santander´s response to the green paper long term...

Santander´s Response to the

Green Paper Long – Term Financing of the European Economy

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Comunicación, Marketing Corporativo y Estudios \ Servicio de Estudios y Public Policy

Ciudad Grupo Santander

28660 Boadilla del Monte (Madrid)

Tel. 91 289 5375. Fax 91 257 01 37 e-mail: [email protected]

Response to the EC Green Paper on long-term financing

2

Santander is grateful for the opportunity to comment on the Green Paper issued by the European Commission on Long-Term Financing on the European Economy. We thank the Commission for its initiative on starting a broad debate on how to foster the supply of long-term financing and how to improve and diversify resources of financial intermediation for long-term investment in Europe. Regarding this debate, we would like to point out some general ideas that are embedded in our answers to the questions:

- We consider the development of the capital markets should not be at the cost of decreasing the role of banking system. But contrary, they should mutually strength each other.

- Long-term investing projects require a stable legal and regulatory framework. - Long-term projects show positive externalities that justify that the public sector designs

stimulus (taxes, regulation, …). - To ensure investor´s appetite is essential to provide a favorable liquidity and capital

treatment. A holistic and comprehensive approach, as the Commission has proposed, is absolutely necessary in order to ensure a consistent framework. Long-term financing is regulated directly or indirectly by many regulations. Analyzing them on a global basis is the first step towards a right diagnosis of the situation in order to design appropriate and sufficient measures and tools are designed.

Answers to Questions

1. Do you agree with the analysis out above regarding the supply and characteristics of long-term financing?

We can support, to a large extent, the analysis of the long-term financing provided by the Commission.

In the next future, new regulatory constraints and other factors may hamper the ability of banks to maintain their lending capacity and this may lead to an increased role of capital markets in providing debt, which means that companies such as insurers, investment and pension funds, will become more important players in financing investment projects. However, banks will still be required to play an important role, especially at stages where their products and capacities of analysis are required.

Consequently, measures should be taken not only to develop other alternative sources of funding, but also to facilitate banks to develop their inherent function of intermediation in the economy.

2. Do you have a view on the most appropriate definition of long-term financing?

We broadly agree with the definition provided by the Green Paper. In particular, we support the

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view of long-term maturities to be above 5 years, as we consider these debt instruments to have distinct characteristics, in terms of purpose, risk and pricing behavior.

3. Given the evolving nature of the banking sector, going forward, what role do you see for banks in the channeling of financing to long-term investments?

We consider that bank financing will continue to play a key role, in particular due to its flexibility on responding to clients‟ needs and its knowledge and expertise in both the financial markets and the clients. Some of the activities for which the banks will still be needed are:

Long-term financing, in cases where bank financing needs to be provided alongside debt issued from capital markets.

Short-term bridge financing, where banks provide funds until a capital markets debt financing has been structured and issued

Guarantees and other risk protection products, providing credit enhancements that facilitate the distribution of loans and other debt instruments

Debt advisory, helping clients and investors to design the structures that meet the needs of both parties

Finally, there will always be some cases where financial support could only be provided by banks (short term financial needs, local small companies, specific projects…).

We also consider that the development of capital markets will be gradual and banks may have a fundamental role in facilitating this. In any case, their knowledge will still be needed in order to provide assessment about the investment project and the clients.

It should be taken into account that several of the most common debt instruments are unlisted and of limited liquidity, which adds into the complexity of some of these types of investments. Therefore, ad-hoc analysis capabilities are required and should be either incorporated into the institutional investors‟ teams or outsourced to other parties, namely banks or other type of advisors.

In infrastructure finance (or project finance) these capabilities are particularly relevant. Projects evolve during their life and during the different phases (e.g. construction and operation) requiring different degrees of analysis: at early stages, the characteristics of those projects differ particularly from each other, so a detailed analysis and monitoring of the investment is needed. At this stage, some of the characteristics intrinsic to this asset class including construction risks, multiple drawdowns, delays, etc. make even more relevant the participation of banks in the asset class in collaboration or complementing the long-term financing provided by institutional investors. In a second step, projects don‟t have these particular monitoring requirements, so they can be followed by other type of investors.

4. How could the role of national and multilateral development banks best support the financing of long-term investment? Is there scope for greater coordination between these banks in the pursuit of EU policy goals? How could financial instruments under the EU budget better support the financing of long-term investment in sustainable growth?

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We are very supportive of the role played by institutions like EIB in recent times, as provider of liquidity to the depressed economic activity. It has had a major role at crisis time strengthening banks ability to provide financing to infrastructure projects and business.

Considering times where bank liquidity is low, multilateral development banks will need to continue to provide liquidity. But they will need to be proactive to take a step back when natural market participants recover their ability to provide liquidity.

Together with this, the development banks can play a facilitator role for capital markets to be developed. In such cases, they will need to promote structures that simplify the entrance of new participants, such as institutional investors. For example, as the implementation of hybrid structures combining institutional investors and bank financing.

Another example of the role that they can play in all situations is to provide guarantees in order to facilitate the entrance of institutional investors in infrastructure projects in which specific phases of the investment, for example the construction phase, needs to be covered.

Also, the multilateral institutions could act as buyer of all debt. This is especially important when banks‟ balance sheets long term lending cannot be distributed (e.g. securitisation). This can lead to two adverse consequences: impairment of the capacity of banks to provide more liquidity and difficulties for institutional markets to develop properly.

5. Are there other public policy tools and frameworks that can support the financing of long-term investment?

It is important to build a system that increases certainty for the investors, so the natural long term lenders are attracted to long term projects. Certainty is boosted by keeping a stable regulatory framework. We have recently witnessed some examples where the regulatory framework has evolved during the life of the project affecting adversely investor´s return.

Additionally, regulators could improve conditions by increasing the homogeneity of concession schemes of made by the public sector in order to provide infrastructure across European countries. Each step in this direction would increase transparency and reduce costs for all participants.

Furthermore, protecting the liquidity on secondary markets (market makers) would not be left aside, because only with the orderly functioning of these, the primary markets could raise the funds in a suitable way.

We would also point the amount of regulation that is expected to be in place in the coming future, which creates uncertainty. Among them, we can highlight the effect of the Financial Transactions Tax, EMIR, MIFID 2/ MIFID, structural separation, shadow banking or short selling. These are focus in markets activities and will have an important impact on the manner participants operate, introducing restrictions on the ability of the secondary markets to channel funding. In particular, Financial Transactions Tax could harm the raising of funds, by penalizing the investment on financial instruments, compared to loans and insurance instruments. EMIR and MIFID II/ MIFIR include rules about the way that participants operate that are good in nature but will require investments and time to adapt and understand the effects on financing the economy through certain kind of instruments. Structural separation could also harm the ability of banks to participate in funding by restricting the efficiency of banks, and particularly by

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turning them weaker as each separated entity will become less diversified.

But the scope is larger than that, because the rest of banking activities are also covered by multiple and important regulation, such as Solvency II, that incentives short term investment by banks and insurance companies. This is especially harming in the latter case, because it prevents these natural long term investors to match their long time assets with the long time nature of liabilities that they hold. The rating requirements under regulation will also bring incentives to invest in the highest rated instruments, causing a crowding out effect for other kind of investments, such as non-rated issuances, loans or SME instruments.

Concerning liquidity requirements, the definition of highly liquid assets is also having an impact, as it clearly favors assets as government bonds and deposits to central banks. That would lead to a decrease in activities more penalized, as lending to SMEs and infrastructures, that are considered by the Green Paper as the objectives for the long term finance.

Finally, the interaction between the different objectives of the regulators and the duration of the regulatory process, itself, is already harming the investment decisions.

6. To what extent and how can institutional investors play a greater role in the changing landscape of long-term financing?

New players such as institutional investors can play a key role on financing European economy alongside with the banking sector. Their role can be limited to provide the final liquidity, by holding the securities structured by banks, or they can be more deeply involved by structuring themselves as it already happens in the case of some sophisticated investment funds based in US.

It is important to consider, though, that European institutional investors are still not actively participating in this kind of investments and the steps to increase their presence in those markets cannot be rash. They should be carefully assessed and these investors should be able to rely on tools or participants that can provide the knowledge needed to better understand the risks and features of these instruments.

There are, in our view, two different aspects that could be improved. On the one hand, the standardization of the instruments can help increase the participation of players that are not able to devote specialized resources to their analysis. This measure could be applied to a number of already existing instruments, such as covered bonds or corporate bonds. On the other hand, there is an amount of institutions that are already participating in both the structuring and the investment phases of the process. In this sense, we would recommend that the participation of these new entrants should be subject to regulations that make their investments stable and sound, in order to create a level playing field with regulated financial institutions and by avoiding the emergence of entities in the shadow banking that could provide those services. The improvement of supervision over those non-bank players will also have the consequence of prevent the impairment of the stability of financial system.

7. How can prudential objectives and the desire to support long-term financing best be balanced in the design and implementation of the respective prudential rules for insurers, reinsurers and pension funds, such as IORPs?

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The Green Paper wisely acknowledges that insurance companies, pensions providers and other institutional investors are well suited for long-term financing and investment. These investors have substantial portfolios with longer-term horizons and, due to the low interest rate environment, continue to seek out diversification and yield in areas like long-term financing. Having said that, there are elements in Solvency II that will make it more difficult for insurance companies to hold such assets. In the aftermath of the financial crisis a reform of the insurance prudential regime in Europe is more than ever needed to allow the Insurance sector to maintain its dual role as a provider of long-term savings and retirement solutions and as a long-term investor in the European economy. However Solvency II in its current design should not be enforced. a) The priority for regulators and supervisors is to address the volatility of the own funds determined under Solvency II framework in Omnibus II. Solvency II values assets at Marked to Market (MtoM) and liabilities at market consistent economic value (MCEV) where swap rates are used to discount liabilities. It fully reflects market volatility and credit/illiquidity spreads enlargement. Solvency II current design leads to a non-economic short-term volatility in asset prices, earnings, and available financial resources (AFR or own funds) for solvency positions. Solvency II, for example, creates by preferring "zero risk weighted" government bonds a sub-optimal asset allocation. Together with the market volatility which is being accounted for in the Solvency Capital Requirement framework, insurers have no option other than to de-risk their balance-sheets in times of market stress and reduce the horizon of both their liabilities and their investments" It annihilates the theoretical positive Solvency II incentive on long term investment by rewarding duration matching. These issues need to be addressed. Effective counter-cyclical tools should be added to Solvency II framework. They aim to smooth the effects of the extreme market volatility of government bonds and corporate spreads on the asset side of the insurance balance sheet, and the potential mismatches between asset and liabilities if liabilities are not properly discounted. EIOPA has conducted a technical assessment on the effects of selected regulatory measures which has been published on June 14th (“Technical Findings on the Long-Term Guarantees Assessment”). Within this context, EIOPA recognizes that “Insurers have traditionally been significant investors in infrastructure and real state as these assets have long term regular cash flows which provide a good match for the cash flows of annuities. Some undertakings consider it critical for them that these types of assets remain within the scope of application of the matching adjustment. Insurers are significant funders of for instance equity release mortgages and residential mortgages. Rendering such loans inadmissible for the matching adjustment might have a possible dual impact on these markets”. It belongs now to regulators and supervisors to deliver the appropriate prudential framework in the final phase of Solvency II negotiation to allow the Insurance sector to maintain its dual role as a provider of long-term savings and retirement solutions and as a long-term investor in the European economy. 2) But in parallel, the Solvency II capital charge on the holding of long-term assets should also be reviewed. More specifically, we would welcome the Solvency Capital Requirement (SCR) to be closer to the market reality; e.g. for infrastructure loans the default probability is lower after the construction phase than for similar rated corporate bonds. In fact, the Insurance sector has been supporting the recommendation made by the EU Commission to EIOPA to

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review SCR for long-term assets such as private equity, infrastructure loans, real estate, asset based securities, loans and long-term dated corporate bonds.

It would be welcome if EIOPA would be prepared to agree with the EU Commission’s views on easing capital charges on long-term investments. Life insurers and occupational pension funds are major providers of funded complementary pensions in the EU. It is important that they can continue to play this role and be able to act as long-term investors. For markets to deliver over the longer term, competition is necessary. The Green Paper refers to markets but it does not sufficiently stress the need to ensure effective competition between different providers. Even if prudential frameworks for different providers might vary for genuine reasons, they still need to be consistent with each other. Unlike life insurers, occupational pension funds often use a mark to market approach only for their assets and use an average discount rate for their liabilities. Given that market rates are currently rather low, the solvency of pension funds looks artificially high. However, if the assumed high discount rate does not become realized over the medium term, the scheme has to be considered underfunded versus its liabilities. Funding stresses that result from a drop in interest rates may further be exacerbated by high existing pension promises, and the scheme being heavily weighted towards pensioners rather than actives. The latter can frequently be found in mature industries or companies that see their work force decline. Against this backdrop, and with public pay-as-you-go systems under strain from an ageing society, it is important that governments are transparent towards their citizens about the state of pension systems and the need for them to save. Public policy should incentivize private pension savings in order to address potential pension gaps but also to foster long-term finance. Long-term investors also need long-term regulatory stability so that they can plan and invest for decades ahead and they also need relatively stable regulatory frameworks over the shorter term. So where there are fears that pensions savings could be „nationalized‟ for short-term political expediency, financial services providers will think twice about their long-term role in the markets potentially affected - and the same uncertainty will also discourage citizens from saving. More generally, but also damaging, is where funded pension providers face „rolling regulatory reforms‟, e.g. national regulations that change on a monthly basis or where the completion of major EU regulatory projects is continuously postponed.

8. What are the barriers to creating pooled investment vehicles? Could platforms be developed at the EU level?

Differences in regulation between countries are the main factors that affect the constitution of pooled investment vehicles across Europe. Divergences in sovereign risk premium are also an uncertainty at these moments, which makes difficult the pooling of assets.

These problems can be addressed by providing external guarantees and by giving more stable regulatory framework for long term projects.

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9. What other options and instruments could be considered to enhance the capacity of banks and institutional investors to channel long-term finance?

The capacity of banks and institutional investors to finance the economy would be enhanced by carefully assessing the regulations that affect their investment decisions. Particularly, the capital and liquidity requirements are heavily impacting the behavior of these participants. On one hand, capital requirements clearly favor short term assets, which leave lower opportunities for long-term investments. On the other hand, the liquidity buffer has to be constructed with government bonds and deposits to central banks. We believe that the inclusion of some RMBs is a step forward, but we recommend to include the rest of categories that are accepted for discount at the ECB, especially securitisations such as consumer credits, cars, SME and cards loans.

In the infrastructures field, the steps should be directed towards the creation of structures where banks and investors would be involved together. Each part should specialize in the areas where they have the best capacities and work together with the other part in projects where they share common objectives. The project bonds initiative is a positive development in this sense, where developments should be made in order to adapt the availability of funds from institutional investors with the funding requirements of the long term projects.

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?

The cumulative impact of all the regulation impacting the financial sector is difficult to be assessed. However, it is absolutely necessary to monitor any cumulative impact of it as the FSB and G20 already claim.

Anyway, there are substantial effects on regulations as structural reforms, taxes, markets infrastructure, etc. that sometimes show negative interactions with the financing of the long term projects in the economy. We appreciate the efforts of developing the small and medium enterprise markets within the MIFID II/ MIFIR regulation. But at the same time we fear the effect of some other initiatives that hinder the role of market makers (such as structural separation initiatives or the FTT), as these players are key to provide liquidity to the new instruments to be issued.

But regarding regulation, it is not only the cumulative impacts of all the reforms that are planned, but also, the uncertainty, or delay in some cases in closing the reforms, which leads to a slowdown in the activity of the entities.

Moreover, we are witnessing some initiatives that hamper the level playing field by the risk of imposing extraterritorial effects on jurisdictions where those initiatives are been considered.

A holistic and comprehensive approach is necessary to ensure consistency. Coordination among regulators of different sectors and different jurisdictions is essential to better assess the interaction between any kind of proposal.

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11. How could capital market financing of long-term investment be improved in Europe?

There is a combined set of measures that could help the ability of capital markets to channel financing. The most important are:

A favorable treatment on capital and liquidity for instruments such as securitisation and project bonds.

Lower dependency on rating agencies, giving the unfavorable treatment that they tend to grant to this kind of projects. Moreover, ratings could have a negative impact on the investment by insurance companies and investment and pension funds, that could be forced to sell when the assets are adversely performing. This would be inconsistent with the long term profile of the projects that are intended to be funded.

Develop European platforms in order to allow investors and suppliers with similar needs to meet with each other.

Increasing the provision of credit enhancement by supranational entities for other instruments that need to be developed, beside the project bonds. That could be used to develop the SME markets.

Increase transparency and predictability for the investors in the regulatory ground.

In order for capital markets to be able to better distribute the instruments among investors, there is a need to favor the development of secondary markets, clarifying and improving the treatment of market makers. They are essential figures for increasing liquidity and they should be positively recognized to be able to carry out their duties in the best conditions. In the current regulatory context there are a number of initiatives that could hamper the market making activity and we would point out the Financial Transactions Tax or structural separation as the most dangerous initiatives for the liquidity providers. Shadow banking or short selling regulatory initiatives should also need to be carefully assessed so that the capacity of capital markets to distribute liquidity is not harmed.

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?

Banks have traditionally fulfilled a role of providing liquidity to the economy due to its knowledge of financial investors concerning the use and behavior of certain instruments. The standardization and simplification of the issuances will favor the transparency and comparability, and allow the investors to have an informed opinion about the instrument they are purchasing. That will also increase the turnover of the instrument.

Concerning project bonds (financing infrastructure projects), we welcome the initiative of the Commission to develop the market for this type of issuances.

The infrastructure projects have two distinct phases. First the construction step (greenfield), where the infrastructure has to be build. This phase is particularly critical, as the execution risks account for an important part of the costs. In this step, a specialized analysis is required, to carefully assess all the aspects that are inherent to each particular project. The role of banks at

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this step is not easy to be substituted, due to their expertise on bringing together client knowledge and capacity of analysis. But it can be supported by facilitating guarantees as a subordination feature, such as letters of credit. In the operational step (brownfield), the infrastructure is already built and it does not need such an intense follow up. We support the actual initiatives of the EIB, offering to provide revolving and subordinated facilities, that covers not only the construction phase but operations as well. The UK has taken a further step introducing in 2012 a Guarantee Scheme for some infrastructure projects with the same goal as the EIB initiative: give access to long term private investors (mainly insurance companies and pension funds) to infrastructure debt, in an investment grade rated bond format that facilitates infrastructure long term financing. The first transaction under any of these two initiatives is still pending to come, which would very likely take place sooner rather than later (2013).

In order to create the appetite from the investor´s point of view, at least two elements have to be considered: rating and the legal constrains for investors to acquire loans. The origination of project bond will address both, as it is an investable instrument. Some features should still be improved in order to increase appetite as the fixed coupons and early redemption they actually show. The rating, itself, will be naturally increased as the project enters the operations step, also helped by the revolving and subordinated facility that the IEB (or others) is willing to provide. We consider that we are witnessing a critical turning point for Project finance in Europe, and we support the initiatives to develop the project bond market. We believe they still have to be heavily supported and give the players enough flexibility to adapt to changes.

Regulatory risk is another relevant issue for investors. The inclusion of mitigations for this kind of risks would also be welcome.

In order to improve the conditions for demand of this new asset class, some considerations should be taken into account, as the treatment in capital under Solvency II that should reflect the particular features of this instrument. The actual rules, treating the Project bonds as a corporate bond, are penalizing the investment by insurance companies, which are the natural players for this market. This is because Solvency II requires capital based on duration and rating without taking into consideration probabilities of default and expected recoveries. Studies show that Project finance Debt has much better default statistics and the Loss Given Defaults are much lower than in Corporates. In our view, it is absolutely necessary to establish a new category of instruments that would be treated according to the historical patterns showed by project bonds, and to the specific features of these assets, such as the big amount of covenants and protections that are included in the structuring. We believe that this is probably the one of the barriers where the European Authorities could have power to influence for a change. The other one is in procurements, where Local Authorities don‟t give sufficient flexibility in the competitive bids for projects. As opposed to loans, it is not possible to assure a pricing for a bond at a particular point in the future. The spread market volatility towards closing should be taken by the Grantor as sometimes happens with the interest risk in long processes.

The development of a secondary market for this kind of bonds is also an important milestone. But this will only take place once the market develops as it happened with the asset back securities when they were first introduced to the market. Once it becomes an asset class, there will be specialization among the investors and market makers will feel comfortable to provide liquidity.

13. What are the pros and cons of developing a more harmonised framework for covered bonds? What elements could compose this framework?

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We have traditionally defended that a harmonized framework for covered bonds was not necessary as the market already knew how to distinguish among different regulatory frameworks and issuers assigning a different price according to their features.

However, it is clear that the need for a harmonized framework is gaining momentum. This is specially due to liquidity reasons (recognizing them as an asset class in the liquidity buffer, ECB collateral framework, …), but also due to the need to define how the bail-in mechanism is going to work allowing for a clear framework of creditors protection. Also, transparency is another reason that is increasingly being demanded by investors and supervisors.

Giving the fact that covered bonds deal with such amount of aspects, a complete harmonisation seems quite hard to achieve. However, there are some aspects where we could start working on in order to make these instruments more comparable:

Transparency. ECB considers transparency as a key aspect. Currently, transparency is quite heterogeneous among markets. It could be improved without making legal changes or even customs. However, special care should be taken when deciding about this because there are some aspects (e.g. the definition of LTV is different among countries) that are different for each country and could not be understood in the same way.

Elegibility criteria regarding assets (ships, plains, mortgages, …) and features (LTVs, insurance, …) could be another field to progress.

Market making. Certain obligatory practices that allow bonds to be comparable could be required.

Finally, there are others aspects that deal with big issues such as legal separation, the appointment of an individualized manager in the event of fail, procuring execution processes, etc. Although these aspects are not impossible to change, they require long and cost legislative processes.

Consequently, the cost/benefit ratio of a complete and total harmonization is quite high. The market has worked reasonably well till now without such harmonization. It is clear that we have to work towards a harmonization, but this should be designed at a low pace, selective harmonization, deeply analysed, working together supervisors, issuers and investors to allow for a transitional period where changes are possible. Transparency and comparability could be achieved under that process.

14. How could the securitisation market in the EU be revived in order to achieve the right balance between financial stability and the need to improve maturity transformation by the financial system?

With regard to securitisation, there is clearly an opportunity to improve conditions in order to increase the financing capacity of prime participants. The securitisation starts at the bank initiative, as a tool to release funds, and make them available to fulfill other client financing needs. As a second step, securitisation also helps banks to diversify and spread their risks , by giving them the opportunity to invest in securities that are less correlated with the risks that the natural client base introduces to the bank balance sheet.

Mainly for this reason, banks represent around 40% of the investors base for securitisations. Another important player in this market, on the investors side, are insurance companies. They

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invest in this asset class in a natural way, as a tool to reconcile their exposures with the long term financial liabilities they manage. Together, they represent 2/3 of the investors in the securitisation asset class.

It is extremely important, thus, to carefully assess the rules that could affect the behavior of these participants, in order to reach conclusions about the future of the asset class. In this sense, both aforementioned groups, banks and insurance companies are heavily impacted by the proposed Solvency II /CRD IV regulations, with banks potentially faced with even higher requirements upon implementation of the Basel Revision of the Securitization framework, especially in capital sphere, but equally in the area of liquidity. Particularly in capital, the treatment of the securitisation under these proposed new rules is quite penalizing with requirements that are proportionally too high compared to the actual behavior of the asset class during the crisis, as well as compared with both the default and loss behavior and the capital requirements of the underlying assets.

It is important, here, to make a clear distinction between the problems which have arisen in the United States with securitisations of a specific asset class which is the subprime mortgages, and most other types of securitizations , which displayed an impeccable behavior, even during the crisis. The currently proposed capital treatment does not take into account the history of the asset class as a whole and overstates the importance of this specific type of transaction , which is not applicable to the European context. In order to improve the securitisation process it is strongly recommended that the capital requirements concerning the asset class clearly reflect an unbiased and facts based view of its actual risks. Moreover, there is an additional impact on the capital consumption if the bank does not externally distribute the full securitisation issuance. Sometimes, in order to meet investor needs, the bank has to structure the instruments, such that the most protected tranche will be sold to investors and the mezzanine and junior tranches cannot be distributed at prices that reflect their actual risks. As a result, banks still have to retain part of the transaction that prevents them to release capital.

Concerning liquidity requirements, it would be recommendable to include all the instruments that are accepted for Repo agreements with the ECB in the list of liquid assets. The first step towards this objective has already been made, in January, with the recognition of some mortgage linked securitisations as liquid assets, but other instruments are penalized by comparison, such as Auto ABS, SME lending, cards or consumer lending, that are equally important for the economic activity. We further note that the criteria for inclusion of RMBS in the HQLA buffer are potentially prohibitive and might be based on historic data which reflect contagion effect of the US subprime crisis rather than factual credit risk losses.

Whilst we know that the NSFR is currently under review, we note that the original Basel proposal would generate a problem in the last year of a securitization transaction: whereas the underlying assets still require 100% stable funding, the securitization transaction including those assets does not fully qualify any longer as stable funding in the last year of the transaction. Given that the assets in question are already included in a securitization, an overlapping securitization transaction using the same underlying assets is not possible.

The effect of the capital requirements imposed on insurance and banks has two indirect consequences for the investment in securitisations by other participants. First, asset managers that are mandated by pension funds have also to take into account the requirements of insurance companies in order to make their asset allocation and this will accordingly penalize the investment in securitisations. Secondly, the reduction of liquidity as a consequence of the lower appetite by banks and insurance companies will also make the asset class less interesting from other investors´ point of view. It should be noted that the barriers to entry for intermediaries / traders have substantially been heightened as well. All this might affect the

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liquidity in the securitisation markets. Lastly, UCITS V de facto also disincentivizes funds´ investments in securitizations.

Together with preserving the important role played by banks and insurance companies, there is a need to improve the perception of the asset class, that has been hurt by the subprime crisis. Initiatives such as “Prime Collateralized Securities” can help attain this objective, by putting a “quality label” on securitisations that meet some criteria in terms of transparency, assets quality or liquidity. The purpose is to highlight and certify the good quality of certain instruments included in this asset class, as well as to recover investors‟ appetite . The binary (yes/no decision) and asset class specific approach of PCS with around 80 different criteria to comply with per individual transaction clearly distinguishes between good and less good quality transactions. It would certainly help re-invigorate a healthy securitisation market if the PCS initiative would be further supported by regulation recognizing the quality of PCS, i.e. by procuring capital relief and by improving its treatment in liquidity buffers.

For more detailed information we further refer to our analysis on post crisis securitization related regulation1 which shows that

Policy objectives propagating securitization as a solution for growth may prove difficult to realize with the current regulatory proposals on securitization, even though in our view most regulations are directionally correct.

The analysis in Annex I can be seen as a first step in a regulatory process which assesses securitization regulation in a holistic way, i.e. comprehensively encompassing all components in the securitization chain. Such a regulatory process is required for securitization to be properly regulated, whilst not being stifled.

Especially since crucial pieces of securitization related regulation are still in a drafting phase, there are relatively simple ways to remedy some shortcomings and to circumvent unintended consequences.

15. What are the merits of the various models for a specific savings account available within the EU level? Could an EU model be designed?

In real estate, in Spain we already had a few specific products for savings that included tax breaks. Savings accounts - housing had the same tax consideration that buying a home, encouraging saving for this purpose with a maximum duration of four years. It is true that these measures should be strongly influenced by the type of housing that each country has as long-term objective, as this product promotes home ownership, compared to other countries that support other models more focused on rent.

With this premise, two distinctions can be made:

• Saving products for application to real estate products for own use.

• Saving products for application to third-party real estate products or general interest (infrastructure, public buildings, etc, ... ).

1 The study has been shared with the Commission (DG MARKT: Unit G3 Securities Markets and Unit G2.3

Securities Markets). For further details, or for asking for a copy, please do not hesitate to contact [email protected]

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The first point would refer to savings that could then be channeled to real estate products. Not necessarily has to be housing. It could also be garages, shops, offices, the latter being for use by SMEs and freelancers. It would be essential that these products have financial or tax benefits to encourage savings. Rebates on income tax, reductions in corporation tax retention, as well as possible reductions in indirect taxes inherent to the purchase of the property on the part of the funds provided by these products or application of the deduction for depreciation of property on the part of the savings set aside for this purpose.

The second point, is more focused on third-party real estate products (securitization) or interest (infrastructure, public buildings, etc..).

These long-term savings would allow for the financing of real estate and infrastructure elements. Given that the return on investment is long-term, the return of the savings products should also be adequate to these terms. However, the current crisis has shown that real estate investments, even circumstantially, may have a significant loss of value or even cease to be viable (eg highway infrastructure), the saver should be given some kind of certainty about the return of the product.

16. What type of CIT reforms could improve investment conditions by removing distortions between debt and equity?

The convenience of any potential reform on this field, especially if they alter the current international homogeneity, should be deeply assessed.

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?

We consider that a lower tax rate could be set on interests coming from long-term investments in financial assets (without discrimination on the basis of the public or private nature of the financial asset). Alternatively, a minimum tax-exempt income could also be set for this kind of incomes. In Spain, for instance, there is a deferral system for those savings held in pension funds which could be completed with a discount on the tax rate in the end, when the revenues of the fund are received (as it already happens in other European countries).

18. Which types of corporate tax incentives are beneficial? What measures could be used to deal with the risks of arbitrage when exemptions/incentives are granted for specific activities?

In our opinion, tax deductions should be granted to corporate investments in assets with long-term funding. Alternatively, financial expenses linked to long-term funding (or at least a certain proportion of these costs) could be excluded from the deductibility limit for financial expenses.

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19. Would deeper tax coordination in the EU support the financing of long-term investment?

We consider that deeper coordination at European level for promoting long-term saving and funding would help to avoid a run of savings to those countries encouraging short-term saving and funding.

20. To what extent do you consider that the use of fair value accounting principles has led to short-termism in investor behavior? What alternatives or other ways to compensate for such effects could be suggested?

We believe that, by promoting fair value, the IASB took for granted that investors, and more specifically short term investors, are the only users of the IFRS. Since the market value is considered as the “true” value, it can only trigger short-termism from management of companies. The fair value model is based on the theory of “efficient markets” which are supposed to react immediately to all information disclosed by companies and which privilege shareholders and short-term investors. The financial crisis demonstrated the procyclicality of the latter. Though during the upwards cycle increasing stock prices triggered an increase in the value of profits and own funds (which led to higher stock prices), in the downwards cycle the phenomenon was the opposite, and fire sales triggered impairments and a reduction in own funds. This was particularly true for banks and insurers. Europe should take the opportunity open by the decision of the SEC to stop the convergence process between the US GAAP and the IFRS, and reopen the reflection on the conceptual approach of the IFRS referential. Whilst it is not clear that a different accounting framework would necessarily lead investors to take a longer-term view, the fair value model as a model par défaut should be questioned. The most recent developments in standard setter's activities indicate that the IASB and the FASB are getting away from their focus on fair value accounting for financial instruments. Alternative measurements categories have been proposed and are now being recognised as an appropriate basis for classification and measurement for certain types of financial assets, such as debt instruments. The recently issued exposure drafts by the IASB proposed three classification and measurement categories for financial assets. These categories are: 1) amortised cost; 2) fair value through other comprehensive income (OCI) with changes in fair value of the instrument reported in other comprehensive income; as well as 3) fair value with changes in fair value recognised in earnings. The FASB aligned their views with the IASB and issued a converging proposal for recognition and measurement of financial instruments allowing the same measurement categories for financial assets. These proposals are intended to increase the decision usefulness of financial instruments reporting for financial instruments users, including investors, by linking the measurement of the financial assets to the manner in which the entity expects to benefit from the related cash flows. We believe that accounting principles should be judged holistically, looking at the overall impact they have on financial statements. Fair value accounting very clearly creates volatility in the financial reporting, to the extent that the changes in fair value movements are reported in net income. Such volatility may be artificial and may not be reflective of the economic volatility of the entity. In other words, capturing short-term market-to-market fluctuations in net income for

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instruments that will be held long-term is punitive to the holder. Hence, additional volatility caused purely by accounting requirements may have a possible effects on short-termism. The accounting for financial instruments should reflect the characteristics of the instrument as well as the business model for such instruments. For example, if an entity intends to hold plain vanilla debt instruments consisting of a principal and interest, which compensates the holder for time value of money and credit risk, while the portfolio of such instruments is not managed on a fair value basis, using fair value accounting with changes reported in net income would not be an appropriate solution. Rather, such an instrument should be measured either at amortised cost or, alternatively, at fair value with changes reflected in other comprehensive income.

However, it is important that a wider scope of asset classes than the one currently proposed by the IASB could be eligible. While insurers do use simple debt instruments in order to match insurance liabilities, the assets strategy is often more complex, involving, for example, the use of derivatives in order to diversify credit exposure and manage interest rate risk. Other assets classes may include investments such as equities, investment property, mortgages and other loans. Hence, for fair value through other comprehensive income (FVOCI) to be appropriate for all types of insurance business, eligible assets must be extended to cover a wider scope of asset classes without limitation due to cash flow characteristics.

In summary, measuring all financial instruments at fair value, with changes reported in net income in all circumstances, may be misleading to the users of the financial statements as well as inappropriate from the preparer's perspective. Amortised cost or fair value with changes reported in equity may better reflect how such instruments are managed and therefore provide better information on the entity's long term strategy for the instruments. Therefore, measurement of financial assets at fair value to the extent that changes in fair value are not reported in net income but rather in equity, could reduce short-termism in investor behaviour. We would like to highlight that the priority is for the accounting basis to reflect the insurance business model and deliver a basis of performance reporting which appropriately reflects the long-term nature of insurance business.

It is also important to underscore that the insurance industry in particular has long-term features that should be recognised in accounting regulation. The insurance industry‟s business model is centred on asset liability management, in which liabilities, guaranteed and related assets are managed together. These assets are managed together to meet their obligations towards policyholders and therefore any accounting standards on financial instruments should be aligned with a standard on insurance contracts. Non-alignment would lead to unjustified volatility and mismatching in performance reporting, not due to business performance but because of the accounting treatment between assets.

21. What kind of incentives could help promote better long-term shareholder engagement?

It is important to link long-term shareholder engagements with efficient corporate governance. Indeed, shareholders engaged in a long-term perspective will be more sensitive to corporate governance issues and to the control mission within the company. Several tools may be used to develop long-term shareholder engagement. First, the promotion of participation among employees seems to be an effective way of

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developing stable shareholding. The employee's financial participation as shareholders can be promoted by many tools such as tax incentives or the employer's participation in exchange for a detention of shares over several years (in France, for instance, 5 years). The system can be even more attractive for companies if the shares detained are gathered in a mutual fund by which employees act through a common voice. Mutual funds, which give employees exclusive access to their company but also to other companies, may also be a useful way of channelling employees‟ savings in a specific direction. The promotion of employee shareholding schemes at European level is an objective that must be continually worked upon, both from a legal perspective as well as from a tax/social point of view. It is indeed very heavy for groups that put in place operations in several countries to combine the different applicable rules. Non-financial participation of employees (such as board participation for instance) may also be an efficient way to promote their interest in the company and thereby their will to remain as stable shareholders. The recent EC Action Plan emphasises the importance of institutional shareholder guidelines to ensure engagement with the company. The Action Plan cites the UK‟s Stewardship Code as a good example of best practice for institutional shareholders. The Stewardship code focuses on the transparency of institutional shareholder practices, and underscores the importance of monitoring the company performance and accountability.

22. How can the mandates and incentives given to asset managers be developed to support long-term investment strategies and relationships?

Remuneration in asset management companies is based on the assets under management. As a consequence, such remuneration will vary depending on the type of assets, the underlying assets and their performance. Asset managers have in any case a fiduciary duty to maximise returns for their investors. The determination of the investment strategy is established in the contract agreed between the asset management company and the institutional investor, and depends on the financial profile/needs of the investor. If investors want to have access to a certain level of liquidity, a portion of investments will be made in short-term liquid assets (e.g. monetary instruments). If investors are ready to accept a certain level of risk and illiquidity, they might expect higher performance provided that they accept a longer duration of the underlying investments. It should be noted that the asset management market is highly competitive and, as such, any perceived reward or demand for long-term investing should be reflected in flows of funds - this is arguably what hedge funds and long-only managers have done. With regard to the management of funds, UCITS and AIFMD rules provide for numerous risk mitigants (e.g., capped leverage, restricted eligible assets, mandatory diversification ratios, etc.) and excessive risk-taking is consequently not a key issue. Investors that are clients of asset management companies typically expect their asset managers to use a risk budget (carefully measured and intensively optimized), and draw comfort from the fact that their fund managers are properly incentivized on performance. Indeed, asset management is essentially a performance/risk-driven industry, which hinges on the quality of service rendered to the client. Performance is of the essence. The EU should not penalize its asset management industry by letting its clients perceive - or its non-EU competitors point out - that it is counter-productively constrained.

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23. Is there a need to revisit the definition of fiduciary duty in the context of long-term financing?

The Green Paper is right to seek the alignment of the incentives of asset managers, investors and companies on long-term strategies Simple measures could be implemented to align these incentives, for example: fund manager performance could be reviewed over longer time horizons than the typical quarterly cycle; excessive reliance on measuring performance relative to a market index could be reduced; pension funds could have voting and engagement policies that could be integrated into the investment process; shareowner activism could be given more weight in the selection and retention of fund managers and other matters; advisors to institutional investors could have a duty to proactively raise ESG issues; fund management contracts and fund managers‟ performance could include an evaluation of long-term ability to beat benchmarks; and within companies the implementation of strong cultural norms could be supported by independent whistle blowing mechanisms, overseen by professional bodies who offer the whistle-blower appropriate protection.

24. To what extent can increased integration of financial and non-financial information help provide a clearer overview of a company’s long-term performance, and contribute to better investment decision-making?

The improvement of information will surely lead to better decisions. It is important, however, to take into account the long term focus of the investments, and to improve the information that will help the long term decisions.

25. Is there a need to develop specific long-term benchmarks?

We strongly support the EU Commission objective to reduce overreliance on credit ratings in line with the compromises adopted within the G20 as its use to calculate capital requirements of financial institutions is pro-cyclical and creates herding behaviour.

Contrary to the overall objective of reducing reliance on credit ratings, Solvency II rules do not follow the same line as credit ratings are blindly used in order to calculate the Solvency Capital Requirements according to the standard formula. Credit ratings methodologies are based on short-term assessments and fail to recognise the long-term perspective of the insurance business. This failure is accentuated in the case of unsolicited ratings where credit ratings agencies base the assessment on accounting requirements or other public information without having the appropriate knowledge of the business of the undertaking.

Where the solvency regulation adequately reflects the long-term nature of the insurance business, the solvency ratios could be used as a tool to reflect the creditworthiness of the insurance or reinsurance undertaking. Previous drafts of Solvency II produce high volatility of solvency ratios. The inclusion of measures to reduce the artificial volatility on solvency balance sheets in line with the ones introduced in the long-term guarantees impact assessment carried out by EIOPA beginning this year and recently published (June 14th) is an adequate step forward. Where appropriate measures were included, solvency ratios would provide better information on the creditworthiness of the business than the assessment by a credit rating

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agency based only on accounting or public information.

In EIPOA‟s Quantitative Impact Study 5 (QIS5), a similar approach was used to calculate the counterparty default risk of non-rating reinsurance undertakings. Some argued that it is not practical as solvency ratios of the reinsurance undertakings are only known once the deadline for reporting requirements of the direct insurance undertaking expires. This could be solved by an early communication by the reinsurance undertaking to their clients or by including a compromise by the reinsurance undertaking that the solvency ratio will be within certain limits, so that the insurance undertaking could use it to calculate its own capital requirements.

26. What further steps could be envisaged, in terms of EU regulation or other reforms, to facilitate SME access to alternative sources of finance?

Long-term bonds (+10 years) issued by supranational agencies (e.g. EIB) with favorable fiscal treatment (e.g. lower tax rate on income or lower heritage taxes, …) and being guaranteed by the issuer could be designed. In this way, private investment would be encouraged and consequently it would help to diminish State Member´s deficits.

A secondary market could be set up to allow trading in these securities. In order to fulfill the function of channeling long-term savings, a minimum period of holding these securities could be required for enjoying the benefits of these securities (three to five years).

27. How could securitisation instruments for SMEs be designed? What are the best ways to use securitisation in order to mobilise financial intermediaries' capital for additional lending/investments to SMEs?

Even if analytical capabilities are being increased, the small and medium companies have still more difficulties to build up credibility among the investors. This is one main reason why they still depend on bank lending in an important proportion. The bank that provides them with other financial services is in a better position to make an assessment of the credit quality of the company, but it is arduous for the company to transmit credibility to other participants.

This is, in our view, a barrier that will not be easily overcome. SME financing has special features and risk considerations that should be taken into account before trying to develop dedicated markets. The qualitative factor (i.e. quality of management) can be a determining factor in its performance, something which is not easily identifiable by an investor. On the other hand, in the case of SME the financing should not be addressed on a long term basis, because their needs are often focused on the short term (working capital needs). Banks would be better placed to give this kind of financing. For the long term needs, dedicated markets can also be considered, and securitisation should play a role. The standardization, in this context, is essential so it is a clear objective that the authorities can focus on. But other considerations have to be taken into account, such as the capital and liquidity issues that have already been covered on other sections. It should be noted however that securitization of SME loans could yield the following problems:

1. Given the perceived higher risks in (unsecured) SME loan portfolios, it might be that

investors prefer CMBS to unsecured SME loan ABS, or that external ratings are punitive.

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With the risk retention proposals issued recently by the EBA, there is a potential problem with CMBS as it is hard to determine who should retain the risk (viz EBA DTS on the retention of net economic interest and other requirements relating to exposures to transferred credit risk, par. 30-31)

2. The difference in financing cost for SME in peripheral countries and SME of similar credit quality in non peripheral countries will not be resolved by including such loans in a securitization transaction. As long as the ECB eligibility criteria for repo-ing are based on external ratings, this pricing dichotomy will remain in place. This is because ECAs apply sovereign caps (reflecting a.o. redenomination risk) in their ABS ratings which ultimately translate into higher funding costs for banks and SMEs in peripheral countries.

28. Would there be merit in creating a fully separate and distinct approach for SME markets? How and by whom could a market be developed for SMEs, including for securitised products specifically designed for SMEs’ financing needs?

In allocating their savings in non-risky and short-term products, investors do not benefit from the risk premium offered by longer-term assets. This lack of optimization in the allocation penalizes the growth potential of the economy. One suggestion could be the creation of a long-term savings fund that is intended for retail and institutional distribution. Based on the UCITS IV Directive, its regulatory framework would adjust certain criteria in order to better meet the specific long-term while preserving the UCITS approach that has demonstrated its robustness. This long-term productive savings fund would:

Offer a new channel of financing to the economy by widening the scope of eligible assets: non-listed companies (stocks and bonds), debt securities business (corporate loans), infrastructure financing, etc.;

Facilitate the redirection of savings towards productive investments through the eligibility of products subject to a wide underwriting environment (life insurance, employee savings plans, etc.); and,

Respect the UCITS pillars ensuring: o Guarantee of quality and robustness o Transparent framework o Distribution to individuals like the institutional segment o Possibility of European distribution in the future

European companies need new financing solutions. The scope of eligible assets in UCITS IV is restricted to listed securities. The current framework already includes bonds and other debt securities. The new framework should make eligible non-listed securities or those that are traded on a regulated market. However, changes in the scope of eligible assets require an adaptation of liquidity constraints and valuation rules to allow a better consideration of the owners of the underlying portfolio. Non-listed securities do not benefit from the same liquidity as other assets. It is necessary to protect holders to ensure the stability of the fund during the redemption period. In order to facilitate the liquidity management of the portfolio during the application for repayment, it could set up systems of a notice period of 1 month. Liquidity adjustments:

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The liquidity of an asset is associated with the difference between the purchase price and sales (range bid/ask). Today, a new method of valuing funds emerges and is recognized by regulators: the "swing pricing". This method allows the valorisation to marking to mid price between the purchase price (ask) and sales (bid) of all fund assets. The subscription of the shares will be carried out at the cost of purchase of the funds (ask) and the refunding of the shares at the cost of sales of the funds (bid). This "fair" value would be to the cost of liquidity to incoming and outgoing while fully protecting the rest of the holders. Valuation consideration: The daily valuation becomes a source of misunderstanding in the case of long-term investment. The disclosure of the fund's net asset value in official documentation might prefer an expert value approved by an auditor. The assessment would be published monthly. It would therefore be less volatile and consistent with the spirit of long-term investment. Separately, it must be underlined that for small enterprises, banks may remain an appropriate source of funding. In this context European authorities should ensure that corporates are not overly impacted by new regulation. For example exempt SMEs from the full impact of Basel III, through the lower risk weighting in CRD IV for lending to SMEs. These efforts should be actively pursued.

29. Would an EU regulatory framework help or hinder the development of this alternative non-bank sources of finance for SMEs? What reforms could help support their continued growth?

Regarding the issue of market access for SMEs, we believe it is currently held back by at least three key elements. First of all, information on SMEs and their projects often lacks transparency and/or is not always easily available. In this respect, it is important that accounting/reporting standards are reviewed in such a way that investors are informed about the actual performance of SMEs and thereby facilitate their investment decisions. Second, many SMEs tend to favour a close relationship with their lenders, similar to what is provided by a bank, rather than a system that disseminates risks through various investors. Finally, it is generally acknowledged - by both market participants and regulators- that banks, thanks to their expertise and granular knowledge of their client base - remain best-placed to assess and manage inherent risks related to SMEs. Their involvement in the funding process will therefore remain substantial, though their specific role in the value chain will evolve. These aspects should be carefully considered. Corporate bonds are the main instruments to access the capital market but the previously mentioned constraints act as a deterrent for SMEs, reducing their ability to tap non-banking sources. It should be noted that the market for longer-term funding is primarily from larger SMEs – any bond market set up specifically for a segment of the SME market would be very small. It may be more sensible to use existing bond markets and make them more accessible. In this sense, the aggregation of pension funds investing in riskier assets - mainly represented by corporate bonds - as well as the aggregation of corporate bonds into purposed credit vehicles that fund themselves into the market could represent a feasible solution. Accordingly, it would be necessary to work on the “financial education” of savers, leading them to invest in long-term assets and diversify their investments.

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Most unrated and smaller corporates do not have access to the international capital market – the so-called Eurobond market. For this reason the domestic markets are vitally important for the transmission of liquidity to the corporate sector and ensuring investment and employment. Small-scale issuances of corporate bonds do not have the economies of scale. The cost of issuance is high and liquidity is limited. Documentation requirements are a heavy burden. Reliefs in documentation requirements would be welcome. The creation of a consolidated bonds market which would make bonds evaluation more transparent and attractive would be welcomed. To ease the process of credit evaluation, initiatives should be promoted to coordinate activities of different operators like banks as originators of credits and/or supervisors of bonds issuance, rating agencies, institutional investors and regulators. In order to accelerate the setting up of such consolidated bonds market, a public operator could act as both bonds issuer and purchaser of banks credits – offering further guarantees and keeping contact with rating agencies. In addition, initiatives should be launched in order to bring together exchanges, banks, regulators, investors and corporates in order to discuss the way to ensure a smooth transition towards market-led funding as well as the specific features of a well-functioning SME market. As demonstrated, while intermediation through capital markets and securitisation are credible alternatives to banking intermediation, the switch from a bank-led economy to a more market-led economy will no doubt take time. It is therefore crucial to come up with ways to support this transition. In this respect, development banks can play an important role as alternative providers of funding to the real economy. Furthermore, ne

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