25 juni 2013 D/13/7399/KN ONDERW ERP: Answer to the Green Paper on Long Term Financing of the European Economy

DATUM: KENMERK:

Federation of the Dutch Pension Funds

Transparency Register Number 84476202986-17

Answer to the Green Paper on Long Term Financing of the European Economy

Contact: Sibylle Reichert Head of Brussels Office Federation of the Dutch Pension Funds Rond Point Robert Schuman 9 B-1040 Bruxelles Tel.: +32 2 230 9222 Mobile: +32 474 93 28 41 reichert@pensioenfederatie.eu www.pensioenfederatie.nl

General Remarks
The Federation of the Dutch Pension Funds (the Federation) welcomes the publication of the Green paper on Long Term Fin ancing of the European Economy. The Green Paper is a good start of an important debate on how longterm savings can meet long-term investments and what role institutional investors can have in this process. The Federation is pleased to hereby provide its input to the consultation. The Federation emphasizes that the primary goal of pension funds is to provide beneficiaries with adequate retirement income. The investment strategy and all investments of pension funds should contribute to achieving this objective. The long duration of pension liabilities make pension funds a natural financial intermediary for long-term investments. The Federation supports the European Commissions view on the need for long term finance for the European growth agenda. The Federation agrees with the Commission that it is necessary to evaluate and analyse the cumulative impact of prudential as well as of financial regulation and of fair value accounting on the investment behaviour of institutional investors such as pension funds and their resulting capacity to act as suppliers of long term financial means. In order to further develop additional long-term funding financial instruments at the EU level, a supportive policy framework and a well-structured public-private partnership environment, may promote and increase suitable long-term investment opportunities. The Federation thinks that in this respect, environmental, social, and governance (ESG) factors should be integrated. The Federation is ready to cooperate with the European Commission and all other relevant stakeholders on the further development of a good environment for long-term financing of the European Economy.

Answers to the consultation questions

Question 1: Do you agree with the analysis out above regarding the supply and characteristics of long term financing?
The analysis is limited to the supply side of long-term financing. For a complete analysis of the topic, a broader discussion that deals with both supply and demand, and the interaction between these two, would be useful. Also, a discussion of the different forms that long-term investments can take and the role of the financial sector in each of these forms would be very useful here, instead of as a separate paragraph, because the characteristics of LTI are intertwined with the provision of long-term financing. Furthermore, we agree with the identified actors as being the traditional suppliers of long-term investments or funds. However, we would like to caution for their identification as long-term fund suppliers in the future, because the recent financial crises have caused them to rethink how much capital they can, or are allowed to, devote to long-term investments. The constraints associated with long-term investments vary significantly between long-term investors and consequently their ability to do long-term investments. Pension funds, for example, are large long-term investors, but they also have more onerous constraints than most governments and households. While we agree that market financing is part of the solution to fill the gap, we would like to make some remarks: 1. It is our view that bank lending should not be so quickly dismissed and work should be done to incentivise bank loans with a maturity longer than the current average commercial bank loan maturity of 5 years in developed countries. 2. We believe indeed that it is preferable to have risk located within, rather than outside, institutions whose expertise is precisely to manage risk.

Question 2: Do you have a view on the most appropriate definition of long-term financing?
Long-term financing is a very broad topic. It encompasses many different types of investment and financing. For example, both direct and indirect loans, equity financing, alternative investments and securitised loans. But, taking a different perspective, it also encompasses private savings at banks, pension and insurance savings, public investment, and public-private cooperation. Opinions on what exactly long-term means differ, based on the perspective that is taken in coming up with a definition, where multiple perspectives can be equally valid. Since there is such a diverse landscape of products and maturities, using a broad definition that encompasses most of this landscape seems the logical way forward. Having said this, the most appropriate definition of long-term financing also depends on the specific intentions one has. In subsequent stages, clearly defining subgroups of long-term investment for specific initiatives might be useful.

Question 3: Given the evolving nature of the banking sector, going forward, what role do you see for banks in the channelling of financing to long-term investments?
As the analysis in the Green paper indicates, banks have been hit by the financial crisis and are now in a process of deleveraging and preparing new prudential rules for banks, which decreases the ability of banks to provide long-term financing. However, at their core, banks are institutions that have been designed to provide the maturity transformation of short-term savings (deposits) into long-term investments (predominantly loans). This role is supported by departments that have specialised knowledge and information systems to know and assess the credit risk of both existing loans and new loans issued. The maturity transformation that they have been engaged in historically will remain one of the core elements of banking in the coming years, based on the specialised knowledge and skills that banks have in managing credit risk.

Therefore, banks will remain one of the most important (if not the most important) channel for long-term financing. Other types of investors usually only have limited expertise to take on this role of providing direct long-term financing and will have to engage in other forms of long-term financing, such as investing in traded financial instruments that provide long-term investment opportunities. In short, this means banks will remain an important part of the provision of long-term financing in the future and will still provide their historical role in the maturity transformation process between short-term savings and long-term investment.

Question 4: How could the role of national and multilateral development banks best support the financing of long-term investment? Is there scope for greater coordination between these banks in the pursuit of EU policy goals? How could financial instruments under the EU budget better support the financing of longterm investment in sustainable growth?
Given their privileged position (preferred lender), their knowledge of local markets, and a good understanding of the related risks, these institutions have a unique role as they can supplement funds (scale up). In addition, they can provide private sector financiers with instruments and information to tackle specific barriers and risks. Given their status, national and multilateral development banks are particularly well-suited to provide direct long-term financing of (semi-) public long-term investment projects. The same goes for long-term financing of projects that fail to attract financing from private sources due to market failure (such as a liquidity squeeze due to the illiquid nature of the project) or incorrect pricing in case of positive externalities. Their role could be increased by attracting more private funds to co-finance their projects, and thus further increase both the amount of projects invested in and the scale of these projects. The ability to attract more private funds depends on the attractiveness of the project proposals of development banks.

The closer the risk/return profile of co-investments through development banks is to the risk/return profile of other competing investments, the more private investments can be channelled through development bank projects.

Is there scope for greater coordination between these banks in the pursuit of EU policy goals?
Yes there is scope as best practices can be shared. In addition, making effective use of trust funds, co-financing and human capital.

How could financial instruments under the EU budget better support the financing of long-term investment in sustainable growth?
These instruments could promote and catalyse financial innovation. Utilising the instruments to mitigate tail-end risks and more specifically cover cash-flow deviation, the probability of default of projects will decline and hence the projects become more attractive for long-term financiers. The instruments could help to further develop the financial market and hence release additional longterm funding. Developing a supportive policy framework is also crucial. Policymakers should also help investors address long-term risks, such as by supporting the development of transparent and reliable indices. Governments can issue long maturity and inflation-indexed bonds that facilitate long-term risk management by investors. A well-structured public-private partnerships environment would also be boon, with governments working with institutional investors to assess the scope for promoting the right investment opportunities.

Question 5: Are there other public policy tools and frameworks that can support the financing of long-term investment?
To further promote long-term financing, firstly, the held to maturity principle should be favoured instead of mark-to-market. Secondly, the accumulation of new legislation should be postponed and legislation should instead focus more on giving incentives to long-term investments. A third opportunity for enhancement would be clear industry policy accommodated by a long-term political commitment.

In many European countries commitments are short-lived just over an election horizon. The government should be a trustworthy partner. By creating assets with inflation-linked returns or public-private interests like energy related projects, real estate, and the Emissions Trading System (ETS), some role of government is vital. In order to promote investing in these types of assets, a stable regulatory environment is required. A lack of long-term investment opportunities, such as infrastructure projects, also acts as a barrier. This can be due to poor planning on the part of government which leads to a dearth of projects in the pipeline as well as of financing vehicles that do not give institutional investors the risk/return tradeoffs they need. Finally, better utilisation of the value chain is needed. Another tool when thinking of long-term investment could be public-private cooperation in above mentioned infrastructure investment. In these type of projects, private parties pay for the initial investment, and the government takes care of the subsequent annual returns to the investing parties. This may be an attractive way to lessen the pressure on government budgets in the current environment. Obviously, an important precondition for public-private cooperation to work is that the return profile should be such that private parties are willing to invest.

Question 6: To what extent and how can institutional investors play a greater role in the changing landscape of long-term financing?
Pension funds are one of the intermediaries that link capital providers to the capital borrowers in the economy. To finance the long-term liabilities that they have, pension funds are looking to earn returns based on either growth of the entire economy (equity) or by earning a premium for credit and liquidity risk (bonds and direct finance). In principle, this objective allows pension funds to contribute to stimulating long-term investment by allocating funds to projects that support or enhance the productive capacity of the European economy. This allocation can be done to the extent that the defined long-term investment allocation is in line with the pension objective (real or nominal) and within the risk constraints that they can tolerate.

Most of the long-term investment projects we have seen in the green paper consist of two components: a project financing part and a project implementation part. Pension funds are suitable partners for the financing part. The project implementation part, however, is not the core business of pension funds. Therefore, we believe a suitable partner should be found for the implementation part of the described projects. The intrinsic risks of a project could be split between all participating partners, so as to provide the right incentives for each partner to deliver on their respective responsibilities. In order for a project to be eligible for the investment portfolio of pension funds, it has to satisfy some conditions. 1. A long-term investment should contribute to reaching the pension fund objectives and will have to compete with other investment opportunities available to the pension fund. For example, the project could have higher return-to-risk ratios, better match the liabilities through for example inflation-linked cash flows, or provide diversification benefits in certain risk environments. 2. If the financing is done through one-project-one-financier, the financing becomes unnecessarily risky because of risk concentration. Financing is more attractive if a number of projects is pooled and the risk of the pooled projects can subsequently be shared between a number of financiers. 3. Since the projects in the green paper are mostly illiquid in nature, the return on the investments needs to be high enough to include a illiquidity premium for the investment to be competitive with other investment projects. 4. Long-term investment mostly involves relatively new investment products/projects and is smaller in terms of required funds than many other investment categories. For the investment to be interesting enough for pension funds, there needs to be a large enough choice of similar investments (universe) with each a large enough investment opportunity (funds required by the investment).

5. The bidding process for a long-term investment project should not be too
long, too costly, and should be transparent from beginning to end. 6. The long-term investment projects should give the financier sufficient insight into the risks of the projects, including those of ESG. Transparency and a good understanding of the risks involved in the project are two of the most deciding characteristics of an investment opportunity nowadays. Regarding the sixth point mentioned above, environmental, social, and governance factors should be integrated in the investment analysis and decisionmaking process. The responsible investment policy is made operational in four ways by Dutch pension funds: integration in the investment processes; thematic investment; exclusion policy; and active ownership. With respect to active ownership, clear targets are set that we wish to achieve in having a dialogue with the companies that we invest in. We are transparent about our dialogues but do not seek media attention to force companies to change (no activist approach). Often these dialogues involve joint initiatives with other investors, focusing on sectors, countries, specific topics (such as CO2 emissions) or governments and other regulatory bodies. In taking on the role as intermediaries contributing to the long-term investment, pension funds need to balance the returns and risks that come with these investments. Apart from contributing to the productive capacity of the economy, which we believe is a good for both investors and non-investors, greater allocation to long-term investments should be in line with the risk profile of the fund. Moreover, the pension fund is bound to follow national and international guidelines, laws and regulations and invest according to the pension benefit objective that the fund has. Overall, we believe that long-term investment could prove to be a successful and growing asset class if the suggestions we made above can be addressed.

Question 7: 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?
Long-term financing is firstly attractive to institutional investors when the risk premium on long-term lending is proportional to the amount of risk taken. This is a fundamental point: no matter what the prudential regulation is, if long-term financing offers an inferior risk premium compared to other investment opportunities, the potential for increasing long-term financing is limited. Second, mark-to-market based prudential supervisory rules may impede longterm investment when the long-term investment is an intrinsically attractive portfolio choice. Therefore, the prudential framework should not counteract the support for long-term investments. In the works around the revision of the IORP directive for example, long-term investments have to be classified as other equity for the solvency requirements, according to the specifications in the Quantitative Impact Study (QIS) of 2012. We would welcome the introduction of a separate category next to bonds, equity, and other equity. Another option is to shock the long-term investments using a duration-based approach, in the same way that the class equity is treated in the QIS for a future IORP II. If the duration of the pension liabilities is above a certain level, the shock in the duration-based approach is lower than the normal shock. In a prudential framework a recovery period is set in which an IORP has to recover from an insolvent to a solvent financial position. If the recovery period in a future IORP II is set as short as in Solvency II for insurers, this would decrease the possibility for IORPs to invest in long-term investments. Smoothing mechanisms such as applying an Ultimate Forward Rate (UFR) mechanism to the discount curve or an average of the coverage ratio over e.g. the past three months reduce the volatility of the measures used in the prudential framework. This reduction could raise the possibilities for long-term investments.

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Apart from the prudential framework, the accounting rules should also not counteract the support for long-term investments. IFRS accounting rules could be adapted by e.g. allowing amortised cost based on buy and hold instead of actual value when valuing long-term investments. From the point of view of responsible investment, many institutional investors pursue a policy of engaged shareholdership. This means that institutional investors do not only invest in equity for the financial return equity provides, but also take their social responsibilities by taking an active stance in influencing the policy of corporations in which they hold shares. Concentrating the equity portfolio would make it easier and more effective for institutional investors to pursue this policy. However, the current risk models from modern prudential rules discourage concentrating and reward diversifying the equity portfolio. Institutional investors also try to cooperate to be more efficient and effective in their engagement policy. However, in some countries it is not entirely clear to many institutional investors how the acting in concert regulations that their supervisor imposes should be interpreted. Clearing up these regulations would stimulate the effectiveness of engagement policies by institutional investors.

Question 8: What are the barriers to creating pooled investment vehicles? Could platforms be developed at the EU level?
Pooled investment vehicles are in principle a very useful venue to channel funds into long-term financing. There are several important issues for creating or investing through pooled investment vehicles. These issues are: Does investing through pooled vehicles bring enough benefits to justify the additional costs of investing indirectly? What will the tax treatment of the pool and its participants be in the various countries? How are the redemption provisions drafted? Is there a one solution fits all property? How is the governance of the vehicles arranged?

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With regard to redemption provisions, even though the intention is to invest for a longer term, unexpected circumstances can occur that force an investor to redeem its investment (partially or entirely). Especially in an illiquid fund, it is then important to know whether or not an interim redemption, if necessary, is restricted and if so, what the restrictions are. The one solution fits all property of pooled investment vehicles, means that institutional investors are limiting themselves in their investment options. Every institutional investor has its own point of view and desires with regard to preferred size, type, and credit risk of long-term financing. These different preferences cannot all be catered to through a pooled investment vehicle, since the investment vehicle will have to work based on standardised units. The governance of these pooled investment vehicles is important for long-term investors. Who is ultimately responsible for the investment decisions the fund makes, and how much influence do individual investors have? This can be especially problematic in investment vehicles where a large number of investors participate, thus reducing the influence on investment decisions each of them has.

The EU level
If a pooled investment vehicle is structured at the EU level, attention should be paid to the tax treatment of such a fund (FTT exemption in case an FTT will be introduced). Under Dutch tax law, the tax provisions are designed in such a way that the tax burden is the same for the situation of a direct investment by an investor, an investment through a tax transparent fund, or an investment through an opaque fund. If the tax burden is much higher when using a pooled investment vehicle, the use of such funds will not be interesting for investors. Other issues to be taken into account are: Valuation Reporting Leverage Liquidity management (exit opportunities) Risk management

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The most important condition for pooled investment vehicles to become a success is that investors do not only pool money, but also knowledge. By pooling existing knowledge, institutional investors may profit from each others expertise in different areas so that all of them stand to gain from a pooled investment vehicle. This does probably limit the scope of the pooled investments to local level rather than EU level, since pooling knowledge is much easier to bring about in a cooperation where the parties involved already know each other.

Question 9: What other options and instruments could be considered to enhance the capacity of banks and institutional investors to channel long-term finance?
In order to mobilise the long-term financing capabilities of institutional investors, it is essential that general trust in the banking sector is restored as soon as possible. Banks are the only intermediaries that possess sufficiently developed credit and monitoring departments, without which it is almost impossible to do a proper selection for extending long-term loans, and to monitor these loans effectively during their lifespan. Thus, cooperation and coordination between banks and institutional investors would greatly enhance the possibilities of extending long-term financing to the European economy in a responsible and productive way.

Question 10: 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?
In the last few years, a substantial number of regulations and directives aimed at financial markets has been drafted and in some cases already implemented after initiatives of the European Commission. The regulations and directives generally aim to reduce perceived risk and provide more transparency. Long-term investment itself is especially impacted by overly penalising prudential and valuation rules. If capital requirements are too high, or the risk of high short-term volatility significantly impacting the year-to-year results of institutional investors becomes too large, then investments in long-term assets will be reduced.

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There is a link with cyclicality here as well. Since prices of long-term assets tend to decrease more than those of short term assets in a bust, prudential and especially valuation rules provide an incentive to move out of long-term assets in an economic downturn. A way to circumvent this issue would be to move to smoothed valuation of longterm assets. This will mitigate the pro-cyclical impact of current valuation rules, and might make investing in long-term assets more attractive. Another aspect of prudential reforms is the administrative burden that comes with it. Most prudential reforms come with significant costs in the form of higher administrative burdens. It is not always clear whether an analysis of the costs and benefits has been done for each new regulation or directive. A prudential reform that provides minor improvements for governance, risk management, transparency, or communication requirements but that imposes a substantial administrative burden or adds to the existing administrative burden caused by other regulations may not always be the best choice. An increased administrative burden may reduce the scope for long-term investments and provide an incentive to invest in liquid short term assets with low costs to reduce the overall costs for the institutional investor. One way to gain insight whether this is happening or not is to assess not only the impact of the proposed reform itself, but of the total administrative burden of existing and new regulation when a reform is proposed. In the current works around the revision of the IORP Directive for example, long-term investments have to be classified as other equity for the solvency requirements. This could hamper long-term investments. The introduction of a separate investment category next to bonds, equity and other equity for solvency requirements in which lower shocks are to be applied could prevent this effect. The recovery period that has to be set in IORP II should not be too short, otherwise this would decrease the possibilities for IORPs to invest in long-term investments. The European Market Infrastructure Regulation (EMIR) and the EU Financial Transition Tax may hamper long-term investments as well, as these investments can be structured based on derivatives and securitised deals.

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Lastly, the cumulative development of current and prudential reforms in the EU and in the Netherlands leads to more individual defined contribution promises. In this pension system there are not as many possibilities for long-term investments as in defined benefit systems (or in defined ambition systems).

Question 11: How could capital market financing of long-term investment be improved in Europe?
Removing fragmentation in the European capital markets and leveraging member-state procurement budgets would be a first step in channelling longterm finance in a more efficient way. Another barrier to tackle is to reduce the home bias and support cross-border investments. A second step would be to support innovation and specifically new enterprises which have the potential to become the new stars and be the engine of economic growth in the coming years. Supporting them would free up capital from relatively small (but important from a chain perspective) parties such as family households, boutiques, investment firms, and venture capital companies or funds. From a credit point of view, traditionally banks have provided the vast majority of the funding for non-listed companies in Europe. To accommodate a move towards a model where more (especially long-term) funding flows through capital markets, standard documentation on the part of bonds-issuing party would greatly help in providing insight into the relevant data to assess the risk associated with the bond. Moreover, the costs and complexity of complying with regulation demands keeps many small companies out of the capital market. Decreasing this burden would increase the potential capital market funding for smaller companies. Finally, international regulatory bodies should carefully consider the cumulative impact of new regulations affecting banks and other financial institutions, as these may have unintended consequences on both the micro and the macro level.

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Question 12: How can capital markets help fill the equity gap in Europe?
There are multiple ways to approach this issue, either through measures impacting directly on the equity provision to companies, or through indirect measures such as for example securitisation. One route that would help would be to decrease the costs of trading equity, thus making it more interesting for investors to provide equity to firms, which can then be traded away more easily, if desired. This would also make subordinated loans a more interesting form of finance, both on the part of the companies and on the part of investors. Second, efforts should be undertaken to re-establish the trust between market agents and supervisors with respect to securitisation. One way to achieve this is by developing products that are based on clear and comprehensible structures (no complex derivatives) with low-risk underlying assets. The securitisation markets are a key source for long-term funding. Private sector parties should work closely with EIB or EIF in developing a liquid (corporate) bond market. If equity, as perceived by many, is a better financing instrument than bonds, then the capital market should be able to find a right price for equity versus bond financing. To the extent that the equity gap is caused by non-fundamental different treatment in regulations, these regulations should be adjusted.

What should change in the way market-based intermediation operates to ensure that the financing can better flow to long-term investments, better support the financing of long-term investment in economically-, socially- and environmentally-sustainable growth and ensuring adequate protection for investors and consumers?
A conditio-sinequa-non would be full governmental commitment with government policies aimed at long-term development and not determined by the election-cycle. In addition, governments should develop accommodating policies and be willing to take first losses and give 100% guarantees.

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Question 13: What are the pros and cons of developing a more harmonized framework for covered bonds? What elements could compose this framework?
First, we would like to remark that we believe that the potential for increasing the covered bond markets is limited. Issuing a covered bond for a bank forces the bank to use some of its assets as collateral, which cannot be done indefinitely without deteriorating the financial position of the bank excluding the collateralised assets. Nonetheless, representing institutional investors, we believe that a harmonised framework could greatly increase our investment appetite for covered bonds. Currently, the markets for covered bonds are fragmented along national lines due to differences between local markets with respect to various fields of law governing these instruments (e.g. bankruptcy and property law). A harmonised market for covered bonds has the potential to reduce the required capacity needed to fully assess the relevant characteristics of each individual covered bond market in order to become comfortable to invest in the relevant covered bond. The harmonised framework could attract new investors and increase the appetite of investors that currently already invest in certain covered bonds markets. At the same time a harmonised framework has the potential to increase the appetite to issue covered bonds for by issuers. This increased investors base, combined with an increased issuer base, will result in an increased liquidity in a single European covered bond market. On the other hand, covered bonds are issued by banks who each have their own policies and remain in control of the composition of the security provided and monitoring and collection of the cash flows. We are not sure if harmonisation will reach far enough to enable potential investors, supervisors and rating agencies to evaluate and compare individual covered bonds on a uniform basis. Lastly, in order for the harmonised framework to become a success it is necessary to overcome many differences in national law between the various EU member states which we expect to be a challenging political hurdle.

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In our view such harmonised framework should at least cover the following aspects: Creating a legal level playing field on: Overcollateralisation, haircuts, valuation, legal position bondholder, treatment residual debt, and any other obligations for bondholders; Create favourable capital requirements for bond issuers; Set accounting standards for bondholders; Set flexible but clear collateral requirements; Maximise spreads for offer and bid prices in secondary markets for covered bonds; Covered bonds should at least be rated by two rating agencies; Clearly state any additional terms in a term sheet.

Financial stability and the functioning of the capital markets and the utilisation of instruments is the responsibility of the supervisor. The Dutch Central Bank has made it very clear what its view is with respect to securitisation. As long as the view of the supervisor remains conservative regarding the use of derivatives and securitisation, we have to acknowledge that this will hamper the possibilities for mitigating risks and consequently financing long-term investments. Hence, we refrain from answering questions 14 and 15.

Question 14: How could the securitization market in the EU be revived in order to achieve the right balance between financial stability and the need to improve maturity transformation by the financial system?
See the answer to question 12 for some suggestions on securitisation, replicated here: Efforts should be undertaken to re-establish the trust between market agents and supervisors with respect to securitisation. One way to achieve this is by developing products that are based on clear and comprehensible structures (no complex derivatives) with low-risk underlying assets. The securitisation markets are a key source for long-term funding. Private sector parties should work closely with EIB or EIF in developing a liquid (corporate) bond market.

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Question 15: What are the merits of the various models for a specific savings account available within the EU level? Could an EU model be designed?
To assess the merits of saving accounts at the EU level, it would be good to define more clearly what the purpose and the role of an EU level savings account is. Currently, in the Netherlands there is no lack of opportunities for long-term savings through pension funds and financial institutions such as insurers, so the added value of an EU-level savings account is not clear from a Dutch perspective at the moment.

Question 16: What type of CIT reforms could improve investment conditions by removing distortions between debt and equity?
No comment

Question 17: 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?
In general, long-term savings can be stimulated by applying tax reductions or tax exemptions. One method could be the exemption of taxes (property tax and/or income tax) in case a private household is engaged in a long-term saving arrangement. Such an arrangement could be made either by means of a special bank account, which is blocked for a minimum number of years (long-term deposit), or by effecting a life insurance policy which provides a lump sum payment after a minimum number of years. Another method is applying the EET system not only on pension arrangements (as is already common practice in most of the EU member states), but also on personal life insurance arrangements providing an annuity, and/or arrangements through which households are saving money for health care or elderly care. One could argue that the EET system, which in fact results in a postponement of taxation, implies a disadvantage for the state, because the state has to wait for its money during the years the contributions are paid.

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But on the other hand, it can be argued that the EET system provides continuity of tax revenues for the state even over periods during which the citizens are retired and the benefits are paid. This kind of continuity is of great importance given the ageing of the European population. Nevertheless we realise that the TEE system can also be profitable. One advantage of the EET system is that, given the fact that the benefits are not taxed, the amount of the insured pensions can be mitigated, which results in lower labour costs and higher revenues of corporate tax. But this relates to question number 19. Given the free movement of workers it would be inconvenient to have different systems of taxation between member states. Furthermore, we would like to stress that systems in long-term savings, or savings in general, should not be punished by governments.

Question 18: Which types of corporate tax incentives are beneficial? What measures could be used to deal with the risks of arbitrage when exemptions/incentives are granted for specific activities?
No comment

Question 19: Would deeper tax coordination in the EU support the financing of long-term investment?
It is important that throughout the EU the tax treatment of pooling vehicles (when is it transparent, when not) is clear and national tax qualifications are followed if possible (i.e. if the tax treatment is transparent for tax purposes in the home country, then it should also be so in other EU countries). These tax related issues could be addressed within the current discussions about the fiscal treatment of equity and debt within EU and OECD context.

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Question 20: To what extent do you consider that the use of fair value accounting principles has led to short-termism in investor behavior? What alternatives or other ways to compensate for such effects could be suggested?
Fair value accounting, the frequent reporting requirements, and the potential supervisory reactions triggered by the reported financial situation that all go together, have certainly had an impact on investment behaviour. More specifically, long-term investors would sometimes like to ignore rapidly changing market values that are not driven by fundamentals, but cannot afford to do so because this would violate the short-term financial constraints posed by the supervisory framework which is based on fair value accounting. To prevent hitting the short-term constraints, long-term investors are often forced to move with the herd (or preferably to move slightly in front of the herd) to prevent taking big losses on paper. Unfortunately this can force them to accept moderate losses and may reinforce market volatility as long-term investors sell when others are selling and buy when other parties are also buying.

Question 21: What kind of incentives could help promote better long-term shareholder engagement?
The Dutch Corporate Governance Code and the EUMedion Best Practices already provide enough guidelines for long-term shareholder engagement. In other countries such as the UK and Germany, comparable guidelines are also present. We believe the set of current tools is sufficient and the market has its role to play now. We believe differences in voting power or dividend for loyal shareholders may present negatives and unknown positives, and we are therefore not in favour of such measures. Through their strategy and policies, listed companies can also take the lead and attract long-term shareholders. It is useful to emphasise that for many institutional investors shareholder engagement is important, but that shares only form a limited part of the total portfolio. Bonds are usually a far more important part of the portfolio. Aligning interest for long-term bonds issuers and investors can be achieved by being transparent about the risks of the company through standard documentation.

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As to shares, from an investors point of view long-term shareholders engagement starts with confidence in the long-term strategy of the company. The way the board will be able to implement the strategy and the frequency of communicating about the strategy to investors is crucial. Next to that, the nonexecutive board should supervise the executive board in relation to the longterm strategy. Long-term shareholder engagement will improve if shareholders are involved with the company. Communication, transparency and respect for shareholders rights can contribute to long-term shareholders engagement. Current suggestions of a loyalty dividend or the introduction of special voting rights for long-term shareholders are not preferred instruments. They reward investors that are simply investing in a stock because it is in an index. These investors have no real interest in following the company or being engaged. If the stock falls out of the index, they will sell the shares.

Question 22: How can the mandates and incentives given to asset managers be developed to support long-term investment strategies and relationships?
Whether or not an asset owner wants to set up long-term investment strategies in any asset class, depends on investment beliefs, risk appetite, regulatory environment, and the shorter or longer term goals of the investments. Once it is decided that a long-term investment strategy is to be rewarded, an asset manager should be selected that has an active long-term focused investment policy. Characteristics to look for are: an investment process and philosophy with clear long-term characteristics (incl ESG integration); low turnover in the portfolio; a good track record over the long term (5-10 years).

Mandates should be structured to reflect these characteristics. In monitoring the performance of the asset manager most attention should be paid to the team, the process and the resulting portfolio, as well as the long term performance. Short-term performance has to be explicable, turnover should be low and the asset manager should stick to its long-term process. The asset manager in its turn should put up incentive structures to promote long-term investments and set long-term performance targets next to shorter term targets.

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Supervisory rules play an important role as well. Too much focus on risk and publishing of quarterly or yearly performance indicators of asset owners can lead to suboptimal and counterproductive investment decisions. De-risking when low risks assets are very expensive and re-risking when risky assets are becoming expensive is an often seen pitfall and exacerbates the markets over- and lack of reaction to short-term news flows. Furthermore, too great a focus on costs can also be detrimental for active and engaged investment strategies. Researching companies well and being an engaged shareholder is a time consuming and labour intensive profession. It simply costs more than following an index. The Dutch industry itself has composed standards such as the ICGN Model Mandate Initiative and works through organisations like ILPA to create better alignment. Measures that improve alignment between investors and asset managers are for instance that managers invest in their own product, not having an annual paid out performance fee, and possibilities to have claw backs.

Question 23: Is there a need to revisit the definition of fiduciary duty in the context of long-term financing?
We do not see the need to revisit the definition of fiduciary duty. The public discussion seems to focus on long term financing in relation to how shareholders can be committed to companies for a long(er) period. This discussion often starts from a view that long-term shareholders can create a solid shareholders basis for a company. However whether or not long-term investing is in the best interest of the clients, (the asset owners), depends on many factors including the asset category and risk-appetite of the client. Therefore the investment decision on short-, medium- and long-term investing should be up to the asset owner and should be left outside any EU recommendations or EU regulation. Furthermore, a long-term investment strategy does not automatically mean that an investor is a long-term shareholder in a company. In our view a long-term investors should be considered as active investors that are committed to use their shareholders rights and enters in dialogue with companies to create shareholders value in the long term.

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Asset managers of pension funds have a (fiduciary) duty to their clients to create value (in the long term). Holding shares in a company for a long term could be in conflict with their fiduciary duty if the shares in a company should be sold in order to create value for the portfolio. Next to the conflict with fiduciary duty, mandates given to asset managers are not always long-term. Often these are not longer than 3 years (source Eumedion position paper on betrokken aandeelhouderschap p. 5, footnote 11).

Question 24: To what extent can increased integration of financial and nonfinancial information help provide a clearer overview of a companys long -term performance, and contribute to better investment decision-making?
Integration of non-financial information in the investment decision-making process is crucial. Non-financial information can help to understand the risk reward characteristic of a company as environmental, social, and governance factors can be of influence to the risk/ return profile of a company. If sustainability and CSR-related information would be integrated into the companys annual reporting this would greatly contribute to helping Socially Responsible Investing move towards mainstream investing. Currently ESG specialists in the Responsible Investment teams at asset owners analyse different data than their front-office colleagues, and have different engagement meetings with issuers. Integrated reporting would help move forward the ESG integration into investment decision-making and would make it easier to assess the companys ESG-related risks.

Question 25: Is there a need to develop specific long-term benchmarks?

From a practical point of view it is very hard to come up with a long-term benchmark. However, having such a long-term benchmark would be useful in writing longer-term contracts with external asset managers and would have a definite added value.

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Having said so, as long as the asset management contracts and incentives are determined well and the monitoring of the asset owner by the regulator and the asset manager by the asset owner is done accordingly, there is no need for longterm benchmarks in our view.

Question 26: What further steps could be envisaged, in terms of EU regulation or other reforms, to facilitate SME access to alternative sources of finance?
By definition, SMEs are small-scale firms that are dependent more on local/national regulation than on EU regulation. Whether or not SMEs can access alternative sources of finance is and will first and foremost remain a regional issue. As discussed in the Green Paper, one of the problems for many SMEs in obtaining funding is that the new capital and liquidity requirements in Basel III force banks to extend fewer loans, decreasing the available funding for SMEs through banks. However, the real problem is the following: a substantial fraction of SMEs is not or less able to get loans anymore, even if banks could afford to extend it. This is caused by a balance sheet with company-specific assets, which the company values highly but the bank values far less. What many SMEs therefore could use to access more loans is to strengthen their own funds, which in turn will enable them to obtain bank and non-bank finance more easily. This critical point should be kept in mind when trying to design solutions for SME funding. Finally, reporting requirements for SMEs are very strict and frequent. This fosters transparency, but comes at a cost and time investment that is disproportionate for many SMEs. Reducing the reporting requirements may well improve the financial situation of SMEs directly (by decreasing costs) and indirectly (by freeing up more time for productive activities on the part of the SME).

Question 27: How could securitisation instruments for SMEs be designed? What are the best ways to use securitisation in order to mobilise financial intermediaries capital for additional lending/investments to SMEs?
Currently many local and national exchanges are working on the implementation of a separate platform of SME financing.

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This is not always done through securitisation, as many of these platforms bring together multiple investors that invest directly in SMEs. The answer to this question could best be discussed with the parties involved in those platforms.

Question 28: Would there be merit in creating a fully separate and distinct approach for SME markets? How and by whom could a market be developed for SMEs, including for securitised products specifically designed for SMEs financing needs?
It is possible to develop a separate SME securitisation market, and doing so may alleviate part of the funding problems of SMEs. Since SMEs operate locally, such a securitisation market can best be organised through local exchanges. Many country exchanges already have such a platform or are developing one. These initiatives could be further stimulated by partnerships of institutional investors and banks, where the institutional investors help banks in the funding (and thus a reduction of capital requirements) in return for an appropriate compensation. However, different market participants have different perceptions of what is appropriate, which is a serious obstacle to such partnerships.

Question 29: Would an EU regulatory framework help or hinder the development of this alternative non-bank sources of finance for SMEs? What help could support their continued growth?
This is a very hard question to answer. It is obvious that the existing local initiatives to facilitate and stimulate credit extension to SMEs through the channels mentioned in the previous questions have developed without any EU regulation. This leads to the conclusion that an EU regulatory framework is not necessary to develop alternative sources of finance for SMEs. Also, since most SMEs work locally, a local approach to the financing of these companies seems a fruitful approach, since monitoring and risk management are easier and less costly on a local level. This indicates that the local exchange growth that we are currently seeing will expand much further in the near future.

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What would really support continued growth of alternative funding sources for SMEs would be a strengthening of own funds on the part of many SMEs themselves, which would increase their creditworthiness and would make them a more attractive debtor for all providers of funding. What would really help in this respect is sustained economic growth in the EU.

Question 30: 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?
Many forms of long-term finance have been mentioned in the Green Paper. The single most important point to foster the long-term financing market remains a positive economic climate with a proper, but not excessive focus on risks. Any measure that stimulates economic conditions can therefore be considered as stimulating long-term financing and growth.

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