Europe’s road­blocks to long-term in­vest­ment

Financial Mirror (Cyprus) - - FRONT PAGE -

One of the ma­jor chal­lenges fac­ing the Euro­pean econ­omy is the lack of liq­uid­ity in its cap­i­tal mar­kets. Since the 2008 global fi­nan­cial cri­sis, an enor­mous num­ber of new rules have been put in place. In or­der to fa­cil­i­tate the long-term in­vest­ment that Europe des­per­ately needs, it would be wise to re­assess the broader reg­u­la­tory en­vi­ron­ment that has emerged over the past six years.

With banks re­luc­tant to make new loans, in­sti­tu­tions such as pen­sion funds are well placed to meet the des­per­ate de­mand for cap­i­tal. In­deed, the sav­ings of work­ers who may not be re­tir­ing for sev­eral decades are par­tic­u­larly well suited for long-term in­vest­ments. The trou­ble is that in many cases, rules and reg­u­la­tions in­tended to en­sure fi­nan­cial mar­kets’ sta­bil­ity im­pede the abil­ity of pen­sion funds and oth­ers to al­lo­cate sav­ings smoothly and ef­fi­ciently.

The im­por­tance of proper reg­u­la­tions can­not be un­der­stated. When prop­erly drafted and ap­plied, they en­sure fi­nan­cial sta­bil­ity, main­tain (and, if nec­es­sary, re­store) con­fi­dence in the mar­kets, and fa­cil­i­tate long-term in­vest­ment, help­ing cit­i­zens meet their fu­ture fi­nan­cial needs. But if reg­u­la­tions are not well tai­lored to the var­i­ous types of mar­ket par­tic­i­pants and to how mar­kets ac­tu­ally work, they can choke off op­por­tu­ni­ties that would oth­er­wise ben­e­fit in­vestors and the econ­omy.

The new mar­gin re­quire­ments for de­riv­a­tives, in­tro­duced in or­der to re­duce sys­temic risk, are one ex­am­ple of such a choke­point. It might make sense to ap­ply them to banks or hedge funds, but pen­sion funds are highly cred­it­wor­thy in­sti­tu­tions that pose lit­tle or no sys­temic risk to fi­nan­cial mar­kets. Forc­ing them to set aside as­sets for col­lat­eral pur­poses only drains cap­i­tal that could be used for long-ter­min­vest­ment.

Such in­vest­ment in­volves a va­ri­ety of prod­ucts, mar­ket play­ers, and ju­ris­dic­tions, and, as a re­sult, the ef­fect of reg­u­la­tions can be dif­fi­cult to see, much less quan­tify. For starters, the im­pact of rules and reg­u­la­tions can be di­rect or in­di­rect. Rules that ap­ply specif­i­cally to long-term-in­vest­ment prod­ucts or strate­gies can be clas­si­fied as hav­ing a di­rect im­pact. Rules that ap­ply to in­vestors or their coun­ter­parts, com­pet­i­tive prod­ucts, or com­ple­men­tary parts of the mar­ket can be de­scribed as hav­ing an in­di­rect ef­fect.

A well-crafted reg­u­la­tory frame­work min­imises the ad­verse con­se­quences for long-term in­vest­ment, while max­imis­ing the pos­i­tive ef­fects. New reg­u­la­tions are con­stantly be­ing in­tro­duced. It is im­por­tant to an­a­lyse care­fully whether the new reg­u­la­tions are ac­tu­ally needed and, if yes, to fore­see and fill reg­u­la­tory gaps with rules that en­sure the smooth flow of sav­ings to new and ex­ist­ing projects.

For ex­am­ple, stan­dar­d­is­ing reg­u­la­tions re­lat­ing to cov­ered bonds, green bonds, and cross-bor­der in­vest­ment through real-es­tate trusts could en­cour­age more long-term in­vest­ment. In a more in­di­rect way, a gen­eral reg­u­la­tory push that in­creased the avail­abil­ity of projects suit­able for long-ter­min­vest­ment and har­monised lo­cal in­sol­vency regimes could also have a pos­i­tive ef­fect. Prom­i­nent ex­am­ples of reg­u­la­tions with a di­rect neg­a­tive im­pact in­clude ex­ist­ing rules on se­cu­ri­ti­za­tion and pro­posed rules on as­set-based cap­i­tal charges.

The in­di­rect neg­a­tive ef­fects of such reg­u­la­tions on long-term in­vest­ment are, by na­ture, more dif­fi­cult to dis­cern, but they can be just as harm­ful as the di­rect ef­fects – es­pe­cially if they leave in­vestors with fewer funds avail­able for long-term in­vest­ment. Mar­gin re­quire­ments for de­riv­a­tives trans­ac­tions have this ef­fect, as do reg­u­la­tions that in­crease bank­ing costs.

Th­ese types of in­di­rect neg­a­tive ef­fects have not been cen­tral to pol­icy dis­cus­sions con­cern­ing how to boost long-term in­vest­ment. But they de­serve care­ful con­sid­er­a­tion. It is cru­cial that we iden­tify the full scope and scale of their im­pact on the al­lo­ca­tion of cap­i­tal. Oth­er­wise, they risk off­set­ting the pos­i­tive im­pact of in­vest­menten­hanc­ing re­forms.

As leg­is­la­tors and reg­u­la­tors con­tinue to shape the in­vest­ment en­vi­ron­ment, it is im­por­tant not only to mon­i­tor and eval­u­ate the i mpact of each piece of ad­di­tional reg­u­la­tion; the way rules in­ter­act with one an­other – and with new rules as they are in­tro­duced – must also be un­der­stood. Un­nec­es­sar­ily broad reg­u­la­tions should be avoided in fa­vor of rules that are specif­i­cally tai­lored to the var­i­ous par­tic­i­pants in the mar­ket. Al­low­ing long-term in­vestors such as pen­sion funds to pro­vide the Euro­pean econ­omy with much-needed cap­i­tal has the po­ten­tial to pro­vide huge benefits to fu­ture re­tirees, as well as to the broader econ­omy. But that will not be pos­si­ble un­less, and un­til, the right reg­u­la­tory en­vi­ron­ment is cre­ated.

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