Opinion of the Economic and Social Committee on the 'Communication from the Commission - European capital markets for Small and Medium-sized Enterprises: prospects and potential obstacles to progress'
Date: 1998-05-27
Institutions: European Economic and Social Committee
Subjects: capital market, financial market, investment, small and medium-sized enterprises, stock exchange

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6.2.1.
Firstly, it calls upon the Commission to make
concerted practical efforts to explain the workings of
the Single Market, and so produce specific findings based
on regularly documenting the practical consequences of
EU measures.

6.2.2.
Lastly, the Committee urges those Member
State companies and entrepreneurs who consider it in
their interest to establish themselves and operate in
another market to roll up their sleeves, harness all their
undoubted dynamism and exploit every opportunity
they have to overcome by their own efforts as many
obstacles as they can.

Brussels, 27 May 1998.

The President

of the Economic and Social Committee

Tom JENKINS

Opinion of the Economic and Social Committee on the ‘Communication from the Commission
— European capital markets for Small and Medium-sized Enterprises: prospects and potential
obstacles to progress’

(98/C 235/04)

On 13 May 1998 the European Commission decided to consult the Economic and Social
Committee, under Article 198 of the Treaty establishing the European Community, on the
above-mentioned communication.

The Section for Industry, Commerce, Crafts and Services, which was responsible for preparing
the Committee’s work on the subject, adopted its opinion on 6 May 1998. The rapporteur
was Mr Pezzini.

At its 355th plenary session (meeting of 27 May 1998) the Economic and Social Committee
adopted the following opinion by 101 votes to one, with one abstention.

1. Overall remarks

The European Commission is to be congratulated
1.1.
on its positive and sustained efforts to stimulate the
creation of European capital markets suitable for small
and medium-sized enterprises (SMEs). Its actions were
described in an earlier Communication ‘Reporting on
the feasibility of the creation of a European Capital
Market for smaller entrepreneurially managed growing
companies’ (1), on which the ESC did not deliver an
opinion. These endeavours by the Commission respond-
ed to an earlier request by the Committee to ‘carry out
a feasibility study on the establishment of a recognized
European capital market giving European firms,
especially small firms, access to capital.’

In this follow-up communication the Com-
1.2.
mission has produced a constructive document. Never-
theless, there are certain points, such as the manner in

(1) COM(95) 498 final, 25.10.1995 .

which EU securities legislation operates in practice,
which have not received the detailed examination they
deserve. There are others in which factors other than
those put forward by the Commission are significant.

There are a whole range of other factors besides
1.3.
the adequate provision of finance which determine
whether firms will grow to a significant size. It was
decided that the most significant of these deserved
examination in this opinion in order that a better overall
assessment of the problems might be made. A number
of the recommendations made arise from a fact-finding
mission by the ESC to the USA made in November 1997.
This was largely inspired by the reference to the US
capital markets in the introduction to the Commission
communication and by the encouragement to examine
the US situation given by Commission President Santer
in his speech at the Economic and Social Committee on
28 October 1997. As a result, this opinion covers a much
wider field than the Commission communication, which
merely deals with capital markets for SMEs.

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1.4.
A further criticism of the communication is that
it fails to make clear that the new European capital
markets are only of value to companies which, whilst
technically SMEs (under 250 employees, less than ECU
40 million capital turnover and ECU 27 million on the
balance sheet), are either of medium-size, particularly
innovative start-ups, or firms that are particularly capital
intensive.

the speedy and full application of existing European
Union legislation would help. Finally, in the field of
investment and the free movement of
institutional
capital, the Commission maintains that failure to remove
discriminatory national restrictions could make the
taking of infringement proceedings necessary.

1.5.
In the USA, too, only some 2 % of companies at
the most, albeit those with above average prospects for
growth, attract external funding from informal private
investors (‘Business Angels’) or venture capital funds.
The Commission estimates that there are perhaps 20 000
firms at the most in the whole of the European Union
which might go on to have their shares traded on a stock
market at some point. They are, however, the firms that
hold the promise of enjoying the highest rates of growth
and creating significant new employment, good reasons
for the Commission to have devoted such a degree of
attention to their financing needs which have historically
been less well catered for in Europe than in the USA.

2. Summary of the Commission document

2.1.
The main objectives of the communication are
to explore the potential barriers to the admittance to
trading on capital markets of the shares of SMEs;
to start a European-wide debate on the appropriate
conditions for access to equity finance; to describe, and
draw attention to the progress made by various initiatives
to create new financial markets in the European Union
such as ‘EASDAQ’ and ‘Euro-NM’; to outline the
actions the Commission is currently taking and intends
to take in the future to overcome the barriers to the
development of SME-orientated capital markets and
ensure their smooth operation.

2.2.
The communication identifies two main areas
creating potential barriers to the development of these
capital markets. The first relates to the attitudes,
capacities and constraints originating within small and
medium-sized enterprises themselves. In particular, the
attitude of SMEs towards their financing, their expertise
or lack of it in financial management, and the burdens
which arranging an introduction on a stock market
would place on them.

2.3.
The second group of potential obstacles concern:
the cross-border trading of shares on pan-European
stock markets; particular currency related problems;
differences in taxation and national accountancy prac-
tices; corporate governance and institutional investment.
The Commission believes that in certain of these fields

3. Detailed comments on the communication

3.1.

Introduction

Other than for the comments set out in section 1 of
this opinion, the points made in the introduction are
accepted.

Further progress in the development of SME
3.2.
capital markets in the European Union, and their
prospects.

A number of capital markets more attuned to
3.2.1.
the needs of innovative and rapidly-growing companies
than have been traditional stock markets, now exist
in Europe. Two, EASDAQ and EURO.NM, have
pan-European ambitions. The London AIM (Alternative
Investment Market) currently appears to be more
focused upon the United Kingdom.

3.2.2.
The growth rates of companies seeking admis-
sion to these markets is likely to be far in excess of the
10 % cited in the second paragraph of page 2 of the
Communication. When comparing sales in 1996 and
1997, three-quarters of the companies whose shares
traded on the EASDAQ market experienced a growth
in excess of 25 %. Nearly a third of all companies on
the market showed a turnover increase of over 100 %.

3.2.3.
The long-term success of these markets will
depend on their admitting a sufficient number of
innovative companies, as it is these who appear to
particularly excite the interest of investors. Any initia-
tives to increase their numbers, particularly in fields such
as biotechnology, would make a welcome contribution.
Unfortunately, there is no completely reliable method
of determining at an early stage which are the companies
that are likely to grow rapidly and be successful in the
long-term. What largely determines their eventual ability
to attract external investment is the perceived quality of
their management.

3.2.4.
Efforts need, therefore, to be concentrated on
encouraging more business start-ups and seeing that
they have access to finance, together with timely advice,
so improving management quality and reducing the
current high rate of mortality, some 50 % within the
first five years of existence according to the European
Observatory for Small Business. There are already good
schemes in operation within the EU which can provide

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guidance when policies are being developed. One exam-
ple is the ‘Artigiancassa’ financial facility in Italy.

such assistance a condition for receiving a loan
guarantee.

3.2.4.1. Given that undercapitalization and inability
to provide security for loans is common among new
firms:

A loan guarantee facility for SMEs, with special
arrangements for very small ‘micro’ loans, should
be made available in all Member States. The means
of delivery, whether
through state organized
schemes, or other mechanisms such as Mutual
Guarantee Systems, would be for decision in the
light of national circumstances. Given that many
small enterprises do not adopt a limited company
format, special attention needs to be given to their
specific needs.

Guarantees might not need to have as high an upper
limit as in the US Small Business Administration scheme
($ 1 million, of which $ 750 000 is guaranteed) but at
least ECU 250 000 would seem appropriate. Properly
run, these facilities should not be a great burden on the
public exchequer. Loan defaults in the US are currently
less than 2,5 % of the total guaranteed and fees charged
to firms for the granting of loans would offset part of
this. Based on the experience of Mutual Guarantee
Systems, the so called ‘Multiplier’, which enhances the
ability of consortia to underwrite loans, has a multiplier
of 22. That is, with a 50 % guarantee and a hypothetical
venture capital fund of ECU 100, it would be possible
to grant a loan of ECU 4 400. This figure allows for an
insolvency rate of 4 % and the cost of investigating
credit worthiness.

Whilst the establishment of such a structure will not be
as cheap as in the case of the SBA Score programme,
where mentors only receive out of pocket expenses, it
need not be overly expensive. In the last full year of the
United Kingdom Small Firms Service (1990), keeping
300 advisers in the field only cost around ECU 14 million.
The attendant reduction in both business failures and
ill-advised start-ups makes the establishment of such
structures a first-class national investment. There is
reason to believe that by extending this system, the
business failure rate will fall considerably, perhaps even
by 80 %.

3.2.4.3. Not all firms cease activities because of
lack of finance or mismanagement. An unquantifiable
number do so because they find regulatory burdens
imposed upon them impossible to cope with. There
must also be many who are deterred from starting a
business because of
the bureaucratic procedures
involved. The European Commission and Member
States recognize this, but action to address the problem
needs to be speeded up.

In the USA new firms only need to make arrange-
ments to pay social security contributions and
register with the tax authorities. Member States
should reduce start-up formalities to what they
consider to be the bare essentials in a similar manner,
while bearing in mind the different economic and
social structures. They should also consider raising
VAT registration exemption levels, as already per-
mitted by the VAT Directives, so assisting the very
small business.

A major reason for business failure is a lack
3.2.4.2.
of knowledge of the relevant sector and a lack of business
and financial management skills. There is nothing magic
about these and they can be imparted in the majority of
cases providing the person giving the advice has the
necessary business experience and counselling skills.
The pity is that many of those most in need of advice
seldom seek it.

Each Member State, with the cooperation of the
appropriate private-sector organizations, should
ensure that business mentoring on a one-to-one basis
is available at reasonable cost to any self-employed
person or SME proprietor or manager. Mentors
should have had business experience and be members
of a professional body (which could include national
SME and craft organizations) able to ensure they
receive proper initial and on-going training. Con-
sideration should be given to making the seeking of

The administration of firms paying very small amounts
of VAT costs more than it yields, so this reform would
have no budgetary cost, whilst giving new firms a
breathing space before having to absorb what is for
many a complex system, requiring them to pay for
external advice in order to ensure compliance.

3.2.4.4.
Unless considerable amounts of noise or
harmful emissions are concerned it is easy to found a
business in the USA and operate it from home. It has to
be wondered whether firms such as Microsoft and Dell
Computers, which both started in a garage, would ever
have commenced operations in some parts of Europe.

There is a need for public authorities to pay
more attention to substance rather than form when
authorizing new start ups, and to simplify authori-
zation procedures. Restrictions on starting a business

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and operating it from a private home for a limited
period should be relaxed where there is no question
of public nuisance or inconvenience or harm to the
environment or employees.

apparently easier and cheaper to patent discoveries in
the US.

If a major objective is to encourage the
3.2.4.5.
creation of innovative firms, the US experience that their
growth appears to take place most readily around
universities or research centres needs to be noted. There
are examples of such centres in Europe already, but not
enough, neither are they yet sufficiently large.

Top priorities should be the encouragement of the
establishment of more high technology business
parks around universities and other research centres
and the improvement of the overall quality of those
that already exist, thereby increasing the chance of
commercial application of scientific discoveries. In
each case it is also vital to provide back-up, in the
shape of venture capital funds.

There is a need for the Commission to examine current
best practice in the Member States and to disseminate
the results in order to encourage further developments.

3.2.4.6.
US academics seem far more willing to
establish or participate in businesses than their European
counterparts. One reason may be a greater availability
of early stage and seed capital (a gap now being addressed
following the Heads of Government Extraordinary
Council on Employment in Luxembourg), coupled with
expert business advice. Another one may be cultural,
with far more emphasis being placed on academic rather
than worldly success in Europe.

An examination is needed into methods which would
help make academics more aware of the possibility
of developing commercial applications of their theo-
retical knowledge, particularly within a business in
which they have a stake. It may be necessary to
consider incentives, such as the provision of more
funds for pure research to the departments of
academics who respond positively. Member States
should also loosen traditional restrictions which
prevent academics from undertaking any type of
commercial activity.

There will be practical problems to overcome, not
least defining the ownership of intellectual property,
particularly where the centres of learning involved are
wholly funded by the state. Nevertheless, the existence
of difficulties should not be made an excuse for inaction.

3.2.4.7.
cation of research in Europe may be that

Another reason for less commercial appli-
is

it

The intention of the Commission to produce early
draft legislation aimed at creating a true European
patent is warmly welcomed. The Council and the
European Parliament are urged to rapidly consider
and approve this legislation, along with the equally
important draft Utility Model Directive.

3.2.4.8.
In the more enterprise-oriented areas of the
United States, entrepreneurs who go bankrupt are not
made to shoulder so much blame. The federate state
laws allow them to learn from their mistakes and to get
their business back on its feet or start a new one.

Member States should examine their national legislation
on bankruptcy and seek to amend it in order to limit the
number of unnecessary bankruptcies and to give a
greater chance of starting again to those who, though
unsuccessful, acted in good faith.

3.2.5.
Another factor which will determine whether
or not these markets are successful is whether there will
be sufficient interest from investors. So far, levels of
interest by institutional investors appear encouraging,
more questions arise in respect of private investors. One
reason for the lack of interest in equities by individual
European investors, referred to in the seventh paragraph
of Section II, is certainly cultural. Europe is not an
enterprise culture in the same way as is the USA.
When it comes to investment, the security provided by
fixed-interest investments has been traditionally more
important than the potential for higher returns offered
by equity investment. It can be anticipated that the
creation of a single European currency will tend to
change investor attitudes. Rates of return on government
securities will tend to be lower, as will the amounts
issued. This means that investors will need to consider
alternatives.

Already,

3.2.6.
investor attitudes do seem to be
changing and another factor in the apparent lack of
interest in equities may have been a lack of opportunity.
Recent evidence, including the success of privatization
issues, shows that there may be a more pent-up demand
than estimated. In any case, the majority of smaller
private investors are likely to hold their stakes in equities
indirectly, through collective investments and those
made by insurance companies and pension funds. It is
important that these institutional
investors are not
restricted in their investment policies by outdated
national rules, which will become increasingly irrelevant
in a single currency zone (see also point 3.4.1.2.5).

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3.2.7.
Growing companies are capital hungry and
lack of funds frequently inhibits their rate of growth in
Europe. This is less so in the USA where a greater variety
of sources exist. In the USA informal private investors
or ‘Business Angels’, who are frequently successful
businessmen, are prepared to invest relatively substantial
sums (said to be in the range of $ 50 000 to $ 100 000) in
businesses with the potential for fast growth. In addition,
the advice and contacts they can bring to the company
are said to be as valuable as the money they invest. An
encouragement they receive is that they are allowed to
offset losses against tax payable on other activities under
defined circumstances. Similar investors do appear to
exist in Europe, but the picture is uneven and potential
investors complain that it is difficult to locate suitable
companies. The US Small Business Administration has
recently tried to improve links in the US by establishing
a national data base promoting contacts.

The Member States should examine how informal
private investment might be encouraged, both
through tax incentives and the establishment of
contact networks, where these do not already exist.

3.2.7.1. When the informal private investor’s partici-
pation is no longer sufficient, Venture Capital Funds
should theoretically take over for the higher-growth
firm, effectively bridging the gap until it has reached the
point where a stock market floatation is possible. In
practice, even in the USA, this only happens in the case
of a very small number of companies as median
investment sizes become increasingly large. The US
Small Business Administration has endeavoured to fill
some of the gap by providing guarantees for smaller
venture capital investments.

The Council having acknowledged that a problem
exists (Point 48 of the Luxembourg Conclusions),
the Commission has reacted by tabling a draft
proposal for a Decision permitting such guarantees
to be given. This proposal will be the subject of
a separate Opinion of the Economic and Social
Committee.

3.2.8.
A noteworthy feature of the American scene is
the number of small companies that grow to medium-
size. One reason may lie in the field of capital taxation,
which was reduced in the US in the 1980s. Owners of a
business are more willing to take the risks involved in
growing rapidly if they are allowed to keep a substantial
part of the results of success should they eventually float
the company on a stock exchange or sell it. If they do
not wish to do either, they may be interested in handing

it down to younger members of the family without
incurring succession duties which bleed the company
of finance it needs for trading and funding further
expansion.

Member States should examine the effects of capital
taxes and succession duties on SME growth and
introduce reforms where necessary. This is some-
thing which the Committee has advocated on a
number of occasions.

It is after all the total yield rather than the actual
rates of these taxes which should be important to
governments.

3.2.9.
Another necessity is the provision of high-
quality information, particularly on new share issues,
to investors. For larger share issues this is a complex
but practical possibility, but for smaller offerings this is
currently made difficult where cross-border issues are
concerned by two main factors. The first is the absence
of a common definition of a public offer within the
European Union. The second the restrictive manner
in which the mutual recognition provisions of the
Prospectus Directive (1) are being interpreted by the
Member States. They are frequently requiring trans-
lations of what are massive documents, together with a
considerable amount of additional information, together
with the placing of expensive advertisements in national
newspapers. This is perfectly legal, but forces issuers of
‘SME stocks’ to limit an Initial Public Offer of shares
to one Member State, relying elsewhere on private
placements of shares with professional investors. In
addition, the widely differing national rules on advertis-
ing effectively exclude many private investors, either
through ignorance or because only a private placement
is taking place in their country of residence. These two
factors have the unfortunate result of restricting liquidity
in the after-market and reducing share prices. Unless
these difficulties are overcome it will be virtually
impossible to tap the pool of funds and interest in the
shares of innovative SMEs that potentially exists in
Europe. Neither will it be possible for the SME capital
markets to provide funding for Europe’s future commer-
cial and industrial ‘champions’ in the way they otherwise
could.

3.3. Potential obstacles to the listing of SMEs on stock

exchanges

Five questions are asked by the Commission in this
section of the Communication. They are addressed in
the same order.

(1) 89/298/EEC (Council Directive coordinating the require-
ments for the drawing-up, scrutiny and distribution of the
prospectus to be published when transferable securities are
offered to the public).

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3.3.1. D o e s a s u f f i c i e n t n u m b e r o f S M E s
e x i s t i n E u r o p e w h i c h a r e s u i t a b l e
s t o c k m a r k e t
a
r i p e
a n d
f l o t a t i o n ,
h o w c a n
s o ,
i f
t h e s e b e i d e n t i f i e d ?

f o r
a n d

It would appear from the partial studies
3.3.1.1.
made to date, and mentioned in the Commission’s
Communication, that sufficient firms with the willing-
ness and the potential exist, but whether many are yet
ready, or even aware of the opportunities presented by
a stock exchange flotation is less certain. Given that
firms tend to be reticent about revealing their affairs
to strangers, and there being much less information
available in the public domain than in the USA, it is
difficult to think of methods by which they might
be identified. Perhaps professional advisers (bankers,
lawyers, accountants) and organizations (chambers of
commerce, etc.) might be induced to help in the
identification of firms who are potential candidates for
flotation.

a barrier to proceeding. Considerable effort is required,
which must be coupled with the high cost of diverting
management time from the development of the company.
These requirements are, however, inseparable from the
transparency required by both investors and market
regulators. It is difficult to see how the Commission
suggestion of making private companies adopt similar
standards of financial transparency would address the
problem. It would merely place an additional burden on
companies not seeking and never intending to seek
external equity finance.

3.3.3.2.
As to the other suggestion, that financial
training being provided for companies preparing a
prospectus,
it is the
it must be pointed out that
sponsors to the issue, not the company, who prepare
the prospectus and the reporting accountants who satisfy
themselves as to the accuracy and presentation of the
figures. It is to be hoped that companies who had reached
this stage would also have developed a reasonable level
of financial expertise. Otherwise, they are likely to
encounter problems in meeting the on-going obligations
of a public limited company.

3.3.2. A r e o w n e r s o f

S M E s w h i c h a r e
t o
f l o t a t i o n w i l l i n g
r e a d y
a c c e p t
d i m i n u t i o n
p o s s i b l e
o f c o n t r o l w h i c h a p u b l i c s h a r e
i s s u e i s o f t e n t a k e n t o i m p l y ?

f o r
t h e

3.3.4. D o

h a v e

a c c e s s

t h e
S M E s
n e c e s s a r y
a n d
s u p p o r t n e c e s s a r y t o p r e p a r e a n
s h a r e s
I n i t i a l P u b l i c O f f e r i n g o f
( a n I P O ) ?

t o
a d v i c e

s p e c i a l i s t

3.3.2.1.
If they are not ready to accept the reality that
they will suffer some diminution of control and will be
answerable to a wider public than hitherto, owners of
SMEs should not contemplate a flotation. In many
instances a reluctance to accept this reality is a gener-
ational problem. As many of
those who founded
businesses after the second world war retire, those who
succeed them seem much more willing to give up a
certain measure of control in return for external funding
and the greater opportunities for expansion that follow.
Also, those that have been in receipt of venture capital,
or have attracted informal private investment, have
already become accustomed to outside scrutiny of their
decision-making. The Commission’s idea that more
companies might come forward if there were publicly
supported campaigns to bring home to suitable SMEs
the advantages of flotation is worthy of further consider-
ation, although advice about the most suitable market
for the company and similar matters, clearly fall within
the remit of a professional adviser.

Potential IPOs valued at less than ECU 100
3.3.4.1.
million could well face a problem in that they are
unlikely to be of interest to the larger investment banking
houses. In some of the main financial centres smaller
investment services firms do exist who are prepared to
bring issues of quite a low value to the market, but this
situation is not universal and difficulties in obtaining
proper support and assistance could arise. This is of
concern because one important
factor determining
whether or not investors are attracted to an issue is the
name of its sponsor. It is, after all, they who act
as filter/selector, trainer/preparer and on-going hand
holder of SMEs coming to a stock market. It is to be
hoped that Economic and Monetary Union, along with
increased competition in the financial markets, will lead
to the appearance of more investment firms prepared to
take on smaller share issues, perhaps even outside their
main country of establishment.

3.3.3. D o

h a v e

t h e w i l l i n g n e s s
S M E s
s k i l l s n e c e s s a r y t o
a n d f i n a n c i a l
m e e t
i n f o r -
m a t i o n a n d t r a n s p a r e n c y r e q u i r e -
q u o -
m e n t s
t a t i o n ?

s t o c k m a r k e t

f i n a n c i a l

h i g h

t h e

o f

a

3.3.5. A r e

a n d

S M E s w i l l i n g

a b l e
t o
t h e p r o c e s s
b e a r t h e h i g h c o s t o f
i n
o f
l i s t i n g ,
s t o c k e x c h a n g e
t h e
t e r m s o f b o t h a n I P O a n d o f
o n g o i n g c o s t s o f a l i s t i n g ?

a

The need to produce a high level of financial
3.3.3.1.
information in preparation for a flotation can constitute

Costs of an issue are high, although the figure
3.3.5.1.
of 20 % of the funds raised quoted in the Communication

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must refer to a very small issue. NASDAQ indicates a
typical cost might range from 7 % to 9 % of the value
of the issue. To offer special help with the costs of an
IPO to SMEs making very small issues would not be of
particular assistance as fees are not paid until after the
new capital has been raised. In any case, stock markets
are unenthusiastic about such issues, which tend to be
illiquid after flotation and on-going fees charged hard
to justify.

3.3.5.2.
Some efforts are being made to meet the
requirements of smaller SMEs, only a minority of
whom are going to be high technology companies
with international ambitions and two seem worthy of
mention:

— the Union of Chambers of Commerce in Lombardy,
Italy, has just established a second-tier capital market
for companies with a capital of ECU 0,5 million
upwards;

— the Irish Stock Exchange launched its ‘Developing
Companies Market’ in January 1997. This provides
a capital market with less onerous conditions than
those applying to stocks on the Official List, in-
cluding a requirement for only one year’s accounts
rather than three. Also, only 10 % of the shares have
to be issued to the public.

More initiatives of this nature creating ‘nursery’ capital
markets, which are comparatively cheap to join, would
seem to be required.

3.3.5.3.
In addition to the two examples quoted in
the previous paragraph, there is the longer-established
German ‘Freiverkehr’ over-the-counter market, on
which the shares of some 500 companies are traded.

3.3.5.4.
The creation of an Internet market might,
for the shares of smaller SMEs in particular, be one
solution worthy of encouragement. In June 1997 the
Australian Stock Exchange (AS) announced its intention
to launch an ‘Alternative Capital Market’ in 1998 on
which unlisted companies of any size would be able to
seek investments via the Internet. The AS calculates that
there are about 1 million SMEs in Australia, of whom
10 % might have real potential for growth and 2 %
interested in seeking outside equity capital. Companies
seeking to join the market would have to make use of
‘sponsors’ approved and supervised by the AS, who

would have to vet the information posted on the Internet
by their client companies. Some mandatory information
would have to be included, but nothing as complex as a
prospectus would be required.

3.3.5.5.
In the USA some companies are beginning to
make offerings of shares via the Internet. A prospectus
has to be produced and filed with the Securities and
Exchange Commission but the companies themselves
set share prices, leading to a lack of transparency in the
after market. So far, it would appear that the majority
of shares issued by this means have been sold to investors
located in fairly close geographical proximity to the
company.

3.3.5.6.
A rather more sophisticated new form of
issue, ‘Public Venture Offerings’, aimed at medium-sized
companies, is now being offered in the USA, also via the
Internet. Typical amounts raised are between $ 5 million
and $ 10 million. A prospectus has to be filed with the
Securities and Exchange Commission and with the
regulatory authority in each of the States in which stock
will be offered. The offer can then be advertised without
restriction and be subscribed to by up to five institutional
and an unlimited number of private investors. Stock
cannot be traded for a period of 18 months from the
date of issue. This form of funding is hard to tap,
possibly because of its newness. Out of 2 000 firms
expressing interest, one investment firm only agreed to
launch offerings for four. Nevertheless, this appears to
be a financing instrument with potential.

3.3.5.7. One problem to be faced if similar develop-
ments are to be encouraged in Europe is that of adequate
regulation and the avoidance of fraud. Even the US
Securities and Exchange Commission is not yet in a
position to issue a set of rules, meaning that it may well
fall to the Commission to be the first to comprehensively
face this issue, hopefully establishing a framework of
rules within which a meaningful, transparent and honest
market in the shares of SMEs may develop.

The positive efforts made by the European Com-
mission in the field of electronic commerce are
acknowledged and supported. Building on this, the
European Commission and the Member States are
asked to launch consultations, preferably main-
taining liaison with the US Securities and Exchange
Commission, in order to devise a framework of rules
appropriate to cover securities offered to investors
by means of the Internet.

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3.4. Potential barriers to the cross-border trading of

shares on SME capital markets

3.4.1. P o i n t s r a i s e d b y t h e C o m m i s s i o n

3.4.1.1. Currency-related problems

The Commission view that these can only be solved by
the introduction of the euro and the consequent impetus
to cross-border trading in securities is endorsed. This
will of course depend on the number of Member States
participating from the outset and cannot be viewed in
isolation from the performance of the EU economy.

3.4.1.2. The regulation of securities trading at the EU

level

3.4.1.2.1.
The European Union has some 18 equity
markets and 18 regulatory organizations. The USA has
three principal or ‘national’ stock markets, all highly
efficient and doing a good job for investors and
companies. Since 1996, when Congress passed legislation
which overrode State regulations where stocks traded
on these markets were concerned, they have just one
regulator, the Securities and Exchange Commission. At
present, the fragmented European regulatory structure,
together with the investment firms operating within it,
cannot compete effectively with the US model.

Currently, EU legislation on financial ser-
3.4.1.2.2.
vices permits the free movement of capital and provides
for the right of establishment. What is missing is
any consistent interpretation of the rules by national
regulatory bodies. This, together with the inconsistent
manner in which the options provided for in financial
services legislation have been exercised at the national
level, are possibly the most fundamental problems
remaining in relation to the organization and operation
of stock markets in the EU. The single currency alone
will not provide the solution — although it will be a
start — as its full benefits will not be felt within the
financial services sector under the current legislative and
regulatory regime.

3.4.1.2.3.
Particular problems exist in terms of the
provisions of the Prospectus Directive when companies
seek admission to a market outside their home Member
State. The directive does not provide for the automatic
mutual recognition of a prospectus prepared under the
provisions of Article 12 in order to gain admission to
regulated markets, even though this has been vetted by
a competent authority. Some authorities are prepared
to issue a certificate certifying they have vetted a

prospectus, others will not. Indeed the current patch-
work of national regulatory arrangements, reflecting
the different ways in which certain of the options
contained in its articles have been perfectly legally
transposed into the laws of the Member States does not
make achieving mutual recognition under the terms of
Article 21(1) of the Prospectus Directive as easy as it
should be.

3.4.1.2.4.
As pointed out in point 3.2.9, major diffi-
culties also arise because of the requirement by some
competent authorities for the translation of the prospec-
tus and the addition of additional information specific
to that Member State concerning local
income tax
aspects, financial organizations retained to act as paying
agents for the issuer in that Member State, and the way
in which notices to investors have to be published. In
practice, they are placing an almost impossible burden
on smaller issuers.

3.4.1.2.5.
To allow such anomalies to remain will
undermine some of the benefits of a single European
currency as well as placing European capital markets at
a disadvantage compared with those in the USA. Capital
markets in the USA are not only efficient, they offer
choice to companies and broaden opportunities for
investors. The fundamental reason appears to be the
regulatory climate, which ensures transparency and
fosters competition. This in turn increases market size
and reduces costs, both for investors and companies
raising capital. Even though the European Union now
has an overall framework of rules governing financial
markets and services these are extremely complex, are
supplemented by specific national provisions and policed
by national regulators.

The European Commission and the Member States
need to consider whether the present legislative
and regulatory regime encourages the deepening of
capital markets which is now essential and take
appropriate steps to amend it, particularly the
Prospectus Directive. This would not need major
change to turn into an effective instrument, but
would require some of the Member States to forego
some of the legislative options they now enjoy, which
were framed at a time when financial markets were
far more national in character than they are now
becoming. Whilst a European regulatory body, along
the lines of the Securities and Exchange Commission,
is unlikely to be created for the foreseeable future,

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greater efforts are needed to ensure that enforcement
at the national level is more coherent than is now
the case.

fast changing business environment would be unneces-
sarily restricted, further handicapping Europe in its
attempts to compete with the rest of the world.

3.4.1.3. Differences in national laws and practices

3.4.1.3.1. Taxation

Whilst the Commission is correct in saying that double
taxation agreements exist in most instances, this is
not the case for all Member States, with two being
particularly deficient in this regard. Nevertheless, it is
apparently the lack of information about national
peculiarities rather than the differences themselves which
cause problems.

This deficiency is something that the Commission
might consider addressing through the drawing
up of a comprehensive guide, or encouraging its
production.

3.4.1.3.2. Accounting standards

The Commission view that these do not create a major
problem is endorsed, although it would be helpful to
analysts, who are the source of much public information
on companies,
if more accounts were prepared in
accordance with international accounting standards.
This is, however, something for stock exchanges to
deal with through internal rules, not the European
Commission. For this to work effectively, however,
some Member States will have to amend national
legislation, as already agreed in principle, in order to
permit companies to use international standards. It is
understood this is something they have undertaken to
carry out and they are urged to do so speedily.

3.4.1.3.3. Corporate governance

3.4.1.3.3.1.
A Europe-wide debate on what would be
a necessary level of corporate governance standards
appears to have value, but there must be doubts about
any solution based on legal provisions, particularly
given the difficulty in framing either a directive which
could gain agreement in the Council, or sets of national
rules that would be at all coherent.

An initial difficulty is to adequately define
3.4.1.3.3.2.
corporate governance. The definition adopted by Ernst
& Young in a report drawn up for the Commission as:
‘all the rules on functioning and control that govern
corporate existence in a given historical and geographical
framework’ is extremely broad. An attempt to translate
this into legislation, particularly at the European level
given the under developed nature of even the most basic
concepts of corporate governance in some Member
States, could prove an extremely complex undertaking.
A danger is that the flexibility management needs in a

3.4.1.3.3.3.
Even codes of conduct have to have an
element of flexibility if they are not to prove unduly
onerous for the smaller private company. One European
stock market already lays down certain basic principles
of corporate governance which companies whose shares
are admitted to trading have to meet and continue to
meet:

— the Board of Directors must have at least two
independent members (which excludes all executives
or employees of the company or its subsidiaries, a
shareholder with a beneficial interest exceeding 20 %
and any individual having a relationship likely to
affect their independence of judgement);

— a Remuneration Committee, composed entirely of
independent directors and operating in line with the
best international practices when setting remuner-
ation and incentive packages for directors and
executives, must be established;

— an Audit Committee, with a majority of members
being independent directors, must also be created
and maintained;

— all related party transactions must be reviewed on
an on-going basis, using a body with an independent
majority, such as the Audit Committee, which should
also review situations where possible conflicts of
interest appear to arise.

3.4.1.3.3.4.
If other European stock exchanges were
to make similar binding rules, corporate governance
problems in respect of public limited companies, at least
as far as the overall conduct of executive directors was
concerned, would be largely overcome. Other problems
may manifest themselves in the future. Given the relative
newness of this subject, there could be merit in adopting
a step by step approach, only attempting to deal with
abuses as they arise, preferably by means other than
legislation.

3.4.1.3.4.

Institutional investment

Two fundamental reasons for a lower volume of funding
available for venture capital investment in Europe is
that there are less fully-funded pension schemes in
existence and where they do, considerable constraints
on their investment policies exist in some Member
States. It is believed that the creation of more such
schemes will become essential given the demographic
problems facing Europe in the next century and in order

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to maximize their performance these funds will need to
be able to obtain the higher returns obtainable from
investments. The
making significant venture capital
Commission position, underlying the importance of
institutional investment for the success of these markets
and the need for the removal of outdated and unnecessary
restrictions on investment by pension funds, is endorsed.

assurance of the reliability of such a market. When
coupled with the stringent rules imposed on firms whose
shares are traded upon it, it is clearly inappropriate for
rules to apply, or be judged by regulators to apply,
which are more stringent than those applied to ‘official
stock exchanges’. The Commission is asked to examine
how this anomaly might be overcome.

Pension funds should, subject to proper safeguards
which are strictly supervised, have freedom to devise
investment strategies which are in the best interests
of the members of such funds.

4.2. The US experience

4. Other significant points requiring consideration

4.1. The restricted concept of the ‘Regulated Market’

4.1.1.
The legal concept of the ‘Regulated Market’
only applies in the case of the Investment Services and
Capital Adequacy Directives, not to any of the other EU
directives on financial services. This has a number of
potential consequences:

i)

It would appear that shares admitted to trading
could actually be classified as unlisted securities
under certain circumstances, even though they had
to meet standards of regulation and transparency as
strict, or stricter, than those imposed by an ‘official’
stock exchange.

ii) Should the classification of ‘unlisted securities’ be
applied, financial services firms may have to accord
them a nil weighting when calculating solvency
ratios, so restricting institutional investment.

iii) Investment firms dealing in UCITS (Undertakings
for collective investments in transferable securities)
may, under the provisions of national law following
on from Directive No 85/611/EEC, have to carry
out a ‘due diligence’ investigation of the regulated
market concerned before making any investments in
shares traded upon it.

iv) Directive No 88/627/EEC on the information to be
published when a major holding in a listed company
is acquired or disposed of does not apply. This could
lead to a situation where a substantial holding could
be built up in a company traded on these markets,
with the acquirer having no obligation to inform
either the company or the market concerned.

It is presumed that the Commission regarded
4.1.2.
the designation ‘regulated market’ to carry with it an

4.2.1. Whilst there are major economic and social
differences between the USA and the European Union,
there appear to be lessons to be learned from the former
which could improve the situation of SMEs, particularly
financially, but also with regard to management con-
sultancy. This could assist the creation of more new
firms and therefore jobs.

To adopt new initiatives or adapt existing
4.2.2.
structures in the light of those lessons would not mean
that the whole of Europe would become a hive of
entrepreneurial activity. Many areas in the USA certainly
do not warrant that description. Growth in innovative
industries and services (demarcating the two becomes
increasingly difficult) seems to be concentrated in centres
of excellence, largely based either around academic
institutions or in areas such as that west of Washington
DC.

4.2.3.
Part of the reason for the high levels of new
firm creation in the US is cultural, with a spirit of
entrepreneurship,
independence and flexibility more
common in the population. Trying to inculcate a more
entrepreneurial spirit in Europe through the educational
system, something which the Commission apparently
intends to foster, will take time, at least a generation.

4.2.4.
Public policy in Europe must be directed to
facilitating the creation of new businesses and ensuring
that there is a lower death rate among firms in their first
five years of life than in the USA and that more are given
the opportunity to grow to medium size.

4.2.5.
The objective must be to give SMEs, particu-
larly those that are new, access to assistance. How it
is delivered, whether through government agencies,
contractors, or otherwise is a matter of choice for
Member States, preferably after consultation with the
social partners. They should, however, ensure that the
‘displacement effect’ is kept to the minimum. That is,
assistance should not be granted in such a form that it
provides an unfair short-term competitive advantage.

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5. Analysis of the Commission’s conclusions

It is impossible to challenge the Commission
5.1.
conclusions as set out in the Communication, except to
say that the process of achieving the objective of a
genuine SME equity culture in Europe may be a long
process. This will be less so given a new and positive
commitment from legislators and national regulatory
authorities to reduce unnecessary barriers. In particular,
it is essential that innovation in the securities markets is
not retarded, or even stifled, by regulatory problems. It
must always be borne in mind that the main purpose of
securities’ laws and that of regulators is to:

— regulate the relationships between share dealer and
client so that the latter is not treated unfairly or
exposed to the risk of fraud;

— protect investors more generally against fraud and

market manipulation.

5.2.
It is not to try to guard them against market
risk or to protect specific national market interests,
something that will prove increasingly difficult to achieve
in today’s global financial markets.

The primary economic role of the equity markets
5.3.
is to channel passive savings into productive investments.
What the investment firms cannot do currently is to
ensure the optimum level of liquidity in the market
because of the restrictive attitude of national regulators
and legislators in regard to the approval of prospectuses,
the definition of a public offer and what qualifies as a
‘Euro-security’ (see Article 3(f) of the Prospectus Direc-
tive 89/298/EEC). The Commission should ensure that
this Article of the Directive is correctly implemented at
the national level.

5.4. What Europe needs in order to maximize levels
of firm and job creation, aided by efficient financial
markets as in the USA, but maintaining its distinct social
identity, is:

— a greater flow of good companies seeking admission
to stock markets. This means increasing total busi-
ness numbers; making sure they do not suffer
shortages of finance; have access to informed busi-

Brussels, 27 May 1998.

ness advice; do not have their progress retarded by
unnecessary regulatory burdens; and can legally
protect their innovations more easily;

— the encouragement of a greater flow of investment
into equity capital at all stages of company develop-
ment;

— the availability of ‘nursery’ equity markets, probably
at the regional level, from which companies can
move to larger national and pan-European markets
when they have reached an appropriate stage of
development, as well as the utilization of the possi-
bilities offered by the Internet; and,

— the reform of European securities regulation in order
to promote greater transparency and competition
and to allow the efficient operation of a truly
pan-European financial services sector.

5.5.
It is recognized that in each instance some of the
Member States may already have perfectly adequate
mechanisms to address the problem raised, whilst more
are likely to be introduced as a result of the Extraordinary
European Council on Employment held in November
1997. The objective of these recommendations is to
encourage the development of an overall framework
that facilitates SME development and the creation of
new jobs in all parts of the European Union through
filling the gaps in the support framework that remain.
This,
in turn, will have positive effects on overall
economic prosperity in the European Union, considering
that most companies are SMEs. The form in which
measures are introduced will depend on the traditions
and structures in each Member State.

6. Additional comments

6.1.
The Committee welcomes the positive policy
developments outlined in the Commission Communi-
cation ‘Risk Capital: A Key to Job Creation in the
European Union’ (1). It also notes that the vast majority
of suggested initiatives follow the same approach as in
this Opinion. In endorsing the views contained therein,
the Committee asks to be consulted on the continued
evolution of policy in this area.

(1) COM(98) 522 final.

The President

of the Economic and Social Committee

Tom JENKINS