SUPPORTING LONG-TERM FINANCING OF THE EUROPEAN ECONOMYOCTOBER 2013

The importance of infrastructure investment, fi nancing small and medium sized enterprises (SMEs), fostering a venture capital culture and reviving the securitisation markets.

The European Financial Services Round Table (EFR) was formed in 2001. The Members of EFR are Chairmen and Chief Executive Officers of international banks or insurers with headquarters in Europe. EFR Members believe that a fully integrated EU financial market, a Single Market with consistent rules and requirements, combined with a strong, stable and competitive European financial services industry will lead to increased choice and better value for all users of financial services across the Member States of the European Union. An open and integrated market reflecting the diversity of banking and insurance business models will support investment and growth, expanding the overall soundness and competitiveness of the European economy.

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Contents

InTRoducTIon 04

• Infrastructure investment 05

• Financing small and medium sized enterprises (SMEs) 07

• Venture capital 10

• The importance of securitisation 12

• The role of the insurance sector 14

• The banking sector underpins the economy 17

• Financial sector taxation 20

EFR VISIOn 21

EFR MEMbERS 22

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IntroduCtIon

The European economy has been under substantial pressure over the past few years due to a combined sovereign debt crisis, banking crisis and a growth and competitiveness crisis. This has led to a slowdown in economic growth, increasing unemployment – especially among young people – and fragmentation across Europe. The European Union, European Central Bank, the Member States and the private sector have all taken a number of important steps to address the situation but more needs to be done.

The EU Commission in its “Green Paper on the long-term financing of the European economy” (March 2013) rightly asserts that the most pressing challenge for Europe is get back on a path of sustainable and inclusive growth, creating jobs and enhancing its competitiveness internationally. Furthermore, the Commission identifies large-scale, long-term investment as a key driver for reviving growth and employment across Europe.

The European Financial Services Round Table (EFR) commends the Eu commission for initiating a debate about how to foster the supply of Long-Term Financing (LTF) and how to improve and diversify the system of financial intermediation for long-term investment in Europe. The EFR is contributing to the debate by addressing seven important topics: infrastructure investment, financing small and medium sized enterprises (SMEs), fostering a venture capital culture, the importance of securitisation, the key role of the insurance sector, the changing dynamics of the banking sector and financial sector taxation. If addressed properly, these areas can contribute substantially to long-term growth and employment prospects across Europe.

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InfrastruCture Investment

Clear rules and innovative financial instruments can help increase investment in properly designed infrastructure projects

Increased investment in infrastructure projects can boost employment, economic growth and potentially, depending on the characteristics of the projects, are sound assets to invest in. Infrastructure projects, when they give rise to stable and predictable cash flows may be suitable investments for insurers and asset managers.

In Europe banks have traditionally played a major role in funding infrastructure, particularly in the riskier construction phase. However, project complexity, long lead times and particularly stricter prudential rules mean that traditional bank funding for longer term projects like infrastructure and low carbon technology is becoming more expensive.

Insurers are also excellently positioned to provide long-term funding. They match long-term assets with long-term liabilities. Insurance companies involvement in infrastructure funding will strongly depend on an effective cooperation and a fair split of risks and rewards between the banking and insurance sectors.

There is also a clear role in infrastructure investment for development banks, which by supporting existing funding vehicles and through their own initiatives (such as project bonds) help to build awareness of, and confidence in, a relatively new market and asset class. The project bond initiative, created by the EU and European Investment Bank (EIB), should be recognised as an important programme to help improve capital financing for infrastructure.

Investors need to be able to see a clear pipeline of infrastructure projects to enable them to plan and prioritise their potential deals. At national and European level the visibility of the infrastructure pipeline seeking private finance could be made much clearer, particularly for small and medium sized projects. one way to improve the visibility of the infrastructure pipeline would be for the Eu commission to collate details of available and upcoming infrastructure deals, perhaps on a website, and to standardise some key metrics e.g. nature of the asset, funding requirements.

Separately, new long-term investment funds (LTIF) could facilitate the raising of capital across Europe. Carefully calibrated, rules on LTIFs could inspire the same confidence as Undertakings for Collective Investment in Transferable Securities (UCITS.) The key to the success of a proposal is to set out product regulation that adds real value and whose rules, such as diversification or redemption limits, are easily understood by both investors and providers. If LTIFs widened the investor base / demand for infrastructure debt or equity then this could motivate asset managers to build up their expertise in long term investment over time.

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Given the pressure on bank funding, it is important to revitalise capital markets and improve their capacity to lend to the real economy in the new funding environment. Achieving such a shift will require new funding models, new sources of investment, and supportive policy. In particular, it will be important to deliver greater scale to develop market capacity. While the private sector needs to develop new funding models – such as bank / bond hybrid structures – some of the necessary change can be delivered through public policy – including:

• Greater deliverability and consistency, through a stronger pipeline of projects, helping to make the process more efficient and more predictable;

• Given the demise of the monolines, new methods of delivering credit enhancement, building on the EIB’s Project Bonds Initiative, to create a more attractive investor proposition, particularly during the riskier construction phase;

• Opening up procurement to bank / bond hybrid solutions;• Better calibration of prudential rules;• Achieving greater consistency in, or harmonising, national procurement frameworks, to deliver

greater transparency and predictability for investors. This is particularly important if Europe is to attract FDI given the estimated 80% of pension assets and 70% of insurance assets held outside Europe.

Recently there has also been an increased appetite for listed vehicles to own infrastructure assets. Many of these vehicles own infrastructure assets, are listed and have both institutional and retail investors. The Eu commission may want to consider how its proposals would impact on this type of vehicle. More broadly, the questions on infrastructure could be enlarged to manufacturing investments and their financing. Traditional solutions are obviously still available but they can be improved through innovation. Innovative solutions, to be envisaged by banks and insurers, should cover the level of acceptable risks.

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fInanCIng small and medIum sIzed enterprIses (smes)

Access by SMEs to financing and different types of market access is key for economic growth and should be actively promoted through conducive private and public sector initiatives

It is very important for growth prospects in Europe that small and medium sized enterprises (SMEs) have access to the necessary financing. Banks, insurance companies and other stakeholders such as Development Banks all play a crucial role in the financing of SMEs and LTI. Their support and contributions should be well recognized and actively supported through conducive public policies and regulatory initiatives.

Taking the financing needs of SMEs into consideration when developing new prudential rules

Although the recently adopted compromise on CRD IV / CRR is less penalizing for banks providing funding to SMEs, it is of the utmost importance to reflect on new ways to provide funding to the real economy. Indeed, the deleveraging of banks is still ongoing and, as a result of the Solvency II Directive, equity investment by institutional investors will prove increasingly more difficult in the future.

Promoting market access for SMEs

The banking sector also plays a fundamental role in the retail market of SMEs and by providing short term and working capital funding needs. Banks will continue to originate credit and to play a major role in assessing credit risk thanks to their specific skills in this area, their local knowledge and day-to-day relationship with enterprises through the holding of their accounts. Insurance companies also invest in SME’s, especially larger ones that have securitised loans.

Regarding the issue of market access for SMEs, the EFR believes 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.

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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, encouraging them to invest in long-term assets and diversify their investments.

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 welcomed.

The creation of a consolidated bond market which would make bond 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 bank as originators of credits and/or supervisors of bond issuance, rating agencies, institutional investors and regulators. In order to accelerate the setting up of such a consolidated bond market, a public operator could act as both bond issuer and purchaser of banks credits – offering further guarantees and keeping contact with rating agencies.

Promoting innovative financial instruments

new innovative financial instruments should also be developed in order to promote alternatives to bank lending for customers. Measures to develop co-investment and Public Private Partnerships (PPPs) should be considered as well as the creation of new financial instruments combining loans and guarantees.

Over the past decade securitisation has become an important element for the financing of SMEs in Europe with growing significance in some European markets, including Spain, Germany, the UK and Italy. However, the strong decline of the European structured finance market has profoundly affected the status and outlook of SME securitisation. SME securitisation, like other securitisations, is still suffering from the economic and financial crisis. In the first quarter of 2012, EUR 7.7 billion of SME securitized products were issued in Europe, a 51% decline from Q1 2011. Furthermore, only 19% of the total issuance of SME securitised products in Europe in the first quarter of 2012 was placed in the market, with the balance being retained by the issuer.

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The structure of SME lending prevents the sale and/or treatment on financial markets in particular because of their modest size. Securitisation arises as a source of refinancing due to the transfer of the risk (from the banks’ balance sheet to the financial market), which has important benefits for the companies (opportunity and financing costs) as well as for the credit institutions (facilitated refinancing).

Greater involvement from the public sector

Public sector support also plays a crucial role in reactivating the SME securitisation market, as is evidenced by the recent initiatives taken by KfW bank, the German government-owned development bank. This government-backed scheme has proven its effectiveness in channelling cheap funds to SMEs during the current economic downturn and represents a model that could be adopted successfully elsewhere. Through securitisation platforms it has helped commercial banks to transfer loan risks from SME portfolios to the capital markets, thereby giving credit institutions more scope to extend new SME loans. It is important, however, that public support for SME securitisation must be made conditional on ensuring “additionality” i.e. extending new loans to SMEs so that they profit from the support given to the transaction.

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venture CapItal

The development of venture capital should be promoted as a valuable source of investment for SMEs

Venture capital, and other forms of private equity, is widely acknowledged as an important source of finance, especially for early-stage and high-potential companies. This is especially true for companies in the biotechnology, IT and software industries that may be too small to raise funding in the public markets. As such, Venture capital is associated with job creation and should therefore be positively encouraged.

But as the EU Commission has recognised there is a shortage of funding in the EU for venture capital, which impacts the ability of SMEs to grow. In the EU, venture capital and "business angel" finance currently provides only 2% of SME financing, while in the US the figure reaches 14%.

The development of venture capital should therefore be promoted in Europe and “business angels” should be given incentives to take a more active part in financing European SMEs. not only is it important to have a European passport for venture capital funds, but one should also think of ways to pool resources in order to promote pan-European investment funds and funds of funds in order to increase access to finance for SMEs. Initiatives such as the EVFIn – European Venture Funds Investors network – launched in 2011 by several national public operators in the area of private equity with the aim to develop pan-European funds of funds should be supported.

There is also no integrated venture capital market in Europe, as venture capital funding is fragmented along national lines thereby increasing funding costs and limiting opportunities for entrepreneurs and investors alike. As such, the new EU regulation that makes it easier for venture capital funds to raise capital across Europe – through a so-called EuVECA status goes a long way in addressing this issue. But there remain significant obstacles in the form of double taxation, tax treatment uncertainties and administrative requirements that will continue to weigh on the growth of this important market.

In the UK, the Business Growth Fund (BGF), a GBP 2.5 billion venture capital company owned by five banks (but operating as a separate business) focuses on fast growing companies with a turnover of GBP 2.5 million. The BGF makes equity linked investments of between GBP 2 million and GBP 10 million with a long term investment horizon and is willing to co-invest alongside other investors.

The banks’ investments in the fund benefit from a favourable capital treatment, allowing the fund to generate economies of scale. With some adaptation, the BGF model could be applied more widely within Europe. In order to encourage countries, banks and other investors to establish such operations, the EU could agree to co-invest alongside local banks and other investors (such as pension funds and insurance companies) in local funds of this nature. This investment could be channelled through the European Investment Bank and European Investment Fund to ensure that there is an appropriate infrastructure to oversee these investments.

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“Enterprise networks” represents another way to enhance the capacity of banks to channel liquidity to the firms, by increasing their competitiveness. Enterprise networks are increasingly active in Italy, thanks also to an “ad-hoc” legislation issued by the Italian Government. The project aims to facilitate the aggregation of different enterprises, with the purpose of fostering their internationalization, their innovation capacity and their competitiveness on both the domestic and the foreign market. Banks perceive the network as a unique interface in all commercial and financing activities. Financing is granted after a positive evaluation of the “network business plan”, in terms of feasibility and sustainability of its objectives, and a simplified financing process, with a unique risk evaluation structure. This may also mean an improvement of the risk standing of participating firms, resulting in a reduction of financing cost for them. Developing harmonised rules at EU level on the working of such business networks could favour the aggregation of SMEs from different countries thereby improving further their financial and commercial standing and their access to finance. In terms of an EU regulatory framework, as mentioned above, attention should be focused on ensuring that consistency in term of the aims and impact of current regulatory initiatives rather than just creating additional layers of regulation.

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the ImportanCe of seCurItIsatIon

Revitalising the securitisation market − through careful adjustments in the prudential regulatory framework − would help address the funding gap and raise SMEs and infrastructure financing

Access to securitisation markets for issuers has become increasingly important to overcome the funding gap between lending to the real economy and money raised from depositors. It is, essentially, an enabler for growth of the real economy. Moreover, a number of years later, the vast majority of European securitisations have demonstrated high credit resilience and strong price performance. This segment has great potential, although the lack of market confidence as well as a lack of trust by public opinion and authorities has hampered smooth market functioning.

Against that background there is an important trade-off between the risk posed by securitisation and its function as a key tool for bank funding and liquidity. As a response to the need for a revitalisation, the EFR has helped launch Prime Collateralised Securities (PCS), an independent, not- for-profit initiative to define and promote standards of “best practice” in the asset backed market, including standards of quality, transparency, simplicity and liquidity. It is encouraging that the ECB and EIB have recently announced a consultation on initiatives to promote a functioning market for asset-backed securities collateralized by loans to non-financial corporations. It should be noted that European Investment Fund guaranteed securitisations are assisting in this area.

But concerns about regulation are weighing on market sentiment for asset-backed securities. For securitisation to become more widely used it is important that the review of both the liquidity and the capital charge for securitisations currently discussed in the basel committee is well-balanced and consistent. The EBA will need to carefully assess the eligibility of PCS transactions towards liquidity coverage ratio requirements. Regarding covered bonds, which also proved resilient and useful as a funding and investment instrument during the financial crisis, it is also important to consider unintended consequences of regulatory intervention.

Similarly, on the insurance side, the treatment of Asset Backed Securities as currently foreseen under Solvency II implies that it is highly unattractive for insurers to invest in these types of securities and, hence, that they will divest from this asset class. Securitisation in its intended form is a healthy transition mechanism of risk in the financial sector. To unlock risks at banks and to accelerate lending to SMEs and individuals a well-functioning securitisation market is essential.

If the regulatory framework around securitisations is fair, equivalent to other asset classes and provides some capital relieve to banks it will create the conditions for banking lending through capital market financing. Also once high quality securitisations are defined, it will allow retail funds to purchase these investments and thereby help meet the long-term finance needs of the economy.

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A dedicated securitisation programme should be established, where SMEs (as defined under the EU general definition) could collateralise ABS securities and these would be supported by the EU.

Finally, we would suggest regulators consider a temporary reduction of risk-weighting of ABS backed by SME (provided such bonds are investment grade): this reduction will be applied to both investors (banks and insurances) and originators provided that i) at least 80%, for example, of the relevant bond will be sold into the capital market and ii) the originator complies with funding domestic SME within a certain timeframe. This reduction will be “limited” to the earlier of i) the maturity of the specific security and ii) in an agreed upon number of years from the issuance of the related note.

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the role of the InsuranCe seCtor

Volatility in assets and liabilities must be in addressed in Solvency II for insurers to hold more longer-term assets

Insurance companies, pensions providers and other institutional investors are excellently positioned for long-term financing and investment. They match long-term assets with long-term illiquid liabilities. This was also acknowledged by the EU Commission in its “Green Paper on the long-term financing of the European economy.” These investors have substantial portfolios with longer-term horizons, and continue to seek out diversification and yield in areas like long-term financing.

Infrastructure projects, when they give rise to stable and predictable cash flows may also find suitable funding from insurers. Insurance companies involvement in Enterprises and Infrastructure funding will strongly depend on an effective cooperation and a fair split of risks and rewards between the banking and insurance sectors.

Making Solvency II “Long-Term Investment friendly”

In the aftermath of the financial crisis a reform of the insurance prudential regime in Europe is 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. The worst case scenario for the European insurance sector would be to have to apply different prudential regimes in each Member State with a cherry-picking of a selection of Solvency II provisions and non-economic arbitrary additional capital requirements over the existing fragmented and obsolete prudential framework known as Solvency I.

Substantial elements of Solvency II need to be revisited and economically sound counter-cyclical tools need to be included in the final architecture in order to avoid a severe negative impact on the provision of long-term financing.

The priority for regulators and supervisors is to address the volatility of the own funds determined under the Solvency II framework in Omnibus II.

Solvency II values assets at Mark to Market (MtoM) and liabilities at market consistent economic value (MCEV). It fully reflects market volatility and credit/ illiquidity spreads enlargement. Solvency II in its current form leads to a non-economic short-term volatility in asset prices, earnings, and available financial resources (AFR or own funds) for solvency positions. The design of the measures in omnibus II needs to ensure that long-term investment is encouraged by reflecting duration matching, and not requiring capital for risks that insurers are not exposed to.

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This issue needs 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. 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.

But in parallel, the Solvency II capital charge on the holding of long-term assets should also be reviewed. More specifically, the EFR 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 review ScR for long-term assets such as private equity, infrastructure loans, real estate, asset based securities, loans and long-term dated corporate bonds. Long-term investments in infrastructure and renewable energy projects are not at all or only very moderately correlated with other financial risks at capital markets. However, with capital requirements of 49%, investments in low risk infrastructure projects are treated under the new prudential rules similar to investments in far riskier investments such as private equity or hedge funds. The high capital requirement limits the scale of insurers’ investments in infrastructure projects. A separate risk class with significantly lower capital requirements should be considered.

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.

Enabling life insurers and occupational funds to continue to play their role as long-term investors

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. There is a strong 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 workforce 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.

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Stimulating private pension savings and promoting long-term regulatory stability

Public policy should incentivize private pension savings (e.g. by setting up auto-enrolled or mandatory savings programmes) 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. In recent years there have been moves in some countries to rollback on reforms aimed at making pension systems more sustainable, in the most extreme cases even renationalising some provision. Such measures create uncertainty for financial services providers who have committed to investing in and helping to build the pension system and can disrupt the underlying financial markets which support companies and growth.

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. An important precondition for long-term investment is a minimisation of political and regulatory risk. For investments with maturities of 10, 20 or more years, it is vital that investors can be confident about the persistency and legal certainty of political and regulatory decisions. This means that structures or institutions are needed that prevent regulators or government from making decisions that have retroactive effects on promised returns.

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the bankIng seCtor underpIns the eConomy

Promoting smart regulations to ensure that banks can continue to play an active role in the financing of the economy

Banks are traditionally the most important financial intermediaries in Europe. Banks typically take short-term deposits and make longer-term loans. This creates a so-called maturity mismatch or transformation, where a bank’s liabilities are of shorter duration and more liquid than its assets. According to calculations based on ECB figures, the euro area Monetary Financial Institution’s balance sheets amounted to EUR 34,500 billion as of Q3 2012, of which only EUR 8,500 billion were long-term resources. Conversely, they owned nearly EUR 20,000 billion of long-term assets, meaning that they created EUR 11,500 billion of long-term resources in the economy. As such, banks have a natural role in transforming household assets into long-term financing. Any new regulatory initiative should be carefully reviewed for its potential impact on the financing of the economy.

Banks will continue to be the most important intermediary in Europe, as alternative models such as “originate to distribute” are unlikely to reach the scale that exists in the US. Banks will naturally keep a role in financing SMEs, which usually experience more constraints than large corporates in accessing the capital market (due to the higher cost of listing and their size). Banks have a close relationship with SMEs and are well equipped to recognise their needs. Accordingly, SMEs require more flexibility when they ask for a credit line and banks can represent the best compromise, as they offer i) a re-negotiable debt ii) and a less costly and more favourable financing. nevertheless, both weakening demand and deleveraging by banks have contributed to the current scarcity of long-term financing. The EU in its Green Paper quite rightly highlights the fact that many currently proposed regulatory changes will further reduce the ability of the banking sector to channel long-term investment in the future. In this sense, there is a need for regulatory consistency when considering further actions and reforms to encourage both LTF and SME financing.

The new Basel liquidity ratios will unquestionably reduce the liquidity risk in banking balance sheets, but in reducing banks’ ability to transform maturities may also lead to an unintended contraction in longer-term funding of the economy.

The preservation of the economy’s longer-term financing volumes appears to be inconsistent with a major decrease in banking intermediation. Long-term financing comes on the one hand, from long-term savings (which are channelled by capital markets, other financial intermediaries such as mutual funds, pension funds and insurance companies) and on the other hand, from short-term savings which are transformed into long-term credit instruments by banks. Moreover, beyond central banks, commercial banks also have money creation powers permitting them to create ex nihilo new resources and hence, savings.

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The Eu commission’s Green Paper also clearly highlights that the potential impact of proposed reforms targeting bank structure will curtail the ability of the banking sector to provide financing for long-term investment. Banks will continue to play an important role in financing investments but a number of proposed regulations will make this much more difficult than is currently the case.

The recommendations of the Eu High Level Expert Group for the separation of trading activity from deposit taking banks would fundamentally undermine the universal bank model and would increase funding costs for affected banks. This in turn would feed through into higher costs of credit and a reduction in market making capacity amongst EU banks. Both of these effects would undermine the ability of the banking sector to maintain lending levels and to channel capital into long-term investments in Europe. Furthermore, in order to meet the new capital and liquidity requirements imposed by the Capital Requirements Directive IV (CRD IV) and Capital Requirements Regulation (CRR), banks have been rationalizing their business models by tightening underwriting standards or declining certain types of lending including long-term financing. The analysis in the IMF’s Global Financial Stability Report (GFSR) April 2012 underlines the magnitude of bank deleveraging in Europe. The report suggests that 58 large EU-based banks could shrink their combined balance sheet by as much as EUR 2 trillion by to the end of 2013, or almost 7% of their total assets. The negative impact of this deleveraging process on the real economy and long-term financing is even larger in Europe by international comparison given the greater dependency on bank intermediation than, for example, in the US.

Co-legislators expressly acknowledge the possible risks of the new prudential requirements for long-term financing when calling on the EU Commission to report on the impact of the CRR on encouraging long-term investments. While excessive maturity transformation must be avoided in the future, some aspects of the new legislative package have the potential to considerably constrain the supply of LTF. This is especially true for the new liquidity provisions. Both liquidity ratios (LCR and nSFR) require careful consideration during the observation period in order to get the calibration right and to limit the negative impact on LTF.

European Market Infrastructure Regulation (EMIR), which is charged with increasing the stability of the over-the-counter (OTC) derivative markets, is a welcome tool to increase financial stability and market transparency for regulators but negative effects on long-term investment stemming from the regulation cannot be excluded. For non-cleared derivatives, significant margin requirements exist even in cases where central clearing is not (yet) available for technical reasons for bespoke derivatives. Corporates attempting to hedge their risks will thus often have to pay margins, which takes capital away from investment and which will, moreover, have a pro-cyclical effect as there will be increased margin requirements in stressed times. In other words, corporates cannot hedge their risk without allocating capital to margins and their derivative operations will thus have a significant impact on their balance sheets and will ultimately reduce the capital available for long-term investments.

Besides this, the obligation to centrally clear standardised derivatives on Central Counterparties (CCPs) also results in increased (initial and variation) margin requirements. As much as central clearing has a positive effect on financial stability and is therefore welcome, increased stability is not "for free". Initial and

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variation margin requirements result, again, in higher clearing costs and consequently bind capital, which obviously cannot be allocated elsewhere - including lending or investment into long-term projects.

Consequently, if the EU wants to support LTI, it is important to assess the potential impact that risk reduction - e.g. requirements in CRD or EMIR - will have on growth including on LTI and how to find the best balance between the two.

The potential impact of the EU Recovery and Resolution Directive should be noted. Whilst the EFR recognises the need for the effective resolution of systemically important institutions, but notes that current proposals in the European Parliament call for a 1.5% ex ante fund based on banks’ deposits or total liabilities. This is likely to reduce funds available for long-term financing from the sector.

Taken together, major changes in banking regulations could lead to an extensive search for alternative ways of financing, and there is a risk that these alternatives will be provided outside of the regulated sector. It is advisable to calibrate the existing banking regulation to keep banking business within the banking sector.

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fInanCIal seCtor taxatIon

A proposed Financial Transaction Tax would have disruptive implications for the financial sector and broader economy

Tax systems should be designed in such a way to distort as little as possible the economic decisions of citizens and companies. Unfortunately this is precisely the effect of the proposals for a Financial Transaction Tax (FTT) currently being discussed by eleven Member States. not only would the current form of the FTT risk distorting cross border investment decisions across the EU by creating disincentives to interact with counterparties within the FTT zone, it would also have disruptive implications for government and corporate debt, and equity markets, with the cost of funding for EU corporates and governments likely to increase as a result.

The implementation of the FTT is also expected to lead to increased cost for products that are mainly used for hedging or funding purposes, e.g. interest rate swaps, foreign exchange swaps and repos and money market funds. The FTT would also reduce the net investment returns of retirement savings, hence resulting in lower benefits for pensioners. This would make retirement savings less attractive at a time the EU Commission recognises in its White Paper that complementary retirements ought to play a greater role in securing the future adequacy of pensions. Furthermore, in the Green Paper the EU Commission recognised savings as a main source of LTI financing (in addition to FDI).

Though arguments have been advanced to the effect that the FTT will encourage longer-term investment, as short-term transactions will be rendered uneconomic, that assumes that the level of demand for EU investments will remain static in the face of new cost barriers. Rather, it is more likely that overseas investors will simply look for opportunities outside of the FTT zone as a result of the tax. If the flow of overseas investment will be diminished by the FTT, so too will domestic investment as further capital is taken out of the banking system and investors face lower returns and change their savings behaviour as a result. Furthermore and, as is well known, long-term investment involves a number of risks that need to be carefully managed over the lifetime of the investment project. However, as it stands, the FTT would inevitably increase the cost of hedging transactions undertaken in the real economy to manage risk and, by so doing, discourage long-term investment decisions.

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efr’s vIsIon

The European Financial Services Round Table (EFR) was formed in 2001. The Members of EFR are Chairmen and Chief Executive Officers of international banks or insurers with headquarters in Europe.

EFR Members believe that a fully integrated EU financial market, a Single Market with consistent rules and requirements, combined with a strong, stable and competitive European financial services industry will lead to increased choice and better value for all users of financial services across the Member States of the European Union. An open and integrated market reflecting the diversity of banking and insurance business models will support investment and growth, expanding the overall soundness and competitiveness of the European economy.

Increased fragmentation as a result of the post-crisis regulatory response underlines the need to safeguard the Single Market and to protect the level-playing field. The EFR therefore strongly encourages national governments and the EU institutions to continue their efforts to create a truly single market for wholesale and retail financial services, which will play an essential role in providing long-term financing for the economy in Europe. Furthermore strong market discipline is essential to ensure fairness and alignment of interests of the financial sector and the real economy towards serving the citizens of Europe and the world.

The integration of financial markets does not stop at the EU’s borders – markets are increasingly global. EFR Members therefore encourage both national and European leaders to establish internationally consistent and coherent financial regulation and supervision and to support and promote free and open markets throughout the world.

EFR Members’ companies combined represent 1

• Around 997 million customers • More than 2 million employees • EUR 34.15 trillion total assets • EUR 10.86 trillion assets under management

1 Please note that double counting of customers may occur

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efr’s members

Walter B. KielholzEFR chairman and chairman of the board of directorsSwiss Reinsurance company Ltd.

Paul Achleitner chairman of the Supervisory boardDeutsche Bank AG

Sergio BalbinotManaging directorGenerali

Henri de Castrieschairman of the Axa Group Management board and cEoAXA

Jean-Paul ChiffletChief Executive Officer crédit Agricole SA

Michael Diekmannchairman of the board of ManagementAllianz SE

Annika FalkengrenPresident and cEoSEb Group

Douglas FlintGroup chairmanHSbc

Federico GhizzoniChief Executive Officer unicredit Group

Francisco Gonzálezchairman and cEoBBVA

Ralph Hamers chairman of the Executive board and cEoInG Group

Sir Philip Hampton chairman The Royal Bank of Scotland Group plc

Antonio Huertas Mejíaschairman and cEoMAPFRE

Javier Marín RomanoChief Executive Officer banco Santander

John McFarlane chairmanAviva plc

Baudouin Protchairman of the boardbnP Paribas

Urs Rohnerchairman of the board of directorscredit Suisse Group

Martin SennChief Executive Officer Zurich Insurance Group

Tidjane ThiamGroup chief ExecutivePrudential plc

Björn Wahlroos chairmannordea

Axel WeberChief Executive Officer ubS

Alex WynaendtscEo and chairman of the Executive boardAEGOn nV

EFR – European Financial Services Round Table (asbl)Rond Point Schuman 11b-1040 brusselsbelgiumTel: +32 2 256 75 23Fax: +32 2 256 75 70secretariat@efr.bewww.efr.be

Siège socialrue Royale 97b-1000 bruxellesbelgiumRPM BXL 0861.973.276