Institutional investors will not provide long-term financing to the real economy without access to genuinely long-term instruments

Policy makers increasingly wish to see institutional investors become more involved in the financing of the real economy, but matching the supply of long-term capital provided by such investors with long-term investment demand is not self-evident and requires a policy and regulatory focus on the type of instruments that long-term investors need, rather than which sectors of the economy qualify as ’long-term’ investment.

In its recent responses to the European Insurance and Occupational Pension Authority’s (EIOPA) consultation on the design and calibration of the Solvency II Standard Formula for long-term investment (May 2013), and to the European Commission’s Green Paper on long-term financing (June 2013), EDHEC-Risk Institute has highlighted three important points:

1. Providing long-term finance to the real economy is not part of the mandate or mission statement of insurers or pension funds, which cannot be expected to have much interest in financing infrastructure or SMEs per se.
2. Instead, they are increasingly attracted to such investments because of the risk factors to which they provide exposure, and the extent to which increasing their exposure to the aforementioned risk factors helps them achieve their own investment objectives.
3. Thus, insofar as long-term financing will increasingly be provided by institutional investors in Europe, it will be to respond to institutional investment needs and focus on those investments and instruments that can best allow them to meet their long-term investment objectives while respecting their short-term constraints, especially their funding or solvency ratios.

Hence, we argue that the design of prudential frameworks like Solvency II should not be altered to accommodate ’infrastructure’ investments for example, but ’project financing’ i.e. the type of investment vehicle and instruments that allow long-term investment to take place and embodies what investors are after when they consider investing in infrastructure. Indeed, it is perfectly possible to invest in infrastructure without making a long-term bet (e.g. listed infrastructure).

Policy makers and regulators should support the use of existing long-term instruments, as well as the creation of new ones that better respond to investors’ needs e.g. inflation-linked infrastructure debt.

EDHEC-Risk Institute will continue to contribute to the debate on long-term investment, including through its participation in the next G20 meeting of Finance Ministers in Moscow (July 2013) and the next OECD/APEC meeting on institutional investment in infrastructure in Indonesia (August 2013).