When government leaders and policymakers talk about the importance of SMEs (small and medium sized enterprises) in driving innovation, job creation and economic growth, one of the areas often overlooked is how these companies can finance that growth. Despite their economic importance SMEs struggle with access to finance, according to an OECD report from 2015, Financing SMEs and Entrepreneurs.
On the release of a new report on financing SMEs through listing on stock exchanges, Staci Warden, executive director, Center for Financial Markets, Milken Institute said, “Given the importance of SMEs for job creation and economic growth, expanding access to finance for these businesses is one of the most fundamental issues for inclusive economic development.”
While this is true in many countries across advanced, emerging, and developing economies, it is particularly pronounced in economies with less developed financial sectors. The IFC estimates the finance gap for formal SMEs in developing countries to be around US$1 trillion.
Policymakers have increasingly emphasized the importance of expanding SMEs’ financial access to non-bank sources of funding, including public equity financing. This has taken a variety of forms including, for example, promoting the creation of dedicated SME exchanges.
In the past few decades, an increasing number of stock exchanges worldwide have set up specialized SME boards or market segments with the intention of expanding SMEs’ financial access (among other reasons). Many of these boards encourage listings by having different entry standards than the main board, streamlining the listing process and reducing the associated costs.
Few studies have comprehensively examined the effectiveness of equity markets, and SME exchanges specifically, in meeting the financial and other listing motives of SMEs, especially from the perspective of SMEs themselves. The World Federation of Exchanges (WFE) and the Milken Institute Center for Financial Markets (CFM) both recently published new research findings examining how and why SMEs access stock exchanges, as well as the role of stock exchanges in financing SMEs.
Although the specific focus areas of the two organizations differed somewhat, the two studies have large areas of overlap and complementarity. The WFE and the Milken Institute fielded an almost identical, jointly developed survey questionnaire targeting listed and unlisted companies across Jamaica, South Africa, and India (Institute focus countries) and South Africa, Canada, China, Nigeria, and Mexico (WFE focus countries). The Milken Institute also surveyed senior stock exchange managers while the WFE surveyed retail and institutional investors and market intermediaries in their respective focus markets.
The primary findings of the report can be summarized as follows:
- For the surveyed companies, stock exchanges are performing the very important function of providing SMEs with access to cost-effective finance. Indeed, 60 percent of firms said, ‘raising capital at lower cost’ was an important reason for listing, and 76 percent of surveyed firms cited the lower cost of capital as their reason for raising public equity, rather than other types of capital.
- In addition to finance-related matters, SMEs also listed to position the firm for growth; to enhance brand and reputation; and to diversify the investor base.
- In response to a survey question about whether firms would list again, 74 percent said they would, demonstrating the positive experience of being listed.
- The report also highlights areas where the company experience of being listed was worse than expected. These include time and costs of aligning financial record keeping and reporting with listings requirements, and meeting ongoing listings requirements.
- Among unlisted firms, the reasons for not listing varied across the different countries, ranging from concerns about the cost of listing, and meeting regulatory requirements, to not knowing enough about listing to make a decision.
- Two key factors were identified that could make listing more accessible: containing costs; and improving firms’ ability to understand and meet the listings requirements.
From the aggregated results in the survey of listed and unlisted SMEs, over 90 percent of all surveyed listed firms raised capital at the time of listing and a further 22 percent raised additional equity capital post-listing. In line with the theory that equity capital offers a more affordable source of finance than some of the alternatives, 76 percent of firms cited lower cost of capital as their reason for raising public equity capital as a means of financing.
Thirty-five percent of listed firms that answered positively when asked if they would list again said the ability to raise funds at lower cost was one of the reasons they would. Finally, amongst unlisted firms that said that they would consider listing in the future, the opportunity to raise capital at lower cost was the second most frequently given reason.
Nandini Sukumar, CEO, WFE said, “Our joint research suggests that stock exchanges can contribute positively to SME growth. This is particularly important as SMEs play such a vital role in generating economic growth, particularly in developing countries where SMEs are instrumental in creating jobs, building thriving private sectors, and diversifying economies.”
The WFE’s SME Working Group has 21 member exchanges from across all WFE geographies. Its ongoing mandate is to identify critical success factors for SME markets. Established in 1961, the WFE is a global industry association for exchanges and clearing houses. It represents over 200 market infrastructure providers, including standalone CCPs (central counterparty clearing house) that are not part of exchange groups. Of its members, 41 percent are in Asia-Pacific, 40 percent in EMEA and 19 percent in the Americas. WFE exchanges are home to nearly 45,000 listed companies, and the market capitalization of these entities is over $67.9 trillion; furthermore, around $84.18 trillion in trading annually passes through the infrastructures WFE members safeguard (as of the end of 2016).
The WFE and publishes over 350 market data indicators – its statistics database goes back over 40 years, providing information and insight into developments on global exchanges.
Read the report in full here.
[Photo: An exchange member of WFE]