Better small company reporting is key to unlocking EU Capital Markets Union

Stephen Haddrill
A deeper and more diversified financial system in Europe could be to the advantage of the City
Smaller quoted companies are vital to generating long-term sustainable economic growth and creating jobs. Smaller enterprises have the capacity for dynamic growth, development of new markets and sustainable job creation. But how best to attract the capital they need to achieve their potential?
The European Commission’s proposal for a Capital Markets Union has sought to address this issue by suggesting ways to rebalance the availability of risk capital and debt by unlocking investment for smaller entities through measures including simpler reporting requirements. Europe needs to attract more equity capital and enable it to flow efficiently over borders to smaller companies right across the Union.
Smaller companies in Europe, and particularly the UK, rely heavily on banks to finance their expansion when compared to their counterparts in the United States. US companies receive around five times more funding from capital markets than those in the EU. In the interests of growth, we should be encouraging alternatives such as equity placements via a public listing. Equity markets play an important role in absorbing risk and reducing economic shocks, and may serve as an important way for relatively small innovative companies to raise finance and grow. The UK has a wealth of experience in the development of capital markets, financial regulation and governance structures that it shares with the world and which contribute to the City’s leading position on the global stage. A deeper and more diversified financial system in Europe could be to the advantage of the City.
Investors, though, may only be tempted to come on board if they feel confident in and trust the information from smaller entities on which they base their decisions. Good quality corporate reporting, governance and audit are therefore important in fostering investment in all companies but particularly in smaller entities, where other publicly available data and analysts’ reports may be absent.
But we can’t swing the pendulum overnight. While investors want to allocate their capital among smaller listed companies, there is sometimes a disconnect between the information they receive and what they need. The limited availability of analysts’ reports and other data makes high quality reporting by smaller companies paramount. A recent study by the FRC, looking at the quality of reporting by smaller quoted companies, reveals a gap between what investors want to see reported and what smaller quoted companies are able to tell them. It is in exactly those areas where investors tell us they need high quality information that companies have been found wanting.
Smaller companies believe that investors pay little attention to their annual reports and so don’t prioritise high standards of disclosure. As a result, reporting becomes a compliance exercise rather than an opportunity to provide relevant information. Investors want companies to explain clearly the business model and report clearly and concisely on the company’s position, performance (including cash flows) and prospects. In the financial statements, investors want information on accounting policies and other judgements, estimates and provisions.
But reporting is not the only obstacle. The quality and constructiveness of the dialogue and engagement between investors and smaller companies can have a noticeable effect on the level of trust among investors, their willingness to allocate capital and the impact on returns over the longer term. The UK’s Stewardship Code has promoted purposeful monitoring and dialogue since 2010, and in the last five years (underpinned by improvements in transparency and quality of corporate reporting) it has helped to improve monitoring and has built better quality engagement.
We must, of course, avoid wherever possible the temptation to increase the burden of regulation simply to achieve better quality reporting by smaller companies and engagement by investors. The best way to regulate, in my view, is to have access to the stick but to use the carrot where possible.
The investment landscape is changing. Portfolios are increasingly global and this places more demands on investors and companies, particularly smaller companies with limited resources. The globalisation of investment will persist. The challenge for investors is to follow the principles of stewardship across national borders if they are to gain confidence. The challenge for smaller companies and policymakers is to enable it to happen.
Get reporting and engagement right and smaller quoted companies can more assuredly set themselves on the path to sustainable growth and prosperity, to the benefit of the UK and Europe.
Stephen Haddrill is chief executive of the Financial Reporting Council.

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