EUROPEAN COMMISSION Brussels, 8.6.2017 SWD(2017) 224 final COMMISSION STAFF WORKING DOCUMENT Economic Analysis Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE AND THE COMMITTEE OF THE REGIONS on the Mid-Term Review of the Capital Markets Union Action Plan {COM(2017) 292 final}

{SWD(2017) 225 final}



Contents List of abbreviations Executive Summary Introduction 1 CMU: a general framework 1.1 The design of the CMU action plan 1.1.1 Overarching objectives 1.1.2 Strategic objectives 1.1.3 Operational objectives 1.1.4 Completed actions so far 1.2 CMU mid-term review: focus on supervision and capacity building 1.2.1 Pan-European enforcement and supervisory convergence 1.2.2 Building capacity for Europe's regional markets 1.3 Key indicators 2 Financing for Innovation, Start-ups and Non-listed Companies 2.1 Markets and banks along the funding escalator 2.1.1 Interaction between bank and market-based funding 2.1.2 The SMEs funding jigsaw 2.2 Characteristics of Europe's funding escalator

2.2.1 Funding with risk concentration 2.2.2 Funding with risk dispersion 2.3 General policy implications 2.4 Key indicators 3 Making it Easier for Companies to Enter and Raise Capital on Public Markets 3.1 Access to public markets: long-term trends 3.1.1 Financial structure of EU firms 3.1.2 Developments in public equity and debt markets 3.2 Drivers of going public 3.2.1 Equity 3.2.2 Corporate bonds 3.3 General policy implications 3.4 Key indicators 4 Strengthening banking capacity to support the wider economy 4.1 Asset securitisation 4.1.1 Trends in securitisation markets in Europe 4.1.2 Levers to revive securitisation in the EU 4.2 Covered bond markets 4.2.1 Market trends 4.2.2 Market barriers and challenges

4.3 European Secured Notes (ESNs) 4.4 Improving the functioning of a secondary market for NPLs 4.4.1 The stock of non-performing loans 4.4.2 Developments in loan sales markets 4.5 General policy implications 4.6 Key indicators 5 Institutional investment: Investing for Long-term, Infrastructure and Sustainable Investment 5.1 Long-term institutional investments at the forefront 5.1.1 Trends 5.1.2 Drivers 5.2 Infrastructure 5.3 Sustainable finance 5.4 General policy implications 5.5 Key indicators 6 Fostering retail investments 6.1 Key trends in retail investments 6.1.1 Saving Rates 6.1.2 Household Financial Assets: a balance sheet analysis 6.1.3 Europe's retail market structure 6.2 Characteristics of retail investment services markets

6.2.1 Structural information asymmetry 6.2.2 Transaction costs in cross-border provision of retail financial services 6.2.3 Behavioural Aspects: biases in retail investment decision-making 6.3 General policy implications 6.4 Key indicators References List of abbreviations AIM Alternative Investment Market CCP Central Counterparty (clearing) CCTB Common Consolidated Corporate Tax Base CESEE Central Eastern and South-Eastern Europe CMU Capital Markets Union CR-3, CR-5 Concentration Ratio top-3 and top-5 companies CSD Central Securities Depository ECB European Central Bank EDGAR Electronic Data Gathering, Analysis and Retrieval system EEA European Economic Area EFSI European Fund for Strategic Investment EIB European Investment Bank ESA European Supervisory Agency ESMA European Securities and Markets Authority ESRB European Systemic Risk Board ETF Exchange-Traded Fund EU European Union EU-27 European Union 27 Member States (excluding United Kingdom) EUR Euro EA Euro area EuSEF European Social Entrepreneurship Funds EuVECA European Venture Capital Funds GDP Gross Domestic Product IPO Initial public Offering M&A Mergers and Acquisitions MFI Monetary Financial Institution MiFID Markets in Financial Instruments Directive MiFIR Markets in Financial Instruments Regulation NFC Non-Financial Corporations P2P Peer-to-Peer PP Private Placement PPP Public-Private Partnership RES Renewable Energy Sources SAFE Survey on the Access to Finance of Enterprises SEC Securities and Exchange Commission SME Small and Medium Enterprise STS Simple, Transparent and Standardised SWD Staff Working Document USD United States Dollar T2S TARGET2-Securities VC Venture Capital



Executive Summary This Commission Staff Working Document (SWD) accompanies the Communication on the Mid-term Review of the Capital Markets Union (CMU) Action Plan. The document provides an in-depth economic analysis of underlying long-term trends and capital market failures to underpin the policy priorities of the Mid-Term Review. Each chapter includes an introduction about long-term trends and main indicators. This is followed by a discussion about the drivers of those trends and the general policy implications. Chapter 1 proposes a coherent economic framework underpinning the CMU long-term objectives and provides aggregate indicators about measures of financial integration, as well as investments. The diversification of the financial system in Europe is still far from optimal, but there are signs in the post-crisis recovery that the financial integration process is moving towards a more sustainable path. Based on the economic framework the chapter identifies a number of indicators to measure progress towards the completion of CMU, also leveraging on internal empirical work conducted by the Joint Research Centre (JRC). Particular attention, as key highlights of the Mid-Term Review, is paid to cross-cutting policy issues such as supervisory convergence and capital market capacity building for the Central, Eastern and South Eastern (CESEE) region. Chapter 2 reviews developments in the pre-IPO (initial public offering) ecosystem for unlisted companies, such as start-ups, scale-ups and other Small and Medium sized Enterprises (SMEs), to review the areas of non-bank funding for innovation that may call for action. Market-based finance and bank financing complement one another - the banking sector and capital markets have complementary roles and comparative advantages in different stages of development of an economy. Nonetheless, financing constraints remain, in particular for start-ups, scale-ups and non-listed companies. On the one hand, banks tend not to lend to young companies without collateral and certain future cash flows. On the other, capital markets are under-developed in several Member States, leaving SMEs vulnerable to stress in the banking sector. Market-based solutions in this area include business angels, private equity and venture capital, which rely on risk concentration and strong influence on the governance of the firm, as well as crowdfunding and private placement, which rely on risk dispersion and information disclosure by the company seeking funds. These forms of funding need a more holistic approach to help them develop a better ecosystem. Moreover, many entrepreneurs, start-up and small businesses fail due to cash flow problems although having a viable business model. Solutions such as supply chain finance (invoice trading) can help companies overcome temporary cash flow problems. Chapter 3 focuses on raising equity and debt finance on public capital markets. Access to bond and equity markets occur in waves, depending on macro-economic, firm-specific and institutional factors. Initial access to equity markets facilitates subsequent access to finance (equity, bond, and bank financing) and mergers and acquisition (M&A) activity. Firms' financial structure and access to public markets differs depending on the firm's size (large firms versus SMEs) and across Member States. Dependency on bank-based financing decreased following the financial crisis but still remains high on average. SMEs overall access to external finance shows signs of improvement, but SMEs still face structural barriers to access public markets due to higher information asymmetries, high fixed costs, underdeveloped ecosystems and relatively low demand from institutional and retail investors. Proportionate regulation could help targeting those firms for whom access to public markets is relevant – like fast-growing young SMEs – while ensuring investor protection to preserve sufficient demand from investors. Chapter 4 reviews how banks can use capital markets to support bank lending. STS securitisation aims to support the revival of the EU securitisation market, which will provide banks with an important tool to manage their balance sheet and transfer risk. Market practices to achieve greater standardisation and transparency of deals can support this process. Covered bonds have proven to be an effective long-term funding instrument for the mortgage loan and public sector loan portfolio of banks. A larger EU market for covered bonds, based on existing covered bond frameworks, would reduce issuance costs for banks and offer an asset class to investors. The development of a new dual recourse instrument similar to covered bonds – a European Secured Note (ESN) – could provide a focused way of financing SME and infrastructure loans. As several banks across the EU have built-up a large stock of non-performing loans (NPL), improvements to the functioning of the NPL secondary market would benefit from the expansion of the investor base to specialised buyers such as hedge funds and investment firms, helping banks to refocus on their core business. Chapter 5 discusses long-term institutional investors' participation in capital markets and to support infrastructure and sustainable investments. Equity finance is an important source of long-term investments. The corporate sector in some Member States remains highly leveraged and start-ups, in particular, ask for equity rather than loan finance to support their growth. Equity investment by insurance undertakings and pension funds however remains low. Capital markets could support sustainable finance by redirecting private funds to environmentally-friendly production processes and help to generate financial returns with positive social externalities. Chapter 6 argues for greater engagement of retail investors in capital markets. EU households have one of the highest savings rate worldwide, but those savings are held predominantly in cash deposits, which may generate insufficient returns to meet long-term liabilities, such as education, health and ageing population. Retail investors are important to support market liquidity for stocks and bonds and thereby reduce the cost of finance for EU businesses, including SMEs. Lack of retail investors' participation relates to market frictions in the forms of explicit transaction costs, information asymmetry and behavioural biases. On the supply side, a lack of (domestic and cross-border) competition may lead to rent-seeking behaviour by service providers. New market entrants, such as FinTech companies, could put competitive pressures on incumbents in the years to come. On the demand side, investors' deviation from the optimal portfolio choice can be minimised through more effective transparency of retail investment products (information disclosure) and ability to deal with behavioural frictions. This SWD analyses and monitors trends in capital markets that are relevant to the objectives of the CMU action plan. Building on its 2016 commitment to further develop and update indicators to measure CMU objectives,the SWD includes a section at the end of each chapter with a recap of the indicators used in the text. While other factors beyond CMU actions have a sizable impact on the evolution of capital markets in Europe, these indicators offer an insight on the state of development and integration of European capital markets that will inform current and future policy actions.

Introduction This Commission Staff Working Document (SWD) accompanies the Communication on the Mid-term Review of the Capital Markets Union (CMU) Action Plan. The economic analysis on the functioning of capital markets in the European Union (EU) in this SWD provides the economic context for the policy actions in the mid-term review. The SWD provides a general context for identifying weaknesses and market failures in the functioning of EU capital markets, some of which may be suitable candidates for action in the CMU mid-term review. The SWD seeks to review the main structural shifts in EU capital markets, understand the drivers of change building on insights from economic theory and conclude, where possible, with key messages for implications on policy. It analyses and monitors trends in capital markets that are relevant to the objectives of the CMU initiative through the use of indicators. This SWD extends and complements the economic analysis done previously. In particular, the SWD that accompanied the CMU Action Plan of September 2015 provided a thorough rationale for the objectives of the CMU. The 2016 European Financial Stability and Integration Review (EFSIR) provided an extensive statistical overview of the EU financial system, including capital markets. The SWD starts by introducing a general framework underlying the CMU in Chapter 1 and is then followed by five thematic chapters reflecting the CMU policy areas. Chapters 2 to 4 focus on funding sources and chapters 5 and 6 look at asset allocation.



1CMU: a general framework This chapter presents a general framework for the CMU based on economic theory. The framework identifies relevant indicators to measure the progress of the CMU action plan in the long term. It also provides a framework to prioritise actions. The first section looks at the potential design of the plan and its objectives, which help to identify the long-term indicators. The second section reviews the implementation of the plan so far and its main actions. The last section discusses the future challenges of the CMU mid-term review, with special focus on the institutional architecture. 1.1The design of the CMU action plan The CMU action plan builds upon three levels of objectives: (1) Overarching objectives, which set the long-term goal of a single market for capital; (2) Strategic objectives, which set the direction on how to create a single market for capital; and (3) Operational objectives, which define what is the scope of individual policy actions to be effective. 1.1.1Overarching objectives Capital markets are a fundamental part of the financial system. They provide funding to firms and returns to millions of households that have to meet long-term liabilities, like health, education and retirement. A single market for capital would contribute to two overarching objectives in the Commission's agenda for the years to come: 1)Greater support to private and public investments through the development of a capital market architecture that supports all European countries; and 2)More sustainable financial integration process to stabilise and improve the functioning of Europe's financial system. Greater support to public and private investments Since the crisis, European economies are still struggling to get back to normal. The difference between actual and potential GDP (i.e. output gap) is constantly below zero and the economy is performing below its potential (see Figure 1.1 ). Source: European Commission calculations from AMECO.

The weakness of public and private investments is playing an important role in this output gap, compared to other advanced economies. In particular, assuming investment growth and GDP growth at the rates forecasted for 2017, it would take until 2023 for the investment share to recover to 22%, its level in the years 2000-05 (European Commission 2017).At net of its consumption, the creation of fixed capital has been constantly dropping since early 2000s and only slightly recovering after the recent financial crisis, both in absolute value and returns. Source: European Commission calculations from AMECO. Capital markets can provide a strong support for both public and private investments. For instance, public-private partnerships (PPP) are important tools for infrastructure investments to complement public investments. Capital markets allow the use of risk premia to evaluate public and private investments (risk evaluation). Greater capital markets activity also stimulates private and public investments by providing an exit to investments, especially illiquid ones. Their development across regions in the EU would rely on actions to build capacity in terms of investor base, market infrastructure and supervisory practices. Finally, the Commission is already working to use capital markets to foster public and private investments. The European Fund for Strategic Investment (EFSI) is one of the three pillars of the Commission's Investment Plan for Europe and helps to finance strategic investments in key areas such as infrastructure, research and innovation, education, renewable energy and energy efficiency. The European Fund for Strategic Investment has the goal to mobilise at least EUR 315 billion in additional investment over the period 2016-2018. Its success is therefore relevant for areas of interventions discussed in the following chapters (in particular, 'Make it easier for companies to raise funds on capital markets' and 'Promote investment in long-term, sustainable projects and infrastructure projects'). The take up of infrastructure or innovation projects under the EFSI instrument represents a useful indicator to assess the extent to which this instrument is boosting long-term investment in Europe. The approval process by the European Investment Bank (EIB) Group having started in April 2015, the number of approved transactions as of April 2017 reached 477. This represented approved financing from the EIB Group of EUR 33.9 billion, expected to trigger a total investment of EUR 183.5 billion. A more sustainable financial integration process A well-functioning single market for capital relies on a sustainable financial integration process to efficiently allocate resources (Monti Report 2010). The crisis, and following financial fragmentation, suggested that diversification of financial flows is key for a sustainable financial integration process (Five Presidents’ Report 2015). Europe’s financial system is heavily reliant on bank financing, while the economy may need the support of a financial system that adapts better to the needs of all the firms developing across the funding escalator. The lack of diversification manifested itself via limited geographical risk diversification (see Figure 1.4 ), i.e. deviation from the optimal allocation, as well as limited portfolio diversification (see Figure 1.5 ). Source: European Commission (JRC) calculations from the JRC-ECFIN FinFlows dataset. Note: outward diversification index (equity and debt). Source: European Commission (JRC) calculations from the JRC-ECFIN FinFlows dataset. Note: Bilateral country flows within the EU. This integration process based on low risk diversification (geographical and portfolio risk diversification) resulted in lower cross-border risk sharing and did not prevent massive consumption drop across Europe, and more prominently in the euro area, when the GDP shock hit Europe's economy. In particular, investment portfolio flows are largely allocated to debt instruments (let alone the system’s overreliance on bank lending; ESRB 2014), while the equity component (which is the one that absorb risk most effectively) is very low on average in the last decade but increasing in the post-crisis. Additionally, home bias (measured as the holding of domestic assets versus their optimal intra-EU allocation) also remains very high, especially in equity instruments, even though experiencing a declining trend in the last two years (see Figure 1.7 ). In effect, the geographical and portfolio diversification of the financial system in Europe is still far from optimal and there are only timid signs in the post-crisis that the financial integration process is moving towards a more sustainable path, measured by the level of co-movement between price and quantity-based indicators of integration (see Figure 1.6 and Figure 1.7 ). Equity markets Bond markets Source: European Commission (JRC) calculations. Equity markets Bond markets Source: European Commission (JRC) calculations. Note: No data for Croatia. 1.1.2Strategic objectives In order to achieve the overarching objectives mentioned above and deal with the long-term issues to create a single market, as highlighted by the Monti report (2010), capital markets would need to be more: 1)Competitive and efficient (to deal with 'market fatigue').

CMU should deliver greater access to finance (private investments) and a better framework for public investments (for demand-side policies). Liquidity and market microstructure are also part of the market functioning and efficiency. Increased competition between funding sources and within the financial sector would result in more diversified asset side for capital providers and liability side for capital seekers. A more competitive market and industry structure are key to overcoming ‘market fatigue’. Technologies applied to financial services (FinTech) provide an indispensable toolkit to promote access, efficiency and competition among capital markets service providers. 2)Financially stable and integrated (to deal with 'integration fatigue'). Improving channels of private risk sharing (i.e. cross-border holdings of financial assets), through the risk dispersion provided by cross-border capital market transactions, is key for financial stability. In effect, on a cross-border basis, capital (and credit) markets are the main channel of risk absorption in case of asymmetric shocks like the last financial crisis (Asdrubali et al. 1996, among others). Stability also includes sounder investor protection to be enforced at EU level. As Figure 1.8 and Figure 1.9 suggest, both greater geographical risk diversification and lower home bias (i.e. propensity to hold domestic assets over other EU foreign ones) could be associated with greater risk sharing via cross-border credit and capital markets (obtained from the net factor income). This means that the more the financial system is diversified according to the 'importance' of the partner country (geographical risk diversification) and according to the 'importance' of the local capital markets vis-à-vis the total EU markets (home bias), the greater is its overall stability, resulting from the greater ability to absorb risk (see Figure 1.8 and Figure 1.9 ). Source: European Commission (JRC) calculations. Last available estimate is for 2015. Note: For illustrative purposes, Figure 1.9 does not include Ireland and Luxembourg where home bias is close to zero. Diversification also involves funding sources. In effect, lack of financial diversification exposes the system to further instability caused by the volatility of some financial flows when there is a structural shock (see Figure 1.10 ). Source: ECB and European Commission calculations. Bank loans do usually have a much higher volatility, compared to listed shares and debt instruments, which are more resilient to asymmetric shocks. 3)Cohesive (to deal with 'eroding consensus'). CMU also helps to strengthen the cohesion of the single market plan, as: it is a multi-currency project; it does not need public risk sharing; it does not need an institutional overhaul (like for banking union), beyond the upgrade of the current institutional framework. It also interacts well with banking union, as it complements the importance of greater cross-border credit markets. 1.1.3Operational objectives A capital market transaction is a market-based financial transaction that typically involves several capital providers (investors). Compared to a traditional bank lending operation, where there is one institution as the capital provider, which directly collects and processes information, market-based transactions involve multiple capital providers in every transaction (typically through the issuance of a financial instrument), who do not have the size and cost structure to undergo complex due diligence to collect and process information about the capital seeker. As a result, a system of rules and procedures is usually designed and enforced, in order to give investors and capital seekers the certainty that the transaction will take place and sufficient information will be available, if they do not have the scale to produce the information themselves. For instance, regulators typically foresee disclosure rules to complement the voluntary disclosure of information by the issuer. Components of a capital market transaction are thus: (1) Information flows that allow price discovery and so pricing; (2) The execution infrastructure that allows access to markets and products; and (3) The rules and contracts that allow uniform rules to be applied with a high degree of legal certainty across the EU. On a pan-European scale, the CMU action plan therefore promotes the following operational objectives: 1.Greater data availability and comparability on a cross-border basis (for price discovery); 2.More accessibility to markets and product (with fair access); 3.Stronger enforcement of rules and procedures (to achieve greater legal certainty and investor protection).

As specified in Figure 1.11 , once defined the three levels of objectives (overarching, strategic and operational), the CMU action plan has identified one general area of intervention on supervision and capital market capacity building and six specific areas of intervention according to the developing phases of the funding escalator and investment, which are defined as follows: 1.Strengthening supervision and building capital markets capacity in the EU; 2.Financing for innovation, start-ups and unlisted companies; 3.Making easier for firms to raise money on public markets; 4.Strengthening banking capacity to support the economy; 5.Investing for long-term, infrastructure and sustainable investments; 6.Fostering retail investment; and 7.Facilitating cross-border investments. 1.1.4Completed actions so far Over the past 18 months, the Commission has delivered the following 20 actions (out of 33) in accordance with the list announced in the 2015 CMU Action Plan. Note: legislative actions are shaded in grey; Tick '√' means that the measure has an impact on that dimension of capital markets and 'X' otherwise Price discovery Market and product access Enforcement Financing for innovation, start-ups and non-listed companies 1.Pan-European venture capital fund-of-funds and multi-country funds (proposal and adopted and selection of managers to be finalised in Q2 2017) X √ X 2.EuVECA and EuSEF legislation review (proposal adopted in July 2016) X √ X 3.Study on tax incentives for venture capital and business angels (adopted in June 2017) X √ X 4.Industry high-level principles for banks' feedback to declined SME credit applications (adopted in May 2017) √ √ X 5.Map out existing local or national support and advisory capacities across the EU to promote best practices (staff working document adopted in June 2017) X √ X 6.Report on crowdfunding (published in May 2016) √ √ √ Making it easier for companies to enter and raise capital on public markets 7.Regulation to modernise the Prospectus Directive (agreement reached in December 2016) √ √ X 8.Common Consolidated Corporate Tax Base (CCCTB) and debt-equity tax bias (proposal adopted in October 2016) X √ X Institutional investors - Investing for long term, infrastructure and sustainable investment 9.Review of infrastructure calibrations for banks through the CRR proposal (proposal adopted in November 2016) X √ X 10.Solvency II calibrations for insurance companies' investments in infrastructure and European Long Term Investment Funds (proposal adopted in April 2016) X √ X 11.Call for evidence on the cumulative impact of the financial reform (Communication adopted in November 2016) √ √ X Fostering retail investment 12.Following the Green Paper on retail financial services and insurance, the Commission adopted on 23 March 2017 the 'Consumer Financial Services Action Plan: Better products and more choice for EU consumers.' √ √ √ 13.Consultation on the main barriers to the cross-border distribution of investment funds (consultation closed in October 2016) X √ X 14.Assessment of the case for a policy framework to establish a European personal pension product (legislative proposal due by end of June 2017) X √ X Leveraging banking capacity to support the wider economy 15.Credit unions' authorisation outside the EU's capital requirements rules for banks (proposal adopted in November 2016) X √ X 16.Simple, transparent and standardised (STS) securitisations and revision of the capital calibrations for banks (proposal adopted in September 2015) √ √ X 17.Consultation on an EU-wide framework for covered bonds and similar structures for SME loans (consultation closed in January 2016) X √ X Facilitating cross-border investment 18.Report on national barriers to the free movement of capital (adopted in March 2017) X √ √ 19.Business restructuring and second chance framework (proposal adopted in November 2016) X √ √ 20.Assisting ESMA in developing and implementing a strategy on fostering supervisory convergence (Supported ESMA in implementing its first and second annual work programme on supervisory convergence in 2016 and 2017). √ √ √ 1.2CMU mid-term review: focus on supervision and capacity building The CMU action plan is a structural reform programme, which is being implemented and reviewed over a long time span. Since its launch in September 2015, the action plan mostly focused on measures to improve access to markets and products (see Section 1.1.4), via lowering direct costs. Actions, such as the revised Prospectus rules or the regime for standardised and transparent securitisation, aim to reduce fixed costs of access to markets by lowering listing costs. Other actions to fine-tune prudential treatment of transparent and standardised securitised instruments seek to improve product market access. Actions to address availability of information flows (price discovery) or strengthen rule enforcement to ensure legal certainty are less prominent. The review of the CMU action plan broadens the policy agenda by adding actions to promote greater price discovery and enforcement across the EU. Among those actions, a key development is the intent to ensure the well-functioning of the capital markets’ supervisory architecture. This will ultimately benefit market and product access, price discovery and enforcement of EU rules and private contracts altogether. A sound supervisory architecture would then implement and enforce the Single Rulebook across Europe. Finally, the plan foresees actions to support capacity building for local or regional capital markets that have limited scalability, which would have beneficial impact on the three functions mentioned above. 1.2.1Pan-European enforcement and supervisory convergence

Capital markets comprise a wide spectrum of market segments ranging from local financial providers that sell products to retail investors to large and complex wholesale market providers like stock exchanges and CCPs that might hide cross-border financial contagion risk. The supervisory approach for EU capital markets needs to be pragmatic and combine supervisory convergence and direct supervision in the most effective and proportionate manner. The ability to enforce contracts with a common supervisory treatment across the EU is key component of a well-functioning capital market, as it is the case for the US (see Box 1). Supervision of capital markets in a complex multilateral environment, as the EU, has to deal with two types of economic costs: monitoring costs and coordination costs. First, every financial transaction generates monitoring costs. The cross-border dimension of European markets raises this cost even further for national supervisors, who may be discouraged or not allowed to expand their supervisory activity cross-border, while many financial services firms nowadays do operate cross-border. The inability to monitor the counterpart effectively, especially in a dispersed environment like capital markets, requires risk signalling mechanisms that are also delivered by the supervisory infrastructure, such as minimum licensing requirements to enter a market and ongoing monitoring. A well-functioning supervisory mechanism also reduces other monitoring costs by interposing itself between investors and capital seekers in the enforcement of rules and contracts. Enforcement tools include effective and uniform sanctions, redress procedures and proper implementation of EU rules. The credibility of capital market operators is the driving force of capital market integration and a sound supervisory architecture contribute to that too. As a consequence, strengthened pan-European supervision would need to consider areas where to expand the exclusive powers of the pan-European supervisor. Second, supervision in a community of sovereign states may also face significant coordination costs, due to a collective action problem. As a result, some member states may decide to not align themselves, via 'gold plating' EU rules, with others that cooperate via strictly implementing EU legislation. Supervisory convergence could minimise the risk of a ‘race-to-the-bottom’ in enforcing EU rules, as well as forum shopping and regulatory arbitrage by private entities operating cross-border. A more solid supervisory architecture at EU level would therefore ensure the implementation of a Single Rulebook for capital markets in the EU, reducing compliance costs for firms and investors, as well as operational costs for supervisors. The latter implies a greater binding role of the pan-European supervisor in solving conflicts among national authorities and more representation of the EU interests in the decision-making bodies of the key European agencies. Enforcement and supervision in the EU The underlying rationale for setting up the European Supervisory Agencies (ESAs) was to deepen the EU financial Rulebook, ensure closer cooperation and exchange of information among national supervisors and advance the coherent interpretation and application of rules. By contributing to the promulgation of common rules and ensuring supervisory convergence and coordination the ESAs should shape the further development of a single rule book applicable to all EU Member States and thus contribute to the functioning of the Single Market. To this end, the ESAs have been assigned in the founding Regulations and subsequent secondary Union legislation regulatory, supervisory, financial stability and consumer protection roles and powers. The creation of a common supervisory culture, with convergent supervisory practices, is a long term process. The ESAs have so far focussed principally on their regulatory role, as deepening the common rule-book was the upper-most priority in the wake of the crisis. Their supervisory and enforcement role may produce even greater impact in the long-term and needs to be stepped up to achieve more consistent implementation and supervision of new EU rules. Correct and consistent implementation of EU law at national level is essential to enforce a single rulebook, particularly when transposing EU Directives into national law. Significant compliance costs may result from divergent and/or inconsistent transposition of EU Directives into national legislation. When transposing EU Directives, Member States may deviate from the text of the Directives or interpret the rules (including definitions) in different ways. Such divergences undermine the single rulebook and the level playing field and create complexity and additional compliance costs for firms operating cross-border. In addition, in several areas, some Member States go beyond what is required by EU law when implementing legislation at national level. In this context, the ESAs have started conducting peer reviews, but their scope is often very limited and more intrusive powers (such as the 'breach of EU law') have been rarely used. The need to reinforce the EU dimension of supervision and to strengthen the supervisory framework has been stressed in the Commission Communication on Capital Markets Union – Accelerating Reform of September 2016. The Five Presidents' Report has also acknowledged the need to strengthen the supervisory framework to ensure the solidity of all financial actors. Role and functioning of ESMA The European Securities and Markets Authority (ESMA) is the capital market supervisor for Europe’s capital markets. The decisions are taken by the Board of Supervisors (BoS), consisting of national competent authorities (peers). Currently ESMA exercises direct supervisory powers only over trade repositories and credit rating agencies. As capital markets deepen and get more integrated, there is a need to ensure that the capacity to supervise and manage risks, especially cross-border, keeps pace. This gives rise to questions on whether ESMA's current toolbox and powers are sufficient and appropriate to underpin efficient and cost effective supervision also in a deeper CMU. The growing cross-border component increases monitoring and coordination costs that cannot be dealt with at national level. For example, the development of more integrated capital markets could justify the centralisation of supervision in certain areas where risk emerges from this cross-border dimension. Reflections on a stronger role for ESMA could most productively focus on those market segments or functions where the degree of integration creates strong spill over effects or synergies that cannot be effectively overseen by nationally segmented operators. Strengthened powers for ESMA would ensure that market participants with a similar business model, size or risk profile are subject to the same intensity and extent of oversight to ensure a level playing field among market participants and equal protection for domestic and cross-border investors. It would also ensure that potential risks to financial stability that might arise, following the integration of the markets, would be monitored and mitigated in an effective manner across Member States. Moreover, there are general market support services with a 'public good' dimension that have strong economies of scale and are capable of reducing costs for Member States and supervised entities. These services are mainly data collection, management and publication. This centralisation process is applicable to all sorts of data reporting, including transaction reporting, accounting, business registry information. The simplification that centralisation brings about will improve cross-border data accessibility via greater standardisation and streamlined submission procedures. This process would benefit supervised entities, supervisors and investors at large. Box 1.Powers of the U.S. Securities and Exchange Commission (SEC) The U.S. Securities and Exchange Commission (SEC) is responsible for enforcing federal securities laws, proposing securities rules, and regulating the securities industry including stock and options exchanges and the electronic securities markets in the US. The mission of the SEC is to protect investors, maintain fair, orderly, and efficient markets, and to facilitate capital formation. The SEC has several key powers. First, the SEC interprets and enforces federal securities laws. It investigates violations of securities laws and regulations and takes actions when violations have been uncovered. The SEC can bring a civil action, or an administrative proceeding which is heard by an independent administrative law judge. The SEC does not have criminal authority, but may refer matters to state and federal prosecutors. Second, the SEC oversees the disclosure made by public companies, as well as the registration of transactions, such as mergers, made by companies. The SEC requires public companies to disclose meaningful financial and other information to the public, providing a common pool of knowledge for all investors. It maintains an online database called EDGAR (the Electronic Data Gathering, Analysis, and Retrieval system). EDGAR provides investors with access to the information filed with the agency. It is also possible to file complaints and report violators of securities laws via EDGAR. Third, the SEC oversees securities trading and markets. It oversees the inspection of securities firms, clearing infrastructure, brokers, investment advisers and ratings agencies, as well as private regulatory organizations in the securities, accounting and auditing fields. The SEC interprets proposed changes to regulations and monitors operations of the industry. Fourth, the SEC oversees registered investment companies, which include mutual funds, as well as registered investment advisers. The SEC focuses on ensuring that disclosures about mutual funds, ETFs and other such investments are useful to retail customers, and that the regulatory costs which consumers must bear are not excessive. Finally, the SEC can make use of no-action letters to issue guidance in a more formal manner. A company seeks a no-action letter from the staff of the SEC when it plans to enter uncharted legal territory in the securities industry. For example, if a company wants to try a new marketing or financial technique, it can ask the SEC staff to write a letter indicating whether it would or would not recommend that the SEC take action against the company for engaging in its new practice. 1.2.2Building capacity for Europe's regional markets The importance of geographical location proximity in complex financial ecosystems is an unsettled discussion in economic literature. In order to create liquidity, capital markets need volumes and so rely on strong economies of scale. As a result, also due to technological developments in recent years, capital markets tend to consolidate around big clusters of liquidity, which are usually big Member States or regional trading hubs, due to benefits that spill over the entire economy (Pandit et al. 2002). Nonetheless, not all forms of finance need centralisation to develop. Geographical proximity still matters for many of them and for specific categories of users, such as start-ups. For instance, despite its ability to make geographical proximity less important, crowdfunding is not able to overcome all the distance-sensitive costs related to information (Agrawal et al. 2015). It is less clear whether public equity markets for SMEs at national level or more locally are more beneficial than centralised regional hubs in any given area (Klagge & Martin 2005). While trading of listed blue chips becomes increasingly international, cost of equity is higher for firms that come from countries with a weak governance and institutional design (Boubakri et al. 2016). Spatial proximity between financial intermediaries and SMEs facilitates information exchange to lower transaction costs and non-cost barriers for capital provision (Klagge & Martin 2005). Some specialised regional stock markets can also attract the interest of other forms of finance (like private equity), which finds in these markets either an exit or a guide to price SME risk. There is also evidence that firms’ propensity in looking for external finance grows in proximity of venture capital markets (Colombo et al. 2016).

The development of capital markets across the EU should consider the different maturity of capital markets across Member States. For market based finance to be a viable and sustainable alternative to bank lending, the CMU needs to build the financial circuits, market conventions and technical and legal infrastructures that will allow market participants to operate at local, regional or national level while, at the same time, to transact confidently on a pan-European scale. There is a need to broaden the geographical reach of capital markets so that all Member States reap the benefits of deeper and more integrated capital markets. Mobilising the local investor base in regional markets requires more than the presence of a regional market. Some Member States would need to strengthen their capacity also in other areas than access and competitiveness of financial intermediation, such as supervisory capability or other policy areas that help to create an environment conducive to capital mobility in the region, as well as clustering of specific forms of finance (e.g. venture capital, private equity or SME crowdfunding tools). Technical assistance may help these Member States. The Central Eastern and South-Eastern Europe (CESEE) region is an area where some capacity building for the development of a regional hub in specific forms of finance can be achieved. The incidence of bank finance in this area is lower than the rest of the EU (154% of GDP versus 410% of GDP). Banks are mainly foreign-owned and they operate under limited interference by local governments, thus with a more market-oriented behaviour. Non-financial firms’ access to capital markets is lower that the EU average (6% versus 21% for the EU). Issuance of debt securities is considered irrelevant for SMEs in the CESEE region (ECB Safe Survey on Access to Finance). Insurance and pension funds are only partially involved in capital markets activities, often because the national regulatory framework creates additional constraints. Households exhibit strong bias towards cash or deposit instruments, but their participation in equity investments is mixed across countries. 1.3Key indicators Support to public and private investments Indicator Last 5-year average Latest observation Value Ouput gap (actual minus potential GDP, % of GDP) -1.83% 2016 -0.69% Net fixed capital formation (% of GDP) 2.42% 2016 2.63% Net returns on net capital stock (index value rebased in 2010 as equal to 100) 101.6 2016 105.8 A sustainable financial integration process Indicator Last 5-year average Latest observation Value Geographical risk diversification index (outward flows, equity and debt; index value between 0 and 1) 0.5 2015 0.5 Debt portfolio investments intra EU (end of period; EUR trillion) EUR 8.71 trillion 2015 EUR 8.25 trillion Equity portfolio investments intra EU (end of period; EUR trillion) EUR 4.22 trillion 2015 EUR 4.98 trillion Price-based integration in EU (bond markets; index value between 0 and 1) 0.31 2016 0.4 Price-based integration in EU (equity markets; index value between 0 and 1) 0.51 2016 0.46 Quantity-based integration in EU (home bias; index value between 0% and 100%) 82% 2015 80%



2Financing for Innovation, Start-ups and Non-listed Companies Access to a diversified pool of funding options is critical for financial stability and economic growth. Successful entrepreneurs, start-ups, scale-ups and firms need access to different types of financing to fund innovation and their expansion. This chapter reviews the funding channels via capital markets for innovative and growing firms seeking to raise equity or debt outside the banking system, and explores the overall challenges to improve the pre-IPO environment in the EU. 2.1Markets and banks along the funding escalator A company's financing needs evolve with its growth in size and specialisation over time. Its stage of development, growth objectives, innovativeness, operations, and credit profile determine its financing needs. This is generally defined in corporate finance as the 'funding escalator'. In the start-up phase, a company needs mostly cash to develop its business idea. Most founders begin by investing their savings, making use of personal credit facilities, and tapping family and friends for funds (Robb and Robinson (2014)). For founders who have exhausted such ‘personal’ finance, raising outside finance is a considerable challenge. For instance, start-ups generally do not generate steady cash flows to pay interest and—beyond re-mortgaging the founder’s personal assets — they lack other kinds of collateral (Schmalz et al 2013). This makes them unattractive candidates for standard corporate debt financing (e.g. loans) (Berger and Udell 1998; Aghion et al 2004). Source: Commission services. Although retained earnings increase when a company is successful and grows, a firm's external financing stays typically high in the growth stage. Once the firm enters the mature stage, financing structures adjust to the pace of earnings, business growth and collateral at disposal. At a certain point, the company may decide to go public, offering its stock to the general public on a security exchange as a means of equity financing and/or issuing bonds. If a firm cannot or does not want to put all retained earnings to operational use, it may decide to buy back its debt or equity. There are various ways in which funding other than bank lending is provided. Leasing, factoring and various forms of trade and supply chain finance are capable of easing corporate financial problems, but are usually more expensive than bank loans. Loans by non-banks, including crowdfunding and peer-to-business platforms, are other potential sources of finance but are underdeveloped to date, even if they often carry lower borrowing costs than bank loans. Still another source of alternative finance, particularly suited for fast-growing firms, is private equity (especially in the form of venture capital). 2.1.1Interaction between bank and market-based funding

Banks and capital markets are two vital components of the financial system, complementing each other. Bank and market funding offer different mechanisms to overcome information problems, such as adverse selection and moral hazard. Bank-based financial systems enjoy economies of scale and scope in information gathering and processing, ultimately giving the bank an informational advantage in its relationship-based activity. Traditional credit channels, based on bank loans, rely on the heavy cost structure of the credit institution, which can collect much information on the credit risk of a borrower and/or ask for collateral to overcome information barriers because it can internalise the legal costs of such procedures. As a result, banks are in a better position than capital markets to address the inherent agency problems between debtors and creditors in long-term funding relationships (Leland and Pyle (1977) and Diamond (1984)). The relationship-based funding allows a firm to develop a reputation for good creditworthiness and ultimately to access finance at a lower cost (the "certification effect"). This way, banks also gain special knowledge from performing complementary functions on a large scale (e.g. account keeping for borrowers, provision of payment instruments). As a result this funding tool is more suitable for firms that already have a history of cash flows and business operations. Market-based funding fills the funding gap left by traditional credit channels. The availability (or not) of collateral and future cash flows are typically priced-in the overall cost of financing and not necessarily a barrier to access funding. As a result, the strength of capital markets is to provide services to finance novel, longer-duration and high-risk projects. Non-bank finance at early stage of firm development is generally more flexible than bank finance (e.g. as regards repayment schedules or providing finance based on expected future earnings). Therefore, by complementing bank funding, capital markets enlarge the potential investor base. Using US data, Adrian et al. (2013) find evidence that bonds and banks were substitutes during the 2007-09 crisis. For Europe there is evidence that the bond market, to some extent, had filled the funding gap left by the banking sector. Cariboni et al. (2017) find an increase in the access to the bond market by the corporate sector (amount issued, number of issuance, first time issuers, even by riskier and unlisted companies) in the period 2012-2014. Thus a more balanced funding structure between bank and market sources can make the real economy more resilient to shocks hitting the banking sector or the public markets. 2.1.2The SMEs funding jigsaw Firms' financing constraints affect their investment decisions and growth prospects. Empirical evidence suggests that financing constraints affect particularly small, young, or single-unit firms. Their business prospects are more difficult to evaluate for investors, as they are perceived as riskier due to the lack of business diversification and collateral. Indeed, information asymmetries are often more pronounced for small firms in their early stages, namely from Stage 1 (inception) until stage 3 (expansion) in the funding escalator model. According to the 2016 ECB Survey on the Access to Finance of Enterprises (SAFE), market-based sources of finance such as equity and debt securities account only for respectively 12% and 3% of the total funding of a SME. The use of alternative financing sources increases with the size of the firm, even though multiple tools alternative to bank lending exists in the early stage of business development (Table 2.1). In effect, most start-ups fail, so funding a start-up is a risky endeavour. It is not uncommon that the company doesn't have a product yet when it asks for funding. Even if the company had a product, they often need to develop the market for it. To forecast cash flows and therefore putting a valuation on such a firm is not an easy task as production costs and market size have to be estimated. These factors greatly intensify the core problems of any business financing arrangement—namely, uncertainty, information asymmetry, and the risk of opportunism (Gilson (2010)). Micro % Small % Medium % Large % Retained earnings 24 30 38 46 Grants/subsidised loans 12 16 20 22 Banks overdrafts 38 43 40 42 Bank loans 28 39 43 48 Trade credit 26 30 35 38 Other loans 9 12 19 28 Leasing 19 40 50 56 Debt securities 1 1 1 4 Mezzanine 1 2 4 6 Equity 4 6 8 9 Sources: ECB and European Commission Survey on the access to finance of enterprises.

Note: More than one funding source possible. Insufficient financial knowledge is an obstacle restricting SMEs' access to external funding. SMEs tend to lack general familiarity on how to finance their business and how to tap alternative sources of finance, including the relevant information to submit to potential investors or lenders. A 2016 British Business Bank survey shows an increase in awareness of peer-to-peer lending platforms amongst smaller businesses. For equity crowdfunding, the increase in awareness appears to have plateaued after several years of rapid growth. Awareness was higher amongst scale-ups compared to the start-up and stay-ahead groups. However, the gap between awareness of the existence of finance types and awareness of specific providers (i.e. who to contact) is increasing. Although awareness of venture capital has increased to 64% in 2016, the results of the survey suggest that less than one in five smaller businesses can name a specific provider. Only a minority of SMEs (13%) reported using external advice when applying for finance in 2016 and this figure has fallen from previous years (around 19% in 2015). A Call for proposals on improving access by innovative SMEs to alternative forms of finance under Horizon 2020 has been published on the Research Participant Portal of Directorate-General for Research and Innovation's Europa site. A lack of awareness about credit reports and credit history and their importance for funding purposes also restricts the external finance options. Many SMEs are not able to get their own credit history to justify funding. The lack of transparency on banks’ feedback to SMEs about their creditworthiness makes it even harder for SMEs to build their financial knowledge and, most importantly, for investors to gather information on the risk profile of the company. Banks' feedback to borrowers varies in quality in Europe. The lack of verifiable information about SMEs restricts access to multiple market-based funding sources. Investors and lenders need some level of verifiable information about a company and financial statements, as well as a firm's credit history and payment behaviour, are essential to assess the repayment capacity of an SME. Credit information services are also useful to assess the creditworthiness of clients or suppliers. Credit institutions also share only partial data with other market participants (such as business registries, credit bureaus and business information and scoring firms) varying significantly across Member States. The lack of standardised, verifiable and accessible credit information about SMEs represents a significant barrier for alternative finance providers to invest into European SMEs. This funding gap is further widened by the general constraints on access to finance for SMEs in Europe. The 2016 ECB SAFE survey states that SMEs continued to signal improvements in the availability of external sources of finance and that banks show increased willingness to provide credit at lower interest rates facilitating further access to bank financing for SMEs. However, there is still significant divergence across countries regarding the difficulties in accessing external sources of finance. Some 24% of SMEs in Greece, 12% in Ireland and 11% in Italy, Portugal and the Netherlands, respectively, mentioned that access to finance was the most significant problem, compared with 7% of SMEs in Austria, 7% in Slovakia and 6% in Germany. While different productivity levels can justify some of these divergences, the results of the 2016 European Commission's Innobarometer survey also confirm that access to funding is a key obstacle for spurring R&D and the commercialisation of innovative products or services. It is also harder to access finance for firms operating in countries whose regulatory environment is considered risky, burdensome or overly expensive due to extensive bureaucracy. Access may be easier, instead, for firms that are able to resort to foreign capital markets, such as firms that are part of a multinational group. However, unlike large corporations, small companies have very limited access to foreign capital markets. 2.2Characteristics of Europe's funding escalator In the pre-IPO space, the level of information that is required for the fund provider changes with the degree of risk concentration in funding. Business angels, venture capitalists and private equity funds, which rely on risk concentration, often operate with information mainly on the business idea and its development, exercising active control on the governance of the firm. Private placement for mid-caps and crowdfunding, instead, relies much more on the information provided by the entrepreneur and there is limited expertise and possibility for the fund provider to have a strong influence on the governance of the firm. 2.2.1Funding with risk concentration Venture investments are long-term investments in private, unlisted companies with the potential for growth. Investment is concentrated in one or few investors. In return for investment into the company, business angels, venture capital and private equity funds receive equity stakes in the business and partner with management teams to support growth plans and make improvements to the business with the aim of increasing its value. The returns on investment are realised either through a sale (or exit) of the business or through the distribution of the firm's profits. This kind of equity investments are typically made in less mature companies, like seed or start-up companies (especially for business angels and venture capitalists) and scale-up firms (mainly for venture capitalists and private equity funds). These market-based investments are often characterised by a high degree of proximity between the investor and the entrepreneur, as the investors often adopt a very hands-on role in the deals in which they invest, providing entrepreneurs with advice and contacts. Business angel investment 'Business angels' are private individuals that provide financial support and often operational counsel mainly to start-ups, without relying on financial intermediaries. With their know-how, capital and contacts, business angels provide support throughout the growing phase of the company they invest in. Kerr et al (2011) suggest that ventures funded by successful angel groups experience superior outcomes to rejected ventures, by improving survival rates, exits, employment, patenting, Web traffic, and financing. They confirm the positive effects for venture operations, combined with a higher likelihood of successful exits. The main exit strategy for business angels is acquisitions by larger companies. The visible part of the angel investment market is those investments made through an angel network or syndicate (OECD (2016)). Due to the informal nature of the investment and the absence of any official definition of angel investment, the overall size of the market of business angel investments is a difficult estimation. Available figures suggest that the amounts invested by business angels in the EU are small and highly concentrated. The 2015 statistics compendium by the European Trade Association for Business Angels, Seed Funds and Early Stage Market Players (EBAN) show that the visible part of business angels' outstanding investment in the EU amounted to EUR 607 million in 2015 (a growth of 5.0% from 2014). The investors’ community grew to 303 650 investors closing 32 940 deals (EBAN 2016). The United Kingdom is the largest European business angel market with EUR 96 million of investment in 2015. Spain, Germany and France are the following biggest players, while Finland, Denmark and Sweden are continuing to grow at steady rates ( Figure 2.2 ). Business angel activity is increasing in the CESEE (including Baltic) regions, but the markets remains very small.

EU Member States use personal income tax incentives for business angel investments in different ways, partly explaining significant cross-country differences. Most incentives are not applicable to cross-border investments in the EU amplifying fragmentation of local business angel ecosystems and national or European networks. Source: EBAN European Early Stage Market Statistics 2015 Venture capital An important source of finance for start-ups is also venture capital. This category of investors manages the high risk of failure by diversifying their investments across a portfolio of companies, and through careful selection of the firms in which they invest, using specialist expertise to assess the quality of the entrepreneurial team and their proposed product (Gompers and Lerner (1999)). They take – often substantial – control rights and use them to enhance the quality of decision-making and mitigate the potential for opportunism by the entrepreneur (Kaplan and Strömberg (2003)). Venture capital is usually invested through funds, often provided by institutional investors. Venture capital requires geographic proximity for the investor to be able to participate actively in decision-making (Lerner 1995). Consequently, venture capitalists tend to be based in areas where there are large ‘clusters’ of new firms, typically near a source of technological innovation such as a university (Martin et al 2002). Despite positive effects on economic growth, venture capital constitutes a small part of total SME external financing. Venture capital represents a very small percentage of GDP in EU Member States (less than 0.05% of GDP). The amount of venture capital invested was EUR 4.4 billion across 3 134 deals in 2016 (Invest Europe 2017). Companies active in growing business sectors such as life sciences, communications and electronics attract the majority of the available funds (KPMG 2016). The venture capital industry in Israel and the US is more mature, representing in 2015 around 0.38% and 0.33% of GDP respectively. Europe also lacks "unicorns" in the EU, i.e. young private companies with limited performance record that are valued at over EUR 1 billion). The EU has only 17 unicorns in just a handful of Member States (as of July 2016), compared to 90 in the US and 40 in Asia. EU venture capital funds remain fragmented and lack scale (the average size of EU venture capital funds is half the average size of US funds) and geographical reach (around 90% of venture capital investment is concentrated in eight Member States and venture capital investment is virtually non-existent in some Member States). Similar to trends experienced elsewhere in the world, European venture capital investors have become more selective. The evaluation of investment decisions takes longer and due diligence is more extensive. The EU venture capital market needs to stimulate private VC funding as government agencies have been the most important contributor to the EUR 40 billion that the EU venture capital market has raised since 2007 (Invest Europe 2017). Established or growing technology hubs exist across Europe (London, Berlin, Madrid, Paris, Dublin and Stockholm). Europe’s varied technology hubs may be an important advantage when it comes to stability. At the same time, the complexity of this diversity creates challenges for start-ups when they reach a scale that surpasses the initial domestic scale. Different regulatory environments, cultures and languages all add to the complexity. This leads some of the start-ups to abandon the option to grow internationally within Europe and target the US or China first. Source: OECD. Note: 'Total' for those countries that have no breakdown. During the fourth quarter of 2016, the governments of Germany and France took a major step toward growing their innovation ecosystems. The two governments announced the creation of a joint EUR 1 billion fund to assist start-ups in their countries to evolve beyond the seed-stage, which is the most difficult challenge. Source: Invest Europe The maturity level of various tech hubs throughout Europe is rising, with new centres like Scandinavia and France emerging, while established hubs in Germany, the United Kingdom and Ireland continue to evolve. Creating the conditions for these ecosystems to develop and integrate across Europe is an essential pre-condition for capital markets to support innovative firms. Moreover, consolidation among start-ups in Europe is expected, particularly with acquisitions led by corporate investors looking for strategic investments. There are a number of well – capitalized companies in the region, which are actively looking for M&A. FinTech and health-tech are expected to continue to be major investment areas for VC investors in Europe, while emerging areas, such as Artificial Intelligence, machine learning and deep tech, are expected to take on a higher investment priority. Main obstacles to the development of venture capital investments are market fragmentation and constraints on the supply side of the market. European venture capital investors have difficulties with reaching critical size and sufficient diversification in their portfolios. Three quarters of venture capital funds were in 2014 smaller than EUR 82 million and only 20% of funds had raised more than EUR 100 million over the last six years. Moreover, the activity is concentrated in a few Member States, such as the United Kingdom and France. Larger venture capital funds would be able to realise scale economies, specialize and thus possibly attract additional capital commitments for individual companies. However, the high degree of fragmentation along national lines limits the growth of the market and prevents economies of scale from materializing, which implies relatively high transaction costs. Private equity Private equity refers to investments in the equity of a company provided on a private basis, typically by funds that collect funds from multiple entities, including banks, NFCs, institutional investors (e.g. pension funds or asset managers), high net worth individuals (HNWI) and governments. By investing in private equity funds, banks and NFCs typically aim at acquiring an indirect strategic interest in entities that could generate synergies for their businesses. Public authorities, on the other hand, invest in private equity funds as a mean of achieving public policy goals, such as supporting specific sectors of the economy, activities that are ultimately expected to boost productivity, growth and employment. Common investment strategies in private equity investments include: leveraged buyouts, venture capital, growth capital, distressed investments and mezzanine capital.

In 2016, the total amount of equity invested in European companies remained stable at EUR 53.7 billion compared to 2015, representing the second highest level since 2008. The number of companies decreased by 7%, but remained over 5 900, of which 83% are SMEs. Over a third of the total amount invested in European companies came from cross-border investments. Almost 400 funds raised new capital. This decrease by 9% compared to 2015 indicates a trend towards larger funds in 2016. In the last four years, European private-equity funds have raised over EUR 240 billion to invest into companies in Europe, more than twice the amount raised in the four years following the financial crisis (Invest Europe 2017). Half of the total private equity investments in Europe are managed out of the United Kingdom. Most of that cash comes from overseas firms and investors that access the bloc via the United Kingdom. Moreover, the sector is heavily reliant on access to talent from across the EU and to the single market. France and Sweden follow in importance. As regards the type of private equity investors, over one third of private equity funds raised in 2016 came from institutional investors, in particular pension funds (34%), investment funds (18%) and insurance companies (12%). Private equity investment is considered particularly attractive by some insurance corporations and pension funds as the long-term nature of their liabilities allows them to invest in long-term and less liquid assets, with the objective of generating a higher return. Private equity investment by public authorities reached 10% of the total. Regulatory or self-imposed constraints on asset allocation of investors into private equity funds, such as banks, insurance or pension funds may create barriers to investments in this type of funding, which is a key element for the scaling-up of innovative firms. 2.2.2Funding with risk dispersion Funding in the pre-IPO space can also take the form of a dispersed funding tool, with different barriers hampering its cross-border developments. These barriers are mainly informational ones for proper price discovery or transactional costs, in the form of compliance or other listing-type costs. Box 2.Supply Chain Finance (SCF): the role of market-based solutions On-time payment is essentially what corporations would like, even if prompt payment cannot always be managed. Supply Chain Finance management solutions allow companies to optimize their working capital effectively. SCF is not a static concept but is an evolving set of practices using or combining a variety of techniques. In 2015, the Receivables Finance industry in the EU provided over EUR 168 billion of working capital financing to over 171,000 businesses, about 85% of which are SMEs. Revenues generated by reverse factoring solutions are expected to grow at an annual rate of 20%, approximately. Payables finance or reverse factoring could offer access to an untapped market worth USD 800 billion in unrealized profits as of today. This figure only takes into account the solutions offered to purchasing companies rated as investment grade (McKinsey 2015). Efficient supply chain is an important part of any business establishment that can have a significant impact on operations and the very survival of the venture. Faced with increasing pressure to meet short-term liquidity needs, companies are looking for easy and convenient ways to manage their working capital and supply chain. As a result, the need for innovative financial supply chain management solutions has been increasing. And that is where financial technology companies have recently been triggering a transformation towards greater efficiency and seamless solutions. A growing number of Fintech start-ups are enabling SMEs to access payment services that were previously the domain of large corporates. Supply chain finance enables buyers to ease payment terms while also ensuring the cash flow of their suppliers is improved, thereby reducing instability within the supply chain. The enabling of transparency across the supply chain means that suppliers always know precisely when they will be paid and can plan their finances accordingly. Predictability is often more important than speed when it comes to payments. Crowdfunding Crowdfunding refers to raising capital through large numbers of small contributions for a specific project. Crowdfunding platforms are websites that enable interaction between fundraisers and the crowd. The crowdfunding sector in Europe has continued to grow over the last years. Based on one of the largest datasets currently available, with figures from 367 European platforms which are stated to represent 90% of the visible market, the European alternative finance market grew by 92% to reach the value of EUR 5.43 billion in the year 2015 (University of Cambridge Centre for Alternative Finance 2016). In 2015 the United Kingdom remained market leader in terms of size with a total market volume of EUR 4.41 billion, followed by France (EUR 319 million), Germany (EUR 249 million), the Netherlands (EUR 111 million), Finland (EUR 64 million), Spain (EUR 50 million), Belgium (EUR 37 million) and Italy (EUR 32 million). When looking at market volume per capita, the United Kingdom was first with EUR 65.88, followed by Estonia (EUR 24.02) and Finland (EUR 11.65). In terms of crowdfunding type, peer-to-peer consumer lending and peer-to-peer business lending accounted for the largest activity in 2015, with approximately one third (EUR 366 million) and one fifth (EUR 212 million) of total market activity respectively. Equity-based models, such as equity-based crowdfunding and real estate crowdfunding across Europe account for around a fifth, while non-financial return based models accounted for another 16% in 2015. Source: European alternative finance report 2016 Equity-based crowdfunding is particularly significant for funding business start-ups. The average deal size in equity-based crowdfunding is now approximately EUR 459 000, in contrast to just over EUR 190 000 for debt-based securities, just under EUR 100 000 for peer-to-peer business loans and just under EUR 10 000 for peer-to-peer consumer loans. A third form of crowdfunding used for business is ‘loan’ crowdfunding (also known as ‘crowdlending’ or ‘marketplace lending’). As the name suggests, this involves (retail) funders advancing credit to businesses, usually with the aid of credit scores produced by the platform. It too has grown very rapidly as a form of small business finance. As mentioned above, debt financing is unsuitable for firms without fixed assets, which is borne out by the fact that loan crowdfunding tends to be sought by established small businesses, as opposed to start-ups (Mach et al 2014). Asset class shares within P2P have remained very consistent. For the last 2 years SME lending has represented around 45% of the volume while consumer and invoice lending have 38% and 12% respectively. Furthermore, there is a rising institutionalisation of crowdfunding – 26% of peer-to-peer consumer lending, 24% of peer-to-peer business lending and 8% of equity investment. This is combined with a high degree of automation in lending (selection or bidding processes) – 82% of consumer loans, 78% of traded invoices and 38% of business loans. Invoice trading is gaining momentum – growing from EUR 7 million in 2014 to EUR 81 million in 2015. Finally, the formation of new platforms has peaked and a phase of consolidation has started. Source: European alternative finance report 2016 Due to the lack of a precise definition of crowdfunding and the absence of applicable EU legislation, localised platforms that want to operate cross-border have to comply with several – and often divergent - national rules. Market activity in the crowdfunding sector remains mostly domestic. Almost half of platforms indicated that not even a part of the funds they helped raise were supplied by foreign investors. A third of platforms indicated that they had raised less than 10% from foreign investors. Different consumer or investor protection rules, among other factors, seem to lead many platforms to refuse to provide their services to non-residents and make extension to new markets possible only through new establishments. With regards to foreign outflows, 76% of platforms reported that 0% of the funds raised went to projects outside the national border. Private placement A private placement is generally understood as a medium or a long-term financing transaction of debt securities (in a loan or a bond format) between a listed or unlisted company and a small number of institutional investors, without a public offer. Investors involved in private placements are usually banks, mutual funds, insurance companies and pension funds. Private placement markets broaden the availability of finance for unlisted medium-sized companies. A key benefit of taking the private placement route for mid-sized companies is the diversification of their funding away from bank lending. In the current low rate environment, the development of private placements is also beneficial for institutional investors as it allows for higher yields, asset risk diversification and long-term asset matching.

With more than EUR 26 billion at the end of 2016, the German Schuldschein is by far the largest private placement market in Europe (Scope Ratings 2017). More than 80% of Schuldschein loans are bought by banks, particularly German savings and cooperative banks. Schuldschein have also created a growing interest among international investors since they represent a third of the total number of investors. The demand for issuing by foreign firms reached 45% in 2015 in the German Schuldschein market (Scope Ratings 2017). The European private placement markets beyond Germany are smaller, but growing, with EUR 8.4 billion raised and 103 deals in 2015, compared to 4.7 billion and 85 deals in 2014 (Dealogic 2016). Outside Germany, the French Euro-PP market remains the private placement largest market with EUR 4.8 billion in 2015. Insurance companies are the largest investors in French Euro-PPs. Source: Dealogic The credit quality of issuers accessing the French Euro-PP market is wider than in the German market as it is open to non-investment grade credit quality as well. HSBC estimate that around 40% of the issuers have an implied BBB- (investment grade) rating, 15% of them have a better rating, and around 28% are an implied BB+/BB grade. Despite its recent success, the development of private placement markets is very uneven and the PP market was sluggish in 2016. Although private placement activity is now well-established in France (Euro-PP) and Germany (Schuldschein) and is taking off in few other Member States; it remains largely underdeveloped in many EU jurisdictions. Due to a lack of a mature private placement market in the EU, companies in the EU have historically been actively tapping the US private placement. In 2015, Europe-based groups raised EUR 8.1 billion of private placement funding in the US, representing 20% of the EUR 40 billion total paper issued in the US in 2014. 2.3General policy implications Successful entrepreneurs, start-ups, scale-ups and other small and medium-sized firms need access to different types of financing to fund innovation and their expansion. The work focuses in particular on strengthening market-based finance in a number of key areas, notably the following: 1. Venture capital: EU venture capital markets remain fragmented, lacking scale and geographical reach. Good progress has been made on the implementation of the venture capital package that the Commission brought forward in the CMU Action Plan. It is expected that the European VC Funds-of-Funds will be able to commence capital raising and investing in Q3 2017. It will have firepower of around EUR 1.6 billion, with cornerstone investments of up to EUR 400 million from public finances. Agreement on the European Venture Capital Funds (EuVECA) proposal could pave the way to extend the range of managers eligible to market and manage these funds, increase the range of companies that can be invested in by EuVECA funds, and make the registration and cross-border marketing of these funds easier and cheaper. The comprehensive study is being published on tax incentives for venture capital and business angel investments offered by the Member States. It identifies good practices for the design and implementation of key features (e.g. targeting) of such tax incentives which could help improve their effectiveness and foster the development of local capital markets 2. Markets for the private placement of corporate debt have made big strides in recent years, but their development is very uneven in Europe. Building on the experience of well-functioning national regimes (such as Schuldscheine in Germany and the Euro-PP market in France), the dissemination of best practices could enhance the take-up of private placement across a wider selection of EU Member States which are big enough to host a local private debt market. Moreover, insurance undertakings could be incentivised to invest to a greater extent into markets for privately placed corporate debt and for private equity through a reduction of the prudential treatment of these instruments in Solvency II. 3. Supply chain finance: Many entrepreneurs, start-ups and small businesses fail due to cash flow problems although having a viable business model. Market practices on supply chain finance to help companies overcome temporary cash flow problems, such as factoring and invoice trading, are already well established and should be further boosted by the increasing up-take of electronic invoicing (notably in light of the implementation of Directive 2014/55/EU on electronic invoicing in public procurement). FinTech firms are opening up new supply-chain financing opportunities for SMEs that were previously unavailable. Banks are also partnering up with FinTech firms to improve the existing models. The identification of best practices would provide support for the development of supply chain finance. 4. Better connecting SMEs with alternative finance possibilities: Member States have taken local initiatives or support initiatives to better connect SMEs with alternative finance providers and disseminate SME information to support creditworthiness assessment, in particular by harnessing the potential of FinTech solutions. In April 2017, the Commission services also published a Call for Proposal under the Horizon 2020 programme to improve access to alternative forms of finance by innovative SMEs. The aim would be to allow funding capacity building projects to address information barriers for SME funding and increase the range of financing opportunities by drawing on these successful local initiatives. 2.4Key indicators

EU SMEs' funding structure Indicator Last 5-year average Latest observation Value Issuance of equity by euro-area SMEs over the last six months, % of total SMEs surveyed (SAFE survey) 4.3% Jun 2015 1.4% Funding with risk concentration Indicator Last 5-year average Latest observation Value Angel investments outstanding investment (visible part), EUR million EUR 580 million 2015 EUR 607 million Venture capital, investment, EUR billion EUR 3.8 billion 2016 EUR 4.4 billion Private equity, investment, EUR billion EUR 46.9 billion 2016 EUR 53.7 billion Funding with risk dispersion Indicator Last 5-year average Latest observation Value Alternative Finance (Crowdfunding) Volume by Model in Europe, EUR billion NA 2014 EUR 1.2 billion European Private Placement Volume (EURO PP plus Schuldschein), EUR billion EUR 19.7 billion 2015 EUR 27.8 billion 3Making it Easier for Companies to Enter and Raise Capital on Public Markets Raising capital on public markets broadens the financing alternatives available to firms. Access to public markets benefits firms by diversifying their investment base and by facilitating subsequent access to financing and M&A activities. For SMEs, ready access to equity markets also offers an 'exit strategy' for investors who invested in the earlier stages of the firm's life cycle. Given that SMEs might face additional structural barriers compared to large firms, they are discussed separately. Investors benefit from public markets also thanks to additional diversification opportunities and increased transparency. In effect, mandatory disclosure of listed firms mitigate information asymmetries, reducing investors' search costs and allowing them to take better informed investment decisions. In a broader perspective, it stimulates the use of market-based financing which, in turn, supports economic growth (Cornède et al. 2015). 3.1Access to public markets: long-term trends EU capital markets, relative to the size of the economy, remain underdeveloped and fragmented compared to other developed countries like the US or Japan. For instance, stock market capitalisation to GDP in Europe was about one third of the ratio for the US in 2015. Significant differences in the depth of equity and bond markets also exists within Europe, with Member States that joined more recently often having less developed markets. 3.1.1Financial structure of EU firms EU firms are typically known for their overreliance on bank lending, especially for SMEs. In the period from 2002-2008, banking lending accounted for 70% of total financing in the euro area, compared to only 40% in the US (See Figure 3.1 ). Source: ECB, Federal Reserve System. Furthermore, loans grew in the run up to the crisis at the expense of market-based financing. The financial crisis revealed the rigidity of this undiversified funding model, as the capacity of banks to lend, especially to high-risk sectors and SMEs, became seriously impaired due to deteriorations in the quality of banks’ balance sheet assets and capital constraints. Corroborating this finding, Campolongo et al (2016) show that the role of cash is more important during the banking and sovereign debt crises. Following the financial crisis, the dependence on bank financing in the euro area has decreased, accounting for 50% of total financing in the period from 2002-2016. This statistics is mainly driven by big corporates' access to non-banking funding, such as corporate bonds. Source: ECB and Eurostat. Note: Consolidated data.

Dependency on traditional credit (bank loans and other loans) has remained stable over the past 10 years at around 30% (see Figure 3.2 and Figure 3.3 ). Bank loans are particularly important in countries like Greece and Cyprus, while they have a low importance for firms in Belgium, Luxembourg and Ireland. Although evidence on equity is mixed across euro-area Member States, there are only a handful of countries where companies rely on listed shares on a solid basis. Other equity & unlisted shares, which is not public market-based funding appears to be the dominant source of equity and overall funding. Listed shares represent 20.9% of overall funding of NFC in the EU in 2015. NFCs' outstanding debt securities in the EU have also increased in recent years, but are rather small compared to total NFC funding. Source: ECB and Eurostat. Note: Consolidated data. Focus on SMEs A firm's financial structure and its financing mix are dependent on a firm's size. For SMEs, bank-related products are perceived to be the most relevant financing source for SMEs, while the use of market-based financing is marginal at best (see Table 2.1 ). Based on the 2016 ECB SAFE survey, market-based sources of finance such as equity (12%) and debt securities (3%) are relatively less important for SMEs. In most countries included in the 2016 survey (except Greece and France), SMEs indicate that they have sufficient access to external funds compared to their needs for external financing (external funding gap), marking a significant improvement compared to 2013-levels were the financial gap for countries was still predominantly negative. Nevertheless, SMEs are very heterogeneous: some low-growth, very young or SMEs with strong family ties might not have the need to attract external funding, while other SMEs might have a strong need for external funding but might still be faced with a negative funding gap. SMEs in Europe are indeed very diverse in their financing mix and the extent to which they experience access to finance problems (Masiak et al. 2017). Debt-financed and internally-financed SMEs report comparatively the most problems with access-to-finance with respectively 23.4% and 27.6% of all SMEs that report high occurrence of access-to-finance problems belonging to these two groups. At the same time, about 50% of the SMEs that report low access-to-finance problems are internally-financed SMEs, illustrating that there is also a large group of internally-financed SMEs that do not experience supply-side restrictions and consciously choose not to finance externally. 3.1.2Developments in public equity and debt markets The relative size of European public equity and debt markets is low and shows significant dispersion across Member States. The value of corporate bond and stock markets as % of GDP equals 12% and 56% for the EU (10% and 51% for EU27, respectively), compared to 31% and 112% for the US. United Kingdom figures hold the middle between US and EU27 figures with corporate bond and equity markets equal to 18% and 78% of GDP (Wright & Bax 2016). Capital market development also varies considerably across European countries. Countries that joined the EU more recently often have lower ratios than the EU27 average. As a general indicator of access to public markets, 3,796 prospectuses were approved in the EEA in 2015, coming from 3 931 in 2014. Equity Issuance IPO activity in Europe has been moderate and rather volatile over time (see Figure 3.4 ). The number of IPOs decreased dramatically during the financial crisis. The activity, measured by volume, rebounded strongly after the crisis but has lost momentum since. In 2016, European IPO activity declined significantly with a drop of 27% in the number of IPOs compared to 2015. This represents a 51% decrease in value to EUR 27.9 billion ( Figure 3.4 ). The number of IPOs is also much lower than before the crisis. Taken together, the figures suggest that the deal size per IPO has increased. The breakdown of IPO activity based on the market capitalisation of the issuing firms clearly illustrates that large firms account for the majority of the total deal value (see Fi gure 3.5 ; see note for definition of cap segments). In 2016, they account for 66% of total deal value compared to 24% and 6% for mid- cap and small-cap firms. In addition, the number of IPOs is also much more volatile for smaller firms compared to large firms, illustrating that the IPO market for smaller firms is less stable and more vulnerable to shocks. Source: Dealogic The average value per IPO has increased from EUR 113 million in 2006 and even EUR 75 million in 2009 to EUR 144 million in 2016. IPO activity in Europe is also strongly concentrated: the United Kingdom plays a prominent role with 28% of the total EU28 market measured by IPO value in 2014-2016, representing approximately one fifth of all IPO deals (See Figure 3.6 , box). The EU market is also concentrated measured by IPO to GDP (see Figure 3.6 ) or measured by IPO concentration per stock exchange. The London Stock Exchange account for 24% of IPOs measured by value, while CR-3 (London, Frankfurt, Madrid and CR-5 (CR-3 plus Amsterdam and Milan) account for 44% and 57%, respectively. Figure 3.5 Breakdown of IPO activity according to firm market capitalisation, % of total value Source: Dealogic. Note: Break-down is based on market capitalisation. Following the World Federation of Exchanges, large market cap segment comprises companies with a market cap > USD 1.3 billion; mid-market cap segment comprises companies between USD 1.3 billion > market cap > USD 200 million; the small market cap segment comprises companies of between USD 200 million > market cap > USD 65 million; the micro market cap segment consists of companies with a market cap < USD 65 million. Looking at long-term trends worldwide, IPO activity (for firms in general and growth firms) has decreased in advanced economies. Over the period 1995-2014, IPO activity in advanced economies decreased significantly with the number of IPOs and amount raised in 2014 shrinking by 63% and 57%, respectively compared to the average in the period 1995-2000 (OECD 2015a). The opposite trend is noticeable for emerging markets spurred by IPO activities of Chinese companies, accounting for 62% of all capital raised on emerging markets since 2008. Sources: Dealogic, AMECO Corporate Bond Issuance

Corporate bond issues increased and have mitigated the effect of bank lending constraints at least for large firms. Compared to 2006, the number of corporate bond issuances in Europe has nearly doubled in 2016 to 788, representing a volume of EUR 240 billion in 2016 ( Figure 3.8 ). This trend mirrors the evolution witnessed in advanced economies were non-financial corporate bond amounts nearly doubled from 2000 to 2014. The strong increase in issuing activity following the 2008 financial crisis suggests that in this period debt securities had some degree of substitution effect for shrinking bank lending (see Figure 3.8 ). This finding is confirmed by world-wide data that demonstrate that the number of first time bond issuers increased significantly in the 2008-2010 period (OECD 2015a). In addition, the risk profile of bonds changed, with riskier bonds being issued after the 2008 financial crisis. The relative importance of the high-yield bond issuance fell dramatically during the crisis, representing only 3% of the total issuances (21% in 2006). High-yield bond issuances grew very rapidly in the post-crisis period, peaking at EUR 57 billion in 2014 (representing 26% of total issuances), to decrease to EUR 41 billion in 2016. Source: Dealogic Contrary to large firms, SMEs reacted to the shrinking availability of bank financing by relying increasingly on internally generated funds and alternative financing like trade credit (Masiak et al. 2017, Casey & O’Toole 2014, Ferrando & Mulier 2015). Source: Dealogic 3.2Drivers of going public 3.2.1Equity The decision to issue equity to the public is determined by general economic conditions, the institutional framework and firm-specific factors. In considering an IPO, a firm has to evaluate the advantages of an IPO with costs associated with the IPO process and the costs of being listed. IPOs occur in waves. This might occur (i) if managers try to time the IPO to profit from relative overvaluation, (ii) because they are tempted by previous successful IPOs, or (iii) because they may want to go public when they face low adverse selection costs which would lead to clustering of IPOs over the business cycle. Although many studies conclude that firms appear to time their IPO to profit from (relative) overvaluation, Ditmar and Ditmar (2008) challenge this conclusion: they conclude that IPOs waves are related to the fact that equity issues occur more frequently in the early stages of the business cycle when cash flow is likely to be too low compared to the many interesting investment opportunities. As a result, broad regulatory initiatives that are put in place to support economic growth will positively affect the probability that firms will go public. Various firm-specific motives could support a firm's intention to conduct an IPO. Firm could offer public equity to reduce their cost of capital and optimize their financing mix. Going public also allows a firm to diversify its financing structure and ownership which results in more external monitoring and enhances corporate governance due to increased market scrutiny, although - as suggested by the pecking order theory (Myers & Majluf 1984, Myers 1984) - firms that face high asymmetric information costs might prefer to exhaust internal financing first. Firms might also attempt to obtain an optimal debt ratio, which according to the static trade-off theory is reached when the corporate tax advantage of debt is balanced against the (discounted) value of the costs of financial distress (see also Modigliani & Miller 1958, 1963). This theory indicates that equity financing suffer from a tax disadvantage – given the widely applied interest deductibility of debt financing – and that policy actions to reduce this unequal tax treatment between debt and equity finance could influence a firm's reliance on equity. Additionally, a firm's capital structure will also be affected by IPOs if it increases a firm's financial flexibility and bargaining power with banks. This will reduce the cost of credit, lower the overall cost of capital and allow firms to diversify its funding. Going public also allows insiders to cash out, which might be particular relevant for venture capitalists for which the IPO provides an elegant opportunity to exit. Going public might also be initiated with a view to future M&A activities. Companies could become a takeover target or shareholders may want to establish a market price when they intend to cash out or sell the company. Alternatively, the firm may want to acquire other companies in the post-IPO period. Finally, an IPO may be undertaken to increase reputation, credibility, and investors' recognition. Empirical evidence suggests that the motives depend on firm characteristics such as age, size, etc. In a survey of Chief Financial Officers (CFOs) from 12 European countries, CFOs view enhanced visibility, financial flexibility and funding for growth are important universal factors (Bancel & Mittoo 2009). Other studies conclude that going public to facilitate subsequent acquisitions is a key driver (Celikyurt et al. 2010, Brau & Fawcett 2006). Newly listed firms are very active acquirers. Although this partly reflects the fact that they are often active in industries with intense M&A-activities, they are more active than firms already listed in these industries. Moreover, newly listed firms are predominantly acquiring firms (instead of being take-over targets). IPO activity also affects subsequent market activities and funding practices. A firm's M&A appetite is supported not only by the initial capital injection but also by subsequent access to capital markets. Hence, well-functioning and liquid capital markets are important in order to ensure the further development and growth of firms (Helwege, Pirinsky, & Stulz 2007). M&A activities by IPO firms are supported by the fact that the IPO largely resolves the uncertainty regarding the value of the firm (Zingales 1995). This uncertainty resolution, together with improved public information after the listing, also positively affects the firms bargaining power when securing additional financial means. Empirical evidence shows that in the post-IPO period firms reduce the cost of bank credit and increase their debt capacity (Pagano et al. 1998, Celikyurt et al. 2010). This evidence suggests that mandatory information and disclosure requirements of firms positively affect a firm's visibility and access to f