04 September 2017

ECMI - Developing EU Capital Markets for SMEs: Mission impossible?

The European Commission’s renewed activities to develop market-based financing need to be stepped up in order to develop a credible capital market to finance SMEs in the EU, writes Apostolos Thomadakis.

Bank lending is the most common source of external finance for SMEs, but it doesn’t suit all of them. Young, innovative and fast-growing SMEs, in particular, do not have the required cash flows and collateral for bank financing and need alternatives to unlock their growth potential. Market-based finance is one alternative to help finance the activities of these SMEs.

Equity finance is key for innovative companies that create value and growth, and especially, for companies that have a high risk-return profile. Seed and early stage equity finance can boost firm creation and development, whereas other equity instruments, such as specialised platforms for SME public listing, can provide financial resources for growth-oriented and innovative SMEs. Additionally, equity financing may be more suitable than debt financing for SMEs that lack collateral, have negative or irregular cash flows, or require longer maturities for their investments to pay off.

The importance of SMEs financing through public markets is well-recognised in the Commission Green Paper on Capital Markets Union. The reviewing of the Prospectus regime, which was set as the number one priority, has now been completed and resulted (last June) in a Regulation that aims to: i) make it easier and cheaper for small companies to access capital; ii) introduce simplification and flexibility for issuers (in particular for secondary issuances and frequent issuers); and iii) improve prospectuses for investors. In addition, the action plan introduces a new category of multilateral trading facilities (MTFs) called ‘SME Growth Markets’, which will provide an opportunity for new companies to ready themselves for listing on a large exchange. Moreover, the Commission – together with the International Accounting Standards Board (IASB) – intends to explore the possibility of developing a voluntary tailor-made accounting solution, which could be used for companies admitted to trading in SME Growth Markets.

It is clear that the European Commission is committed to making capital markets a credible alternative to bank finance as part of its CMU initiative. But it remains questionable whether this is enough to reduce the information asymmetry and transaction costs. European equity and bond markets remain underdeveloped (partly due to capital market fragmentation) and access to public markets is lower for SMEs. As SMEs show little or no appetite to changing their external financing mix over the next three years, much remains to be done.

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