The Capital Markets Union has been an initiative started by the EU-Commission in 2015 to promote the medium and long term financing of investments and innovations within the EU after the outbreak of the financial crisis. At the core of this plan is the strengthening of equity financing through the capital markets using shares, risk capital and other forms of equity as well as through the extension of the bank sector’s lending capacity by reviving the securitisation market on the financing side.
Because the Commission perceives the stagnation of financing within the EU as a crisis of banks, it tries to reduce the banks’ predominant role in financing enterprises. It considers the bank-centric financing environment an obstacle for private but also public investment activity. The key to the chosen path towards boosting private financing of investments via strengthening so called “market-based financing” is – in the Commission’s perception – the high market capitalisation in the US compared to the EU as well as the assessment of risks from US and European securitisation transactions. On the one hand, the Commission sees a substantially higher market capitalisation in the US and thereby a lower dependency on financing from banks and on the other hand it deems European securitisation transactions as materially less risky. Therefore it generally intends to promote outside financing through securitisations, which leads to a separation of the traditional banking sector and the traditional capital market and to the development of a “hybrid capital market”, which – assumedly – is more robust against external shocks.
In this hybrid system, banks transfer the risks of their business activity through the structured sale of granted loans or claims to the capital market. This transfer of risk is the consequence of (i) less-costly refinancing of loans than through deposits and (ii) the increase of their credit arrangement capacity (sourcing and origination) through the relief of the required regulatory equity capital. In addition, they decrease the expense incurred by an intensive risk evaluation of their borrowers. Insofar the Capital Markets Union’s goals are competing with the measures aimed at tighter control and regulation of the securitisation market.
The Capital Markets Union therefore is based on the idea that bank lending should be supplemented or replaced entirely by securitisation. This ignores the substantial negative implications securitisation transactions may bring with them for borrowers and investors:
- A borrower, who has negotiated a financing arrangement, may find himself in an anonymous structure of a special purpose vehicle with bankruptcy-remote character. The bilateral agreement of a loan is dissolved. A trustful business relationship is broken up with one of the consequences being that contract amendments or restructuring measures are difficult to implement. Furthermore borrowers may be exposed to attacks in distressed situations from activist investors.
- Investors do not have access to the claims and possibly the underlying collateral – this is especially true for synthetic securitisations. The influence on restructuring measures for non-performing loans is low. Therefore investors have no control over their investments.
Investors and borrowers often are sceptical towards (anonymous) securitisation transactions. However, borrowers increasingly agree to a transfer of risk, provided that the additional creditor is a professional market participant. Additionally investors are prepared to invest in credit pools if it is ensured that the pool’s manager is a professional market participant.
These conditions are generally met by credit funds:
- Credit funds are regulated as Alternative Investment Funds (AIFs) by the Alternative Investment Funds Managers Directive (AIFMD). Their managers are required to have adequate expertise in the lending business in order to be permitted to effect such investments.
- The AIF as “lender of record” in a bilateral agreement with the borrower has direct access to the claims as well as the collateral. Hence investors have direct access to their investments via the manager they selected.
From the EU-Commission’s perspective credit funds fulfil all requirements to achieve the intended transfer of risk – including across borders. Market developments already point substantially in the direction of credit funds, with regulators’ support – BaFin, for example, has permitted AIFMs to grant loans under certain conditions. But also on the risk management side, convergence processes are underway as credit-process requirements of banks and AIFs are being aligned.
Investors and borrowers are increasingly interested in investing in credit funds or accepting credit funds as creditors. Therefore the Commission should contemplate whether instead of securitisations it should rather spur the transfer of loans into credit funds.
Dr. Thomas Keller