>> Updated: Analysis of EU, US SME Financing Systems
>> New: ESBG high-level messages on CMU
Updated: July 2018
Capital markets can only complement the role of bank lending. Although the European Commission insisted that the Capital Markets Union will firstly aim at benefitting SMEs, those benefits will be limited to specific market segments such as start-ups or established companies that might be tempted to switch from bank financing to capital markets financing.
ESBG is convinced that it would not be in the interest of the European economy – especially in the markets that are strongly based on SME structures like the majority of continental Europe – to favour funding from capital markets over traditional bank lending. Not a policy of substitution but a policy of complementarity should be regarded as the best way forward in order to create a more competitive European Union.
ESBG welcomesthe successful conclusion of the legislative processes for Simple, Transparent and Standard securitisation, the Review of the Prospectus Directive and the EuVECA and EuSEF funds Regulations as the first tangible results of the CMU action plan. For the second half of the CMU project, ESBG calls for a reflection on ways to improve the set of investor protection requirements. The current product disclosure rules under MiFID II and PRIIPs need to be rethought as a whole to achieve both objectives of investor’s confidence and access to capital markets, while reducing the excessive formalism that retail investors are facing.
In addition, ESBG suggests that the role of banks in financing innovative projects should be supported. In contrast to “normal” investments, the success of innovative business projects is often uncertain and involves high economic and technical risks, while they offer hardly any collateral facilities for a classic loan financing. Depending on the intended purpose and duration, bank loans with the inclusion of public subsidies are particularly suitable for financing promising start-ups. By improving the tax framework for venture capital, this form of financing could also become even more important for entrepreneurs.
An ESBG study shows that US SMEs rely on bank lending as much as their EU counterparts. SMEs rely significantly on bank loans for funding: 77% of outstanding SME funding in Europe comes from banks. Evidence also shows that bank lending remains the favourite sources of SME financing for 50% of SMEs. Only 10% of SMEs consider access to finance as their primary issue, however, despite regional variations. In Europe, 78% of SMEs receive all or part of the loan requested while rejection rate has been continuously declining from 15% in 2009 to 8% in 2015.
As part of the Juncker Commission’s priority to boost jobs, growth and investment across the EU, the Capital Markets Union (CMU), a key pillar of the Investment Plan, aims to tackle investment shortages head-on by increasing and diversifying the funding sources for Europe’s businesses and long-term projects. The Commission’s overall goal for the CMU is to create opportunities for investors, connect finance to the wider economy, and foster a more resilient financial system, with deeper integration and more competition. In September 2015, the Commission adopted an action plan setting out 20 key measures to achieve a single market for capital in Europe. This was followed by a mid-term Review in June 2017 where the Commission reflected on the achievements so far and developed new priorities, and in March 2018 a communication entitled “Completing the Capital Markets Union by 2019 – time to accelerate delivery” accompanied by legislative proposals on European covered bonds, Cross-border distribution of investment funds and Law applicable to cross-border transactions in claims and securities.
The idea of a Capital Markets Union was first launched by European Commission President Jean-Claude Juncker and is a part of his Investment Plan. Deeper and more integrated capital markets shall be created in the 28 Member States.
“With the CMU, the Commission will explore ways of reducing fragmentation in financial markets, diversifying financing sources, strengthening cross border capital flows and improving access to finance for businesses, particularly SMEs”
– European Commission on Capital Markets Union
The European Commission thus published a Green Paper in February 2015, targeting a consultancy phase with all interested parties to put together the components for the CMU by 2019. Insolvency, securities laws and tax treatments are main topics. The aim of this long-term project is to:
unlock more investment for all companies, especially SMEs, and for infrastructure projects;
attract more investment into the EU from the rest of the world; and
make the financial system more stable by opening up a wider range of funding sources.
ESBG supports the European Commission's proposal to develop criteria for identifying simple, transparent and standardised securitisations and shares the view that a functioning securitisation market – supplementing bank loans as a main financing instrument – is essential to support economic development, and for providing sufficient credit to companies, particularly to small and medium-sized enterprises. This is especially true where banks require a complementary, functioning market that allows them to boost lending, in the event of higher credit demand by corporate borrowers, beyond their capacity of on-balance-sheet lending within the scope available under the Basel III regime.
However the European Commission's proposal excludes an important part of the securitisation market necessary for the banking system to place parts of their credit risk exposure to professional investors: synthetic securitisation. Synthetic securitisations are particularly suitable for this purpose, since they only require comparatively straightforward contractual agreements – and no full transfer of title of the underlying loan receivables (regardless of whether these are not desired for reasons of business policy, or downright illegal). There exclusion would negatively affect banks whose clients are SMEs preferring bank loans – leading to competitive distortions. Instead, the focus should always be on the benefit of a form of financing for the real economy: the issue as to whether a financing constitutes a simple, transparent and standardised securitisation should not be determined on the basis of the type of funding alone.
In addition, the proposed reduced risk weights for qualifying securitisations will be considerably higher than today. Even a reduction from 15% to 10% for qualifying securitisations would mean an increase of the floor from 7% to 10% compared to the current situation. Left unchanged, these rules would substantially reduce the incentives for banks to participate in securitisations and consequently undermine the role securitisation could play in funding Europe's real economy.
Simple, Transparent and Standardised Securitisation
To exploit the full potential of the securitisation market for the economy it is crucial that the combination of the following parameters support transactions and do not render them impossible or too expensive:
Homogeneity and concentration of portfolios: both criteria have to be interpreted in a flexible manner with regard to smaller and medium sized banks, otherwise smaller and medium sized banks will struggle to provide homogenous portfolios sufficiently large to attract capital markets;
Keep the risk retention rate at the current of 5% in particular as any higher retention rate will make it exponentially more difficult to reach a Significant Risk Transfer.; and
Keeping the floor levels of risk-weights at the current CRR levels, which being 7% for STS securitisations and 10% for non-STS securitisations.
Other elements will be key for the success of the European securitisation markets:
The inclusion of synthetic securitisation in the STS framework when they are based on existing loans without any speculative element.
Having reasonable costs for the process of securitisation and in particular a useful independent third party certification of STS criteria that provides actual legal certainty, a reasonable disclosure framework, proportionate sanctions and leverage ratio relief for the securitisation tranches sold.
The Commission Securitisation initiative adopted on 30 September 2015 is a package of two legislative proposals: a Securitisation Regulation that will apply to all securitisations and include due diligence, risk retention and transparency rules together with the criteria for simple, transparent and standardised ("STS") securitisations; and a proposal to amend the Capital Requirements Regulation to make the capital treatment of securitisations for banks and investment firms more risk-sensitive and able to properly reflect the specific features of STS securitisations.
With these proposals, the main objectives of the European Commission are to revive markets on a more sustainable basis so that STS securitisation can act as an effective funding channel to the economy, to allow for efficient and effective risk transfers to a broad set of institutional investors, to allow securitisation to function as an effective funding mechanism for some non-banks (such as insurance companies) as well as banks and to protect investors and to manage systemic risk.
ESBG believes that there could be challenges to achieve a common harmonisation of covered bonds, one of them being the diversity of legal frameworks in the EEA, including insolvency and mortgage legislations across the European countries. Many European countries have already succeeded in establishing sound regulated covered bond markets. If there is to be a common European regulatory framework, this must build on best practice among national regimes, be in compliance with international standards, and not disrupt well-functioning markets.
Expanding the categories of eligible asset classes beyond public sector loans, residential and commercial mortgages may lead to the dilution of the covered bond concept. This may in turn reduce confidence in covered bonds and reduce the attractiveness of the instrument for investors, issuers and government institutions.
Sound coordination between the legislative framework on securitisation and the other initiatives within the CMU Action Plan is important, as the regulatory regimes must adequately reflect the different risk/return profiles between securitisation and covered bonds.
As part of the CMU's Action Plan, the Commission released a consultation on Covered Bonds in the EU. This paper evaluates signs of weaknesses and vulnerabilities in national covered bond markets as a result of the crisis, with a view to assessing the convenience of a possible future integrated European covered bond framework that could help improve funding conditions throughout the Union and facilitate cross-border investment and issuance in Member States currently facing practical or legal challenges in the development of their covered bond markets.
ESBG supports the proposal's objective of reducing the burden on issuers while safeguarding a high level of investor protection and considers the proposal to be an important step towards the CMU. ESBG especially welcomes the aim of facilitating the approval process for frequent issuers.
However, further work might be needed in respect of other issues, such as the alignment with the PRIIPs regulation. In addition, there are other parts where the proposal is on the right track, but could be more ambitious.
The universal registration document regime, introduced by Article 9 of the proposal, is case in point. ESBG strongly supports the concept, but does not believe that the approach goes far enough to be of much use. Also, further reflections should be made on which cases the requirements are counter-productive and hence should not apply, in particular for small credit institutions.
Two other key elements of the proposed legislation are:
Derogation for non-equity securities issued by small and midsized credit institutions (Article 1(2)(i)): The purpose of this derogation is to relieve small and midsized credit institutions from the requirement to produce expensive prospectuses for certain securities. Credit institutions are using these securities for refinancing purposes, and the obtained capital is used for capital lending to SMEs that do not have access to capital markets themselves and consumers. ESBG would have liked to see the limit raised above 75,000,000 as it is just a bit too low for many retail and savings banks.
The summary prospectus: we are concerned that the limits proposed to the number of risk factors and number of pages would undermine the relevance of the summary. Indeed these limits would exclude many information on the one hand and over-simplify the information remaining on the other hand. ESBG prefers the current system where there is no limit.
On 30 November 2015, the European Commission published a proposal for a Regulation on the prospectus to be published when securities are offered to the public or admitted to trading and repealing the current Prospectus Directive. The main objectives of the prospectus revamp are: to make it easier and cheaper for smaller companies to access capital markets; to provide simplification and flexibility for all types of issuers, in particular for secondary issuances and frequent issuers which are already known to capital markets; and to improve prospectuses for investors by introducing a retail-investor-friendly "key information"–type summary, catering for the information and protection needs of investors.
>> Updated: Analysis of EU, US SME Financing Systems