Market Gaps on Access to Finance - Bank of Valletta

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Malta Business Bureau – <strong>Market</strong> gaps in access to finance April 2013 3.5 Financing instruments for SMEs The main sources of finance which have been available to Malta based SMEs relate primarily to traditional sources of finance (assistance from family or friends, bank overdrafts and loans, trade credit, hire purchase, and/ or leasing). Formal private equity markets and financial instruments are relatively inexistent, with support measures provided by Government or other institutions mostly being grant or loan-based. Most financial instruments can be classified as either loans or equity, while it is now also common to find hybrid type of instruments which combine elements of both debt and equity 63 . These sources of finance can be obtained from private sector institutions and financial intermediaries, from government or through EU programmes, or any combination of these sources. The EC has been providing a balanced mix of flexible financial instruments under the 2007-2013 Programming Period with the aim of enabling public sector resources to be used in a more efficient way by drawing upon commercial practices and actors and by stimulating the participation of private sector capital. According to a Communication issued by the EC, and as per the February 2013 European Council conclusions, innovative financial instruments should play an increasingly important role in the EU budget spending for the 2014-2020 Multiannual Financial Framework (MFF) 64 . The term “innovative financial instrument” is used by the EC to refer to interventions other than pure grant funding. The EC’s intention is, however, not to replace grant funding with financial instruments as grants will still be necessary, but to complement grant funding with other forms of intervention in order to increase the volume of finance and the impact resulting from the EU budget intervention. These financial instruments are being advocated to support investments which are expected to be financially viable but which do not give rise to sufficient funding from market sources. This shift to financial instruments is influenced by the contractionary fiscal policy being adopted by most Member States governments, as well as the experience to date with such instruments. The main advantage of financial instruments is their multiplier effect, whereby risk coverage (in the case of loans and guarantees) or risk participations (in the case of equity) induces private investors to invest, and whereby the repayments of capital or interest and proceeds of an investment can be reused for the instrument in subsequent cycles. In addition, such instruments require less administrative controls compared to grants. These innovative financial instruments referred to in the EC’s Communication include instruments which provide equity/ risk capital (e.g. such as the JEREMIE-funded equity fund Catalyst Romania 65 ), debt instruments such as loans (e.g. JEREMIE instruments in Poland) or loan guarantees to intermediaries that provide financing to a large number of final recipients who have difficulties in accessing finance (e.g. JEREMIE initiative in Malta), or risk sharing instruments with financial institutions (e.g. JEREMIE instrument in the Languedoc-Roussillon region, France). Where appropriate, such EU support can be provided indirectly via dedicated investment vehicles, in particular where participation of private investors alongside public investors is being sought. 3.5.1 Rationale for innovative financial instruments According to the EC, the increased adoption of these types of instruments is based on the following objectives 66 : 63 European Commission (2012), Financial Instruments in Cohesion Policy 64 European Commission (2011), A framework for the next generation of innovative financial instruments – the EU equity and debt platforms; European Council (2013), Conclusions – Multiannual Financial Framework 65 http://www.eif.org/what_we_do/jeremie/news/2012_news/3TS_Romania.htm 66 European Commission (2011), A framework for the next generation of innovative financial instruments – the EU equity and debt platforms Page | 30
Malta Business Bureau – <strong>Market</strong> gaps in access to finance April 2013 3.5.1.1 Pursuit of EU policy objectives These instruments ensure there is necessary financing for areas of EU interest and thus assist in correcting market failures/imperfections that give rise to an insufficient funding in such areas. This is the case in areas which are perceived as too risky by the private sector. These instruments can also lead to important non-financial effects such as demonstration effects in the targeted markets, triggering wider application to other sectors. The consistent application and promotion of best practices through the EU instruments may foster a qualitative development of certain markets, such as for instance the venture capital markets, and increase intermediary sophistication over time. These instruments also offer a higher degree of flexibility through the possibility of tailor-made support and delivery structures. In addition, the expertise of the EU and the financial institutions responsible for the implementation of such financial instruments can be transferred to national, regional or local authorities. 3.5.1.2 Increasing efficiency and effectiveness of public resources By pooling resources from various sources, financial instruments can catalyze investments for identified market gaps, achieve economies of scale and/or minimize the risk of failure in areas where it would be difficult for individual Member States to achieve the required critical mass. In line with the subsidiarity principle, an EU level instrument should be able to be more advantageous than a series of financial instruments at national, regional or local level, due to higher volumes under management, cost efficiencies through harmonised implementation standards and terms and lower implementation costs, e.g. management fees charged by the financial intermediaries. This might be applicable locally, where difficulties in obtained the required critical mass due to Malta’s small size can be circumvented through an amalgamation with a pan- European instrument (this also applies to venture capital funds). 3.5.1.3 Promoting enhanced performance and financial discipline Well-designed innovative financial instruments can promote enhanced performance by setting appropriate success indicators suited to the achievement of public policy objectives in line with best practices. National and local institutions can also benefit from the EU institutions’ knowledge in the design of financial products. 3.5.1.4 Multiplier effect of the EU budget Innovative financial instruments create a multiplier effect for the EU budget by facilitating and attracting other public and private financing for projects of EU interest throughout the various levels of the implementation chain (intermediaries and final beneficiaries). Through risk coverage (in the case of loans and guarantees) or risk participations (in the case of equity), the EU intervention may induce new/ additional investment in cases where investors would have not invested at all or invested less without the support from the EU budget. Such direct financial "leverage" or multiplier effect can be achieved through co-financing by international financial institutions (e.g. EIF, EIB) or through the additional debt volumes banks and guarantee institutions are requested to provide to final beneficiaries. Furthermore, an additional multiplier effect is achieved during the lifetime of the innovative financial instrument, if repayments of capital or interest and proceeds of an investment can be reused for the instrument. Such "revolving" character can considerably increase the reach of instruments, leading to a further indirect multiplier effect. After this period, repayments of the initial investment plus an eventual participation upside will flow back to the general budget, which also positively impacts the overall cost-efficiency of the intervention. The possibility of using the same funds several times through various revolving cycles contributes to the impact and sustainability of such revolving instruments. The impact of revolving funds can be Page | 31
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Market Gaps on Access to Finance - Bank of Valletta

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