How to harmonize capital markets and regulation across Europe? Petra De Deyne, Regulatory Affairs Manager for Global Markets at BNP Paribas, presents the new initiative of the European Commission to build a single market for all 28 Member States of the Union.
After the crisis of 2007-2008, financial stability was the key priority for the European Commission. In order to restore that stability, the resilience of banks needed to be strengthened and systemic risk in the markets needed to be contained, which had Brussels produce that famous “tsunami” of regulation. Today, most of the work to make banks and markets stable again is done and the respective legislation has been or will soon be implemented.
Growth as a priority
The next item on the European Commission’s to-do list is now to create growth. Therefore, corporates need to grow their businesses, invest and expand. Historically, corporates have been very much dependent on bank lending if they want to expand. However, on the back of capital and liquidity requirements imposed by bank regulation, some banks have found it more difficult to fulfil their role of traditional lender. Seeing their bank funding channels drying up, larger corporates turned to capital markets, but did not always meet favourable borrowing conditions and interested investors. For some of the smaller corporates, getting funding had become as good as impossible. A survey done by the ECB and the European Commission in 2014 on the access to finance of enterprises (SAFE) showed that 35% of SMEs did not get the full financing they asked their banks for in 2013.
Looking at the US, we notice that corporates get about three quarters of their funding directly from the capital markets, and rely only to a small extent on bank lending. In Europe the situation is the other way round. So Europe wondered if they could create a funding landscape that would resemble more the US situation. That would mean that those in need of financing would meet directly with those that have money to invest. It would reduce the dependency of the real economy on banks, which would again contribute to financial stability. However, what is needed in that case is a harmonized, well integrated capital market in Europe. And this is where comes in the initiative of the European Commission: build a Capital Markets Union.
So in short, this is what CMU is about: it is a plan to create a single market for all 28 Member States of the European Union, where, on the one hand, funding choices for corporates will be diversified beyond bank lending and where, on the other hand, investment opportunities and the investor base will be broadened.
So what’s the plan?
“The Plan”, which the European Commission published in October 2015, sets 4 clear objectives:
- Support job creation and growth
- Connect financing effectively to investment projects across the EU
- Make the financial system more stable
- Deepen financial integration and increase competition
“The Plan” also defines 5 priority areas for action, with over 30 different initiatives for reviews, assessments, reports, initiatives and legislative proposals, all to be taken between now and sometime in 2018.
The first priority is to provide more funding choices for Europe’s corporates and SMEs. Here we will see initiatives to support venture capital and innovative forms of financing, such as crowdfunding. The EU is also thinking about ways to provide necessary data on SMEs to investors, so that they can make well informed investment decisions.
Second, long term investment has to be promoted. An initiative here is to make sure that capital requirements for insurers are reviewed so that they see their investment needs more efficiently met. Measures will also be taken to promote investment in infrastructure projects.
Third, the range of investment choices both for retail and institutional investors has to broaden. In this area, we will see, amongst others, incentives to promote pensions savings and private placements.
The fourth priority is to enhance the capacity of the banks to step up lending. This may sound contradictory, as the idea of the CMU is to move away from traditional lending. However, for a lot of SMEs, banks will still remain the prime source of financing. So Europe wants to make sure that banks can offload more assets from their balance sheet so that they have extra space to lend.
And lastly, the EU wants to dismantle barriers that would hamper cross-border investment across the Member States. This is quite an ambitious area, where certain tax issues will be tackled, and where we will see a certain harmonization as far as national insolvency laws and securities laws are concerned.
Simultaneously with the publication of “The Plan”, the European Commission issued a couple of legislative proposals and 3 consultations, as a matter of launching the short term actions right away and getting the train out of the station.
The European Commission takes immediate action in the field of securitization. This may seem quite controversial as some will still consider this as the root of all evil. However, it is a critical tool to finance the economy and it sits high on the Commission’s agenda. In order to kick start the securitizations market, the EU has come up with a legislative proposal, the purpose of which is twofold:
- First, it aims at reinstalling confidence. Therefore, a quality label is introduced: “Simple, Transparent and Standardized” securitizations. That means that any “STS” securitisation will comply with over 20 different standards, thus helping investors to better understand these products and ensuring quality. Second, it incentivizes banks to restart the activity again by giving these STS securitizations a better capital treatment, compared to other forms of securitisation.
- Next to that, the EU has issued a proposal to adjust Solvency II rules for insurers, so that they would have to deploy less capital when investing in long term infrastructure projects or in European Long Term Investment Funds (ELTIFs).
Also note that the European Commission is looking into covered bonds. Currently there are 26 different covered bond frameworks in the EU, an area which could possibly benefit from a certain level of harmonization. While the idea is not to create a single framework for Europe, the Commission would look to promote best practices, step up transparency and remove barriers that would hamper cross-border investments. We also saw a consultation venture capital and a call for evidence on the cumulative impact of financial legislation.
In the medium term, a review of the Prospectus Directive is on the cards. This is a logical move, given that the EU would like to attract many more corporates directly onto the capital markets to issue debt. Making prospectuses cheaper and less burdensome for smaller issuers on the one hand and more user friendly for investors on the other hand, would be a welcome help in that respect.
Another initiative is a Green Paper (this is a first, general exchange of views between the EC and the industry to explore a certain topic) on Retail Financial Services. Here he European Commission is exploring ways to enhance competition and make sure that consumers have access to a broader range of services in order to get the best deal around, when it comes to mortgages, savings products, insurance, banks accounts etc.
In the long term, count 2017/2018, we can expect further steps to support SME growth markets and private placements, along with plans for a pan-European Pension Fund. As already mentioned earlier, matters regarding withholding tax and insolvency law will get attention as well.
Benefits for companies
All in all, CMU certainly has a fully packed and ambitious agenda. Now what’s in it for companies, really? Potentially a lot. However, we appreciate that the road to a real CMU may be a far longer one. 2019 seems awfully close for some of the changes to happen. Rebalancing financial intermediation for example will most probably be a gradual, organic process that will go hand in hand with political interests, FinTech developments etc., rather than a major shift on a particular point in time.
Also, it will need a change in mind-set and behaviour by all stakeholders involved. The effects of a CMU may be more pronounced for the corporate sectors of certain countries with relatively small capital markets. For these countries, some of the initiatives could be particularly beneficial. Their domestic capital markets may currently not be able to cater for their large corporates, pushing them away to international markets. CMU could bring them back home and expand their markets.
The benefits of CMU will be different for the different types of companies:
- Start-ups will get special attention, as their innovation and entrepreneurial spirit are key to Europe’s growth potential. At this moment start-ups can turn to crowdfunding, but this is only developing and there is already some investment by business angels. However, these funding channels remain small and local and will not always provide the necessary funding at critical moments in their expansion. The initiatives to step up venture capital for example may be particular beneficial in that respect.
- Small companies that are struggling to get bank funding, especially in those countries that have been hit the hardest by the crisis, may unlock more funding via securitization. SMEs in particular could be positively impacted, as the intended side effect would be that securitisation allows banks to step up the lending capacity, knowing that bank lending for this type of corporates may remain a very important source of funding. Next to that, the European Commission also wants to work closely together with the SME growth markets, a new market sub-category created under MiFID II to facilitate access to capital for SMEs, to ensure that the regulatory environment for these markets delivers the expected results.
- Medium and large-sized companies, which may already have access to capital markets, should also feel the effects as CMU will support investors who wish to place larger amounts of capital in the market. The initiative to promote private placements, building on successful experiences such as the one in Germany and through supporting market-led initiatives such as the one by ICMA on the use of standardized documentation could be quite helpful. Tackling tax issues could come in helpful as well.
What is important too is that the European Commission is also planning to review the functioning of the European corporate bond market and to see how market liquidity can be improved. A well-functioning secondary market will be crucial for the success of the primary debt markets.
So all in all, the Capital Markets Union is an ambitious, yet challenging plan of the European Commission. Ambitious because it intends to reengineer Europe’s traditional funding channels. Challenging because of the wide range of issues that need to be tackled to get there and the tight deadline. The outcome should be that corporates meet with investors in an efficient market place, thus broadening the scope of options for both parties to contribute to economic growth.
(Source: Focus Magazine CIB)
Crowdsourcing: the basics
Are you undecided about the various ways of increasing your offering? Has R&D encountered a technical problem? Perhaps your clients know more.
The concept of crowdsourcing is simple: you call for the contribution of your customers and/or the general public. An approach which is gaining popularity worldwide even though it is not actually new. As far back as 1714 crowdsourcing by the British government led to the invention of the chronometer and therefore a reliable method of calculating longitudinal position at sea.
Three hundred years later the basic principles remain the same: in crowdsourcing you work with a network of individuals and communities within and largely outside the company. They make a contribution in the form of ideas, time, expertise or financial support. This enables new solutions to be accessed and makes realisation of joint projects and optimisation of tasks possible while keeping down costs.
This system is based on exchange, transparency and communication. It also works for all sectors and at all management levels. You should be able to engage a community of designers for your product development for example and choose the best proposal together with the public. Then you will bring it onto the market, possibly even financed via crowdfunding.
The crowd is ready for this
This is certainly no science fiction, as proven by the growing success of the system. It is also the ideal time to get involved with crowdsourcing:
- communicating with the crowd is easier than ever before thanks to technological development, the social media boom and the development of online communities;
- the crowd is straining at the leash: a joint survey by several European universities showed that 54% of Europeans would like to support projects by companies and private individuals creatively and/or financially;
- co-creation, or developing a project together, is hot. The crowd can join in with a project for a whole host of reasons: the necessity for a creative outlet, commercial motives, dedication to society or just for a sense of honour or fun;
- the economy urgently needs sources of financing and innovative projects in order to achieve new growth and to increase competitiveness.
It will definitely take some getting used to as such a system radically changes the way in which a company gathers information, carries out research, produces and even finances projects. At the same time relationships with clients or users change as they evolve into potential colleagues, financiers and ambassadors.
But this does not have to be a threat. On the contrary, crowdsourcing provides you with a unique opportunity to relinquish your traditional methods. You can now look externally for ideas, get feedback from the crowd on ideas developed internally or even combine both approaches. The possibilities are endless.
The dos & don’ts of crowdsourcing
A good crowdsourcing project creates a win-win situation where the initiator and the crowd feel that they are achieving something together. How do you approach that?
In crowdsourcing the 'crowd' component is at least as important as the 'sourcing' component. In order to be successful you must build up this community and win it over. This is where the challenge lies: the crowd is not an anonymous, homogeneous mass but a collection of individuals and sub-groups. You need to seek out and mobilise each one separately. 5 tips for a powerful crowd dynamic:
Take care of the presentation of your project
Your project must appeal. Present it with photos, short films or a clear presentation – vague sketches or a half-baked concept are inadequate. Keep your explanation as simple as possible. After all not every potential funder is a specialist or an engineer.
Also, don't forget to keep your target amount as realistic as possible. Above all do not create the impression that the campaign is an excuse for personal enrichment or that you will channel the money off into other, existing projects. If you work with rewards, ensure that they are original and attractive, divided up into transparent and attainable blocks of financing.
Build your crowd
Look for the suitable crowd and get these people right behind your project. Approach them via all possible channels and assign them various roles: creative or technical input, critical analysis, ambassadorial, ... When doing so keep the threshold as low as possible, within your company as well. It is recommended that you bring as many of your people as possible into contact with the crowd in order to ensure healthy cross-pollination.
Live your project
A project without animation has little chance of success. So be motivated and keep motivating others. Respond to queries, take comments into consideration and intervene where necessary. Remember that participants cannot be squeezed to produce viable ideas. They too must go through a creative process in which they can gradually shape their input. So ensure that they continue to be involved. For this purpose it is necessary to approach each sub-group differently: encourage, win over (again), congratulate, permanently challenge, ...
Keep your campaign exciting
Keep communicating, even if some of the messages may be negative. The greater the involvement you demonstrate, the greater the loyalty of the funders and the greater their willingness to accept delays or problems.
A good dosage is important here. Ensure that news is provided at regular intervals to keep the crowd involved so the attention on your campaign does not fade away.
Your project, your rules
The principle: you decide where you want to go with your campaign while being open to suggestions from the crowd. So you lead the crowd to the desired end product rather than the other way round. Otherwise the outcome may be rather different to what you had hoped. A few examples of how not to do it are the recent – and hastily cancelled – campaigns which resulted in the product name iSnack 2.0’, a chocolate bar filled with mince, or a washing-up liquid with a scent of roast chicken...
Crowdfunding: financing with extras
Are you looking to finance a new project which has some risk attached to it? Present your plans to the crowd and discover how quickly small acorns can become mighty oaks.
Crowdfunding or participative financing involves looking for a (large) number of potential moneylenders. These may be professional investors or co-entrepreneurs or equally your clients or the general public. They will finance your project or company on a quid pro quo basis.
This specific form of crowdsourcing is centuries old. Just think about the construction of the Sagrada Família (Gaudi cathedral) in Barcelona or the plinth for the Statue of Liberty in New York. The way in which it happens is rather different today: via online payment or online platforms, often with lots of publicity on social media. The emergence of social media is undoubtedly one of the reasons for the increasing popularity of crowdfunding, together with the search for alternative sources of financing as a result of the crisis.
Much more than just a source of financing
While crowdfunding focused on cultural or humanitarian initiatives for a long time, its emphasis has recently shifted to commercial projects and even the financing of start-ups and small and medium sized companies. The advantages are clear:
- companies can meet the cost of – mainly innovative – projects which are less suitable for (complete) financing via a bank loan, business angels or a private equity partner. This may be because they have considerable risk attached or demonstrate too little concrete potential for growth, the required amount is too low or the company does not want to have an external party join in with the company capital.
- Financing is just one part of the story; creating sufficient 'buzz' and a community around your project will make you much more visible. Simultaneously, you carry out market research. Is there a call for your product or service? Is the design suitable? And are you bringing it onto the market in the right way? Thanks to this interaction you can also make adjustments to the product during the design phase, thereby reducing the risk of an unsuccessful launch.
- By taking the input of the crowd into consideration you will create a much closer bond with your target market, with clients developing into co-designers, fans and ambassadors.
Challenges and risks associated with crowdfunding
Although crowdfunding provides almost inexhaustible possibilities, it also involves a number of challenges and risks. An overview.
1. For the company
You open the company up to the public. This is of huge benefit in terms of marketing and strategy but it also means that everyone has access to the complete financial situation. You must therefore be prepared to be completely open and sometimes share sensitive information.
This new business model turns all traditional models on their heads. The greatest challenge is learning to deal with this and finding a good balance in the area of
- control: how do you divide authority between the company and the crowd? There is no golden rule but research conducted by the University of Toronto suggests that the ideal system has 80% of the project firmly in place with the crowd having a say in the remaining 20% (e.g. choice of colours, technologies, points of sale etc.);
- transparency: to what extent do you wish to share your knowledge, technology and research and development results with others – including potential competitors? How will you protect your copyright and intellectual property in such a case?
A significant risk is of course the fact that you may not achieve the desired funding and the campaign fizzles out. However, this is an advantage in a sense. The campaign helps you assess whether there is a demand for your intended product or service on the market. If this does not appear to be the case, you will at least find out in time and be able to avoid the much higher loss of a failed product launch, both financially and in terms of reputation. You can use the feedback received to instigate changes and make a new attempt later on.
If you add up all the fees and the marketing, time and energy involved in a crowdfunding campaign, the cost of this form of financing can be extremely high. With reward-based funding there are definitely a few flies in the ointment. You must declare the funds collected as taxable income. In addition, a pledge is regarded as a sales transaction which is therefore subject to VAT for companies. Take these factors into account when setting your prices. Otherwise the tax office may bring you an unpleasant surprise...
2. For the investor
For a moneylender the challenge primarily involves finding good projects. There is no shortage of attractive initiatives. Quite the opposite in fact. With reward-based campaigns it can sometimes even be difficult to resist the temptation. But what will your investment yield?
Putting money into a project always remains a bit of a gamble, even if you have analysed it thoroughly and you believe in it. Success is never certain and unforeseen problems may occur at any time. With lending or equity-based formulas your complete investment could then be lost.
The chance of this happening is smaller for the reward-based model, as is the amount invested. There is always the possibility, however, that the initiator will not meet his commitments, will only partially meet them or severely delay meeting them. In very rare cases fraud may be involved with the collectors (and your contribution) disappearing into thin air.
A clear picture
Do you want an objective opinion before joining a Belgian crowdfunding project?
If the project has a prospectus obligation, you can look at it with the FSMA approved prospectus. Among other things this contains further information about the initiator and the legal form of your investment (share, loan etc.). An approval or licence from the FSMA or the National Bank of Belgium does not however mean that these bodies automatically deem the project suitable for investment – it is up to you to weigh up the risks.
You can also use the FSMA website to check whether the internet platform and/or the initiator are under special supervision by the FSMA or the National Bank of Belgium.