Long-Term Financing in Europe

Abstract

Although policymakers in Europe are increasingly focused on fueling economic growth and job creation with infrastructure projects that require long-term investment, there are potential obstacles to channeling investment capital appropriately. To help shape the policy debate, CFA Institute recently brought together key thought leaders and policymakers at the forefront of the long-term financing debate to explore the implications for investors of less dependence on bank financing and more interest in investment capital. Speakers included John Kay, chair of “The Kay Review of UK Equity Markets and LongTerm 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. Discussion centered on three major topics: regulation, the transition from relationship banking to transaction banking, and better due diligence. In Europe, regulation has focused more on market conduct than on market structure, but most of the roundtable participants agreed that structure is a longer-term issue. Further complicating matters in Europe is the diversity of needs within European countries; some countries have a large need in the mortgage market while others are targeting infrastructure or public works. The transition 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 to match cash flow needs. Investors may not currently have the same level of expertise where long-dated maturities are concerned. Longer-term financing needs better due diligence and the possibility of nonbank loans. In the aftermath of the financial crisis, financing has lacked diversification, with the drying up of the securitization market and the difficulty of finding seed capital in private equity. CFA Institute is closely monitoring the debate around long-term financing. In a June 2013 comment letter to the European Commission, CFA Institute reflected the opinions developed in an EU members’ poll. The comment letter highlighted five priorities: (1) regulatory framework, (2) short-termism, (3) investment vehicles, (4) securitization, and (5) fair value accounting. First, a regulatory structure at the EU and national level that incentivizes long-term investing is essential. Second, in regard to 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. Third, concerning investment vehicles, innovation in developing new pooled fund vehicles targeted toward infrastructure and other long-term investments (“long-term investment funds”) is welcome and can afford investors important diversification opportunities. Any such new investment vehicles should offer enhanced disclosure to investors regarding risks and redemption restrictions. Fourth, a revival of the securitization market is welcome but must not be characterized by the complexity and opacity of deals in the past. CFA Institute proposes a special designation that would distinguish those long-term investments that satisfy a suitably high standard of disclosure quality. Finally, CFA Institute refutes the notion that fair value accounting policies contribute to short-termism and argues 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. Because Europe is trying to stimulate its sluggish and diverse economy, especially through small and mediumsized enterprises (SMEs), long-term financing will be the focus of many 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 European Parliament and for a new Commission. With investors playing a growing part in SME financing, it is essential that policymakers consider these issues from an investor perspective.