EC CMU Action Plan | ELTIF | Capital Markets Union | AIFMD | UCITS
Over the past two weeks, we have seen two important consultations published by the European Commission, as well as an interesting speech given by Steven Maijoor, the Chair of ESMA. On 19 October, the Commission published a formal consultation on the review of the European Long-Term Investment Funds (ELTIF) regime. This was followed on 2 October by a new consultation on the Alternative Investment Fund Managers Directive (AIFMD), that will set the broad direction of travel for the collective funds industry not covered by the existing UCITS directives.
I will return to AIFMD later in the piece, but first I wanted to look at the ELTIF consultation in more depth. This consultation is particularly interesting, as it is the first material output from the Commission following the publication of the Capital Markets Union (CMU) Action Plan in late September. ELTIFs are seen as an integral part of a successful CMU, and are being reinvigorated to provide new and more diverse funding for unlisted companies, listed SMEs, infrastructure projects, as well as to support sustainable investment objectives.
In its final report in June, the CMU High-Level Forum (HLF) commented that “The EU has been suffering from a chronic shortage of financing for companies that have the potential to grow into global players as well as for long-term investments required for environmental sustainability”’. It further highlighted that “ELTIFs were conceived as a financial instrument to address the lack of late-stage venture capital financing, notably compared to other major economies, but the initial take-up has been slow due to the legal requirements applied to ELTIFs”. It is perhaps noteworthy that the developing role of ELTIFs is in part very similar to that of a number of Sovereign Wealth Funds (SWFs) who invest in a similar way but are, of course, funded in a very different manner. Ideas to create a SWF in Europe have also been mooted, although without specific and identifiable funding as we see in some naturally resource rich countries, it could face similar challenges to those being seen with ELTIFs. One of the factors that has been identified, and that is associated with the slow take-up of ELTIFs in Europe, is the lack of participation by retail investors; both the HLF and the consultation have highlighted this issue.
This point brings me to the speech made by Steven Maijoor at the recent Irish Funds Annual Global Funds Online Conference 2020 on 22 October. In his address entitled, “Retail investors and asset management are the pillars of a successful Capital Markets Union”, he considered how historically the European Union and its Member States have relied heavily upon their banking systems to support economic growth. He further suggested that there is a strong link between deep, liquid capital markets and household participation in these markets, as both investors and markets can thrive when the right regulatory frameworks are in place. Whilst I see his comments resonating back through into the consultation, I also see some anomalies around what we may actually want from these funds.
Those of you who are familiar with ELTIFs will already be aware that the current regulation specifically forbids them from the short selling of assets, and puts significant restrictions on any securities lending activities where the latter must not affect more than 10% of the fund’s assets. Presumably, these restrictions reflect concerns that the so-called ‘short-termism’ often associated with both of these activities would undermine these funds; I actually think this somewhat misses the point. First, I am not sure what role ELTIFs would actually play in terms of short selling. Numerous studies have provided clear and empirical evidence that short selling is important for the development of efficient capital markets, further suggesting that short selling is not detrimental for long-term valuations.
On this point, we also need to think about liquidity and in particular the role that securities lending plays in providing that liquidity. Restricting that liquidity invariably leads to higher bid-offer spreads, inefficient price discovery, and most importantly an absence of effective secondary market trading opportunities. Much has been said by the Commission and the HLF about incentivising retail investors to participate more widely in the capital markets, and Steven Maijoor identified it as a fundamental success factor to deliver the CMU. Notwithstanding that and whilst ELTIFs may be seen as a more specialised investment and perhaps not for everyone, it is still important that there is a clear and efficient secondary market in these funds. Without this, it seems problematic to expect retail investors to lock-up their personal liquidity in these schemes that offer either limited or restricted redemption until maturity. The pandemic has taught us all that we may need to suddenly create more flexibility in and around our personal financial footprints, and as ISLA looks to respond to this current consultation, we will be taking forward these ideas into our response.
Before I close, I wanted to talk briefly about the AIFMD consultation. In looking at how regulation and policy develops and evolves, there is no doubt that policy and regulatory ideas that have appeared first in the AIFMD world, invariably find their way into the broader UCITS directives. Whilst the headline securities lending volumes from within the AIFMD community tend to be low, regulatory changes here that can find their way into the UCITS framework can have significant implications on a community that represent one of our industry’s largest blocks of lendable assets. Whilst we still have to review the consultation in detail, I would highlight the focus on delegation where the Commission is clearly looking at ways to revise this, including the development of quantitative criteria and assessment of core functions that may not be delegated. In a post-Brexit world, this clearly has implications for all of us, and we will continue to track this workstream closely over the coming months. More specifically, I would highlight where the consultation seeks views on the need and appropriateness to expressly define tri-party collateral management services within the AIFMD. This particular issue has all of the right attributes to jump into a wider UCITS context, and we will be asking our new Collateral Management Steering Group (CMSG) to opine on this point over the coming weeks.
On a more general point, I would just draw your attention to our recent communication outlining the creation of a series of new working groups, including the CMSG. They are designed to set much of our regulatory agenda into 2021, and full details of these working groups may be found here.
Finally, if you have not registered for our complimentary CDM Showcase event on 1 December then I would stress the strategic importance of this initiative to the future of our industry, and look forward to welcoming as many of you there (virtually) as possible.
Andrew Dyson, CEO