EUROPE – The EU may seek preferential treatment for certain types of long-term asset classes in Solvency II and the proposed new solvency rules for occupational pension funds, according to an early draft of the European Commission's Green Paper on long-term investing that IPE has seen.
The paper is set to call for a balance between the need for long-term investment capital on the one hand versus future capital requirements in Solvency II and proposed new rules for IORPS.
The draft also questions the role of fair value accounting and raises the need to promote securitisation markets, while also floating the idea of a European retail savings account to fund long-term investment projects and seeking to promote better corporate governance.
The draft highlights that pension funds' ability to function as long-term investors depends on the time horizon for investment decisions, and on their ability to generate high investment returns.
"While some pension funds target a certain level of annual returns, this is not a requirement," the draft says.
"The trade-off is therefore around the need to specify a maximum level of risk pension funds can afford to bear, in order to generate the required level of annual return."
The draft points to the need for Brussels to review the IORP Directive to support long-term financing by making the valuation of liabilities more "realistic" and creating incentives for better risk/return management over long periods of time.
Additionally, the draft cites the need to "stimulate" securitisation markets to convert illiquid assets into tradable instruments and reduce the reliance on bank funding, and covered bond markets, which remain fragmented across Europe. It highlights the European project bond initiative, which aims to develop a liquid bond market.
It also refers to tax rules. While it argues for further discussion on the design of corporate taxes that currently favour debt over equity issuance, it also argues that the financial transaction tax (FTT) should incentivise long-term investment.
It says the FTT "could indirectly support long-term financing by penalising undesirable and speculative short-term financial market transactions and instead incentivising longer-term horizons".
Moving to corporate governance, the draft points out that long-term financing relies in part on long-term investors engaging sufficiently in the companies in which they hold shares and maintaining an interest in their long-term value.
"However," it adds, "there are a number of factors that may preclude this, creating instead a more shortened outlook. A lack of engagement by long-term investors can reduce the focus of companies on longer-term strategies."
Additionally, shareholder value prioritises the maximisation of share value over the longer-term fundamental value of the firm, according to the draft, while the nature of the relationship between investors and asset managers can contribute to increasing short-termism and mispricing.
In light of these issues, the draft makes a number of suggestions such as mandating private saving programmes – including auto-enrolment or insurance schemes.
"Mandating private saving programmes represents an additional option for increasing long-term savings rates and therefore also the level of resources potentially available to finance long-term investment," the draft says.
"This approach has already been adopted by national authorities in some EU member states and in other countries around the world.
"In practice, the feasibility and impact of such compulsory schemes depends on their design, including in relation to the nature of taxation regimes for savings and their complementarity with existing pension schemes."
The European Commission originally planned to release its Green Paper on long-term investing at the end of last year.
However, a person working within the internal market division told IPE at the time that the paper was an "evolving" piece of work, and that the Commission had some "intense" internal processes, suggesting that the launch might be postponed.