Small and medium size enterprises (SMEs) are a major driver of economic activity, in developed and emerging markets alike.
In India, for instance, SMEs not only provide key inputs to Indian industry but are also estimated to contribute a substantial portion of gross domestic product and are among the largest employers in the country.
But raising capital remains a key challenge for them. While bank credit and capital markets both play a pivotal role as capital sources for the SMEs in some of the developed markets, those in the emerging markets are still heavily dependent on the banking sector for capital. Even there, lenders prefer larger-sized clients to smaller companies due to risk perceptions.
Bond issuances have generally been seen to be more successful if done by large companies, as compared to the smaller companies. In terms of equity capital, most of the smaller firms may find it difficult to garner equity financing on the main exchanges.
Given this scenario over funding sources coupled with SMEs’ inherent importance for economic growth, an SME stock exchange is believed by many to give a boost to their finance raising needs. Such a financing platform would attract early-stage, growth investment firms, who may get a niche platform to analyze and invest in the next generation of blue chips.
Looking at the Indian scenario, while the recent steps of the main equity bourses to launch SME exchange platforms are positive moves, the long-term success of the venture will largely depend on its format and execution – which faces some challenges.
DIVERSE SECTORS
Firstly, this platform will need to bring together the Indian SME universe, which is very diverse in terms of sectors and segments. Investors will need to study research reports on these companies and shares listed on smaller exchanges are often less researched.
The ability of major sell-side intermediaries and buy-side fund managers to ensure regular delivery of research insights on such a diverse sector universe is a challenge, given the specific skill-sets and knowledge that each sector demands.
Moreover, corporate governance practices and disclosures need to be followed in a standardized manner across the universe; otherwise it will make the process of stock selection challenging. The success of the main equity exchange platforms has traditionally been in stocks with high liquidity. These are the stocks that are constantly on the radar of investors, both domestic and foreign.
As a result, not all listed stocks are traded actively. In fact, most of the shares with lower trading volumes on the main exchanges are actually the smaller companies, which struggle to garner investor interest.
During periods of broad-based market rally, there is still some interest that flows down to the smaller mid-caps and small-caps following the initial rally in the large-caps. But during periods of market downturn, these smaller companies struggle to generate investor interest.
Periods of market downturn also render primary market activity sluggish, which impacts the success of the exchange platform.
Globally, SME exchange platforms have seen mixed response. Most of the SME exchanges are part of the larger exchange organizations, similar to the Indian scenario. Most of the global platforms have targeted either niche segments, or have offered attractive terms and requirements.
MEETING THE CHALLENGE
Some global examples are UK’s AIM, which maintained flexible requirements like no minimum listing size and trading in any freely available currency, Japan’s Jasdaq which targeted only small technology stocks, USA’s Nasdaq First North for small, young and growth companies, Tokyo Exchange’s Mothers, a market for high-growth and emerging stocks which provides venture companies access to funds at an early stage of their development.
There is also London’s PLUS Markets which aims to create a deep pool of small and mid-cap liquidity in Europe, Toronto Stock Exchange’s TSX Venture Exchange which provides access to public venture capital to facilitate growth for new ventures, Johannesburg Stock Exchange’s Alternative Exchange, a parallel market focused on good quality small and medium sized high growth companies, and Hong Kong’s Growth Enterprise Market, which offers growth enterprises an avenue to raise capital and investors an alternative investment in high growth-high risk businesses.
To address the challenges, the new SME exchange platforms being launched may need to target and identify high growth sectors and companies and ensure those stocks get listed on its platform. Increasing research coverage into these companies’ growth story to attract retail interest and small-sized investment firms would be a key enabler in generating interest, activity and liquidity.
Expanding research coverage will enable transparency, information access, and understanding on a larger universe of stocks and help showcase companies with strong business performance and corporate governance. This could, in turn, help investors identify value-picks from amongst the mid and small cap universe and help them participate in these companies with much greater conviction.
On the distribution side, the key for sell-side intermediaries would be to identify and target niche pockets of liquidity for this segment. Improving corporate governance and adherence to good governance principles would prevent fraud, and it is critical to identify those who score highest on corporate governance practices, including audited accounts disclosure, annual management statements and enterprise policy statements.
SMEs may bring in further professional management and independent board members who can utilize their experience and talent to take those companies on a higher growth trajectory, and exchanges may target such ‘professionally-driven’ companies to list on their platforms.
The transaction costs involved should be kept at reasonable levels to act as an incentive.
Lastly, the launch timing is dependent on the existing market conditions, so the companies will need to time them right. Access to capital at the right time to a growth company can reap rewards. However, addressing the challenges should take priority, in order to build the long-term reputation, trust and participation.
- The author works with a leading capital markets company in India. The views expressed are entirely personal and may not represent those of the company. This article is meant for information purposes only, and does not construe to be any investment advice or solicitation for any financial instrument. Any action taken on the basis of the information contained herein is your responsibility alone.
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