COMMISSION OF THE EUROPEAN COMMUNITIES 
Brussels, 05.05.1997 
COM(97) 187 final 
COMMUNICATION FROM THE COMMISSION 
European capital markets for Small and Medium-sized Enterprises: 
prospects and potential obstacles to progress 

CONTENTS 
I. INTRODUCTION 
II. FURTHER PROGRESS IN THE DEVELOPMENT OF SME CAPITAL 
MARKETS IN THE EUROPEAN UNION, AND THEIR PROSPECTS 
III. POTENTIAL OBSTACLES TO THE LISTING OF SMEs ON STOCK 
EXCHANGES 
IV. POTENTIAL BARRIERS TO THE CROSS-BORDER TRADING OF 
SHARES ON EUROPEAN SME CAPITAL MARKETS 
IV.i. Currency-related problems 
IV.ii. The regulation of securities trading at the EU level 
IV.iii. Differences in national laws and practices 
IV.iv. Institutional investment 
V. CONCLUSIONS 
A 
I. INTRODUCTION 
One of the financial problems faced by many fast-growing European Small and Medium-
sized Enterprises (SMEs) is the difficulty in raising on European capital markets the 
external equity capital they need for expansion. The European Commission has already 
taken up the issue of access for European SMEs to capital markets: its progress to date 
was summarised in a Communication of 25th October 19951, which noted that the 
absence of provision of SME capital markets in Europe has led an increasing number of 
European companies to seek flotation on US stock markets, especially the NASDAQ 
market2, and has also restricted the opportunities for European venture capitalists to exit 
from their investments. New SME capital markets are to be encouraged not only because 
of the directly beneficial effect they could have in allowing firms to access long-term 
finance, but also for the positive role they could play in stimulating the European venture 
capital industry, and financial services in Europe. 
The 1995 Communication also summarised the role played by the Commission in the 
financing of a feasibility study by the European Venture Capital Association (EVCA) into 
the possible creation of a European capital market for growing SMEs, and in the creation 
of the European Association of Securities Dealers, which arose out of that study. The 
positive conclusion of the EVCA study influenced, directly or indirectly, the creation so 
far of two private sector financed projects for the creation of a European capital market 
for growing internationally-oriented SMEs. These two initiatives, described in that 
Communication, are the EASDAQ market (European Association of Securities Dealers 
Automated Quotation), and the Nouveau Marché/Euro-NM initiative. 
These encouraging and promising initiatives were made possible by the liberalisation 
brought about by Community legislation, in particular the Investment Services Directive3, 
which allows securities traders to deal anywhere in the Union on the basis of a "passport" 
provided by the regulator in their home Member State, and opens up regulated EU 
securities markets to "remote membership" for traders located in other Member States. 
However, the Communication noted that while the existing body of European law, once 
fully in force, should allow the creation of these markets, a number of possible obstacles 
had been identified which might hamper the efficiency of their operations. 
The Industry Council of 6th and 7th November 1995 asked the Commission "to go deeper 
into the conclusions of its Communication and report on ways to overcome the various 
obstacles currently existing in the Member States, including obstacles inhibiting the 
channelling of funds of institutional and private investors, in order to support the creation 
of secondary European capital markets for SMEs, taking into account the national 
systems and experiences already under way." The European Parliament, in a resolution of 
4 July 19964, welcomed the Commission's Communication, and the initiatives it described, 
but noted that for the new markets to be successful, a number of issues, including 
liquidity, regulation, and possible protectionism, needed to be addressed. 
1 COM (95) 498 final, entitled "reporting on the feasibility of the creation of a European Capital Market 
for smaller entrcpreneurially managed growing companies". 
2 See also the Commission's Green Paper on Innovation, COM(95) 688 final. 
3 93/22/EEC, of 10.5.1993. 
4 A4-0168/96 
1 « 
This further Communication therefore sets out to respond to those requests by defining 
better the potential obstacles to the efficient operation of these new capital markets for 
growing SMEs. First of all, however, it describes recent developments in the creation of 
SME capital markets in Europe, and discusses their perspectives; it then outlines the many 
barriers of attitude and capability regarding stock market flotation which can hinder SMEs 
from seeking a flotation; finally, it deals with more specific barriers to cross-border trading 
in equities in general, and on SME capital markets in particular, for example, in the 
regulatory and legal fields. 
II. FURTHER PROGRESS IN THE DEVELOPMENT OF SME CAPITAL 
MARKETS IN THE EUROPEAN UNION, AND THEIR PROSPECTS 
Since the publication of the previous Communication, the two European initiatives already 
referred to, Euro-NM and EASDAQ, have continued to make progress, as have plans for 
national SME equity markets. 
These markets are for SMEs which need capital in order to grow, either in greater 
amounts or at a lower cost than banks will provide, because of the risk associated with 
smaller growing companies. Where successful, these SMEs, often based on new 
technologies, can attain very high growth rates - well over 10% per year - and some of 
them may well become the champions of tomorrow, although others will fail. It is thus in 
the nature of things that many SMEs listed on such markets will become large companies 
at some point, while not necessarily giving up their listing. An SME stock exchange is 
therefore not necessarily one which only lists SMEs; it is one which, compared with other 
exchanges, normally concentrates its Initial Public Offerings on firms at an earlier stage of 
their development. 
The French Nouveau Marché began trading on March 20 1996, and by the end of 1996 
eighteen companies were listed (including two non-French ones), with a total market 
capitalisation of over 220 million ecu. The Nouveau Marché intends to become an 
Europe-wide equities market, and to this end has linked up with other recently-established 
nationally-based SME stock markets, the Nouveau Marché of the Brussels Bourse, and 
the Neuer Markt of Deutsche Bôrse AG., together with the Amsterdam Stock Exchange's 
Nieuwe Markt, to form a network of markets called "Euro-NM". Euro-NM is a European 
Economic Interest Group, which aims to promote synergies by harmonising rules and 
regulations, integrating commercial and technical activity, and carrying out common 
marketing. 
The EASDAQ market is a private initiative, independent of any existing stock exchanges: 
over ninety financial institutions from twelve countries (including most Member States) 
are participating in the project as shareholders. The market opened on September 30 
1996; the first Initial Public Offering took place on November 27 1996, and several more 
have been made since. EASDAQ's target is 20-30 such flotations in its first year of 
operations, and a total of several hundred companies listed after five years. 
However, it is not only at the European level that plans are being made for SME capital 
markets. Within the Member States, a number of nationally-based markets are either in 
operation or in the planning stage. The "Neuer Markt" of Deutsche Bôrse A.G., the 
Belgian Nouveau Marché, and the Amsterdam Stock Exchange's Nieuwe Markt, which 
are all participating in the Euro-NM network, have already been mentioned. In the UK, 
the London Stock Exchange's Alternative Investment Market has been operational since 
mid-1995 and has over 160 companies quoted, with a market capitalisation of over ECU 
3.5 billion. The Vienna stock exchange recently announced a special programme, entitled 
FIT, to allow SMEs easier access to a listing; FIT is due to start in mid-1997. In Italy, 
there are plans to create a new market called METIM (Mercato Telematico delle Imprese 
Medié); it will have a national and local orientation, and will be focused on family 
companies as much as technological ones. In Ireland too there are plans for a new SME 
stock exchange. 
The Commission strongly welcomes all of these initiatives. As only a relatively small 
proportion of SMEs considering a stock exchange flotation will be sufficiently 
international to warrant a listing on a Europe-wide exchange, these national SME capital 
markets will play an essential role in providing SMEs with improved access to equity 
finance. SMEs which have reached a stage in their development where a stock market 
listing is appropriate need to have a choice of stock markets - national or international -
according to their specific needs. The new competitive climate in European investment 
services will oblige markets to focus more closely on services to their clients, and one 
welcome consequence of this is the development of capital markets providing a better 
range of services to SMEs than was hitherto the case. 
The perspectives for these various markets depend on a number of factors, including the 
extent to which the potential obstacles described later in this Communication are 
overcome. The development of a greater "equity culture" in Europe will also be 
important, in particular where high-risk high-potential-return investments, such as SME 
equities, are concerned. Evidence from the United States shows that equities of growing 
SMEs outperform the national stock market indices, and in Europe, equities in general 
have consistently produced better returns than bonds. Yet despite the evidence European 
investors, unlike US investors, tend to favour bonds over equities, and blue-chip equities 
over SME equities, in order to reduce the perceived risk. Some welcome exceptions do 
exist however: in Sweden 35% of private financial assets is invested in shares, compared 
with 17.5% in the UK, 10% in France and 5.5% in Germany; in the USA the figure is 
21%5. 
The new SME capital markets also have the opportunity to learn the lessons from the 
second-tier capital markets of the late 1980s. One of the most important of these is that 
sufficient liquidity is an essential prerequisite for success. Low trading volumes can 
produce high volatility in share prices, and deter investors from fear of being caught in the 
"mouse trap" of being unable to sell their shares because of low demand. Ensuring 
sufficient liquidity will therefore be one of the main challenges faced by the new SME 
capital markets; this can only be achieved with a high level of regulation and transparency. 
The advanced information technology used will also be a key factor for success: a 
combined information, trading, clearance and settlement system providing a quick efficient 
and "seamless" service is much valued by investors, and the new SME capital markets 
have all put a great deal of effort into their computer systems. Choice of trading system 
Source: German Federal Ministry for the Economy. 
(quote-driven, order-driven or auction, for example) is also important, as different systems 
are more suitable depending on the size and urgency of a transaction. 
Nevertheless, the experience of NASDAQ in the United States shows that it can take a 
number of years for a new market to become highly successful. The new SME capital 
markets, European or national, are private for-profit ventures, and much will depend on 
their commercial decisions and skills, and their cost. For in the single market for 
investment services, stock exchanges must compete with each other on the basis of the 
service offered to the customers, firms and investors. Investor protection and full 
disclosure of information will also be important in establishing confidence in the new 
markets. Nonetheless, it is believed that these markets have a good chance of success, as 
they fill a gap that was previously unsatisfied in the provision of finance to SMEs and 
opportunities to investors. 
III. POTENTIAL OBSTACLES TO THE LISTING OF SMEs ON STOCK 
EXCHANGES 
Despite the great potential for growth of the new European SME capital markets, with 
the likely beneficial effect on the financing prospects of European SMEs, some problems 
do remain, which could slow down progress or reduce its effect. Many of these potential 
difficulties lie in the attitudes of SMEs towards their financing, their expertise in financial 
management, and the burdens which a stock exchange listing would place on them. 
These problems can be broken down essentially into five questions: 
i) Does a sufficient number of SMEs exist in Europe which are suitable and ripe for a 
stock market flotation, and if so, how can they be identified? 
ii) Are owners of SMEs which are ready for a flotation willing to accept the possible 
diminution of control which a public share issue is often taken to imply? 
iii) Do SMEs have the willingness and the financial skills necessary to meet the high 
financial information and transparency requirements of a stock market quotation? 
iv) Do SMEs have access to the necessary specialist advice and support necessary to 
prepare an Initial Public Offering of shares (an IPO)? 
v) Are SMEs willing and able to bear the high cost of the process of a stock exchange 
listing, in terms both of an IPO and of the ongoing costs of a listing? 
To the first question, the answer is almost certainly yes. It is not only young high-
technology companies which might be quoted on small cap stock market for the first time, 
but also more mature family companies facing a succession issue, for example. Well over 
500,000 companies exist in Europe with over 20 employees and an average turnover of 
over 5 million ecu6, and even if only a few percent of this total are suitable for a stock 
market listing, this would give a figure of 10-20,000 companies; this fits EASDAQ's 
assessment of 15,000 companies in Europe potentially suitable for listing7. These 
companies, although only a small minority of all SMEs, have the greatest job-creation 
potential. Another indicator of the existence of suitable companies for a public share issue 
6 Source: Enterprises in Europe, Fourth Report, 1996. Figures for European Economic Area. 
7 EASDAQ quoted in the Frankfurter Allgemeine Zeitung, 24.9.1996. 
is the numbers of European companies choosing to be quoted on NASDAQ. About eighty 
European companies are now listed there. 
One possible problem consists in identifying those companies which are and those which 
are not suitable for a listing. Many companies may incorrectly believe that they could not 
have access to the financing they need by means of a public offer of shares; evaluating the 
potential of a company for "going public" is a skill that directors of SMEs do not always 
possess, and they may be deterred from specialist external evaluators because of the cost. 
Here there could be lessons to be learnt from practice in the USA, where there is over 
twenty years of experience in evaluating firms for quotation on NASDAQ. 
It is suggested that one possible solution to this problem could be the preparation of some 
form of European auto-assessment methodology, to help SMEs evaluate their aptitude for 
a stock market quotation. This might involve the study of experience in the USA and 
elsewhere, the drawing-up of a guide, available in different language versions and adapted 
to the conditions of the different Member States, to help SMEs evaluate themselves. Such 
an activity would need to be carried out by an appropriate expert body. 
Another possible limiting factor on the number of potential SME flotations on stock 
markets is unwillingness among company owners to dilute or lose their control over the 
company to the benefit of new shareholders. This is an understandable attitude; however, 
if the alternative is to rely on expensive bank loans, forgo expansion of the company, or 
make a trade sale, a public share offering may be the best option (if the company is ready 
for it). Moreover, a stock market listing does not necessarily imply the sale of a 
controlling majority of shares in a company; also, entrepreneurs may not be aware of the 
range of types of shares that exists, some even without voting rights. 
Financial institutions will naturally try to persuade companies identified as potential 
market flotations, and this should make more companies aware of the possibilities open to 
them. These activities, coupled with expert independent advice, should help overcome 
unwillingness by owner-run companies to make a public share offering. But if this does 
not turn out to be the case, there could be a justification for public support in this area, in 
the form of campaigns to bring home suitable SMEs the benefits of flotation. 
It may also happen that a company does not want to be quoted on a public stock 
exchange because of the stringent transparency rules, mainly in the field of financial 
information. Or, it may be willing to release such information but not have the resources 
to produce the necessary accounts. Here, cultural and legal factors have an influence, as 
the amount of financial information required from private and public companies varies 
considerably between Member States, but in almost all cases, a stock market quotation 
considerably increases the requirements. An additional cost factor is that flotation on one 
of the new European SME stock markets may involve a company needing to produce 
accounts according to rules different from those usually used in its home Member State 
(for example International Accounting Standards), thus making additional documentation 
necessary8. 
8 See section lV.iii.2. 
The promotion of a culture of financial transparency across Europe, including for private 
companies, could help the situation in reducing the gap in financial reporting requirements 
between publicly-quoted companies and others. Beyond this, financial training will 
certainly be needed for companies preparing a prospectus for a share offer. It is becoming 
widely accepted that reducing the financial information requirements imposed on SMEs 
wishing to issue shares publicly could be counter-productive, as it would make potential 
investors less likely to invest in those companies. 
Even if all these factors have been overcome, bringing a company to market is a long and 
complicated task which requires the involvement of an expert financial intermediary, 
usually a investment bank. These financial skills may not exist to the necessary extent 
everywhere in the EU to satisfy the potential demand from SMEs, especially if the new 
SME markets fulfil their full potential and there are many companies wishing to be 
quoted. Although providing such financial services should clearly be left to free 
competition between financial intermediaries in the long term, if their relative shortage 
looks like hindering the progress of SMEs wishing to float, it may become necessary to 
stimulate the development of such skills by selective training and information, especially 
between Member States with more highly-developed capital markets, especially SME 
markets, and other Member States. 
However, expert support services tend to be costly: bringing a company to a stock market 
flotation is an expensive business. The French Nouveau Marché estimates that the legal 
and accountants' fees linked to the listing process can represent up to 13% of the funds 
raised, and the fees of the compulsory adviser/market-maker can come to 7% of the 
capital raised9. Increased competition between financial intermediaries such as investment 
banks will hopefully reduce these costs in the future, but currently, public intervention is 
sometimes made within the Member States to help SMEs meet them: for example, the 
French Agence Nationale pour la Valorisation de la Recherche provides, under certain 
circumstances, reimbursable advances to companies to cover part of the cost of a stock 
market Initial Public Offering (IPO). In many cases the cost of an IPO can be transferred 
to the new shareholders, thus reducing the overall cost, but there are still also the ongoing 
costs of a stock market listing (subscription charges, legal and accountancy fees, audit 
fees and so on). 
IV. POTENTIAL BARRIERS TO THE CROSS-BORDER TRADING OF 
SHARES ON EUROPEAN SME CAPITAL MARKETS 
In a number of areas, potential obstacles exist which could hamper the cross-border 
trading of shares on European capital markets. Some of them could deter individual or 
institutional investors from investing in markets in countries other than their own; some of 
them are problems faced directly by the markets themselves or by intermediaries. These 
barriers apply, of course, to all European capital markets; however, they could prove 
particularly acute for European-level SME capital markets, for which cross-border 
transactions might constitute a very high proportion of their turnover. Although many 
9 Source: Courier ANVAR, June 1996 
potential barriers may become apparent in the future10, only those which have already 
been identified as potentially important are discussed below. 
IV.i. Currency-related problems 
Currency risk is often cited by securities dealers as one of the most important barriers to 
their participating in cross-border transactions. Although the risk can be hedged through 
derivative products, this adds to the cost of the transaction. Also, for institutional 
investors exchange rate changes can distort fund performance information and act as a 
deterrent to investment. Besides, the currency-matching requirements imposed by national 
governments on institutional investors are only possible because of the existence of 
different currencies. Currency differences make the development of interpénétration 
between national markets more difficult and thus reduce the liquidity of markets. 
The introduction of a single currency is therefore an essential prerequisite for a truly 
integrated European securities market in general, and for the new European capital 
markets for growing SMEs in particular to fulfil their full potential. The single currency 
will increase the transparency of capital markets and the comparability of investor 
information, reduce investor risk, and make cross-border transactions easier, quicker, and 
cheaper. It will improve the liquidity of European capital markets and, through its strength 
and stability, attract inward investment in European equities. Indeed, European capital 
markets are one of the areas of the European economy that have the most to gain from the 
rapid introduction of the euro. 
IV.ii. The regulation of securities trading at the EU level 
It was primarily the advent of the single market in the securities field on 1 January 1996, 
with the entry into force of the Investment Services Directive (ISD)11 and the Capital 
Adequacy Directive (CAD)12, which made possible the creation of new European capital 
markets for growing internationally-oriented SMEs. Thus, in many ways the successful 
future operation of these new markets is dependent on the complete and accurate 
transposition and application by the Member States of the single market legislation on 
securities trading, in order to establish genuine and fair competition between securities 
markets. The Commission will play an active role in monitoring the application of these 
directives, and in helping to resolve any interpretative questions that may arise. 
Questions concerning the practical application of the Directives will require close co­
operation between the regulatory bodies of Member States; a hypothetical example would 
be if an investment firm authorised in one Member State were to commit serious 
misconduct in a another Member State. Co-operation between national regulatory bodies 
in the securities field is already strong, being legally underpinned by specific requirements 
in Directives such as that covering stock exchange listing particulars. In 1995 the 
Commission adopted a proposal for a Directive on the setting up of a Securities 
Committee13, which would replace the existing High Level Securities Supervisors 
10 See "Legal and tax issues arising from cross-border dealings on EASDAQ", European Venture 
Capital Association and European Association of Securities Dealers, 1996. 
11 93/22/EEC, of 10.5.1993. 
1293/6/EEC, of 15.3.1993. 
13 COM (95) 360, 17.07.95. 
Committee, and have competence in respect of both the Investment Services and Capital 
Adequacy Directives, but this still awaits approval by the Council in co-decision with the 
European Parliament. 
The Directive setting up a Securities Committee will, when adopted, bring into being a 
Committee which will assist the Commission in the exercise of technical rule-making 
powers under the ISD and the CAD. The Securities Committee will also be a useful 
advisory body which the Commission can consult when envisaging new initiatives in the 
field of securities markets. It will not have any role in the day-to-day regulation of 
securities, which remains the responsibility of national regulators. Co-operation between 
regulators is requested under securities market directives, and this is given practical effect 
by the drawing-up of bilateral agreements between regulators, called "memoranda of 
understanding". 
Investing in SMEs involves high risks, and potentially high returns. It can reduce overall 
risk, if carried out as part of a strategy of diversification of investments and if the 
investments made are sufficiently spread. The objective of regulation of SME capital 
markets, as of other capital markets, is to establish transparency and thus to protect 
investors, not from investment risks, but from any abuse by firms, market participants, 
other investors or the markets themselves. 
In the longer term, more wide-reaching regulatory issues look certain to arise. Given the 
current trend of market developments, with internationalisation of trading and the use of 
novel trading systems other than traditional stock exchanges (including so-called 
Proprietary Trading Systems and possibly the Internet), it appears possible that regulatory 
authorities may face an increasingly difficult task in.enforcing existing legislation. Also, 
with the spread of cross-border electronic trading it could become increasingly difficult to 
decide when and where trades are actually performed, and the question of which 
regulatory body is competent could become harder to determine. These issues, if they do 
arise, will need to be monitored and evaluated for their implications on securities market 
regulation. 
IV.iii. Differences in national laws and practices 
In the newly-established single market for securities, and especially on European capital 
markets for growing SMEs, more and more transactions will involve two, three or more 
Member States. Differences in national laws and practices could act as a disincentive to 
such transactions. 
National legislation in the three areas discussed below may have an important incidence, 
direct or indirect, on cross-border trading in shares on SME capital markets. 
IV. Hi. 1. Taxation. 
The first of these is the tax area, where foreign investors can find themselves at a 
disadvantage compared with investors based in a Member State. For example, both capital 
gains tax and withholding tax on dividends varies enormously between Member States. 
Double assessment for tax between EU countries will usually be avoided through double 
taxation treaties, though this can necessitate additional administrative procedures. Net 
income can depend on whether the country of origin of the shareholder operates a credit 
or an exemption system with regard to dividends originating outside the country. 
However, as investors in high-risk, high-return SME markets will probably be seeking 
capital gains rather than dividend revenue, it is hard to know to what extent these 
differences will influence their investment decisions. 
In certain Member States, specific tax reliefs exist to encourage investment in equities. 
For example, schemes whereby losses made on investments in unquoted private 
companies (up to a ceiling) can be set against overall tax liabilities exist in several Member 
States, and in France and the United Kingdom the relief is maintained even if the company 
subsequently lists on the Nouveau Marché or AIM respectively. In all such cases where 
specific national tax reliefs exist, it would be desirable for them to be extended to cover 
investments made on other European capital markets (at least for companies incorporated 
in the Member State concerned); this would avoid possible tax discrimination between 
different firms from the same Member State, according to which stock market they choose 
to list on. 
In April 1996 the Commission produced a discussion paper for the ECOFIN Council, 
"Taxation in the European Union"14, which noted that as regulatory and economic barriers 
to the establishment of the Single Market are progressively removed, taxation is rightly 
perceived as an increasingly important residual factor preventing the full realisation of the 
Single Market and its goals of sustainable growth and a high level of employment. Tax 
disadvantages linked to cross-border financial transactions were identified as a factor 
complicating the lives of citizens. The Council decided as a result to set up a high-level 
group to examine ways of making progress on these and other tax issues affecting the 
single market. The Commission's report on the work of this group was published on 22 
October 199615. It concluded that action is necessary to eliminate the existing barriers to 
cross-border income and capital flows; subsequently, the Dublin European Council of 13-
14 December 1996 endorsed the setting-up of a permanent group to take a strategic 
overview of tax policy, and to co-ordinate national tax policies, while respecting the 
principle of subsidiarity. 
IV. Hi. 2. A ccounting standards. 
This is another area in which national differences could discourage investors, although 
research16 suggests that large investors are used to dealing with accounting differences 
and that other factors have greater influence over their decisions. The International 
Accounting Standards Committee is currently attempting to produce a core package of 
accounting standards for adoption by IOSCO (the international securities regulators' 
body) in 1998; in its Communication of November 1995 "Accounting Standards, a new 
strategy vis-à-vis International Harmonisation"17, the Commission declared its intention to 
become involved in this work. The first priority of its strategy is to enable large listed 
companies to produce only one set of consolidated accounts that can fulfil the 
requirements of the EU Accounting Directives and those of International Accounting 
Standards (IAS). A task force set up in November 1995 has concluded that with the 
14 SEC(96) 487 final, 20.03.1996. 
15 COM(96) 546 final. 
16 The European Equity Markets, European Capital Markets Institute, 1996 
17 COM (95) 508 final 
exception of two minor matters, European companies can prepare their consolidated 
accounts on the basis of existing IAS without conflicting with the Accounting Directives. 
Its report will constitute the basis on which each Member State will decide whether and to 
what extent companies can apply IAS when they wish to do so. In the meantime capital 
markets wishing to attract business, and firms wishing to attract investment, must decide 
which accounting conventions and practices to adopt, within the limits imposed by 
national rules. 
IV. Hi. 3. Corporate governance 
Corporate governance, in its widest sense, involves the rights and duties of the 
management of a company towards its shareholders and other stakeholders, and the 
mechanisms which the latter have for controlling the activities of the management. The 
composition and powers of the board of directors and the information which they must 
provide are important aspects of corporate governance. Protection of minority 
shareholders is another, and it is mainly in this area that corporate governance issues are 
relevant to the new SME capital markets, as it is possible that absence of shareholder 
protection could discourage investors from investing in firms listed on such markets. The 
directors of companies being floated on these new markets may be inexperienced in 
shareholder relations, and national differences in such matters as conceptions of the 
directors' duties and the structure of the board of directors (single-tier and two-tier 
boards, for example) will further complicate matters for investors. 
In Europe, shareholder interest in governance is increasing, and institutional investors are 
also taking greater interest in the internal management of the companies in which they 
invest. Institutional investors based outside the EU, especially in the United States, are 
also sensitive to corporate governance issues. The Commission welcomes the renewed 
emphasis in several Member States on good standards of governance, and believes that a 
Europe-wide debate on appropriate corporate governance standards would be helpful. 
In addition to national and European legislation on corporate governance, stock 
exchanges may decide to impose supplementary corporate governance requirements on 
companies wishing to be quoted on them, and such standards can play a part in 
competition between exchanges. Beyond this, it remains to be seen whether a clear set of 
European corporate governance principles would be useful, and if so, what form it might 
take and what content it would have. In its recent Green Paper on statutory auditing in the 
EU18, the Commission pointed out that it might be useful to issue a Recommendation at 
EU level on possible ways to improve the present system of corporate governance. 
IV. iv. Institutional investment 
Institutional investors, including collective investment funds, insurance companies and 
pension funds, will be a key in determining the success of the new European capital 
markets for SMEs (although individual investors will certainly play an important role too). 
On US stock markets institutional investors own 31% of shares, with pension funds 
18 COM(96) 338 final, 24.07.1996.. 
10 
owning 24%; in the UK the figures are 59% and 51% respectively, in Germany 22% and 
12%, and in Italy 11% and 1%19. 
Pension funds in particular are set to undergo much growth in coming years: the pressure 
on unfunded social security pension schemes in many countries due to an ageing 
population and unemployment, are likely to lead to a great expansion of provision for 
retirement through funded pension schemes. One report20 estimates that pension fund 
assets might increase by up to nine times, to over 10,000 billion ecu, by 2020. These funds 
will be looking for new investment opportunities, which will inevitably lead to the new 
SME growth markets being closely analysed by pension funds, and by other institutional 
investors, for such opportunities. 
However, the freedom of such funds to invest freely is currently limited by a number of 
restrictions in Member States. Many of these restrictions are normal and justifiable 
prudential requirements (and in addition, many funds have their own internal risk-
diversification rules, such as restrictions on investments in unlisted securities, which fund 
managers must respect). But many nationally-imposed restrictions, such as certain 
prohibitions on foreign investments, or obligations to invest in government bonds, are 
discriminatory. Some requirements to invest in matching currencies may be excessive and 
not necessarily prudential. Such restrictions can lead to investors obtaining sub-optimal 
returns on their investments, and can also lead to distortions: for example, a pension fund 
may find itself unable to invest in a company from the same Member State simply because 
it is quoted on a foreign market. 
As European capital markets for growing SMEs are by their nature international, and 
because they will need substantial institutional investment in order to succeed, these 
national restrictions on investment could have a disproportionately higher effect on them 
than on other capital markets. The abolition of these restrictions is essential, not only in 
the interest of pension fund contributors and of companies seeking equity funding, but 
also for the completion of the single market and the application of the Treaty provisions 
on the free movement of capital. The Commission has now written to certain Member 
States asking that they take steps to remove discriminatory restrictions not authorised by 
the Treaty of Rome21. Failure to act could result in infringement procedures before the 
Court of Justice. In addition, efficient capital markets will be one of the subjects covered 
in a Green Paper on pension funds, currently being prepared by the Commission. 
V. CONCLUSIONS 
As a consequence of the difficulties faced by European SMEs in accessing capital 
markets, they are largely undercapitalised: only 10% of European SMEs surveyed in 1996 
were financed by external equity, while 49% had long-term loans, and 54% had 
overdrafts22. Firms take many more years on average in Europe to be floated on a stock 
19 Source: Corporate Governance in Europe, Centre for European Policy Studies, 1995 
20 Source: European Pension Funds: their impact on European capital markets and competitiveness, 
European Federation for Retirement Provision, June 1996 
21 Article 73 forbids restrictions on capital movements, except proportionate ones base on prudential 
grounds. 
22 Source: Grant Thornton Business Survey 1996 
11 
exchange than in the United States. The initiatives for European SME capital markets 
over the last few years, are therefore opportune and necessary, although they constitute 
only part of the solution. A start has been made towards a structure of SME-oriented 
capital markets, European and national, which can fill this important gap in SME financing 
and provide attractive investment opportunities. New technologies, and a high level of 
transparency, should enable these markets to attract new investment, but the rapid 
technological advances also raise issues concerning how best to regulate capital markets. 
The establishment of these new markets has been made possible by EU single market 
legislation in the field of securities trading, essentially the Investment Services Directive 
(ISD), which removed former insuperable obstacles to the establishment of fully European 
markets, such as the existence of national monopoly markets with restricted access for 
foreign dealers. Nevertheless, a number of potential difficulties remain, which could hinder 
the access of SMEs to equity capital, and the development of markets designed to respond 
to their needs. Many are questions for individual stock exchanges to decide as part of their 
strategy. Those dealt with here - problems of access for SMEs to stock exchanges in 
general, and potential obstacles to cross-border trading in shares on European capital 
markets for growing SMEs - may require intervention, either at the level of the European 
Union or that of Member States, and this Communication suggests some lines of action. 
Improving access for SMEs to equity capital via listing on a stock exchange, and tackling 
the possible hindrances to this within SMEs themselves, is one of the objectives of the 
Commission's Third Multiannual Programme for SMEs, adopted by the Council on 9 
December 199623. The Multiannual Programme also includes the exploration of 
innovative financial instruments for SMEs, and in this context the Commission intends to 
study the feasibility of other means of SME financing through securities, including for 
example the issuing of bonds. 
The improvement of access for SMEs to equity finance, both through the development of 
suitable SME-oriented capital markets, and through helping SMEs overcome the inherent 
difficulties which can prevent them being floated on such markets, will have a strongly 
beneficial effect on the European economy, and on the level of employment. Increased 
access to equity finance would produce a chain reaction of positive effects for companies: 
it would allow them to invest in research and expansion; by decreasing debt-equity ratios, 
it would make banks more willing to supply further debt finance; by improving the 
opportunities for venture capitalists to exit their investments it would free up venture 
capital for investment in start-ups and young companies. There would also be wider 
economic benefits: better opportunities for European investors, especially pension funds, 
thus alleviating current difficulties in funding pensions; more inward investment to Europe 
from elsewhere; the development of financial services in Europe. 
For all these reasons the Commission believes that the opportunities provided by the 
creation of national and European capital markets for growing SMEs should be 
maximised. All efforts should be made, including the measures described or suggested in 
this Communication, to further the establishment of a genuine SME equity culture in 
Europe. 
23 97/15/EC. Official Journal L 6/25 of 10.1.1997. 
12 
ISSN 0254-1475 
COM(97) 187 final 
DOCUMENTS 
EN 08 09 
Catalogue number : CB-CO-97-179-EN-C 
ISBN 92-78-19069-1 
Office for Official Publications of the European Communities 
L-2985 Luxembourg 
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