EUROPE – The European Commission's green paper on long-term financing could bring more investors into the fold – but first it will have to deal with EU regulation, writes Shayla Walmsley.
Was the European Commission’s failure to mention real estate in a recent green paper on long-term financing the result of accidental oversight or the desire for a quiet life? It is probably safe to the assumer the latter.
One single mention of "buildings" – in contrast to copious coverage of infrastructure – reflects little more than nervousness on the part of its drafters. According to a source with sight of earlier versions, property made an early appearance, but concerns that it is still associated with bubbles in the collective European imagination led to its swift removal. Property appears between the lines, as it were.
Putting aside the matter of whether real estate is included in the paper's analysis implicitly, the principal question is: what are the chances that pension funds and other institutions will step in?
One surprising feature of the green paper is its acknowledgement that prudential regulation could damage the chances of liability-driven investors taking on a financing role. The effect of Solvency II will be to encourage insurers to focus on short-term debt rather than long-term equity. The cumulative effect of liquidity requirements could be to drive both banks and pension funds out of the market, the report suggests.
Even assuming regulators will be amenable to tweaking long-fought-over rules, there are fundamental points of disagreement. The G20, for example, defines ‘long term’ as anything over five years. For some pension funds, an infrastructure project with a 10-year life could be deemed short-termist.
But optimistic pension funds could plug the gap if there emerges "a new type of vehicle" to entice them. Covered bonds make up one candidate on the basis that they have proved resilient during the crisis – even in Spain’s massive multi-cedula market, despite questionable collateral. Others include securitisation products underpinned by low-risk assets and project bonds. Equity is better, it says. But it is also more expensive.
Although the report says new initiatives will be market-based, the danger is this could amount to a regulatory assumption that, if they build it, investors will come. It also begs the question why the market has not developed them before.
Take securitisation as an example. According to the report, reshaped markets "subject to appropriate oversight and data transparency" will mobilise additional lending and manage risk by encouraging high-quality, transparent and standardised securitisations based on "clear and unleveraged structures, using well-selected, diversified and low-risk underlying assets". Exactly what, how and when it does not make clear.
The potential for regulatory overkill is not the only problem. As a recent OECD report on the same topic pointed out, it is not that pension funds and other institutional investors are short of capital that could be invested in real estate. Rather, they have not necessarily behaved like long-term investors given post-crisis liquidity rules.
You can have liquidity. You can have long-termism. But can you have both?
Juan Yermo, head of the private pensions unit and the author of a past OECD report on infrastructure investment, claimed that despite the potential match between "real asset" projects and institutional capital, little more than 1% of pension fund capital is invested in infrastructure. It only makes up, on average, 6% of allocation to alternatives. Investor size, lack of in-house expertise, inadequate financial instruments and regulation, not to mention investment restrictions in some cases, militate against it. The exceptions – Australian and Canadian institutions allocate on average 10% of their portfolios to infrastructure – are exceptional.
Just because banks will not come up with the capital, does not mean pension funds will. They have, as Yermo pointed out, a long way to go.