In need of a cure

Equity markets appear to a little lacklustre. Once the symbol of a nation’s economic virility and its ability to support new businesses, European stock markets have slowly diminished as the preferred route for raising capital in developed economies.

The Kay Report, an examination of increasingly short-term nature of investment in the UK, by Professor John Kay, an economist at the London School of Economics, stated: “The IPO is no longer the aspiration of a fledging business…British companies now rarely use primary equity markets as a source of funds for new investment: if they raise new equity at all, it is usually part of some financial restructuring.”

Moreover, it argues that the commitment of pension funds and insurance companies to equity markets has waned over the last decade because of more rigorous scrutiny of pension funds deficits and the growing popularity of liability-driven investment strategies.

The UK equity market’s ills are evident in the forced sale of PLUS Market Group, which divested its UK SME market, PLUS SX, to ICAP after tumbling issuance levels and trading volumes made its business untenable despite diversification attempts. An unwillingness to accept the plans of PLUS SX’s new owners could leave some high-profile listings such as Arsenal Football Club and brewery Shepherd’s Neame looking for new sources of funding.

The London Stock Exchange’s AIM market isn’t doing much better, with new issues declining to 891 at the end of June 2012, from 1,337 in June 2007.

But this isn’t just a UK malaise. The SME Strategic Planning Committee, a group backed by NYSE Euronext, advocates the creation of a pan-European small- and mid-cap exchange to help boost liquidity in this sector. Meanwhile, MiFID II contains a series of provisions for creating SME-focused multilateral trading facilities.

But are such initiatives tackling the symptoms of a deteriorating SME market rather than addressing its causes?

In his report, Kay suggests that – rather unlike MiFID II – regulation to encourage long-term equity investing should be tailored to the needs of market users, i.e. companies and savers, rather than market intermediaries. “The range and scale of failures in the financial system since 2008…has demonstrated that the inadequacies of regulation lie in inadequacies of design rather than deficiencies in implementation,” the review states.

Perhaps the answer for policy makers in Europe is to take an approach similar to the Jumpstart Our Business Startup (JOBS) Act in the US, which was passed into law in April and seeks to ease the regulatory burden on smaller companies looking to raise capital.

The Act eases the burden on firms looking to raise capital through financial markets, such as extending the period for compliance with certain rules and exemptions from some disclosure and regulatory requirements related to raising funds through public and private means.

If the goal is to breathe new life into equity markets as a means of financial intermediation between savers and companies then rules need to better assist companies in launching new issues through structures and incentives that support them, rather than trying to tinker with the infrastructure.