Agreeing on the need for a single European financial services market is not an issue. Members of the financial community coincide on the principle that an integrated market is key to converting the European Union into one of the world’s most competitive economies by the end of the decade.
Nor is there a problem acknowledging that to achieve this cohesion it’s essential to improve the quality and comparability of listed companies’ financial statements. Everyone recognizes that the current level of minimum information requirements and the frequency of company reporting fail to meet investor needs in modern global financial markets. That’s why the European Commission is trying to put together harmonized standards of disclosure that would provide safeguards to all European investors.
Controversy arises, however, over what these rules should look like and how to achieve the desired harmonization, and here Europe shows it’s a victim of its own history. For centuries each member state has boasted its particular savoir faire and resisted interference with its internal affairs. Different cultures, languages and legislation make it difficult to find a single pan-European model for how companies should communicate with their shareholders and the level of information they must disclose.
Of course each state or bloc of states would like the new EC regime to look like its existing domestic legislation, but choosing any one country’s rules as a reference would create conflict. The UK’s system would be the obvious choice. Its corporate disclosure practices are above the European average, as are its regulations on takeovers and mergers, listing rules and accounting standards. This is because London is the largest equity investment center in Europe, it has had a more sophisticated investment system for longer and, therefore, its legislation is better developed, explains Angus Prentice, executive director at Thomson Financial in London. ‘However countries such as Germany and Switzerland are making a very good effort to catch up with the UK,’ he adds.
Ulrike Diehl, managing director at German analyst association Dusa Deutsche Vereinigung, confirms the German parliament is about to approve legislation ‘against markets and stock manipulation’, which is to be the ‘most developed’ in Europe.
Other regions still have very relaxed policies, their IR practice is still very young, and they are reluctant to introduce a set of rules that would dramatically change the way companies communicate with investors and analysts.
Despite this inertia, Europe’s large companies are more likely to accept new rules because they can afford the added cost such changes would involve and they are more used to communicating with investors. Take the example of Spain, where companies such as Telefónica or utility Iberdrola are already following current US disclosure rules. ‘We reckon the eventual EC legislation will be very similar to the American legislation,’ says José MarÃa Escolano, director at the Spanish IR association, Aeri.
Small-cap fear
Small companies, however, typically feel more vulnerable and fear that giving out certain kinds of information to the market can sometimes be dangerous. ‘They have a natural tendency to keep themselves quiet,’ says Prentice.
Tom Jones, vice chairman of the International Accounting Standards Board (IASB) and former principal financial officer of Citicorp, doesn’t think the final EC document is going to jeopardize smaller companies. As one of the chief architects of international financial reporting standards (IFRS), Jones says the EC’s requirements for transparency ‘won’t be mandatory for small-caps.’ Rather they could just decide whether to follow them or not. This remains to be clarified as the outline for the EC directive doesn’t make any distinction between different sized companies.
Due to all these differences between various countries and small and large companies, Prentice foresees a ‘long and painful process’ before the EC finally achieves the consensus necessary for a single set of disclosure rules. The 2003 deadline proposed by the Stockholm European Council ‘seems very optimistic’ at the moment, says Andrew Smith, director at private bank Brown Shipley.
The EC has already been working for years to design a new finance regime. So far, though, it hasn’t been able to find a model everybody agrees on. Just the opposite; it has encountered fierce attacks from the financial community. Its first mistake was to choose a group of people – so-called Wise Men – who ‘didn’t understand the capital markets,’ according to Smith. Yet they were responsible for putting together a set of rules to suit companies of any size from any country country. Smith’s view is shared by a partner at a London-based law firm, who makes this analogy: ‘It is like giving someone who has never sewn anything in their life the responsibility for designing a suit to fit people of different sizes and styles.’
Perhaps aware of this, the EC launched an internet-based consultation on the Wise Men’s recommendations for markets, investors, consumers and regulators to respond to. It should have been the other way round, says Smith: ‘The EC should have first asked the financial community what were its objectives, then gathered a group of experts to give them advice on how to achieve their aims and, from there, to design a draft.’
A spokeswoman at the International Primary Market Association says, ‘The EC should withdraw its proposal and start a new one listening to the market’s propositions. There is no rush. The important thing is to find the most appropriate directive.’
But Colette Neuville, president of France’s association of minority shareholders, Adam, says there is indeed a rush: ‘Harmonization should be accelerated since the number of companies that are merging is increasing and they are not giving enough information about their strategies to their shareholders.’ Pierre-Henri Leroy, director at Paris-based proxy voting advisor Proxinvest, supplies an example: ‘When Equant merged with France Telecom, they didn’t offer the same price to minority shareholders, who were cheated.’
Leroy is also concerned about a current trend among French companies: ‘In countries such as the Netherlands, Belgium and Luxembourg, companies don’t have as many obligations to their shareholders. Therefore, domestic companies such as EADS, Equant, STMicroelectronics and Gemplus decided to get registered in those countries instead of France to avoid responsibilities to their investors,’ he affirms.
Wise plans
Exactly what does the EC document say about disclosure? The recommendations of the Lamfalussy committee of Wise Men are that companies should provide financial information more often – quarterly reports instead of semi-annual ones, for example – to all shareholders at the same time. To achieve that, the EC wants reports to be published electronically rather than just in the one or two national newspapers currently required.
The Wise Men proposed that for each member state one competent authority be established. This authority would be the independent securities regulator of the member state, in charge of ensuring investor protection and market transparency. So each independent regulator would enforce pan-European rules to protect shareholders’ rights, whatever company and country they invest in. The report avoids distinctions between institutional and retail investors, saying that all of them have to receive the same information at the same time.
But what is the motivation behind these rules? What can be said to persuade reluctant companies to be more transparent and accept the same set of rules throughout the EU? How can they benefit from harmonized standards?
Prentice of Thomson Financial has a clear view of the situation: companies that offer a higher level of transparency and more consistent information receive better coverage and a better reception by non-domestic sell-side analysts and institutional investors than their peers. ‘If investors could pick up a report that was easy and quick to understand they would feel more confident about investing in other countries’ companies,’ he maintains. ‘Otherwise, it raises the risk of investing in a country where information is not clear.’
Robin Jansen, IRO at the Netherlands’ ABN Amro, adds his support. ‘It is a good idea to harmonize the standards and to have bases that make all European companies’ accounting systems comparable.’
Smith of Brown Shipley disagrees:
‘An over-regulated marketplace and overprotected investors are a disruption for companies,’ he argues. According to this banker, each investment involves some risk and it is up to each investor to decide where to put their money. If the decision taken is ‘stupid’, then that is their own responsibility.
He points out that public companies go through yearly cycles, so quarterly reports are ‘meaningless’ and ‘misleading’ and ‘the more periodical the information is, the more likely it is the investor will misread the signals’ of a company’s performance. For Smith, quarterly reports should be optional, useful only for ‘those firms without a significant track record that want to show how they are progressing.’
Reducing volatility
Peter Hall, investor relations manager at BP, has a different point of view. ‘Quarterly reports could help remove volatility,’ he says, and investors could focus on longer-term investments rather than making speculative bets every three months. ‘If a company is not doing very well, it is better that it puts out statements more regularly to inform the market of what is happening instead of just waiting for the half-yearly results, because in six months lots of things could happen.’
For Hall, the inconvenience of quarterly reports is that the information disclosed is only an estimate for the previous three months. The official results don’t come out until at least two weeks later, which creates a situation that ‘leaves you open to misinterpretations’ in the intervening period. The company, then, has to be very careful because if the eventual numbers are not the same as those given in the report, investors could demand compensation.
Resisting transparency
Indeed, Clas Roehe, head of investor relations at Germany’s Dresdner Bank, says the fear of being hit by lawsuits means some companies prefer not to release quarterly reports. His point is supported by Jansen at ABN Amro: ‘After the introduction of Reg FD some US companies got paralyzed with respect to their communication efforts because they were so afraid to make a fair disclosure mistake that they stopped communicating completely so that no mistakes at all could be made.’
As a result, IROs are demanding more protection from the EC. They tend to agree on having equivalent standards of transparency, but at the same time they want to have some degree of confidence that they are not going to be hit by a lawsuit every time they make an ‘unintentional’ mistake in one of their reports.
Klaus Rotter, the German lawyer who won the first case in Germany brought against a publicly traded company – Infomatec – for publishing false information, says that investors’ confidence in the market will only be regained through the introduction of ‘strict rules’ that are properly enforced. At the same time, Rotter differentiates between those companies that wittingly disclose false information and those that do it unintentionally.
Bill Stokoe, a UK Investor Relations Society board member, says that with the globalization of markets and the increased US interest in investing overseas, Europe should have a harmonized and open market. He hopes the end result of the EC consultation process will be a sensible environment in which companies can operate. At the moment, he says, the only group happy with the EC’s proposals are the leading newswires, because they could benefit from a huge increase in statutory announcements.
For Smith, the eventual EC document will be open to each member state’s interpretation. That means they will all ‘water down the wording’ of the text and each follow what they consider most appropriate.
In other words, the final document should be characterized by its flexibility, respecting the differences both between EU countries and between small and large companies in the region. However, the financial community should also be prepared to adopt a more tolerant attitude and cooperate to help achieve the EC’s wished for harmonization, which at the moment seems at risk of hitting an impasse.
