«Rome, 25th June 2013 This paper was drafted by a working group, chaired by Prof. Rainer Masera (Università degli Studi Guglielmo Marconi), with the ...»
A specific regulatory framework would increase LTFs visibility and attractiveness. In addition we deem crucial for their success that they are also granted valuable tax benefits targeted to raise the interest of short-term oriented retail investors. Should they eventually decide to trade the liquidity of part of their savings with the participation in the long-term investment of the economy, the cost of the tax breaks would be likely fully repaid in the mid term.
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?
It has already been indicated that prudential reforms, in particular CRD 4 and Solvency II, can have negative effects on the level of cyclicality of investments. General considerations on specific negative features of Solvency II have been indicated7.
The need to review some proposals of CRR and CRD4 cannot but be reiterated. The regulators are conscious of the relevance of the issue of long-term financing, but have postponed the exam of this issue to the end of 2014.
In particular, the problem should be faced by making a downward adjustment of the capital requirements: (i) at least up to maximum amount agreed, laid down as a percentage to the portfolio of each bank; (ii) even if the operations are in the hands of medium and small sized and/or not rated externally operators; (iii) even if the single operations are not of relevant amount (for example, green energy projects).
Question 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?
7 See Wehinger (2011).
28 The need to support equity finance for SMEs has already been highlighted. Specific proposals on the measures that the Commission could introduce in capital markets to provide for this need are indicated in the response by ABI. The main points are reiterated here.
The principal companies managing markets, also as a result of the changes introduced by new legislation, have promoted “trading venues” (Multilateral Trading Facility) for the negotiation of SMEs‟ equity securities, targeted to professional investors and generally characterized by obligations, admission costs and a more contained permanence for the issuers compared to what is foreseen in the regulated markets. Some markets dedicated to the SMEs (e.g. AIM UK, Euronext) already possess the requirements to attract enterprises coming also from other countries. In other markets of a more domestic dimension, the number of investors specialized in this asset class must grow, with specific support for financial institutions coming from the public sector.
Recently, the financial crisis has highlighted the need, especially for SMEs, for diversification of the sources of finance by collecting the necessary financial resources through the issue of debt directly in the market. Both the platforms of domestic character to encourage the negotiation of securities issued by enterprises and the markets aimed at issues sold through private unlisted placements (e.g. the German market of Schuldschein) have been developed in Europe in addition to the EMTN market.
The fragmentation at a domestic level of the markets for debt securities of SMEs does not promote the provision of financial resources for SMEs. It would, therefore, be useful to encourage, by respecting the appropriate institutional characterizations of each country, a harmonized non-regulated European market for bonds issued by SMEs, characterized by harmonized entrance and permanence procedures, as well as by standardized documentation, and by low costs of admission.
Question 13: What are the pros and cons of developing a more harmonized framework for covered bonds? What elements could compose this framework?
As was already indicated in the previous point, it appears desirable to gradually construct a harmonized framework for the “guaranteed” bonds, without creating a “one size fits all” system. It is evident that a greater harmonization in the field of covered bonds would favor the penetration of these tools in international market, thereby reducing costs of transaction and favoring liquidity of the market for this asset class.
All in all, thus being useful, developing common standards on covered bonds does not seem to represent the highest priority when it comes to creating an incentive for long term investment.
We consider a revitalization of the securitization market to be more urgent, as these instruments play a pivotal role in maturity transformation strategies of financial institutions.
There are many sub-categories of securitisations, including asset-backed securities (“ABS”), collateralized debt obligations (“CDO”), collateralized loan obligations (“CLO”), etc.
Securitisations have acquired a bad reputation and new issuance has declined dramatically after being blamed, at least in part, for the credit crisis. This reputation is to a large extent unfair and unjustified by the performance of these assets in Europe. For example, according to the April 2012 Fitch Ratings report “Solvency II and securitisation”, at end-July 2007 total losses for AAA tranches in Fitch‟s ratings portfolio were estimated to be 6.5% for US residential mortgage backed securities (RMBS). By comparison, European, Middle Eastern and African AAA total losses are estimated at only 0.8%.
Insurers are typical buyers in this asset class.
While insurers are currently invested in a range of securitisations (for example, of the 13 companies surveyed, securitisations accounted for around €53 bn), their investments are focused on specific parts of this market, namely:
ABS (general term used for bonds or notes backed by a pool of assets) MBS (bonds whose cash flows are backed by mortgage loans).
In addition, and perhaps more importantly, insurers tend to be attracted by senior tranches of assets only enabling them to access some of the additional spread pick-up available on the underlying collateral pool without increasing the riskiness of their investment portfolio.
We fully support any initiative to improve data transparency in order to fight well known issues relating to asymmetric information, both i) at the securitization stage and/or in terms of suboptimal screening activity at loan origination and ii) after securitization, in terms of suboptimal monitoring.
The paper “Securitization is not that evil after all”, published by U.Albertazzi, G.Eramo,
L.Gambacorta and C.Salleo in 2011, provides a few ideas which seem to be worth investigating:
information or loans characterized by better-than average quality.
Originators might retain a high share (much higher than in the past) of the securitized portfolio‟s risk by keeping the most junior (equity) tranche as a signaling device of its (unobservable) quality or to express a commitment to keep monitoring borrowers.
Finally, relying on securitisations on an ongoing basis implies enjoying a flawless reputation; this should represent a natural disincentive to sell off bad parts of the loan portfolio.
Some market commenters are optimistic that the securitisation market will start to grow again.
However, as of today, there is less optimism about insurers increasing their allocation to this asset class, because Solvency II is expected to place high capital requirements on these assets. A much “softer” treatment is expected for covered bonds.
Question 16: What type of CIT reforms could improve investment conditions by removing distortions between debt and equity?
The Italian banking system has on many occasions expressed itself in favor of greater fiscal coordination in the European Union, and supported the project of creating a harmonized tax base for European companies (CCCTB). The difficulties in the realization of this project, which did not have any relevant evolution after the initial presentation, must therefore be faced up to resolve.
Question 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?
Saving is fundamental: without its contribution there can‟t be investments and sustainable growth in the medium-long term, nor is the State capable of achieving its institutional objectives. The conditions that allowed for the miracle of the Italian economy need to be recreated: high rates of savings, private and public investments, international competitiveness, even with the discipline of fixed exchange rates.
Even before considering the case for saving incentives, the EU legislator should ensure an optimal framework of reference for the formation and use of savings, by avoiding the introduction of contrasting and distortionary elements. For instance, the preoccupation of 31 insuring benefits for long-term investments appears in contradiction with the proposal for the introduction of a financial transaction tax, which - according to the proposal of the Commission would also affect operations involving debt securities, both public and private.
The legislation to support long-term savings should therefore:
Favor the detention of long term investments by the saver without regard to the deadline of the issue (thus avoiding the repeat of distinctions similar to those once foreseen in Italy, which penalized the issues of short-term securities compared to medium and long-term ones).
Expect that the benefit operates regardless of the instrument, i.e. independently from the fact that one deals with shares or bonds, mutual funds, insurance policies.
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?
Banks have considerable discretion in setting the book value of assets higher than values implicit in stock prices and to limit asset impairment under stress. Market prices and book values differ significantly, especially during a period of financial distress. Excessive discretion may deliver inaccurate accounting information at a time of turmoil, with potential adverse consequences for the allocation of capital in the economy. Market prices (notably price-to-book ratios) should therefore play a primary role in bank supervision as an instrument for Prompt Corrective Actions (PCA): market values have a superior signalling content compared to accounting aggregates in predicting banking system distress during financial crisis [Masera and Mazzoni, 2013].
As of today, insurance companies finalize their individual financial statements following local GAAP principles and their group financial statements following international accounting standards (IFRS 4 for the valuation of insurance contracts, which allows the adoption of local GAAP). Going forward, further implementation of IFRS 4 standards and the introduction IFRS 9 standards (for asset valuation) might introduce elements of artificial volatility in the balance sheet. The new IFRS 4 e IFRS 9 should be designed in order to correctly represent the long term nature of the insurance business avoiding artificial volatility.
Insurers should not be required (but be permitted) to adopt IFRS 9 before the mandatory effective date of IFRS 4. Otherwise it may put into question the usefulness of financial reporting for users in the period between IFRS 9 and IFRS 4 adoption, as users will experience two major changes in an insurer‟s financial statements in short succession. A staggered adoption would not
Question 22: How can the mandates and incentives given to asset managers be developed to support long-term investment strategies and relationships?
The recent legislative and regulatory changes show a preference for remuneration criteria which encourage long-term investments; some of these changes have already been adopted (remuneration guidelines are an example), other are still in the process of being issued. before new legislative interventions, with the risk of a hypertrophy, it would be appropriate to let markets react and adapt to the regulatory changes already decided and under way.
Question 26: What further steps could be envisaged, in terms of EU regulation or other reforms, to facilitate SME access to alternative sources of finance?
The lack of a true banking union enhances the difficulties of the ECB to spur growth, since low interest rates and very large loans to banks are not properly transmitted to the real economies (and notably to SMEs) in peripheral countries. It would, therefore, be especially important if the ECB could support, through direct acquisitions of securitised SME loans, the credit flows to this vital sector of many European economies.
More generally, the system of co-guarantees in favour of credit granted to infrastructure and SMEs should be developed in a consistent European framework by putting together EC, EIB, EIF, Central National Guarantee System and co-guarantees offered by public and private operators.
In this regard, Italy has a positive experience through the operation of Fondo di garanzia per le PMI (Guarantee Fund for SMEs). The model created for debt finance has been opened also to equity issues.
In addition, it is necessary to promote the use of alternative and complementary financial channels in Europe, also in favor of SMEs. In the short run, the combination of recessionary fiscal policies and stringent capital rules determine a paradox: in the US, large companies, which have easier access to capital markets, have a larger role than in Europe compared to SMEs; in Europe, SMEs have a higher weight and are more dependent on the banking system in their financing.
33 Therefore, the stringent rules in EU need to be revised, by balancing the aim of financial stability with that of sustainable recovery.