The following article has been written by Peter James Sant, chairman of the Financial Services Business Section of the Malta Chamber of Commerce, Enterprise and Industry. Mr Sant is also a lecturer with the ifs University College. Over the years, Mr Sant has specialised on EU Affairs and improving the Access to Finance for SMEs through EU financial instruments.
It is a known fact that SMEs particularly micro enterprises (that is enterprises that employ up to 10 persons) are the key driver of the Maltese economy. Over the years, SMEs have relied on own sources of funds or bank financing to grow their business. Due to riskiness of their start-up operations businesses have a higher tendency to fail compared to traditional enterprises that have been operating for a period of time. Therefore, start-ups tend to find it much more difficult to rise the required funding to cover their initial working capital and investment costs. The initial period of operations of start-ups is also known as the valley of death.
Debt versus Equity Financial Instruments
Traditionally, Maltese entrepreneurs' tend to prefer to go for debt type of financing compared to equity as they like to retain the control of their organisation by not giving up any shareholding. Equity issues in Malta are usually done through initial public offerings on the Malta Stock Exchange through a primary listing. Currently, there are only 23 entities listed on the Stock Exchange. The shadowing banking sector in Malta, namely the corporate bond market and private placements, has been the alternative source of financing for SMEs and corporates in Malta. Within the last two years, a certain amount of deleveraging has been taking in terms of traditional bank lending.
The diagram above illustrates the financing life cycle of SME financing and the type of financial instruments that the European Commission is providing through the European Investment Bank and the European Investment Fund in partnership with the private sector. Till today, Malta has tapped into three financial engineering instruments that are traditional guarantee products through the Jeremie and SME Micro Credit Window. The Jeremie Instrument was part supported by the Structural and Investment Funds for Malta for the 2007-2013 programming period and the Competitiveness Innovation Programme 2007-2013. The next interesting available financial instrument is the SME Instrument. (Source: European Investment Fund Jeremie Presentation given in 2012)
With a lower eagerness to issue equity instruments on the Maltese Stock Exchange most of the instruments traded are corporate and government bonds and the equity that was initially issued in relation to the part privatisation of former government-owned enterprises such as the commercial banks and the former national telecom. It is interesting to note that the amount of venture capital in Malta is very limited but there are a number of financial and telecommunication companies in Malta that have their equity resulting from venture capital and Hedge Fund operations. Over the years, a number of Maltese SMEs have gone up to the UK to pitch their ideas and raise funding through business angels and venture capitals.
Long-Term Financing of the European Economy
In order to further improve the access to finance in Malta for SMEs, it is important that more equity related financial instruments (that is Risk Capital Instruments and Mezzanine Finance) are made available to Maltese SMEs and enterprises while a strategic financing framework is needed to channel part of the third pillar funding into Maltese SMEs. If we are speaking about access to finance for SMEs and financing the instruments to finance out capital investment, we need to think strategically and ensure that part of the pension funds is used in a profitable and sustainable manner to finance our economic growth. Malta has developed since Independence when Maltese funds were used to finance our economy in a competitive manner. Malta does not have a problem of funding but needs to have the right financial structures to finance its SMEs into innovative and creative industries that tap into international markets particularly the EU's internal market. The Communication document of the European Parliament and the Council on Long-Term Financing of the European Economy reference COM/2014/0168 needs to be carefully analysed in this context.
Within the euro area, the trend is for the banking sector to finance short- to medium-term projects while pension funds, hedge funds and insurance companies whose maturity transformation is longer will be used to finance the European Union's capital and infrastructural projects. The role of the European Investment Bank (EIB) places a lead part in this process. Malta is a shareholder of the EIB but it seems at times we find it hard to finance capital projects. The EIB has financed a number of key capital projects over the years including the construction of the Malta International Airport Terminal, EneMalta, the new Parliament that is Malita plc and the Interconnector between Sicily and Malta.
The new EU President Jean-Claude Juncker has called on for a €300bn ($409bn) public-private investment programme to revive the European economy, create jobs for the young and stimulate growth over the next three years. The money should be mobilised from existing budget resources, the EIB and the private sector, without changing the bloc's strict rules on budget deficits and debt reduction. "We need a reindustrialisation of Europe," the former Luxembourg prime minister said, promising a work programme in February 2015 for investments in energy, transport and broadband networks and industry clusters.
Financial instruments
Following the successful take up of the Jeremie initiative in Malta that resulted with the assistance of over 600 SMEs, the creation of a loan portfolio of €62m and €100m of capital investment successfully operated by Bank of Valletta, the Maltese authorities with the European Commission and the European Investment Fund are working on the launch of the SME Initiative. Over summer, the Maltese government and the European Investment Fund commissioned PricewaterhouseCoopers to conduct a gap analysis on the access to finance in Malta. In the interim period, the Maltese government, through the Deputy Prime Minister's Office, the Parliamentary Secretary for EU Funds and the 2017 EU Presidency Dr Ian Borg and the Planning and Priority Planning Division, has championed the SME initiative and ring fenced €15m of Malta's 2014 to 2020 European Structural and Investment Funds. The Maltese authorities have certainly been a leader, with the Spanish counterparts, in taking up this voluntary financial instrument. For the first time, the European Union will be blending for financial instruments Member State Structural and Investment funds with Brussels based centralised funds under the Horizon 2020 and the Programme for the Competitiveness and small and medium-sized enterprises (COSME).
At the end of October and beginning of November, two important events have taken place - the signing of the Partnership Agreement between Malta and the EU on Malta's 2014 to 2020 Structural and the Investment Funds programme. Furthermore, at a pan European level, there was an agreement on the adoption of the work programme for 2015 and the financing for the implementation of the Programme for the Competitiveness and small and medium-sized enterprises with an initial budget allocation of €15m out of the €264m. It is worth noting that the European Commission has allocated €162.9m for financial instruments for 2015. The two specific headline objectives being:
• ENT/SME/15/A/N01 - Financial Instruments - Loan Guarantee Facility Including the SME Initiative intended to enhance the access to finance for SMEs in their start-up, growth and transfer phases through debt instruments.
• ENT/SME/15/A/N02 - Financial Instruments - Equity Facility for Growth intended to enhance the access to finance for SMEs in their start-up, growth and transfer phases through equity instruments.
More information on the Programme for the Competitiveness and Small and Medium-Sized Enterprises is found on the following links: http://ec.europa.eu/enterprise/initiatives/cosme/index_en.htm, http://www.eif.org/what_we_do/guarantees/single_eu_debt_instrument/cosme-loan-facility-growth/index.htm, http://www.eif.org/what_we_do/equity/single_eu_equity_instrument/cosme_efg/index.htm
The SME initiative
The proposed initiative is conceived as an anti-crisis measure with budget commitments over three years, building on the EU financial instruments that support lending to SMEs (COSME and/or Horizon 2020). It is proposed as a "joint instrument", that is a mechanism allowing member states to allocate European Structural and Investment funds (ESIF) under their responsibility to programmes managed directly by the Commission, with disbursement geographically linked to contributions. This mechanism is provided for by the Common Provisions Regulation (CPR) governing the implementation of ESIF and the principle of such combination is endorsed by both COSME and Horizon 2020. Participation by member states will be entirely voluntary.
The SME Initiative may take the form of uncapped portfolio guarantees or securitisation operations using funds from COSME, Horizon 2020 and ESIF combined with resources from EIB and EIF. COSME and Horizon 2020 will provide the legal basis for actions under the SME initiative. Under both uncapped guarantees and securitisation, ESIF will guarantee the most junior tranche of the portfolio (that is, the highest risk) and a combination of ESIF, EU (that is, COSME and/or Horizon 2020) and EIF resources will cover the mezzanine tranche. The senior tranche will be covered by EIB and, if possible, national promotional banks. In the case of securitisation, the senior tranche should achieve high credit rating and could be sold to institutional investors. The contribution of COSME to the SME initiative can be estimated at this moment to an amount of around €15m for 2015.
The EU is offering a number of financing opportunities both through Malta-based and Brussels-based financing opportunities; it is a question of identifying and tapping into them. Government resources are already flat out closing the 2007-2013 and opening 2014-2020 programming periods with millions of euros at stake. It is not just a question of what the Maltese authorities can do more but a question of how I can tap into them myself as an entrepreneur and business community.