25 June 2013
Response
Green Paper – “Long-term Financing of the European Economy”
BlackRock is one of the world’s pre-eminent investment management firms and a premier
provider of global investment management, risk management and advisory services to
institutional and retail clients around the world.
As of 31 March 2013, BlackRock’s assets under management totalled € 3.07 trillion
(US$3.936 trillion) across equity, fixed income, cash management, alternative investment
and multi-investment and advisory strategies including the iShares® exchange traded funds
(ETFs). Through BlackRock Solutions®, the firm also offers risk management, strategic
advisory and enterprise investment system services to a broad base of clients, including
governments and multi-lateral agencies, with portfolios totalling more than € 11 trillion (US
$14.2 trillion).
In Europe specifically, BlackRock has a pan-European client base serviced from 22 offices
across the continent. Public sector and multi-employer pension plans, insurance companies,
third-party distributors and mutual funds, endowments, foundations, charities, corporations,
official institutions, banks and individuals invest with BlackRock.
BlackRock supports the aim of encouraging smart, sustainable and inclusive growth to meet
Europe’s long-term investment needs and welcomes the focus on channelling savings
effectively and efficiently. We therefore welcome the opportunity to comment on the
European Commission’s Green Paper.
BlackRock is registered in the Interest Representative Register with ID number
51436554494-18.
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Executive Summary
As with all matters of public policy. BlackRock supports regulatory reform globally where it
increases transparency, protects investors, facilitates responsible growth of capital markets
and, based on thorough cost-benefit analysis, preserves investor choice.
The Green Paper has the ambition to find the most effective policy framework to support
substantial levels of investment in key sectors of the European economy by increasing
funding from outside the banking and public sector. The effectiveness of future regulatory
initiatives will be judged on their ability to intermediate capital either directly from investors to
target companies and projects or by using capital markets to provide long-term funding
opportunities in key sectors. BlackRock believes the design of future reforms requires a
detailed understanding of the investment needs of, as well as the regulatory and accounting
requirements specific to, core institutional investors such as pension funds, insurance
companies, sovereign wealth funds and direct retail investors.
To put our detailed response to the Green Paper into context, BlackRock draws attention to
four key themes, which we believe need to underpin policies aimed at growing long-term
financing in a world where banks face capital constraints:
1. Different investors have a variety of future liabilities and long-term investment needs
2. Long-term investment is a multi-faceted concept using multiple strategies and asset
classes
3. There is a real risk of current accounting and regulatory initiatives inhibiting long-term
financing
4. There are many positive steps policy makers, both at the European and national level,
can take to incentivise long-term financing of the European economy by investors
1. Different investors have a variety of future liabilities and long-term investment
needs
Investors typically invest to be able to meet their future liabilities. As policy makers
contemplate the long-term financing needs of Europe, it is imperative to consider the longterm investment and liability needs of pension plans, insurance companies and domestic
savers.
The ability of institutional investors to finance projects for the long term as a way of matching
future long-term liabilities is limited by each investor’s liability profile – which is different for
each one. For example, a defined benefit scheme closed to new members with a large book
of maturing liabilities will take a different investment approach to an open defined
contribution scheme with a large number of new members.
Accordingly, one of the challenges faced by institutional investors is balancing the
expectations and needs of beneficiaries and policy holders who sit at very different points in
the investment cycle. Asset liability matching techniques used by institutional investors
accordingly employ a variety of strategies and asset classes designed to meet both shortterm and longer-term liabilities as they become due.
Retail investors may have some of the longest-term investment needs of any of the
economic players with liabilities stretching many decades into the future but have far less
ability to predict their future liquidity needs than institutional investors. In addition to having to
construct a portfolio to meet their expected income needs many decades in the future, retail
investors are very sensitive to the need to be able to meet unpredictable short-term
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liabilities, such as family events or the risk of unemployment, by holding shorter-term less
volatile liquid assets.
Typically, clients specify their investment objectives as well as any constraints in their
investment guidelines, which are part of the investment management agreement (or
contract) between the asset manager and the client when the former manages a separate
account on behalf of that client. Asset managers appointed by investors have to tailor the
investment strategies and assets they invest in to the specific mandate and needs of each
client or client segment. Assets under management (AUM) represent client assets (rather
than the manager’s own balance sheet assets) all of which are subject to pre-defined client
mandates. The role of an asset manager is to act as a fiduciary for its clients, carrying out
their instructions to implement these strategies. We discuss this further in Section 2
below. In addition, investment managers may offer clients the opportunity to invest in
commingled funds (or pooled vehicles) that similarly specify an investment objective and
constraints. In both separate accounts and commingled funds, the asset manager is required
to stay within the boundaries set by the investment guidelines; managers explicitly do not
have discretion to invest outside of these constraints.
2. Long-term investment is a multi-faceted concept using multiple strategies and
asset classes
In investing assets on behalf of clients, asset managers such as BlackRock use a variety of
strategies and asset classes across listed companies, private companies and other
investment opportunities such as infrastructure.
Long-term investing comes in many forms and is not limited to the provision of capital to
private issuers or unlisted projects but also to investment in publicly traded issuers.
Mainstream equity and bond funds and securitisation vehicles have long been an important
source of capital for long-term funding of companies and projects. While there is an
understandable focus on financing SMEs (small and medium-sized enterprises) and
infrastructure to drive future growth in the European economy, we also wish to emphasise
the role of listed equity and bonds in providing long-term capital to companies. Asset
managers continue to provide deep pools of long-term finance to companies through active
and index investment strategies.
Asset managers act as fiduciaries, which means our primary duty is to act in our clients’ best
interests and put our clients’ interests above our own. In practice, this translates into
understanding the specific needs of different clients and managing portfolios accordingly
using a wide variety of techniques. This includes protecting and enhancing the value of our
clients’ assets – in other words, the securities in which we invest on their behalf. The client
chooses the type of strategy they wish the manager to follow as well as the asset classes in
which the manager may invest. When implementing strategies there are a number of drivers,
which influence a manager’s decision to adopt a “buy and hold” strategy over underlying
assets on behalf of their clients:
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Positions in both equity and fixed income index portfolios are held for as long as the
security meets the requirements for inclusion in the index
Active fixed income managers typically hold positions to maturity to benefit from
consistent income streams.
BlackRock’s active investors are also, overall, long-term in approach. Active portfolios
typically invest in fewer companies than are represented in an index. The fund manager
is therefore selecting those companies that he or she believes has the best prospects
over the long term. Within this long-term framework, managers may also use tactical
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asset allocation strategies to respond to market volatility or to meet short-term liabilities
as they fall due.
Investment is not just about the choice to buy or sell an investment. Achieving our client’s
future goals depends on our ability to maximise the value of the assets they entrust to us.
Encouraging the highest standards of board leadership and executive management in the
companies in which we invest is central to achieving clients’ goals by increasing the longterm value and sustainability of their investments.
3. There is a real risk of current accounting and regulatory initiatives inhibiting longterm financing
Investors are faced with the immense logistical challenge of implementing a myriad of new
regulations, which may have the cumulative effect of encouraging “short termism” rather
than “long termism” with increased holdings of lower risk and short-term assets. While
investors need to respond to an environment of falling yields by restructuring their portfolios
to take greater exposure to alternative sources of income and capital growth, policy makers
need to allow investors to make a longer-term assessment of the risks and volatility of assets
in which they invest. With the current requirements for risk-based capital, risk management,
collateral, and mark-to-market of assets, these investors may face disincentives to investing
with a long-term horizon. Increasing the ability and willingness of investors to take longerterm investment decisions to meet their long-term liabilities will require a concerted policy
effort to deliver a consistent and long-term regulatory framework, which is conducive to longterm decision making.
In addition, there is sometimes confusion between market finance and banking activities,
including banks’ ability to leverage their balance sheets and their historical use of off-balance
sheet financing techniques. BlackRock believes the term “shadow banking” should be used
to solely refer to banks shifting of activities off their balance sheets. “Shadow banking” is
often applied inappropriately to many market finance activities that are important to matching
borrowers and lenders without using a bank or a bank’s balance sheet to make those
connections. Market finance is important to allocate capital to drive the growth of the
European economy. It is therefore timely to revisit the merits and the consequences of
“shadow banking” reforms for European growth.
BlackRock is also concerned that certain of the regulatory solutions proposed to improve
corporate governance may wrongly usurp the role of the board of directors in the name of
protecting investors. We believe companies and their boards should have sufficient space to
be able to take the same long-term perspective we do to investing and in particular to the
governance, environmental and social factors that affect value. Specifically, we view as
counter-productive proposals to introduce enhanced rights for long-term shareholders with a
view to increase long-term decision making by companies. Enhanced dividends for longterm shareholders run the risk of raising the cost of capital as a result of the complex
operational processes required for handling differential dividends, especially for
shareholders who in turn pass dividends received onto underlying clients. Enhanced voting
rights for long-term investors breach the principle of shareholder equality and run the risk of
entrenching the rights of majority shareholders at a time when shareholder focus has been
on improving rights for all shareholders.
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4. There are many positive steps policy makers can take to incentivise long-term
financing of the European economy by investors
BlackRock believes that bank deleveraging will lead providers of market finance to
supplement, but not replace, banks and the public sector as a source of financing to key
sectors of the European economy. There are a number of positive steps policy makers can
take to encourage this flow of capital from global as well as European investors to support
the long-term growth of the European economy. Retooling existing conduits to remove
barriers and to facilitate the provision of capital by market finance participants and existing
types of financing vehicles is the most effective way of encouraging this trend. These
include:
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Providing properly calibrated incentives to investors to allocate capital to long-term
projects, particularly in the area of prudential capital
Designing a consistent regulatory framework for key sectors such as infrastructure which
provides for predictable pricing or tariff structures, otherwise contractual and regulatory
uncertainty is likely to result in investors requiring higher risk premia or deciding not to
invest at all
Standardising the conditions for the provision of capital by non-bank lenders throughout
the EU by a European asset passport, especially associated to a pan-European pooled
fund solution such as the European Commission’s forthcoming proposal for long-term
investment funds (LTIF)
Ensuring that the on-going implementation and future review of the AIFMD (Alternative
Investment Fund Managers Directive) recognises the benefits of allocating capital to
long-term investment opportunities in the EU so that investors are not discouraged from
using alternative investment funds due to excessively burdensome regulation
Aligning reporting obligations under Solvency II and AIFMD with similar global and
European initiatives
Reviewing the framework for accounting for long-term investments without losing the
benefits of transparency provided by fair value accounting
Revisiting the merits and the consequences of “shadow banking” reforms so that they do
not inhibit the flow of capital to grow the European economy through market finance.
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General presentation
In addition to responding to a number of the Commission’s specific questions we discuss the
role asset managers play in capital markets, how they meet their clients’ investment needs
and together how this can contribute to the long-term financing of the European economy.
1. Understanding the strategies asset managers use to meet client needs
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Acting as fiduciaries asset managers are under a duty to each of their clients to
act in their best interests, and in accord with their instructions and
expectations.
Asset managers generally take medium to long-term views on behalf of their
clients when executing client strategies but a simple buy and hold strategy is
not always appropriate to protect clients’ objectives or to protect their interests.
Clients can choose to meet their overall investment needs using shorter-term or
more active strategies without this inhibiting long-term growth.
Adding value to investments by engaging on corporate governance issues is a
core part of a manager’s duty to clients.
Asset management remuneration is designed to be aligned with clients’
interests by linking compensation with long-term performance.
When asset managers such as BlackRock invest in, they act as agents for their clients
subject to the parameters of the client’s mandate and guidelines. They are subject to a
fiduciary duty to each of their clients to act in their best interests, and in accordance with
their clients’ instructions and expectations. The asset management agency model is longterm in approach and structured to support long-term investment - the vast majority of our
clients have long-term investment horizons – the vast majority of our asset management
strategies are long-term by design and nature, and as such underpin long-term economic
growth.
When choosing assets to invest in, investors seek key characteristics such as secure cash
flows or exposure to growth with acceptable levels of risk. The success of existing and future
funding instruments for the growth of the European economy depends on their ability to meet
these client needs. Accessing more illiquid investments often comes with a more complex
structure given the tailored nature of the investment and lack of liquid secondary markets.
The more complex these instruments are, the greater the difficulty investors will have in
assessing future cash flows and pricing in the potential for growth and risk of default.
Within this wider context, there are a number of misconceptions regarding investors’
perceived reluctance to take long-term investment decisions, which we address below:
Length of holdings by investors
Across various portfolios, the average holding period is usually multi-year, with certain
securities representing long-term holdings:
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Index investors hold positions for the very long term1 and these represent a sizeable
book of assets. For example, a 2011 report of the Greenwich Associates found that UK
institutional investors elected passive management for 35% of their UK equity holdings in
1
Positions in index portfolios are held for as long as a company meets the requirements for inclusion in the
index.
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2010.2 To give an indication of scale, BlackRock managed US$363 billion in European
index equity mandates spread across institutional index mandates, ETFs and other
pooled index funds.3
A significant percentage of fixed income investment is bought and held until the bond
matures.
BlackRock’s active investors are also overall long-term in approach. Active portfolios
typically invest in fewer companies than are represented in an index. The fund manager
is therefore selecting those companies that he or she believes have the best prospects
over the long term. We note that a minimal correlation between earnings and share price
exists over a one-year investment horizon, but over the medium to long term, the
correlation increases significantly to become the single most dominant factor influencing
share price performance. The table below shows the level of this correlation.4
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Active UK small and mid-cap investment managers typically have holdings of 10% to
15% or more of a company and take a 3 to 5 year investment view to take advantage
of this correlation.
Figure 1 shows that the average holding period of UK stocks in BlackRock’s UK All Cap
Core portfolio is around 4 years.
2
Greenwich Associates, “Market Graphics – UK Investment Management”, 2011.
BlackRock data as at 30 April 2013
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Source: BlackRock data as of October 2011
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Figure 1: UK All Cap Portfolio
BlackRock’s data is consistent with the conclusions of a recent Investment Management
Association survey, which showed that the average holding period of UK stocks by its
members was at least four years.5 The statistics cover all investors in UK equities, not just
UK investment managers, and point to an average holding period of between 30 and 48
months depending on the year of analysis.
BlackRock’s experience is also consistent with external studies conducted by Eumedion on
the Dutch institutional market, which found that “the funds investigated in this study held
more than 80% of the portfolio for five years or more. On average, a Dutch equity was kept
in the portfolio for roughly three and a half years”.6
Investors have different investment horizons based on their long-term liabilities and their
short-term cash flow needs. Investors may also choose to rebalance their asset allocation
based on changing market conditions. These and other factors, in turn, impact the turnover
in an individual portfolio.
Portfolio turnover rates
Portfolio turnover rates have attracted much attention as an indication of short termism by
investors. BlackRock notes that these rates can present a misleading picture especially in
open-ended funds as they include secondary market activity by clients subscribing and
redeeming and not just the asset manager’s long-term strategy. Pooled vehicles offer the
ability for investors with different time horizons or liability profiles to invest alongside each
other and make investments to which they would not otherwise have access. In many cases,
the corollary for co-investment is the need to provide direct or secondary market liquidity to
investors, otherwise the fund will not be scalable or indeed viable. This does however mean
that pooled funds typically have a continual flow of subscriptions and redemptions.
From a portfolio management perspective, turnover of stock is also a reflection of sound risk
management practices leading managers to determine the proportion of individual stocks
5
“Asset Management in the UK 2011-2012 – The IMA Annual Survey”, IMA, September 2012.
Eumedion,“The Duration and Turnover of Dutch Equity Ownership - A Case Study of Dutch Institutional
Investors”. The study also found that “Holding periods have not decreased in the last ten years, based on the five
observed funds. Overall, the data suggests that more turnover cannot be easily linked to a shorter holding period,
which in turn cannot be related to an investment horizon. Here too, a long holding period might be indicative of a
long investment horizon, but a short holding period cannot be indicative for a short investment horizon.”
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held in a portfolio. Given asset price changes over time the manager will review relative
weightings on a regular basis to ensure that the weightings remain in line with the initial
allocation. If one stock has increased rapidly in value a manager may well sell part of the
holding to bring the weighting into line. On the contrary, if a stock drops significantly in value
the manager will need to determine whether the fundamentals justify purchasing further
stock to maintain the initial weighting or reassess the suitability of holding the stock in the
portfolio at all.
References to industry level portfolio turnover levels and standard length of ownership levels
in the past have also aggregated proprietary trading by banks with institutional investor
holdings and so provide a misleading view of actual holding period by institutional investors.
Further detail on why portfolio turnover rates can appear so high can be found in a recent
IMA paper on the topic.7
Adding value through corporate governance engagement
BlackRock believes that it is a core part of our fiduciary duty to clients to engage with
companies in which we invest. Encouraging the highest standards of board leadership and
executive management in the companies in which we invest is central to achieving that goal.
As a long-term investor with significant investment in index-tracking strategies, we are
patient and persistent in working with portfolio companies to build trust and develop mutual
understanding. Any review of the scope of the fiduciary duty of asset managers should
reinforce their primary duty to protect clients’ interests. We support the inclusion of additional
criteria such as consideration of responsible or socially useful investment as a way of
meeting this primary duty by maximising the value of assets clients entrusted to us rather
than an end of its own.
BlackRock actively participates in and supports initiatives to improve corporate governance
and long-term value creation such as the UN Principles for Responsible Investment
(UNPRI), the International Corporate Governance Network, the US Council of Institutional
Investors and Eumedion in the Netherlands. For fuller detail of how BlackRock engages on
specific issues such as shareholder rights and diversity, please see our annual Corporate
Governance Review.8
In respect of actively managed mandates, consistent with its duty to its clients – absent a
different mandate or focus – a manager may decide it is in its clients’ best interests to sell a
stock rather than continue to engage. Index managers, in particular, view engagement on
corporate governance as critical to adding value to the clients’ investments.
We will vote against management when we think that is in our clients’ best long-term
interest. However, we believe that effective stewardship requires much more robust
engagement than simply casting negative proxy votes. In our experience, real change in
behaviour by a company takes research, reflection and thoughtful planning. Boards have to
strike a delicate balance between divergent shareholder opinions, regulatory demands and
strategic priorities. We think companies and their boards should have sufficient space to be
able to take the same long-term perspective we do to investing and in particular to the
governance, environmental and social factors that affect value. Management and boards
therefore need the opportunity for thoughtful deliberation and to fashion responses that are
truly aimed at creating shareholder value – rather than simply responding to a publicity
campaign.
7
IMA: “Understanding Equity Turnover Data: Initial findings from IMA research submitted to the Kay Review”
http://www.investmentfunds.org.uk/assets/files/consultations/2011/20111128_IMATurnoverResearchInitialFindings.pdf
8
BlackRock Corporate Governance Review 2012: http://blackrock.uberflip.com/i/120266
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Alignment between long-term performance and compensation
Asset managers are subject to strong incentives, which underpin our long-term approach:
There is a strong correlation between asset management share price and earnings.
Fee and compensation structures are designed to align long-term performance with
variable remuneration assessed over a multi-year period with a proportion typically
deferred over a number of years. These structures are designed to ensure that
remuneration does not inadvertently incentivise perverse outcomes by encouraging
short-term, risky behaviour; and delivers rewards that are proportionately related to the
value proposition for clients.
In addition, unnecessary turnover of portfolios (“churning”) does not benefit the asset
manager.
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2. Combining long-term financing and investors’ needs
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Understanding investors’ needs to invest to meet future liabilities is key to
developing a more conducive framework for long-term financing of the European
economy by institutional investors.
Investors have a wide range of liability profiles which may directly influence their
ability to take positions in illiquid assets, especially as these may show greater
short-term volatility.
Prudential rules exist to protect the interests of the ultimate beneficiary.
Technical changes to these rules to encourage greater focus on “long-term
assets” should not undermine the on-going solvency of institutional investors.
Outside tax-incentivised pension wrappers, the vast majority of retail investors
require relatively liquid investment to meet potential unpredictable short-term
liabilities.
Asset managers channel financing to the European economy by allocating the capital of our
clients to European companies, governments and projects. Asset managers continually
assess new instruments for their ability to meet clients’ investment needs and actively seek
innovative solutions for investments, which support the financing of the European economy.
The debate on long-term investing is often reduced to a discussion of the benefits of
investing in illiquid assets. BlackRock believes the starting point should be to consider what
asset mix is best suited to individual investors’ liability profiles and other investment needs.
Institutional clients, such as pension funds and insurance companies, have greater ability to
use actuarial profiling and liability modelling to determine their likely short- and longer-term
liquidity needs. Policy makers should encourage most investments in illiquid and private
assets such as infrastructure, SME and other similar investments by designing vehicles,
which address the specific needs of end investors. Then it will be up to insurers and pension
schemes to assess the suitability of particular offerings and decide whether they want to
invest directly in these vehicles, hire a manager for a mandate or invest in a commingled
fund.
Prudential regulation of institutional clients such as insurance companies and pension funds
is designed to protect the interests of the ultimate beneficiary such as policy holders. Future
changes to client mandates to allow greater investment in longer-term illiquid assets will
depend on the suitability of these assets to meet investors’ needs and investment horizons
without compromising on-going solvency requirements. The willingness of these institutional
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investors to provide more capital to long-term assets requires policy makers to take a view
as to the right amount of risk-based capital to protect policy holders’ legitimate expectations
while still encouraging longer-term investment.
Retail investors may have equally long investment horizons but have far less ability to
predict their future liquidity needs. Outside tax-incentivised pension wrappers, the vast
majority of retail investors need liquid financial instruments even when investing for the long
term to meet unpredictable short-term liability. In addition, many infrastructure projects are
complex in nature and direct investment in them requires a level of due diligence and
assessment that retail investors are ill equipped to perform. However, investing in the
equities or bonds of liquid, regularly traded listed companies whose business model is based
on developing long-term growth and infrastructure also supports the long-term growth
agenda.
3. Restructuring the European economy to provide a greater role for market finance
will take time as will removing barriers to investment
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Banks will continue to play a key role in originating and underwriting the risk of
many investment opportunities.
Public authorities and public investment banks will also continue to be critical in
structuring and providing credit enhancement to many investment opportunities.
Sustained regulatory coherence is key to providing a supportive framework for
growth and long-term financing. This is needed not only at the level of investors
but also at the level of regulations affecting strategic investment opportunities
such as infrastructure and SMEs.
BlackRock recommends a number of specific changes to accounting policy to
allow more accurate representation of the future returns of long-term investments
BlackRock encourages practical measures to further improve engagement.
between institutional investors and the boards and management of listed
companies but warns of potential unintended consequences of some of the
proposed changes.
Encouraging increased cross-border investment by investors both inside and outside the EU
in key sectors such as infrastructure and SMEs depends on the development of consistent
regulatory treatment of investors. This consistency will allow and encourage investors to
allocate capital on a pan-European basis rather than to focus on specific markets.
The success of pan-European instruments such as EU long-term investment funds (LTIFs)
or securitisations will reflect their ability to offer investors access to consistent pan-European
investment opportunities, which they could not obtain effectively through individual direct
investment. Examples could include standardised treatment on default of the underlying
investment in each Member State, the ability to provide loans to corporates, or the abolition
of discriminatory tax treatment. In particular, any policy decision to ascribe a more
favourable prudential or regulatory treatment of certain long-term assets such as
infrastructure or loans could be linked to their inclusion in a pan-European pooled investment
product meeting basic diversification, due diligence and reporting requirements, such as in
the European Commission’s forthcoming proposal on long-term investment funds.
BlackRock believes that banks will continue to play a key role in originating and underwriting
the risk of many investment opportunities especially to smaller companies. Efforts to
encourage banks to continue to provide loan finance are essential. The needs of medium-
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sized or intermediate companies are different and it is particularly at this level that there are
opportunities for non-bank entities to provide alternative sources of finance.
Arguably, the availability of funding is currently tightest not for SMEs, which banks often
acknowledge they have to refinance, but for leveraged intermediate size companies (ISCs) –
companies’ borrowing €20mm to €250mm.9 Public authorities, acting through public
development banks, will also continue to have a key role to play in structuring and providing
credit enhancement to many investment opportunities by offering a stable and committed
source of seed capital for projects which might not otherwise come to fruition. We would
point out in this context the role played by multi-seller asset-backed commercial paper
(ABCP) vehicles in making more efficient working capital for Europeans SMEs.
Equally as important is ensuring that new regulatory initiatives are introduced in a coherent
manner and that well-intentioned initiatives designed to stimulate growth do not conflict with
initiatives designed to promote stability, but rather, that they dovetail together. Financial
regulatory reform fundamentally impacts asset managers and investors. We strongly support
a credible impact analysis of the cumulative effect of the current wave of regulatory reform.
We are concerned that in some instances, regulatory overshooting may be impeding
consumer choice and growth of European capital markets.
Very specific examples exist where the costs of regulatory reform appear to be outweighing
the benefits. It is little understood that the data requirements for new regulatory reporting
initiatives, such as AIFMD, are significant and costly to provide in the format provided. While
we fully understand the need for data, more focus on designing systems for collecting data
such as trade repositories, centralised data reporting with the relevant European Supervisory
Agency (EBA, EIOPA or ESMA) and standardisation of identifiers such as LEIs is required
before the detailed reporting, as required by AIFMD, come into force. Firms are currently in
the position of setting up systems for many overlapping data requests without agreement on
common technical standards.
However, an even greater concern arises where there are instances of regulatory
frameworks appropriate for one financial sector (e.g. banking) applied to other sectors (such
as asset management, insurance or the pension fund industry) without obvious
consideration of the business models or the impact on the end-investor. We are encouraged
by the recent announcement from the European Commission to postpone applying Solvency
II-like capital requirements to pension funds but remain concerned about the unintended
consequences for the viability of certain activities carried out by asset managers on behalf of
clients labelled “shadow banking”.
Future reforms of AIFMD will consider extending the marketing passport to non-EU AIFs
(Alternative Investment Funds). It is important that the terms of the future passport do not
inhibit investors’ ability to select investment opportunities outside the EU, by imposing
prescriptive rules with prohibitive levels of cost and regulatory complexity on non-EU AIFs
rather than focusing on core areas of equivalence. It is also important to bear in mind that
investment by European investors outside the EU does not necessarily mean reducing
financing to European companies as many overseas markets and projects are key export
targets in terms of equipment, know-how and services for European companies.
We support practical measures to further improve engagement between institutional
investors and the boards and management of listed companies. As set out in the
Commission’s European Company Law and Corporate Governance Action Plan, changes in
regulation and practice could and should be made to promote greater transparency of
companies’ corporate governance, reinforce constructive shareholder influence, and
9
See Standard & Poor’s, “The Squeezed Middle”: S&P Says Europe’s Midzise Companies Need Up to €3.5
Trillion Funding by 2018”, 25 June 2013. twitdoc.com/24Z3
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facilitate collective shareholder action where appropriate. However, there are structural
constraints on what shareholders can achieve in certain circumstances. As the Commission
has recognised previously, it is supervisory authorities who have the front line responsibility
for banks, non-bank financial institutional institutions and other regulated entities. The role of
the asset manager should be to enhance the value of clients’ assets and to ensure
management are running the company in the best long-term interest of shareholders. This
includes:
• engaging with the companies that we invest in on a number of corporate governance and
performance-related issues
• voting at shareholder meetings (for those clients who have given us a legal right to vote
on their behalf)
• engaging on wider policy issues that are in our view fundamental to protection of
investors and their rights as shareholders.
Changes to quarterly reporting requirements
BlackRock acknowledges the concerns behind proposals to drop the mandatory quarterly
reporting requirement, e.g. in the Transparency Directive. While further investigation into the
impact of quarterly reporting might be worthwhile, we believe that there is a debate to be had
about the frequency of reporting that strikes the right balance between giving shareholders
information they need and allowing companies to communicate their long-term objectives.
We also believe that increased integration of financial and non-financial information will
provide a clearer view of a company’s long-term performance and contribute to better
decision making.
Changes to incentivise more effective engagement
BlackRock supports practical measures to further improve engagement between asset
managers and the boards and management of listed companies.
Better long-term shareholder engagement will be facilitated by providing shareholders with a
uniform toolkit across EU Member States to exercise their voting rights, for example, by
eliminating impediments to exercising voting rights such as share blocking. We do not
believe that changes to companies’ share structure by introducing enhanced voting rights or
dividends dependent on the length of ownership will benefit long-term engagement with
companies. Rather these measures could well be counterproductive by entrenching a core
group of shareholders to the detriment of minority shareholders, diminishing the incentives
for issuers to engage on corporate governance issues with any shareholder outside the inner
core. In addition, the cost of monitoring and applying these provisions to share registers and
underlying sub-registers would be significant for issuers at a time when the primary policy
aim is to increase access to capital rather than raising the cost of capital.
4. Asset managers are actively engaged in designing investment solutions for
clients, which finance long-term projects
Investment in infrastructure projects is attractive to clients. BlackRock currently
sees potential in infrastructure equity, especially in the area of renewable power.
Infrastructure debt is also attractive to investors by providing inflation protected
yields above government debt
• Investors need to build up experience of investing in this asset class and
understand how it can assist them in meeting their liability profiles
BlackRock
and other
asset long
managers
are actively
engaging
inbuilding
initiativesup
to familiarity
facilitate and
• Developing
accurate
performance
data
is key to
investment
into
alternative
asset
classes
by
their
institutional
clients.
to allow accurate credit and liquidity risk analysis of the asset class
•
13
Alternative asset classes are distinct and numerous. The two charts below show examples
of strategic investment allocation to alternative assets by UK and Europe ex UK plans
respectively.10
For the purpose of this response, we have focussed on the drivers which are leading
institutional investors to invest in infrastructure, in particular infrastructure debt. We do,
10
Mercer’s European Asset Allocation Survey 2012 – Charts 11 and 12. The charts show the proportion of plans
that have a strategic allocation to a particular investment strategy as well as the average allocation to that
strategy for those that have made an allocation.
14
however, look at other opportunities for clients and note that many of the criteria clients use
to decide whether to invest into infrastructure are common to many other assets classes.
For our clients to invest in long-term infrastructure in scale, the opportunities must meet their
investment requirements. The trade-off between liquidity, risk and yield must be appropriate:
• The cash flows must be similar to liability cash flows (nominal or inflation linked)
• Opportunities must fit within the overall portfolio strategy and must add more value than
other alternative investments.
The product design must not create obstacles to investment:
• The product must have transparency and a competitive pricing structure
• The product design must exhibit characteristics which are consistent with regulatory or
accounting requirements.
With these drivers in mind, BlackRock has committed considerable resources to developing
solutions allowing investors to access long-term infrastructure projects. This is particularly
the case as in the current low yield environment, institutional investors are also looking for a
Solvency II-optimised alternative to investment-grade corporate and sovereign debt.
One of the areas of particular focus has been on senior infrastructure debt, which we believe
offers stable, predictable cash flows, and attractive returns providing inflation protected
yields above government debt. Typically, it represents a core fixed income substitute of
between 5 and 30-year maturities, offering low correlation to core and investment grade
bonds.
Key characteristics which can make senior infrastructure debt attractive to institutional
investors include the ability to provide:
•
•
•
•
•
•
•
Investment grade quality in essential and core infrastructure11
Revenue streams backed by real assets with a social utility aspect
Fixed rate, floating rate or inflation-linked options
Liquidity premium over medium- to long-term maturities
Controls, with regard to security, remedies against borrowers, and the ability to monitor
performance in detail
Private debt opportunities in primary and secondary transactions
Debt issued in the currency in which the investor’s primary liabilities are denominated
e.g. euro, sterling, US dollar.
Our experience is that institutional clients across the world are increasingly turning to longterm illiquid assets to diversify and increasingly considering renewables and utilities,
commercial real estate and long lease property. This indicates that for risk controlled
illiquidity, some sophisticated institutional clients are prepared to give up liquidity for the sake
of enhanced yield. The take up of these asset classes is dependent on developing accurate
long-term investment performance data as investors adapt their due diligence and risk
monitoring processes. We note studies, such as those produced by the main rating
agencies, are coming to the market looking at issues such as the credit risk of infrastructure
debt.12 However, institutional investors still require both a greater range of data and the
willingness to develop teams with the specialist skills needed to analyse data as it becomes
more available.
11
Assets may not be formally rated by external rating agencies due to the private nature of investments.
Examples include: Fitch, “Infrastructure Ratings Prove Resilient through the Downturn”, March 2011; Moody’s,
“Default and Recovery rates for Project Finance Loans”, October 2010; Standard & Poor’s, “Figuring the
Recovery Rates When Global Project Finance Transactions Default”, October 2010.
12
15
We also recognise the view of key regulators that the prudential treatment of infrastructure
as an asset class is not intended to act as disincentive as compared to other asset classes
with a similar risk or duration profile. However, we believe that it could be justifiable at a
political level to build in additional technical criteria to standard prudential capital models,
which could incentivise allocation to longer-term infrastructure investment, thereby
recognising the wider economic benefits of stimulating long-term sustainable growth. Larger
institutional investors can run their own internal modelling to reflect risk but there is potential
for policy makers to decide that pan-European pooled vehicles investing in a diversified set
of key asset classes such as infrastructure or SME financing should benefit from a more
favourable capital treatment for solvency purposes and thereby appeal to a wider
institutional and global investment audience.
Finally, at a national level across EU Member States, we have noted that there are
numerous restrictions on institutional investors investing in pooled fund solutions holding
illiquid assets, such as prohibitions on allocating investments into AIFs, tax disincentives on
investment into AIFs, and restrictions and / or prohibitions on non-banking entities providing
loans. As well as direct legislative action looking at new investment vehicles, we also believe
the European Commission can provide a valuable role in encouraging Member States to
update their national frameworks to reflect and provide a supportive and consistent
regulatory, tax and accounting framework, to encourage increased financing by investors to
long-term investment opportunities.
BlackRock has written extensively on a number of the issues including the regulation of
market finance entities and corporate governance that the European Commission includes in
its Green Paper. We would encourage the Commission to cross-reference the remarks in
this response with those in the related BlackRock comment letters and ViewPoints:
•
•
•
•
•
•
•
•
June 2013: Response to the ECON Questionnaire on Enhancing the Coherence of EU
Financial Services Legislation
April 2103: Annual review of Corporate Governance: Shaping Global Governance
January 2013: Response to the House of Commons and Department of Business
Innovation and Skills joint request for evidence on the Kay Review
January 2013: Response to Financial Stability Board’s Consultative Document –
Strengthening Oversight and Regulation of Shadow Banking
October 2012: Response to the European Commission’s Green Paper on UCITS reform
July 2102: Response to the Financial Reporting Council’s Consultation Paper on
Revisions to the UK Stewardship Code
June 2012: Response to the European Commission Green Paper on “Shadow Banking”
November 2011: Response to the Call for Evidence of the Kay Review of UK Equity
Markets and Long-Term Decision Making
Copies of all these documents are available at: http://www.blackrock.com/corporate/engb/news-and-insights/public-policy/letters-consultations
16
Specific questions asked in the Green Paper
THE SUPPLY OF LONG-TERM FINANCING AND CHARACTERISTICS OF LONG–TERM
INVESTMENT
1) Do you agree with the analysis set out above regarding the supply and
characteristics of long-term financing?
BlackRock agrees that reliance on bank lending in corporate and household financing is
higher in Europe than compared to other regions. This can hold back any economic recovery
whenever the banking cycle experiences a trough, and therefore it is desirable to encourage
other countercyclical sources of finance, which are more able to withstand short-term
volatility in asset prices. Different forms of financial intermediation are more or less effective
in providing shock absorbers in taking long-term investment risk and exhibit different level of
resiliency to the risk of the volatility of their assets. Taking some examples:
•
Pension funds have long-dated, contingent liabilities (i.e. the beneficiary has to be alive
to receive expected benefits). Pension funds can invest in long-term assets, and
“absorb” the volatility and indeed earn money from it in the long term due to their longterm horizons. Pension funds offer an effective form of long-term investing that absorbs
the risks.
•
Similarly, most liabilities of insurance companies are long-term and contingent
(depending on the contractual right of policy holders to call on the policy) with pass
through of volatility to balance sheets. For example, this may lead to a decline in
insurance company equity and debt decline after natural disasters. Overall, the structure
of insurance companies’ long-term liabilities makes them also an effective absorber of
volatility.
•
Banks, by contrast, have deposit liabilities payable on demand at par. They hold debt
and relatively low levels of equity, which means that they are not efficient at absorbing
volatility. Historically, banks absorbed volatility by not marking assets to market very
often and holding assets to maturity. The regulatory focus on marking assets to market
has constrained how much risk and volatility banks can take on because of the liquidity
mismatch between liabilities and underlying assets. Increased levels of equity capital
would reduce this pressure, but as long as banks have difficulty marking assets to
market or raising capital they will remain very pro-cyclical in their nature.
•
Investment funds are essentially 100% “equity” funded. Typically, they operate on the
basis of daily mark-to-market valuation of their liabilities to reflect the volatility of their
assets and changes in value of assets are directly passed through to the holders of the
fund’s liabilities (e.g., its investors). This then depends on the ability of those underlying
investors, such as pension funds and insurance companies, to absorb these liabilities.
BlackRock believes there is ample room for more market financing within Europe,
particularly in the Eurozone, to provide a more diversified market structure, which is better
able to withstand cyclical shocks. The current low level of market financing within Europe is
a reflection of the current lack of incentives for the provision of institutional finance outside
the banking sector. BlackRock recommends measures to enhance the role of capital
markets, leading to greater macroeconomic flexibility and financial markets’ responsiveness
to financing opportunities. These measures should include action to reduce investor
conservatism and bring about a level playing field for European private financing solutions.
17
BlackRock also agrees that there is a continued role for targeted public financing including
anti-cyclical investment in public-interest infrastructure, especially where governments can
take advantage of historically low interest rates without jeopardising public finances.
2) Do you have a view on the most appropriate definition of long-term financing?
BlackRock believes that long-term financing is a multi-faceted concept. As mentioned in our
introductory comments, long-term financing comes in many forms and is not limited to
providers of market finance, including mainstream equity and bond funds and securitisation
vehicles, which have long been an important source of capital for funding companies and
projects. Asset managers continue to provide deep pools of long-term finance to companies
through active and index investment strategies. Active equity managers have many
incentives to invest for the longer term as turning over portfolios adds to costs and
decreases the value of assets on which managers’ fees are calculated. Fixed income
managers will frequently look to hold positions to maturity to benefit from consistent income
streams. Positions in index portfolios are held for as long as a company meets the
requirements for inclusion in the index.
Any definition of long-term financing should not therefore be limited to specific asset classes,
which are not traded on public markets. It is also essential not to inhibit shorter-term trading
strategies and investment in short-term assets to allow investors to continue to meet their
short-term liabilities and to react appropriately to changes in market volatility.
Within this wider perspective, definitions of long-term financing need to reflect the suitability
of specific asset types for an investor’s investment needs. This is especially the case where
long-term financing often takes place in illiquid markets with privately held securities,
resulting in a lower degree in valuation transparency compared to investing in liquid markets
with publicly tradable securities. Investors will look for the following characteristics which are
typically available on publicly-traded assets before deciding whether a specific-long-term
project meets their long-term needs:
•
•
•
•
•
The risk and return characteristics of such long-term investment projects should
adequately reflect the project’s level of cash flow uncertainty and default probability.
The capital lock-up and the risk characteristics should fit into an investor’s overall
investment policy.
The performance and risk drivers must be capable of being assessed.
There must be adequate insight into the cost structure of the investments, from
promoters and/or the managers of such investments.
Contractual certainty and a coherent regulatory framework especially for projects with
public involvement in terms of pricing or contractual review to avoid excessively high risk
premia.
ENHANCING THE LONG-TERM FINANCING OF THE EUROPEAN ECONOMY
Commercial banks
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?
In order to meet forthcoming capital requirements, banks’ restructuring of bank balance
sheets is expected to continue which will reduce long-term funding opportunities. Banks will
still maintain a key role in providing finance for SMEs (small and medium-sized enterprises)
as this forms part of their key role of lending to the economy and in many infrastructure-type
products, due to their ability to originate deals and conduct credit analysis. We expect,
18
however, that debt such as debt infrastructure and SME loans, particularly of loans to
intermediate-sized companies, will increasingly be held by institutional investors. Importantly,
debt finance will be in the format of both loans and bonds. Therefore the distinction between
bank loans and bonds will become blurred and less relevant over the coming years as
institutional investors become greater providers of debt capital.
National and multilateral development banks and financial services
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 long-term
investment in sustainable growth?
Development banks play a key role in kick-starting projects through their extensive
experience of credit assessment of long-term investment opportunities. Their experience of
projects of this nature will encourage co-investment from the private sector. Development
banks may also encourage co-investment when their participation is coupled with the ability
to offer credit enhancement, building on these banks’ own high ratings. This is particularly
the case where the market is not able to provide funding on its own, due to the size or nature
of the project, and where a committed public sector seed investor will bring in other
investors.
For example, we are aware that development banks such as the European Investment Bank
are seeking to address the limited supply of project bonds. This could be done by providing
partial guarantees or by sponsoring issuance, which would increase the credit quality of
project bonds, making them more attractive to institutional investors. However, it is important
to ensure a proper balance between ratings and pricing. Otherwise there is a risk of pushing
bonds towards say, single A status, to an extent that returns are diluted.
The remit of development banks should therefore focus on unlocking capacity rather than on
simply providing cheap debt in sectors where the private market is willing and able to provide
capacity.
5) Are there other public policy tools and frameworks that can support the financing
of long-term investment?
As a general point, one of the major concerns expressed by investors is the need for a
consistent and coherent regulatory framework for policy making that allows for contractual
certainty for investment decisions to be implemented over several decades. Contractual and
regulatory uncertainty translates into higher required risk premia by investors, especially if
the size of such projects reduces the ability of investors to implement project diversification.
Those jurisdictions and regions with a track record of consistent and considered policy
decision making are likely to attract a greater range of committed long-term investors than
jurisdictions or regions with a history of a more volatile decision making process.
More specifically, there are a number of initiatives which we see as valuable examples
including:
•
•
The NAPF’s Pension Infrastructure Platform (PIP) in the UK is a platform designed to
give pension funds access to the asset class on terms suitable for pension funds and
which are not currently available in the market by issuing bond-type instruments to its
investors. The PIP will then channel its funds into infrastructure investment, potentially
both greenfield and brownfield projects.
European Project Bonds – see our answer to question 4 above.
19
•
•
Ensuring a proper framework for productive long-term finance is not suppressed by
regulatory risk-weightings – see our answer to question 7 below.
Encouraging the ability of companies to draw on non-bank sources of financing – see
our answer to question 11 below.
Institutional investors
6) To what extent and how can institutional investors play a greater role in the
changing landscape of long-term financing?
See also answers to questions 1 and 2 above.
There are a number of key drivers, which mean investors across Europe are
increasingly turning to alternative asset classes in the search for returns. Focussing
on these drivers is key to understanding the extent to which institutional investors can
play a greater role in long-term financing.
In particular, one key decision is whether an investor wishes to gain exposure to
assets such as infrastructure for asset-liability management (ALM) purposes for
return-seeking purposes. Matching assets to liabilities typically favours investment in
more debt-like instruments because the key risk then becomes default risk rather than
market or pricing risk. This means that if, for example, an investor is looking at
infrastructure for investment provision there is a strong bias towards illiquid debt, but if
surplus assets are being invested investors are more likely to be driven by a riskreturn analysis and will be more willing to look at equity returns.
Within Europe, there is growing focus on secure income assets (infrastructure debt,
commercial real estate debt) and other sources of capital growth (infrastructure equity
and private equity) which are not traded on public markets. As discussed in our
answer to question 1, institutional investors, such as pension funds and insurance
companies, act as absorbers of market volatility and prudential regulation should
recognise this. We discuss this issue including issues such as the appropriate level of
matching adjustment further in question 7 below.
In addition, investors, in particular insurers, recognise several key benefits to investing
in illiquid assets of the types mentioned above:
•
•
•
•
Evidence of higher spread than liquid credit, associated with the added complexity of
sourcing and managing these types of assets.
Credit diversification: despite the lack of mark to market pricing, there is reasonable
evidence of strong cash flow, and an intrinsic diversification of credit (default) risk.
Higher returns: private equity and infrastructure equity assets offer a diversified source
of risk, and higher returns – though their ability to match liabilities precisely is more
limited. Insurers are in general more cautious about increasing allocation to these asset
classes, as these attract the 42% type 2 equity capital charge.
Overall, for debt alternatives, an effective matching adjustment framework, coupled with
hold to maturity investment should make these assets more attractive, as mark-tomarket volatility is replaced with a cash flow orientated investment focus.
There are, nevertheless, a number of drivers which may inhibit increased investment in
financing illiquid assets:
•
Asset allocation by institutional investors is likely to provide an upper limit on the size of
illiquid investment within their portfolios. Pension plans will soon be confronted with net
20
•
•
•
payments to participants as the greying of the workforce in Europe approaches. Going
forward for many pension funds, this will increase the need for greater liquidity. The
same applies to the life insurance sector.
Investment structures where investors have to wait several years to receive returns
above the initial capital commitment will become less acceptable for institutional
investors when net payments become a fact and are on the rise. This can occur,
commonly in equity investments, if there are negative returns for the first years as a
result of capital drawdowns and where an investment portfolio has not yet started to
mature (e.g. the J-curve effect in private equity investment).
Complexity is another issue. Often infrastructure financing contains a very high legal
content that leads to complexity that not all institutional investors are able to cope with.
Larger investors with dedicated infrastructure finance teams will not have an issue with
such complexity, but smaller investors will. For governments to tap into the pool of funds
that smaller investors might be able to supply, standardisation of complexity needs to be
accomplished. One example is the NAPF’s initiative to launch a Pension Infrastructure
Platform in the UK.
Another key issue is improving the quality of data available. BlackRock’s experience is
that for newer asset classes – including those discussed under long-term finance,
institutional investors are demonstrating a clear focus on establishing high quality data
and analytics from the outset. This includes not only the expected asset level data, but
also requests for credit analysis and time series data. Greater take up of infrastructure
will develop when this data becomes more widely available. Initiatives by the European
Commission to encourage specialised rating agencies, or co-operation between
European and national multilateral development banks in data sharing could be
invaluable in this process.
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?
IORPs
We support at this stage the Commission’s recent announcement not to proceed with the
application of Solvency II-style prudential rules to institutions for occupational retirement
provisions (IORPs), and would encourage the Commission to ensure that productive longterm investment is not penalised by regulatory risk-weightings if new capital requirements
for pension funds are included in future revisions to the IORP Directive. We acknowledge
that this is a complex area.13 However, there are a number of challenges to take into
account when designing any future regime:
•
•
•
The complexity of the calculations can hardly be justified without knowing the outcomes
that will be required.
It is difficult to evaluate whether the draft technical specifications provide enough
guidance without greater insight into the role of the holistic balance sheet approach and
how it might operate and be used in practice.
The administrative burden will be unacceptably high for many pension schemes given
the complexity of the calculations.
Solvency II
We support the Commission’s recent announcement not to proceed with the application of
Solvency II-style prudential rules to IORPs, and would encourage the Commission to ensure
13
For more details see our comment letter in response to EIOPA’s Consultation on the Draft Technical
Specifications QIS of the IORPD review – EIOPA, July 2012.
21
that productive long-term investment is not unduly penalised by regulatory risk-weightings if
new capital requirements for pension funds are included in future revisions to the IORP
Directive.
In respect of Solvency II, BlackRock believes that it is justified from an economic and
investment perspective for insurers to hold long-term assets against liabilities that are
predictable and stable. Insurers will have an incentive to invest from a liability-driven
perspective if the appropriateness of the assets is correctly recognised in the matching
adjustment mechanism under Solvency II. A key question is whether under Solvency II the
capital charges and balance sheet impacts associated with investment into assets such as
infrastructure and commercial real estate debt are appropriate given the nature of both
assets and liabilities.
In this context, BlackRock has considered in detail EIOPA’s recent Discussion Paper on
Solvency II14 and is in broad agreement with the in-depth analysis it has carried out on
market value volatility, noting that EIOPA’s primary role is to protect policy holders rather
than a wider remit to encourage growth and long-term financing. Any exceptions to the
proposed risk weightings need to be grounded on the basis of fact and data, but EIOPA
does not have access to sufficient data to make a definitive decision at this
stage. However, we would not be against a decision to make infrastructure, socially
responsible investments or private equity more attractive for insurers on political grounds by
way of a clear derogation or exemption, rather than encouraging EIOPA to introduce
artificially suppressed capital requirements.
BlackRock also believes that the greatest scope for encouraging the use of long-term
finance assets by insurers, especially in respect of illiquid debt, will be seen when
considered in the context of cash flow matching (the Matching Adjustment). BlackRock
welcomes the recent conclusions of the Long Term Guarantees Assessment in support of
certain Matching Adjustment Proposals.
Lower charges may in certain circumstances be determined through internal models, such
as where an insurer has the ability to better model assets and liabilities than the scope of the
standard formula permits, or has specific data supporting a bespoke calibration of their
particular assets.
Level of capital charges for infrastructure debt
•
Most insurers investing in the asset class have a buy and hold strategy, which means
that intrinsic value of cash flows of their assets should be fairly stable as long as the
asset class continues to offer stable credit performance. Where used for close matching
of annuity style liabilities, BlackRock would expect some degree of dampening with
regards to spread risk.
•
The current Standard Formula for long-term investments tends to focus on spread
volatility through the use of credit ratings, implicitly linked to the spread volatility
observed in liquid credit. This seems pragmatic, given the limited pricing data publicly
available.
Level of capital charges for infrastructure equity and private equity
•
We believe the 49% charge is actually not excessively high and not prohibitive for private
equity and infrastructure equity.
14
EIOPA Discussion Paper on Standard Formula Design and Calibration for Certain Long-Term Investments, 8
April 2013.
22
•
•
Economic diversification between illiquid equity investments and other exposures is
reflected through the diversification built into the standard formula.
Fund of Funds are discussed positively as reducing the risk profile in the discussion
paper and we agree with this and do not believe that the additional layer of fees in a fund
of funds model (which are more or less constant) will lead to a higher volatility of returns.
Future initiatives: Use of the Matching Adjustment in Solvency Capital Requirements
(a) Key Considerations
BlackRock believes there are a number of key considerations when evaluating a Matching
Adjustment:
•
•
•
•
Adjustment of spread to reflect expected losses (fundamental spread)
Reinvestment risk associated with prepayment
Reinvestment risk associated with funds recovered after default
As EIOPA have noted, infrastructure debt characteristics vary significantly.
Where assets are used for matching, Insurers need a good understanding of asset cash
flows, rather than market value volatility, and as such benefit from asset level credit analysis
and an understanding of historical prepayment characteristics. This should allow them to
understand default and recovery characteristics, and accompanying reinvestment and ALM
impacts associated with prepayment and default.
(b) Structured Credit
One of the questions raised in the Green Paper considers encouraging increased investment
into securitised assets. Structured credit assets such as securitisations currently attract a
high capital charge. BlackRock believes, however, that there is scope for certain, high quality
structured assets to be included in an efficient matching portfolio. To the extent that these
assets are hold to maturity, spread volatility becomes of lesser importance, and the focus
should be on strong asset cash flows.
8) What are the barriers to creating pooled investment vehicles? Could platforms be
developed at the EU level?
Direct investment by banks (and public authorities either directly or through state-owned
investment banks) have traditionally been one of the sources of finance to SME finance and
infrastructure. However, BlackRock does believe there is also space for a pan European
brand or label as that to be proposed by the European Commission for long-term investment
funds, which could be applied to existing alternative investment funds (AIFs) that meet
certain minimum requirements on diversification and asset types.
We would strongly recommend against designing LTIFs as a mainstream retail investor
vehicle, which would require detailed product regulation, and focus instead on marketing
them to professional investors and "semi-professionals" (using the concept established by
the EuSEF and EuVeCa regulations). This would then avoid unnecessary product regulation
in the world of institutional investors.
If the European Commission wants to encourage smaller and medium-sized pension funds
to invest in LTIFs, it is also worth bearing in mind that they may prefer to co-invest with
others in a single large project to spread concentration risk. The diversification of assets is,
then, less important than the ability to share in the returns from a project the pension
23
scheme could not take on directly. The UK PIP platform, mentioned in our response to
question 5, is an example of a structure designed to allow smaller EU pension funds to
invest as part of a consortium. The Commission’s proposals for LTIFs could facilitate the
take up of structures like this on a pan-European basis.
It would be particularly useful if LTIFs could benefit from a passport allowing them to access
asset types on a similar basis as banks, such as in the loan market (see comments on
question 11 below), or if they facilitate investment by smaller and medium-sized institutional
investors who would not invest directly and would prefer to outsource asset selection and
due diligence. Appropriate adjustments to standard capital requirements in prudential
regulation, such as Solvency II, to explicitly recognise the benefits of diversification that
LTIFs bring, could also encourage institutional investor take up.
We are aware of legislative or regulatory investment restrictions in a number of EU Member
States, which prevent institutional investors investing in non-UCITS vehicles such as LTIFs.
As well as legislative measures, the European Commission should also consider
coordinating with Member States to ensure that such national legislation as well as tax and
accounting rules are updated to allow institutional investors to invest in LTIFs.
9) What other options and instruments could be considered to enhance the capacity
of banks and institutional investors to channel long-term finance?
Please see answers to questions 5, 7, 8 and 11 where we make a number of specific
suggestions.
The combined effects of regulatory reforms on financial institutions
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?
Please see point 3 in our General Comments where we address a number of these points.
The efficiency and effectiveness of financial markets to offer long-term financing
instruments
11) How could capital market financing of long-term investment be improved in
Europe?
General comments
There are a number of improvements to capital markets, which could be generated by the
development of more liquidity, by encouraging listings, market making and removal of tax
inefficiencies or stamp duty.
Infrastructure
In the infrastructure sector, financing would be increased were concession granting
authorities to encourage fund managers and individual investors to support consortiums at
the bidding stage of a project.
Finally long-term fixed rate investors need prepayment protection. We would urge that
concession-granting authorities need to support and advance this.
24
Developing the non-bank loan market
Our experience has been that the greatest demand for non-bank funding has come from
leveraged intermediate size companies – see comment on definition of an ISC in question
26. These ISCs are too small to issue high-yield bonds and are often ill-prepared for public
market disclosure requirements. Writing loans of this size is more scalable and economic for
institutional investors than for pure SME loans. In the US, a number of institutional players
provide a material portion of funding for these size businesses. In Europe, this space has
traditionally been dominated by banks but, as banks pull back, institutional and opportunistic
investors are increasingly filling the void and funding these intermediate sized companies.
The development of capital aggregation vehicles for assets like mezzanine debt or secured
subordinated debt can help minimise equity requirements. Such vehicles need to be tax
efficient and attractive to investors across Europe and beyond. At present, each European
country has complex rules that make it hard to create simple structures for this purpose.
This process could be encouraged by the proposal for a European LTIF as referred to in
question 8, analogous to the Business Development Company (BDC) in the US to pool
investor capital. A BDC is a publicly listed vehicle designated to invest in lending to
companies with certain pre-set criteria. If LTIFs were to receive an EU-asset passport under
which all EU countries would give the LTIF the same status as approved lenders, i.e.
becoming preferred creditors, and the same tax status etc., this would stimulate provision of
investing/lending. Key issues which would have to be addressed in the creation of an EU
asset passport include:
•
•
•
•
•
Remove legislative preference given to banks, for example in bankruptcy proceedings
Standardise procedures for taking security, enforcement and for creating loans/bonds, in
particular equivalent standards for European company registers for registering and
enforcing pledges and similar charges
Equalise treatment of bank loans and bonds in bankruptcies
Remove barriers to lending (as distinct from deposit taking) such as the need for banking
licenses etc. by allowing other regulated institutional investors or vehicles to lend
Additional initiatives to align tax incentives at national level including the removal of :
withholding and of transaction taxes on lending/interest, at least within the EU
legislative preference given to banks, for example in taking security (stamp duties
etc.) and transaction taxes.
12) How can capital markets help fill the equity gap in Europe? 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?
As discussed in questions 21-23 below in regards to managers’ fiduciary duties, the proper
exercise of a manager’s fiduciary duty requires managers to consider issues of economic,
social and environmentally-sustainable growth and assess how these criteria can contribute
to adding long-term value to clients’ investments. This needs to be a dynamic and evolving
process rather than a pure box-ticking exercise.
13) What are the pros and cons of developing a more harmonised framework for
covered bonds? What elements could compose this framework?
No comment.
25
14) How could the securitisation 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?
Although issuance is lower than it has been historically, this is not necessarily a sign that
the securitisation market is not functioning/needs reviving. For example, low volumes of
publicly placed prime residential mortgage-backed securities (RMBS) is not an issue of
investors unwilling to invest, but alternative sources of funds for issuers (such as central
bank schemes) and a reduced willingness to lend and thus requirement for less funding.
However, one of the key disincentives to invest in securitisation at the moment is
uncertainty over where regulation will come out and previous guidance (e.g. Solvency II) on
the capital required to be held against the asset class – see comments on question 7. We
hope that the EIOPA review of the calibration across investments will iron out some of the
inconsistencies whereby a senior tranche of an RMBS transaction attracts a higher charge
than an investment in the whole underlying pool.
Securitisation has been raised in the context of how to attract different sources of finance to
SMEs. A white paper from PCS Europe (Prime Collateralised Securities) mentions in its
section on maturity transformation, re-financing risk (i.e. the reliance on the underlying
borrower to re-finance their loan in order to meet the repayment due).15 Whilst re-finance
risk has clearly caused problems in securitisation transaction, this is actually a rather
different risk from maturity transformation and needs to be separately addressed.
Maturity risk
There is no full maturity transformation in vanilla securitisations. The legal final maturity in
regular securitisations is set based on the maturity of the underlying assets. The only type of
maturity shortening generally found in these structures is through the inclusion of call
options. These allow (particularly with mortgages) bonds to be issued with a shorter
average life than the underlying assets by relying on the original issuer repurchasing the
assets at a later date. These calls are optional and non-call does not result in a default on
the bonds, which continue to amortise in line with the underlying assets. However, a noncall is likely to be reflected in the size/price of future issuance. Many transactions saw
optional calls not exercised during the crisis (non-conforming RMBS where issuers were no
longer in business, Australian RMBS where APRA banned banks from exercising anything
other than 10% clean up calls, delayed calls from some Dutch banks, some UK whole
business transactions due to the economics of the transaction) but the market still functions.
Re-finance risk
Re-finance risk was particularly prevalent in the commercial mortgage-backed securities
(CMBS) market. The continual re-financing of securitised loans in the run up to the crisis
meant that many loans were at peak leverage at the top of the market. However, once the
market turned, the in-built assumption that the loans would be able to re-finance at the end
of the loan term (typically ~5 years) did not materialise in many cases. Few borrowers were
able to access alternative funds in order to meet their obligations. To a lesser extent, the
SME market is also heavily reliant on re-financing although this is less obvious from deal
performance. Typically a large proportion of SME loans have a bullet structure (where the
whole of the principal is due to be repaid at the end of the loan) but rather than being
genuinely repaid are typically re-financed, generally with the original lender with whom the
SME has an on-going relationship. Whilst this makes sense from a business perspective for
the SME given the tax treatment of debt, it means that analysis of historic default rates on a
15
PCS, “Europe in transition – Bridging the funding gap”, March 2013.
26
bank’s book of lending does not show the whole picture. The fact that the historic lending
policy (and financial strength) of the lending institution is embedded in the data can make it
hard for investors (or credit rating agencies) to appropriately assess the risk of a pool.
Standardisation of securitisation structures?
Some structures are particularly complex and a level of standardisation could be beneficial.
We would support initiatives to reduce unnecessary complexity particularly in the area of
hedging arrangements. We note any such initiative would have to recognise differences in
underlying financial systems, products, legal frameworks (e.g. the concept of assets being
“on trust” or the ability to sell “future receivables”). Initiatives to standardise securitisation
structures should also contain sufficient flexibility be able to react to regulatory changes and
investor appetite (e.g. requirements for a different currency from the underlying asset or
bullet payments). Given that the ability to analyse and demonstrate understanding of
securitised vehicles is a fundamental requirement for investors (as made more explicit in
AIFMD, Solvency II, latest Basel rules) further rules on investors is not an area which needs
an additional layer of regulation.
Cross-cutting factors enabling long-term saving and financing
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?
Given that savings accounts such as the UK Individual Savings Account (ISA) or French
Livret A or plan d’épargne en actions (PEA) are designed around specific national tax
benefits, and there is no common EU tax base, it does not seem feasible to have an EU
model.
Taxation
16) What type of CIT reforms could improve investment conditions by removing
distortions between debt and equity?
We note two key questions, firstly regarding the relative incentives for companies using debt
versus equity financing and secondly the incentives for long-term investors to invest in debt
securities as opposed to equity securities.
Debt versus equity financing
There have been long standing tax benefits of debt financing for companies stretching back
many decades. We are not aware of data showing that the tax treatment of debt financing
has on its own affected how firms finance themselves and whether this has led to
correspondingly higher levels of leverage.
Overall we believe that a change to the tax deductibility of debt interest would not be in
investors’ or the economy’s best interest as this would lead to an increase in the cost of
capital and reduced economic activity. Raising the cost of capital for SMEs, for example,
would inhibit expansion and in the case of more established firms would raise the hurdle for
new projects. Firms can currently fund new projects very quickly by raising debt – this cannot
be said for equity, which is much more time-consuming to raise.
There are specific sectors where an imbalance between equity and debt capital has been
identified , such as in the banking sector, but this is an issue which is being addressed by
the Basel III capital rules rather than by tax policy. Otherwise we note that at the moment
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corporate balance sheets are if anything underleveraged.
CIT reform affecting investors
Returning European tax systems to full imputation, such that tax exempt pension funds are
not disincentivised to buy equities would remove distortions between debt and equity. We
realise, however, that tax harmonisation decisions have to be taken by unanimity so
progress on hard legislative proposals will be slower than agreeing an understanding of best
practice reforms to tax regimes.
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?
We note, as large scale operators of many different types of pooled investment products in
Europe, that taxation regimes favour UCITS. We refer here not to the taxation of the vehicle
itself, but rather to taxation in the hands of end-individual investors, and, in a few cases, to
withholding regimes applying to the fund’s portfolio. To illustrate:
•
•
•
Germany – tax law is being altered in tandem with the introduction of the AIFMD to
restrict access to AIFs to the favourable ‘transparency’ regime
Italy – private investors in UCITS pay a concessionary 12.5% or 20% rate of tax on
investment returns, whereas investment into non-UCITS attracts tax at the full marginal
rate
Spain – a concessionary withholding 1% tax rate applies to dividends paid by Spanish
companies to UCITS, but dividends paid to non-UCITS bear the full charge.
Current tax policy seems to largely equate Alternative Investment Funds with hedge funds.
Yet, strategies involving long-term commitment investing, purchase of non-traded debts, and
direct holdings of infrastructure assets cannot fit within the UCITS framework and are thus all
AIFs too.
Simplicity being a goal in tax policy, we would advocate the simpler approach of extending
the tax treatment of UCITS to all AIFs. The alternative would be to create a third category of
funds such that UCITS and AIFs are joined by a defined category of ‘Long-term Investment
Funds’ similar to the LTIFs being considered by the Commission, which would have the
same tax treatment as UCITS.
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?
We note that historic tax policy in most OECD countries has been to accept that foreign
investors in transferable securities can invest without paying any tax other than withholding
on income (i.e. capital gains are tax free) but to tax fully investment in any real property.
Thus, tax policy disincentivises foreign investment in infrastructure assets, which typically
includes significant direct property holdings.
19) Would deeper tax coordination in the EU support the financing of long-term
investment?
We are not conscious that the national differentiation of tax systems is a particular
impediment at present. However, we do note that most of the tax measures we discuss at
questions 18 and 19 would require action by national tax authorities individually.
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Accounting principles
20) To what extent do you consider that the use of fair value accounting principles
has led to short-termism in investor behaviour? What alternatives or other ways to
compensate for such effects could be suggested?
Fair value accounting has led to some short-term investor behaviour. However, there is a
delicate balancing act between presenting financial information in a way that reflects asset
and liability values at a point in time and performance for the period then ended, and
providing information that enables investors to understand the longer-term attributes of those
assets and liabilities. The criticism of International Financial Reporting Standards (“IFRS”) in
this context includes the following:
•
•
•
•
Recognition of losses on assets carried at amortised cost is deferred because
impairment is not recognised until an event occurs that impacts future cash flows. (Note
that the guidance in IFRS 9 (effective from 1January 2015 with early adoption permitted)
will further accelerate recognition of impairment losses.
Fair valuation of financial instruments through income and other comprehensive income
fails to reflect the amount that may be realised upon sale for instruments that an entity
intends to hold for the long term.
Entities that own financial instruments and that follow fair value accounting, such as
pension plans, may be adversely impacted by using fair value at a point-in-time for
actuarial determinations.
Fluctuations in paydown rates on asset-backed securities may cause greater volatility in
the recognition of income than under U.S. Generally Accepted Accounting Standards.
Fair valuation of financial instruments does reflect the value on a reporting date; subsequent
market recoveries can be tracked by investors and factored into their decision making. We
would not be in favour of abandoning the fair value model where currently applied. Nor
would we be in favour of reducing the frequency of required reporting. Nonetheless, IFRS
can be further enhanced by the following steps, which would help to mitigate short-term
investor behaviour:
Additional disclosure
There are a number of new disclosures under IFRS 9, Financial Instruments, that will
enhance investor understanding, including a past-due aging analysis of amortised cost of
debt instruments on non-accrual status; a disaggregated list of debt instruments on nonaccrual status; and an explanation by financial class of significant changes in the collateral
securing an entity’s financial assets. IFRS 7, Financial Instruments: Disclosures, also
requires disclosures with respect to the sensitivity of “Level 3” financial instruments for which
fair values may be more subjective, hence leading to greater potential volatility in fair value
movements.
Other disclosures
Companies should be encouraged to provide additional information that facilitates an
understanding of future cash flows. For example, disclosure of the underlying contractual
cash flows for portfolios of financial instruments and loans would enable more informed
decision making.
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Presentation changes
The Green Paper highlights research, which indicates market-consistent valuation may
encourage long-term investors to increase their risk exposure, provided the volatility is
recognised outside profit and loss. There is already a precedent for this treatment under
IFRS 9, whereby certain fair value gains and losses on equity and debt instruments are
recognised in Other Comprehensive Income (OCI) rather than in profit and loss. In an
accounting sense, there is no obvious principle that drives the distinction between reflecting
gains and losses in profit and loss or OCI. However, in practice reflecting gains and losses in
OCI is often seen as a compromise to reflect longer-term changes in value, which may not
directly or immediately result in cash flows but which are value relevant, in equity.
Consequently, if reflecting fair value movements in OCI can help encourage long-term
investors to increase their risk exposure to equities, then it is worth assessing how the
accounting framework under IFRS can be modified to accommodate this.
Regulatory capital
Financial institutions that are required to maintain regulatory capital normally base their
calculations on capital as presented in the financial statements, with further adjustments for
intangible assets, haircuts on certain financial assets, etc. IAS 39, Financial Instruments:
Recognition and Measurement, requires that certain financial instruments be presented at
fair value. Short-term investor behaviour may reflect the uncertainty over a financial
institution’s ability to meet its minimum capital requirements and the impact of fair value
accounting. Regulators should determine whether additional guidance and management
disclosure is appropriate to address short-term market reaction to sudden market
movements.
Actuarial determinations
Pension plans normally perform at least annual actuarial valuations of their assets using
point-in-time fair values against projected future funding requirements. We believe that
funding models should consider a longer horizon for valuation of assets and for determining
their expected returns.
Alternatives to fair value
Fair value accounting may have certain drawbacks, but it is more conceptually robust than
alternative accounting treatments, such as the historic cost method, “buy and hold” and
“target date” approach.
The main alternative method to fair value accounting is historic cost accounting, which
involves recording assets on balance sheet at their acquisition price. Historic cost accounting
is generally a more conservative basis of accounting as gains, particularly in periods of rising
prices, are deferred until settlement. There is little debate about the reliability of historic cost
accounting values, however their relevance is questionable. Indeed, the historic cost values
are only relevant if there has been no material change since the date of
acquisition/recognition. Clearly, in the overwhelming majority of instances asset values will
have fluctuated significantly since acquisition/recognition. Therefore, the financial
statements, of which these form part, will not accurately reflect the underlying value of the
assets at the reporting date. The impairment rules under the historic cost model would result
in a diminution of value being reflected, but there would be no recognition of positive
movements above the asset’s cost. This would make it difficult for market participants such
as investors to accurately appraise the entity that owns the asset. For example, it would be
more difficult to distinguish between entities that are performing well relative to their
competitors and similarly identify poorly performing entities. Accordingly, the important
30
control of market discipline would be less effective due to the lack of transparency in the
financial statements.
The “buy and hold” and “target date” approach methodologies are designed to reflect
management’s intent to hold the assets for a longer-time horizon. The “buy and hold”
method would utilise the asset’s forecast return as a basis of valuation. This is a significant
departure from fair value based on the current exit price, being the price that would be
received to sell an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date. Clearly, this would add a higher degree of
subjectivity to the asset’s valuation and may result in management being able to manipulate
the forecasts in order to support an asset’s carrying value. The “target date” approach
proposes a time-weighted, mixed valuation model of cost and market value. This would be
used to value assets that are subject to a binding commitment to hold for a long time
horizon, with the objective of reducing shstockort-term valuation volatility. However, it is
likely that market participants will seek to convert these hybrid values back to pure market
values and therefore it is doubtful this methodology would have the desired impact.
Our overall conclusion is that although fair value accounting is not a perfect solution it is
preferable to the available alternatives. See also our comments on questions 21-23 on
quarterly reporting.
Corporate governance arrangements
21) What kind of incentives could help promote better long-term shareholder
engagement?
22) How can the mandates and incentives given to asset managers be developed to
support long-term investment strategies and relationships?
23) Is there a need to revisit the definition of fiduciary duty in the context of long-term
financing?
Acting as a fiduciary
BlackRock, as a fiduciary investor, is responsible to act in the best interest of our clients at
all times. The relationship between us and our clients is determined by the mandate given to
us by clients and is outlined in the investment management agreement (IMA). While the
mandates/IMAs include the details of what asset owners require and expect from BlackRock,
mandates, first and foremost, reflect the asset owner’s long-term investment strategy for the
portfolio as well as its short-term liquidity needs. In order to assess how incentives, through
investment mandates, can influence a long-term behaviour and thinking of investors, one
needs first to acknowledge and understand the liability profile of the investor.
We believe that there is a need for a broader discussion of the concept of fiduciary duty to
engender a better understanding by asset managers throughout Europe of its full scope. We
do not consider that further changes to the application of fiduciary standards by asset
managers at an EU level are required.
Acting as a fiduciary to our clients means that our responsibility is first and foremost to our
clients. In BlackRock’s view, fulfilling our fiduciary responsibilities to our clients will
sometimes involve engagement with companies. If we cannot protect our clients’ interests
through engagement, we will vote against board resolutions and, ultimately for active
portfolios, reduce or sell a shareholding. Some policy makers believe that asset managers
have a responsibility to engage with companies to ‘make them better’ and potentially to hold
stocks even if this might no longer be justified from an investment perspective. In our view,
31
where engagement has failed, reducing or selling a shareholding should not be seen as a
derogation of our fiduciary duty towards our clients but the fulfillment of it.
Enhanced voting rights
Better long-term shareholder engagement will be facilitated by providing shareholders with a
uniform toolkit across EU member states and eliminating impediments, which prevent
investors from exercising their existing rights such as blocking shares for voting. We do not
believe that changes to companies’ share structure by introducing enhanced voting rights or
dividends dependent on the length of ownership will lead to a material change to long-term
engagement with companies. Rather, these measures could well be counterproductive by
entrenching a core group of shareholders to the detriment of minority shareholders. In
addition, the cost of monitoring and applying these provisions to share registers and
underlying sub-registers would be significant for issuers at a time when the primary policy
aim is to increase access to capital rather than raising the cost of capital. A recent report by
Mercer, Stikeman Elliott and the Generation Foundation further describes the challenges
associated with loyalty dividends.16 These issues also need to be taken into account in the
forthcoming securities law legislation.
Quarterly reporting
Based on our experience in recent years, the demand for greater disclosure on short-term
earnings, such as quarterly reporting and management’s discussion and analysis, has
helped boards to communicate better their operating results in the context of their strategic
objectives. However, quarterly reporting potentially places undue focus on short-term
developments that may have little material impact over the longer term. We agree there is a
debate to be had about the frequency of reporting that strikes the right balance.
Also, consideration might be given to whether there should be more flexibility in reporting
requirements, which can be disproportionately costly for smaller companies but we note that
it may be challenging to achieve the right balance between meeting shareholder
expectations and not unduly burdening smaller companies.
Asset manager compensation
BlackRock’s approach to compensation, which mirrors that of many other asset managers,
reflects the value senior management places on its clients, employees and shareholders.
Consequently, our compensation structure is designed to align with client and shareholder
interests, to reflect performance and to attract and retain the best talent and to reinforce
stability through the organisation.
The predominant compensation model includes a salary and a discretionary bonus reflecting
firm, business area, and individual performance. For most investment professionals,
compensation reflects investment performance over the short, medium and long-term and
the success of the business or product area and the firm. Variable compensation deferred
from annual bonus awards is paid out in BlackRock’s stock, which vests over a number of
years. In addition, a limited number of investment professionals have a portion of their
annual discretionary awarded as deferred cash that notionally tracks investment in selected
products managed by the employee.
The intention of these awards is to align further investment professionals with the investment
returns of the products they manage through the deferral of compensation into those
16
“Loyalty rewards and incentivizing long-term shareholders”, February 2013, Mercer LLC, Stikeman Elliott LLP
and the Generation Foundation.
32
products. Clients and external evaluators have increasingly viewed more favourably those
products where key investors have “skin in the game” through significant personal
investments. However, such co-investment is not always possible. For example, as a result
of the significant compliance burden with respect to the US Foreign Account Tax
Compliance Act (FATCA), a US national is generally precluded from investing in a UK fund.
The combined effect of this approach means that the variable compensation an investment
manager receives in any one year reflects the investment performance achieved over a
considerable time period.
Information and reporting
24) To what extent can increased integration of financial and non-financial
information help provide a clearer overview of a company’s long-term performance,
and contribute to better investment decision making?
BlackRock supports the principle of high quality, succinct narrative reporting. We believe
that the informative quality of the narrative reports should be improved whilst giving
companies an appropriate level of flexibility in respect of the nature and scope of disclosure.
We support guidance rather than regulation that would focus on balancing the need for
reports to be complete and comparable with the need to be concise and accessible to all
users.
When preparing annual reports, companies should focus on the matters material to their
long-term success and on those that explain performance during the period under review.
All focus should be on providing information to investors that is useful for making their
investment decisions. We think that narrative highlights should give both what is most
material in the long/medium term outlook and what the companies believe are material
changes to previous narratives about that outlook. The areas that a business decides are
most applicable can itself contain useful information.
25) Is there a need to develop specific long-term benchmarks?
For less liquid classes, especially for infrastructure equity and debt, it is key to develop
sources of long-term performance data which institutional investors can use to assess and
benchmark the risks of investing in this asset classes. We do not believe there is a need to
mandate the use of any specific benchmarks at this stage.
In the non-listed equity market, we note that broader equity indices are used as proxies
where specific indices are not available for a specific asset class. In BlackRock’s experience
indices, such as the MSCI World TR or the S&P 500 TR, are commonly used benchmarks in
the market. The choice of which listed equity index to use as a proxy is, critical, therefore. An
understanding of whether it performs consistently across the whole economic cycle is
particularly important. By way of example, our own data shows higher correlation of
performance to the MSCI World than to the LPX 50 (the proxy originally used by CEIOPS).
Also, the largest quarterly fall in our private market portfolio over a ten year period was very
similar to the largest fall in the MSCI World TR and was much lower than the largest
quarterly fall in the LPX 50.
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The ease of SMEs to access bank and non-bank financing
26) What further steps could be envisaged, in terms of EU regulation or other
reforms, to facilitate SME access to alternative sources of finance?
In our answer to question 11, we note a number of restrictions on the ability of non-bank
entities to provide loan finance to companies, which inhibits the development of a liquid USstyle European private placement market.
We would also emphasise that it is important to properly categorise different types of SME
as the standard definition is very broad. The French National Institute of Statistics and
Economic Studies (INSEE) defines an intermediate-sized enterprise as a company with
between 250 and 4999 employees and turnover which does not exceed 1.5 billion euros or
a balance sheet total which does not exceed 2 billion euros. Companies with fewer than 250
employees but a turnover of greater than 50 million euros and balance sheet exceeding 43
million euros can also be considered as intermediate-sized enterprises under this definition.
We consider this to be a useful additional categorisation to the standard EU SME
definition.17
We believe that the most likely source of non-bank finance is to intermediate-sized
companies who are large enough to merit individual credit analysis by institutional investors
but for whom issuing debt or equity on public markets may not be cost efficient.
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?
The policy objective seems to be to encourage SMEs’ access to capital markets without
transferring the requirement to individually underwrite each of the borrowers to the endinvestor (as this would not be practical). If banks no longer act as intermediaries, another
entity must fulfil the role typically played by banks in the traditional SME securitisation role.
One solution may be to create an SME aggregator institution. This would be a corporate
entity set up to issue directly into the capital markets at benchmark size and then pass
through the funds directly to a group of SMEs who it had fully underwritten. Since the loan
would be a direct pass through of terms, the corporate would take no interest rate or
currency risk and the SME would get the execution benefits of a larger entity. This would
generate no maturity mismatch and with government support there should be confidence
that lending would not suddenly cease causing a drying up of funds and increased defaults.
To provide some comfort for bondholders a small liquidity cushion could be created by
withholding say 1% of each of the loans into a trust account. Each SME would pay an
upfront percentage fee for the loan and an on-going bps fee to the aggregator to cover its
costs. Given the underlying credits would likely be sub investment grade or low investment
grade on average, there would need to be a first loss piece made available (by central bank /
government etc.) – this should also cover the requirement for there to be a 5% retention.
Profits should hopefully be positive but likely limited – these could be used to build reserves
and increase available credit enhancement over time or pay some sort of small return to
government (akin to excess spread).
17
Article 2 of the Annex of Recommendation 2003/361/EC
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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?
29) Would an EU regulatory framework help or hinder the development of this
alternative non-bank source of finance for SMEs? What reforms could help support
their continued growth?
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?
No further comments.
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