Europe turns to non-bank lending for growth

In March, a speech by Steven Maijoor, chair of the European Securities and Markets Authority, highlighted how non-bank lending is one of the foundations of the proposed Capital Markets Union (CMU).

Overall, the new initiative aims to support economic growth in Europe by easing capital availability for companies, particularly small businesses, Maijoor told delegates at the National Association of Pension Funds annual investment conference in Edinburgh. It will also support investors seeking to invest in mid-sized companies. At present, investors still have a strong bias towards companies in their own countries meaning transactions that could be beneficial for both investors and companies are not happening, Maijoor explained.

Europe must develop and maintain a greater diversity in funding, much like in the US, he continued. The initiative will focus on funding vehicles including investment funds, initial public offerings, venture capital, securitisation, private equity and crowd funding.

“We, more than ever, need to develop alternative funding channels to ensure that the benefits of capital markets and non-banking institutions are maximised for the real economy. Pension funds, with their longer-term focus and willingness to take calculated risks, are ideally placed to actively participate in this development,” he said.

Making capital markets more efficient and more attractive for EU investors, as well as strengthening and harmonising supervision will also be essential ingredients for the proposed CMU, delegates heard. 

THE JUNCKER PLAN

Despite record low interest rates, growth in the Eurozone has remained moribund since the crisis, as spooked national governments embarked on austerity drives. The banks have, for the most part, successfully recapitalised. 

But the liquidity created by a series of European Central Bank moves including very cheap financing for banks, has failed to trickle down to the real economy, small businesses in particular. 

Politicians, concerned about near zero growth rates and the threat of deflation, approved the €315 billion European Fund for Strategic Investments (EFSI) in March. Dubbed an investment plan for Europe, the so-called Juncker plan will support lending for ‘riskier’ projects.

The European Investment Bank (EIB), one of the region’s largest institutional investors in infrastructure projects, is in the process of launching the fund, named after Jean-Claude Juncker, the new European Commission (EC) president who trumpeted the policy prior to his election last July. 

The EIB will manage the initiative, alongside its regular lending activity to infrastructure and small- and medium-sized businesses. All projects to be supported have to be approved by the bank’s governing bodies and the new model will be supported by an EC guarantee.

EFSI aims to bring external sources of financing into Europe by lending money or linking it with some public funding to improve the conditions of loans. The fund has commitments of €21 billion; €5 billion from the EIB and €16 billion from the EC. The €315 billion touted size refers to the total cost of the projects that the fund expects to invest in over the three- to five-year timeframe. The EIB can lend up to half the cost of a project. 

The fund is there to help attract and reassure other sources of financing, be it institutional investors, pension funds or traditional bank lending or indeed state finance, Richard Willis, spokesman for EIB tells PDI.

Debates about how the fund will work are ongoing. At the time of writing, Members of the European Parliament were debating whether the EFSI plan could put other European funding at risk.

The EIB, the largest issuer of bonds of any super national institution, will raise money to lend into EFSI projects. It may use a range of other instruments including guarantees and equity, all of which is under discussion at present, as well as the use of project bonds. Typically, the EIB lends around a third of a project’s cost, generating around three times its own investment by attracting private investors to a project. However, if a deal is to be funded through project bonds or some equity engagement, the leverage could be ten or twelve times or even more.

“It’s important to compare the use of grant funding at the moment at a national and European level, where it’s simply one euro of taxpayer’s money which is given out for one euro of project cost. It isn’t scaling up and therefore it isn’t as effective,” Willis explains.

COMPETITIVE ADVANTAGE

A detailed list of potential projects gathered from the 28 member states was presented to the European Council in December. “There were a whole range of different schemes, showing that there are investment needs out there, be it new innovative research and development needs essential for European competitiveness or simply upgrading hundred year old tube lines and railways,” Willis adds.

EIB subsidiary, the European Investment Fund (EIF), a fund of funds which supports venture capital investments through guarantees and some equity stakes, could contribute to roughly a quarter of the EFSI projects. The EIB expects to have clarity on the first handful of projects to be assessed for support under the new scheme by May. One of the challenges for the bank meanwhile, is identifying which deals are considered ‘risky’ compared to its existing mandate.

Another challenge will be whether companies want to partake in the scheme. There is a risk that private, innovative and more commercially sensitive investment companies will hesitate to seek investment publicly because they don’t want their ideas pinched. “We will have to see how that balance of risk and transparency works out,” Willis says.

REMOVING BARRIERS

Elsewhere, channels for alternative lenders continue to evolve, breaking down barriers to investment in Europe.
The European Parliament voted to approve the creation of European Long-Term Investment Funds in March. A response to bank reluctance to lend to small businesses or open-ended research projects, their design enables the channelling of non-bank funds from pension funds, insurance companies, professional and retail investors, into long-term projects to deliver infrastructure, intellectual property or research results. 

Another new legal framework, called the Irish Collective Asset Management Vehicle, should have the effect of attracting US investors into European loan funds, domiciled and regulated in Ireland. It marks a significant development for fund promoters seeking to market a European fund vehicle to US investors, Gerry Thornton, partner at law firm Matheson, explains in a paper published in April. Similarly, last month, the Italian legislature gave final approval to a set of measures designed to allow non-banks to lend directly.

It’s clear that European authorities see non-bank funding as playing an instrumental role in boosting Europe’s uninspiring recovery. Long-term there will be lots of twists and turns before a concrete CMU is in place, but the ball is rolling, and in the meantime, other initiatives and legislative improvements are being executed. 

After years of austerity, Europe is set to embark on an ambitious plan for investment and numerous channels are opening up to allow private capital to enter. Benefitting the investment community is not the priority of authorities hoping to stimulate the real economy, but the knock-on positive impact for the fund industry is inevitable.