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Long Term Financing

 

Background

In 2013, the IMF, OECD, FSB and other international institutions issued reports on factors affecting the availability of financing for long-term investment. These reports emerged as a response to commitments made at the G20 Summit in Mexico in 2012. The European Commission contributed to this debate with a Green Paper on LTF published in March 2013. After a public consultation, the Commission published a Communication on Long-Term financing in March 2014 with a wide-range of proposals in 15 action areas, including the role of development banks, securitisation, European Long-term Investment Funds (ELTIFs) and tax and accountancy measures, among other things.

The first legislative proposal to emerge from this work stream was the Commission’s draft regulatory framework for ELTIFs, published in June 2013. Legislative work on the proposed regulation was interrupted by the EU elections but lawmakers eventually reached an agreement in November 2014.  Towards the end of 2014, the existing LTF work essentially folded into the new Capital Markets Union (CMU) project of the incoming Juncker Commission. The new Commissioner for Financial Stability, Financial Services and Capital Markets Union, Jonathan Hill, launched a Green Paper and consultation on CMU on 18 February 2015, together with consultations on securitisation and the Prospectus Directive. The Green Paper on CMU identifies five early priorities, including implementing the ELTIF regulation, developing high quality securitisation, standardised credit information on SMEs, private placement, and a review of the Prospectus Directive to ease listing requirements for smaller companies.

Actions of Finance Watch

In June 2013, Finance Watch responded to the European Commission consultation on Long-term Financing. The response was accompanied by a blog article on Long term financing. In early 2014, we advised Parliament negotiations on the ELTIF Regulation, suggesting them not to allow the transfer of funds between ELTIF and non-ELTIF compartments of Alternative Investment Funds (to avoid creating a loophole in the regulation of hedge funds) and to not allow retail investors to invest directly in ELTIFs, but rather to use UCITS as a wrapper to limit the exposure to a single ELTIF and to ELTIFs in general, and to help consumers benefit from the liquidity and transparency requirements in UCITS. We also pushed to reduce the overly positive assessment of securitization as a mechanism for economic recovery in the Parliament’s non-legislative report responding to the Long Term Financing Green paper.

In December 2014, Finance Watch published a position paper on the European Commission's Long-Term Financing initiative, “A missed opportunity to revive “boring” finance?” We examined critically the assumptions behind the Commission’s approach to capital market financing, analysing in depth some of the systemic risks that it might introduce, and formulating policy recommendations. The paper was accompanied by a cartoon on long term financing (pdf, 9 pages, also available in French, German, Polish, Italian, Dutch and Spanish). The position paper provided as well the basis for a discussion panel on collateral use in our February 2015 conference "The long term financing agenda – the way to sustainable growth?" On the 18th February 2015, following the European Commission’s Green Paper on the subject, Building a Capital Markets Union, Finance Watch published a press release, expressing some concerns on the project. In March 2015 Finance Watch explained the Capital Markets Union through the publication Capital Markets Union in 5 questions, while in May 2015 FW replied to the Green Paper and organised a Webinar dedicated to CMU. In June 2015, Finance Watch's Secretary General, Christophe Nijdam, spoke at the European Parliament's ECON Committee public hearing on "Stocktaking and challenges of the EU Financial Services Regulation: impact and the way forward towards a more efficient and effective EU framework for Financial Regulation and a Capital Markets Union". We also organised a webinar on securitisation (27 July 2015), part of the CMU project, which is available online.

Key risks

The financial crisis of 2008 did not start as a banking crisis, but as a shadow banking crisis. It showed that traditional banks were more robust and focused on the real economy than some investment banking activities that required a bailout. The CMU is the promotion of shadow banking and of the investment banking model, yet in our view, the lesson from the crisis is that we need more traditional and local banking.

The higher pro-cyclicality of non-bank lending raises a moral question since it means you need an entity that will buy when everyone wants to sell, yet shadow banking does not have explicit and direct access to public safety nets and the crisis has shown the ineffectiveness of private backstops. This means that we must decide between extending access to public safety nets to shadow banking, which would increase moral hazard, or alternatively shrinking the size of – and not promoting – shadow banking.

Lastly, the idea that enough has been done in terms of regulation and that we should now focus on short-term growth is misleading and risky. While much regulation has been put in place since the crisis, most of it is focused on making individual banks more robust but very little has been done to make the financial system as a whole more robust and stable. This is indeed very different: making the system more robust requires, for example, ensuring that financial institutions do not run into trouble at the same time. If one medium-sized bank runs into trouble, this is not a threat to the financial system as, for example, other banks can buy the troubled bank and ensure continuity of service. If, however, most banks experience troubles simultaneously as happened during the crisis, governments need to intervene to bail them out with taxpayers' money. As long as this is not addressed, we will not have reduced the risk of future crises, which is a pre-requirement for sustainable growth.

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