It is common ground that securities law reforms in the last two decades have greatly increased the regulatory burden for companies accessing public equity markets: a plethora of obligations aimed at preventing abuse and facilitating enforcement have compounded the impact on compliance of broad-sweeping provisions on insider trading and market manipulation; disclosure mandates have been broadened in various directions, not always with the goal of investor protection in mind and the adoption of IFRS, together with various audit reforms, has led to an increase in audit fees.
Due to fixed costs effects, this regulatory escalation has disproportionately hit smaller listed companies. Despite that, the credit crunch has pushed many small and medium enterprises (SMEs) in the direction of public markets, making the freezing effect of the new rules arguably less visible than would have otherwise been the case.
The European Union has so far been very cautious in considering the relaxation of existing rules with a view to favouring SMEs' access to capital markets. That is understandable: deregulation always entails a risk for the policymaker; if a scandal follows, if only temporally, it will be natural for the media and political entrepreneurs to blame it on deregulation. Further, deregulation runs contrary to the best instincts of the European Commission and its staff: any step in that direction may sound like a retreat in the long march towards an ever more harmonized single market, which is the Commission's existential goal. Finally, and relatedly, converting some of the existing mandatory rules into optional ones, which is a milder form of deregulation, runs counter to the idea that a single set of rules is needed to reduce transaction costs in an integrated EU market.
That may also explain why the SME Growth Market experiment has been so timid: this new label, reserved to multilateral trading facilities (MTFs, the EU equivalent of US alternative trading systems) in which more than half of the issuers qualify as SMEs, hasn't so far delivered much in terms of alleviation of regulatory burdens. All an issuer on these markets obtains in terms of regulatory relief are, first, an exemption from the requirement of producing insider lists on an ongoing basis and, second, the possibility of posting inside information on the SME growth market trading venue instead of the issuer's own website. (In addition, issuers with a market capitalization below 500 million euro may use the EU Growth Prospectus format for IPOs of companies seeking admission to trading on SME Growth Markets. Note, though, that no prospectus is required in the case of admission to trading on an MTF, and hence on an SME Growth Market, when, as is common practice, the issuer does not also engage in a public offer of its shares.)
Despite that, the main existing alternative markets for SMEs have applied to be registered as SME Growth Markets (AIM) or announced their intention to do so (Alternext, now Euronext Growth). After all, they have nothing to lose from making this step, which can in fact be mainly seen as a goodwill gesture vis-à-vis EU policymakers.
In December 2017 the Commission launched a consultation aimed at easing SMEs' access to EU capital markets: 'making a success of the SME Growth Market' is its centrepiece.
The Consultation Document contains proposals in four main areas: (1) the definition of SME Growth Markets, (2) the conversion of some market-based rules into hard law rules, (3) delisting and transfer of listing from an SME Growth Market to a regulated market (an exchange), and (4) the alleviation of the regulatory burden for companies admitted to trading in those markets, mainly by broadening the exemptions from MAR rules aimed at facilitating enforcement of market abuse rules. In this post, I address the proposals relating to the definition of SME Growth Markets, which is also a way to criticize the choice of easing SMEs' access to capital markets exclusively by revising SME Growth Markets rules.
The Consultation Document appears to envisage minor changes to the definition of SME Growth Market. It asks, first, whether the threshold (200 million euro in market capitalization) to qualify as an SME should be higher or lower or remain the same. Second, it addresses the percentage of companies that have to be an SME for the MTF to qualify as an SME Growth Market: should it go down to below 25% or up to three quarters or be anywhere in between?
Before addressing these two questions, one must ask a more general question: is the choice of only allowing MTFs to be authorized as SME Growth Markets justified? In other words, why should regulated markets (exchanges) not be able to use that label as well? The main problem with this restriction is that demand for SME Growth Markets' securities may find a limit in regulators' choices as to whether and to what extent institutional investors are allowed to invest in securities not traded on regulated markets. It is in fact standard for regulators of mutual funds, pension schemes and insurance companies to broadly allow them to invest in financial instruments listed on regulated markets. But restrictions are often imposed for investments in non-listed shares, a category that each jurisdiction's regulators may identify as including financial instruments traded on non-regulated markets such as MTFs. While such rules may be harmonized within the EU (and in fact so they are for some institutional investors such as UCITS), there is nothing EU policymakers can do to affect choices made by third country regulators. The risk that they exclude SME Growth Markets or all EU MTFs would be even higher if any of the existing or future SME Growth Markets turns out to be the trading venue of companies involved in widespread fraud or post-bubble, Neuer Markt-style collapses.
The current choice of reserving the SME Growth Market label to MTFs would seem to rest upon the fear of investor confusion: if the regime for listed companies were to be split into two, with one set of more protective rules for large listed companies and one set of less comprehensive rules for SME listed companies, investors may fail to notice the difference. That, is they may not appreciate that, in the case of SME listed companies, they are investing in less regulated companies, and hence riskier shares. As a consequence, they may overpay for them and suffer if market abuse or other forms of misbehaviour materialize in the SME regulated market or segment.
Even leaving aside the fact that share prices should reflect differences in legal protection, so that retail investors would be unlikely to overpay for shares in more lightly regulated issuers, there is some schizophrenia to this argument: policymakers allow retail investors to access regulated markets for shares, subject to a set of rules mainly ensuring enhanced issuer disclosure. Generally, then, transparency is held to provide for sufficient investor protection. Why would then disclosure about which segment or which category of regulated market an issuer is listed on be insufficient to alert investors that they are investing in riskier stock?
As to the quantitative parameters to identify SME Growth Markets, the European Commission is suggesting a fine-tuning exercise: they would remain the same, but possibly the figures would change.
However, the existing criteria (market cap of the single issuer below a given threshold to qualify as an SME, and a majority of SMEs in a given MTF) made sense when the new regime was first introduced with MiFID II: specialized markets for SMEs, such as Alternext/Euronext Growth and AIM, already existed back then and it would have been incongruous to design criteria that would have left them out. Eventually, some high growth companies with shares traded on such markets had already reached a larger size; but given the associated higher costs, they were unwilling to 'graduate' to a regulated market. It was thus only natural for EU lawmakers to use criteria and thresholds that would allow those trading venues in. Yet, now that the SME Growth Market rules have entered into force and those markets have opted in, those criteria are harder to justify.
On the one hand, why should non-SME issuers be allowed to enter such Markets and thus take advantage of the alleviated burdens that find a justification in fixed-costs effects for SMEs? And what if an SME Growth Market attracts mainly successful, fast-growing SMEs and soon finds itself populated mostly by non-SMEs? Should it be the victim of its own success and abandon the label? To be sure, the by now large issuers in this successful Market will be themselves in the position to bear higher regulatory costs. But what about the minority of firms with shares traded on those same MTFs that languish as SMEs or even struggle to survive? Why should they also be involved in the consequences of other firms' success?
It would make more sense to identify as SME Growth Markets those trading venues that only let in companies below a given size in terms of capitalization at the time they are admitted to trading, no matter how much they grow thereafter. Of course, that should be done while at the same time grandfathering the current rules that have allowed existing SME markets to opt into the SME Growth market category.
To conclude, a differentiated regulatory framework for large issuers and SME issuers is fully justified and the European Commission's first steps in this direction deserve praise. However, a better way to favour SMEs' access to public markets by building upon the new SME Growth Market label would be to allow regulated markets or segments thereof to be treated as such but at the same time to restrict new admissions to SMEs only.
Luca Enriques is the Allen & Overy Professor of Corporate Law at the University of Oxford and an ECGI Research Fellow.