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AEIP RESPONSE to the EC Green Paper on the Long-Term Financing of the EU Economy

Brussels, June 25th 2013

General remarks
AEIP welcomes the opportunity to comment on the European Commissions Green Paper on the LongTerm Financing of the EU Economy. The European economy is facing a difficult situation, characterised by extremely high unemployment (12,2% in the Euro area according the latest data release by Eurostat1), consolidation of public finances and banking sector deleveraging. AEIP shares the view that there is an imperative need for re-launching growth and investments if Europe wants to maintain the sustainability and adequacy of its welfare model, which might be put at stake by a prolonged economic crisis. AEIP represents since 1997 the social protection institutions jointly established and run by the Social Partners. AEIP Members cover a number of social protection branches, such as pensions, healthcare, long-term care, health & safety at work and unemployment benefits. Within the pension field, paritarian institutions are involved in both the managing of the first pillar and of the second pillar pensions, in accordance with the different European pension systems. AEIP represents pension schemes that are managed on pay-as-you-go (PAYG), mixed and funded basis, as well as defined contributions (DC), defined benefits (DB), and hybrid schemes. According to the different European systems, second pillar pensions fall either under the scope of the IORP directive or Insurance directive (Solvency I). Today, AEIP has 27 members (mostly occupational pension funds - IORPs) in 18 European countries, and it covers, through its members, about 75 million European citizens and 1.3 trillion in assets. Paritarian institutions of social protection represent a successful result of the European social dialogue model, offering to their members services in a number of social protection fields, i.e. retirement provision, health care, health and safety, unemployment benefits and long-term care. Amongst them, pension funds deal with long-term commitments and are true long-term investors by nature. They are an important source of institutional investments, and can play a stabilising role in crisis situations, as suggested by different studies2. However, today occupational pension funds operate in an environment characterised by extraordinary low interest rates and high market volatility. These factors have a direct impact on the ability of pension funds to efficiently match their assets and liabilities.

Eurostat News Release Euro Indicators 82/2013, 31 May 2013

See for instance the OECD Report to G20 Leaders The role of banks, equity markets and institutional investors in long -term financing for growth and development, February 2013

Long-term investments are increasingly becoming a mainstream topic of research among think tanks and international organisations3. Many studies have been published by several research institutions, all providing with data and analysis on different aspects related to the long-term investing of the EU Economy. AEIP believes it is important to gather data on this topic, especially on the potential of assets that are not exchanged on financial markets, such as infrastructure and private equity. The EC Green Paper on Long-Term Financing of the European Economy represents a significant milestone in the development of future economic policies aimed at fostering growth and jobs. It will be essential that the European institutions focus on how long-term savings can match long-term investments demand, identifying the proper role for financial markets, social institutions and assessing the cumulative impact of currently-debated regulations. In its response, AEIP builds on the material already published by different institutions and provides with technical and political opinions, wishing to raise some genuine concepts for the policy debate.

Q1: Do you agree with the analysis out above regarding the supply and characteristics of long-term financing?
The analysis undertaken by the European Commission in the working document attached to the Green Paper is correct. However, AEIP believes that particular attention should be given to the potential outcome of a prolonged crisis (and funding gap) on the European welfare systems. Indeed, the ability of the financial markets to channel long-term financing to the European economy should not be analysed and tackled separately from the demographic challenge Europe is facing. AEIP considers that there cannot be any increased involvement of pension funds into the financing of long-term investments without a broader engagement with the demographic problem, the related labour market policies, and a further empowerment of occupational pensions in Europe.

Q2: Do you have a view on the most appropriate definition of long-term financing?
AEIP believes there is not a unique definition of long-term financing (or long-term investment). The Association shares the approach adopted by the European Commission in the staff working document attached to the Green Paper and refrains from using a narrow approach, identifying any particular length (i.e. 5 years) for distinguishing long-term financing and short-term financing.

The OECD is currently undertaking a project on Institutional investors and long-term investment. The Centre for European Policy Studies (CEPS), together with the European Capital Markets Institute (ECMI) launched a task force on long-term investing and the single market for long-term savings

Moreover, it would be beneficial for this discussion to identify the objectives of a possible definition of long-term investment. Indeed, AEIP believes that it would be risky to use any artificial, detailed definition of long-term investment for regulatory purposes. Any definition of long-term financing should be principle-based in order to accommodate the different nature of Long-term Investments and Long-term Investors, which may be usually, but not exclusively, characterised by the presence of the following characteristics 4: Patient capital, acting in a counter-cyclical way; A direct engagement as shareholders, bringing forward ESG principles in the investment strategy; A stronger focus on investments that have a direct impact on sustainable growth, such as infrastructure, cleaner energy, SMEs financing and venture capital. Much of the capacity of occupational pension systems to deliver adequate returns to their members stems from their ability to match the duration of their liabilities and assets, thus implementing long-term investment strategies and taking long-term risks. However, being long-term investors should not mean buying and holding assets for a certain amount of time, but rather implementing an investment strategy which allows and requires for engaging with investments providing long-term, stable and inflation-linked returns, in an active way (i.e. hedging the risks). If the European Commission would anyway provide for a legal definition of long-term financing (or longterm investment), AEIP suggests that a flexible definition allows for better policy making and adaptation to different contexts and regimes. Finally, AEIP highlights the epistemological nature of the discussion on long-term investments. It is difficult to label an investment as long-term ex-ante. An institutional investor might take a decision based on expectations which might not prove true in the short or medium term, thus reallocating its resources to other investment opportunities. Any legal definition of long-term investing that could be used for granting fiscal incentives or other policy benefits might hinder the ability of institutional investor to best allocate their resources and create wrong incentives. While this seems to be common sense, it should be here reminded that the prudent person principle requires to European pension funds to invest in the best interest of their members and beneficiaries5.

OECD Discussion Note, Promoting longer-term investment by institutional investors: selected issues and policies , EUROFI High Level Seminar 2011.
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Article 18, Directive 2003/41/EC on the on the activities and supervision of institutions for occupational retirement provision.

Q5: Are there other public policy tools and frameworks that can support the financing of long-term investment?
Some AEIP members have a particular experience in investing in real economy activities, such as infrastructure, real estate and venture capital. They find that, according to their experience, not only a proper prudential framework must allow and possibly incentivise investments in the real economy, but also (and foremost) the legal framework for participating in infrastructure investments must be clear and open to private investors. From a broader policy perspective, AEIP suggests that being occupational pension funds long-term investors by nature, an empowerment of occupational pensions in Europe would serve the twofold purpose of guaranteeing more adequate pensions to European workers, while channelling more resources to long-term investments.

Q6: To what extent and how can institutional investors play a greater role in the changing landscape of long-term financing? Q7: 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?
As explained in the European Financial and Stability Report 20116 released by the European Commission, the European banking industry is undertaking a structural deleveraging. As this is happening in a time of fiscal consolidation, the European economy is suffering of a funding gap. This topic is currently being debated at G20 and G30 level, and has drawn the attention and efforts of International Organisations such as the OECD, the IMF and the FSB. Within this debate, the role covered by institutional investors, i.e. pension funds and insurance undertakings, has drawn particular attention. As mentioned above, AEIP believes occupational pension schemes can play a major role in the changing landscape of long-term financing, partially filling the gap left by banks and governments. However, the extent to which these actors are able to play a greater role than before in channelling longterm financing to the real economy depends on a number of factors. For instance, it can be argued that as long as the interest rates will remain as low as they are now, pension funds will increasingly look for good returns from alternative types of investments (i.e. corporate bonds, infrastructure, real estate, venture capital). The prudential regime applied to institutional investors should thus not hinder their ability to invest in these asset classes or encourage them to not invest in these.

Commission Staff Working Document - SWD(2012) 103 final, European Financial and Stability Report 2011, 13 April 2012

Indeed, as suggested by the OECD and other studies7, currently-debated regulatory reforms such as Solvency II and IORP II might have a significant impact on the investment strategies of institutional investors, pushing them away from equities and alternative investments. Moreover, applying a SolvencyII-like regime to pension funds across Europe would have serious consequences on the ability of pension funds both to deliver good pensions to European workers and to channel long-term financing to the European economy, also discouraging employers from providing occupational pensions because of the cost/risk balance. AEIP has followed thoroughly the discussions over the review of the IORP directive and has released several papers on this topic8. The Association welcomes the announcement by Commissioner Barnier on May 23rd to postpone any provision on the harmonisation of quantitative requirements for pension funds in Europe within the forthcoming IORP II directive. However, AEIP would like to highlight that the forthcoming governance and transparency measures that will be contained in the new directive should fully respect the proportionality principle, as well as be coherent with the solvency regime that might be adopted in the future (particularly taking in account Commissioner Barniers announcement), and not create excessive administrative burden for small and medium pension funds. AEIP strongly believes that the review of the IORP Directive can not be handled separately from other initiatives of the Commission with respect to pension policy and the goal of the regulation should instead consist in facilitating the establishment and existence of good and transparent pension schemes for the European workers and citizens, recognising the key role of social partners in setting up occupational pension funds. The Association wonders whether adopting a uniform risk-based supervisory regime for IORPs is appropriate and believes that market consistent valuation of assets and liabilities should be further investigated, as it introduces market volatility into IORPs balance sheets and is likely to push them towards investing with a shorter time horizon. In particular, AEIP highlights that the Solvency Capital Requirement (SCR) - one of the key element of the Solvency II framework currently debated also for IORPs - and its capital charges push for a uniform asset mix and investment strategies among all institutional investors, increasing the risk of pro-cyclicality and moving away from long-term investments, which at the moment are in any way taken into consideration by the model. Regarding the current debate on the implementation of Solvency II, AEIP regrets that said framework does not allow for a valuation of the adjustment and steering mechanisms paritarian institutions might
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OECD Working Papers on Finance, Insurance and Private Pensions N.30, The effect of solvency regulation and accounting standards on long-term investing: implications for insurers and pension funds, by Clara Severinson and Juan Yermo, November 2012
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See for instance the AEIP Response to the EIOPA Consultation on the daft technical specifications of the IORP II QIS and the relative Position Paper.

have in some countries. Unfortunately, their unique features, such as the ability to increase employers contributions and their long-term liabilities are not properly taken into account in the calculation of the Solvency Capital Requirement (SCR). Moreover, the recent Long-Term Guarantee Assessment carried out by EIOPA shows there is an unsolved issue on the provision of guarantees in long-term insurance schemes. Finally, AEIP would welcome any policy initiative aimed at providing for favourable treatment of engaged shareholdership. Indeed, occupational institutional investors, in particular those which are managed on a paritarian basis, are best suited to engage as active shareholders, bringing forward social, environmental and good governance stances in the policy of the companies they invest into.

Q8: What are the barriers to creating pooled investment vehicles? Could platforms be developed at the EU level? Q9: What other options and instruments could be considered to enhance the capacity of banks and institutional investors to channel long-term finance?
Most European pension funds are small and their ability to channel long-term finance could be limited to bonds and equities. AEIP thus welcomes the idea brought forward by the European Commission of longterm investments funds that could make infrastructure investments more accessible to small and medium pension funds, offering the appropriate know-how and experience, while enjoying economies of scale and reducing the risk exposure. However, for long-term investment funds to be successful, it will be essential to address a proper governance model, as each investor might have his own viewpoint and preference toward the size, type and risk of long-term financing. If the pooled investment vehicle will work based on standardised units, the engagement by pension funds might be hindered. In order to tackle this issue, it might be important for the participant investors not only to share money and risks, but also knowledge and investment principles.

Q10: 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?
To evaluate the potential cumulative impact of different prudential regulations on the European economy is not an easy accomplishment. A recent paper9 released by the Financial Stability Board tackles this issue, arguing that there is little tangible evidence to suggest that global financial regulatory reforms

Financial Stability Board, Financial regulatory factors affecting the availability of long-term investment finance Report to G20 Finance Ministers and Central Bank Governors, 8 February 2013.

have significantly contributed to current long-term financing concerns, although on-going monitoring is needed (P. 13). AEIP welcomes the opinion of the FSB, as many regulatory reforms are still in their early phase of design or implementation and data on their impact is not yet available. Nevertheless, it is AEIPs belief that some regulatory reforms need to be carefully designed before being tested and implemented, taking into considerations the potential distorting impact they might have on the markets and on the provisions of services, especially if they put a business model at stake, as it is the case for institutions dealing with long-term liabilities. European institutions should also consider the impact that the discussions on the implementation of a Solvency-II-like regime on pension funds might have on the willingness of European employers to establish new occupational pension schemes both at industry and corporate level. Similarly, AEIP invites the European Commission and other relevant policy makers to take a holistic approach to the current regulatory agenda, taking into account the inter-connectedness of the legislative proposals delivered and the potential impact these might have on different categories of stakeholders. Also, the Association questions that the same model was used to draft the supervisory regime of different categories of actors. Banks, insurance companies and institutions for occupational retirement provisions have each unique features: they serve different purposes and engage in different internal decision making. What they have in common is the participation to the financial markets. Similar prudential regulations would likely push them towards similar investment patterns, increasing the risk of pro-cyclicality. AEIP believes that addressing right incentives and undertaking constant monitoring should be the basis for a new regulatory approach. AEIP is also convinced that each regulatory reform needs to stem from a careful analysis of the role covered by each actor operating in the financial markets for the society, taking into account the incentive/disincentive mechanism that move its actions. Also, any forthcoming assessment of a given reform should be undertaken on its own, but rather consider the possible interactions with other reforms (currently-debated or already approved), thus identifying any indirect cumulative impact on financial markets and society as a whole.

Q17: 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?
Tax incentives can be a powerful tool and can certainly play a role in stimulating long-term savings, either directly or indirectly.

Particular saving products can indeed be tax-exempted or provided with a favourable tax treatment, in order to increase the interests of households in allocating their savings into these products (e.g. long-term bank deposits). Tax incentives can also have an indirect impact on long-term savings of households, for instance guaranteeing a favourable fiscal treatment of occupational pensions contributions and payments. This is particularly relevant for those countries which have voluntary occupational pension schemes. Another method to favour long-term investing by means of fiscal incentives would be applying the most recurrent occupational pension fiscal treatment (EET: exempted-exempted-taxed) system to other social protection schemes. AEIP suggests that a particular incentive for long-term investments might be provided by favourable fiscal treatment (or exemption) of socially responsible investments and alternative investments (i.e. infrastructure and SMEs financing). This might be implemented in a number of ways.

Q19: Would deeper tax coordination in the EU support the financing of longterm investment?
AEIP believes that improved tax coordination at EU level might simplify the framework for the fiscal treatment of investments at cross border level. However, the recent enhanced cooperation procedure aiming at establishing a Financial Transaction Tax in 11 EU Member States does not seem to go in the direction of favouring long-term investments by pension funds, as it would be levied on them as well.

Q20: To what extent do you consider that the use of fair value accounting principles has led to short-termism in investor behaviour? What alternatives or other ways to compensate for such effects could be suggested?
Occupational pension schemes do not need to assess their solvency requirements on a short time basis due to their long term liabilities. Doing so would be incompatible with their need to invest in assets that, while risky, yield very positive long-term returns, on average (p.18), as suggested by Bassanini and Reviglio10. Similarly, accounting standards can have an impact on the way pension funds allocate their resources. AEIP has already commented on the problems and concerns arising from the IAS 1911. This accounting

10

Franco Bassanini et Edoardo Reviglio, Financial stability, fiscal consolidation and long-term investment after the crisis, OECD Journal: Financial Market Trends, 2011 (1).
11

See the AEIP Analysis of the influence of IFRS on the European Pension sector and the Joint ABC-AEIP-EFRP-NCCMP Comment Letter on the IASB Exposure Draft (ED/2010/3) of September 2010

standard does indeed require sponsor undertakings to attribute current market values to assets whose valuation should be based on several years (p. 21). Moreover, introducing market volatility into sponsor undertakings balance sheets might push for changing the nature of a pension scheme from defined benefit to defined contribution arrangements. AEIP suggests that in order to improve the provision of long-term financing to the European economy, the IFRS accounting standards should possibly provide for different (more favourable) treatment of longterm investments. AEIP believes any such measure should not be linked to a long-term investment detailed definition. Instead, it should be left to the pension funds to identify assets that are kept for longterm purposes and those which are not. This might eventually be coherent with the proposals suggested by Bassanini and Reviglio (p. 22), on the need to (i) introduce accounting criteria that reflect long-term investors specific business model; (ii) distinguish between different temporal durations/matching liabilities and investments; and (iii) take into account the valuation of future cash flows over the long-term.

Q22: How can the mandates and incentives given to asset managers be developed to support long-term investment strategies and relationships?
AEIP believes that designing incentive mechanisms at regulatory level would be too difficult. The relationship between the asset owner and the asset manager must be left to the ability of the two to agree on a set of long-term performance data. The ability of the asset manager to comply with the Environmental, Social and Governance principles set out by the investor should also be considered in a comprehensive evaluation.

Q25: Is there a need to develop specific long-term benchmarks?


It does not appear clear which purpose long-term benchmarks would serve. AEIP would refrain from using any benchmark that could evaluate a long-term investment from a purely financial point of view.

Q30: In addition to the analysis and potential measures set out in this Green Paper, what else could contribute to the long-term financing of the European economy?
As stated in the responses to Questions 1 and 5, AEIP suggests that being occupational pension funds long-term investors by nature, an empowerment of occupational pensions in Europe would serve the twofold purpose of guaranteeing more adequate pensions to European workers, while channelling more resources to long-term investments.

CONTACTS: Bruno GABELLIERI


Secretary General

bruno.gabellieri@aeip.net info@aeip.net Francesco BRIGANTI Director francesco.briganti@aeip.net AEIP - The European Association of Paritarian Institutions Rue Montoyer 24 B- 1000 Brussels +32 2 233 54 20
AEIP represents the European Paritarian Institutions of Social Protection in Brussels since 1997. The Association gathers 27 leading large and medium-sized Social Protection Management Organizations which equally represent the employees and the employers through a joint governance scheme; plus 39 affiliates from 22 countries AEIP represents its members values and interests at the level of both European and International Institutions. In particular, AEIP through its working groups - deal with EU coordinated pension schemes, pension funds, healthcare schemes, unemployment schemes, provident schemes and paid holiday schemes. The final goal of AEIP is to achieve pan-European paritarian schemes of social protection.

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