- Philippe De Backer – MEP, Committee on Economic and Monetary Affairs, European Parliament
- Levin Holle – Director General, Financial Markets Policy, Federal Ministry of Finance, Germany
- Robert Ophèle – Second Deputy Governor, Banque de France
- Kamil Sasko – Section of Financial Markets, Ministry of Finance, Slovakia
- Gunter Dunkel – President, Association of German Public Banks (VÖB) & Chairman of the Management Board, Norddeutsche Landesbank (NORD/LB)
- Vincent Remay – Advisor to the Chairman, Tradition
- Robert Scharfe – Chief Executive Officer, Luxembourg Stock Exchange
- Carlos López Marqués – Deputy Director International Affairs, Bolsas y Mercados Españoles (BME)
- Guillaume Prache – Managing Director, Better Finance
Different instruments need to be considered for further diversifying the financing of EU SMEs
Capital markets are a necessary complement to banks for the funding of EU companies. Although there is no longer a credit crunch situation in the Euro area, future evolutions remain uncertain with the tightening of many banking rules, a panellist considered. Banks will however remain the predominant source of funding for SMEs.
Different financial instruments have to be considered for further diversifying the financing of EU companies. However what works well should not be hampered, several speakers emphasized.
Securitisation, if it is performed in a simple, transparent and standardised way, can be a potent tool for supporting the financing of SMEs. A panellist however stressed the difficulty of securitising SME loans and suggested that the securitisation of household loans or the use of covered bonds could be more appropriate tools. The relevance of private placement and transferable loans for financing medium-sized enterprises was also emphasized. The EU can build on existing domestic frameworks such as Schuldschein and EuroPP to further develop private placement at the EU level, but policymakers should be careful not to over-complicate the current domestic rules which are quite effective. Loan originating funds should also be more clearly part of the CMU agenda, a speaker suggested. In addition there is an opportunity to develop a simple and cost-effective Pan-European Personal Pension Product (PEPP) that could fuel investment into SMEs and infrastructure projects, given the propensity of many retail savers to invest in packaged products and their need to save for retirement. Such products should however be encouraged to invest in the whole spectrum of equity markets and not only in blue chips in order to fund SMEs and provide investors with higher returns (as a reference, the Euro Stoxx Total Market Index grew by +50% over the last 14 years, whereas the Euro Stoxx 50 only returned +8%, which is lower than inflation).
A combination of regulatory and market-led initiatives is needed to progressively diversify the funding of EU companies
The Capital Markets Union (CMU) can stimulate the development of instruments to support the financing of SMEs such as those mentioned above, however private sector initiatives are also necessary. The use of pooling instruments to bring SMEs to the market was cited. A speaker also stressed that large institutional investors should play an important role in the initiation of a more active market for SME securities, focusing on the largest parts of the market e.g. buying portfolios of securitised loans. Incentives may be needed; in Germany for example promotional banks get budgets from the federal states to invest in medium-sized companies.
Investor protection rules and actions to improve financial literacy are important elements for developing capital markets and SME markets in particular, as these companies are relatively risky and savers have a very limited experience of securities markets in some countries. Care must however be taken in the definition of investor protection rules, a speaker emphasized, as they may lead to a perception that there can be significant return on capital market investment without real risk. In addition the classification of investors in MiFID may need to be reviewed, a panellist suggested, as there appears to be too wide a gap between professional investors and retail ones.
Another important element is taking into account the specific needs of SME issuers and understanding the type of support that they may require for further diversifying their funding. This is particularly necessary in countries that have under-developed capital markets e.g. in Eastern Europe and where a strong improvement of market conditions and market infrastructures is needed. EU requirements should not impose too stringent requirements on the issuers of such countries that may have very small and illiquid markets, a speaker claimed. Moreover the measures to encourage more cross-border investment should not focus too much on specific types of investors (e.g. venture capital) as diversified investors are needed to support the development of small capital markets.
Achieving a better balance between debt and equity is desirable in the context of a stronger development of EU capital markets
Smaller companies in Europe are very reliant on bank financing and debt. Several speakers were in favour of a stronger development of equity in order to further diversify risks, by a rebalancing of debt and equity, and to avoid some of the refinancing problems associated with bonds.
The need to first develop EU capital markets as a whole – not just equity - was however stressed by a panellist. EU capital markets are very underdeveloped compared to the US, which have deeper and more liquid corporate bond markets in particular. Although issuance volumes of corporate bonds have increased in the past years in Europe, the trading capacity has decreased and the bond market structure has not evolved in the same way as the equity market, remaining very much an OTC and buy-and-hold market. The priority should be to restructure the bond market and further develop EU capital markets, the speaker believed; an appropriate balance between debt and equity could be achieved in a second stage.
Developing a stronger “equity culture” and the level of financial literacy is necessary for attracting more investors to the equity market
There are variable levels of equity culture among retail investors. Some of them (e.g. the clients of ebrokers) have a strong experience of equity markets and are aware of the risks that they are taking, but most retail investors have a limited practice of equity markets and many who invested in the years 2000 are quite reluctant to start buying stocks again.
An investor representative pointed out that individuals hold directly on average 17% of their financial savings in shares (both listed and not), according to ESMA, not counting indirect holdings; this is higher than the share held by West European insurers, which is less than 8%. The lack of equity culture therefore concerns also institutional investors as well as intermediaries who have stopped marketing equities and bonds directly to individuals since they sell them in a packaged form, the speaker stressed. The increasing longevity of the population has an impact also on the share of equity in pension fund portfolios, a speaker remarked, since this share diminishes as the payment date of the pension approaches.
Appropriate incentives and information are also essential for developing retail interest in the equity market
Taxation is a first issue, as many countries have developed more tax advantages for relatively safe products than for equities, a speaker believed. In addition fiscal incentives for investing in SME shares differ across Member States, which does not encourage cross-border investments. ETFs or private equity funds invested in securities of different Member States could be a solution in this regard, provided the underlying assets are sufficiently liquid.
Access to research is a second issue; research on SMEs is limited and could be further reduced by MiFID inducement rules. A solution proposed could be to use the proceeds of the Financial Transaction Tax to fund access to research for medium-sized companies.
The identification of the appropriate channels for distributing SME securities to retail investors is a third issue. Some speakers considered that electronic channels and ebrokers could be the best solution, given the risks and costs that weigh on retail banks for this type of activity.
The importance of ensuring a sufficient level of liquidity was also stressed. Retail clients who might not be able to sell at an appropriate price the shares of companies that they bought at the IPO and that perform well, because of liquidity problems, might be discouraged to invest in equity in the future.
Finally, several panellists confirmed that the review of the prospectus directive, which is one of the short term priorities of the CMU is urgently needed; many prospectuses are at present complex and lengthy legal risk-hedging documents intended for lawyers, and they are a source of confusion for investors. They must evolve to become useful documents for investors, including only the essential information that is needed to make investment decisions. Developing a two page summary, inspired by the UCITS or KID documentation from PRIIPs, in addition to the renewed prospectus was suggested in order to facilitate its use by retail investors. Member States will however need to relinquish some domestic considerations for sufficient progress to be possible, a speaker stressed.
There should also be a suitable ecosystem and taxation system for issuers
Taxation is an issue also on the issuer side, as it is more favourable to debt than equity. This could provide an opportunity to review the debt-equity taxation balance with the current low interest rates, a panellist suggested.
Another issue to be addressed is the erosion of the investment ecosystem specialising in SMEs (i.e. lawyers, advisors, accountants…) which has greatly decreased over the last 10 or 15 years and needs to be reactivated.
1. Key priorities for diversifying the financing of EU SMEs
Capital markets are a necessary complement to banks for the funding of EU companies
A regulator stressed that there is no longer a credit crunch in the Euro area, thanks to the ECB monetary policy decisions and the introduction of a single supervisor. This trend can be illustrated by the rate of growth of bank loans which is now back "in solid positive territory" in the Euro area, both for households and for non-financial corporations. Even if there are still large differences between some countries, there is a clear improvement generally in the EU and almost all "sensible" demands for loans receive a positive answer. However, this does not mean that bank lending is no longer at risk. Indeed, the future could be uncertain, the regulator warned, due to the tightening of many rules. This is the reason why it would be very wise to diversify funding.
An industry representative remarked that an economy financed only by banks is worse off than if it were open to capital markets, even if there is always a risk in such an evolution. The general position of the German public banks for example is that there should be more opportunities than threats in developing market-based financing as a complement to bank financing.
In the foreseeable future, even with enhanced securities regulation, banks will remain the predominant source of funding for SMEs, an official emphasized. Against this background, the panellist supported the proposal of the EU Commission in the context of the Capital Requirement Regulation (CRR) review, aimed at creating a simplified regime for smaller regional banks financing SMEs
A market infrastructure operator’s expectation was that the CMU implementation would bring added value by making capital markets more accessible to smaller companies. However "what works well today" should not be hampered. What is needed for SMEs is well-functioning capital markets that can complete bank lending, to which there is no real alternative at present.
Different financial instruments need to be considered for further diversifying the financing of EU SMEs
The panellists cited several instruments that can be used to further diversify the financing of European SMEs and increase the role of capital markets: notably securitisation, covered bonds, private placement, loan origination investment funds and pan-European pension products.
Simple, transparent and standardised securitisation and covered bonds
An official considered that securitisation can be a "potent tool" to improve the funding sources of SMEs, particularly if it is performed in a simple, transparent and standardised way. Two elements would further support the development of securitisation. As long as the criteria mentioned above are met, the inclusion of synthetic securitisations, which are important for SME financing can be considered also, as well as the inclusion of asset-backed commercial papers (and not only those of a very short-term nature).
An industry representative added that securitisation is an opportunity not only for SMEs but also for medium-sized companies below the usual capital market thresholds.
A regulator was however doubtful that the securitisation of SME loans could be a solution. It is feasible but is "a very difficult task". Developing securitisation for loans to households seems more promising. This would alleviate banks’ balance sheets and allow them to extend more loans to non-financial corporations. Moreover bonds covered by loans to non-financial corporations could be developed. This is happening in France and in Italy, and is probably a better way to develop the funding of SMEs.
Private placement and transferable loans
A regulator suggested that all forms of private placement, be it through Schuldschein or Euro PP, are very welcome. This segment of the financial market is developing for medium-sized enterprises. Very small enterprises will not be able to use these tools however and will have to continue to rely mainly on the banking system.
Developing a market for transferable loans is an opportunity, an industry representative suggested, and the regulatory simplification of the treatment of loans on banks’ balance sheets should help. The concept of "transferable promissory notes" that exists in Germany (or Schuldschein in German) is interesting to further assess and should represent a significant input for the Capital Markets Union (CMU). Indeed, the Schuldschein regime involves simplified documentation and allows the easy transfer of loans in the form of promissory notes between banks and also to investors. This instrument is not limited to Germany. There are many international investors interested in using it to invest in the German Mittelstand (medium-sized enterprises) and many international companies from Europe and outside Europe already using Schuldschein to attract German investors. This is however not a solution for SMEs, but for medium-sized companies, because the minimum size of an issue is € 10 million.
Although Schuldschein can be a useful solution to consider at the European level for fostering cross-border investment (e.g. for helping institutional investors to invest part of their portfolio in medium-sized companies of other member states), care must be taken not to hinder the current use of such instruments. The process for issuing Schuldschein should be kept simple. The problem is that quite often European initiatives tend to create more complexity as their primary aim is to cover the whole of Europe and all its jurisdictions. This should be possible with the Schuldschein "as it is", the speaker believed, and this is a great opportunity that must not be "squandered" by too much regulation and complication.
An infrastructure operator agreed that "what works well" should not be hampered. Private placements have proven to be very efficient and useful instruments and they are an important component of EU capital markets. Investors, as much as issuers, have recognised this instrument as being both flexible and valuable. Some Multilateral Trading Facilities (MTFs) list "enormous amounts" of private placements. The Luxembourg Stock Exchange for example probably operates the biggest MTF in Europe in this area with 10,000 issues listed and there has been no evidence of any increased risk or default level, so investor protection is "certainly ensured" in this area.
Loan originating investment funds
An official added that the possibility of developing a framework for investment funds originating loans is a proposal that has gained in importance recently but that should be more clearly part of the agenda of the CMU, as such funds are important for providing a new stable funding source.
Pan-European pension products investing in a broad range of non-financial company equity
The key issue, according to a representative of savers and individual investors, is to make long-term packaged products, especially pension and life insurance products, more attractive to retail savers and at the same time to support SME and infrastructure project financing with such instruments. The proposal was made to the EU Commission to add a sixth short term priority to the CMU action plan focused on pensions and retail savers, the speaker explained. The idea is to set up a simple and cost-effective Pan-European Personal Pension product, the PEPP, which could support investment in EU SME equity and in infrastructure. Households are indeed mainly long-term investors with 90% of their savings in long-term assets and 60% if real estate is excluded, and an increasing proportion of their investments are made through packaged products rather than directly in shares and bonds. Moreover a solution to support SME equity which "does not cost anything and does not require any new regulation", is to make it possible for PEPPs to invest in the "whole spectrum" of equity markets rather than only focusing on large caps, the investor representative suggested. Today, when most people comment on the performance of equity markets they are actually only referring to a small part of the market; for example, the Dow Jones for the US market, which is only 30 stocks. Likewise in Europe, the usual reference point is the Euro Stoxx 50, which is only 50 stocks, but performance can be quite different when looking at the wider European equity market. Every year Better Finance publishes a research report on the "real" return of long-term savings. This report includes a graph that shows that over the last 14 years from 2001 to 2014, the STOXX Europe 50 returned +8% - this is lower than inflation which amounted to +34% over the same period - whereas the Euro Stoxx Total Market index, which includes about 1,400 stocks, returned +50%. This is more than six times the performance of the so-called "European equity market" that most commentators refer to. This is potentially "very good news"; first for investors because if more products were benchmarked against broader indexes, they would have a stronger guarantee to see the real value of their savings increase; secondly for the European economy, there would be a much larger amount of funds going into SMEs. This would also be very positive for private equity since going onto the market is the main "exit route" for such investors. In comparison, in the US, many equity products are targeted towards a large market including small caps.
A combination of regulatory and market-led initiatives is needed to progressively diversify the financing of EU companies
The CMU should stimulate the development of instruments to support the financing of SMEs, however a market infrastructure operator stressed that regulation cannot solve all problems. The private sector also needs to take some initiatives. Some good ideas have been put forward in the market such as the use of pooling instruments to bring SMEs to the market, which could facilitate the access to the market by reducing costs and reporting constraints.
An industry representative emphasized that it is important not to go too fast with the CMU. Progress needs to be made carefully; comparatively it took the US about 40 years to create a culture where the public invests in equities internationally.
The usual way to introduce new instruments is to go first through large institutional investors that have the research capacity and some capacity to manage illiquid instruments, the speaker believed, because the instruments promoted in the CMU will not be liquid from the very beginning. In Germany it is Mittelstand, not SME, loans that are being securitised and they go into completely illiquid portfolios for which there is no trading. The first step is to involve the institutions that are active in these markets and not to focus too much on small markets. The crowdfunding sector in Germany for example is € 100 miilion which is not really significant.
Moreover, the institutions involved in SME financing need some incentives. For example, some of the main SME investors in Germany are promotional banks because they get budgets from the federal states to subsidise companies. Hence, they invest in "all kinds of small companies", not really start-ups, but companies that are expanding. Institutional investors need to come into the market and for that they need financial instruments which they can rely upon. In Germany they use Schuldschein or promissory note loans for investing in medium-sized companies, which is a step in this direction.
Developing investor protection and support for SME issuers
Several panellists stressed that investor protection is an essential element for achieving the Capital Markets Union.
An investor representative reminded the audience of some comments made by Commissioner Hill about the importance of individual investors: "EU households are the main source for the long term funding of the European economy. This is why savers and individual investors must be placed at the heart of the CMU initiative".
A market infrastructure representative stressed that investor protection is essential for promoting investment in SMEs, as such companies can be relatively risky. In MIFID, the classification of investors is very clear cut but may be too much so. There may be too wide a gap between those who are very knowledgeable, the professionals, and those who only have a very basic understanding of capital markets but who should still be considered, as they represent quite an important potential.
An official explained that the low level of development of capital markets in most of Eastern Europe in particular can be directly linked to the traditional "heavy dependence" of businesses on bank loans and to the fact that people in the region are not used, most of them, to capital market financing. Unless there is a strong and continuous focus on promoting the financial literacy of ordinary EU citizens, it might not be possible to achieve all of the ambitious goals of the CMU project, the speaker believed.
Other important elements concern taking into account the specific needs of SME issuers and understanding the type of support that they may require.
An official considered that although major European companies will most likely benefit from the CMU and the development of alternative funding sources, underdeveloped capital markets such as Slovakia will need adequate support to further diversify the funding of local companies and especially SMEs. Taking into account the needs of entrepreneurs and small enterprises is necessary in order to reap the full potential benefits of the capital markets and is therefore in the interest of EU policymakers. The panellist suggested that this can be achieved by a continuous improvement of both market conditions and market infrastructures and by setting up a wide variety of alternative financial instruments that would better address the specific needs of SMEs over the different stages of the business cycle. Moreover, this would certainly contribute to increasing the European financial sector’s resilience by providing new sources of finance for economic growth and, more importantly, by promoting real investment into the European economy.
In order to improve the promotion of equity financing in Eastern Europe in particular, the official identified two key challenges that need to be dealt with. Firstly, the requirements of EU regulations on issuers, investors and intermediaries are "overwhelming" for small and extremely illiquid markets. It is not clear whether this really creates a level playing field across all EU Member States. Secondly, Member States should lift obstacles to cross-border movement of capital so that a diversified set of investors with different risk appetites can access foreign markets more easily. Such improvements should benefit all investors and there should not be too strong a focus on specific types of investors such as venture capital. Developing equity financing is possible but regulators must accept that the output of measures will vary across Member States.
2. Achieving an appropriate balance between debt and equity financing
The financing of EU companies is currently very reliant on debt and capital markets are under-developed in many Member States
Several panellists considered that the reliance on debt is excessive in Europe at present.
Smaller SMEs are still very dependent on bank financing and debt in Europe and some regulatory proposals are pushing towards even more debt, a public representative stressed. A better balance needs to be found between debt and equity and to achieve this, medium-sized companies should be encouraged to adopt more equity financing. The issue is to identify the most effective actions for moving towards more equity financing such as some changes in "mentality" or taxation. There is no "magical wand" but a sum of different actions is needed.
A regulator emphasized that developing equity is "the most promising avenue for diversifying the financing of EU companies", since equity does not involve the same refinancing problems as bonds.
An official agreed that there is too much reliance in Europe on debt for financing enterprises. This topic is of crucial importance notably in small and underdeveloped capital markets in the EU. In Slovakia for example, bonds generated 99.33% of the total financial volume traded on the stock exchange in 2014, and out of that 95% were bonds issued by the government. Therefore, the question is not really whether to, but how to reasonably support alternative ways of funding.
Answering a question from the chair about whether the dynamics of equity markets depended on the size of the country, another official did not believe this was a major factor. For example, Germany has been facing the issue of trying to move retail investors into equity products for decades.
A market infrastructure operator however stressed that the main objective is first to develop European capital markets, which are "undersized". Increasing equity financing will then be a question of achieving the right share in the overall funding of companies. At present, there is an estimated € 2 trillion funding gap until 2020 and € 1 trillion of infrastructure needs, and there is a 75% dependence on bank funding in Europe. Europe has 23 million SMEs of which only 11,000 are market-funded. There has also been a dramatic decline in Initial Public Offerings (IPOs); in the 90s there was an annual average of more than 100 IPOs, whereas in the period between 2000 and 2009 the total number of IPOs dropped to just over 600. € 0.7 billion of funding came from crowd-funding, 3.2 billion from venture capital, 10 billion from IPOs and 31 billion from private equity buy-out.
European corporate bond markets and equity markets are both underdeveloped. The companies that are financed on the capital market account for only 15% of GDP in Europe, whereas they represent 35% of GDP in the United States. Corporate bond markets are less liquid and less broad than in the US and there is a lack of liquid benchmarks for these markets, which are mainly institutional. Institutional investment accounts for 95% of the total volume. This is a buy and hold market and there is a decline in corporate bond liquidity due to the new regulatory developments such as the new Basel III capital and liquidity requirements which affect both primary and secondary liquidity. Markets have increased in terms of issuance volumes but the trading capacity has decreased. This is due in part to the fact that the whole market structure for corporate bonds is outdated and does not correspond to the needs of the investors and issuers of today, the speaker stated. Equity markets have changed dramatically during the last 15 years; central order books have been set up and competition has developed with new types of venues. At the same time bond markets have not evolved in the same way and are still functioning as they did 20 years ago. They are still OTC and assets are still priced by request for a quote. There may be some electronic operations but voice trading is still predominant.
The priority should therefore be to "revamp" the corporate bond market by first changing the market structure, the speaker suggested. Lifting obstacles in the equity market should be a second step. Ultimately, the right balance between debt and equity financing must be led by market forces, but regulators and the private sector should establish a sound and transparent foundation on which these decisions can be based.
A speaker from the audience pointed out that non-regulated markets, particularly bonds, are not accessible to retail investors because the minimum denomination is € 100,000.
Another market infrastructure representative stressed that having a well-functioning ecosystem and taking care of all the steps in the value chain is essential. The buy side has been well taken care of with MIFID and the Prospectus Directive. However, some aspects still need adjusting on the sell side in relation to MIFID II, CRD IV, and Basel III.
Different issues need to be addressed in order to increase the relatively low share of equity in the overall funding of EU companies
A first issue is taxation, a regulator considered. Some taxation obstacles need to be addressed for developing equity, both from the issuer and the investor side. Issuers have a tax advantage with bond financing because of the possibility to deduct interest from their revenues. But there is an opportunity with the current interest rates close to zero to correct this tax bias in favour of debt because doing so would be almost neutral for issuers. From the investors’ standpoint, most countries have developed tax incentives for the safest products that have the lowest returns, but not for the riskier ones. The time has now come to review these taxation issues, the regulator believed, and to change "the current environment". Changes should also be made regarding the calibration of prudential requirements in Solvency II.
Another panellist agreed that this might be the right time to address the taxation issues related to equity and debt, although taxation might not be the most important issue at present hampering investment in the EU capital markets.
A second issue hindering equity financing is access to research, the regulator emphasized. While large firms can easily get access to research, this is not the case for SMEs and the rules concerning inducements are making this more difficult. The regulator proposed that the Financial Transaction Tax (FTT) envisaged in some EU countries should be used to fund access to research for medium-sized companies, and this would also allow investors to get better information about potential investments.
An industry representative added that many retail investors invest in equity because their brokers provide them with research (although they do not necessarily conduct it themselves). Inducement rules may limit the possibility for intermediaries to provide research, and this could have a strong impact on their equity activity.
A third issue is how to direct more retail savings into long term investment, an official remarked. This has not been addressed successfully so far by the institutions that are in this market, the pension funds and the insurance companies. They have lowered the share of equity in their investments massively and not only for regulatory reasons. For example when insurance companies reduced their equity investments after 2001, this was not only for regulatory reasons, it was also because of the perception those companies had of the market. More generally there is a "deep underlying culture issue", which is the need to convince retail investors that equity products make sense for long term savings.
A market infrastructure representative stressed that markets are costly and complex both for SMEs and for retail investors. Thus, there is a predominance of passive investments. Moreover there is an erosion of the local investment ecosystems (i.e. lawyers, advisors, accountants etc. specialising in SME issuers) which used to be quite active some 10 or 15 years ago. "Nobody cares" about local mid-sized companies anymore, although this is usually the stage where they start entering into the capital market. The market situation is not very good either.
Another issue is to identify the right distribution channels for SME securities. An industry representative believed that there is no role for commercial banks to originate private equity funding for example from their client base. This is not because banks are not interested in private equity but simply because of the regulation related to such instruments which has basically eliminated that channel. Reviewing prospectuses to make them more accessible for retail investors is important, but it is essential to think also about who will distribute them. It will not be the banks that distribute equity to small retail clients because the cost and the risks are too high. Technology is the solution, the speaker believed. Equity shares will be bought over the internet; the CMU should therefore also support this evolution.
Another industry representative agreed that the internet will play an important role for retail investors and mentioned that in the last 3-4 years the turnover of Bourse Direct, an ebroker had increased by about 50%, not only in the blue chip but also in the SME sector.
Finally the use of instruments such as convertible debt and subordinated bonds was discussed.
Answering a question from the audience about convertible debt, an industry representative was of the view that such instruments are "very good" but are not adapted to retail investors. Those who invest in SMEs that way are professionals, because there is a need to understand the implications of a conversion into equity.
An investor representative stressed that convertible debt can be issued by some relatively large companies. It is also possible to invest in medium-sized companies through subordinated debt. Although many owners of medium-sized enterprises do not want to "share power" with other shareholders, they might be ready to issue subordinated bonds. In many cases this a solution that is worth exploring in order to help issuers to solve their financing problems, because subordinated debt may be counted as own funds if it is sufficiently well packaged. In addition investors may be well rewarded.
3. Attracting more investors to the equity markets
Different actions for attracting more investors to the equity markets were discussed.
Developing a stronger "equity culture" among investors is a key challenge in Europe
A regulator considered that the issue of encouraging an equity culture is a very complex problem,, its roots probably dating from 200 years ago when equity markets started to grow. The regulator emphasized two issues related to regulation that need to be overcome for developing a stronger equity culture. The first one is that investor protection regulation has led to a certain extent to the perception that there can be significant returns from investment without real risk in the end. Another regulatory issue is related to the access to public markets. The Prospectus Directive in particular includes a great deal of useless information that issuers have to provide for legal reasons. It is generally agreed that this is tremendously discouraging for favouring the development of an equity culture.
There is a variable level of equity culture among retail investors, an industry representative emphasized. The clients of ebrokers for example have quite a developed equity culture; they like to take risks and are aware of the risks they are taking, which is why they purchase shares of IPOs in the biotech sector for example, even if these firms are very small and very risky. This provides a significant amount of funding for these companies. "Traditional" retail investors are different; they often purchased equity at the beginning of 2000 and lost a great deal of money. Hence, it is difficult to persuade them to return to the market. Liquidity is another issue for retail investors. If it is not possible for the clients of ebrokers, because of limited liquidity, to sell at a decent price the shares of companies that they bought at the IPO and that are doing well, then some of these investors will not return to the market for quite some time. Therefore, if liquidity cannot be offered by market makers this will create issues in the market and the CMU may not be very useful for such investors, the speaker believed.
With regard to the development of an equity culture, an investor representative claimed that there should first be a focus on institutional investors. According to ESMA, individuals hold on average 17% of their financial savings directly in shares (both listed and not) and that is not counting their indirect holdings of shares in mutual funds, unit-linked life insurance and pension funds. Comparatively West European insurers only held 8% of their assets in shares in 2010, before Solvency II. This means that the equity culture is not only a problem for retail investors. In addition, retail investors are more active proportionally in SMEs and IPO investments than institutional investors. A problem also exists with the "equity culture" of retail intermediaries, who stopped marketing equities and bonds directly to individuals a few decades ago, largely because they are now selling them though packaged products. As a result the wider public is less literate about equity and bond instruments than 40 years ago.
A public representative agreed that institutional investors have to step in and that incentives are required, which might be in part regulatory. An issue however is that in many countries investments in SMEs are mainly performed by promotional banks with public money, so the problem remains of attracting more private investment into SMEs.
Incentives to develop equity financing
Several speakers emphasized the importance of incentives for developing retail interest in the equity market.
A public representative stressed that much work remains to be done both by policymakers and regulators but also by the market to make sure that "the right products" are put forward and are delivered to the "right people". In this perspective, incentives are very important. Market players and the public authorities need to make sure that the incentives are appropriate for getting all the markets working.
A market infrastructure operator remarked that in countries where there are "overprotective" State pension systems individuals usually have no motivation to consider other financial instruments with which they are less familiar, because their savings are already being taken care of. In this context the PEPP is a very attractive idea, the speaker believed.
A regulator stressed that a pension fund has to be run according to the age of the future pensioners. Individual portfolios have a large portion of equity at the beginning. This portion decreases regularly with the age of the holder and as the payment date of the pension approaches. With the increasing longevity of the population, there is a clear trend to reduce the share of equity in portfolios in order to secure the payment of pensions. If there are no strong incentives, either on the regulatory or on the taxation side, or via innovative products such as PEPPs, the share of equities will not increase. A strong initiative is needed in this perspective.
Another industry representative explained that the individuals who invest in equities e.g. in IPOs tend to do so in their home country. This is not because they are not interested in stocks listed in other EU countries, but because of the lack of legal and fiscal harmonisation. For example the fiscal incentives for investing in SME shares may differ across countries. A solution could be to package some SME bonds or equity listed on different stock exchanges into Exchange Traded Funds (ETFs). This would be a step towards a further harmonisation of these assets. The issue however is that ETFs should be liquid, meaning that the underlying assets need to be liquid as well. Another solution could be for retail investors to invest through private equity funds, as is the case in the US, but this also requires quite a liquid market.
A review of prospectuses is urgently needed
Several panellists stressed the need for an urgent review of the Prospectus Directive.
The Prospectus Directive is a key concern which is rightly a short term priority of the CMU. The objective of the revised prospectus framework should be to provide investors with an "information memorandum" aimed at helping them to make appropriate investment decisions instead of the current documents which are mainly of a legal nature intended to limit the liability of issuers. There is also an issue of cost. Producing prospectuses of several hundred pages – a speaker in a previous session mentioned that the average prospectus is 347 pages long in France for example - is very costly for SMEs looking to tap the capital market. A "back-to-basics" approach is necessary taking into account the needs of issuers and investors.
It is doubtful whether retail investors read the current prospectuses, an investor representative agreed. The content of prospectuses is indeed mainly "legal verbiage" and the summary prospectus is "no better"; the summary can be 25 pages long and does not always contain the key information investors need, for example the interest rate of a fixed rate bond. A review of the prospectus directive is urgently needed, the speaker stated. Disclosure should be proportionate to the size of the issuer in terms of content, but more importantly the information should be usable, which means that a short standardised and intelligible summary prospectus must be available. This can be inspired from the information that is provided for investment funds or in the context of PRIIPS1.
An official claimed that the revision of the Prospectus Directive is "a real chance for change" because no one seems to support the current regime. Most people agree that it is not an investor instrument, but a risk-hedging instrument for the originator and the only people who read it are lawyers, not investors.
Two things clearly stand out, the official stressed. Firstly, there must be a document, other than the prospectus, geared to the needs of retail investors, even once it has been revised. This should be a two page summary; there are a number of examples such as the Key Information Document (KID) related to PRIIPS. Secondly, with regard to the prospectus itself, there should probably be a lighter version, depending on the market concerned. The concept of proportionate disclosure for SMEs does not really seem to work because it is difficult to decide how to apply proportionality. It may in fact be more appropriate to have a "bipolar world" with the revised full prospectus applying to regulated markets and a lighter version for listing securities on different markets, which would allow originators not to go through the whole procedure and to have lower costs in such a case.
A market infrastructure operator stressed that non-regulated markets are generally much more regulated than it might appear. There is a great deal of information available and issuers adapt the information provided to the investor profile. The conditions for public offerings are so restrictive that these alternative markets have developed, but if they were opened up to retail there would be exactly the opposite effect - in fact it would "kill" these alternative markets rather than create a new opportunity for retail.
An official gave an example from Slovakia. When prospectuses started becoming longer, investors believed that if the length had changed it meant that some elements were "hidden" and this actually deterred some investors. This was not necessarily because they did not understand the prospectus, but their perception was that something had been hidden. Prospectuses however are not much of an issue for Slovakia given the current thresholds in the Directive, because 99% of companies in the country are SMEs with only up to 7 people working in the company.
A public representative stressed that the EU Commission and the EU Parliament are in favour of reviewing the Prospectus Directive. However, in the first round of discussions on this review many Member States have indicated that they did not want any significant change. Although everybody seems to agree that changes are needed, when it comes to the details, there seem to be many domestic considerations blocking progress.
1 The Regulation on key information documents for packaged retail and insurance-based investment products (PRIIPs) introduces a key information document (KID – a simple document giving key facts to investors in a clear and understandable manner) covering not only collective investment schemes but also other ’packaged’ investment products offered by banks or insurance companies.
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