(Bloomberg) -- The world's largest association for alternative investment managers has been lobbying policymakers in Europe to relax securitization rules, a move it says will make it easier to channel private credit into the region's growing defense industry.
The London-based Alternative Investment Management Association, whose members include hedge fund behemoths Millennium Management and Bridgewater Associates, is currently "in the final phases" of trying to provide officials in Brussels with "whatever evidence and materials they need to justify reforms," said Jiri Krol, AIMA's global head of government affairs.
The goal is to address an existing "bottleneck" in financing for small and mid-sized enterprises (SMEs) in the defense industry, he said in an interview.
"It's going to be the unlisted middle market, possibly non-sponsored companies that don't have access to the bond market or might have difficulties with bank financing, where we as asset managers can step in and through credit transformation, through securitization, we can bring in the broader investor base," Krol said.
Efforts to ratchet up spending on Europe's defense industry are redrawing the bloc's investment map. Policymakers have approved hundreds of billions of euros in government spending on defense, and are going all out to encourage private capital allocations for military equipment. That's as Europe struggles to supply Ukraine with the weapons it needs to fight Russia amid fraught ties with the US.
The development is redefining ESG investing, with defense no longer considered a no-go for asset managers incorporating environmental, social and governance factors in their products. On Tuesday, Euronext NV unveiled indexes as part of a broader palette of products targeting what it called the new ESG: energy, security and geostrategy.
"Amid global tensions, Europe must defend its own values, interests and way of life," Stéphane Boujnah, chief executive of Euronext, said in an emailed statement. "To guarantee our capacity for innovation, our energy supply and our defense capabilities, we all need to take action now."
AIMA wants the European Union to relax current rules so that banks and insurers can use lower risk-weights for investing in securitized products based on pooled loans to SMEs. That would lower the financial buffer that investors must have to guard against losses. It also would have major implications for Europe's defense industry, where growth is currently threatened by the hurdles that new entrants face in getting access to finance.
The European Commission is due to submit its proposal for handling securitization across industries in the coming months. A spokesperson for the commission said the College of Commissioners is scheduled to vote next month on the proposed regulation.
AIMA also is working on "educating" members about the defense sector's "needs and structure and peculiarities," Krol said. And there's an effort underway to engage with the defense sector "about what it is that we do, our track record and what are the benefits of using private credit versus some of the traditional sources of finance."
Defense investments remain "quite unique, so it's not going to be something that everybody will jump into and have a defense-focused fund," he said. However, it's also clear that there are "going to be more opportunities, and people are going to gear up to capitalize on them."
Europe's existing rules on how to handle loans bundled into financial products are still heavily shaped by the experiences of the 2008 financial crisis, when securitizations contributed to the mispricing of risk.
Current requirements for financial institutions mean investments in securitized instruments require upwards of 12 times as much capital as would be assigned to a single loan with a similar credit rating, according to Krol.
"The European framework is extremely punitive," he said. As a holdover from the global financial crisis almost two decades ago, Europe's securitization rules "really need to be scaled back now and brought to the same level that other investments have in terms of the regulatory burden," he said.
Earlier efforts to free up capital for European businesses have supported the market for risk transfers such as synthetic securitizations. These allow banks to transfer some of the risk in their portfolio without moving the physical assets underlying the product. Hedge funds and private credit managers are regular buyers of such securitizations.
But much more is needed, Krol said. "You've got an extremely inefficient regulatory framework that makes it very hard for people to invest from multiple angles," he said.
A reform of Europe's securitization rules would be "a massive, massive potential win," Krol said. "It is the proverbial €1 trillion bill lying on the sidewalk, and we're just hoping it gets picked up by the policymaking community."
What Bloomberg Intelligence Says...
"Amid US military cuts and with Europe potentially doubling outlays to counter conflicts on its doorstep, some pension funds are lifting bans on investing in defense stocks."
And "the Stoxx Aerospace & Defense Index has sharply outperformed US peers, fueled by higher EU defense spending."
(Adds reference to Euronext plan in sixth paragraph, Euronext CEO comment in seventh.)
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