22 Jan 2015
Regulation designed to make financial markets safer can discourage investors from providing the long-term capital European companies need to grow. We must have a regulatory regime that gives market supervisors the confidence that investors are acting prudently, but also ensures investment reaches Europe’s businesses and entrepreneurs.
Policymakers recognise that small and medium-sized companies can be engines for economic growth, job creation and prosperity across the European Union. Commission President Jean-Claude Juncker’s recently-unveiled €300bn-plus European Fund for Strategic Investment is a real opportunity to direct both public and abundant private capital where it is needed most. It is timely that the European People’s Party has taken up this theme at its annual dialogue in Brussels on Thursday, entitled: “Helping SMEs and start-ups grow and prosper – From credit financing to equity financing”. Here are the key points I shared with fellow speakers and attendees.
Regulatory uncertainty harms investment
We shouldn't underestimate the impact of regulatory uncertainty on institutional investors. New regulation – or even just the prospect of new regulation – can spread concern among large investors and cause them to hold back critical investment until the outcome is clearer.
Take Solvency II, a piece of legislation that has been in preparation for over a decade. We know from our members that uncertainty about the capital treatment of private equity assets caused insurers to reduce or delay their investments into private equity. Sadly, in many ways, these are just the kind of investors and investments that Europe needs to encourage – ones from capital providers who can take a long-term view and provide companies with stable and enduring finance.
How do you measure the risk of investing in a long term asset?
Underpinning much investor regulation is the premise that the riskiness of an asset is more transparent (and better understood and managed) if we all know what it’s worth at any given moment. The understandable concern of regulators is that there is scope for wishful thinking if market participants are allowed to decide for themselves how to value their assets.
Yet long-term assets are often very illiquid and have no daily market price. Fast-growing start-ups that are not yet turning a profit are hard to value – but they still need finance of the sort that venture capital can provide. We need to recognise that not all assets function like shares in a mature, stock market-listed, company and work to find an approach to measuring risk that better suits the characteristics of long term assets.
EU rules need consistent implementation
Similarly, the implementation of new legislation can create unwanted consequences. The Alternative Investment Fund Managers Directive was introduced to regulate the way private equity (and other types of alternative) funds operate across the EU.
However, 18 months after AIFMD entered into force, there are still member states where the directive has not been transposed into national law. Meanwhile, in others, extra costs are being heaped on private equity and venture capital managers who simply want the freedom to talk to potential investors across the EU. Such barriers run contrary to the notion of a free market for capital, and ultimately restrict investors’ choice and companies’ access to crucial investment.
There is no simple answer to the uncertainty and inconsistencies regulation can produce. No-one wants rushed legislation, so regulators need to take time to acquire evidence, consult market participants, and assess the potential impact. But we also have to remember that it's not just the end result that changes behaviour: markets and investors start to be influenced from the moment that regulatory change is put on the table. And when new rules are introduced, regulators must see that they are applied consistently and within the agreed deadlines.
Europe has no shortage of bright ideas
Every day, entrepreneurs are developing new products and services and pioneering the sort of transformative concepts that have the scope to change the way we work, play and live. The problem we face is getting funding into those businesses – not to get them off the ground – but to turn fledgling companies into groups with global sales, profits and the job creation that inevitably flows from that.
Those companies need support and if we are serious about promoting long-term investment in Europe, through private equity and venture capital, then we need to encourage investors to commit a greater share of their capital to those assets. Regulation has to ensure investors and the managers they back act prudently, but also accept the fundamental characteristics of those investments.
So we need a framework that helps youthful and dynamic European companies attract the finances they need to grow – be that from supportive long-term private equity investors, or from the broad range of other players that can thrive under a capital markets union. In that way, start-ups and SME’s will really prosper.
Michael Collins, Deputy Chief Executive and Public Affairs Director, EVCA
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