European Union Tries to Limit Access of SMEs to Capital Markets

The European Union is famous for adding an ever increasing regulatory burden on companies. So when it announces that it will reduce the burden of excessive regulation one is naturally skeptic about its real motivations. This week’s announcement of proposals to reduce the burden for Small and Medium Enterprises (SMEs) imposed by the so-called Transparency Directive (2004/109/EC) provides a clear illustration of such dubious practices.

The Commission announced its intention to exempt SMEs and other listed firms from the obligation to provide quarterly accounts, invoking its burden in terms of cost and that it is not necessary for investor’s protection. These two arguments are clearly false. First, a firm that is so weak that it cannot support the cost of reporting on a quarterly basis should not be listed at all. Second, any investor knows that failure to publish financial information in a timely manner is the first symptom to identify troubled companies that should be avoided.

Indeed, if the Commission had surveyed professional investment analysts it would realize that they favor monitoring companies using trailing indicators for the past 12 months and obviously these cannot be calculated without quarterly accounts.

That is the reason why even stock markets famous for their lack of transparency, like South Korea and Japan, progressively had to adopt the standard practice of publishing quarterly accounts.

What will be consequences of SMEs not publishing quarterly accounts? Basically they will not be followed by analysts and consequently will not attract institutional investors, which provide most of the capital available in the market. By being forced into the speculative segment of markets they will be identified as dangerous assets and reinforce the bias in favor of large-cap stocks. That is, most SMEs will be barred from the capital market.

In fact, the large-cap bias is already a major problem in European markets. For instance, to realize the dimension of this problem one can compare the markets of Tel Aviv and Paris. In France there are 850 companies listed in the market, of which only 530 provide enough information to be correctly analyzed; while in Israel there are 460 listed companies of which 260 provide such level of information. That is, France with an economy twelve times the size of the Israeli economy barely has twice the number of investible stocks that Israel has.

To sum up, the Commission has managed to find one of the rare instances where lighter regulation is synonymous with worse regulation. Or to say it differently, it wants to persuade SMEs to shoot their own foot.