Scaling up: Scale replaces Entry Standard

Frankfurt Stock Exchange: New segment launched

By Norman Wasse, LL.M.

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The race is on! On March 1, 2017, the new Scale segment was introduced on the German Stock Exchange. It replaces Entry Standard, which had been in place since 2005 but had fallen into disrepute recently. There had been a number of irregularities of late, especially in the field of mid-tier bonds. These include losses of up to 20% as in the case of the German wooden pellet producer, German Pellets. Low transparency requirements appeared to be to blame for such irregularities and this new standard aims to strengthen investors’ confidence in the Open Market.

Regulated Market vs. Open Market

The German stock market comprises two markets: the Regulated Market and the Open Market. The Regulated Market at the Frankfurt Stock Exchange consists of General Standard and Prime Standard. Both are heavily regulated. To be listed on the Regulated Market, companies must meet strict requirements such as having prepared an IPO prospectus and offering a minimum number of shares. This is different from the Open Market, which is not officially regulated. The Open Market is governed by private law under the aegis of the German Stock Exchange. Companies whose shares are admitted to trading on the Open Market are not deemed “listed” companies under German corporate law, therefore admission and listing requirements for the Open Market are less challenging (i.e., no need for an IPO prospectus or analysis of shares and bonds issued). This lower threshold eases access to the capital market for small and medium-sized enterprises. As a result, Scale is still a segment of the Open Market but with tighter transparency rules.

Scale replaces Entry Standard

Because of the aforementioned problems with Entry Standard companies, the German Stock Exchange has replaced it with the Scale segment effective as of March 1, 2017. This segment enables small and medium-sized companies to seek out investors for growth finance. However, not every company that was included in Entry Standard has been automatically transferred to Scale. To avoid further difficulties, there are stricter admission requirements for Scale. Entry Standard merely required a formal application for admission and a short exposé, whereas the Frankfurt Stock Exchange has introduced five new admission criteria for Scale, of which at least three must be met:

• Annual turnover of 110 million
• At least 20 employees
• Positive annual net profit
• Positive equity capital
• A minimum of 15 million equity capital

Stricter subsequent obligations

Obligations and transparency requirements following admission have also increased. A cooperation with a Frankfurt Stock Exchange Capital Market Partner – financial institutions, law firms, auditors and investor-relations consultants – is mandatory. These firms are nominated by the Frankfurt Stock Exchange on the basis of certain criteria: They must have several years’ relevant professional experience and a minimum number of previous issues. Currently, more than 50 such partners have been appointed, including Baader Bank, Berenberg and equinet Bank. They will help issuers gather the relevant information, conduct due diligence, and, after admission, help companies meet the more stringent transparency standards. Companies will also be given support to fulfill regular reporting requirements in the form of annual and semiannual reports. Finally, Scale companies will have to fully comply with Market Abuse Regulations, including such obligations as the duty to publish ad hoc announcements.

Analysis requirements and increased costs

In the future, the Frankfurt Stock Exchange will assign analysts to prepare the mandatory analysis of the listed companies in an attempt to improve transparency. The Exchange will bear the costs for this analysis, reducing conflicts of interest to a minimum. The analysis will be conducted alongside the IPO and take the form of an initial report that will be regularly updated thereafter. Companies will be free to commission further analyses at their own expense. Quotation fees are expected to rise following the introduction of the new standards.  Indeed, it is estimated that the cost may double from 150,000 to 1100,000.

Optimistic start

When trading began on March 1, 2017, 43 companies with 37 shares and nine bonds shifted to the new segment, among them Beta Systems Software, Corestate Capital Holding and Scherzer. This number has since increased and more companies are predicted to follow. Companies that were listed in the Entry Standard and have not applied to transfer are now trading in the Basic Board of the Open Market.

In March, Deutsche Börse further added the Scale All Share Index to the indices it offers. It tracks the performance of the Scale segment as a whole and the overall share performance of all companies listed in the segment.

As the first IPO in Scale, research and production service provider IBU-tec advanced materials AG was listed at the end of March 2017, with a placement volume of around 120 million.

Outlook

The stricter requirements in the new segment have been welcomed. The Frankfurt Stock Exchange hopes to regain trust in the market and avoid high default rates. It remains to be seen whether the new regulations will meet these expectations, especially given that only three out of the five criteria have to be fulfilled, a very low threshold that does not prove the integrity or success of the issuer. Furthermore, the Frankfurt Stock Exchange was often criticized for its failure to improve liquidity in the Entry Standard and it is unclear whether that will change under the Scale regulations. We also await the reaction of shareholders in companies that do not fulfill the requirements for Scale to meet stricter requirements in the traditionally less-regulated Open Market. All of this, combined with recent case law laid down by the Federal Supreme Court, means that gradual withdrawal from the German Stock Exchange may now be possible.

nwasse@mwe.com