Not too hot, not too cold
“The Union has today set itself a new strategic goal for the next decade: to become the most competitive and dynamic knowledge-based economy in the world, capable of sustainable economic growth with more and better jobs and greater social cohesion.”
These words, which were part of what has become known as the Lisbon Agenda, were published after the March 2000 European Council summit.
In fact, the Council set itself a deadline of 2010 to achieve that target. But unlike Germany’s Agenda 2010, which produced meaningful results in terms of labour market competitiveness, the Lisbon Agenda singularly failed.
Now, supporting the more modest Europe 2020 strategy, the European Commission is soon to issue a Green Paper on long-term investing.
A draft currently doing the rounds in Brussels acknowledges that there are considerable structural inefficiencies in the chain of investment mediation. As the Kay Review of UK Equity Markets and Long-Term Decision Making points out, too few people are paid to make strategic long-term asset allocation decisions. Far too much cash, both private and corporate, is currently held in short-term holdings.
The draft raises the idea of incentivising certain investment classes through preferential capital requirements in insurance and pension solvency regulation. But this would encourage politicians to produce laundry lists of “desirable” asset classes. The overall architecture and calibration of capital requirements should be free from political interference.
Countries like the Netherlands have tried to forge a balance between capital buffers and long-term risk taking in their pension fund investment regulation. This is fraught, as can be seen in banking prudential rules, and as the Green Paper notes. Make the capital requirements too strict and you risk cutting off bank lending. Calibrate the requirements too loosely and you risk lending bubbles and future problems. Translated into pensions, the balance is between too little risk taking with stricter funding requirements and too little security if too much risk is taken.
The Commission may soon understand that Solvency II is choking off the long-term investment potential of insurers. Too strict an application to pensions will choke off another avenue of long-term financing for the broader economy. And this is already taking into account that pension funds are moving into areas of niche lending vacated by banks, including infrastructure and real estate debt, and even trade finance.
Policy makers should not overlook equity markets, which are cursorily treated in the draft. Cash-rich corporates may not rely on equity markets to finance investment, but they do need long-term investors. Equities offer institutions good long-term return potential, and European pension funds are already global leaders in the area of corporate governance, working to create long-term synergies of interest.
The draft Green Paper correctly notes that mandating private (pension) savings plans will be essential if the Union is to enjoy a healthy supply of institutional long-term capital.
Accordingly, the Commission should promote policies to boost pensions savings. It should abandon the quixotic task of tinkering with solvency rules for defined benefit pensions that are a national preserve. Simply, if you want to have capital to allocate to tomorrow’s long-term investment needs, you’d better foster the policy framework to attract it.
If more national governments were to focus their institutional energy on boosting workplace pension savings, they might help create the sticky capital that Europe needs to help it achieve the praiseworthy aims expressed in Lisbon 13 years ago. And supervisory rules must be carefully calibrated so as not to choke off the supply of patient capital.