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Keiron Root reports on the concerns of small businesses over increases in red tape. The Economist Intelligence Unit (EIU) published a survey of senior corporate executives in 2005 that came to the unsurprising conclusion that red tape is now the biggest threat to business growth.
The level, depth and cost of regulation on business has increased dramatically in recent years, to the extent that it is having a material effect on the performance of many firms, with growing numbers of chief executives, finance directors and risk officers coming to regard regulatory risk as the most significant threat to their business, ahead of things such as country, market, credit risk, terrorism and natural disasters.
In the survey, nine out of ten executives said they expected the business costs of regulation to rise over the next three years. They argued that regulation has had unforeseen consequences for business, with many respondents reporting that it has stifled innovation in their companies or that they are concerned that their companies will become less competitive compared with rivals operating in less-regulated countries.
And they point out that it is their customers who will ultimately foot the bill for rising regulatory costs. Many companies are struggling to get to grips with international regulation and regulation acts as a significant deterrent to overseas investment. Fifty-seven per cent of those surveyed said the regulatory burden in a particular country has a significant impact on their decision to invest there, while more than a third of companies have been deterred from investing in a new market because of regulatory issues.
The survey was carried out on an international basis and focused primarily on major global companies, but the basic findings will ring true with companies of any size. Senior managers acknowledge the need for regulation but most seem to believe the benefits of recent changes are outweighed by the problems they create. The burden of regulation falls upon all companies of whatever size but there is little doubt that it is proportionately greater for smaller companies, as they will have a smaller resource base from which to meet it.
Concerns over increasingly burdensome regulation are closely linked to the greater emphasis that has come to be placed on corporate governance in recent years.
Again, although the focus is often on large international concerns, the issues that this process represents can have a proportionately greater impact on smaller enterprises. Indeed, increasingly, company boards are likely to be caught between the devil of the regulators on one hand and the deep blue sea of shareholder activists on the other.
At a European meeting of The Conference Board, a pan-European, Brussels-based forum for exchanging management information and helping businesses strengthen their performance, Guy Jubb, Head of Corporate Governance for Standard Life Investments, observed: "Shareholder activism is now part of the corporate governance toolkit. The risk to a sustainable enterprise of investor activism is that investors start interfering. It is worth pointing out that many, but not all, shareholder activists have short-term horizons.
"However, boards shouldn't be afraid to embrace active shareholders. If they can work together, as they often can, they often build a bond of mutual trust which helps to nurture a common understanding of the long-term and sustainable objectives of the enterprise."
At the other end of the process lie the regulators. The introduction of the revised Combined Code on Corporate Governance last year, following a review of the role and effectiveness of non-executive directors, has thrown this process into sharp relief.
As far as smaller companies are concerned, the very size and scope of the Combined Code (83 pages with 16 principles and 48 provisions) creates potentially costly administrative issues.
For it is clear that smaller companies do have specific requirements when dealing with the burden of regulation. The Quoted Companies Alliance (QCA) published a simple guide to the Combined Code aimed specifically at smaller companies, which condensed its key provisions into a ten-page document.
The need for such guidance was highlighted by cases where actions taken to comply with the previous rules created anomalies with the Combined Code. For example, those companies that recruited two independent non-executive directors and appointed one as chairman, now find that the chairman is primarily regarded as non-independent and is not eligible to sit on the remuneration or audit committees.
Chris Yates, Chairman of the QCA corporate governance committee points out: "The partnership of boards providing stewardship with investors providing capital requires that the two parties communicate regularly on progress and concerns, with neither ticking boxes as a substitute.
"This is at the heart of good governance regardless of company size and we hope our guide will encourage the time commitment required by both."
That the effect of changes to corporate governance rules on smaller companies has become a major political issue is evidenced by the creation of an all-party parliamentary group for corporate governance. With around 100 MPs as members, the purpose of the group is to address concerns that tighter financial regulation, brought in as a result of problems at major global corporations, will prove unnecessarily burdensome for smaller businesses.
For example, more recent concern has been the EU's directive dealing with the publication of prospectuses and other forms of fundraising. This came into effect in July 2005 and there were concerns that there would be a disproportionate burden on smaller firms looking, for example, to use brokers to place shares with discretionary private clients.
Under the old Public Offers of Securities regulations, private-client brokers taking part in a placing were counted as a single qualified investor, no matter how many of their clients they ultimately passed the shares on to. Under the Prospectus Directive, a prospectus has to be issued when shares in any company are offered to more than 100 people.
Since a very high proportion - more than nine per cent - of companies raising finance on Aim, for example, do so through placings rather than direct offers to the public, it was clearly an expensive prospect for small companies considering flotation.
A month or so before the implementation of the directive came confirmation that a prospectus would not have to be issued in such circumstances.
However, such confirmation only came following a period of consultation on implementing the Prospectus Directive, during which Apcims, the brokers' lobby group, the London Stock Exchange and the QCA had noted concerns that existing practices could be subject to further regulation. Specifically, it was understood that, in the event that the broker was involving more than 99 of its clients, the requirement to produce a prospectus would be triggered.
Reacting to the news, Angela Knight, Apcims' Chief Executive, said: "We are delighted to learn that the Treasury has taken our joint representations on board about how this directive should be interpreted. The potential cost to firms of issuing a prospectus unnecessarily would have been passed onto their clients, making these new issues a less attractive proposition. This commonsense decision by the Treasury means that firms can continue to offer new issues to their clients without attracting further unnecessary costs."
Andrew Smith, QCA Chairman and Director of Corporate Finance at stockbrokers Collins Stewart, added: "This comes as a great relief to all those involved in raising capital for smaller quoted companies.
"The advice obtained from Queen's Counsel by the QCA and Apcims was clear and has contributed to the overturning of what was assumed to be a fait accompli. This ruling is of major importance to the fundraising abilities of companies joining Aim or Ofex and will help maintain private client investments and hence liquidity."
Smith's comment about overturning "what was assumed to be a fait accompli" is instructive, as it illustrates the importance of communicating with the regulators.
By and large, regulators are keen to involve as many interested parties as possible in the process of developing regulations, because they want a system that will work. Properly presented, cogently argued and timely contributions to the consultations that invariably precede the introduction of new rules can, and do, have an effect. BiographyKeiron Root has been a financial journalist for 20 years, contributing to a wide range of specialist financial and investment publications plus the financial sections of the national press. He is Consulting Editor of Treasury Management International, Editor of What Investment Trust and Editor-in-Chief of What Investment magazines.
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