Oireachtas Joint and Select Committees

Tuesday, 31 March 2015

Joint Oireachtas Committee on Finance, Public Expenditure and Reform

Green Paper on Capital Markets Union: Discussion

2:00 pm

Photo of Aideen HaydenAideen Hayden (Labour)
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On 18 February, the European Commission published a Green Paper entitled Building a Capital Markets Union. The blueprint for such a union is a key priority of the Juncker Commission and is one of the most significant policy developments in the area of financial services. The creation of a single market for capital is intended to remove obstacles that currently inhibit and obstruct the free movement of capital. By eliminating these barriers, it is hoped cross-border EU investment will expand. This could have an effect on jobs and growth, as capital which may be currently frozen is unlocked and distributed to the most productive parts of the economy.

The capital markets union, CMU, is also designed to increase the availability and choice of funding to the SME sector. Difficulties in the banking sector and the requirement to repair balance sheets are considered to have adversely affected lending to SMEs. A transition to markets-based finance would provide an alternative source of finance for start-ups and innovative enterprises. The objective of CMU is to link investors and savers with viable and employment generating businesses, in the process making the investment chain more efficient.

The joint committee over the course of today's hearings will gain an insight into the key issues outlined in the Green Paper. The committee is interested in learning about the different aspects of the initiative, and from a diverse range of stakeholders. The committee intends to make a submission to the Commission and this session offers an opportunity to inform that. More important, the hearing allows for a constructive debate on both the key issues outlined in the Green Paper and the broader concept of capital markets integration.

I thank all the witnesses sincerely for making themselves available at short notice. Committee rooms and slots are at a premium and, therefore, we had to seize the opportunity when one became available to allow us to prepare a submission on this topic before the middle of May. There will be four sessions this afternoon of a maximum of one hour each. I welcome to the first session Mr. Mark O'Mahoney, director of policy, Chambers Ireland, and Ms Regina Breheny, director general, Irish Venture Capital Association. Both will make opening remarks of approximately five minutes each, although I will not be strict about that. A question and answer session will follow to clarify matters that may arise. I remind members, witnesses and those in the Public Gallery that all mobile phones must be switched off.

I advise the witnesses that by virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of their evidence to this committee. If they are directed by the committee to cease giving evidence on a particular matter and continue to so do, they are entitled thereafter only to qualified privilege in respect of their evidence. They are directed that only evidence connected with the subject matter of these proceedings is to be given and are asked to respect the parliamentary practice to the effect that, where possible, they should not criticise or make charges against any person or persons or entity by name or in such a way as to make him, her or it identifiable. Members are reminded of the long-standing ruling of the Chair to the effect that they should not comment on, criticise or make charges against a person or persons outside the Houses or an official by name or in such a way as to make him or her identifiable.

I invite Mr. O'Mahoney to make his presentation.

Mr. Mark O'Mahoney:

I thank the committee for the opportunity to present. Chambers Ireland is Ireland's largest business network. We represent business throughout Ireland and, what is important in the context of this discussion, we are also a member of the European chamber of commerce. The European Commission’s decision to move towards the establishment of a single capital market is welcome. The development of a fully functioning single market for the movement of capital throughout the 28 member states will support EU competitiveness by facilitating the effective and efficient allocation of capital and ease access to finance for the real economy. Ultimately, an efficient CMU will support the Commission’s priorities of jobs and growth for Europe.

Equity markets in the EU are dwarfed by those in the US and there remains an over-reliance on loan financing, typically from retail banks, to finance SME activity across the EU. The downside of this over-reliance on bank credit became apparent during the financial crisis when banks deleveraged and credit to SMEs was severely constrained across the EU. A capital markets union will facilitate the development of a new range of innovative financing options for European businesses and reduce the unhealthy dependence on bank loan finance.

The Green Paper sets out a comprehensive and ambitious programme which will take some years to implement. There are significant obstacles that will need to be addressed in advance of a full capital markets union being achieved. However, there are areas in which progress can be made in the short to medium term and we believe it is essential that focus is placed on these to deliver benefits in the short term and to generate positive momentum for the project.

The first of these is standardising credit information for SMEs. The development of a common standard on balance sheet information on SMEs across the EU would be useful in allowing for the accurate assessment of investment propositions across borders. However, due to the vast differences that exist between member states, the chances that this is feasible in the medium term are low. A minimum amount of common comparable information across the EU could, however, be developed and shared with interested parties. The European Central Bank could play a role as a co-ordinating body. The standardisation of SME credit information may also become a driver for the development of cross-border peer-to-peer lending mechanisms and other innovative financial services. This aim must be balanced with the recognition that European SMEs are already struggling under a weighty administrative burden, so mandatory public disclosure of company information in addition to national reporting requirements should be opposed.

The development of a European private placement market offers some potential for Irish companies, but it remains highly fragmented and defined by domestic investments. In addition to support for the pan-European corporate private placement market guide covering a voluntary framework for common market standards and best practices which has been endorsed by Europe’s leading central bankers and capital markets players, the EU and national policy-makers should take into account tax legislation, for example, an exemption from withholding tax for private placements. Simple steps such as the utilisation of standardised documentation across the EU would also encourage potential investors to look across borders for opportunities.

If managed correctly, the development of a standardised European-wide securitisation market could be of significant benefit to SMEs. Allowing lenders to pool SME loan portfolios and convert them to securities which can attract investment from those with greater risk tolerance will remove some risk from bank balance sheets and increase the appetite for SME lending. However, clear regulatory oversight of securitisations is essential.

The final point relates to the tax treatment of equity. Despite a general agreement on tax policy being biased against equity, very little has been done to change that. Policy-makers could consider changing the tax treatment of equity to remove the bias. This is particularly relevant in Ireland as we seek to reduce the typical reliance on loan finance to fund projects and introduce innovative new finance products to part-fund capital investments.

The development of the capital markets union will be a long and challenging process, but the benefits to European productivity and competitiveness will be significant. We believe CMU is a worthwhile project. If it is delivered as envisaged, it will unlock investment and facilitate the development of a new range of financing options for European companies in the real economy. There will undoubtedly be benefits for Ireland and Irish companies and opportunities for Ireland to leverage its role as a centre of financial services and a centre of excellence for fund management. A caveat would be that it is difficult to see where some of the proposals would be relevant for the typical Irish SME. Notwithstanding this, it is a positive initiative and we would support its delivery.

Ms Regina Breheny:

On behalf of the Irish Venture Capital Association, I thank the Chairman, Deputies and Senators for inviting me to meet the joint committee this afternoon. I will give some brief background of what we are and what we do before I make some recommendations.

The IVCA is the representative organisation for venture capital firms in Ireland. These VC firms have specialist domain knowledge and invest primarily in fast-growing, high-tech companies operating in the ICT and life sciences sectors. These companies are developing deep technologies, addressing global markets and creating thousands of high-calibre jobs. VC provides equity capital to fund the start-up, growth and expansion of innovative SMEs that are high risk and high potential but are unable to access credit markets because their underlying assets are typically based on intellectual property. VC firms bridge the five-to-ten year funding gap between small amounts of money raised from friends and family to funding from bank debt at a much later stage.

A particular feature of the VC model is that a VC fund is precluded from taking on debt, distinguishing it from the buyout part of the private sector industry. It usually invests equity for a minority shareholding. As leverage is not an issue, thus it must be said that venture capital activity does not pose any systemic risk.

VC teams usually have a technology background and are scientists, engineers or researchers or they come from a business background with deep industry experience. A core skill is the ability to identify novel technologies that have the potential to generate high commercial returns at an early stage. Normally the interests of the VC fund and entrepreneurs are aligned and both have a common interest in building a business around a piece of technology and exiting it through an IPO or a trade sale over time.

International studies indicate that venture capital stimulates growth, innovation, research and development, new businesses and entrepreneurialism. In Ireland, VC as a percentage of GDP trebled from 0.06% in 2003 to 0.22% in 2014, the second highest level in Europe after Finland. Throughout this period the number of new innovative companies raising seed capital increased fourfold. Irish technology companies have spawned a significant number of new companies and created a new generation of serial entrepreneurs who are now dominant as angel investors in the early stage sectors.

The IVCA's economic impact analysis shows that, over the past decade, venture-backed companies have created high-calibre jobs, with employment growing by 11% per annum since 2003. They are export led, with exports growing by 12% per annum since 2003 and revenues by 17% in the same period. These companies are knowledge based and graduates represent 73% of the workforce. The research and development spend by venture-backed companies represents 30% of all Irish SMEs' share of total spend on BERD, which is the measure of spending on research and development. Growing Ireland’s indigenous export-oriented SME sector is becoming a national imperative as these companies provide 50% of the jobs in the economy and generate 10% of exports. A strong and well-financed venture capital industry is vital to this growth. This imperative is emphasised also in Europe and is reflected in policy guidelines and in the fact that VC as an asset class has been carved out of the more stringent regulatory regime applying to private equity.

We welcome the Green Paper on CMU. It highlights what is well known, that access to risk capital is much lower in Europe for a variety of reasons and this is more pronounced as one moves up the risk curve. The report also highlights the need to improve access to finance, especially for SMEs, to increase and diversify sources of finance and to improve market efficiency across member states. It promotes VC as having an important role to play. However, while there has been progress on regulation and finance, vigilance is required and sanctions may be needed to prevent gold plating and to ensure additional costs are not imposed by individual countries in an uncompetitive way. In addition, a co-ordinated approach needs to be followed to ensure the VC asset class is not excluded or restricted as an investment under the current discussions on prudential rules for the insurance and pensions industries. Joined-up thinking is essential in this regard.

The industry in Ireland is performing very well, but this story is not consistent across Europe. While the level of VC investment activity worldwide has been adversely affected by the credit crunch, with no growth and significant volatility throughout this period, there has been strong investment in Ireland throughout the recession and €401 million was raised by Irish SMEs in 2014 alone. Annual investment activity in Ireland has grown by 65% since 2007 while fund-raising in Europe as a whole was halved over this period.

The focus of venture capital activity is on investment in high-tech, early stage companies in the ICT and the med-tech sectors. More than 500 of these companies have been supported by Irish VCs in the past ten years. Consequently, Ireland is recognised as a major force in technology development.

In the past ten years, €1 billion in capital has been imported by Irish venture capital firms through syndication with US and European-based venture capital funds. On average, every euro invested by an Irish venture capital firm is matched by a euro from an international venture capital firm. Since 1997 the number of venture capital funds operating in Ireland has more than doubled and the average size has increased from €20 million to €75 million. In Europe the average fund size is €60 million but the median size is €27 million. That is how small the industry is. It is also very fragmented.

Irish venture capital firms have invested in a wide range of deal types and many of the firms are entering their fourth investment cycle. They have specialist domain knowledge in the sectors in which they invest. Unfortunately, deal size is an issue both in Ireland and across Europe. In the US, SMEs receive five times more funding from capital markets than in the EU, and, in venture capital terms, US companies receive up to ten times more funding than in the EU. This is particularly evident in the growth and expansion stage.

The venture ecosystem is well developed, with spin-outs coming from publicly funded research centres and, with the emergence of incubation centres and accelerator programs, these start-up companies are now better prepared in terms of investor readiness than ever before. Almost all of the leading US ICT, pharma, med tech and biotechnology companies have located their European headquarters here. They draw talent and are breeding grounds for the entrepreneurs of tomorrow. Most exits in Ireland are through trade sales mainly to these multinationals, thus further expanding and embedding the presence of the multinational industry in Ireland.

In essence, the US is composed of a number of venture capital hubs. There is Silicon Valley on the west coast, Austin in Texas, Boston in Massachusetts, and New York. It is unlikely that a homogenous industry can be spread evenly across Europe. This seems to be the purpose and intent of the policy in the capital markets union document. Venture capital hubs are already emerging in Europe and policy initiatives should focus more on driving this process and supporting what is being created by the private sector.

It is our ambition to ensure that Dublin is a venture capital hub alongside London and Berlin. We already have many of the building blocks in place. To create a best-in-class venture capital hub, Ireland needs, on the demand side, to attract skilled labour and startups fromother states. To achieve this, key initiatives around personal tax will be essential. We see the UK as our main competitor. Unfortunately Ireland’s tax regime has lost significant competitiveness compared to the UK. There is now a misalignment between the Government’s tax policy in regard to entrepreneurship and the key objectives in the Action Plan for Jobs. The main areas of contention are the capital gains tax regime, where rates here are currently 33% as against 10% in the UK, reduced by entrepreneur’s relief, and there is also a lack of share option schemes to incentivise entrepreneurs. These are barriers to encouraging entrepreneurs to set up in Ireland. All a person has to do is drive one hour to the North to avail of the better regime that operates in the UK.

On the supply side, we need to increase the amount of capital in order to scale opportunities. In this regard, Irish venture capital firms have performed very well because of their ability to import international private capital by syndicating deals. This process has gone some way towards alleviating the lack of depth in Irish and European capital markets. This is a unique advantage for Ireland and, from a competitive viewpoint, local venture capital firms should be supported by the State through Enterprise Ireland, by the Ireland strategic investment fund, ISIF, and by the European investment fund, EIF, in order to capitalise on this advantage.

Fundraising for venture capital funds in Ireland, and in Europe generally, is very challenging. Support from the private sector is limited. In Europe, the international long-term investor has decreased its share of venture capital funding from 35% to 15%. The main reasons for this include a significant fragmentation of investment opportunities. There are not enough large venture capital funds to absorb the investor’s bite size. There is a significant gap between the size of the investor and the size of the venture capital fund. Prudential rules at EU level are restricting the venture capital asset class as an investment. Further, there were high performance expectations, which, unfortunately, after the dotcom crash around 2000, were not met.

There is also a distinct absence of certain classes of institutional investor that have historically supported US venture capital firms. These include private equity funds-of-funds, university endowments, foundations and family offices. Most life assurance companies operating in Ireland are foreign-owned and are managed from abroad, with little influence on decisions to invest in the Irish venture capital asset class. There is also a limited pool of Irish pension funds of sufficient scale and management resources willing to invest in Irish venture capital. They are largely semi-state or public sector defined benefit schemes. Many of these defined benefit schemes are in deficit and have been actively seeking to reduce their risk profile.

Photo of Aideen HaydenAideen Hayden (Labour)
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I understand we did not receive a copy of Ms Breheny's submission.

Ms Regina Breheny:

No. The committee did not.

Photo of Aideen HaydenAideen Hayden (Labour)
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It is quite difficult for us to follow such a lengthy statement without having received it in advance. Are we coming to its conclusion?

Ms Regina Breheny:

Yes. I will now deal with initiatives to free up private sector capital. These initiatives should be considered and could include, for example, the establishment of a fund-of-funds mechanism, using a PPP model, in Europe, with preferential treatment for the private sector and the State taking a subordinated position. I think that would be essential in terms of attracting private sector money. This fund would in turn invest in individual venture capital funds. This mechanism could satisfy large investor appetites and create larger pan-European funds that could invest in larger tickets required to scale business.

The venture capital threshold in the alternative investment fund managers directive, AIFMD, of €500 million should be increased to €1 billion to allow bigger funds to be created without undue regulatory issues. We also need a Government or EU initiative to underwrite a liquidity mechanism that allows defined contribution schemes to invest in selected Irish-focused investments such as venture capital. We also probably need some tax relief for retail investors if we are going to encourage them to look at venture capital funds as an asset class.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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I thank both witnesses for their presentations. I have many questions. If I can pull back from the detail that both witnesses gave, within the context of a capital markets union, what are the biggest opportunities? It is very useful to have both witnesses here. We have Chambers Ireland representing producers, but we also have Ms Breheny representing investors in producers. From both witnesses' perspectives, what are the biggest opportunities of the establishment of the capital markets union? What will happen for their members that is currently is not happening?

Ms Regina Breheny:

I hope the EU will follow through on its objective. There is much talk and noise about the importance of venture capital, but we have not seen much action yet in terms of increasing the capital available. I hope that will be the result of it. Something has to be done to bring the private sector to the table and to encourage it to invest in venture capital as an asset class.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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Specifically referring to the capital markets union, if it works, what will happen? In the world of venture capital, how will we know it has worked?

Ms Regina Breheny:

There will be more private sector capital willing to invest in the venture capital asset class. That would be the net effect.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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What are the current barriers? Some of them were laid out in Ms Breheny's statement, but what are the biggest barriers? Let us assume that we have a bunch of venture capital firms in Ireland, still fairly small-scale, and we have two hubs in Berlin and London of a bigger scale. We then have a load of cash floating around. It is owned by pension funds, private equity funds, corporates, Governments and so forth. Ms Breheny wants those funds and those fund managers reinvesting in venture capital. It sounds as though they have seriously deleveraged their venture capital exposure over the past number of years. What is involved? What barriers need to be taken away to get them to reinvest?

Ms Regina Breheny:

They need a vehicle big enough to absorb their bite size.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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What does that mean in layman's terms?

Ms Regina Breheny:

If a pension fund pool of money is of the order of a couple of billion and a venture capital fund has €100 million, it will not get much bang for its buck by investing 10%, or €10 million. It does not feel like putting the effort into understanding, monitoring and going through the process of due diligence unless there is a vehicle large enough for it to be able to put in a couple of hundred million, whereby the due diligence is done over a whole series of venture capital funds underneath a layer.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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Is the idea that one would pool venture capital funds?

Ms Regina Breheny:

Yes.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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It is almost a securitisation exercise of venture capital funds. If there are 100 different funds from around Europe with €1 billion to invest, they could not be bothered putting in €10 million each, but they will drop it into a pooled company. We are talking about a layer sitting on top - the intermediary.

Ms Regina Breheny:

Yes.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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That does not exist right now. Is that right?

Ms Regina Breheny:

No.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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Is that for legislative reasons? Is it not allowed to exist?

Ms Regina Breheny:

No, it is not that. It is just that the system has not evolved to a sufficient extent. It also adds a layer of cost, but that cost would be justified if it brought about the result one needed. It just has not evolved that way. Also, for prudential reasons, the private sector has largely backed away. Somebody needs to bring the private sector back to the table with a proposal for that kind of mechanism. Individual venture capital funds and bodies such as ours are too small to have been able to promote and market a process like that.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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I presume the market could take care of that itself. Ms Breheny and I could decide now that we were going to set up a pan-European venture capital pooling intermediary and then go around to all of the wealth funds and say "Give us €1 billion which we will divvy up between the different venture capital funds". Why is that not happening already?

Ms Regina Breheny:

The European venture people are trying to do that, but they do not represent money as such. The private capital industry is dominated by buy-out funds and they are significantly bigger. As a subset of that asset class, venture capital is tiny and has a very small voice even though there is a great deal of noise around the asset class and the quality of what it does within the real economy. It still has a very small voice.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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In that case, Ms Breheny's organisation would like the State to step in and help set that up.

Ms Regina Breheny:

Yes.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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As part of the CMU, what should the State do?

Ms Regina Breheny:

Funds should be allocated under the Juncker plan, or EFSI, to a pooled mechanism that might subordinate state rights, etc., and attract private sector capital to create a large pool at the top which can then invest in venture capital funds below. That would bring significantly more money into the venture capital asset class and grow the venture capital funds at the same time.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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The combination of the European Investment Bank fund and Commission money is looking to do that. They have said they will underwrite the first 7% and are looking for scaling of approximately 15 to 1 of private investment money to public money. They will not get 15 to 1 but that is what they are looking for. They are saying they are willing to underwrite the risk to the tune of approximately 7%. Through quantitative easing, QE, Draghi is flooding the market with free money. If the EIB and the Commission are already willing to underwrite private enterprise with public money and the ECB is flooding Europe with free cash, why is that not enough?

Ms Regina Breheny:

I am not an economist. I do not know the answer to that. We do not see anything happening to bring new money to the asset class. That is the problem.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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Are venture capitals allowed to access QE money? Can they go straight to the ECB?

Ms Regina Breheny:

No.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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Can venture capital funds go straight to the EIB and look for it to underwrite some of the risk?

Ms Regina Breheny:

The EIB does not necessarily give equity. This is equity money not debt money. That is the big issue. Venture capital funds are specifically precluded from taking on leverage.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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So they cannot take EIB money.

I want to pick up on tax policy. Ms Breheny is in the industry and I accept that her knowledge and expertise on this far exceeds mine. I have spoken to venture capital funds based here and in London, Boston and the Valley. There is a growing pool of venture capital money in Dublin and we are getting an exciting hub here, but whenever I have talked to people about what it takes to invest, I have never heard mention of tax. The lobby groups mention tax all the time and never stop talking about it. From a producer's perspective, Ireland has an extremely low corporation tax rate and the lowest employer's PRSI rate in Europe. For the chambers' members, who are ultimately the people in whom funds are investing, we are highly tax-efficient. I am not saying Ms Breheny is wrong, but I have never heard an actual investor say the tax policy in a country-----

Ms Regina Breheny:

It is the entrepreneurs.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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I am talking about the venture capital investors.

Ms Regina Breheny:

We are talking about the entrepreneurs. They are the ones who suffer when they sell out. It is a long process for them and they tend not to take a commercial salary early on. It is sweat money. However, they are crucified with capital gains tax when they sell their companies. In the UK, the rate is significantly lower so there is a relative incentive. That is the problem. The UK was very far behind Ireland until a year or two ago, to the extent that activity here in terms of fundraising for companies was approximately 25% of what it was in the UK. That was notwithstanding the fact that the UK economy is 16 times the size of Ireland's. However, the UK is catching up very quickly now because of its progressive tax regime for entrepreneurs.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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Is that specifically on CGT?

Ms Regina Breheny:

Yes. It is called "entrepreneur's relief" over there.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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Has the policy introduced by the Minister of tax relief on the reinvestment of capital gains helped?

Ms Regina Breheny:

One has to sell first.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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Yes, but there are ways of avoiding the 33%.

Ms Regina Breheny:

At the end of the day, it will help, but it is too soon for that to have had an effect.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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I thank Ms Breheny.

I would like to ask Mr. O'Mahoney about risk. The capital markets union seems like a good idea. One removes transaction costs, improves the free movement of capital and makes it possible for Irish-based investors to look at opportunities in London or Berlin, while investors in those areas can meet with Mr. O'Mahoney's members and do debt for equity rather than making straightforward loans. The free movement of capital is a fine idea until one looks at what it has actually done around the world for the last number of centuries. While a great deal of wealth has been created by the more efficient redistribution of supply and demand for capital, a great deal of damage has been done as well. Most of the growth we see in the USA, Europe and Ireland relates to debt. It is not real growth. It is not something any engineer, scientist or business person would recognise as growth. The Federal Reserve and the ECB are printing money and giving it to banks for free. Those banks are buying sovereign debt and becoming vastly wealthy for doing nothing. We were meant to deleverage. We all saw in 2007 and 2008 what happens when one has debt-fuelled growth and the amount of capital in the system far exceeds and outgrows the underlying real economy by a huge factor. It is happening again.

We have not deleveraged and, in fact, we are on the way back up again. The Federal Reserve has printed a vast amount of money and now the ECB is doing the same.

One of the risks of the CMU is that it facilitates more and more debt. The members of the organisations present are the producers. They are the people who must take on this debt and then sell widgets, services and products to pay it back. Are they concerned? Is the Chambers of Ireland concerned that it has been made easier for hot money to arrive over from the Valley, Japan or wherever there happens to be free cash? In Australia there is an asset price bubble, which means there is a load of extra cash. What happens if that suddenly arrives in Europe and Ireland? That hot money will drive up asset prices and leave members of the organisations that are before us today massively in debt. They will find themselves unable to pay it back when all the asset prices and economic activity go back down. Is there a concern among the witnesses' organisations that the CMU will make it easier for hot money to get into the Union and move within the Union, and that this will drive up asset prices and create a false economic growth that is ultimately damaging to their members?

Mr. Mark O'Mahoney:

The issue around inflated asset classes and their super-liquidity at the moment is a concern. It is probably more of a macroeconomic concern than something our members would be concerned about on a day-to-day basis.

The point has been well made that if there is a lot of hot money looking for a home and this floods into bonds based on SMEs or SME debt, for example, without due diligence as to its quality, there is a risk that ultimately the businesses will fail and it will not be an efficient use of capital. Facilitating the flow of capital for the sake of it is not necessarily a good thing. From the point of view of our members, we would look for a diversification of the avenues in which they could access finance - not necessarily easy money, but a broader spectrum of financial instruments or products that they can access. SMEs would not necessarily need to know what the backing is behind the bank or front of house from which they are procuring a financial product. They would need to know that it is suitable for them and their financing needs.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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Not many of the committee's members are present, but they are watching the broadcast and the debate is also being recorded. I ask the witnesses to explain to the committee what implementation of the CMU would mean, on a practical basis, for members of their organisations.

Mr. Mark O'Mahoney:

On a practical basis, for the vast majority of our members, the direct benefits will be relatively limited, because an Irish SME typically has fewer than 50 employees - not necessarily a medium-sized corporate entity, or mid-cap - which will affect whether they will benefit from some of the proposed measures, such as a review of the prospectus directive or the private placement market. That will typically suit the Mittelstand or the larger SMEs at the core of Europe. However, there are opportunities to encourage more venture capital and in areas around crowd-funding and non-traditional bank finance and reducing the overall reliance on bank finance and debt. One of the key benefits of the CMU will be helping to change the culture in terms of Irish SMEs looking beyond the retail bank and traditional loan finance. There is also the principle of an efficient flow of capital within the Union.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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Let us discuss a few of those elements. Banking will be redefined in the next decade, and peer-to-peer lending will explode. Let us take it as an example of what could happen from the point of view of citizens or investors and members of the organisation. Let us assume a widget manufacturer in Clonshaugh lends money to a widget manufacturer in Bavaria because it knows the business. The funding has been crowd-sourced, they have checked each other out and things are beginning to happen on a citizen-to-citizen level. The CMU could help make this easier. Does Mr. O'Mahoney know what is stopping that from happening now?

Mr. Mark O'Mahoney:

The move towards the harmonisation of regular infrastructure within countries. Domestically, one would see it happen on a national basis. For example, the UK has a fairly advanced peer-to-peer lending market, some of which is supported by the state. Ireland is probably some way off that situation at the moment. Even though it goes against my DNA, probably more regulation or appropriate regulation is needed in peer-to-peer lending.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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Mr. O'Mahoney may not have his job when he gets back to his organisation.

Mr. Mark O'Mahoney:

Very probably. The concept of a lot of people losing a small amount of money is not necessarily a good thing either. In particular, for the private investor or householder whom we are trying to encourage to invest by taking their money out of lower-returning deposit accounts and moving it into a more productive use of capital, some form of investor protection is needed. Similarly to the Deputy's question about hot money, a lot of people pumping money into quasi-blind investments is not necessarily a good thing. Such investments need to be managed appropriately, and regulatory infrastructure is probably one of the main barriers to the effective use of crowd-funding. It is probably quite effective at the moment in smaller projects. We need appropriate oversight and regulation if we want to bring this option up to the scale at which SMEs can benefit and investors can earn an appropriate return.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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May I continue?

Photo of Aideen HaydenAideen Hayden (Labour)
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I want to ask a few minor questions.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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The Vice Chairman can do so, and I will comment later.

Photo of Aideen HaydenAideen Hayden (Labour)
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My questions come from a layman's perspective. There is a view among the lay population that venture capitalists are synonymous with vulture capitalists. What springs to mind is a character like Gordon Gekko, taking over a small company, asset-stripping it and selling it off to the market for its bits and pieces or body parts. As a category of investor, venture capitalists do not have a great reputation. Both delegations have made the point that 80% more investment in the SME sector the United States comes from venture capitalists-----

Ms Regina Breheny:

Ten times.

Photo of Aideen HaydenAideen Hayden (Labour)
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-----than in Europe. That means the reality is the opposite. It is 20:80 versus 80:20. There is a general perspective that the Irish financial system does not support SMEs or investment in SMEs. We need to move towards more engagement by venture capitalists in the European markets in order to promote and stimulate growth.

Mr. O'Mahoney mentioned in his initial presentation the idea of common standards. In other words, if one is going to have a genuine market, or wants to buy equity in a company rather than debt, then we need to develop common standards when providing balance sheet information and so forth, which would allow for an assessment across the EU on a particular investment in a company in any of the EU member states. There was also talk of a minimum set of comparable information that would be developed and shared with the interested parties in which the European Central Bank could play a role - in other words, a standardisation of SME credit information. It could be a little like launching shares on a stock exchange, such as the Green Book requirements or whatever. What has been proposed, and I am open to correction, sounds like a new weighty administrative system. Is that realistic? I am not necessarily talking about it being realistic for some of the big European companies. Is it realistic, in general, for the kinds of company that would want to avail of venture capital finance in order to develop new products? To what extent is the administrative burden more overwhelming than the benefits?

Another question occurred to me as a presentation was being made. Unfortunately, I did not have Ms Breheny's quite lengthy presentation in front of me and it was difficult to make notes on thin air.

She mentioned that tax policy is biased against equity. My understanding from decades of economic deliberation, dating from my university days, is that this nation is generally very risk averse and tends towards opting for the more traditional financial products. Back in the 1990s, we moved towards the business expansion scheme, BES, and tried to encourage individuals to have an appetite for more risky investment backed by tax incentives and so forth. It was clearly abandoned afterwards. To what extent is there room for moving as a nation back in that direction?

With regard to Deputy Donnelly's questions, which were very comprehensive, my query is purely nationalistic. We seem to be doing quite well on the investment front. Ms Breheny mentioned that we are doing comparatively better than other EU states in terms of venture capital investment. The phenomenon seems to be confined to a couple of sectors. Ms Breheny mentioned technology principally. Is it only technology? Why are we getting better? Could the growth be extended to other Irish companies of a similar size? Is there a danger that if we move more towards a single market in capital, we may actually lose out? If the market is to become more efficient, might there be more dragging of capital into the centre and a movement away from investment in the periphery? Are there dangers facing us if we have a more efficient capital market? According to Ms Breheny, we seem to be doing quite well in this regard anyway.

Ms Regina Breheny:

We are not vulture capitalists; we are venture capitalists. We build businesses; we do not take them apart. One reason the industry has evolved and developed is that it builds very successfully on technology and teams with expertise. We are good at this for two reasons. First, the State has been very supportive in terms of providing capital when the private sector had pulled away and also in terms of establishing seed funds. As part of the recapitalisation of the banking system, the banks were asked to put up some funding. The State, through Enterprise Ireland, put up funding and the seed funds were created. The management of the funds was made the responsibility of the commercial VCs. That brought on board a significantly improved and expanded pipeline of new start-up companies, which were there for the taking and the growing. On top of that, the Irish VCs have had tremendous relationships with foreign VCs and were able to pull in the international capital. The two aspects came together to create a business that was much better than what was available in other European markets. That, in essence, is why we have been more successful.

The Vice Chairman is absolutely correct that one of the risks of capital market union is that if those concerned do not accept that hubs are the way to go and that Dublin is to be a significant one, it might pull capital away. That is a big risk. We will have to fight very hard to get the message across. Europe is listening. Two years ago, VC was being pulled into this horrible regulatory regime under the alternative investment management directive. At the very last moment, however, VC was carved out of it. Therefore, somebody is listening, paying attention to the benefits of VC, promoting it and trying to develop it in a way that means money is being put into SMEs, which is its job.

We are largely technology based because there was no great breadth in the Irish economy. Many companies that were on the stock market were doing fine and did not need VC. There has always been a VC industry but it moved more towards technology when the FDI sector became increasingly significant within the economy. There were teams of people coming out of the multinational companies with research under their arm looking for funding, and the VC industry was delighted to be able to support them and the technology. That is where the industry absolutely exploded over the years. One reason we have been really successful at technology investment is the preponderance of the FDI sector that was established here through the IDA.

Photo of Aideen HaydenAideen Hayden (Labour)
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Mr. O'Mahoney. We will conclude very shortly.

Mr. Mark O'Mahoney:

On the question of the common SME information and the related administrative burden, I agree absolutely the issue is that a necessary precursor to whatever the capital markets union will be is the availability of some kind of comparable information at intra-EU level. The asymmetrical information is always the issue. It is a question of how a potential investor in Germany assesses the proposition of an SME in Ireland, Greece or elsewhere. Some mechanism needs to be developed so there can be meaningful comparisons between SMEs' creditworthiness and investment-worthiness without having a system that is unduly burdensome on the SME. I do not have an answer to that at present but SMEs will probably have to examine this. If they want to engage in overseas or cross-border investment, they will have to be willing to put a bit of work into producing information that is comparable.

On the point on equity, a couple of schemes across Europe have considered giving an allowance for equity in the same way as one would get a deduction for debt. Belgium has one, as have Italy and Portugal. It is worth considering again, regardless of the merits or demerits of the BES, because there is a greater imperative at present with the equity gap that we all speak about. The retail banks will fund perhaps 70% of a loan while 30% equity will have to be found elsewhere. Irish SMEs will have to get used to finding or being open to equity investment. That is a challenge, particularly given the nature of the typical Irish SME and the preponderance of family-owned businesses. They are very reluctant to give away equity. It will have to happen if Irish SMEs are to continue to grow. Now is the time to re-examine equity treatment or the tax treatment of equity.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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I have a final question, on equity funding. Has either organisation tried to measure the demand for equity funding in Ireland at present that has not been met?

Ms Regina Breheny:

We know what the demand from hi-tech high-potential start-ups will be. We have articulated that to the Department of Jobs, Enterprise and Innovation. We reckon it will be approximately €1.65 billion over the next five years. We based that on the number of companies we are seeing coming through from the seed stage seeking expansion funding, and on our experience of what these companies require over a period.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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That is approximately €305 million per year. How much of that is currently being met?

Ms Regina Breheny:

It is being met without any great difficulty. In 2014 alone, approximately €400 million was raised, from a variety of sources, including angel investors, VCs and international investors.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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Is there unmet demand for equity financing at present?

Ms Regina Breheny:

The problem we face is that these companies could actually be scaled to be very significant if we could pump significantly more money into them now and in the earlier stages than we have been able to do. If the VC funds were larger, the companies would be in a better position to scale the companies quicker and turn them into much bigger global players.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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If the sum is approximately €300 million per year-----

Ms Regina Breheny:

Currently.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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Does Ms Breheny have a sense of what the market could take based on reasonable investments rather than crazy ones?

Ms Regina Breheny:

It could be a multiple of that.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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Would it be five or ten times that?

Ms Regina Breheny:

Approximately five.

Photo of Aideen HaydenAideen Hayden (Labour)
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In the technology sector?

Ms Regina Breheny:

Yes. It would have a really dramatic effect on driving the globalisation of technology out of Ireland.

Mr. Mark O'Mahoney:

We do not have any visibility of the equity demand within the economy. Typically equity would have been put in, or if the equity gap could have been met by an owner-manager or friends or family etc., they would fill in that piece necessary to leverage the loan finance. That may not be available now and if we are going to move into a period of expansion of the economy, companies will increasingly look for investment capital and growth and they may need to start looking for equity capital or considering it where they have not done in the past or have not had to do it in the past.

Photo of Aideen HaydenAideen Hayden (Labour)
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On behalf of the joint committee I thank our witnesses, Mr. O'Mahoney from Chambers of Ireland and Ms Breheny from the Irish Venture Capital Association, for participating in this meeting and for the material they supplied to the committee.

I propose to suspend briefly to facilitate the arrival of the witnesses for the next session. Is that agreed? Agreed.

Sitting suspended at 3.11 p.m. and resumed at 3.14 p.m.

Photo of Liam TwomeyLiam Twomey (Wexford, Fine Gael)
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I welcome to session B Mr. Pat Lardner, CEO of the Irish Funds Industry Association; Mr. Frank O'Dwyer, CEO of the Irish Association of Investment Managers; Mr. Gavin Purtill, head of capital markets and Mr. Felix Regan, head of communications, both at the Banking and Payments Federation of Ireland. The format of this session will be the same as the last. Mr. Lardner, Mr. O'Dwyer and Mr. Purtill will each make opening remarks of no more than five minutes each. A question and answer session will follow to clarify any matters.

I remind members, witnesses, and those in the Public Gallery that all mobile phones must be switched off.

I advise the witnesses that by virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of their evidence to this committee. If they are directed by the committee to cease giving evidence on a particular matter and continue to so do, they are entitled thereafter to only qualified privilege in respect of their evidence. They are directed that only evidence connected with the subject matter of these proceedings is to be given and are asked to respect the parliamentary practice to the effect that, where possible, they should not criticise or make charges against any person or entity by name or in such a way as to make him, her or it identifiable.

Mr. Pat Lardner:

I thank the Chairman and members of the committee for the invitation to participate in today's meeting. The European Commission Green Paper, "Building a Capital Markets Union", published just under six weeks ago, is the first step in a significant multi-year project which will likely have a significant impact on the Irish investment funds industry. Throughout our discussion today I will refer to Capital Markets Union as CMU.

By way of introduction the Irish Funds Industry Association, IFIA, is the representative member organisation for those companies involved in the international investment funds industry in Ireland. The investment funds our members provide services to are widely held, predominantly by institutional and retail investors outside of Ireland. They invest in global assets and securities and reflect a wide range of investment strategies. The business of internationally distributed investment funds is highly regulated and Ireland has developed into a significant domicile and administration centre for such fund products within a legal and regulatory environment supervised locally and anchored in a number of European directives. The UCITS directive, which was transposed into Irish legislation in 1989, provided a key opportunity for the development of the industry here in Ireland. By developing and continually enhancing the environment in Ireland with the support of an industry that demonstrates excellence and expertise, Ireland enjoys a strong reputation as an investment fund jurisdiction and is now an acknowledged leading international domicile and administration centre for investment funds.

The Irish funds industry employs 13,000 professionals working throughout ten counties in Ireland, making it the single largest employment sub-sector within internationally traded financial services. Ireland is the second largest European centre for the administration and servicing of investment funds. In excess of €3.4 trillion of assets in over 13,000 collective investment schemes, CIS, are administered in Ireland. As such, all significant developments in the European arena are of particular interest and relevance to the Irish industry. In recent years we have also seen an increasing number of jurisdictions seek to position themselves as domicile and servicing centres for investment funds so this business is increasingly competitive. IFIA is an active participant in the industry at European and international level, being a member of both the European Fund and Asset Management Association, EFAMA and the International Investment Funds Association, IIFA.

Earlier this month the Government launched a strategy for Ireland's international financial services sector for the next five years, IFS2020. The strategy acknowledges the spectacular growth in international financial services over the past 25 years, in which the funds industry has played a leading role. The strategy also recognises the need to respond to competitive challenges and opportunities, to innovate and develop new expertise in order to maintain and grow employment in the sector and continue to attract new foreign direct investment.

As the respective timeframes of the IFS2020 strategy and the CMU project are largely contemporaneous, the potential to ensure Ireland is responsive in identifying opportunities exists. We look forward to working with the Government, its Departments and agencies, on the roll-out and implementation of IFS2020 and the potential for new product offerings and services under CMU which will encourage further industry growth and associated employment.

Our discussion this afternoon occurs roughly half way through the initial consultation on CMU, therefore IFIA, like many other organisations and stakeholders, are in the process of forming and testing views on the specific matters and questions contained therein. Any views expressed today should therefore be understood to be initial thoughts which are subject to change, given where we are in that consultation period.

We welcome the CMU initiative on a number of levels. Firstly, the political recognition that capital market based funding of economies is essential but less pervasive than it should be to encourage growth and jobs is significant. The free flow of capital within the Single Market is one of the fundamental principles on which the EU was built and the CMU project should act as an enabler and facilitator. Having multiple sources of financing for economies makes sense and the role of capital markets or market based financing should, as witnessed elsewhere, be stronger.

Second, from the Green Paper and public comments by Commissioner Hill, there is a clear understanding of the importance of investors or asset owners and finding mechanisms that meet their needs "to identify and remove the barriers which stand between investors' money and investment opportunities”. That is a quote from the Green Paper.

An approach based on pragmatism and recognising that a capital market, like any other market, must offer utility both to buyers and investors, as well as sellers or issuers, is the only way to proceed.

A specific initiative on CMU will draw out further the distinctions between bank and market-based financing and the appropriate structures to support each.

The Green Paper sets out the areas that the Commission believes should be included under the broad CMU initiative. Rather than reiterating all the points contained in the Green Paper and accompanying working document, we would highlight the following as being relevant for further examination through the consultation process:

Effective, i.e. liquid, secondary markets are an essential for primary markets to be seen as credible; investment funds are both an effective aggregator of investor capital and provide a mechanism to allow the unique risks of a specific investment - because of underlying risk, liquidity or other factors - to be absorbed via diversification in a manner that is less likely to compromise the achievement of an investor’s overall objectives; national economies, and the capital markets that currently serve them, are far from homogenous so the measures implemented en routeto CMU will need to be flexible enough to reflect these differences; a common understanding of what a SME is, from a size and capital appetite perspective, across markets is important to identify in assessing actual versus perceived benefits; the concept of passporting has proven to be effective in the investment funds world. Additional usage of this mechanism may prove beneficial in developing a CMU which encourages capital, assets, securities and investors to move freely; an effective CMU should aid the efficient usage and deployment of bank lending capacity; and, private markets, whether in equity or debt, require specific focus and are further down the development curve.
While an EU initiative, no capital market operates in isolation. The extent to which the measures delivered under CMU make European investment opportunities attractive and accessible to non-Europeans will have a significant bearing on the success of the project. Investment funds will be crucial to this.

This project is also occurring at the same time as the Chinese authorities are internationalising their currency and developing their own capital markets. If Ireland can act as an effective bridge between Asia and the EU it will increase its relevance and attractiveness as a location for internationally-traded financial services.

Stimulating greater capital markets breadth, depth and utilisation should benefit Ireland and the Irish funds industry, as this is likely to bring about increased activity and demand for services supporting the capital markets. Achieving the goals identified in IFS2020 will, in part, be linked to how Ireland responds to the opportunities and challenges encountered along the road to CMU.

Photo of Liam TwomeyLiam Twomey (Wexford, Fine Gael)
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I thank Mr. Lardner and now call on Mr. Frank O'Dwyer to address the joint committee.

Mr. Frank O'Dwyer:

The Irish Association of Investment Managers, IAIM, is pleased to have an opportunity to contribute to the discussion on proposals to build an EU-wide capital markets union. The IAIM is the representative body for institutional investors operating in Ireland.

Like my colleague, I should say that the association will be responding to the consultation, but our board has yet to finalise its position. The views I am expressing today are not settled policy and, indeed, some of the opinions may well be my own.

It is abundantly clear that dependence on bank financing in the EU is markedly higher than in the US where up to 75% of funding of the real economy is provided by the markets. It is interesting to note that up to two years ago, non-bank financing was generally referred to as shadow banking. It was a term that was quite pejorative and likely to inflame legislators and policy makers. It is really over the past 18 months or so that people have begun to call it what it is - markets-based financing.

A simple comparison, however, between the US and Europe can be misleading. The US has always been a single market, with one language, a relatively uniform legal system and, proportionately, a much greater number of very large institutional investors. Generally, across all regions of the US, investors have similar attitudes to risk.

In contrast, the EU has 28 legal systems, 24 languages and, more important, 28 different economies and differing national priorities. There are 11 currencies and very different attitudes across the Union towards savings and investments.

For example, in Germany there is a marked predisposition to avoid risky, complex or new investment-type products. The Commission's own supporting documentation shows that in the case of the US, 13.5% of the savings and investment assets of US citizens are in cash or deposits, while 31.2% of them are in shares and other equities. In Germany, almost 41% is in cash and under 10% is in shares or other equities. The diversity within Europe is evident from the fact that in Sweden, for example, only 16% of investments are in cash, with 33% in equities. There is therefore a wide disparity across Europe.

Despite all of this complexity, the association welcomes the project. The EU needs to eliminate barriers which impede the movement of capital both within the Union and between the EU and the rest of the world.

The Green Paper is underpinned by a desire to see greater flows of capital markets funding into the SME sector. As the debate unfolds, I suggest that a fundamental starting point is the adoption of some standardised definition of what an SME is. The reality is that a small-sized enterprise in Germany would be a large business in Ireland, Latvia or a number of other EU member states.

In Germany, a company with a market capitalisation of €200 million is considered an SME, although that is larger than some companies listed on the Irish stock market. For policy makers and legislators, it is important to have a common understanding of what is the target group of businesses, the target sector, of the real economy that this initiative is meant to address.

The Green Paper does, even if indirectly, acknowledge this issue because it identifies a range of measures which are necessary to build a capital markets union. In some of the larger economies, all of the proposed measures are likely to have some merit. However, in smaller economies such as Ireland's, some of the proposals will have much more relevance than others. For example, I do not believe that relaxing the Prospectus Directive requirements would have a meaningful benefit for Irish SMEs as a whole. Nor do I believe that initiatives to facilitate mini-bond markets or bond markets specifically aimed at SME issuers, would be of significant benefit to Irish SMEs. I also believe that some innovative thinking may be needed for smaller member states, such as Ireland, to maximise the benefits which would emerge from a capital markets union.

It would be remiss of me not to refer in these opening remarks to what I see as the greatest challenge to the success of this project. Legislators will have to address the balance of regulation. The Green Paper and supporting working papers acknowledge that the financing of SMEs and infrastructure represents long-term, illiquid investments with greater risk characteristics. However, the largest sources of investment funds, the owners of funds, in the EU are insurance companies with assets of approximately €8 trillion and pension funds with assets of approximately €4 trillion. Both of these owners of funds are currently heavily regulated. In both cases, current and impending regulatory changes penalise, in one fashion or another, investment in long-term illiquid assets.

Having said that, in no way do I wish to narrow this debate to regulatory issues or to question the need for prudent regulation of pension funds or insurance companies. However, if we are to encourage investment in SMEs and infrastructure, then legislators and policy makers will have to engage in this debate. The process simply cannot work unless that debate is addressed.

Institutional investors are keen to have new asset classes in which to invest, including loan origination funds and other real economy-friendly products. We welcome Commissioner Hill’s commitment to engage with providers of investment funds as the CMU project progresses.

Mr. Gavin Purtill:

We are grateful for the kind invitation to the Banking & Payments Federation Ireland, BPFI, to appear before the committee today and to make a submission on its review of the recently published Green Paper on capital markets union. BPFI is the voice of banking and payments in Ireland with over 70 members, including 35 international banks, which are represented by our affiliate organisation, the Federation of International Banks in Ireland, FIBI.

Our submission document includes some background information on capital markets union, CMU. In the interests of time I would like to outline briefly what BPFI sees as the eight priorities for CMU at this initial stage. First, CMU should enhance existing markets. Policy makers need to avoid introducing measures that are likely to have negative impact on capital flows and investment.

Second, the Commission must ensure a level playing field between markets and EU and non-EU actors. To ensure an effective Single Market, it is necessary to align regulations so that they do not act to prevent cross-border activities or distort competition. So-called shadow banking activities should not benefit from less onerous or even preferential regulatory treatment and should be subject to the principle of same risk, same rules.

Third, the single rulebook must be completed by close convergence of supervisory practices that must be effectively and consistently enforced across all member states. Member states should not be competing on legislation but instead competing on business-friendly environments to attract investment.

Fourth, the CMU should emphasise the importance of liquidity and market making. Liquid capital markets will boost the process of moving capital from slow-growing sectors to dynamic innovative industries and raise the confidence of investors.

Fifth, efficiencies in cross-border investments should be delivered with the removal of existing tax barriers. Several tax barriers have been identified which impact negatively on cross-border investments, such as the complexity and cost of obtaining the tax relief. We would like these to be addressed under CMU to promote cross-border activity.

Sixth is the improvement of financial education. The Commission should take steps to improve the level of financial education in the EU, for both retail investors and SMEs. This would help retail investors to better understand the functioning of capital markets and their role within markets, while SMEs would benefit from increased knowledge of possible funding options available within capital markets.

Seventh – our last two priorities are shared with the Commission as seen by their consultations on the prospectus directive and on securitisation – we would like to ease the burden on firms going to market and to see a review of the prospectus directive. The threshold for producing the prospectus should be significantly higher to ease the burden on SMEs. A revised prospectus directive should make it easier and cheaper for firms to go to market, while still preserving a high level of investor protection.

Finally, we would like to restore the economics of and revise the rules for securitisation. The Commission needs to revitalise the market for simple, standard and transparent securitisations. This should include a revision of the capital requirements for securitisations and recalibration of regulations on simple, standard and transparent securitisations. We support the Commission’s Green Paper on capital markets union and its desired outcomes of increasing the pool and variety of finance available, improving cross-border investment opportunities and making the economy more resilient to economic shocks.

I thank the members for their time and look forward to their questions.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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I thank the witnesses for their time. There are some obvious advantages to CMU. Transaction costs are reduced, competition is increased - in theory, anyway - and the end consumers, be they SMEs, large organisations or citizens, should see the advantages of that through lower prices and lower costs of financing. There is also an obvious danger, however. I do not know if the committee is doing a report on the Green Paper but I believe it is weak and written as if the last 15 years had not happened. It lists all the advantages, which are real, yet there is not a single word about the fact that it was the free movement of capital that caused the bubble and subsequent collapse. It is a very intellectually and technically weak piece of work, which is what I want to ask the witnesses' opinions on.

Obviously, it is not in BPFI's or its members' interests for us to repeat the mistakes of the past. When the euro was set up we had a massive jump in how easy it was for European money to move across borders. We were into a single currency, there was all manner of lining up of regulations. It became much easier to move money and capital between eurozone borders. In Ireland this tsunami of hot money came in. There was a massive asset price bubble, the money got pulled back out again, the bubble collapsed, the banking sector was destroyed, the economy was destroyed and so on. The single trigger of that event, although there were failings across the country in banking, politics, regulation and all of that, was the creation of the eurozone and the substantial increase in ease of capital moving around.

There is now famous Reinhart and Rogoff book, This Time is Different: Eight Centuries of Financial Folly, which tracks 800 years of financial crashes. It is a big book with a very simple basic message that capital has been swishing around the world for centuries and leaving an awful lot of destruction in its wake. This has not been the case all the time, as capital has obviously been useful and a lot of good things have been built because investors could move money around so that supply could meet demand. Nonetheless, what we are seeing now?

McKinsey released a report, "Debt and (not much) deleveraging" in February, which looked around the world at what has happened in terms of corporate, financial sector and government debt. Contrary to what everyone thought was going to happen, namely that debt would go down and governments, households and everybody would deleverage, actually debt has just gone up and up. It is pump primed by a few things such as the Chinese central bank, the Fed, and now of course the European Central Bank with quantitative easing, QE. Trillions of euro are being made available basically for free on a weekly basis to banks and other institutions around Europe. They are buying sovereign paper with it and government yields are going down, which is a useful thing, but we are also seeing another asset price bubble. House prices have shot up 50% in the last two years and we are going to see that spilling over into equities and so on. Bond yields have fallen and we are back in another cycle of debt-fuelled growth.

The real economy is growing at a fraction of the pace at which the capital markets are growing. We are all being lulled into this sense that we are back, while in fact we are not. Central banks around the world are printing money and we are simply continuing debt-fuelled consumption. Engineers, scientists, shopkeepers and people in the real world are not becoming more productive as quickly as the amount of capital and balancing debt is.

Can I ask each of the witnesses, in the context of what has happened with money being able to flow around and in and out of the eurozone much more easily and given that there are obvious advantages which the Green Paper has laid out, if they are worried there is an unintended consequence in the form of another repeat of hot money destroying the economy or parts of it? Is there anything that should be done as part of CMU to try to stop some of the damage that global capital markets can cause?

Photo of Liam TwomeyLiam Twomey (Wexford, Fine Gael)
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Each witness may give his own comments on that, as concisely as possible.

Mr. Gavin Purtill:

I thank the Deputy for his question. In our detailed submission and in my opening statement, we recommended that the same safeguards be in place in the banking and non-banking sectors - banking and shadow banking - to ensure that the regulations introduced as a result of the crisis flow over into the non-banking sector, the same safeguards are put in place and the risks are managed. In terms of the single rulebook, close convergence of supervisory practices of non-banks and banks is what we would look for. Those are two areas we would recognise and look to protect against.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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Is the witness concerned that the CMU is going to lead to hot money? In his view are the safeguards adequate?

Mr. Gavin Purtill:

At this stage the CMU is very much at a white board phase where it is looking to set priorities. The Commission is very much in listening mode and we are engaging with the Commission. We participated in a workshop with the Commission and the Department of Finance today. The Commission will look to build on the priorities. It is too early to have those kind of concerns because we have not seen the end game. Once we see the end game we can formulate whether there are concerns. However, I am confident that the correct safeguards for protection will be put in place and that the single rule book and the insurance of the convergence of regulatory practices across non-banks and banks, will protect against that.

Mr. Pat Lardner:

Deputy Donnelly has asked a number of excellent questions. I will separate the information into a couple of parts. There are risks associated with quantitative easing and they are not necessarily the same risks associated with capital markets union. The interesting question will be, if, at the point at which quantitative easing will be unwound, where we will be in the capital markets union project when that happens.

Speaking for our sector we are a regulated business so there are very strict product rules, for example, about what one can invest in any fund which is distributed. There are rules around what type of entity can manage an alternative investment fund. There are rules around European long-term investment funds. There is an existing body or regulation that has meant that even with regard to some of the well documented difficulties over past years these tended not to happen as much in a regulated fund or product space, which is why funds are important. I would not necessarily concur with Mr. Purtill's view that the same rules that apply to banks should apply to non-banks. The rules that applied to banking did not necessarily always work. There is a fundamental and structural difference. For example, if a depositor gives money which is put on a balance sheet to be deployed in various mechanisms or ways, that is different to a contractual relationship wherein if a depositor gives money for a particular investment purpose within particular product rules because that is a totally different activity. What we are trying to establish with capital markets union is the premise that a singularity or a single way in financing the economy in itself brings risks with it. Therefore, having a range of financing mechanisms is of benefit. That is by no means to say that funds are right or banks are wrong. All of these important sources need to be brought to bear and they all have a benefit.

In terms of knowing one's customer, Ireland as a jurisdiction has been very much to the forefront in exchange of information, and in its obligations under the OECD with regard to transparency to ensure clear information with regard to the regulated funds' activity and as to the identity of investors in the funds. There will always be risks of capital movement. The down side of the question is that if we want commercial activity, which involves a risk, we must have capital to fund it.

Mr. Frank O'Dwyer:

I have a sense that some of this is behavioural, in an odd way. A number of years ago I heard Lord Turner speak about the early documentation that underpinned the idea of a single currency. That think-talk process in Europe envisaged the idea that a British citizen could walk into a bank in Paris and get a mortgage and that we would all be integrated. However, this did not happen. There is a national approach with regard to investment and capital markets. If within CMU we come up with some form of regulated way or regulated product where SME loans can be pooled and sold, is it likely that a pool of French loans will be sold to French people and Irish loans will be sold to Irish people. Irish investment managers, French banks or German insurance companies, all competing in a CMU, will all be pushing product into their own jurisdictions. I have a sense that maybe that kind of behaviour is a risk. I would love to point to lots of detailed research but it is more a strong sense.

After the banking crisis we saw financial nationalism taking action as every non-domestic bank pulled their assets out of Ireland and other jurisdictions. That kind of thing might also be at play at some level in the capital markets union. It is not a very scientific answer but I have just have a sense that there is some behavioural stuff going on there.

Photo of Pat RabbittePat Rabbitte (Dublin South West, Labour)
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Did I misunderstand Mr. O'Dwyer or is he saying that the benefit of CMU really will not impact very widely on the Irish SME sector because of the typical size, formation and ownership of the typical Irish SME and that a good deal of this is probably academic from their point of view?

In respect of the regulatory environment, are Mr. Lardner's points about institutional funds specifically or about regulation generally? Why is he so ambitious for Ireland as being the bridge between Asia and Ireland? What is so distinctive about Ireland that we could aspire to being the bridge builder with Asia?

In respect of the matter that has arisen about quantitative easing, QE, I would have thought that the decision that policy-makers have to make and had to make at the time that Mr. Draghi and his board made the decision, was that it was a question of QE versus a eurozone economy in a tail spin in terms of further deflation throughout the eurozone and that the actions taken by Mr. Draghi were motivated by the fact that CMU is a quite separate concept.

Mr. Frank O'Dwyer:

I think care needs to be taken not to assume that a stated objective of an EU initiative to help SMEs, means that an extremely large pool of Irish business is going to directly benefit. I think such an assumption would be a mistake. It is an issue of scale. If we loosely define the "S" part of SME in the larger economies of maybe, of market capitalisation of say, €20 million or €25 million, at the top end, to be €200 million, that rules out a direct value to large chunks of the real economy in Ireland. However, I mentioned innovative approaches. One is an indirect benefit to the extent that there is an ability of banks to pool portfolios of loans and then that there are investors able to take those securitised products and leave yet more head room for the banks to lend within their capital bases. That is an indirect benefit.

There are ways of being innovative. Large institutional investors in Europe possibly considering a play on the Irish economy might look at a pool of loans that are with the acknowledged leading edge end of Enterprise Ireland's food and agri-sector companies or maybe the technology or the fin-tech side or life sciences. If they have some way of pooling together the best of what we have I could conceive of people being interested. It would not be directly going to a life sciences company that needs a couple of million euro but maybe in some form of aggregation. People would take an interest in it because they would say, touch wood, that these sectors in Ireland are well done, well managed, outward looking and that there is upside there. In that sense I think we need to be smart about how we think about it as directly impacting in terms of medium and long term funding into what we in Ireland call SMEs.

A good example is a session organised by the Department of Finance at the Stock Exchange a number of months ago about the concept of mini bonds. There are mini bond markets in Germany and UK. Market participants and investments made the point that the minimum cost to a company to get together a bond prospectus and some form of specialist investor rating is probably €250,000 including legal fees, tax fees and accounting fees. That means the minimum ticket size of the bond issue is between €8 million and €10 million. The number of companies in Ireland that cannot access bank finance and for which a bond issue of between €8 million and €10 million solves the problem is small. In that context, we must examine the matter.

Mr. Felix Regan:

I can add to the response to the question put by Deputy Rabbitte about the significance of capital market union for SMEs. The standard definition of an SME in EU terms is any business employing up to 250 employees. The reality is that 91% of SMEs in this country are employing fewer than ten people. Let us look at the impact on the SME sector of capital market union here and in other countries. Talking to business representative bodies, I have recently discovered that the vast majority of SMEs in other countries are also quite small. Ireland is not unique in that respect. We all share the concern about this challenge. The previous speakers, Mr. Mark O'Mahoney from Chambers Ireland and Ms Regina Breheny, alluded to the same. Either we can collectively focus policymakers at European level to make an element of capital market union realistically tangible for the cohort of SMEs, 91% of them in this country, or else we acknowledge that capital markets union will always be about the 9% of SMEs in this country that have been scaled up. The figure might actually be 3% or 4% of companies in this country are of that scale. It is a challenge that is recognised to some extent by everyone but we have the opportunity at this early stage to interrogate it and challenge it. If we cannot succeed in that regard, we must make sure collectively that the message does not go out that capital markets union is for SMEs because SMEs in Ireland mean the joinery works in Wicklow employing eight people or the restaurant in Dublin employing seven people. That may not be the typical SME that will benefit in any way from capital markets union.

Mr. Pat Lardner:

There were three aspects to the question and I will try to answer them sequentially. The comment about the regulatory environment reflected the investment funds context, whether for broad distribution to retail and institutional investors - UCITS - and in the alternative investment funds area, and to respond to concerns about the movement of capital. We have already seen a 25 year track record, with good success, in a regulated investment funds framework in Europe encouraging savings, which is part of what CMU is about, and doing it in a way that has investor protection and utility from the investor point of view at its core.

The second point was about Ireland's role as a bridge. I keep going back to UCITS, which is the longest standing product construct in Europe, with 25 years reputation. I speak from an Irish point of view in terms of economic activity and employment. The services provided here allow us to connect managers, providers of investment strategies from some 50 different countries around the world, and to help to deliver the investment strategies and collect investment capital to investors in 70 countries around the world. A creation of Europe in UCITS allowed us to take on a greater role far beyond its original intention or inclination.

The only reason I highlight Asia is from a demographic perspective and a wealth perspective. In CMU, the European long-term investment fund, LTIF, proposal is one where we are trying to get an ageing population and ageing infrastructure in Europe to see more economic investment, which provides downstream activity. My overall hope is that it will provide benefit if we can, as we have successfully done funds in other parts of internationally traded financial services, position ourselves to bring together the providers of solutions and the providers of capital.

There are two parts to the final third question. My comments about quantitative easing were not a critique of quantitative easing. As a decision and a mechanism, it is absolutely appropriate in the circumstances in which the policymakers found themselves in. CMU must create liquid markets and if we leave the market to itself that is fine but quantitative easing creates an external influence on market by introducing liquidity. At some point the liquidity must be removed and at the point at which the liquidity is removed, the question is what impact it has if there are broader and more liquid markets.

My final comment ties in SMEs and broader concerns. The benefits to Ireland in CMU can be in two respects. I will describe one as direct and the other as indirect. In the direct point of view, it may provide financing from the SME point of view. Whether a larger number of SMEs get direct financing is a question none of us can answer. However, if the way CMU operates allows banks to securitise in a clear and a safe way and recycle capital on their balance sheet, it may create more lending capacity. That is one possible benefit. The broader benefit is one I describe as indirect. If Ireland as a location, as a country and as a provider of export services, can position itself, what does it do? It creates benefits in employment and in revenue for the State. From the SME perspective, if there is an announcement in Dublin, Cork, Galway, Limerick, Kilkenny and Drogheda, places where our industry is present, it not only creates direct employment in those enterprises but also creates the other key thing SMEs need, which is business. Financing a business is one thing for an SME but creating demand for it is another. There is a dual opportunity and we hope, as we develop, that we can create a broader employment footprint as we look at the opportunities in the direct and indirect sense provided by CMU.

Photo of Liam TwomeyLiam Twomey (Wexford, Fine Gael)
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As there are a couple of minutes left, is there a short question and answer that we can include?

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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I agree that the question about quantitative easing is what happens when the ECB turns off the tap. When the Fed turned off the tap, it did not go so well. However, it is not just about that. If CMU is in place in four years' time, this would be round 1 of quantitative easing. We have just started another asset price bubble and the ECB will fuel a bubble through quantitative easing. Something will happen in the next five or six years and we will see another collapse and then the ECB will do exactly what the Fed did and turn it back on. We are into a quite standard boom and bust asset bubble burst, fuelled by monetary policy or quantitative easing. If we are talking about how easy it becomes to move money around the Union, the fact that the money tap is being used in a very serious way is relevant. They are flooding the market with liquidity and we are talking about making it easier for that liquidity to move around the market. I agree but what the witnesses are talking about is the end of phase 1 of quantitative easing and there will be second, third and fourth phases over the next 20 years. I will ask a further question.

Photo of Liam TwomeyLiam Twomey (Wexford, Fine Gael)
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It needs to be sharp if Deputy Donnelly wants answers.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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Will this translate into lower borrowing costs for consumers, mortgage holders and SMEs in Ireland in the coming years?

If so, what sort of quantum do the witnesses think we might be talking about?

Photo of Liam TwomeyLiam Twomey (Wexford, Fine Gael)
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Who would like to take the question?

Mr. Felix Regan:

I will try to answer that question. It is a bit like gazing into a crystal ball, but in simple terms, if it is as I understand it, the mechanics of CMU should, first, create a wider range of financing options, which in itself should bring a competitive dynamic to a marketplace and perhaps indirectly feed into the provision of finance across a range of channels. Second, it could lead to a lowering in the cost of funds, which should conceivably give rise to scope for lower retail-priced finance at the consumer or SME stage. That is the theory of it, but it remains to be seen if the process will deliver that way. As I understand it, that would be the theory that should conceivably deliver that sort of picture.

Mr. Frank O'Dwyer:

On a pan-European basis, if one thinks about the origin of a loan, someone must take on the risk. Someone must deal with whatever security is being provided. Unless we have harmonised insolvency law and the bits of contract law that matter, when one has more than one set of lawyers looking at different languages and legal principles, one will not achieve lower financing cost benefits. The way the system needs to progress is to take bite-sized things that are doable and achievable. If we are going to wait until we have harmonised legislation on insolvency in Europe to decide the priorities on liquidation and how one exercises a security, then it will be 2020 before we achieve efficiencies. My view is that we need to look at the bits that might work and get those into play fast.

Mr. Pat Lardner:

Very briefly, more efficient markets usually mean lower costs. We are not engaged in lending to the SME sector specifically, and I do not have a basis of fact on which to answer the question asked.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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In Mr. Lardner’s case, does he see it as reducing the yields? I guess that is the analogy.

Mr. Pat Lardner:

Yes, one would see it that way. As a general point, in terms of investment fund provision, we have seen the associated cost go down as it has become a bigger, deeper and broader market. I am extrapolating to say that I would see something similar.

I will make one final comment, as I know we are tied for time. There is no single measure, change or silver bullet that represents a fully integrated CMU. I completely agree with Mr. O’Dwyer’s point that it is a series of measures. It is about trying to find out how one eases and frees up things in different areas incrementally to try to move the situation forward, because we are not starting off from the same place. The aim is to try to bring everyone closer to the same place, but we are not starting from that point.

Mr. Gavin Purtill:

I wish to make some quick points on the matter. In terms of the cost of funds for SMEs, for example, if bank funding is 70% and the remaining 30% is equity, CMU proposes innovative solutions in that space, including venture capital, angel investors and crowd-funding. If they are successful, that should bring down the cost of funds for SMEs.

On the banking side, there has been a consultation paper on securitisation. If that recalibrates regulations around securitisation to make it more attractive and revive the market, whether on capital risk rates or the liquidity coverage ratio on insolvency, then it will allow banks to de-risk and to transfer risk off their balance sheets, which will drive down their cost of funds, and the benefits will be passed on to the consumer. A number of things should lead to a reduction in the cost of funds for SMEs.

Photo of Liam TwomeyLiam Twomey (Wexford, Fine Gael)
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I thank Mr. Purtill. As we have finished this session, I thank the witnesses for attending. The issue will be important in the future and it is vital that they get the opportunity to put their opinions on the record.

As our members are also members of the banking inquiry, if the meeting goes on a bit, unfortunately, they will not be able to attend, but everyone will get access to the Official Report of what was said. We will also put together a report which will be available on the committee’s website.

Sitting suspended at 4.05 p.m. and resumed at 4.15 p.m.

Photo of Liam TwomeyLiam Twomey (Wexford, Fine Gael)
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We now turn to scrutiny of COM (2015) 63 - Green Paper on building a capital markets union. I welcome Mr. Peter Brown, lecturer at the Institute of Investing & Financial Trading, and Dr. Constantin Gurdgiev, an economist at Trinity College Dublin. The format of this session will be the same as the previous one. Mr. Brown and Dr. Gurdgiev will make opening remarks, which will be followed by a question-and-answer session to clarify any matters.

I remind members, witnesses and those in the public gallery that all mobile phones must be switched off. I draw the attention of witnesses to the fact that by virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of their evidence to the committee. However, if they are directed by the committee to cease giving evidence on a particular matter and they continue to so do, they are entitled thereafter only to a qualified privilege in respect of their evidence. They are directed that only evidence connected with the subject matter of these proceedings is to be given and they are asked to respect the parliamentary practice to the effect that, where possible, they should not criticise or make charges against any person, persons or entity by name or in such a way as to make him, her or it identifiable.

Members are reminded of the long-standing parliamentary practice to the effect that they should not comment on, criticise or make charges against a person outside the House or an official either by name or in such a way as to make him or her identifiable. I invite Mr. Brown to make his opening remarks.

Mr. Peter Brown:

I would be very much in favour of building a capital markets union. The concept of opening up funding to the SME sector outside traditional banking and opening up investment opportunities for retail and SME investors is very positive. It is a very ambitious plan. The one thing that really needs to be pointed out is that we have just had the most stunning bond market rally in Ireland. Irish bonds, even from the past three years, have collapsed from 6% down to 0.25% for five-year money and 0.7% for ten-year money. It is a stunning market rally. However, €90 billion worth of retail investor money was on deposit with banks during that period, earning practically nothing - 2% net of DIRT at 41%, earning practically 1%. So we have a large investor base and a bond market, neither of which visited each other in that period of time. If the investors had been in bonds, which more or less carry the same risk, they would be sitting on a 6% tax-free return for five-year money, or a 35% tax-free return if they were in ten-year bonds.

If we are going to build a capital markets union, we must ask what is wrong with the current capital markets structure that the investor cannot find the returns that are there in the capital markets. First, we must ask who made those massive returns. The Irish bond market is €220 billion. If someone even bought €10 billion of it, they would have a profit of €5 billion in a three-year period, which is stunning.

The reality is that the investor market is not sophisticated enough to understand bonds. The investor market in Ireland only understands deposits. It does not understand bonds. More worryingly, the financial services sector is not sophisticated enough to sell bonds. One must ask why it did not sell bonds to its clients. It certainly bought them itself. Why was the Irish investor not in the bond market? Why was it only foreign hedge funds who made those fortunes? One US hedge fund walked away with €4.5 billion in profit from the Irish bond market. Why was the investor not in the bond market? If we are going for a big capital markets union to expand it, we must start with the present. My contention is that there is a massive lack of education. Reading through the paper, there is very little that is related to education - only one sentence. The paper is massively short on education. To get the SME to issue a bond into the future requires a huge amount of education to get the SME up that curve.

To get the investor community to buy a bond requires a huge level of education but, unfortunately, to get the financial services professionals to sell a bond also requires a high level of education. I do not believe someone can go into a local bank branch and ask for a bond instead of a deposit. If someone had done that three or five years ago, they would be worth a lot of money now. Unfortunately, it was a product that was not on offer. It is the lack of focus on education in the Green Paper that I find disappointing. I believe there is a huge level of education to be done before we get to a wider capital markets union. That must be a focus in the Green Paper.

There is a lot of reliance on the concept of regulation, but I want to state that the investor is not comforted by more regulation. Regulation did not stop Lehman Brothers from going bust. It did not stop the United Kingdom banks from going bust. It did not stop the Irish banks from going bust. Regulation does not stop banks from going bust. It does not stop poor financial products from hitting the street. It is education that stops people from buying poor financial products. It is education that stops financial institutions from issuing poor financial products. For some of the investment products linked to the capital markets that were released by major financial institutions during the Celtic tiger period, one would have to ask how a product that poor could get through the board, the management team, the product development team and the point of sales team. The answer to products like that ending up on the street is education. It was not that they deliberately wanted to sell poor products; they were just not educated enough to actually do it correctly.

I welcome the Green Paper. It is very important that SMEs have an alternative source of funding, because Irish banks will be stressed into the future. Irish banks cannot raise funds at the same price they could previously. Before the crash, Irish banks raised money in the wholesale market, just as Deutsche Bank, Barclay's or Royal Bank of Scotland could do. That has changed. They have to pay more for their funds now so they will charge higher rates to their customers.

Greater access to funding is a very positive step, as is access to the capital markets for the investor, but we need to realise in the paper that a good deal of education will be required.

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.

Photo of Liam TwomeyLiam Twomey (Wexford, Fine Gael)
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I thank Dr. Gurdgiev.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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I thank both witnesses. I have raised a matter at all of today's sessions. When I read through the Green Paper, it worried me because it was intellectually weak and there was no counterfactual analysis or risk assessment. It felt like it was written by a cheerleader for free capital markets. Obviously, reducing transaction costs is good and diversifying sources of funding is useful. There has been much discussion of the debt-for-equity financing over the banking model. However, the last 15 years have shown us categorically that the poorly regulated free movement of capital, particularly now that the quantitative easing, QE, tap has been turned on, can be a profoundly dangerous and damaging thing. Not a single paragraph in the Green Paper mentions that if we make it easier for capital to flow around, into and out of the eurozone, there are associated risks. Dr. Gurdgiev mentioned one, namely, stripping away some of the ability to arbitrage or spread risk over various macroeconomic situations among eurozone members. Is either witness concerned by the paper's lack of critical thinking or suggestion of the risks associated with freeing up capital movement into and within the eurozone?

Mr. Peter Brown:

I will be honest. Documents and Green Papers are not my expertise, but I view this as a long journey during which the issues that the Deputy rightly outlined will come to the fore. This paper is premature, as our capital markets and investors do not meet. We have much work to do before we can get off the ground and head into some of the complex issues to which the Deputy referred. It will be a long, drawn out process with many hurdles that mean it might never happen, for example, the financial transaction tax, the uniformity across Europe that would be required to get something like this through, etc. This is not a final document that will address the issues raised by the Deputy, but a starting point on a concept.

Dr. Constantin Gurdgiev:

I will quote the third sentence in the preamble: "But to strengthen investment for the long term, we need to build [there is no argument about that] a true single market for capital – a Capital Markets Union for all 28 Member States." The Deputy is correct in the sense that the EU does not allow in this paper any derogation from the core concept of a singular market. The question then becomes one of what the singular market is.

I am concerned by the lack of substantive assessment, listing and pricing, let alone analysis, of individual risks and the potential for things to go wrong. I am also concerned by the general approach that the EU has taken recently to a great deal of regulation, for example, the idea that harmonisation repairs all of the problems, that we need a genuine monetary union and a banking union, and that we need a unified tax system across financial services. This approach to policy making hinges on the extreme technocratic assumption that, once a particular union is in place, the regulation and supervision mechanisms built around it will function perfectly in addressing the future known and unknown challenges. We know from the history of finance that this is not the case. For example, Professor Franklin Allen of the Wharton School has put on record that, historically, all of the large systemic financial crises had a similar pattern - overconfidence by regulators who, after the crisis, build institutions to address the causes of the previous crisis, with the financial services hiring the brightest young people to bypass those regulations, leading to more crises, which are usually of greater proportions and of a higher frequency. Nothing in the EU's approach would prevent this vicious cycle from repeating. That worries me.

From the point of view of today and the future, it is none the less important that we consider whether we should fund our companies, entrepreneurs and enterprises through equity, the banks' relationships or the direct markets of bonds issuance. Giving investors and enterprises access to a more diversified base allows for better risk management and targeting, that is, ensuring the suitability of particular investment vehicles to the objectives of the enterprise and the investor.

Mr. Brown raised crucial caveats. Education is important for investors, companies and regulators.

Another issue I raised is supervision, not just the regulation. The issue the Deputy raised is crucial as well, the nitty-gritty details of how we assess those policies, how we write them and how we structure them. That remains to be done in the future, and none of it is done here.

Photo of Stephen DonnellyStephen Donnelly (Wicklow, Independent)
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The people who were here earlier today were speaking about the fact that this would diversify risk, there would be securitisation and so forth. It was like being in America in the early 2000s. It was the same conversation: "We will make it easier and we will make the markets more efficient. The markets know how to allocate risk and everything will be good." It is unsettling to listen to very well intentioned people saying that this time will be different.

I have two more questions. I am very taken by the idea of equity financing and the fact that we do not have much of it here. It is a longer-term, steadier, less volatile financing mechanism for Irish SMEs or bigger companies. We do not do much of it. When I talk to venture capitalists outside Ireland and ask them why that is the case they do not talk about regulation or the items in the Green Paper. They talk about a culture. They tell me that, in their experience, the problem for people in Ireland is that founders think in terms of three to five year exits. They tell me that if one talks to somebody in Boston or London who is founding a company, they will talk about what they want their company to be 20 years hence. However, they say that if one talks to an Irish entrepreneur, they talk about the amount of money they think they can clear in three years and exit. That has nothing to do with regulation but is an entirely cultural issue. Does the witness think anything can be done about that? I am not convinced. We are in the realm of total speculation, but I do not know whether the culture will trump making it easier for equity products to come here.

I will conclude with the following question. Do the witnesses think that bringing in a CMU will substantively reduce the cost of borrowing for SMEs in Ireland?

Photo of Liam TwomeyLiam Twomey (Wexford, Fine Gael)
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Before you answer that question, there is a theme coming through from the debate. Irish SMEs are small, family owned and not big corporations. As was pointed out, what is classified as an SME in Germany would be considered a large company in Ireland. How adaptable is this model? Are we stuck with the bank financing model because that is just the structure of our SMEs or is it possible that we can move to equity based financing? Is there a model for it or are we simply not at the races, to put it mildly?

Mr. Peter Brown:

The answer is that we are too small, to be brutally honest. The SMEs are too small and we are too small. The people who would buy that type of equity are not in Ireland but are abroad, and Ireland is too small a market. One could create a very tiny market but it would have no liquidity and would not attract anything.

I was talking to an SME during the week and I can give the committee an idea of what SMEs are struggling with. The enterprise is an importer and must buy dollars. The dollar has risen by 30% since May 2014. I said to the person that surely his bank brought him in and gave some support and advice on it, but there was no contact from the bank at all. He said their bank would not have the expertise to even discuss it with the enterprise. When one starts from there, one is then looking at SMEs raising equity, floating it and so forth. To be honest, it is a step too far for our SMEs. There are a small number, perhaps in the technology area, but they are in the venture capital area to a greater extent than in any other area.

In response to Deputy Donnelly, there is a culture of how quickly one can get one's company to profit, what is its worth and how quickly one can get the money. We suffer from that culture in the SME sector, unfortunately. The reality is that the Irish market is not sophisticated and the financial services professionals within it are not as sophisticated as they would like a person to think they are. My company is involved in diplomas in investing and in educating the investor to see that there are alternatives to just leaving one's money on deposit in a bank. However, it is a very scary thing for many people to mention a bond because they will be asked what it is. The level of education on the investor side is very small and certainly a leap into buying SME stocks is a long way away.

Photo of Liam TwomeyLiam Twomey (Wexford, Fine Gael)
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Mr. Brown and Deputy Donnelly made the point that we try to grow companies and sell them as soon as possible, but there is a problem with growing a company in Ireland. One reaches a certain point and it is very hard to grow the company beyond that point because of access to capital and to expertise. Is it cultural or is it because the system is set up that way?

Mr. Peter Brown:

I am the owner of a company that was founded in 2010. Access to capital is certainly an issue, and scaling is an issue. The market is very small. If one is concentrated on Ireland and the Irish market, it is very small. Then there is an international dimension and a scale. There are challenges in that regard. There is no question that many Irish SMEs are small, family run companies and if people get a pension out of them they will sell them.

Dr. Constantin Gurdgiev:

The issue of scaling is very important. We know that most of the Irish SMEs exit before reaching €20 million in sales. It is too early. A three to five year horizon is about right, although sometimes it is a little longer, but it is usually driven by the quantum of what they can exit at in terms of the capital gains and the number of partners. From that point of view the early stage funding by the VCs is certainly a disadvantage because one does not wish to dilute the equity very early. However, the ability to develop the functional, if only small, or perhaps even integrated market with other European countries, in terms of the equity for those types of companies, can assist that process. One can raise and liquify one's share through that market much more efficiently than by getting the full exit from the company, if one is a founder, and as a result of that one can go beyond €20 million in sales, grow and raise funding for it.

In many ways it is a catch 22. We do not see many companies which grow beyond €20 million precisely because we do not have the capability for them to grow. It is not so much the market size because most of the successful companies in Ireland are trading internationally to a large extent, so they do not have that problem. They very quickly discover how to use the revenue base in the country to push themselves into the global markets. There are many such successful companies. However, giving companies a platform where they can grow without having to opt for not selling at all or selling the entire company would be advantageous in that context. In the longer run I would be hopeful that we can develop far more functional SME and start-up equity or direct debt type of capital markets. In the short term it is a challenge. We already have one and it does not generate a great deal of interest.

In terms of the culture, we are not the only subject to the culture. SMEs in Italy, for example, which are the backbone of the Italian economy to an even greater extent than is the case in Ireland, do not have the problem of staying longer. These are multi-generational companies and family firms, and they have a very significant issue in terms of going to the market and either raising debt in the markets outside of the banks or issuing equity into the markets. What drives their consideration of not taking the equity market route for raising funding is the consideration of family ownership. They want to have tight control of the ownership. Cultures are different and cultures are always present. In general, however, we should give companies the chance to make a choice regarding where they raise funding and not push them straight into the hands of the banks, especially given that the banking sector is not exactly performing and is not likely to be performing in an enterprise growth conducive way in the years to come. It will be expensive for a number of reasons and it will be difficult to raise funds for companies in that sector. We should be looking at the diversification.

Photo of Richard Boyd BarrettRichard Boyd Barrett (Dún Laoghaire, People Before Profit Alliance)
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I apologise for my late arrival. One has to bi-locate and tri-locate in this place when one is in a small party. Having listened to some of the discussion, I have not fully developed an expert understanding of what is being discussed so I am on a learning curve. However, I would be very anxious and suspicious about all of this. The labyrinthine and opaque world of international finance is quite terrifying.

Its capacity to unleash devastation on economies, really out of the blue as far as ordinary citizens are concerned, is a big problem. That the vast majority of participants in the economy can suddenly be devastatingly affected by the ebbs, flows and shifts of international capital is one lesson we should draw from the recent bubble and burst. Private capital moves into areas where it thinks it can make a quick buck and it moves out just as fast when over investment in those areas leads to a bubble and a crash. So one gets over-investment at one point and then an investment retrenchment and flight at another point. On the face of it, this is just facilitating that process. It is actually making a bad situation worse. If one can pin point who are the investors and if there is a relationship between the investor and the enterprise, then one feels there is some transparency and maybe some potential to control investment. What we seem to be talking about here is facilitating anonymous investment from people who happen to have savings or accumulated capital, all over Europe, in different places, and who then throw their money into some vehicle, which will then invest it on the basis of getting a maximum return at any given point in time in another place. So there is no relationship at all between the real economy and the investor. To my mind that is just what led us into the mess in the first place. So, sell me this, but I really do not see the advantage of it. Can I put it to the witnesses, the problem which lies at the back of this, so far as I understood from the finance representative who was before the committee earlier-----

Photo of Liam TwomeyLiam Twomey (Wexford, Fine Gael)
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Ms Regina Breheny, the director general of the Irish Venture Capital Association?

Photo of Richard Boyd BarrettRichard Boyd Barrett (Dún Laoghaire, People Before Profit Alliance)
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-----is the pretty big retrenchment in investment, here and generally across Europe in the aftermath of the crash? Those with money are very nervous about where they put it and they do not really want to invest it in the real economy. So we try to cajole them into investing in the real economy. To facilitate that and encourage them, and I heard mention of capital gains taxes and all that kind of stuff, we end up incentivising them and I really worry about that. There is another way to deal with the problem of loads of privately accumulated capital and savings sitting there not invested in the real economy unless it is no risk and absolutely guaranteed to make a big profit - I thought capitalism is all about risk, but it appears it is not. Private capital today is the enterprise of investing and ensuring no risk. I believe we actually need to address the fundamental problem of risk averse private capital resulting in no investment. What we need to do is take some of that money back from them and into the hands of public authorities, controlled by the people, in order to have democratic investment decisions. That is the problem we grapple with - too much money concentrated in the hands of too few people.

Photo of Liam TwomeyLiam Twomey (Wexford, Fine Gael)
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Deputy, can you ask the witnesses to answer you?

Mr. Peter Brown:

I am not here to defend the capital markets or the Green Paper. However, now that we owe the capital markets €220 billion there is very little we can do about the fact that we are involved in it. We are not going to be uninvolved in the capital markets any time soon. If it was up to me I would do financial markets education in schools so that school leavers would understand the difference between a variable and a tracker, understand the difference between different investment products and understand the effect that financial markets have on everyone's lives in their lifetime. I fully agree with the Deputy that it is stunning how the financial markets can affect people's lives, wealth, jobs and security throughout their lives. That is the way it is. Once we have a capitalist society which chooses to borrow from the financial markets we are involved in the financial markets.

I am in favour of improving the financial markets from the investor side. Investors here have €90 billion worth of retail deposits sitting in the bank, accepting risk but not getting a return. They are using banks like a safety deposit box - they have some risk and are not getting a return for it. They have missed out on the second greatest bond market rally this State has ever seen. The reality is that the people who have walked away with all the money from the Irish bond market rally are foreign investors because nobody has educated the Irish investor to understand that there are other ways to make money in the capital markets besides deposits. We need to educate people and open the financial markets and make them easier to access for the investor and the SME, so that the SME is not stuck all the time going to non-competitive banks to borrow their money. That is an improvement. In Ireland we are past the point of whether one likes the financial markets, because we owe so much money. We are slaves to the bond market. The interest rate we pay on our bonds is the most important determining factor of the future of this economy for decades to come, whether we like it or not. It is hugely important how much we pay for our debt and at what rate we fund our debt. Whoever earns interest from our debt is also hugely important. I would much prefer to see Irish investors earn the interest from our debt than foreign hedge funds, which is exactly what has happened. I am not here to defend the financial markets - but we are in them.

Dr. Constantin Gurdgiev:

The Deputy mentioned the capacity of the financial markets to generate crises. I agree with the Deputy it is tremendous, and it has been rising over time. The crises becomes sharper and sharper, and with less and less space of time between them. However, if one looks at the last crisis, it is not the equity market which caused any problem. It was caused by instrumentation in some of the liberalised markets, such as securitised paper. In other markets it was the creation of new instruments, again securitised paper is a good example, or asset backed securities or the most simple of all financial products, the bank loans. It was the bank loans which brought down this country, not the stock market. The stock market played a very little and a very tangential role in the entire crisis, as a follow up to what the banks were actually doing, because it reflected the banks valuations. Quick moves in the markets worry the European Commission. This is part and parcel of the several proposals that the European Commission put forward. One of the explicit targets of the financial transaction tax, which I mentioned before, is to reduce the volatility in financial markets. Without going into academic discussions of whether it is a good idea or a bad idea, the point is that in financial markets we can select those parts which work for us and use them to work for us. We can down-play, regulate tightly, supervise tightly and decentivise the ones which do not. With the capital market union proposal it is crucial to distinguish the long-hold equity investors - people who go into the businesses on a relationship basis, using only direct equity purchased through private equity, or through the lists of equities on the exchanges. They buy the stock of a company and hold it for three, five or ten years. In a number of countries around the world these investors are distinguished and rewarded with higher, tax adjusted returns by reducing their capital gains taxes - in some countries down to zero. There are some incentives in Ireland but they are not sufficient.

If we want to discourage rapid moves by speculators in and out of the market we should encourage long-term investors who build their relationship on an activist basis by engaging with the company, participating with advice and opening access to the markets for them. We can do that but we need to make sure the proposed union allows us to do it by incentivising those types of investors. I do not mean we should positively incentivise them in the sense of giving something to them. We should, however, level the playing field by, for example, having the same capital gains for somebody who puts money into an uncertain enterprise for five or six years as for a person who gives money to the Government by buying its bonds. I do not argue for over-incentivising investors but nor do I argue for subsidising holders of Government bonds, corporate bonds and the bonds of banks. We should support equity and debt to the same extent but this is not, unfortunately, part of the proposal.

The question was asked whether capital markets investors were risk averse. They are risk averse because all human beings are risk averse. The only ones who have a risk preference are those who go to Las Vegas and play Russian roulette and they do not last very long. Investors in the markets do not pursue a risk-free return but they do pursue a risk-adjusted return. We should bear in mind that SMEs generally imply higher risk because they have higher rates of default and fewer assets, at the time of default, to be captured to compensate investors. An investor in equity has the lowest priority when it comes to the liquidation of an enterprise which fails. That is yet another asymmetry in the relationship between equity investors and debt investors. Whether we like it or not the markets are the most efficient way to decide these things. If we were to follow the Deputy's line and take money away from people to invest it we will trigger even bigger risk aversion - what is known in behavioural economics as "loss aversion" - which is when people run for the hills with all their money and there is nothing to capture and nothing to invest.

Photo of Richard Boyd BarrettRichard Boyd Barrett (Dún Laoghaire, People Before Profit Alliance)
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One can chase after them.

Dr. Constantin Gurdgiev:

One cannot chase them beyond the borders of Ireland. We can, however, work with the markets but my concern with the Green Paper is that it is unclear how much room it gives Ireland to work and how flexible we will be allowed to be in shaping a properly functioning market. That is a very big question which members of the committee should address.

Photo of Liam TwomeyLiam Twomey (Wexford, Fine Gael)
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Securitisation was a dirty word only a few years ago as it was thought to have contributed to what happened to the world economy but it is creeping back into the conversation around CMU.

Mr. Peter Brown:

There are a lot of things in financial markets which are unpleasant and high risk, such as leveraged products. Securitisation is a way of packaging up assets and cleaning up the balance sheet. One creates some room by hiving these assets off to somebody else who is at a distance and who cannot evaluate it as closely. In doing so, one can do other things and it is thus an accelerant of credit in the market. The markets boom and they bust. They have done that since time immemorial and they are more than likely to do it again.

There are some stunning features of the market at the moment. For example, Irish bond rates are at 0.25%. When we owed €40 billion people would only lend us money at 5% but now we owe €240 billion people want to lend us money at 0.25%. That is a stunning bubble and it has replaced the property bubble on banks' balance sheets. If anything happened to the bond market we would be back to square one. The market is full of risk all the time and securitisation is an accelerant of that so heavy levels of securitisation are not a good idea.

Dr. Constantin Gurdgiev:

I would not be as negative on securitisation as Mr. Brown but I agree with him that heavy concentration in the market on any particular instrument, be it a complex instrument or a plain vanilla equity deal, is not a good idea. The markets function best when they are diversified and when different instruments are available.

In theory, securitisation is not a bad thing. It is about packaging and pricing risk together and offloading that risk from the balance sheet of the institution to private investors so that the institution can free some of the resources to lend again. When it is abused it is a bad thing, as it is when it is mispriced. The key issue is the same as with the question of how to stop the excesses of bank lending. We should look at placing the risk of mispricing risky assets in the hands of those who are paid to price those risks. So, if a bank issues a securitised package and the package is mispriced, as might be evidenced by a mismatch in the ratings it is given and the quality of the underlying security and assets, the bank in question should be responsible for it. It should be the same as if a car salesman sold a car which was supposed to be a certain year and a certain make but was not. As long as we do not rescue or underwrite financial intermediaries, and provided we make sure they purchase their insurance in the open markets themselves, we will do away with a large part of the problem.

The second tier of protection is to have very robust enforcement of regulations, something that we have not seen in Ireland or elsewhere but which has contributed to the mispricing of risks in the markets. Is securitisation evil? No. Can securitisation be used as an instrument for mispricing risk? Most certainly, but so can cars or apples or oranges.

Photo of Liam TwomeyLiam Twomey (Wexford, Fine Gael)
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We have to finish this session as we were supposed to start another at 5 p.m.

Photo of Richard Boyd BarrettRichard Boyd Barrett (Dún Laoghaire, People Before Profit Alliance)
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The witnesses have not allayed my fears at all.

Mr. Peter Brown:

We will never allay the Deputy's fears about the financial markets because they are a scary thing and they always will be.

Photo of Richard Boyd BarrettRichard Boyd Barrett (Dún Laoghaire, People Before Profit Alliance)
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May I make another point?

Photo of Liam TwomeyLiam Twomey (Wexford, Fine Gael)
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No. This slot has finished as we have new witnesses coming in. I thank the witnesses for attending. It was excellent stuff and it will help us in our deliberations.

Sitting suspended at 5.05 p.m. and resumed at 5.15 p.m.

Photo of Ciarán CannonCiarán Cannon (Galway East, Fine Gael)
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I welcome Mr. Aidan Carrigan, assistant secretary at the Department of Finance; Mr. Niall O'Sullivan and Ms Rosie Keane from the markets and securities unit in the Department; and Mr. Oliver Gilvarry and Mr. David Owens from the Central Bank of Ireland. The format of this session will be the same as the last one, with the witnesses making some opening remarks of no more than five minutes each. A question and answer session may follow to clarify any matter. I remind members that they must switch off mobile phones. I advise the witnesses that by virtue of section 17(2)(l) of the Defamation Act 2009, witnesses are protected by absolute privilege in respect of their evidence to this committee. If they are directed by the committee to cease giving evidence on a particular matter and continue to so do, they are entitled thereafter to only qualified privilege in respect of their evidence. They are directed that only evidence connected with the subject matter of these proceedings is to be given and are asked to respect the parliamentary practice to the effect that, where possible, they should not criticise or make charges against any person or persons or entity by name or in such a way as to make him, her or it identifiable.

Mr. Aidan Carrigan:

I thank the committee for the invitation to be here today to discuss the European Commission’s Green Paper on capital markets union, which was published in February. The Green Paper is only the first phase in a process that will run for a number of years. Therefore the benefits of capital markets union, such as they may be, will only become apparent over time. However, the Commission has set out clear high-level objectives for capital markets union. They are to improve access to financing for all businesses across Europe, particularly small and medium enterprises, and improve investment projects such as infrastructure; increase and diversify sources of funding from investors in the European Union and all over the world; and make markets work more effectively and efficiently, linking investors to those who need funding at lower cost, both within member states and across borders. Nobody can argue with the desirability of these high-level objectives, which are underpinned by the key principle that capital markets should benefit the economy, jobs and growth.

The Department submitted an information note on the Green Paper earlier in the month. In this note we set out a short summary of the Green Paper and its objectives. We indicated that we support the capital markets union initiative but advised that it was still at a very early phase and that we would need to consult further before developing clear policy positions across the various strands of capital markets union. We further advised that we were considering organising a workshop and launching a public consultation. I can confirm that the Department, in conjunction with the European Commission, organised a workshop that took place this morning, with a key speaker from the European Commission and attendance from across financial services. We used the opportunity to launch our public consultation document, which was uploaded to our website today. We expect these events will help inform the development of our policies on an initiative that is still at an early phase.

At the outset it might be useful to set out in some detail our current understanding of the key elements of capital markets union. This initiative is not occurring in a vacuum, and in many respects it is a reaction to the dominant role of banks in funding the European economy and their continued difficulty in effectively fulfilling their primary functions of lending to the "real economy". A stated objective of capital markets union is to move closer to US levels of capital markets financing. It is argued that even if a relatively modest movement in the direction of the US levels can be achieved, EU financial markets will be more efficient and, importantly, more resilient to shocks.

The general idea of a capital markets union is not new. The EU has implemented policies to develop and integrate its capital markets for decades, such as through the financial services action plan in the 1990s. However, EU capital markets today are still characterised by fragmentation, where much trading and securities ownership takes places within national borders. This is considered to significantly limit the potential of the capital markets to contribute to Europe's high-level objectives of jobs and growth. From this perspective, capital markets union can be seen as a wide range of initiatives and legislative proposals in different fields, which when taken together aim at ending the fragmentation of European capital markets, as well as providing alternative sources of finance for businesses.

As we see it, there are two core elements of capital markets union that will need to be addressed, the market segment element and the horizontal integration element. The market segment approach is concerned with how to advance different types of capital markets, such as individual measures on securitisation, private placement, funds and crowdfunding, etc.

In contrast, the horizontal integration approach is concerned with how to address issues which impede the development of cross-border capital markets generally. Potentially this could involve greater harmonisation of accountancy, insolvency and tax laws to capital markets and greater supervisory convergence across the EU. Essentially it would be seeking to remove the barriers of the free movement of capital across borders.

For the purposes of today’s debate I would like to elaborate on what we see as two of the most important thematic areas from the Green Paper, the funding of SMEs and developing the securitisations markets.

Photo of Liam TwomeyLiam Twomey (Wexford, Fine Gael)
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My apologies Mr. Carrigan the committee must suspend, there is a vote in the Dáil. We will resume immediately after the vote. Thank you.

Mr. Aidan Carrigan:

For ten minutes?

Photo of Liam TwomeyLiam Twomey (Wexford, Fine Gael)
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Yes.

Sitting suspended at 5.21 p.m. and resumed at 5.40 p.m.

Photo of Ciarán CannonCiarán Cannon (Galway East, Fine Gael)
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The meeting is back in public session. Mr. Carrigan can recommence. I am sorry for the delay.

Mr. Aidan Carrigan:

I wish to elaborate on two of the most important themes from the Green Paper, namely, the funding of SMEs and securitisations. The Green Paper explores the ability of capital markets to work better for the small and medium enterprise sector. The traditional dependency of SMEs on bank finance, in particular lending, is highlighted, and of course this is something with which we in Ireland are familiar. Different European Union member states have different conceptions of what “SME” means and, to date, capital markets have tended to focus more on companies in the medium rather than the small enterprise sector. It is not readily apparent from the Green Paper that many of the proposals will directly benefit the average small business in Ireland. This is an area we intend to critically review with a view to ensuring that smaller companies are not excluded from the benefits of capital markets union.

The Green Paper does set out ideas and proposals for reducing SME dependency on bank financing. Before SME markets or instrument types can develop to their potential there are important structural impediments to tackle. For example, the Green Paper highlights the need for higher quality credit information for SMEs and the potential advantages that may arise from standardised credit data and credit scoring. Within a national context members will be aware that a central credit registry, under the auspices of the Central Bank, is scheduled to go live next year and should greatly improve the coverage and quality of SME credit information.

Other issues mentioned in the Green Paper include the potential to develop SME growth markets and also a potential role for crowd funding in becoming a viable alternative to bank-based financing for some SMEs. It would seem to us that crowd funding could potentially play a positive role in financing small and micro businesses. We are aware of existing crowd funding platforms operating in Ireland and have closely monitored EU developments in this emerging area.

In relation to the proposed priorities for early action, we note the related Commission consultation paper on securitisation. This paper follows on from recent contributions by other European institutions, for example, the ECB and the Bank of England, which call for a review of this area and set out the potential benefits of a high-quality securitisation market. This allows for a broader distribution of financial sector risk and can help to free up banks' balance sheets to allow for further lending to the economy. This may, for example, allow banks to expand their SME loan books.

The Green Paper also recognises the potential risks and seeks to address those by putting forward a framework for safe, simple and transparent securitisations. We are fully in agreement with the Commission that the development of the securitisation market should only be facilitated by legislators on the basis that such instruments are safe and sustainable.

Within a domestic setting, the recent international financial services, IFS, 2020 strategy anticipates the potential opportunities that CMU may provide for the sector. It sets out a range of actions which will ensure that Ireland is best placed to attract high quality investment. I refer in particular to the recommendation to examine the potential to develop Ireland as a securitisation hub should CMU open up opportunities in this regard.

Other important themes surface in the Green Paper, for example, the potential for an increased role for the insurance and pensions industry, the greater participation of retail investors in the capital markets and horizontal integration elements that focus on the "union” part of capital markets union. These will need to be carefully considered as part of our consultation.

It is important to reiterate that the capital markets union initiative is still at a very early phase. In reality, it will not be until the European Commission's action plan is published later in the year that we have something concrete before us. Therefore, while the Department is proactively engaging with the subject matter we are not in a position to give definitive views today. We intend to submit comments on the Green Paper in advance of the 13 May deadline. Events such as today’s Oireachtas finance committee hearing and today’s workshop, as well as any submissions received from our open public consultation, will help inform our views and input on the Green Paper.

We support the objectives of sourcing additional capital to businesses to support growth and employment within the EU and our initial position is to welcome the CMU initiative as an opportunity for Ireland. Our objective is to position ourselves at the EU level to ensure Irish interests are understood and taken into consideration. I thank the committee for the opportunity to address it today. I am happy to take questions.

Mr. Oliver Gilvarry:

I thank the Joint Committee on Finance, Public Expenditure and Reform for inviting the Central Bank of Ireland to this meeting to discuss the recent European Commission's Green Paper on building a capital markets union.

Capital markets union, CMU, is a key priority of the current European Commission with President Juncker stating that in order to "improve the financing of our economy, we should further develop and integrate capital markets." Commissioner Hill has reiterated this goal and has highlighted the aim is to build a single market for capital from the bottom up by identifying barriers constraining the movement of capital and eliminating them one by one.

The reliance on bank funding in Europe is well documented and is outlined in detail in the green paper and the supporting European Commission staff working document. The superiority of capital-based financing systems versus bank-based is uncertain. Academic literature is divided on this point with no clear supporting evidence in support of either side. There is evidence that the impact of economic shocks on consumption is less pronounced in economies which have more integrated capital markets. Examples are Canada and the US where the capital market channel allows for a greater diversity of risk sharing than in the EU where the credit market or banking system is the main channel to absorb shocks. This would imply that having a more diversified funding model is a good thing and this makes intuitive sense as having more alternatives for financing would provide more options for entities looking for financing. In addition, the provision of equity-based financing is found to be more inherently stable compared to debt financing.

During the debt crisis in Europe, debt financing had been more prone to capital flight than equity financing. Part of this is the fundamental structure of such financing as equity financing is longer term in nature than debt with little to no re-financing risks. Furthermore, greater cross-border holdings of equities across the EU would allow for more effective risk sharing between member states.

While the provision of more market-based financing will potentially have benefits as outlined above, we need to be clear that reliance by SMEs on bank-based funding will continue. The European Commission's green paper also states that banking union will provide a "platform of stability to underpin the development of CMU across all Member States." Therefore, CMU will not replace bank finance but rather supplement it.

The Central Bank believes the provision of more diversified funding models in Europe is positive but highlights some caveats. In the green paper, the European Commission outline its five key priorities, such as lowering barriers to accessing capital markets and building sustainable securitisation and i particular, streamlining the current prospectus regime and proposing a framework for simple, transparent and standardised securitisations, which are subject to separate consultations. Any changes in these areas or others outlined in the paper must take into the impact on consumers and the level of protections they are afforded. A balance must be struck between promoting greater diversification of funding channels in Europe while ensuring investors, particularly retail investors, are adequately protected. Protections that are currently in place must not be unduly diluted. Supervisory convergence should be considered in some cases as the solution rather than diluting existing protections. Avoiding dilution of rules related to macro-prudential protections is also important.

We must remember that macro-prudential policies must also be considered with the implementation of CMU. CRD IV/CRR has imposed new requirements on financial institutions across the EU which have only been in place since January 2014 and some of these deal with macro-prudential risks. Market-based financing should not be seen as a way of avoiding macro-prudential rules. Consideration should be also given to regimes which aim to mitigate macro-prudential risks arising from market-based financing. For example, last year, the Central Bank introduced a regime that covers loan origination by investment funds. This regime was introduced post-discussions with industry and, importantly, after discussions with our European counterparts and after receiving advice from the European Systemic Risk Board, ESRB, particularly in the area of mitigating potential macro-prudential risks. While not replicating bank capital rules in full, the regime does aim to ensure such activity does not result in entities avoiding the macro-prudential requirements found in banking regulation.

To conclude, the Central Bank welcomes the green paper from the European Commission and the proposed approach, which has a mixture of short, medium and long-term measures, along with legislative and non-legislative tools. The proposals of the European Commission to promote market-based financing will not, in our view, to replace bank financing but rather to complement it. They involve providing more options for non-financial corporations to access funding in Europe and as an alternative source of funding for economic growth.

CMU may also make Europe more like other jurisdictions and limit the negative impacts from economic shocks in the future. Furthermore, we call for careful consideration of any reduction of protections for investors as loss of investor confidence in financial instruments will impact the ability of entities to raise financing from these instruments and impact the liquidity of them in secondary markets, both of which are key in ensuring market-based financing becomes entrenched and grows as a form of funding for non-financial companies in Europe.

We are actively involved in this debate at a European level, are engaging with the European Securities Markets Authority in its discussions on this topic and are working with other competent authorities to achieve supervisory convergence across member states regarding the legislation currently in place. We will continue to an active participant in this debate in Europe and we will provide advice to the Department of Finance as required on the topic as it develops over the coming years. I thank the committee for its time.

Photo of Ciarán CannonCiarán Cannon (Galway East, Fine Gael)
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I have two questions for Mr. Carrigan. In his presentation, he said that it is not immediately apparent what the benefits to the Irish SME sector may be arising from strengthened CMU. How do we ensure that our SMEs benefit to the maximum extent? Some early contributors, particularly Dr. Gurdgiev, said that the Irish market may be too small and that our SMEs are simply too small in comparison to what one might understand an SME to be in other jurisdictions to attract the kind of investment that may be freed up through this kind of instrument.

Mr. Aidan Carrigan:

That is a valid position to take given our current knowledge of what the proposal entails. SMEs in Europe are generally far larger organisations than SMEs in Ireland. I have debated this with my colleagues at European Council meetings and we are not alone in being a smaller country with an economy heavily reliant on smaller enterprises so there is a shared concern among a wide range of members. We will bring our wish to see benefits to the table. However, there are already benefits inherent in the proposal. First, the proposal on securitisation creates stronger financial institutions and provides a wider base of sources of finance for financial institutions. It allows them capital reliefs from removing moneys off their books and frees up further moneys. The banks then look for markets for lend to and might begin to be more favourably disposed towards lending to SMEs than before. There are indirect benefits.

CMU talks about the need to standardise and improve credit information quality. We have already gone some way in the development of our credit registry, which will commence next year under the Central Bank. That kind of development around Europe better positions SMEs to access credit from financial institutions. Part of the problem has been the quality of information the SME can bring to the financial institution.

I spoke about crowd funding in my opening statement. Crowd funding has the potential to focus on smaller enterprises. It will not be on a huge scale but it could be very beneficial to start-up companies and new ideas. We need to see this area develop. Of course, there are regulatory concerns and consumer protection issues around that and we will work closely with the Central Bank in looking at that but part of this process must draw attention to all these other issues such as mini bonds and crowd funding. Within the Department of Finance and as part of this project, we will examine the potential of those in an Irish context to support SME finance.

Photo of Ciarán CannonCiarán Cannon (Galway East, Fine Gael)
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My next question was to have been about crowd funding because it is an area I have a lot of interest in and one that is vastly under-utilised in terms of funding opportunities for Irish SMEs and micro-businesses. How does Mr. Carrigan envisage making the crowd funding model more accessible to Irish SMEs or somehow legitimising it as a funding opportunity for fledgling Irish businesses? What opportunities does this present to make crowd funding a more viable option in the future or does it present any? It is just something the Department has identified where it sees an opportunity?

Mr. Aidan Carrigan:

First of all, crowd funding is already happening. Mr. Niall O'Sullivan has been attending meetings in Brussels on behalf of the Department that look at developments in other countries where it is happening. It is happening to a greater extent in some countries. This debate is being facilitated by the European Commission as part of its CMU programme. We are looking at the experience in other countries, what is happening in the market here and opportunities. It does not necessarily mean that the State will intervene.

This is one of those areas that may or may not benefit from irregulation, it may develop better left to its own resources. It is an area that we are interested in. We are aware that there are consumer protection issues but we are also aware of the opportunities. I know in the UK it is quite developed as a source of financing. We are looking at the experience of other countries and if we can pull all that together, with the other developments under capital markets union, it is one of these issues that can make part of the package of measures which will help improve financing.

Photo of Ciarán CannonCiarán Cannon (Galway East, Fine Gael)
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On behalf of the committee I thank all of the witnesses for their time and their contributions. The committee will be making a submission to the consultation process. There may also be questions arising from members of the committee that will be forwarded to witnesses. They might be so kind as to respond to those. Unless there is any other business the meeting is adjourned. Thank you.

The joint committee adjourned at 6.05 p.m. until 2 p.m. on Wednesday, 1 April 2015.