Promoting the recovery of Europe's SMEs with hybrid funding

In an own-initiative opinion, the European Economic and Social Committee (EESC) recommends promoting the use of hybrid debt to fund SMEs. This would diversify funding sources and reduce reliance on bank loans, while encouraging investment and supporting the Capital Markets Union.

In the opinion, approved at its October plenary, the EESC noted that the COVID-19 crisis had left many firms over-indebted and at risk of insolvency. Companies face an equity and hybrid capital shortfall estimated at between EUR 450 and 600 billion. This shortfall is being compounded by the energy crisis and economic tensions caused by Russia's invasion of Ukraine.

At the same time, companies still need long-term financing to adapt to the green and digital transitions and remain competitive. SMEs generally find it more difficult than large companies to access this kind of financing.

In short, the highly subordinated instrument that is proposed comes at the right time and is in line with the objectives of the relief package for SMEs adopted by the European Commission. It is a solution that would make available to the whole EU something that already exists in some countries and would support the much-needed completion of the capital markets union and the banking union, said the opinion’s rapporteur, Antonio García del Riego.

Hybrid loans are a type of subordinated debt that includes bonds and dual-share schemes. Should a borrower default on their loan, creditors with subordinated debt are paid out after other so-called 'senior' creditors, but before shareholders.

An easy-to-implement solution

To make this form of funding available to companies of all sizes, the EESC proposes an EU-wide framework that would benefit from the liquidity and scale of the Single Market, attract institutional investors and support the Capital Markets Union.

This would require collaboration between private and public institutions, including banks, asset managers, the public sector, and institutional investors.

Spain, Germany, France and Portugal already use hybrid loans in the form of participative loans. These are an easy-to-implement, long-term solution that allows families to retain control of their businesses. In addition, they have tax deductibility advantages and low issuance costs and offer lenders an attractive return.

The EESC recommends that these instruments be considered as quasi-equity, so that they are not classified as debt on the balance sheet, and rank just before equity in the payments hierarchy in the event of default or insolvency. This will ensure that companies' debt ratios and corporate ratings are not affected.

Protecting against the risks

The perceived risk of banks being crowded out will be avoided because hybrid loans would restore companies' solvency and ensure banks remain willing to keep lending to them.

Introducing market standards such as credit ratings would prevent non-viable companies from accessing these instruments.

Existing European initiatives, such as the ESCALAR programme, are aimed at scale-ups or newly established companies financed by venture capital funds. The EESC’s proposal would complement those already in place and focus on established SMEs, which make up the majority of European companies.

The heart of the EU economy

In the EU, SMEs represent 99.8 % of all firms, almost two-thirds of employment and more than half of the value-added generated by the non-financial business sector.

Full opinion