While the 'crypto hype' seems to have the finance industry firmly under its spell, the EU Commission is persistently continuing its goal to develop a more attractive regulatory framework supporting access to (classical) public funding for small and mid-sized enterprises (SMEs). In addition to the already implemented new rules aiming to boost market-based sources of financing for EU companies at each stage, two new legislative proposals were launched in May with a view to attract new SME issuers to EU capital markets. The overarching aim of the new proposals is to support access to public funding for SMEs in Europe.
The new proposal for a regulation regarding the promotion of the use of SME growth markets (currently referred to as COM (2018)331 final) will amend the existing Market Abuse Regulation (EU) 596/2014 (MAR) and the Prospectus Regulation (EU) 2017/1129 (Prospectus Regulation) and strike the right balance between investor protection and market integrity on the one hand, avoiding unnecessary administrative burdens on the other. An additional proposal for a delegated regulation regarding certain registration conditions to promote the use of SME growth markets (currently referred to as Ares (2018)2681237) shall amend the existing Commission Delegated Regulation (EU) 2017/565 that supplements the Market in Financial Instruments Directive (EU) 2014/65/EU (MiFID II) with regard to organizational requirements and operating conditions for investment firms. At the time of writing MiFID II has just had its six-month anniversary since entry into force, and in many ways SME growth markets, their benefits and their use case are still in their infancy despite the many advantages that they offer investors, SME issuers and the real economy. As these changes will have profound impact on investors, intermediaries and issuers, some of the impacts and preparatory action may want to be discussed with professional advisers at a quite early stage.
Why the changes?
The current initiative of the EU Commission refers to the term "SME growth market", which has been introduced by MiFID II and means a multilateral trading facility, i.e. a category of capital markets 'trading venue' regulated pursuant to MiFID II (MTF) that is registered as an SME growth market in accordance with Article 33 of MiFID II.
Here it is important to understand the structural difference between an MTF in terms of Art. 4 (22) of MiFID II and constitutes a so called "open market" which is privately operated by an investment firm or a market operator (e.g. Scale as an open market segment of the Frankfurt Stock Exchange) and the regulated market in terms of Art. 4 (21) of MiFID II, which is authorized and functions regularly and in accordance with Title III of MiFID II (e.g. the Prime and General Standard segments of the Frankfurt Stock Exchange).
The creation of the new market category of "SME growth markets" within the existing MTF regime was designed to improve their visibility and profile of these trading venues and ensure the development of common regulatory standards across the EU. SME growth markets are also a policymaker's tool to facilitate an easier form of cross-border listing for SME issuers. That functionality is not only key in deepening liquidity and the investor base for issuers, creating more choice for the "real economy" but also in delivering on one of the fundamental aims of the EU's Capital Markets Union objectives in creating more integrated cross-border markets and investor access. Cross-border trading and resulting funds flows based on dual listings also allows for peace of mind for investors and confidence that non-domestic exposures are robustly vetted and protected by a domestic based trading venue.
MiFID II stipulates certain requirements for an MTF registration as an SME growth market, for example, that at least 50 percent of the issuers whose financial instruments are traded on an SME growth market should be SMEs, this criterion, however, to be implemented in a flexible way. That assessment should be made on an annual basis. A temporary failure to meet the 50 percent threshold should not mean that the trading venue will have to be immediately deregistered or refused to be registered as an SME growth market, if it has a reasonable prospect of meeting the threshold from the subsequent year.
"Small and medium-sized enterprises" are defined in Art. 4 (13) of MiFID II as companies that had an average market capitalization of less than €200 million on the basis of end-year quotes for the previous three calendar years "for the purposes of this Directive". With regard to issuers without any equity instrument traded on any trading venue, the classification as an SME is governed by Art. 77 (2) of the Delegated Regulation (EU) 2017/565, stating that such issuers shall be deemed an SME for the purpose of Art. 4 (13) of MiFID II if, according to its last annual or consolidated accounts, it meets at least two of the following three criteria: an average number of employees during the financial year of less than 250, a total balance sheet not exceeding €43 million and an annual net turnover not exceeding €50 million. This determination is not as it reflects Art. 2 of the Annex to the EU Commission's Recommendation 2003/361/EC.
It is also of importance that the EU Commission does not see the SME growth markets as the final step in the scaling up of issuers and wants successful companies to be able to move one day to regulated markets. Basically, an SME growth market is considered to be an open market. Such transition from an SME growth market to a regulated market shall be facilitated by simplified disclosure regime for the admission on a regulated market, if a company is already admitted to trading on an SME growth market for at least three years thereby having a sufficient track record and the required information on financial performance and reporting requirements.
Why now and what is changing?
The reason for the EU Commission moving to implement further exemptions for SMEs and to strengthen the role of the SME growth market 'offering' is that, according to the EU Commission, despite the existing benefits, EU capital markets for SMEs are struggling to attract new issuers. With no willing and ready issuers, the value add that SME growth markets aims to provide is ultimately underutilized. Part of that may be due to a lack of sufficient awareness in available financing channels, but also a lack of confidence in initial public offerings (IPOs) as achieving financing objectives in a cost and time efficient manner. The number of IPOs on SME-dedicated markets steeply declined in the European Union in the wake of the 2008 financial crisis and has not significantly picked up since. As a result, Europe is producing only half of the SME IPOs that it had generated prior to the financial crisis (478 IPOs on average per year in 2006-2007 vs. 218 between 2009 and 2017 on EU SME MTFs). Between 2006 and 2007, an average of €13.8 billion was risen annually on European SME-dedicated MTFs through Initial Public Offerings. This amount fell to €2.55 billion on average during the period ranging from [year-end] 2009 to 2017.
As a result, the EU Commission is now aiming to reinforce the attractiveness of the SME growth markets by further legislating of a reduction of compliance costs and administrative burdens for issuers listed on SME growth markets. The exemptions, however, shall be applicable to all issuers on such markets, irrespective of whether the issuer itself is an SME or not. That offers a number of opportunities in its own right.
The intended exemptions are in particular:
Market Sounding: Communication of information to qualified investors for the purposes of negotiating the contractual terms and conditions of their participation in an issuance of bonds for an SME growth market issuer (bonds private placement) shall be excluded from the scope of the market sounding regime pursuant to Art. 11 of the MAR, provided that an adequate non-disclosure agreement is in place.
Liquidity: Not all competent authorities throughout the EU have established accepted market practices with regard to liquidity mechanisms (such as market-making arrangements or liquidity contracts) pursuant to Art. 13 of the MAR. Therefore, not all SME growth market issuers currently have access to liquidity schemes as such exist around the EU. The respective amendment of Art. 13 of the MAR will enable SME growth market issuers to enter into a liquidity contract with a liquidity provider in another EU member state in the absence of an accepted market practice established at national level. ESMA will be mandated to draft implementing technical standards, setting out a contractual template to be used for the purposes of entering into a liquidity contract to ensure compliance with the conditions set out in Art. 13 of the MAR. However, this shall not prevent the member states from implementing their own standards in this regard.
Delay of ad-hoc disclosures: SME growth market issuers shall be able to provide explanations for the decision to delay the public disclosure of inside information only upon request of the competent authority. Currently, every issuer is obligated to provide the competent authority with a written explanation of how the conditions set out in this paragraph were met, immediately after the information is disclosed to the public (Art. 17 (4) sentence 3 of the MAR). Also, the SME growth market issuer will not be obligated to keep a record of such explanation anymore. The exemption, however, does not cover the issuer's obligation to inform the competent authority that disclosure of the information was delayed.
Manager's transactions: SME growth market issuers should be allowed to disclose transactions within two days after those transactions having been notified by the persons discharging managerial responsibilities or the persons closely associated with them. Currently, Art. 19 (6) of the MAR stipulates a deadline of three days for each – the issuer and the respective persons. The provision was broadly criticized in the market as it is almost impossible for the issuer to meet the deadline if the respective person reports to the issuer at the end of the third day, thereby formally still being within their own deadline period. Accordingly, most issuers implemented internal policies, obliging the respective managers and associated persons to report at least within a period of two days. In terms of practical terms this means:
List of insiders: SME growth market issuers shall be authorized to include in their lists of insiders only those persons who, due to the nature of their function or position within the issuer, have regular access to inside information. Although the current Art. 18 (6) of the MAR already provides an exemption for SME growth market issuers with regard to the obligation to draw an insider list, if they ensure the personnel's legal awareness with regard to insider dealings and unlawful disclosures and are able to provide the competent authority an insider list upon request. However, according to the EU Commission, this exemption has only little relieving effect as the issuers still need to monitor the respective insiders with regard to the specific projects "just in case". The existing loosening of requirements should therefore be replaced by the possibility for SME growth markets issuers to maintain only a list of permanent insiders, which should include persons who have regular access to inside information due to their function or position within the issuer.
Easier transition to a regulated market: The transition from an SME growth market to a regulated market shall be eased somewhat due to a simplified disclosure regime for the admission on a regulated market. Therefore, SME growth market issuers will be included into the scope of Art. 14 of the Prospectus Regulation, governing the simplified disclosure regime for secondary issuances, provided that they were admitted to trading on such growth market for at least three years. However, in order to avoid departing from regulated market standards, SME growth market issuers, that would want to use the simplified disclosure regime for a transfer to a regulated market, should prepare their most recent financial statements, including comparative information for the previous year in accordance with the International Financial Reporting Standards pursuant to Regulation (EC) No 1606/2002.
Growing the appetite for SME growth markets
Despite the EU Commission's efforts to attract SME issuers to public listings by enforcing the SME growth markets, the most interesting provision of MiFID II is contained in Art. 33 (4), stating that the respective investment firm or market operator operating the MTF is not prevented from imposing additional requirements with regard to their SME segment. However, this open clause bears potential to thwart the Commission's efforts to a harmonized SME growth market regime throughout the EU. Moreover, the respective operator's understandable aspiration to ensure the security and integrity of the respective segment on the one hand, may on the other hand lead to further financial and administrative burdens for the respective issuers.
A comparison of the admission requirements of Scale (Frankfurt Stock Exchange), Euronext Growth and AIM (London Stock Exchange) show significant differences regarding the admission regime. This means that the EU's Single Rulebook and the aims of the Capital Markets Union to make it and the Single Market more single are currently resting on a set of diverging admission regimes. For example, whereas AIM, has no requirements regarding free float, company history or track record, Frankfurt Stock Exchange's SME growth market offering, Scale, requires at least 20 percent free float or at least 1 million shares, a company history of at least two years and the financial statements of the last two years (the last one must be audited). In comparison, Euronext Growth requires a free float of €2.5 million and audited financial statements of the last two years. Scale further asks for an estimated minimum market capitalization of €30 million at the time of the inclusion into trading, while AIM and Euronext Growth have no minimal market capitalization requirement.
Another important question remains how the EU Commission aims to attract more market operators to register their SME segments as SME growth markets pursuant to Art. 33 of the MiFID II. So far, only AIM (London Stock Exchange), AIM Italia (Borsa Italiana) and NEX Exchange (UK) were registered accordingly, while other SME segments, like Scale, despite conducing a majority of its operations as if it were an SME growth market, are merely highlighting a general willingness to register as an SME growth market in the future and are coupling that with commitment to ongoing monitoring of the market's demand for such an offering. The improvement on the demand side on the part of issuers, however, should ideally correspond with a growing interest on the supply side, which, however, is not really visible so far.
Outlook and next steps
This legislative proposal is only one further step on the EU Commission's regulatory path towards a wider availability of market-based financing across the EU. All of this is supposed to deliver on the aims of the Capital Markets Union in 2015. Another regulatory milestone was already achieved in the form of recent revisions to the EU's prospectus regime and the updated Prospectus Regulation (EU) 2017/1129, which shall be applicable in the EU member states directly from July 21, 2019. That newest EU Regulation, amongst other changes, introduces certain specific prospectus exemptions that apply July 20, 2017 or July 21, 2018. The Prospectus Regulation and, therefore, the obligation to publish a formal prospectus instead of other forms of an offering document will not be applicable to offers of securities with a total consideration in the Union of less than €1 million. Additionally, the German legislator published the new draft legislation proposal on July 1, 2018 (Drucksache 19/2435) to exercise the options under the Prospectus Regulation, making clear that Germany intends to implement the exemption threshold of €8 million for prospectus free offerings on the national level. For small companies and mid-caps wishing to raise money across the EU, a new EU "growth prospectus" was conceived at the EU policymaking level and is currently being created. It is anticipated that investors, on the other hand, shall benefit from a clearer structure and content of a security prospectus.
All of these changes are not only timely but welcome in what they aim to facilitate in terms of access, but moreover easier conditions of access. New issuers, their professional advisers and investors will however want to take preparatory steps to take advantage of listing on those trading venues that qualify as MiFID II and SME friendly "trading venues" and in particular, in terms of cross-listings, for those MTFs that are actually registered, regulated and which operate as SME growth markets. Some of these steps will be legal and regulatory, and in particular in respect of existing and/or template documentation, whereas others will be more practical and affect operational workstreams in terms of marketing and listing admission processes in bringing SMEs via IPOs to the EU's capital markets.
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