The perfectly laudable idea behind the EU Prospectus Directive, which came in to force on 1 July 2005, was to create a common set of rules throughout the EU to govern raising money through public markets.
Since then, of course, the problems with the system have become apparent.
While these issues have not hit the headlines recently, mainly due to the effects of the worst fund raising environment since the 1930's, there remain some real differences in the interpretation and application of the directive across Europe. In the UK, for instance, it is accepted practice that a rights issue made to existing shareholders requires the preparation of a full prospectus which is PD compliant, in Germany local regulators seem to have found a way around this issue and do not require the production of such a document.
In addition in very many EU member states, local regulators apply the directive through restricting themselves to a "tick box" checklist exercise to ensure the formalities of the directive are complied. In contrast the practice of the United Kingdom Listing Authority, the branch of the UK's Financial Services Authority which reviews prospectuses and compliance with the directive, is very different – being far more active and directly involved in drafting issues.
Significant Impact
It is now abundantly clear that, as widely forecast, the directive has had a significant impact on the behaviour of small and mid-sized listed companies. Without the budget or administrative resources necessary to comply fully with the requirements of the PD, most of these companies seek quotations on markets which are outside the ambit of the directive – the so-called "exchange regulated" markets such as AIM and PLUS. They also avoid the PD by avoiding making "public offers" of their shares to the investors at large or making appeals for further funds to existing shareholders. As a result while, in theory, anyone can buy and sell their shares, in practice their shareholders tend to be institutional and specialist investors, most of whom are longer term holders. This clearly has a knock-on effect on liquidity which, in turn, affects prices – giving these stocks wide spreads and lumpy and unstable prices.
While dwarfed by current issues in the banking sector, the plight of small and mid-sized companies is fairly close to the top of the agenda in Brussels as it is recognized that these companies provide jobs and contribute taxes throughout the EU.
To be fair the European Commission are genuinely concerned to ensure that small and mid-sized companies can access the capital they need to grow and achieve success without the burden of inappropriately heavy regulation. Behind the scenes the Commission has been generally supportive of the development of "exchange regulated markets" which, in an EU context, include Alternext (Amsterdam, Brussels, Paris and Lisbon) and the Entry Level market in Frankfurt in addition to the UK's AIM and PLUS.
Proposals for Change
As a result the EU Commission may finally be in a position to offer some real regulatory help to small and mid-sized companies. As a result of its review of how the Prospectus Directive has been working, the Commission has published a draft directive proposing to amend the Prospectus Directive in which it has picked up on several proposals made by the Quoted Companies Alliance - the UK's representative body for small and mid-cap quoted companies.
The new draft directive contains proposals to reduce the disclosure requirements for prospectuses to be published by companies with small market capitalisations and SMEs. While it is not yet wholly clear what that means, it is hoped that the Commission will latch on to the existing EU definition of an SME which is currently used primarily in relation to tax legislation. This is a company which meets any two of three tests – (i) less than 250 employees; (ii) total balance sheet not more than €43m; and (iii) annual net turnover not more than €50m. It is estimated that such a test would cover over 70% of the companies listed on AIM.
In addition employee share schemes are to be exempted from the obligation to publish a prospectus. This has been something of an anomaly since the PD was introduced in 2005.
Rights Issue Proposals
A reduction in the disclosure requirements on a rights issue to existing shareholders has also been proposed. This makes complete sense as existing shareholders, who are often the most likely source of additional funds for small and medium sized companies, should not need to be reminded of the risks inherent in buying more shares of the same type as those which they already hold. Yet, unfortunately, this amendment has been limited to companies whose securities are traded on "regulated markets" (i.e. the Official List). This limitation makes little sense from the point of view of investors - who are likely to regard their fully listed shares in the same way as those traded on "exchange-regulated" markets.
The European Commission has also proposed the addition of a provision to the Directive allowing it to amend the fundraising limits over which a prospectus has to be produced without the need for formal legislative changes. At present this amount is €2.5m in any 12 month period. Such a move is clearly to be welcomed provided the power is used to raise the limit by a greater amount than the amount of inflation. A bold move to, say, €10m would be extremely welcome in this current environment.
These proposed changes are still at the early stage of the legislative process and much of the detail has yet to be worked out. No doubt the proposals will now be referred to the Committee of European Securities Regulators (CESR) in Paris to work out the details and this stage of the process will take some considerable time. However there may be light at the end of the tunnel which will make a real difference to small and mid-sized quoted companies.
This article first appeared in the November 2009 edition of AimZine.