Blog Post

EU support for SME IPOs should be part of a broader package that unlocks equity finance

The incoming Commission President has put support for SMEs at the centre of her economic programme. A public-private fund investing in initial public offerings should be carefully targeted, primarily at small firms with risky projects. The announced SME strategy and further measures under the Capital Markets Union programme should address numerous other barriers to both public and private equity finance.

By: Date: September 16, 2019 Topic: Finance & Financial Regulation

Over the first five years of the EU’s capital markets union (CMU) agenda the financing mix of European small and medium-sized enterprises (SMEs) has barely changed, and remains heavily biased towards internal funds, and bank loans. Figures from the latest EIB investment survey show that for medium sized companies external finance accounted for about 37 per cent of investment finance, and that within that component loans and other types of bank finance accounted for about 60 per cent. Newly issued bonds and equity, by contrast, amounted to less than one per cent in total.

The CMU agenda to date has already focused on the various obstacles that SMEs encounter in raising finance on public markets:

First, investors typically find it difficult to evaluate small firms with short track record. Bridging information gaps may have become more daunting for SMEs since brokers had to ‘unbundle’ investment research from execution services under MiFID II since 2018.

Secondly, costs of going public can be substantial. The initial listing will entail underwriting fees, costs for legal advisers, accountants and auditors, and fees payable to the exchange. These costs have a substantial fixed component, so are more prohibitive for smaller companies (according to a recent study this could be 5 to 8 per cent of the amount raised where issuance volume is between EUR 50 to 100 million). Since 2017 there is a streamlined requirement for the prospectus offered by SMEs in an IPO, though ongoing disclosure and compliance costs for listed companies remain daunting for SMEs.

Thirdly, the inherent illiquidity in public equity of smaller firms will raise the cost of capital. With the concept of the so-called ‘SME growth markets’, MiFID II put in place a market type that benefits from various types of lighter regulation, for instance under the prospectus regulation, and the market abuse (insider) regulation. A legislative package under the CMU agenda that was agreed last March now seeks to facilitate trading and raise liquidity further.

Europe’s SME exchanges

Despite past reforms, SMEs remain largely uninterested in external equity. In the EIB survey the proportion of firms that signal interest in new bond or equity issuance are vanishingly small. Issuance on the EU’s junior exchanges that are dedicated to SMEs, such as the New Connect market in Warsaw, has remained well below pre-crisis peaks. The chart below shows roughly EUR 4.5 billion issuance in about 250 IPOs in 2017. Many of these exchanges remain illiquid, and AIM at the London Stock Exchange still accounts for the bulk of European SME IPOs.

Number of IPOs and funds raised (EUR million) on EU junior exchanges:

Source: European Commission.

It is the avowed aim of the Commission’s CMU agenda to mobilise risk-oriented funding for growth companies. With this broad objective there should be no bias towards public markets, as opposed to private equity and venture capital.

In terms of volumes of finance, it is clear that private equity funding outstripped what has been raised through SME IPOs on the Europe’s junior exchanges. Last year, the European private equity sector raised about €97 billion in funds, and invested €80 billion. Nearly half of buyout investment was done in small or mid-market deals of under €150 million each (where there were over 1,200 investments). Compared to IPOs, a larger number and a more diverse set of SMEs have benefited. Arguably, an expansion of private equity finance could be supportive of public markets. These investors typically foster governance and operational changes that make a company more attractive for a subsequent listing, though this is of course often resisted by established owners.

Governance of additional EU support

A new EU fund dedicated to SME IPOs, as it is now proposed, would make the success of a stock exchange debut more likely, and possibly redress the illiquidity problem that may have discouraged preparation of an IPO in the first place. But such a fund should be solely targeted at a well-defined failure in financial markets. This affects primarily small young firms with risky projects.

A new EU programme should crowd in private capital, rather than displace it. This could for instance be done through quality certification of potential issuers, based on the existing national and EU programmes of pre-IPO support, and this should evenly open up all of Europe’s SME growth markets (without bias to the local exchange). A EU IPO fund should not support markets that are inherently illiquid, when in fact issuers would have been better served by a cross-border listing elsewhere in Europe. The Zagreb stock exchange, for instance, now runs a SME trading platform jointly with Slovenia.

Direct investment of EU (or EIB) funds in highly risky young firms would throw up numerous governance problems. Venture capital of course stands out for extensive and costly screening processes, which require specialist skills. Firms that were listed on Europe’s junior exchanges have shown mixed performance at best, and were often beset by corporate governance problems. Support to ‘funds of funds’, as increasingly used by the European Investment Fund, could remove direct control, though this model is costly and would need to be carefully evaluated.

A fresh look at the CMU agenda

The policy direction set out in the Commission President’s manifesto is sensible, as it promises a fresh look at the CMU agenda with a focus on the innovative and strongly growing mid-sized companies. This will entail difficult trade-offs between the aim of greater market funding and liquidity on the one hand and the principles of market integrity, transparency and stability in some of the recent legislation such as MiFID II on the other. A new EU fund could overcome some market failures, and may fit well with the EIB’s increasing focus on equity finance, where some public-private funds have had a successful launch. At the same time, SMEs will need to gear up to a life as a public company, including for the changes new owners can bring, and private equity funding and the broader ‘eco-system’ of capital market services will need to be built.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More by this author

Blog Post

Questions on financial services policy for Valdis Dombrovskis, Executive Vice-President-designate of the European Commission

Completing the banking union is the dominant task in the financial services area for the next five years. In the short term, the Commission should affirm its leadership by pushing for the creation of a credible EU anti-money laundering supervisory agency.

By: Nicolas Véron Topic: European Macroeconomics & Governance, Finance & Financial Regulation Date: September 30, 2019
Read article Download PDF More on this topic

Working Paper

EU trade policy amid the China-US clash: caught in the crossfire?

What risks face the EU with regard to China’s strategic aims in trade policy and how can the EU respond? The US effort to isolate China poses particular risks for Europe. How can the EU counter such efforts with the aim of forging its own distinct trade policy? How should the EU move forward with reform of the World Trade Organization (WTO) in light of differing demands and aims of trading blocs like China and the US?

By: Anabel González and Nicolas Véron Topic: Global Economics & Governance Date: September 17, 2019
Read article More on this topic

Opinion

China's dual banking system: consolidation as the final solution for weak small banks

There are fundamental solvency and liquidity issues for some small Chinese banks, widely influencing both the bond market as well as the broader financial sector. Given the difficulties in creating a level playing field between small and large banks, there is an expectation that small banks will continue to under-perform.

By: Alicia García-Herrero and Gary Ng Topic: Finance & Financial Regulation Date: September 16, 2019
Read article More on this topic More by this author

Opinion

Germany’s Divided Soul

Eastern Germans vote, think, and feel differently than western Germans do, as the results of the September 1 regional elections make clear. To help tackle the underlying economic causes of this divide, the federal government should introduce incentives to encourage foreign investment in the east of the country.

By: Dalia Marin Topic: European Macroeconomics & Governance Date: September 13, 2019
Read article More on this topic More by this author

Opinion

The tricky link between the Hong Kong dollar and capital flows

The Hong Kong economy has been hit by a series of shocks, but it should resist taking drastic measures to keep foreign capital in the city.

By: Alicia García-Herrero Topic: Global Economics & Governance Date: September 13, 2019
Read about event

Past Event

Past Event

China-EU investment relations: Exploring competition and industrial policies

This is a closed-door workshop jointly organised by MERICS and Bruegel looking at China-EU investment relations.

Speakers: Miguel Ceballos Barón, Alicia García-Herrero, Mikko Huotari, Yi Huang and Xu Sitao Topic: Finance & Financial Regulation, Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: September 9, 2019
Read article More on this topic

Blog Post

Hong Kong’s economy is still important to the Mainland, at least financially

Hong Kong’s current situation is important for the world in as far as its role as major offshore financial centre is key for China’s inbound and outbound investment and financing. Capital outflows from Hong Kong are especially risky given Hong Kong's so far useful but rigid monetary regime, namely a peg to the USD under a currency board

By: Alicia García-Herrero and Gary Ng Topic: Global Economics & Governance Date: August 19, 2019
Read article More on this topic

Blog Post

European champion-ships: industrial champions and competition policy

This blog post investigates the debate on whether European competition rules should foster European industrial champions, or allow national champions to grow to a European scale. It explores the criteria that one would intuitively ascribe to industrial champions, illustrating the difficulties in defining either ‘European’ or ‘Champion’. It then conducts a brief look into whether EU Merger decisions have impeded the formation of ‘European Champions’.

By: Mathew Heim and Catarina Midoes Topic: Innovation & Competition Policy Date: July 26, 2019
Read article More on this topic More by this author

Blog Post

Modernising European Competition Policy: A Brief Review of Member States’ Proposals

French, German and Polish governments have jointly proposed options for modernising EU competition policy. The debate to recalibrate European competition rules was already well underway. So, it is not surprising that proposals are consistent with other statements made by France and Germany. Yet, proposals do not address current issues weighing on the international competition community, such as conglomerate effects theory or algorithmic collusion.

By: Mathew Heim Topic: Innovation & Competition Policy Date: July 24, 2019
Read article More on this topic

Opinion

EU policy recommendations: A stronger legal framework is not enough to foster national compliance

In 2011, the EU introduced stricter rules to monitor the implementation of country-specific policy recommendations. Using a new dataset, this column investigates whether these new laws have increased national compliance. There is no evidence that these stricter processes matter for implementation rates, whereas macroeconomic fundamentals and market pressure are important determinants of implementation progress. These results suggest ways to improve the effectiveness of European policy coordination that go beyond stronger legal processes.

By: Konstantinos Efstathiou and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: July 23, 2019
Read article More on this topic

Blog Post

China’s investment in Africa: What the data really says, and the implications for Europe

China has clearly signalled to Europe that it does not shy away from involvement in Africa, historically Europe’s area of influence. But the nature of China’s direct investment flows to the continent will have to change if they are to prove sustainable.

By: Alicia García-Herrero and Jianwei Xu Topic: Global Economics & Governance Date: July 22, 2019
Read article More on this topic More by this author

Blog Post

How should the relationship between competition policy and industrial policy evolve in the European Union?

Competition policy aims to ensure that market practices and strategies do not reduce consumer welfare. Industrial policy, meanwhile, aims at securing framework conditions that are favourable to industrial competitiveness, and deals with (sector-specific) production rules as well as the direction of public funds and tax measures. But, how should competition policy and industrial policy interact? Is industrial policy contradicting the aims of competition policy by promoting specific industrial interests?

By: Georgios Petropoulos Topic: Innovation & Competition Policy Date: July 15, 2019
Load more posts