Aare Tammemäe: even small ones need the capital market (Postimees)

12 Sep 2013

Strong local stock exchange and the development of capital market benefits also the small enterprises, says Aare Tammemäe, the Chairman of the Board of FinanceEstonia.

Taavi Veskimägi wrote in his article on 5th September that Elering could include the money that is needed for the purchase of the gas network through the bonds that are listed on Tallinn stock exchange and are partly aimed at Estonian retail investors. Estonian minister Juhan Parts immediately replied and said that stock exchange is not the solution to the problem, and small- and medium-sized companies are primarily in the need of equity instead.

In fact, successful functioning of the stock exchange and improving the offering of capital to small businesses are closely related. Capital market is similar to the network of roads or education.

Among the capital market participants, investments funds that offer equity take on a big risk with investing into small- and medium-sized businesses. To compensate for the risk they ask for higher yield and they expect the possibility to leave the investment at the appropriate time. To successfully realize the investment and earn the profit, investors usually sell their shares after 5 years.

Local well-functioning stock exchange is crucial for realizing these types of investments, because it is impossible for small- and middle-sized companies to raise capital from other stock exchanges or for investors to sell their shares. If investors see that the companies are moving towards the stock exchange, they are more confident in investing into them.

Stock investors, in turn, will also see that the stock exchange is becoming “alive”, and young and interesting companies want to come there. This situation attracts more and more new investors and increases the trade activity, as well as the ability of the companies to raise capital.

Strategies of financing through venture capital and stock exchange promote the formation of local development centers and high-wage jobs. Better alternatives of raising capital for small businesses is also good news for the banks, because bigger share of equity increases the companies’ capability of borrowing.

Estonian government and the Ministry of Economic Affairs can be praised for making the first steps of revitalizing the capital market; along with Latvian and Lithuanian colleagues and European Investment Fund it has established a fund of funds worth 100 million euros. Fund of fund invests into various private funds that will provide capital to local entrepreneurs in the coming years. This is the first positive step of improving the availability of capital from the state’s side in the last years.

However, it should be kept in mind, that this good initiative may remain incomplete if the capital market is not developed in a complex manner. FinanceEstonia, a private-public cluster initiative, has come up with a number of proposals, how to improve the financing of small businesses and solve the bad state of capital markets. These proposals are published on the webpage of FinanceEstonia.

Many financial investors complain that capital markets are not developing because there is nowhere to invest. Here, the government could prepare a long-term financing program, one of which aims could be raising capital from the stock exchange, as it owns the state enterprises.

Elering could show the initiative and just carry out the loan program that is aimed at the domestic market. In addition to state enterprises, the government could also organize the financing of 2014 investment programs through issuing long-term bonds. Instead of borrowing money from European banks, this would be an important step for increasing the local investors base.

The state’s long-term vision of developing the (financial) infrastructure  outweighs the short-term benefits of bank loans’ more favorable interest rates.

Coming back to the original topic that the functioning of capital markets and improving the financing of small businesses are closely related, then actually there are no better alternatives for improving the financing of small businesses than the funds of funds created by the state. In Estonia, where the stock exchange of international scale might never happen, we might always depend on the State in offering capital to the companies.  Only in the distant future can we assume that the free market will play an important role in financing.

Occasionally, there are ideas of putting pressure on banks so that they would lend more to small businesses. However, this idea does not work, because most of the strong companies were financially very weak in the beginning, and also without the operating history and collateral. Banks do not give loan to this type of companies. So the only solution is offering capital through the fund of funds.

Will there be enough capital in Estonia to participate in the emissions that can reach billions? Estonian private persons and companies keep approximately 13 billion euros in Estonian credit institutions, and the assets that belong to all the funds (including pension funds, insurance companies, other funds) amount to 4 billion euros. This is a considerable amount of capital - 18 billion euros, a significant part of which could boost the economic growth of Estonia and participate in the projects that have strategic importance for Estonian economy (e.g. purchasing gas network).

According to Niklas Johansson, the councilor of the biggest Swedish pension funds AP2, Telia Sonera and Swedish State Pharmacy, it is clear even in Sweden, where GDP is 24 times higher than in Estonia, that the contribution of external capital and retail investors are not enough for the development of capital markets.

For this reason, until this time the local insurance companies and pension funds have “overinvested” in the domestic market – about 40-50% of their assets have been invested into the local stock- and bond instruments.

The participation of Estonian pension funds, insurance companies and other long-term investments in the local economy could be increased, because their share in the current domestic market is less than 10%.

All in all, we are close to giving a strong and decisive boost to improving the companies’ financing, especially for Estonian small businesses. Entrepreneurs have proposed many solutions that could be implemented in cooperation with the state.

Original article can be found here.