AMSTERDAM – One of the major challenges facing the European economy is the lack of liquidity in its capital markets. Since the 2008 global financial crisis, an enormous number of new rules have been put in place. In order to facilitate the long-term investment that Europe desperately needs, it would be wise to reassess the broader regulatory environment that has emerged over the past six years.
With banks reluctant to make new loans, institutions such as pension funds are well placed to meet the desperate demand for capital. Indeed, the savings of workers who may not be retiring for several decades are particularly well suited for long-term investments. The trouble is that in many cases, rules and regulations intended to ensure financial markets’ stability impede the ability of pension funds and others to allocate savings smoothly and efficiently.
The importance of proper regulations cannot be understated. When properly drafted and applied, they ensure financial stability, maintain (and, if necessary, restore) confidence in the markets, and facilitate long-term investment, helping citizens meet their future financial needs. But if regulations are not well tailored to the various types of market participants and to how markets actually work, they can choke off opportunities that would otherwise benefit investors and the economy.
The new margin requirements for derivatives, introduced in order to reduce systemic risk, are one example of such a chokepoint. It might make sense to apply them to banks or hedge funds, but pension funds are highly creditworthy institutions that pose little or no systemic risk to financial markets. Forcing them to set aside assets for collateral purposes only drains capital that could be used for long-term-investment.
Such investment involves a variety of products, market players, and jurisdictions, and, as a result, the effect of regulations can be difficult to see, much less quantify. For starters, the impact of rules and regulations can be direct or indirect. Rules that apply specifically to long-term-investment products or strategies can be classified as having a direct impact. Rules that apply to investors or their counterparts, competitive products, or complementary parts of the market can be described as having an indirect effect.
A well-crafted regulatory framework minimizes the adverse consequences for long-term investment, while maximizing the positive effects. New regulations are constantly being introduced. It is important to analyze carefully whether the new regulations are actually needed and, if yes, to foresee and fill regulatory gaps with rules that ensure the smooth flow of savings to new and existing projects.
For example, standardizing regulations relating to covered bonds, green bonds, and cross-border investment through real-estate trusts could encourage more long-term investment. In a more indirect way, a general regulatory push that increased the availability of projects suitable for long-term-investment and harmonized local insolvency regimes could also have a positive effect. Prominent examples of regulations with a direct negative impact include existing rules on securitization and proposed rules on asset-based capital charges.
The indirect negative effects of such regulations on long-term investment are, by nature, more difficult to discern, but they can be just as harmful as the direct effects – especially if they leave investors with fewer funds available for long-term investment. Margin requirements for derivatives transactions have this effect, as do regulations that increase banking costs.
These types of indirect negative effects have not been central to policy discussions concerning how to boost long-term investment. But they deserve careful consideration. It is crucial that we identify the full scope and scale of their impact on the allocation of capital. Otherwise, they risk offsetting the positive impact of investment-enhancing reforms.
As legislators and regulators continue to shape the investment environment, it is important not only to monitor and evaluate the impact of each piece of additional regulation; the way rules interact with one another – and with new rules as they are introduced – must also be understood. Unnecessarily broad regulations should be avoided in favor of rules that are specifically tailored to the various participants in the market.
Allowing long-term investors such as pension funds to provide the European economy with much-needed capital has the potential to provide huge benefits to future retirees, as well as to the broader economy. But that will not be possible unless, and until, the right regulatory environment is created.
Angelien Kemna is a board member and chief financial and risk officer of APG, a subsidiary of Stichting Pensioenfonds ABP, the world’s second-largest pension fund.
Copyright: Project Syndicate, 2015.