There are opportunities for jobs and growth if the regulatory reform agenda is fully realised, writes Darina Barrett.
The previous European Commission and Parliament were formed as the full scale of the financial crisis was still unfolding. As a result, they focused on post-crisis repair, the resilience of individual financial institutions and wholesale markets, and the stability of the financial system.
Five years on, the impacts of the crisis – and indeed of the regulatory reform agenda itself – are still working their way through to financial markets and the wider economy.
KPMG believes that the recent formation of a new Commission and Parliament provides an opportunity to re-evaluate the work programme within the current political and economic context, and to build for the future. The agenda needs to change to deliver jobs and growth.
The current regulatory reform agenda is overly-focused on the single dimension of promoting ever-greater safety and soundness, in the hope that – at some point – this will begin to facilitate financing and growth. This ignores the strong likelihood that ever-greater regulation has taken Europe to a position in which further safety and soundness is being bought at the expense of growth, both now and in the longer-term.
It is time to switch to a second dimension, in which finance is viewed as a facilitator of jobs and growth, alongside greater competition, competitiveness and innovation. This requires the promotion of long-term financing of capital markets and an equity culture, and of alternative channels of financial intermediation.
We believe in the value of specific proposals for encouraging and facilitating the contribution of the financial sector to jobs and growth in the wider economy. In particular, these proposals focus on developing EU capital markets and on long-term financing.
These proposals are based on three underlying propositions. Firstly, public sector financing is constrained by currently high levels of government expenditure, high government deficits, and the rising costs of education, health and pensions.
Moreover, the public sector is not always best placed to identify and deliver profitable investment opportunities. There needs to be a greater focus on private sector funding, not least for roads, rail and digital technology infrastructure.
In addition, long-term infrastructure financing and the provision of longer-term financing for SMEs is usually best undertaken by long-term investors – either directly or through capital markets (equities and bonds) – rather than by bank lending.
Thirdly, European capital markets remain under-developed, for reasons ranging from the lack of an equity culture to differences across national legislation. There is a need for deeper and more liquid capital markets, and for a single capital market that enables and facilitates effective and efficient long-term intermediation for the benefit of issuers and investors.
The Commission should consider why the EU is so different from the US in terms of the size of its capital market and why so many European companies source finance through the US market. Similarly, a focus should be placed on the fact that the US has been more successful in developing an equity culture among both investors and corporations.
The Commission should also consider to what extent capital markets in the EU are being constrained by legislative or regulatory restrictions. It is unlikely that an effective capital market can be created simply through additional legislation and other government interventions. There needs to be a collaborative effort to ensure that any moves towards a ‘capital markets union’, focuses on creating a genuine single market, with deeper and more liquid European capital markets that meet the needs of companies wanting to raise funds and of investors.
It would also be prudent to remove the preferential tax treatment of interest payments relative to dividends. Current systems of tax relief on interest payments favour the issuance of debt over equity as a means of funding businesses – including the funding of banks.
The Commission could also develop a private placements market, making it easier to fund finance within Europe. There should be greater education of consumers and investors about longer-term and equity investing.
A global approach to the EU financial sector should be adopted as many financial institutions and their customers are global, but are not confined to the EU.
Removing trade barriers, in particular by including the financial sector within the trans-Atlantic and other trade negotiations, and tackling the fundamental lack of competitiveness of many European economies is also important.
Undertaking better analysis of the underlying problems that are causing the lack of financing of infrastructure and for SMEs; and whether initiatives that have been successful in some countries (for example in Germany) could be replicated elsewhere, would be useful.
There should be a focus on the provision of enhanced credit information on SMEs, to encourage the development of both bank and alternative financing channels.
Increased government-backed long-term financing (in whole or through guarantees or government agencies, as with the EIB) alongside the private sector financing of productive ventures would benefit businesses greatly.
Equally, a greater focus on jobs and growth in the impact assessment of new legislation and in post-implementation reviews, and a shift away from relying on the unfounded assertion that ever-safer banks are necessarily better placed to provide additional financing (if banks were funded entirely by capital they could play only a very limited role in financing the wider economy).
The role of insurers
It is important to recognise the role that insurers could play in the provision of longer-term financing, in particular where insurers have long-term liabilities. And a more accommodating approach to long-term infrastructure investment within Solvency 2 could be also taken.
Although Solvency 2 has been helpful in lifting some restrictions on long-term infrastructure investment by insurance companies, this could be taken further by reducing the high capital charges applied to longer duration and lower rated investments, and to unlisted equity. This would ensure that insurers are not penalised by the application of a look-through approach to investment in collective investment schemes.
Allowing infrastructure investments to be tranched would mean that insurance companies and other investors would find it easier to invest in infrastructure if there was scope for these investment opportunities to be structured in tranches, with junior claims being more equity-like and thus potentially more attractive to hedge funds.
In addition, senior tranches could be structured to be more bond-like (with lower but more regular returns and with more scope for external ratings).
Secondary market liquidity has declined significantly as a result of penal capital requirements and moves to impose structural restrictions on banks. Therefore, encouraging investment in capital issues by improving secondary market liquidity in corporate bond issues would improve the liquidity situation.
Providing certainty over the tax regime for long-term investments and implementing the proposals for European long-term investment funds (ELTIFs) would be a constructive attempt to increase the funding of long-term investments, through ELTIFs managed by authorised alternative investment fund managers.
These funds will be able to invest in long-term illiquid assets such as unlisted companies, infrastructure projects and real estate, as well as in other ELTIFs, European venture capital funds and European social entrepreneurship funds.
Access to assets
Increasing the supply of funds by improving access to EU asset management products in non-EU markets, promoting high-quality securitisations of bank lending, reducing the regulatory disincentives for banks undertaking long-term financing would also improve the situation.
Inevitably these suggestions can only help deliver a significant improvement when considered as an entire package. With a new European Parliament and Commission tasked with getting to grips with Europe’s economic challenges, we believe there is ample opportunity to make a fresh start in financing jobs and growth.
Darina Barrett is the head of the financial services market in KPMG Ireland. She is a member of the KPMG Global Investment and Funds Network, ESMAs Investment Management Committee and the Irish Government’s funds strategy working group.