Dr. Constantin Gurdgiev:

I thank the committee for the opportunity to comment on the EU proposals for a capital markets union. Like Mr. Brown, generally speaking I would be a supporter, but a much more cautious supporter, of the idea, for a number of reasons I will outline.

I second Mr. Brown's point about the education, which is a very important issue in financial markets in general and is certainly lacking here. I agree with his view that regulation does not stop crises. We have seen that before. What does help in addition to education, but is not covered sufficiently in the capital markets Green Paper so far, is the issue of enforcement of regulations. That is a major issue that we have witnessed in this country, for example, in regard to bank lending in the past.

I will give the members a summary of my view of the EU proposals in general. First, the European Commission is correct in its analysis of the current state of play and also the pre-crisis state of play in capital markets for the SMEs funding. The European SMEs certainly do not raise enough debt in direct markets - in other words, in the form of corporate bonds. They do not have significant issuance in terms of equity - shares in the markets - and historically they have over-relied on bank credit. Bank credit is not the optimal source of funding for SMEs. Traditionally, around the world, although not so much in the EU, it is primarily used to fund the operational costs of the SMEs rather than capital expenditure and capital expansion. It is not suitable for long-term finance and, as such, it is a higher-cost, higher-volatility and uncertain source of funding.

As a result of that, we have an objective we share with the European Union, and I agree with it that we need to move the SMEs towards more stable and broader sources of funding, including much more reliance on capital markets, particularly on bond markets for issuance of the bonds, and also on equity markets. However, the European Commission sets targets for policy interventions that are well intentioned in many ways but occasionally contradictory, and I will highlight some of those shortly.

The European Commission presents no substantive case in terms of the main thesis that underlies its proposed reforms. That is, it claims that a greater degree of capital markets reorganisation is needed to alter the composition of sources of funding for the SMEs, but does not prove the case that it is needed. To my best knowledge, there is not really any empirical evidence to support that assertion, either in Ireland or outside Ireland. If we look at countries where different models of funding have been used, such as the United States and the United Kingdom, they all have diverse markets. Within the United States there are numerous market platforms which are very different from each other from a regulatory, issuance and cost perspective and in terms of the types of enterprise and the types of instrument on which they trade. There are regional stock exchanges. There are specialist stock exchanges. There are over-the-counter markets. All of them are non-harmonised in many ways and all of them are functioning. However, in Europe, where there is the same level of diversification in the markets, the same desired result is not being achieved. Something else is amiss.

Most of the evidence, including from the US market, suggests that the market differences are not as important. They are important on the margin but not important overall in terms of what SMEs seek with regard to funding sources, which is a crucial issue. SMEs both in Ireland and in the EU tend not to go for equity financing. They tend to go for bank loans, usually a securitised bank loan backed by security through some asset, traditionally property. They also do not seek equity issuance as such, because often these are family firms which do not like dilution by external investors. Also, external investors do not show much interest. For example, if we look at the experience of the market in the UK and Irish Enterprise Exchange, IEX, here in Ireland, we cannot say there is a huge interest among professional and institutional investors in low-liquidity, high-volatility, smaller SME types of startup. Those markets are present and nobody is coming into them. There is certainly thin trading.

Overall, some of the proposals by the European Commission represent positive steps in the right direction, which I will list. A push for better regulation and supervision of investor protection is very important in those markets. We have seen that happen before in alternative investment markets, where the lack of regulation has resulted in mis-selling, so we might as well address that, and it will help investors to come into the market with a little more confidence in terms of SME shares and loans.

The proposals for standardising basic filing and reporting information for SMEs are also positive, as long as they reduce the overall quantum of the regulatory and compliance burden. That has to be meaningful. There is not enough granularity in the proposals to make that judgment, but let us hope they are progressed. Streamlining and reducing the burdens imposed by the prospectus directive, which is mentioned explicitly in the Green Paper, is always welcome, but only if it reduces overall quantum of burden.

Many proposals by the European Commission contained in the Green Paper are of dubious value in terms of attaining the stated objectives of the Green Paper of enhancing the capital markets for the SMEs. I will list some examples. The idea of co-ordinated and pan-European private placement regimes is dubious in value because private placement regimes are diverse regimes. They cover different types of equity and different types of hybrid deal such as equity together with debt. They cover different forms of debt. By their nature they are private placements and, as a result, they are much more targeted towards individual securities and individual issuers. Harmonising those will be very difficult, and I am not sure there is a value added in that.

Another example is mixing two different targets within a single set of reforms. What do I mean by that? There are two targets listed in the Green Paper. One of those is the pursuit of better and greater funding for SMEs, which is welcome, and the other is the pursuit of enhanced infrastructure and long-term investment projects funding. Those two objectives are contradictory. SMEs generally do not participate in large infrastructure projects. They do not benefit from equity or debt raised directly for those projects and, as a result, if we increase funding in one area, given that the quantum of liquidity overall in funding available in the market stays the same, we decrease the funding available potentially in the other area as well.

Focusing on enhancing securitisation markets is positive overall, but again contradictory in terms of the objective of raising more equity funding for SMEs and reducing the debt for SMEs, because securitisation relates primarily to bank lending. The banks take and securitise the debt and then sell those debt-securitised packages into the markets. That is all fine, but it does not free the investors to invest more into SMEs in the form of equity or direct debt issuance.

Harmonising the markets for equity and bond issuance as a means of expanding the appeal for foreign and internal cross-border EU investment flows is a questionable objective. Investments from outside and within the EU flow across borders not only on the basis of the risk-adjusted returns pursued, but also on the basis of hedging and risk management within investor portfolios. If one harmonises markets across the EU, one effectively reduces the ability of the different assets listed on different platforms to act as hedge or risk instruments. As a result, one can reduce the quantum of liquidity available in those markets.

I would cautiously support the overall objectives of the Green Paper and some of its main aspects, but a crucial point is that it is missing the first order of policy priorities, which are not related to the market union. Rather, they relate to the structure within which small to medium-sized enterprises, SMEs, work with financial service providers and raise finance in general. They overlap with the paper issued today by the IMF covering non-performing loans to SMEs in the EU. There are four policy priorities, which I will briefly outline before moving on to questions.

The first policy priority is to reduce regulatory and tax incentives for SMEs to raise bank debt over and above equity. This is crucial from the point of view of Ireland and the wider EU. Currently, we effectively subsidise or support debt issuance and debt raising by companies over and above equity. This is true for larger corporations and SMEs. I will cite an example. In the current proposal under the financial transaction tax, the states of the EU-11 that signed up to it are treated differently in equity and bond trades. The bond trades are taxed at 0.01% and the equity trades are taxed at 0.1%. A penalty of ten times is applied to equity trades. The capital gains taxes applied to equity trades do not apply to bond trades. The taxation of the bond trade's overall structure incentivises more debt raising than equity. We must deal with this issue. Capital gains tax will have to be addressed.

Policy priority No. 2 is to expand access to existing pools of investors instead of first trying to attract external investors. The largest untapped pool of investors in Ireland, in addition to those whom Mr. Brown mentioned, are those who are working for SMEs. They can be granted access to employee share ownership schemes and employee equity, but these are not tax efficient. We have been discussing this for a number of years and Ireland used to have the right tool to incentivise companies to issue equity to their employees. We undid that tool through subsequent legislation. Reviewing this situation is probably priority No. 2 if not No. 1, as it would give us access to available resources.

Policy priority No. 3 is to enhance, streamline and reform the EU-wide system of insolvency, business insolvency resolution, resolution of bankruptcy and resolution of non-performing loans. The IMF has done an excellent job on this front and has outlined what the EU-wide proposals should be and their scope, so I will not repeat them. I will direct members to the IMF's paper, which was published 33 minutes ago, entitled "Tackling Small and Medium Sized Enterprise Problem Loans in Europe". It is available on the IMF's website. I would be happy to provide the link.

The final policy priority is to identify key objectives in longer term reforms. Some of the reforms that have been proposed are contradictory. We must figure out what we want in Europe. Do we want enterprises that are raising more equity and funded on a long-term basis by investors who are interested in staying with enterprises for five years, for example? In that case, we will need to incentivise them and give them derogations from, or a total write-off of, capital gains tax. Alternatively, do we pursue the restoration of the traditional model whereby banks loaned on a relationship basis backed by collateral, usually relating to the property?

I will stop now. I hope that I have given the committee an idea of my views.