05 September 2019

ESMA published responses to survey on short-termism in the financial sector

Deutsche Börse

Building on the work already conducted by ESMA [1] looking at the prevalence of sell-only or net sell Credit Default Swaps (CDS) positions held by UCITS funds, this section of the questionnaire aims to collect information on the use of CDS by all investment funds. The existing evidence shows some use of sell only or net sell holdings of CDS and ESMA would like to explore this topic further in the context of shorttermism.

ESMA will use the information it collects from stakeholders to assess whether the use of such instruments could be one of the potential drivers of short-termism.

Sell-only or net sell CDS positions may indicate increased short-term risk taking by funds in order to generate short-term profits, thereby diverting funds from investment in the real economy and indirectly contributing to a short-term profit taking approach. This is why ESMA would like to explore this area by gathering evidence from stakeholders, particularly regarding the reasons for sell only or net sell holdings of CDS positions, and how the tail risk of CDS is managed. ESMA recognises that there may be other categories of derivatives that may also merit attention, so one of the questions allows respondents to comment on other products as well.

Full Deutsche Börse response

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The Investment Association

The investment industry acts as a conduit through which money moves from savers to businesses. Longterm investment is essential for ensuring a productive and competitive modern economy, which raises living standards, supports a sustainable future and generates sustainable value for savers.

It is important to distinguish between investments taking place over shorter time horizons, and ‘shorttermism’.

The former meets the needs of savers with shorter term investment objectives or may be driven by the investment characteristics of the particular asset class under consideration. Different sources of capital have different recommended holding periods. The latter refers to a behaviour which prioritises short-term interests and profit over long-term value.

The definition of short-termism focuses too narrowly on shareholders. Short-term interests can manifest across different actors in the investment chain. For investment managers, ‘shareholders’ interests’ are aligned with the investment objectives of savers over the relevant time horizon. For pension funds this will often be in excess of 30 years, though may well be less where the saver is approaching retirement. For retail investors, recommended minimum holding periods are typically closer to the region of 3-5 years, although many hold their investments for longer periods.

Full IA response

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EFAMA

There are different sources of capital: public equity, private equity, venture capital, debt, private placements etc. Each type serves a different purpose and has its own specific, recommended holding period. What is long-term also depends on the needs and profile of end-investors.

It is difficult to distinguish between short-term and long-term investing. Market practice distinguishes day traders and high frequency traders, which can undoubtedly be considered short-term investors, from other investors. Using an analogy from money markets, a period up to 12 months can be considered short-term. In our view, this does not mean that there is anything wrong with such an investment horizon: such a horizon suits clients with comparable investment horizons and are alternatives to savings accounts in banks.

- Buy-and-hold investing has to be mitigated with risk management measures.

An asset manager is not simply focused on the maximization of expected return, but on doing so at an acceptable level of risk. The main risk is in the future: prediction of the future is difficult, and even more difficult in the long-term. Therefore, according to modern portfolio theory and its successor, post-modern portfolio theory, investment portfolios consist of a combination of different stocks (not perfectly positively correlated, leading to diversification and reduction of risk) which, although not all equally attractive when considered individually, together offer the maximum expected return for a given level of risk.

Asset managers always take into account the desired returns and risk profile of their clients. Risk management requires concessions to returns and therefore also investments to adjust risks instead of increase potential returns. This leads to a strategic asset allocation, which may have to be adapted temporarily according to market conditions. Such a temporary adjustment, called the tactical asset allocation, may not always be only ‘defensive’, in the sense that negative risks are avoided, but also positive to make the most of opportunities, where short-term gains are possible.

Long-term sustainable growth is dependent on having diverse sources of financing and particularly the supply of patient capital. So there is an obvious connection between the sustainable finance agenda (and the short-termism debate within it) and the CMU agenda. We should avoid approaching the short-termism debate purely from a listed equity point of view. There are different sources of capital out there: public equity, private equity, venture capital, debt, private placements etc. Each type serves a different purpose and tends to have its own “natural” holding period. What is short-term will vary depending on what asset class we are looking at.

There is also a question of what trends we are seeing in how companies raise money. It won’t help if we focus all our energy on listed equity when we know that an ever decreasing number of companies choose the public market route.

Full EFAMA response

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Full press release

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