th June 2013 This paper was drafted by a working group, chaired by Prof. Rainer Masera (Università degli Studi Guglielmo Marconi), with the ...»

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The private equity and venture capital market must return, therefore, to connect itself with its main stakeholders. By taking other European realities as an example, as the data shown above indicate, it is even more opportune now, especially for Italian funds, to get closer to the investors in long-term capital, such as the pension funds and insurance companies, which for the investment cycle are more adaptable to fundraising of funds of private equity, giving the latter, at the same time, the intermediary role of risk capital towards Italian companies.

Furthermore, in a market stage in which the request for finance by SMEs are not fully satisfied by the banking system, the asset management industry can take on an important role by bringing together companies and investors through investment solutions that allow for the direct access by SMEs to the bond market, an asset class in which it is unlikely that individual investors can directly invest with adequate diversification. In essence, it is necessary to support – on the basis 5 Source AIFI, PwC, AFIC, EVCA data from 2007-2011.

6 Compared to what happened in Europe, the Italian statistics on the collection of the sector show the pension funds in fifth place in terms of amount invested (9%).

22 of what has already been carried out in some European countries (e.g. in France) – the development of investment funds, mainly closed and specialized in investment in debt securities of medium-sized enterprises, capable of correctly selecting companies to be financed and adopting diversification polices of the portfolio and risk management and the limited liquidity.

With this purpose, a simplified authorization process with the competent authorities could be provided, with the aim of allowing quicker growth and commercialization of these vehicles, as well as the possibility for financial institutions of the public sector to take on minority stakes of these investment vehicles also.

Among the institutional investors, a relevant role for the expansion of financing for productive investment could be played by the supplementary pension funds. Currently in Italy, people enrolled in pension funds only represent around 25% of the total number of employers and manage a wealth of over €104 billion, to which about €50 billion of Professional social security funds may be added.

There are no products specifically dedicated to pension funds, which are therefore constrained in making use of financial tools available to all economic operators, taking on risks that don‟t concord with the social security investments which, by definition, must refer to the long period.

They could be connected to initiatives of the central or peripheral Public Administration, aimed at realizing infrastructures, public utility and energy works or to the capitalization of small and medium enterprises, thereby providing a positive effect on employment and economic growth.

Question 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?

The experience of the capital standards on banks suggests caution in the introduction of stringent and strong procyclical prudential requirements. With regards to insurance companies, it must be underlined that the Solvency II regime is not currently foreseen in the US. Solvency II focuses on a market-based valuation of both assets and liabilities (the accounting principle) and on a risk sensitive capital standard, which is effectively based on a VaR approach (one-year 99.5%).

As has been indicated by many, and notably by OECD [Severinson and Yermo, 2012], this approach has many drawbacks. For instance, life products are designed and regulated around the principles of book investment yield and cost accounting. The shift to mark-to-market

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The “one-size-fits-all” approach does not address the current specific problems of insurance operators in the various countries. In Germany, the major problem lies in LT guarantees with extremely low long duration yields. In peripheral countries with high sovereign spreads, the problem lies mainly in the possible volatility of LT government bonds, even if they are held to maturity.

More generally, a negative impact on LT investments inevitably arises because of the disincentive to assets held as a match for LT liabilities. Here again, the very different investment scenario in the various countries creates complex adjustment problems. To recap, in Italy government bonds traditionally play a significant role as LT investments. In France, equity investments are especially important. In Scandinavian countries, infrastructure funds play an important role, while in the UK and Spain corporate bonds are favoured.

The European Commission is facing a very difficult task by including in the Solvency II (and CAD IV) framework the concern of providing long-term finance to support the recovery in Europe. By definition, Solvency and VaR increase the procyclical effects in financial markets. As argued by the OECD, but also by ECB/BIS [Praet, 2011], Solvency II leads to homogenous investment strategies across the European insurance sector. Insurers‟ investment strategies «may become more synchronised under a common regulatory framework. Where they used to exhibit contrarian or stabilising behaviour, they may henceforth move in the same direction as markets and the economy, leading to procyclical effects».

The new rules, have the aim of strengthening the security and stability of financial institutions, but they bring about inevitable increases in the cost of financing and non-negligible effects on investment decisions. The new regulatory framework on capital requirements of insurance companies (Solvency II) and on collateral for OtC derivatives (EMIR) could, if not correctly calibrated, discourage investments from insurance companies in some asset classes, and notably in some types of long-term investments.

These rules do to not take into account the aforementioned tendency of the insurer to hold securities to maturity, which makes them less exposed to market risk compared to buy and sell strategies.

With reference to insurance companies, assets discounted at market rates and liabilities at risk free rate create the risk of introducing “artificial volatility” in the balance sheet. In turn, this

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A second important threat deriving from the introduction of poorly calibrated regulations is the one connected to the materializing of a strong disincentive to maturity transformation. The crisis has clearly highlighted the risks associated to an excessive use of maturity lenghtening;

nevertheless, we need to consider that similar practices, made more onerous from a regulatory point of view, on the one hand, contribute to shift the risk on the investors by increasing the cost for the insured and, on the other, prevent also beneficial maturity transformation.

At European level, the current review process of the IORP directive (IORP II) has raised eyebrows, clearly expressed also by the private equity industry; the same approach has been adopted as in the Solvency II Directive, which is highly penalizing, notably because it discourages investment in the asset class of private equity.

The private equity and venture capital sector is now affected by the process of community harmonization in view of the implementation in the Member States of the Alternative Investment Fund Managers Directive and by the forthcoming entry into force of the European regulation for venture capital funds.

The change in national dynamics and the creation of a single European market must rely on a harmonized and sound regulatory and surveillance framework. As highlighted, an important factor which drives the choice of asset classes and the temporal horizon of investments is represented by the regulatory and macroeconomic context.

Also with regard to pension funds, support for long-term financing cannot determine negative effects on sound and prudent management. The aim of the complementary funds is precisely that of providing a complementary pension. In order to fulfill this aim, they must adopt investment strategies that enhance and, at the same time, protect the capital of underwriters.

It should be considered not only possible, but also desirable to pursue the aims (i) of voluntarily channeling part of the resources from pension funds towards the financing and recapitalization of SMEs, and (ii) favoring the investments for sustainable development, as well as public infrastructures projects, always ensuring adequate and stable financial returns. This would allow to pursue the twin objectives of ensuring an adequate return on retirement savings and contribute to economic development.

In this respect, it is useful to recall the fundamental principles of the Italian legislation (D.M.

703/96), which sets out the management criteria to comply with: “the pension fund works with 25 a view to ensuring that its financial resources are managed in a sound and prudent way, having regard to the objectives of diversification of investments; efficient management of the portfolio, diversification of risks, including counterparty risk; containment of transaction costs and maximization of net returns”.

In conclusion, we endorse the OECD analysis [Wehinger, 2011], according to which the regulatory setting often provides unfavourable incentives for long-term investment, which must be corrected.

«In particular, accounting rules that are appropriate for investment banks and trading activities are not very relevant, promote short-termism and therefore sometimes penalise long-term investors. The new Basel III capital and liquidity requirements will probably discourage longterm banking and financial initiatives. Moreover, the IASB mark-to-market philosophy is particularly damaging for long-term investments, attributing instant market pricing to assets whose value takes a longer time horizon to ascertain; and the European Solvency II Directive will discourage insurance companies and pension funds from investing in infrastructure assets, not allowing them to properly match long-term liabilities on their balance sheets with longterm assets.

While OECD figures show institutional investors’ assets at USD 65 trillion in 2009, long-term investment of these assets is facing liability and governance constraints, allowing only a small part to be available as long-term capital. But if enough investors with a long-term horizon were active on financial markets, they could act as shock absorbers, as they did in the past. While institutional investors are starting to invest directly in core infrastructure assets and are increasingly becoming familiar with this asset class, it is estimated they are investing only around 2% of their assets, on average, in infrastructure, much below their balance sheet potential for long-term investment, estimated at USD 7 trillion. Equity demand for infrastructure is likely to increase, but if the supply of capital does not follow suit, this may result in an infrastructure “equity crunch”.

Regulatory reforms conducive to long-term investment should involve not only accounting standards and prudential principles, but also: (1) tax incentives; (2) better (sectorial) regulating mechanisms for project financing initiatives; (3) better corporate governance (including compensation) systems; (4) new long-term financial instruments that source from both public and private funds (perhaps drawing from the recent European experience with equity funds, such as Marguerite and InfraMed, and EU project bonds); and (5) credit-enhancing mechanisms to lower the risk and decrease the cost of long-term initiatives in strategic sectors, such as infrastructure, energy and technology».

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As explained in the document prepared by ABI and as indicated in previous answers, it would be desirable to support the development of investments in equity of unlisted companies by managers of private equity funds.

In this perspective, and according to the Italian experience, an important contribution has come from the Italian Investment Fund (Fondo Italiano d’Investimento) whose capital was subscribed by important Italian banks and by other financial institutions, including public entities.

Long term financing by institutional investors should represent a driving force for the development of additional sources of finance, coming from less experienced investors. A relevant example is represented by the segment of finance through online portals in innovative startups, whose regulatory framework is emerging in Italy and should be harmonized at European level.

As regards investment funds, it is straightforward that closed-end products are the first-best option to provide for long-term financing of the economy. However, taking into account that the bulk of the European fund market is represented by open-end funds, we believe that such products should be specifically considered in this context as well.

Instead, we suggest developing a common EU regulatory framework that moving from the UCITS experience would allow for the creation of funds specifically dedicated to long-term financing.

Should this new framework be developed as a new category of product within the existing UCITS Directive or as a separate stand-alone regulation, it shall provide for asset eligibility, redemption and borrowing rules appropriately chosen to best balance the long-term approach of investment policy with the liabilities features of the product.

In particular, the scope of eligible assets shall be broadened beyond the current UCITS rules. For instance, long-term funds (LTFs) should be allowed to invest in infrastructure, urban development projects, renewable energies, small and medium-sized enterprises and bank loans.

Redemption rules shall be strictly calibrated to the structure of the portfolio. As a general rule a rise in the weight of illiquid or long-oriented investments should be appropriately matched with a consistent reduction of liquidity liabilities of the LTF through the provision of (longer) lock-in periods or restriction to access to early redemption provision, if any.

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