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Capital Markets Union in Europe edited by Busch, Danny; Avgouleas, Emilios; Ferrarini, Guido (1st March 2018)

Part IV Raising Capital on the Capital Markets, 12 Small and Medium Enterprises Growth Markets

Andrea Perrone

From: Capital Markets Union in Europe

Edited By: Danny Busch, Emilios Avgouleas, Guido Ferrarini

From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2015. All Rights Reserved. Subscriber: null; date: 30 May 2020

Capital markets — Financial regulation

(p. 253) 12  Small and Medium Enterprises Growth Markets

I.  Introduction

12.01  Trading venues play a crucial role in the capital-raising process. Listing on a recognized venue signals the quality of the issuer,1 mitigating the risk of adverse selection caused by the asymmetry of information between issuer and investor. In addition, trading venues increase secondary market liquidity, offering investors greater opportunities for exit and a better chance of achieving the expected returns on which an initial investment is based.2 This is particularly important for the financing of small and medium enterprises (SMEs). Liquid trading venues are crucial for venture capital exit3 and therefore represent an institutional precondition for developing venture capital as a means of SME financing.4

12.02  In accordance with the traditional focus of the European Union on SME financing and its more recent attempt to support SMEs’ access to capital markets,5 Directive 2014/65/EU (MiFID II) has introduced the new category of SME Growth Markets (SME GMs). The new regime addresses some recurrent issues relating to the regulation of trading venues, such as listing standards, financial reporting, and prevention of market abuse. Aimed at preserving the status quo, in which SMEs prefer second-tier exchange-regulated markets, typically in the form of multilateral trading facilities (MTFs),6 the MiFID II rules employ (p. 254) a ‘light touch’ approach. Under the new regime SME GMs: (1) constitute an optional feature of the MTF regime intended to result in a ‘specific quality label’7 and (2) are subject to the rules established by each Member State as applied by the local National Competent Authority (NCAs), within the very broad framework provided by MiFID II.

12.03  It will be the argument of this chapter that the MiFID II regulation pertaining to SME GMs represents a missed opportunity, if not a source of potential harm to the capital-raising efforts of SMEs.8 An effective contribution to the development of SME financing at the EU level would have required a more robust approach. As argued in this chapter, a suitable solution could be a centralized pan-European SME market promoted by the European Commission (EC) and a single mandatory regime featuring a strong focus on liquidity and investor protection.

12.04  The chapter is organized as follows. Section II presents the SME GM regime, framing the description around the goals pursued by the MiFID II regulations. A critical evaluation of the SME GM regime is offered in section III, with a special focus on disclosure and market microstructures. Section IV proposes, from a policy perspective, an alternative solution. Section V concludes.

II.  The SME GM Regime

12.05  MiFID II regulation of SME GMs is based on two fundamental goals clearly stated in the Directive recitals. On the one hand, the regulation aims at introducing a specific quality label for MTFs focused on SMEs. By creating ‘within the MTF category’ the optional ‘new sub-category’ of registered SME GMs, MiFID II is intended to raise the ‘visibility and profile’ of trading venues specifically dedicated to SMEs and to foster ‘the development of common regulatory standards’.9 On the other hand, the SME GM regulation targets ‘the correct balance between maintaining a high level of investor protection and reducing unnecessary administrative burdens for issuers’.10 To this goal, MiFID II recognizes the ‘need to provide sufficient flexibility to be able to take into consideration the current range of successful market models that exist across Europe’.11

1.  SME GMs as an optional subset of MTFs

12.06  Under the definition offered by MiFID II, SME GMs are ‘MTFs that are registered as an SME GM in accordance with Article 33’ of MiFID II.12 This registration is optional. As the relevant recital of MiFID II puts it, operators of a market with a focus on SMEs are able ‘to continue to operate’ in accordance with the requirements of MiFID II ‘without seeking registration’ as an SME GM.13 Analogously, ‘an issuer that is an SME should not be obliged (p. 255) to apply to have its financial instruments admitted to trading’ on an SME GM,14 and an MTF may apply anytime for deregistration as an SME GM.15

A.  The quantitative requirements for eligible MTFs

12.07  In order for the SME GM regime ‘to benefit SMEs’,16 registration as an SME GM is granted when at least 50 per cent of the relevant issuers are SMEs ‘at the time when the MTF is registered’ as an SME GM ‘and in any calendar year thereafter’.17

12.08  The Delegated Regulation (EU) 2017/565, adopted by the EC under Article 33(8) of MiFID II (DR) and based on the technical advice provided by European Securities and Markets Authority (ESMA) in December 2014 (ESMA Technical Advice),18 specifies both when an issuer shall be deemed to be an SME for the purposes of the SME GM regime and how to apply the 50 per cent criterion.

12.09  Concerning the first of these issues, the DR supplements the general definition of SME provided by MiFID II. MiFID II defines SMEs as ‘companies that had an average market capitalisation of less than EUR 200 000 000 on the basis of end-year quotes for the previous three calendar years’.19 Such a definition, however, does not capture either SMEs whose financial instruments have been admitted to trading for less than three years or issuers of exclusively non-equity financial instruments. For this reason, the DR provides an enlarged notion of what constitutes an SME for the specific purposes of the SME GM regime. On the one hand, an issuer whose shares have been admitted for less than three years is deemed an SME if its market capitalization is below EUR 200 million, as determined by the criteria set forth in the relevant provisions of the DR. These criteria are based on: (1) the last closing share price of the first day of trading if the shares have been admitted to trading for less than one year; (2) the last closing share price of the first year of trading if the shares have been admitted to trading for more than one year but less than two years; and (3) the average of the last closing share prices of each of the first two years of trading, if the shares have been admitted to trading for more than two years but less than three years.20 On the other hand, an issuer which has no equity instruments traded in any venue is deemed an SME under the definition provided by Directive 2003/71/EC, now repealed by Regulation (EU) 2017/1129 (Prospectus Regulation). Consequently, the DR considers an issuer to be an SME ‘if, according to its last annual or consolidated accounts, it meets at least two of the three following criteria: an average number of employees during the financial year of less than 250, a total balance sheet not exceeding EUR 43 000 000 and an annual net turnover not exceeding EUR 50 000 000’.21

(p. 256) 12.10  As explicitly required by the relevant recitals of both MiFID II and the DR, the 50 per cent criterion is applied with a significant degree of flexibility. The temporary failure to meet the requirement does not result in immediate deregistration,22 and the absence of a previous operating history does not lead to an automatic refusal to be registered as an SME GM.23 From a different perspective, the DR considers relevant only ‘the average ratio of SMEs over the total number of issuers whose financial instruments are admitted to trading’, ignoring other factors which might have been taken into account (eg the size or turnover of the enterprise, the issuance size of the financial instruments, and the number of different financial instruments issued by the enterprise). Under an approach that favours precision over simplicity, the average ratio is ‘calculated on 31 December of the previous calendar year as the average of the twelve end-of-month ratios of that calendar year’.24 Applicants with no previous operating history are subject to this provision after three calendar years following registration.25 Lastly, under the same criterion of flexibility, a failure to comply with the 50 per cent criterion leads to deregistration only when the proportion of SMEs falls below 50 per cent for three consecutive years.26 As explicitly advised by ESMA, an SME GM that is deemed not to meet the qualifying 50 per cent threshold in one year or two consecutive years is not required to disclose that fact to the market.27

B.  Competent authority for registration and deregistration

12.11  MTFs are registered as SME GMs by the NCA of the relevant operator’s home Member State.28 The home NCA is competent to assess on an annual basis whether the 50 per cent criterion has been met29 and to deregister an MTF as an SME GM.30 Both registration and deregistration decisions are communicated ‘as soon as possible’ to ESMA, which publishes the decisions on its website and keeps a current list of registered SME GMs.31

12.12  In addition to the quantitative requirements discussed above, registration and deregistration depend on certain qualitative criteria. These criteria are aimed at balancing investor protection with reducing compliance costs for issuers.

2.  The balance between investor protection and reducing compliance costs

12.13  Both listing and trading in a regulated venue entail significant costs of compliance. Because these costs are mostly fixed, regulatory compliance is more burdensome for smaller issuers.32 Striking the correct balance between investor protection and compliance costs is (p. 257) therefore essential for the success of SME GMs.33 Nevertheless, emphasizing the diverse nature of existing SME trading venues, and with the goal of preserving operating models suited to local markets and jurisdictions, MiFID II does not provide detailed guidance as to how this balance should be achieved. To be registered as SME GMs, MTFs are generally required to ensure basic levels of investor protection by adopting ‘effective rules, systems, and procedures’.34 The specifics are left to Member States and to the firms operating the MTF. The latter are also allowed to impose requirements in addition to those specified by the general SME GM regime.35

A.  Initial and ongoing admission to trading

12.14  To be registered as SME GMs, MTFs need to set ‘appropriate criteria’ for ‘initial and ongoing admission to trading’.36 In more detail, the DR requires that the MTF ‘has established and applies rules providing for objective and transparent criteria’ and ‘has an operating model which is appropriate for the performance of its function and ensures the maintenance of fair and orderly trading’.37

12.15  Such a regime follows the ‘neutral approach’ suggested by ESMA. The rules of existing trading venues for SMEs employ numerous criteria to assess whether an issuer qualifies for admission to trading (eg the composition of the management and board, the systems and controls enabling compliance with the MTF’s rules, the adequacy of working capital, the use of financial reporting standards). The operating models of these venues vary as to who conducts this assessment; in some venues it is done by the market operator ‘in house’ and in others by third-party corporate financial advisers appointed by the issuers.38 For these reasons, the DR avoids prescribing detailed eligibility criteria, especially as they might concern an issuer’s corporate governance or systems and controls. It only prohibits an SME GM from having rules ‘that impose greater burdens on issuers than those applicable to issuers on regulated markets’.39 In this way, the DR once again favours a flexible approach sensitive to local factors and to the goal of reducing compliance costs. The other side of the coin is a largely discretionary power conferred on NCAs. Indeed, because the eligibility criteria provided by the DR are very broad in scope, and because registration as an SME GM is granted by the NCAs, the quality label of SME GM ultimately depends on the local NCA.

B.  Disclosure to investors upon initial admission to trading

12.16  Following a long-standing EU tradition and in line with the general responsibility of an MTF operator to provide ‘sufficient publicly available information to enable its users to form an investment judgement’,40 the SME GM regime adopts a disclosure-based approach as an essential form of investor protection.

(p. 258) 12.17  In general terms, disclosure to investors upon initial admission to trading connected to a public offering of securities falls within the scope of the prospectus regime. Public offering of securities issued by SMEs, however, may be exempted by the requirements of the prospectus regime, typically because they are below the threshold of EUR 8 million or because they are addressed to qualified investors only.41 In these cases, on initial admission to trading, the issuer is required to publish ‘appropriate admission documents’ containing ‘sufficient information’ to ‘enable investors to make an informed judgement’.42 The differences existing among MTFs focused on SMEs concerning the content of the admission document led ESMA to refrain from suggesting specific approaches (eg a ‘top down’ approach, under which market rules specify categories of disclosure required for a prospectus that are not applied or modified for the purposes of the admission documents; or a ‘bottom up’ approach, under which market rules provide a list of minimum information that must be included in the initial disclosure document).43 For the same reason, ESMA has also suggested avoiding the imposition of the International Financial Reporting Standards (IFRS), adding that it ‘would be a source of significant additional cost for some issuers’.44 Accordingly, the DR requires SME GMs to establish and apply ‘rules that define the minimum content of the admission document’ in such a way that investors are enabled ‘to make an informed assessment of the financial position and prospects of the issuer, and the rights attaching to its securities’.45

12.18  Whether the rules identified by the relevant market operator provide investors with sufficient information is evaluated by the local NCA in granting the SME GM registration.46 Once again, the balance between investor protection and flexibility is in this way entrusted to the discretionary decision of the NCA. A specific regulation is, however, contemplated in the particular case of working capital. While the adequacy of the issuer’s working capital is not considered a mandatory condition for admission to trading, the DR follows the ESMA Technical Advice47 in requiring the issuer to state in the admission document whether it has sufficient working capital and, if not, ‘how it proposes to provide the additional capital needed’.48

12.19  As expressly suggested by ESMA,49 the full responsibility for the accuracy of the information contained in the admission document lies with the issuers.50 No formal approval by the local NCA or the market operator is provided for in the DR,51 even though both the recitals and the DR do not exclude this possibility.52 An appropriate third-party review is, in any case, required with reference to the ‘completeness, consistency and comprehensibility’ of the admission document.53 This regime follows the legal scheme set forth in the (p. 259) Prospectus Regulation,54 with the only difference being that the identity of the reviewer is to be decided by the market operator.55 To this end, the operating model of the SME GM may provide an ‘in house’ review or entrust the review to the issuer’s professional advisor, where an advisor-based model is specified. In both cases, the relevant civil liability provisions of the local jurisdiction apply. Lastly, the DR requires the admission document to clearly state ‘whether or not it has been approved or reviewed and by whom’.56 This provision is somehow unclear: it seems to allow the possibility that an admission document is not reviewed, while a review is required by the same DR.57

12.20  Dissemination of admission documents to the public is accomplished by publishing them on the SME GM website or ‘providing thereon a direct link to the page of the website of the issuers where such documents’ are published.58 In ESMA’s words, the website of the market operators works as ‘a one-stop-shop for investors seeking information on SME GM issuers’.59 For the same reason and in line with general MiFID II record-keeping obligations, SME GMs are required to make available admission documents on their website ‘for a period of at least five years’.60

C.  Periodic financial reporting

12.21  Periodic financial reporting is another area where the need to maintain a high level of investor protection to promote investor confidence is balanced with the convenience of lowering the costs of compliance that would result from applying the requirements provided for regulated markets by Directive 2004/109/EC (Transparency Directive). Taking up a middle ground, MiFID II requires SME GMs to ensure that ‘there is appropriate ongoing periodic financial reporting by or on behalf of an issuer on the market, for example audited annual reports’.61 Following the approach adopted by the Transparency Directive and ‘prevailing best practice in existing markets focusing on SMEs’,62 the DR requires issuers on SME GMs to publish annual and half-yearly financial reports.63

12.22  Such a disclosure regime is more flexible than that provided by the Transparency Directive. As to the content of financial reports, SME GM operators are ‘free to prescribe the use of IFRS or financial reporting standards permitted by local laws and regulation, or both’.64 In addition, ‘as less stringent timeframes appear better suited to the needs and circumstances of SMEs’,65 deadlines for publishing financial reports are less onerous than those prescribed by the Transparency Directive. According to the DR, SME GM issuers are required ‘to publish annual financial reports within 6 months after the end of each financial year’ and (p. 260) ‘half yearly financial reports within 4 months after the end of the first 6 months of each financial year’.66

12.23  Public dissemination of periodic financial reports follows the regime described in the previous subparagraph.67

D.  Prevention of market abuse

12.24  The regulatory choice to balance investor protection with a reduction in compliance costs is largely suspended with regard to the prevention of market abuse. Considering that ‘the majority of cases of market abuse involve issuers of a smaller size’68 and in accordance with the approach adopted by Regulation (EU) No 596/2014 (MAR), which applies the market abuse regime across all trading venues, SME GMs are subject to the full application of the MAR framework.

12.25  While acknowledging that ‘the requirement to disclose inside information can be burdensome’ for SMEs,69 MAR nevertheless restates that ‘prompt disclosure of inside information is essential to ensure investor confidence’ in issuers whose financial instruments are admitted to trading on SME GMs.70 Consequently, MiFID II requires issuers on SME GMs to comply with the relevant provisions applicable under MAR.71 Along the same lines, the MAR regime applies also to persons discharging managerial responsibilities within an SME GM issuer and persons closely associated with them.72 Lastly, in accordance with the general provisions of MAR and MiFID II,73 SME GMs are required to arrange for ‘effective systems and controls aiming to prevent and detect market abuse’.74

12.26  The peculiarities of SMEs, however, are taken into consideration in two respects. First, inside information relating to SME GM issuers ‘may be posted on the trading venue’s website’,75 by either publishing it on the SME GM website or by providing thereon a direct link to the relevant page of the issuer’s website.76 In addition, an SME GM issuer may be exempted from drawing up an insider list provided that the issuer: (1) ‘takes all reasonable steps to ensure that any person with access to inside information acknowledges the legal and regulatory duties entailed and is aware of the sanctions applicable to insider dealing and unlawful disclosure of inside information’, and (2) ‘is able to provide the competent authority, upon request, with an insider list’.77

(p. 261) III.  A Critical Evaluation

12.27  MiFID II regulation of SME GMs is problematic for many reasons. As described in the following subsections, among the most critical issues are: (1) the asymmetry between the problems to be solved and the solutions offered, (2) the choice of disclosure as the main legal strategy to protect investors, (3) the failure to take into account the issue of liquidity, and (4) the absence of a connection between SME GM regulation and the other the institutional preconditions required by SME financing in capital markets.

1.  An answer at odds with the problems to be solved

12.28  In the Impact Assessment published in October 2011, the EC was explicit in recognizing that in SME markets regulated as MTFs at a national level ‘different requirements apply and uncertainty in this regard may put off investors’.78 As described in the previous section, MiFID II has chosen to introduce an opt-in regime aimed at not ‘adversely affecting existing successful markets’,79 and whose content depends on discretionary decisions by local NCAs and market operators. By doing this, MiFID II achieved precisely the opposite of what was needed. Indeed, both the optional feature of the new MTF sub-category and the lack of a unified SME GM regime would appear to increase market fragmentation and uncertainty instead of simplifying the regulatory environment.

12.29  In addition, the fragmentation introduced by the SME GM regime casts doubt on the actual ability of the approach chosen by MiFID II to raise the ‘visibility and profile’ of SME markets.80 The broad provisions of the MiFID II regime for SME GMs allow for quite different methods of implementation. In this context, the ‘specific quality label for SMEs markets’ and the ‘unified European quality label for SMEs’ envisioned by the EC81 cannot withstand a basic reality check. Also, it has been noted that ‘market-based discipline appears to be operating well in the EU’s second-tier market’.82 The actual benefits brought about by a ‘quality label’ are therefore unclear and should in any case be balanced with the fact that the introduction of a new regulated market segment may ‘increase costs by imposing regulatory determination as to how second-tier markets should work’.83

2.  The limits of disclosure

12.30  Following the same rationales of the Prospectus Regulation and the Transparency Directive, admission to trading and listing on an SME GM are subject to disclosure rules, as described in the previous section. According to the fundamental goal of lessening administrative burdens and providing ‘further incentives for SMEs to access capital markets’,84 however, the level of disclosure required for an issuer to access an SME GM is not defined in detail. The task of setting the appropriate level of disclosure is delegated to market operators (p. 262) under the rules implemented by each Member State and is supervised by local NCAs, provided that ‘there is sufficient information published to enable investors’ to make an informed investment decision85 and that an SME GM issuer publishes annual and half-yearly financial reports.86

12.31  While transparency is certainly better than opacity, the effectiveness of a strategy based on ‘light’ disclosure is doubtful. Generally speaking, the cost of information processing and investors’ cognitive limitations pose a well-known challenge to the assumption of perfect rationality that underlies disclosure-based legal strategies.87 This objection cannot be countered by emphasizing the role of institutional investors as informed traders operating with the economies of scale required to process disclosed information and incorporate it into prices.88 While the essential role of institutional investors is beyond question, SME markets feature ‘a lack of institutional-investor interest’, because ‘analyzing and investing in smaller companies is not worth the time and effort’.89 Finally, ‘light’ disclosure in the case of SMEs is somehow paradoxical. Even though ‘SME issuers tend to be higher risk’90 and ‘information asymmetries are often more pronounced for small firms’,91 MiFID II lessens disclosure requirements on them where more information should have been required.92

3.  The forgotten liquidity problem

12.32  In SME secondary markets it is difficult to sell (or buy) quickly without offering a discount (or a premium). In the jargon of finance, SME secondary markets suffer from a liquidity problem93 that makes securities cost more and sell for less, eating into investment returns.94 The main reason for the illiquidity of SME markets lies in the lack of interest by institutional investors. Even ‘a well performing investment in smaller companies would have little impact on the total returns’, making it inefficient for an institutional investor to devote resources to analysing and investing in SMEs.95 The more institutional investors stay away from SME markets, the more the opportunities to find a buyer or a seller decrease and so does liquidity. In addition, illiquidity increases the cost of trading, which in turn further increases illiquidity.96

(p. 263) 12.33  The liquidity issue is not addressed in any way by the MiFID II regulatory scheme. In its Impact Assessment, the EC did identify ‘the lack of market liquidity for SME shares’ as a problem,97 but considered that the solution was simply a matter of greater market visibility: ‘by giving more visibility to SME markets and thus more liquidity to their assets, more investors will be attracted to these markets’.98 This connection between market visibility and liquidity is, however, both unrealistic and simplistic. It is unrealistic because, as noted above,99 the fragmentation introduced by the SME GM regime makes implausible the achievement of the specific quality label for SME markets, which, according to the EC, is intended to be the basis of SME GM visibility. It is simplistic because the existence of liquidity requires many other institutional preconditions: selective listing ensuring the quality of the listed companies, strong investor protection, and sensible market microstructure regulation, with a particular focus on trading rules.

4.  An incomplete approach

12.34  SME secondary markets are only one piece of the larger picture of SME financing through capital markets. The relevant ‘ecosystem’ includes market advisory and venture capital, market making-systems, accounting and auditing standards, research on credit and investment information, regulation aimed at investor protection, and various forms of governmental intervention.100 All these institutional preconditions are interrelated and each element works to the extent that the others do.

12.35  Failing to acknowledge this broader framework, the SME GM regime largely lacks a systematic approach. It focuses on some aspects of listing and trading, disregarding the interplay between the functioning of secondary markets and the other relevant aspects of the SME finance ecosystem. In addition, the fragmentation resulting from the different standards of listing, disclosure, and financial reporting applicable in each Member State favours local intermediaries, thus hindering the development of an SME-specialized financial industry across the EU with sufficient economies of scale to ensure at least some of the features required for granting SMEs efficient access to capital markets (eg venture capital, market making, research on credit, and investment information).

IV.  An Alternative Proposal

12.36  The previous discussion justifies the conclusion that the SME GM regime provided by MiFID II has little capacity to effect a significant change, leaving the status quo unaffected. This outcome could lead to an even more radical conclusion: because the obstacles facing SME markets—asymmetries of information, liquidity, high risk of market abuse—are intrinsic and cannot be overcome, attempts to stimulate SME capital markets could be considered to be flogging a dead horse.

(p. 264) 12.37  Although grounded in realistic assumptions, such scepticism would nevertheless be excessive. The US experience proves that a robust, sustainable market for SMEs is feasible under the condition of a ‘dramatically centralised small-cap market’, as demonstrated by ‘NASDAQ and its regulatory structure’.101 In the current situation of the EU, however, centralization cannot be reached by pure market mechanisms. Some form of political action is required. The proposal of this chapter is to create a centralized pan-European SME market promoted by the EC and provided with a regime featuring a strong focus on liquidity and investor protection, to be extended also to local SME trading venues.

1.  A pan-European trading venue

12.38  As the successful experience of Target2-Securities shows, pan-European centralized financial infrastructures are both possible and effective. In trading venues as in the settlement industry, market-led initiatives hardly reduce barriers to cross-border trade because ‘those benefiting from fragmented markets have little incentive to open up existing national monopolies to competitors’.102 Therefore, a ‘supranational organisation with a clear commitment to financial integration and no economic self-interest’103 could be better suited to build a truly EU-wide infrastructure, featuring the appropriate liquidity and investor protection required for an effective trading venue for SMEs.

12.39  The failed experience of a European NASDAQ in the late 1990s is clear evidence of the possible political opposition by national players to a centralized solution.104 As demonstrated by the decision taken for post-trading infrastructures,105 however, in the aftermath of the crises, the EU pendulum is swinging more towards mandated central solutions than to liberalized markets. The recurrent emphasis on the lack of appropriate SME financing by banks106 suggests an analogous momentum towards centralization also for SME trading venues.

12.40  A centralized SME trading venue is capable of avoiding fragmentation, thus increasing liquidity and simplifying supervision. Local offices might reduce transaction costs for issuers by easing their access to operations. Finally, from a subsidiarity perspective, private operators could continue to run local SME trading venues as far as they prove to be more effective for local businesses. Indeed, while a centralized trading venue could offer more liquidity, local trading venues could still be more appropriate for small domestic businesses targeting local investors.

12.41  The governance of such a pan-European trading venue could be politically problematic. Whereas an initiative taken by the EC under the advice of ESMA appears to be the proper approach for blending political evaluation and technical expertise, the governing (p. 265) structures of the trading venue could include a strategical supervisory body, representing both ESMA and the financial sector of Member States, and an executive board composed of experienced independent professionals.

2.  A single regime

12.42  A single regime to be applied to both the centralized and the local trading venues would simplify the regulatory environment, may improve market participation, and could create the conditions for greater market integration at the EU level. A single regime requires, however, identifying priorities and addressing issues with significant distributional effects. From this perspective, liquidity and investor protection should be prioritized. As discussed before, the lack of liquidity undercuts SME secondary markets, while a strong level of investor protection is crucial for increasing market participation.

A.  Increasing liquidity

12.43  Liquidity is strongly connected with the rules of trading. More specifically, it depends on the solutions chosen with regard to certain highly pertinent technical issues: unlisted trading, pre-trade transparency, and the choice between continuous trading and call auctions.107

12.44  In general terms, Regulation (EU) No 600/2014 (MiFIR) does not prohibit unlisted trading nor does it ban ‘dark pools’ in which institutional investors trade anonymously and without full pre-trade transparency.108 Similarly, MiFIR grants a waiver from the general pre-trade transparency regime to equity instruments traded in ‘systems that formalize negotiated transactions which are in an illiquid share’.109 This regime, which is favoured by large institutional investors because it reduces trading costs110 and provides opportunities for more advantageous deals, is often justified on a liquidity rationale. The argument is that, by creating the conditions for better deals, unlisted trading and limited pre-trade transparency supply institutional investors with an incentive to operate as market makers, thereby increasing liquidity. The applicability of this argument to SME markets is, however, doubtful. As discussed in the previous paragraph,111 institutional investors lack interest in SMEs and therefore in the case at hand their role as liquidity providers should not be overemphasized. For this reason, liquidity in SME markets might benefit by adopting an opposite solution. Banning unlisted trading and requiring full pre-trade transparency would concentrate trading on exchanges and create a simpler and more transparent market environment. This might render SME markets less arcane and more attractive for investors, thereby increasing market participation and liquidity.

(p. 266) 12.45  Also the alternative between continuous trading and call auctions could play a role. Continuous trading allows investors to trade at any time the trading venue is open, while call auctions require trades to occur at a certain time. While continuous trading is more flexible, it is ‘spread out temporally, which decreases liquidity’.112 Call auction trading is less flexible; however, by concentrating trades over a certain time period, it could generate high liquidity during the relevant sessions, which might be better for financial instruments—like SME shares—which tend to be illiquid.

12.46  In light of the above discussion, the conclusion appears straightforward. An EU regulatory regime of SME markets with the goal of favouring SME access to capital markets should ban unlisted trading, provide full pre-trade transparency, and mandate call auction trading.113

B.  Protecting investors

12.47  While crucial for market participation, investor protection requires legal strategies appropriate to the specific features of SME markets. Taking into consideration the limited interest of institutional investors in trading SME financial instruments and the higher burden of compliance costs faced by small issuers, traditional legal strategies employed in regulated markets would not appear to be proper. Stringent disclosure and corporate governance requirements are too costly for issuers and very few investors, if any, possess the economies of scale necessary for effectively processing information provided to the market.114 In addition, SME markets present their own specific risks. On the one hand, retail investors in SME markets do not benefit from the protection offered by the presence of institutional investors as informed traders and are therefore more exposed to inefficient prices;115 on the other, the possible illiquidity of SME financial instruments116 and the limited scrutiny applied by supervisors to smaller issuers117 increases the risk of market manipulation.

12.48  In this context, screening and monitoring the quality of listed SMEs, limiting disclosure requirements to essential information, and providing strong public enforcement of market abuse might be appropriate solutions to ensure investor protection.

12.49  More specifically, relatively high listing standards (eg minimum revenues of EUR 5 million for over three years, with EUR 7 million in the listing year) might offer a general guarantee of the business model and the financial stability of the relevant SME.118 Pre-listing screening and continuous post-listing monitoring by a reputational gatekeeper, on the model of the Nominated Advisor (Nomad) introduced by the London Stock Exchange’s Alternative Investment Market (AIM), might be an effective substitute for corporate governance and internal control requirements.119

(p. 267) 12.50  Considering the prevalence in these markets of retail investors, disclosure should be limited to the minimum necessary to understand the SME’s management and business (eg the names and the background of the managers and an overview of the business)120 and the status of company operations (eg annual and half-yearly financial reports based on uniform EU accounting standards). Requirements to disclose inside information should be limited to extraordinary corporate matters and sharp gains or losses, carving out a special perimeter within the general definition provided by Article 7 MAR.121

12.51  Finally, sound and efficient functioning of the system could be fostered by ensuring effective enforcement of market abuse regulations. Indeed, the higher probability of market abuse deters from investing and raises the cost of capital for issuers.122 To this aim, the proposed centralized approach could significantly help by simplifying the enforcement action. A single supervisor focusing on a single trading venue assures effective and efficient enforcement more than multiple enforcers supervising several trading venues in a potentially inconsistent way.123

12.52  From the supply side, additional investor protection is offered by existing regulations on investment services providers. Indeed, both the suitability regime and the new product governance obligation provided for distributors by Level 2 regulations124 could operate to screen the access of retail investors to SME markets, limiting the risks of improper investments.

V.  Conclusions

12.53  It has been accurately noted that the SME GM regime ‘was broadly uncontroversial over the MiFID II/MiFIR negotiations’.125 The reason is not difficult to identify. Leaving the status quo unaffected, the new regime corresponds to the interests of incumbents126 and pays some forms of political dividend to both Member States and the EC. The brunt of this political choice, however, is borne by SMEs seeking finance and, eventually, by the chances for increasing economic growth within the EU. If the EC’s ‘top priority is to strengthen Europe’s economy and stimulate investment to create jobs’,127 the approach to SME markets should have been different. This chapter is an attempt to contribute to the discussion.


*  I am grateful to Mario Anolli, Giuseppe D’Agostino, Victor De Seriere, Carmine Di Noia, Luca Enriques, Han Gulyás, Giovanni Petrella, and Stefano Valente for their insightful comments on an earlier draft. Errors remain my own.

1  Niamh Moloney, EU Securities and Financial Markets Regulation (3rd edn, OUP 2014) 169.

2  Thierry Foucault, Marco Pagano, and Ailsa Roell, Market Liquidity: Theory, Evidence, and Policy (OUP 2013) 5.

3  Moloney, EU Securities (n 1) 174.

4  Gordon D Smith, ‘The Exit Structure of Venture Capital’ (2005) 53 UCLA Law Review 315, 356.

5  Niamh Moloney, ‘The Legacy Effects of the Financial Crisis on Regulatory Design in the EU’ in Eilís Ferran, Niamh Moloney, Jennifer G Hill, and John C Coffee, Jr (eds), The Regulatory Aftermath of the Global Financial Crisis (CUP 2012) 177 ff. SME financing is among the priorities set by the Commission in the Capital Markets Union Action Plan: European Commission, ‘Action Plan on Building a Capital Markets Union’ COM (2015) 468 final 9 f (CMU Action Plan); European Commission, ‘Addressing Information Barriers in the SME Funding Market in the Context of the Capital Markets Union’ SWD (2017) 229 final.

6  Moloney, ‘Legacy Effects’ (n 5) 173 ff. For an overview of existing trading venues for SMEs see Rüdiger Veil and Carmine Di Noia, ‘SME Growth Markets’ in Danny Busch and Guido Ferrarini (eds), Regulation of the EU Financial Markets (OUP 2017) 13.04–13.07.

7  European Commission, ‘Impact Assessment’ SEC (2011) 1226 final 37.

8  Moloney, EU Securities (n 1) 175 f.

9  Recital (132) MiFID II.

10  Recital (133) MiFID II.

11  Recital (133) MiFID II.

12  Art 4(1)(12) MiFID II.

13  Recital (134) MiFID II.

14  Recital (134) MiFID II.

15  Article 33(5)(a) MiFID II.

16  Recital (135) MiFID II.

17  Article 33(3)(a) MiFID II.

18  ESMA/2014/1569, ‘Final Report—ESMA’s Technical Advice to the Commission on MiFID II and MiFIR’ (19 December 2014).

19  Article 4(1)(13) MiFID II.

20  Article 77(1) DR.

21  Article 77(2) DR.

22  Recital (135) MiFID II.

23  Recital (111) DR.

24  Article 78(1) subpara 1 DR.

25  Article 78(1) subpara 2 DR .

26  Article 79(1).

27  ESMA, Technical Advice (n 18) 348, nn 33 and 34.

28  Article 33(1) MiFID.

29  Article 78(1) DR.

30  Article 33(6) MiFID II.

31  Article 33(6) MiFID II.

32  Jeff Schwartz, ‘The Law and Economics of Scaled Equity Market Regulation’ (2013) 39 Journal of Corporate Law 347, 381–82; Guido Ferrarini and Andrea Ottolia, ‘Corporate Disclosure as a Transaction Cost: The Case of SMEs’ (2013) 9 European Review of Contract Law 363, 370; Thomas J Chemmanur and Paolo Fulghieri, ‘A Theory of the Going-Public Decision’ (1999) 12 Review of Financial Studies 249; European Commission, ‘Economic Analysis’ SWD (2017) 224 final, 5; WFE Report on SME Exchanges, (2016) 6 and 21 f.

33  European Commission, ‘Economic Analysis’ (n 32) 45, 49; European Commission, ‘Mid-Term Review of the Capital Markets Union Action Plan’ COM (2017) 292 final 11.

34  Article 33(3)(b)–(g) MiFID II.

35  Article 33(4) MiFID II.

36  Article 33(3)(b) MiFID II.

37  Article 78(2)(a) and (b) DR.

38  ESMA, Technical Advice (n 18) 352–53, nn 3 and 5.

39  Recital (112) DR.

40  Article 18(2) MiFID II.

41  Respectively, Arts 3(2)(b) and 1(4)(a) of the Prospectus Regulation.

42  Article 33(3)(c) MiFID II.

43  ESMA, Technical Advice (n 18) 358–59, nn 4–15.

44  ibid 354, n 10.

45  Article 78(2)(d) DR.

46  Article 78(2)(d) DR.

47  ESMA, Technical Advice (n 18) 355, n 15.

48  Article 78(2)(e) DR.

49  ESMA, Technical Advice (n 18) 360, n 17.

50  Recital (113) DR.

51  Article 78(2)(c) DR.

52  Respectively, recital (113) and Art 78(2)(c) DR.

53  Art 78(2)(f) DR.

54  Article 20(12) of the Prospectus Regulation.

55  Article 78(2)(f) DR.

56  Article 78(2)(c) DR.

57  Article78(2)(f) DR.

58  Article78(2)(h) DR.

59  ESMA, Technical Advice (n 18) 368, n 8.

60  Article 78(2)(i) DR.

61  Article 33(3)(d) MiFID II.

62  Recital (114) DR.

63  Article 78(2)(g) DR.

64  Recital (114) DR.

65  Recital (114) DR.

66  Article 78(2)(g) DR.

67  Article 78(2)(h) and (i) DR.

68  Commission Staff Working Document on the Call for Evidence Accompanying the Document Communication from the Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions [2016] SWD (2016) 359 final 16 (Call for Evidence).

69  More recently, ibid: ‘some respondents argued that the market abuse regime places a high burden on issuers in SME growth markets, which may ultimately result in less activity and thus reduced financing for SMEs’.

70  Recital (55) MAR.

71  Article 33(3)(e) and 33(3)(3) MiFID II.

72  Article 33(3)(e) and 33(3)(3) MiFID II.

73  Respectively, Art 16(1) MAR, and Art 31(1) MiFID II.

74  Article 33(3)(g) MiFID II.

75  Article 17(9) MAR.

76  Article 78(2)(h) DR.

77  Article 18(6) MAR.

78  European Commission, ‘Impact Assessment’ (n 7) 11.

79  Recital (134) MiFID II.

80  Recital (132) MiFID II.

81  European Commission, ‘Impact Assessment’ (n 7) 25 and 37.

83  ibid.

84  Recital (132) MiFID II.

85  Article 33(3)(c) MiFID II.

86  Article 78(2)(g) DR.

87  Luca Enriques and Sergio Gilotta, ‘Disclosure and Financial Market Regulation’ in Eilís Ferran, Niamh Moloney, and Jennifer Payne (eds), The Oxford Handbook of Financial Regulation (OUP 2015) 511.

88  Zohar Goshen and Gideon Parchomovsky, ‘The Essential Role of Securities Regulation’ (2006) 55 Duke Law Journal 711, 758.

89  Jeff Schwartz, ‘Venture Exchange Regulation: Listing Standards, Market Microstructure, and Investor Protection’ (2016) SSRN <https://papers.ssrn.com/sol3/papers.cfm?abstract_id-=2836725> accessed 17 January 2017 (forthcoming in The Handbook On Law And Entrepreneurship 2017); for some empirical data, SME Exchanges (n 32) 20.

90  Moloney, ‘Legacy Effects’ (n 5) 179.

91  European Commission, ‘Economic Analysis’ (n 32) 24.

92  For the different approach chosen by NASDAQ, enhancing disclosure requirements for SMEs see Eric Posner, ‘Copying the Nasdaq Stock Market in Europe: Supranational Politics and the Convergence-Divergence Debate’ Working Paper (2014); but see also section IV.2.A.

93  IOSCO, ‘SME Financing Through Capital Markets’ FR 11/2015; European Commission, ‘Economic Analysis’ (n 32) 47.

96  ibid.

98  ibid 62.

99  Section III.1.

100  IOSCO, ‘SME Financing’ (n 93); CMU Action Plan (n 5); European Commission, ‘Economic Analysis’ (n 32) 46, 49; SME Exchanges (n 32) 12.

101  Solomon M Karmel and Justin Bryon, A Comparison of Small and Medium Sized Enterprises in Europe and in the USA (Routledge 2002) 101.

102  Gertrude Tumpel-Gugerell, ‘The Competitiveness of European Financial Markets’ Business Economics (July 2007) 18.

103  ibid.

104  Elliot Posner, The Origins of Europe’s New Stock Markets (Harvard University Press 2009) 116 ff; Steven Weber and Elliot Posner, ‘Creating a Pan-European Equity Market: The Origins of EASDAQ’ (2000) 7 Review of International Political Economy 529, 549 ff.

105  Karel Lannoo and Diego Valiante, ‘Integrating Europe’s Back Office. 10 Years of Turning in Circles’ ECMI Policy Brief No 13 (June 2009) 7.

106  CMU Action Plan (n 5) 4; IOSCO, ‘SME Financing’ (n 93) 2.

107  For other approaches (ie direct involvement by the European Investment Bank group and national promotional banks and dedicater funds-of-funds), see European Commission SWD (2017) 225 final 7 (Feedback Statement); SME Exchanges (n 32) 26.

108  Articles 4(1) and 5(1) MiFIR.

109  Article 4(1)(b)(ii) MiFIR.

110  Katharina Niciejewska, Dark Pools and Flash Trading: New Trends in Equity Trading? (Anchor Academic Publishing 2015) 5; Guido Ferrarini and Niamh Moloney, ‘Reshaping Order Execution in the EU and the Role of Interest Groups: From MiFID I to MiFID II’ (2012) 13(4) European Business Organization Law Review 588; IOSCO, Principles for Dark Liquidity (2011) FR 06/11, 11–12.

111  Section III.2.

113  ibid 12–16.

114  See section III.2.

115  Schwartz, ‘The Law and Economics’ (n 32) 376 f.

117  Schwartz, ‘The Law and Economics’ (n 32) 372 f; Deniz Angine et al, ‘Should Size Matter When Regulating Firms? Implications From Backdating of Executive Options’ (2012) 15 NYU Journal of Legislation & Public Policy 8–9.

119  The effectiveness of an approach based on reputational intermediaries has been recently confirmed: European Commission, ‘Economic Analysis’ (n 32) 47; SME Exchanges (n 32) 12, 25 f.

120  Schwartz, ‘Venture Exchange Regulation’ (n 89) 22; analogously, Veil and Di Noia (n 6) 13.35.

121  For a similar proposal, emphasizing legal costs to comply with MAR requirements about disclosure of inside information, Veil and Di Noia (n 6) 13.28–13.29, 13.54.

122  Schwartz, ‘The Law and Economics’ (n 32) 372.

123  Moloney, EU Securities (n 1) 437.

124  Article 10, para 2, subpara 3, of the Delegated Directive adopted by the EC under Art 16(12) MiFID II.

125  Moloney, EU Securities (n 1) 175.

126  Ferrarini and Moloney, ‘Reshaping Order Execution in the EU’ (n 110) 590.

127  CMU Action Plan (n 5) 3.