This document is an excerpt from the EUR-Lex website
Document 52013SC0231
COMMISSION STAFF WORKING DOCUMENT EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT Accompanying the document Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on European Long-term Investment Funds
COMMISSION STAFF WORKING DOCUMENT EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT Accompanying the document Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on European Long-term Investment Funds
COMMISSION STAFF WORKING DOCUMENT EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT Accompanying the document Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on European Long-term Investment Funds
/* SWD/2013/0231 final */
COMMISSION STAFF WORKING DOCUMENT EXECUTIVE SUMMARY OF THE IMPACT ASSESSMENT Accompanying the document Proposal for a REGULATION OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on European Long-term Investment Funds /* SWD/2013/0231 final */
1. introduction
A consequence of the
crisis has been to highlight the problem of investors' focus on short term
economic gains which comes at the expense of the underlying purpose of capital markets
which is to finance growth in the real economy. There is a need to
encourage investors to make longer term commitments to assets such as
infrastructure projects by providing 'patient capital' rather than chasing
short term gains. This kind of longer term investment may not be able to be
redeemed for a number of years but can provide stable and predictable returns.
This also benefits the real economy by providing finance to firms and creating
employment. Investors with longer
term liabilities such as pension funds and insurers may find longer term
investments attractive. But there are no readily available pooling mechanisms
such as funds to facilitate this in a way that takes account of the size, scale
and duration of the commitment to those long term investments that is needed.
This is also acts as a barrier smaller investors such as SMEs and high net
worth individuals as well as and retail investors. This Impact Assessment
(IA) looks at whether the creation of a cross border product framework for long
term investments, so-called Long-Term Investment Funds (LTIF), could stimulate
institutional and/or retail investor demand for such assets. This work
compliments the Commission Green Paper on Long Term Financing of the European
Economy.
2. problem
definition
Problem drivers Long term investment in
infrastructure projects, SME financing and the like can be done through a
variety of financial instruments, for example, equity participation and loans.
These instruments often share the common characteristics of being
non-transferable and illiquid with little or no secondary market. Investment in
such assets can require very large up-front commitments of capital which can
deter even major institutional investors from acting alone given the amount of
money needed. Unlike the market for liquid, transferable assets such as securities,
there is no standard framework for such investments. Some Member States (MS) provide
national mechanisms in the form of recognised investment vehicles, others do
not. This fragmentation prevents the development of a single market for
investors who wish to gain exposure to long-term assets which often offer
predictable returns but are illiquid by nature. Investing in long-term
assets, whether via financial instruments or in real assets, entails
substantial risks when these investments are not properly managed. The first
risk is that investors are misled as to the nature and risks of the assets they
invest in due to the lack of a harmonized approach to these assets. Uncertainty
exists over the identity of long-term assets, their risk and returns profiles and
recommended holding periods. The second risk is linked to the characteristics
of the assets, namely that they are illiquid in nature. The third risk is
linked to the fact that funds offering access to these assets might not possess
the relevant expertise in selecting and monitoring assets and tailoring a
fund’s return profile to the needs of potential clients. Due to these reasons,
LTI funds have not always performed according to plan and investors have
sometimes been misled about the return that has been promised. The problems As a result there is no
common, comparable cross border standard for what long term assets or investments
are, who they may be suitable for and how they function. This is in contrast to
the cross border market for liquid assets which benefits from the Undertakings
in Collective Investments in Transferable Securities (UCITS) Directive
standardisation of product rules. The EU's UCITS fund market has €6,350 billion
of assets under management. These factors have led
to fragmentation in the market for long term investment vehicles across the EU.
This has discouraged investors from exploring this market as unlike for UCITS
there is no common, recognisable and regulated product structure they can have
confidence in. The Alternative Investment Fund Managers Directive (AIFMD) will
create an EU passport for managers who wish to offer non-UCITS funds across
borders shortly. But the AIFMD applies to managers, not the funds they offer
and so it does not create product rules or definitions for differing types of
asset classes. It is therefore unlikely to address the problem identified.
Smaller investors face even greater barriers as the AIFMD does not create a
passport for managers to offer cross border retail investment funds so
different national approaches will continue. This has led to a range
of undesirable outcomes. Costs for managers remain higher than they might
otherwise be as cross border investment requires them to deal with a range of
legal and product issues in different MS. Funds are smaller than they might
otherwise be and so the impact of costs on any investment return or yield is
proportionately higher. Retail investors are unable to access funds in other MS
that they are familiar with and have confidence in. Costs remain high and the
choice of funds is restricted. As a result other smaller and retail investors are
unable to enjoy the diversification benefits that access to long term
investments could otherwise bring. The real economy is
also affected as alternative ways of financing long term growth are restricted
and so firms continue to rely primarily on bank financing which has moved its
emphasis on to short term commitments. This restricts the amount of capital
firms have access to from both institutional and retail investors and so acts
as a brake on their ability to invest for the long term and create growth and
employment for the economy.
3. Analysis
of subsidiarity
Fund managers,
investment targets and investors are domiciled throughout the Union. Because
the asset management sector is essentially of a cross border nature, the
current fragmentation of the LTI market has led this sector to operate below an
efficient level. National regulatory approaches to addressing this are however
inherently limited to the Member State in question. Regulating the product
profile of an LTI fund at national level has led to a situation where many
different fund regimes have evolved independently. National action has impeded
the emergence of a Union-wide internal market for those who offer LTI funds to
their investors. The creation of a
stable cross border mechanism to encourage LTI is desirable and could form part
of the drive for economic recovery. Long experience with UCITS suggests that
EU-wide product rules and requirements can prove to be a highly successful way
of stimulating investment into the relevant assets. Therefore action at
European level to create a single market for long term investment funds is
needed.
4. objectives
The general objectives
are to: (1) increase the means for long-term financing across all sectors of
the economy and (2) increase the coherence of the single market. To do this
requires three specific objectives are met. These are: (1) enhance economies of
scale for managers of LTIF, (2) increase the choice and protection for
investors interested in them and (3) increase investment flows into assets with
long-term horizons. Achieving this in turn
requires two operational objectives are carried out: (1) remove the barriers to
a single market for funds targeting long term assets which would expand the
investor base and (2) reduce opportunities for
mis-selling of LTI vehicles.
5.
policy options
To meet the two
operational objectives the IA sets out seven policy options relating to both
product rules and different types of investors. These range from taking no
action to creating product rules for a cross border LTIF available to both
institutional and retail investors. Each option is relevant to both operational
objectives. Option 1 || No action Option 2 || Develop a 'soft' label but not a passport Option 3 || Allow UCITS, which already have a passport, some exposure to long term assets Option 4 || A new fund, the LTIF, would be created with a distinct set of portfolio rules relating to the classes of long-term assets that are eligible for investments. This new LTIF would be open to institutional investors only Option 5 || Same as option 4 but the fund would be open to High Net Worth Individuals (HNWI) as well. Option 6 || The LTIF would be open to all investors, including retail investors. This would entail stronger investor protection requirements. To match the long-term nature of the assets, there would be no redemption rights. Option 7 || The same as option 6, but including redemption rights, after an initial lock-in, for example for three years.
6.
assessment of the impacts of the retained options
Option 1 of taking no
action is not acceptable as it does nothing to address the issues identified. Option 2 would involve
non-legislative measures to encourage the convergence of funds targeting long
term investments or marketing themselves as long term investment funds. This
would most likely require the creation of a voluntary product label and code.
While it would be a low cost option for managers it may only achieve traction if
MS choose to amend their national rules to support it, so it is unlikely to
address the problem of fragmentation. Option 3 would allow a
limited amount of assets that are both illiquid and not transferable to be held
within a UCITS. This would give retail investors access to long terms assets as
well as giving funds that are at least partly invested in long term assets a
passport. However, it would cut across the fundamental UCITS principle that
investors are able to redeem their investments at any time. This has given
investors confidence in UCITS. Any change to it risks undermining its success
and causing confusion about the types of assets UCITS may invest in and the
risks inherent in them. A number of asset managers have also signalled their objection
to such a change as they too are concerned it could undermine UCITS' success. Option 4 would create a
recognisable LTI product capable of being sold to institutional investors
across the EU via a passport. The rules would be modelled on those in UCITS in
relation to, for example, eligibility of assets, but would apply to assets that
are illiquid and long-term in nature. This would not address the problem that
smaller and retail investors will continue to be excluded from making such
investments so they would not be able to diversify their portfolios accordingly
or contribute to the available pool of capital. Option 5 would allow
what are often called high net worth individuals or HNWI regarded as able to
accept higher levels of investment risk access to such funds. Otherwise it is
the same as option 4. While it would have the effect of widening the available
pool of capital and extending to availability of further diversification to
more investors, it still excludes retail investors from the potential benefits
of investing in such funds. Option 6 would allow
funds as defined under option 4 which do not allow redemptions to be marketed
to retail investors across the EU via a passport. This would allow the widest
range of investor’s access to such funds so maximising the potential pool of
capital available to make such investments. To address investor protection
standards needed for retail investors, the fund will be subject to product
rules designed to ensure enough diversification, address conflicts of
interests, increase transparency about costs, and limit the use of leverage.
This inevitably implies some extra costs. Greatly improved and harmonized
product rules may mitigate risks of mis-selling. This will aid institutional
investors as well as retail, building confidence in long-term assets. Making
the fund take a closed-ended form has the advantage of permitting investments
in all types of long-term assets as the structure better matches the
illiquidity profile of these assets. Such a solution has the merit of being
transparent as to the long-term commitment that investing in such assets
requires. Option 7 is the same as
option 6, except that it allows redemption rights. Redemption rights would be
available after a set period, for instance three years, after which investors
would have access to their money on a regular basis. While this would reduce
the danger of retail investors being locked in against their interests it does
not, given the illiquid nature of long-term assets, eliminate it altogether. It
would also mean funds would have to maintain a liquidity buffer to ensure they
are always able to meet redemption requests. This would reduce the proportion
of illiquid long term assets held within funds, so reducing the portfolio diversification
benefits they offer to investors and cutting the amount of money available for
investment in long-term assets. Retained option On this basis, looking
at options 1 to 7, option 6 appears to offer the greatest effectiveness and
efficiency in creating a common definition and reducing barriers to a flourishing
single market for LTIF. By including retail investors, it will open up untapped
capital sources, and it will stand a stronger chance of addressing
fragmentation across national markets. Further, by permitting managers to
market LTIF without redemption rights, it will allow a faster and potentially
deeper take up than option 7 due to its flexibility. This option mirrors the
existing models that exist in the countries that allow investments of retail
investors.
7.
monitoring and evaluation
Evaluation of any
legislative initiative is a priority for the Commission. In the case of this
proposed regulation the monitoring would relate to the growth or otherwise in a
market for EU-wide long term investment funds. Were such a market fail to
develop after a reasonable time period then further evaluation would be needed
to assess whether the regulations themselves need to change.