Investment Industry Role in Long-Term Financing of Europe’s Economy: John Kay, Others Weigh in

Recognizing the need for alternatives to public capital to fund development and reinvigorate European economies, the European Commission issued a Green Paper on “Long-Term Financing of the European Economy” to investigate how to respond to these large-scale, long-term investment needs.

To help shape the policy debate, CFA Institute recently brought together key thought leaders at the forefront of the long-term financing debate to answer this question:  Does the investment industry operate to serve the need of long-term investment for the ultimate benefit of society? Leading the discussion were Professor John Kay, chair of the review of UK Equity Markets and Long-Term Decision-Making, prepared at the request of the UK government, and currently chair of the CFA Institute Future of Finance Advisory Council, and Fons Lute, managing director of  the fiduciary mandates investment team at BlackRock.

A lively exchange of views followed with speakers from the audience, with the debate centering on the current state of play in the investment industry:

• Speakers developed on the issues at stake in Europe, which has witnessed a spate of regulations seeking to harness the role played by the European asset market. Regulation has focused more on market conduct rather than on market structure. Most speakers agreed that structure was a longer-term issue. A further complication in Europe arises from the diversity of needs within European countries; typically some countries have a large need in the mortgage market while others are targeting infrastructure or public works.
• The transition in Europe from relationship banking to transaction banking has increased the intermediary chain, eroding knowledge of both investors and borrowers. In addition longer-term financing needs a diversity of financing matching cash flow needs. Investors currently may not have the same level of expertise when it comes to long-dated maturities.
•  Longer-term financing also needs better due diligence and to explore the possibility of nonbank loans. In the aftermath of the crisis, financing has lacked diversification with the drying up of the securitization market and the difficulty of finding seed capital in private equity.

For its part, CFA is closely monitoring the debate around long-term financing. In its 25 June 2013 comment on the Green Paper, CFA Institute reflected the opinions developed in a poll of 381 members. Important priorities cited by CFA Institute include:

• Regulatory Framework: A regulatory structure at the EU and national level that incentivizes long-term investing is essential.
• Short-termism: Asset owners should hold asset managers accountable for performance over longer-term evaluation horizons rather than the current tendency to focus on quarterly returns.
• Investment Vehicles: Innovation in developing new pooled fund vehicles targeted towards infrastructure and other long-term investments (‘Long Term Investment Funds’) is welcome, and can afford investors important diversification opportunities. We caution that any such new investment vehicles should offer enhanced disclosure to investors regarding risks and redemption restrictions.
• Securitisation: A revival of the securitisation market is welcome but must not be characterized by the complexity and opacity of deals in the past. We propose a special designation that would distinguish those long-term investments that satisfy a suitably high standard of disclosure quality.
• Fair-Value Accounting; We refute the notion that fair-value accounting policies contribute to short-termism and assert that fair-value can in fact reduce the information asymmetry that exists between issuers and investors as to the value of corporate assets and liabilities.

As Europe is trying to restimulate its sluggish and diverse economy, especially through SMEs, long-term financing is a topic that will be the focus of talks within the European regulatory environment. Both the European Commission and the European Parliament will be taking stock in the coming months, preparing for elections in the Parliament and for a new Commission. And as investors play a growing part in SME financing, it is essential that policy makers consider these issues from an investor perspective.