SME Access to Finance Market Assessment for Malta Final Report

SME Access to Finance Market Assessment for Malta

Final Report

06 November 2014 EIF – Research & Market Analysis

1 Series Editor: EIF Research & Market Analysis 15, avenue J.F. Kennedy L-2968 Luxembourg Tel.: +352 24851 http://www.eif.org/news_centre/research/index.htm

Responsible Authors: PwC EU Services EESV Woluwegarden - Woluwedal 18 B-1932 Brussels Belgium

Contact: European Investment Fund 37A avenue J.F. Kennedy L-2968 Luxembourg Tel.: +352 24851 http://www.eif.org/news_centre/research/index.htm

Disclaimer: This report has been drafted by PwC Malta, on the basis of guidelines developed by the European Investment Fund (EIF) Research & Market Analysis. Any views expressed herein reflect the current views of the author(s), and they do not necessarily correspond to opinions of EIF or of the European Investment Bank (EIB). Contents of this report, including opinions, are current at the date of publication set out above, and may change without notice. Opinions expressed herein may differ from views set out in other documents, including other research published by EIF or by EIB. EIF cannot be held responsible for any use of the information contained herein by any person other than EIF. This report has been prepared exclusively for the Managing Authority. Nothing in this report constitutes investment, legal, or tax advice to the Managing Authority (or to any other person), nor shall be relied upon as such advice. Specific professional advice should always be sought separately before taking any action based on this report. The contents of this report are, inter alia, based on current market conditions and consequently any market changes may have an impact on these contents.

Table of contents

1 Executive Summary ...... 13 2 Introduction ...... 23 2.1 Objectives and scope of the study ...... 24 2.2 Relevant regulation ...... 25 2.3 Structure of the report ...... 25 3 Methodology of the study ...... 27 3.1 Literature review ...... 27 3.2 Stakeholder interviews ...... 27 3.3 Online survey ...... 28 3.4 Data analysis ...... 28 4 The market environment ...... 30 5 Existing SME financing instruments ...... 33 5.1 Financial Instruments available for SMEs in the country ...... 33 5.2 Grant schemes ...... 39 5.3 Historical use of structural funds ...... 47 6 Priorities and policies of the Managing Authority for SME financing ...... 53 6.1 Operational Programme I for 2014-2020 ...... 53 6.2 Operational Programme II for 2014-2020 ...... 56 6.3 EU programmes facilitating R&D and innovation among SMEs and Malta’s use of the SME Initiative ...... 57 7 Market analysis and findings ...... 59 7.1 Methodology used to compute supply ...... 60 7.2 Supply side analysis ...... 61 7.3 Methodology to quantify the demand for finance ...... 78 7.4 Demand for financing from micro-enterprises ...... 82 7.5 Demand for financing from small enterprises in Malta ...... 99 7.6 Demand for financing from medium-sized enterprises in Malta ...... 108 7.7 Quantification of potential demand for financial products from small and medium-sized enterprises in Malta in 2014 ...... 115 7.8 Potential demand for equity financing from the SME population in Malta ...... 116 8 Financing gaps, conclusions and recommendations ...... 121 8.1 Rationale behind financing gaps and methodology to compute them ...... 121 8.2 Financing gaps ...... 128 8.3 Access to finance from large companies in Malta ...... 135 8.4 Conclusions and main findings ...... 143

8.5 Recommendations ...... 153 Annexes ...... 157 Annex 1 – Article 37 (2 and 3) of the Common Provisions Regulation n°1303/2013 adopted on 17 December 2013 ...... 158 Annex 2 – Note on the sampling methodology of the online survey ...... 160 Annex 3 – Bibliography ...... 162 Annex 4 – Detailed analysis of the market environment of Malta...... 167 Annex 5 – List of interviews ...... 193 Annex 6 – Glossary ...... 194 Annex 7 – List of indicators used for the AFMA study ...... 196 Annex 8 – Questionnaire for the online survey ...... 198 Annex 9 – Interview guide...... 210 Annex 10 – Minutes of the interviews ...... 212

List of Acronyms

AFMA(s) Access to Finance Market Assessment(s) ARPA Agriculture and Rural Payments Agency BA(s) Business Angels Investors BOV Bank of Valletta CEBI Centre for Entrepreneurship and Business Incubation CBM Central Bank of Malta CIP Competitiveness and Innovation Programme COCOF Coordination Committee of the Funds CP Cohesion Policy CPR Common Provisions Regulation CSF Common Strategic Framework DG REGIO Directorate General for Regional and Urban Policy of the EC DSWS Department for Social Welfare Standards EAFRD European Agricultural Fund for Rural Development EC European Commission ECB European Central Bank EFF European Fisheries Fund EIB European Investment Bank EIF European Investment Fund EMFF European Maritime and Fisheries Fund ERDF European Regional Development Fund ESF European Social Fund ESIF European Structural and Investment Funds ETC Employment and Training Corporation EVCA European Venture Capital Association EU European Union FDI Foreign Direct Investment FEI(s) Financial Engineering Instrument(s) FI(s) Financial Instrument(s) FIA Financial Institution Act FOP Fisheries Operational Programme FPD Funds and Programmes Division FP7 European Commission’s Seventh Framework Programme GAFMA Guidelines for SME Access to Finance Market Assessments GDP Gross Domestic Product GRTU General Retailers and Traders Union HICP Harmonised Index of Consumer Prices HF Holding Fund

ICT Information and Communication Technology IP Intellectual Property IRD Inland Revenue Department JEREMIE Joint European Resources for Micro to Medium Enterprises KBIC Kordin Business Incubation Centre MA Managing Authority(ies) MCAST Malta College of Arts, Science and Technology MCST Malta Council for Science and Technology ME Malta Enterprise MEAIM Ministry for European Affairs and the Implementation of the Electoral Manifesto MFI Microfinance Institution(s) MFSA Malta Financial Services Authority MITA Malta Information Technology Agency MS(s) Member State(s) of the European Union NFC(s) Non-Financial Corporation(s) NPL(s) Non-Performing Loan(s) NSO National Statistics Office OP(s) Operational Programme(s) PE(s) Private Equity Funds PIS Proposed Investment Strategy PPCD Planning and Priorities Coordination Division RDP Rural Development Programme R&D Research and Development SBA Small Business Act SME(s) Small and medium-sized enterprise(s) TCU Tax Compliance Unit TO Thematic Objective(s) TSDU Tourism Sustainable Development Unit UOM University of Malta VC Venture Capital VFGs Viable Financing Gaps WB World Bank

List of Tables

Table 1: Potential financing gap and viable financing gap for loan products for the total SME population in Malta in 2014 ...... 16 Table 2: Potential financing gap for microfinance for micro-enterprises in 2014, including social inclusion ...... 18 Table 3: Viable financing gaps for short-term loans, overdrafts and credit lines in 2014 ...... 18 Table 4: Viable financing gaps for medium and long-term loans in 2014 ...... 19 Table 5: Potential financing gap for equity financing for all SMEs in 2014 ...... 19 Table 6: Conditions and criteria for eligibility of the JEREMIE guarantee instrument...... 34 Table 7: Conditions and criteria for eligibility of the BOV Start Plus programme ...... 36 Table 8: Existing Financial Instruments in Malta ...... 38 Table 9: Grant schemes and programmes in Malta under the 2007-2013 programme ...... 39 Table 10: Progress indictors under Priority Axis 1 (OP I) – Take-up of initiatives by SMEs ...... 40 Table 11: Grant schemes under the 2007-2013 RDP and FOP programmes ...... 42 Table 12: Funding provided under the 2004-2006 programming period ...... 47 Table 13: Funding Distribution by Operational Programme ...... 48 Table 14: Fund absorption progress by Operational Programmes I and II ...... 49 Table 15: Priority axes of Operational Programme I ...... 54 Table 16: Details of priority axes of Operational Programme I focusing on support to SMEs ... 55 Table 17: Priority axes of Operational Programme II ...... 56 Table 18: Details of priority axes of Operational Programme II focusing on support to SMEs ...... 57 Table 19: New loans to all non-financial corporate entities with the year-on-year change .... 65 Table 20: Estimate of loan disbursements to SMEs ...... 66 Table 21: Supply of financial products to SMEs in the previous years and estimate of the annual supply in 2014 in Malta ...... 75 Table 22: Estimated annual supply of short-term loans to SMEs in 2014 in Malta ...... 76 Table 23: Estimated annual supply of medium and long-term loans to SMEs in 2014 in Malta ...... 77 Table 24: Estimate of the annual supply of financial products in 2014 in Malta ...... 78 Table 25: Number of micro-enterprises in Malta ...... 82 Table 26: Annual demand for financial products among micro-enterprises in Malta in 2014...... 95 Table 27: Annual demand for microfinance in Malta in 2014...... 97 Table 28: Annual demand for microfinance for financial inclusion in Malta in 2014 ...... 98 Table 29: Number of small enterprises in the Malta ...... 99 Table 30: Number of medium-sized enterprises in the Malta ...... 108 Table 31: Annual demand for financial products by small and medium-sized enterprises in Malta in 2014 ...... 115 Table 32: Annual demand for equity financing in Malta in 2014 ...... 120 Table 33: Potential financing gap for microfinance for micro-enterprises in 2014 ...... 128 Table 34: Potential financing gap for microfinance for micro-enterprises in 2014, including financial inclusion ...... 129 Table 35: Potential financing gaps per financial product for micro-enterprises in 2014 ...... 130 Table 36: Viable financing gaps for micro-enterprises concerning loan products in 2014 ..... 131 Table 37: Potential financing gaps per financial product for small and medium-sized enterprises in 2014 ...... 133 Table 38: Potential financing gap for equity financing for all SMEs in 2014 ...... 135 Table 39: New loans to all non-financial corporate entities with the year-on-year change .. 136 Table 40: Estimate of loan disbursements to large companies ...... 137

Table 41: Number of large enterprises in Malta ...... 138 Table 42: Potential financing gap for microfinance for micro-enterprises in 2014, including financial inclusion ...... 145 Table 43: Viable financing gaps for short-term loans, overdrafts and credit lines in 2014 ...... 146 Table 44: Viable financing gaps for medium and long-term loans in 2014...... 146 Table 45: Potential financing gap for equity financing for all SMEs in 2014 ...... 147 Table 46: SWOT analysis regarding access to financing for SMEs in Malta ...... 150 Table 47: Stratification of respondents to the online survey for AFMA in Malta compared to the population of SMEs in the country ...... 161 Table 48: Malta – Map and key figures ...... 167 Table 49: Contributions to growth in loans to private non-financial corporations ...... 174 Table 50: Number of inhabitants per region as of 2012 ...... 179 Table 51: Absolute number of active SMEs per region across 2009 to 2012 and percentage change year-on-year ...... 183 Table 52: SME distribution by size of class of employment and number of employees ...... 183 Table 53: Enterprise distribution by sector and number of employees ...... 185 Table 54: R&D expenditure in 2012 as a percentage of GDP relative to EU-28 ...... 186 Table 55: Total R&D expenditure in Malta as a percentage of GDP...... 187 Table 56: Number of patent applications filed under the Patent Cooperation Treaty (PCT), in 2010 per billion GDP in comparison with the EU-27 ...... 188 Table 57: Interviews conducted with the different stakeholder groups for the AFMA study in Malta ...... 193 Table 58: Indicators used to perform the AFMA study in Malta ...... 196

List of Diagrams

Figure 1: Principle of triangulation ...... 29 Figure 2: Budget distribution by Operational Programme ...... 49 Figure 3: Total loans outstanding as a percentage of GDP among EU countries ...... 63 Figure 4: The ladder of equity financing according to the development stage of companies ...... 70 Figure 5: SMAF Sub-index on access to equity finance per country (2012) ...... 71 Figure 6: SME population in Malta according to the size of companies ...... 82 Figure 7: Development stage of micro-enterprises in Malta ...... 83 Figure 8: Sources of funding used by micro-enterprises between 2011 and 2013 ...... 85 Figure 9: Feeling of lack of support among micro-companies when seeking finance ...... 86 Figure 10: Reasons for the difficulties for micro-enterprises in accessing finance over 2011-2013 ...... 88 Figure 11: Perception of change in the conditions of debt financing in 2011-2013 by micro-enterprises in Malta ...... 89 Figure 12: Obstacles to loan financing reported by micro-enterprises ...... 89 Figure 13: Type of collateral provided for debt financing by micro-enterprises ...... 90 Figure 14: Use of funding by micro-enterprises in 2011- 2013 ...... 91 Figure 15: Expected sources of funding in 2014 indicated by micro-enterprises ...... 92 Figure 16: Expected use of funding of micro-enterprises in 2014 ...... 93 Figure 17: Categorisation assumptions for financial products for micro-enterprises and financial inclusion ...... 94 Figure 18: Development stages of small enterprises in Malta ...... 100 Figure 19: Feeling of lack of support among small enterprises when seeking finance ...... 101 Figure 20: Sources of funding used by small enterprises between 2011 and 2013 ...... 102 Figure 21: Perception of change in the conditions of debt financing in 2011-2013 by small enterprises in Malta ...... 104 Figure 22: Reasons for the difficulties for small enterprises in accessing finance over 2011- 2013...... 104 Figure 23: Feeling of discouragement from seeking finance among small enterprises in Malta ...... 105 Figure 24: Obstacles to loan financing reported by small enterprises ...... 106 Figure 25: Use of funding by small enterprises over 2011-2013 ...... 107 Figure 26: Expected sources of funding in 2014 indicated by small enterprises ...... 107 Figure 27: Development stages of medium-sized enterprises in Malta ...... 108 Figure 28: Discouragement of medium-sized companies in Malta from seeking finance ...... 109 Figure 29: Sources of funding used by medium-sized enterprises over 2011-2013 ...... 110 Figure 30: Reasons for difficulties for medium-sized enterprises in accessing finance over 2011-2013 ...... 111 Figure 31: Reasons referred to as difficulties by medium-sized enterprises in receiving loan financing...... 112 Figure 32: Perception of change in the conditions of debt financing in 2011-2013 by medium-sized enterprises in Malta ...... 112 Figure 33: Use of funding by medium-sized enterprises over 2011-2013 ...... 113 Figure 34 Expected sources of funding in 2014 indicated by medium-sized enterprises ...... 114 Figure 35: Expected use of funding of medium-sized enterprises in 2014 ...... 114 Figure 36: Potential financing gaps and viable financing gaps for micro-enterprises for 2014...... 132 Figure 37: Development stages of large enterprises in Malta ...... 138 Figure 38: Sources of funding used by large enterprises between 2011 and 2013 ...... 139

Figure 39: Reasons explaining difficulties of large enterprises in accessing finance ...... 140 Figure 40: Obstacles to loan financing reported by large enterprises ...... 140 Figure 41: Use of funding by large enterprises over 2011-2013 ...... 141 Figure 42: Expected sources of funding in 2014 indicated by large enterprises ...... 142 Figure 43: GDP growth rates in Malta according to Eurostat forecasts ...... 169 Figure 44: HICP inflation for Malta including Eurostat forecasts ...... 171 Figure 45: Interest rates for loans up to and including EUR 0.25m and between EUR 0.25m and EUR 1m (January to July 2013) ...... 175 Figure 46: Interest rates for overdrafts in the Eurozone in 2012 (January to September) ...... 176 Figure 47: Non-Performing Loans as a percentage of total gross loans issued by core domestic banks ...... 177 Figure 48: Projection of the total population of Malta in the long-term ...... 178 Figure 49: Estimated hourly labour cost for 2012...... 180 Figure 50: Population aged 15 and over by highest level of education successfully completed, 2011 ...... 180 Figure 51: Tertiary education graduates by type of subjects studied ...... 181 Figure 52: Malta’s innovation performance compared with other EU Member States ...... 187 Figure 53: Corporate tax rate across countries in 2014 ...... 192

1 Executive Summary The present Small and Medium-sized Enterprises (SME) Access to Finance Market Assessment (AFMA) report for Malta has conducted a thorough analysis of the existing market environment for SMEs, including lessons learned from existing Financial Instruments (FIs) in the country and has implemented a methodological approach, aiming to define the existing gaps regarding SMEs and their access to finance. In order to draw conclusions reflecting the reality of the SME environment in Malta and to provide recommendations for the future Proposed Investment Strategy for Financial Instruments in the framework of the Operational Programme (OP) under the ESI Funds, financing gaps have been identified across different financial products and across three categories of SMEs according to their size, namely micro- enterprises (0 to 9 employees), small (10 to 49) and medium-sized enterprises (50 to 249).

The Maltese economy, driven by gaming, ICT and financial services, outperformed the Eurozone average since the country joined the Union in 2004 and has proved more resilient to the crisis than many of its European counterparts, partly thanks to the strong domestic SME population. In 2008, the Maltese GPD contracted by 2.5% percent (as compared with almost 4% for EU-28), and experienced a sharp recovery in 2010 (4%, 2 percentage points ahead of the EU-28 average) (Eurostat, 2014). This success is partly due to the recent regulatory adjustments and its attractiveness for Foreign Direct Investments (FDIs) from EU Member States (73.2% of total FDI in 2013) (NSO, 2014).

SMEs dominate the corporate landscape of Malta and are a key driver of its economy. SMEs represent almost the entire population of enterprises: 99.8% in 2012, in line with the EU-28 average (99.8%) (NSO, Eurostat, 2014). The population of active SMEs declined by 1.1% in 2011 and by 3.7% in 2012, mainly because of the implementation in 2011 of a new regulation exempting from VAT reporting SMEs with a turnover under EUR 7,0001. Among these SMEs, approximately 95% are micro- enterprises, i.e. 2.5 percentage points ahead of the EU-28 average. Small and medium-sized enterprises accounted respectively for 4% and 0.9% (NSO, Eurostat, 2014). SMEs weight 78.6% of national employment, a higher proportion than in the EU-28 (67.2%) (NSO, Eurostat, 2014). Between 2009 and 2012, the share of micro- enterprises in the employed population decreased by 2.4%, establishing at 32.3% in 2012 (almost 2 percentage points above the EU-28 average). In the same period, the share of small and medium-sized enterprises increased and reached, respectively, 22.1% and 24.2% in 2012 (NSO, Eurostat, 2014).

1 Value Added Tax Regulations, 2010 (Exemption from Registration), coming into force on 1 January 2011, as notified in the Legal Notice 524 of 2010.

Because of the dominance of the banking sector, the supply almost exclusively consists of bank loans, whereas equity and microcredit play a very marginal role in the financing of SMEs.

The Maltese banking sector appears to be in a good position to step-up lending, thanks to a strong capital basis and high levels of liquidities. Indeed, The World Economic Forum rated Malta’s banking sector as the 12th soundest in the world out of 144 countries, and placed Malta at number 15 for financial market development (Malta Financial Services Authority, 2012). However, commercial banks apply interest rates and collateral requirements that are relatively higher than the rest of the Eurozone.

Taken together, young SMEs which often lack collateral and have no credit history can face difficulties in their access to finance: bank loans are unaffordable, whereas alternative products supply is not especially developed.

Bank-lending to private Non-Financial Corporations (NFCs) declined at a fast pace during 2013, falling by 4.9%, after a drop of 0.7% in 2012. Apart from subdued domestic private investment, this could be an indication of continuing tightness in credit standards. The reduction in loans to private sector NFCs was broad-based, but stemmed mainly from reduced borrowings by firms in the construction and wholesale and retail trade sectors. For the first time since the onset of the financial crisis, loans to private NFCs in Malta during the second half of 2013 contracted at a faster annual pace than in the Eurozone as a whole.

On the demand side, the three size categories of SMEs were analysed in order to provide insight into their needs. The findings are outlined in the following paragraphs:

Micro-enterprises represent the vast majority of companies in the country (95% of all SMEs). Micro-enterprises have financial needs for working capital and investment purposes, but are experiencing problems in accessing the banking system. Access to mainstream banking products tends to be limited to those micro-enterprises with a good credit history of the owner, larger turnovers and lower levels of debt financing and sufficient equity invested according to banks’ standards. Micro- enterprises which cannot fulfil the bank’s requirements seek financing from informal sources (family and friends) because they are not aware of the existing Financial Instruments providing guarantees and lack knowledge of banking procedures.

Small enterprises’ share among all SMEs (4% of all enterprises) had been constantly increasing since 2009 signifying that companies are growing within the local market, in line with the growth in GDP. Small enterprises can rely on banking finance to a much larger extent than micro-enterprises. According to the findings presented in previous chapters, small companies have significant access to bank financing. They are perceived by banks as clients of interest and for the most part have the

experience and knowledge to apply for loans. The majority of small enterprises indicated that they did not face obstacles when seeking finance; however, some indicated that costs of financing and other terms and conditions imposed by financial institutions are a growing cause of concern to them.

Medium-sized enterprises represent a very small but economically important segment of the SME population in Malta (0.9% of all enterprises). The financial crisis does not seem to have affected their prospects, leading to a nearly unchanged population of medium-sized enterprises. Their relatively robust asset base allows them easiest access to banking products for different uses and to diversify their types of financing. Short-term loans, overdrafts and credit lines are the most used products for this SME size. Medium-size enterprises are likely to be better educated on the suitability of different products and show for example the highest use of public guarantees.

In addition, the present report analysed large companies’ access to finance. Results from the online survey indicated that only a small minority have insufficient access to loan products. Overall, large companies in Malta do not face any material difficulty accessing finance.

Following the description of Malta’s economic and business context and the dynamics of supply and demand for SME financing, computations described in the report were able to quantify the supply and demand for specific financing products. The quantified total supply of each financial product has been estimated for each of the three categories of SME size. The quantification of the potential demand for finance from SMEs has been based on their future needs expressed in the online survey, and past use of Financial Instruments. The financing gaps have been computed, based on the potential total demand for various financial products across the SME population. However, in order to provide a better picture of the scale of unmet demand among viable companies, a second methodology was implemented to compute financing gaps based on the viable demand (referred to as Viable Financing Gaps or VFGs).

Following the computation methodologies, which will be described further on in the present report, the ranges of the potential and the viable financing gaps per annum for the total population of SMEs in the region are given in the table below. It has to be borne in mind that, against the background of an environment of imperfect information and uncertainty, there is no perfect solution to assess (ex-ante) SME finance market gaps, and the correct quantification of these gaps is impossible. According to the European Investment Fund’s Guidelines for SME Access to Finance Market Assessments (GAFMA), which form the methodological guidance for this report, “[t]he uncertainty and imperfect information refers not only to the “measurement” of existing gaps (assessment of status quo), but also to the forward looking elements as the market assessment has to consider the short and medium- term future (e.g. impact of current changes in bank lending behaviour on the future

access to finance for SMEs)”2. The quantification of financing gaps can only provide indications and is only one element of the analysis; it has to be considered in combination with the additional quantitative and qualitative assessments, performed throughout the present report. Table 1: Potential financing gap and viable financing gap for loan products for the total SME population in Malta in 2014

Potential financing gap Viable financing gap

range (mEUR) range (mEUR)

Short-term loans3, bank overdrafts4 and credit lines5 123 - 136 21- 23

Medium and long-term loans 148 - 164 37 - 41

Total 272 - 300 58 - 64

Source: PwC analysis, 2014.

As presented in the table above, the computations first provided the total financing gap based on the potential demand of loan products ranging from EUR 272m to EUR 300m in 2014. This gap represents a potential request for the whole year. But since SMEs tend to overestimate their needs, and the potential gap calculation is based on the responses of all SMEs and not only the viable ones, they should not be perceived by policy makers as amounts that should be covered in a single year or as gaps which have to be bridged by Financial Instruments. They are only an indication of financing needs in the regional economy, according to the methodologies described in the present report and market constraints experienced by SMEs. However, this indication confirms the need to apply Financial Instruments as public support mechanisms, particularly in order to catalyse further private financing for SMEs.

The estimated potential demand is based on the online survey answers provided by SME owners and is related to their knowledge of their respective markets and the perspective of their company. That is why the following points have to be taken into account when considering the financing gaps based on potential demand: • Potential demand may not actually translate into action; • Lack of previous investment due to the crisis; • Limited knowledge of financing sources and products; and • Uncertain economic environment.

2 European Investment Fund (2014). Guidelines for SME Access to Finance Market Assessments (GAFMA). Working Paper 2014/22. 3 Short-term loans are defined as loans to be repaid in less than one year and are most commonly used to finance working capital needs. 4 Overdrafts are an extension of credit from a bank when an account reaches zero thus allowing a company to continue withdrawing money even if the account has no funds; also primarily used for working capital fluctuations. 5 Credit lines are defined as maximum loan amounts approved by a bank to a company where interest is charged only to the used part of the loan.

The online survey conducted for the present report also allows an estimate of the SMEs that are considered viable (i.e. exhibiting growth) but have previously been unsuccessful in seeking loan financing: they represent circa 10.2% among micro- enterprises and none among small and medium-sized enterprises. The Viable Financing Gap (VFG) has been estimated at between EUR 58m and EUR 64m for all loans for the total SME population in Malta in 2014. This gap will have to be bridged partially by the financial system and partially by publicly supported Financial Instruments, i.e. in order to catalyse private financing for SMEs.

The analysis furthermore highlighted how EU-funded Financial Instruments (JEREMIE, JASMINE and CIP) have contributed, and keep contributing, to the improvement of SMEs’ access to finance in Malta. These Financial Instruments partially cover the scope of current SMEs’ needs (especially in terms of guarantees).

Overall, the existing Financial Instruments supported by public interventions have positively impacted the financing conditions and environment of the national market. They however allow room for improvement:  Involvement of different financial intermediary to enhance competition of products and visibility among SMEs;  Creation of sufficient impact to address the lack of equity and microfinance actors in the market.

The present AFMA report concludes that the impact of existing Financial Instruments could be increased with the use of ESI Funds into diversified existing or new Financial Instruments. This use would allow offering new products to better service SMEs’ specific needs.

The following paragraphs summarise the findings and conclusions per financial product, and present high level recommendations for the formulation of a future investment strategy.

Microfinance Demand for microfinance covers both existing SMEs and people currently unemployed and/or at risk of poverty who see themselves as potential business creators if their access to finance were facilitated (financial inclusion, leading to social inclusion).

There is practically no microfinance market in Malta. The few existing initiatives focus on supporting targeted populations, through charity rather than microfinance for business purposes.

In the case of Malta, the potential financing gap for existing micro-enterprises in 2014 ranges between EUR 108m and EUR 120m. Concerning microfinance for

financial inclusion, a financing gap has been estimated around EUR 6m. The microfinance financing gap may be partly explained by:  High demand from micro-enterprises (especially 0 employee) facing difficulties when seeking financing from financial institutions, notably commercial banks;  The absence of microfinance in Malta;  Difficulties for potential beneficiaries in identifying microfinance products.

The table below summarises the financing gap for microfinance. Table 2: Potential financing gap for microfinance for micro-enterprises in 2014, including social inclusion

Financing gap for existing Financing gap for social Total financing gap for

micro-enterprises (mEUR) inclusion (mEUR) microfinance (mEUR)

Microfinance 108 - 120 6 114 - 126

Source: PwC analysis, 2014. See Boxes 1 and 2 for detailed descriptions of the methodology.

Demand for microfinance products will increase as the number of newly created 0 employee micro-enterprises is expected to continue increasing.

Short-term loans, overdrafts, credit lines

On the supply side, the analysis has highlighted that commercial banks do not face liquidity issues but still apply relatively high interest rates on SMEs’ loans, due to their conservative approach toward financing SMEs leading. Local stakeholders believe that most of Maltese SMEs are under-capitalised when compared to their EU counter-parts.

On the demand side, the priority for SMEs of all sizes is to secure the financing of working capital in order to remain operational in the short-term.

The study reveals viable financing gaps for short-term loans for micro-enterprises, but not for small and medium-sized companies, as illustrated in the table below. Table 3: Viable financing gaps for short-term loans, overdrafts and credit lines in 2014

Viable financing gap for Viable financing gap for Viable financing gap for small and medium-sized micro-enterprises (mEUR) SMEs (mEUR) enterprises (mEUR)

Short-term loans, bank overdrafts 21 - 23 - 21 - 23 and credit lines

Source: PwC analysis, 2014. See Boxes 1 and 2 for detailed descriptions of the methodology.

Medium- and long-term loans

All sizes of SMEs use medium and long-term debt financing in Malta. These loans are sought to finance equipment renewal as well as investment and business expansion. In the short run, micro-, small and medium-sized companies intend to continue investing in their equipment and machinery as well as launch new activities. According to the analysis, micro-enterprises have more difficulties to access collateralisation than small and medium-sized enterprises. Bridging these gaps would foster investment and job creation in the region.

Viable financing gaps were calculated and are presented in the table below. Table 4: Viable financing gaps for medium and long-term loans in 2014

Viable financing gap for Viable financing gap for Viable financing gap for small and medium-sized micro-enterprises (mEUR) SMEs (mEUR) enterprises (mEUR)

Medium and 37 - 41 - 37 - 41 long-term loans

Source: PwC analysis, 2014. See Boxes 1 and 2 for detailed descriptions of the methodology.

Equity A potential financing gap was calculated for equity financing for all SMEs in Malta, and needs to be read as indicative for reasons explained further in the present report. The table below presents the financing gap for 2014. Table 5: Potential financing gap for equity financing for all SMEs in 2014

Financing gap for equity financing (mEUR)

Equity financing 35 - 174

Source: PwC analysis, 2014. See Boxes 1 and 2 for detailed descriptions of the methodology.

The analysis highlighted that equity financing should be considered as key for the support of SMEs in their future access to finance in view of supporting their growth strategies. However, in the design of any FI, consideration needs to be given to the presence of a sufficient critical mass in demand from specific targets for equity investment, their attractiveness to private investors and the ability of the financial intermediary to leverage existing networks and stakeholders (incubators, Chamber of Commerce) to facilitate matchmaking and provide the required mentoring and support to the SMEs.

Recommendations

The use of Financial Instruments is relatively recent in Malta. In recent years some initiatives to implement FIs and support business enterprises through loan guarantees

and direct loans have been introduced, primarily though Malta Enterprise and JEREMIE.

However, the specific nature of the Maltese economy and more specifically the dominance of the banking sector have created some limitations to the use of FIs that need to be overcome.

As an EU member state, Malta has for a number of years been benefiting from various EU funding programmes, particularly grants. The launch of the JEREMIE guarantee instrument in 2011 provided another dimension towards how EU funds could be used to support SMEs in Malta. Given the take-up to date, JEREMIE has been a relative success in Malta and is considered to be a best practice example amongst other member state regions. In going forward, the challenge for Malta will be to understand how EU and national funds can be combined to foster further support for SMEs through the use of FIs. The diversification of FIs beyond guarantees, the involvement of more intermediaries, and the launch of instruments in fields that are still non-existent in the country such as microfinance and equity have to be investigated.

The key recommendations from the analysis conducted in the present AFMA report are detailed below: a. Support and expand the implementation of JEREMIE. The implementation of the JEREMIE guarantee instrument during the 2007-2013 programming period was successful and demand for the product will continue. It stands to reason that this instrument should be further supported during the upcoming EU programming period.

The Managing Authority (MA) should consider expanding the allocation of EU funds for the next programming period towards this instrument, given that the new instrument would span the full duration of the programming period. The MA should consider expanding the allocation of EU funds and diversifying the available Financial Instruments beyond the current JEREMIE guarantee. This could be in the form of risk sharing facilities and/or equity instruments, subject to further investigation and the prerequisites mentioned in Recommendation e). Diversification should also allow JEREMIE to design Financial Instruments more dedicated to start-up or micro-enterprises.

b. Consider developing specific guarantee instruments or complementing the existing instruments to facilitate access to short-term debt for working capital purposes and long-term debt for investment purposes. The analysis has revealed that financing gaps exist for short-term and medium and long-term loans for micro-enterprises. Moreover, it was established that an increasing need for working capital financing is appearing in the market. The main barrier to debt financing for SMEs, especially micro-enterprises, is related to the collateral requirements imposed by commercial banks. Taking into account the lack of microfinance institutions in the country, Financial Instruments in the form of guarantees and other risk mitigation products to support micro- enterprises without collateral could be developed or could complement existing guarantee products. c. Considering the introduction of a risk sharing loan facility. Besides the need for guarantee schemes and collateral support, Maltese SMEs could also benefit from a Financial Instrument which would target a reduction in the cost of lending. It was highlighted in the analysis that interest rates, including bank charges and fees in Malta are high thus affecting the overall cost of financing. With the introduction of a risk sharing loan facility, for example, SMEs and especially small and medium-sized companies willing to expand, could benefit from reduced interest rates.

However, when designing and implementing FIs, several factors have to be taken into account, such as, the leverage effect and the capacity of the market to benefit from these FIs. In the case of Malta, the priority should be put on guarantees which are mostly needed by SMEs and have a higher leverage effect. d. Support the provision of microfinance for existing and potential entrepreneurs. The supply of microfinance in Malta is still very limited and is often provided in the form of standard bank loans. Micro-enterprises are exposed to excessive interest rates and bank charges and often rely on personal assets, such as their personal properties, as collateral. The promotion of a microfinance facility provided by a non-banking institution, to support existing and potential entrepreneurs should be considered. In lack of such a specialised institution, the provision of (collateral- free) microfinance through a risk sharing scheme with commercial banks could also be considered. e. Create the conditions for the development of an environment that will support equity financing and an active Business Angel community. The equity market and business angel environment in Malta have a very weak presence. Early-stage investments in the technology and knowledge-based sectors in Malta are scarcely financed. The investment gap is particularly apparent for companies in their start-up phase, where risk and uncertainty are at their highest.

A Financial Instrument could be used to cultivate a new business mentality and raise awareness among SMEs on the benefits of equity financing. Experience in other countries has shown that equity investments in SMEs through public assistance schemes tend to attract private investors and Business Angels. With the creation of a co-investment fund acting as a lead investor, for example, private investors could be encouraged to invest in companies, especially technology and knowledge-based start-up companies, and such a fund could ultimately encourage the creation of an organised private investment community in Malta.

However, in the design of any FI, priority should be given to develop an adequate business environment as an efficient equity market does not solely depend on sufficient supply – particularly given previous attempts in Malta which have created only limited impact in the market. f. Consider an appropriate combination of grants and FIs for investment purposes or mentoring and training support to SMEs. Malta has implemented several grant programmes in recent years that have proved successful. A combination of grants and FIs for investment purposes could help SMEs complement their financing with banking loans and facilitate the implementation of their business plans. A combination of grants and FIs could also be envisaged in initiatives to mentor SME owners. It has been mentioned in the analysis that SMEs do not have experience in negotiating with financial institutions and in preparing business plans. Mentoring initiatives would support SMEs in applying to banks but also to grant programmes. When setting up such initiatives it is vital to keep the balance between tailoring them to the needs of SMEs and maintaining a scope sufficiently broad to ensure a reasonable take- up. As illustrated by several unsuccessful grant schemes in the programming period 2007-2013 (e.g. on vocational training of farmers or development of new farming products), too specific a programme, however well-meaning, may be inefficient, with only a handful (if any) SMEs using it.

2 Introduction Finding appropriate ways to finance Small and Medium-sized Enterprises (SMEs) is a priority for the European Union (EU)6. Since the early 1990s, policy recommendations at global, European and national level have highlighted the need for the adoption of a coherent approach to improve SMEs’ access to finance. In the EU’s 2007-2013 programming period, Structural Funds support to SMEs was provided via Financial Engineering Instruments (FEIs) in addition to grant finance. DG REGIO’s Summary Report 2012 reported that FIs for enterprises had invested in more than 160.000 SMEs across Europe7 between 2007 and 2012.

The 2014-2020 programming period foresees an increased use of Financial Instruments (FIs) for all Thematic Objectives (TO) and across all sectors 8 . The objective is to move away from grant mechanisms towards Financial Instruments, namely revolving funds focused on productive investment. Furthermore, there is a wide interest in ensuring the strong commitment of private sector financial intermediaries in taking the role of bodies implementing FIs, in order to increase efficiency in the delivery of funds and leverage the amount of funds made available through private participation.

Financial intermediaries are limited by solvency constrains, particularly during the financial crisis, and by the need to apply strict risk management standards. This may increase the difficulties for SMEs to comply with the conditions for access to finance.

For Malta, access to finance is a key priority towards addressing Thematic Objective n°3 related to SMEs’ competitiveness. The national Planning and Priorities Coordination Division (PPCD) within the Ministry for European Affairs is entrusted with directing the future European Structural and Investment Funds (ESIF) resources towards SME competitiveness. In fact, the use of FIs has developed over the past few years at a national level and some instruments have already been designed and implemented. However, the use of FIs in Malta can still be considered limited and solely adapted to the banking sector which remains the dominant formal source of financing for SMEs. That is why, in a constantly changing environment, an updated and more detailed overview of the SME environment is necessary in order to improve, adjust and produce new policies and instruments catering to the needs of SMEs. The preparation of ex-ante assessments becomes, therefore, necessary and, according to the relevant regulation, also mandatory, to assess the conditions and existing barriers SMEs have to face.

6 Think Small First - A Small Business Act for Europe (COM(2008) 394 of 23.6.2008). 7 European Commission, Summary of data on the progress made in financing and implementing financial engineering instruments reported by the MAs in accordance with Article 67(2)(j) of Council Regulation (EC) No 1083/2006. Programming period 2007-2013 (situation as at 31 December 2012). 8 European Commission, Factsheet - Financial Instruments in Cohesion Policy 2014-2020.

The present study assesses the existing supply and demand of funds supporting SMEs in Malta, analyses if and to what extent weaknesses and financing gaps exist in particular markets for SME finance, and proposes high-level recommendations to decrease these gaps and weaknesses given the proven market failures, suboptimal investment situations and financing needs.

2.1 Objectives and scope of the study This SME Access to Finance Market Assessment (AFMA) study presents the assessment of the existing supply and demand for SME financing in Malta. It serves to feed a Proposed Investment Strategy (PIS) to be developed for Malta to address SMEs’ access to finance. Together they constitute the ex-ante assessment required by the European regulation on European Structural and Investment Funds9.

The AFMA study will identify and - where possible - quantify the market failures or suboptimal investment situations and investment needs for small and medium-sized enterprises in the country10. It also takes into account the innovation sector in Malta, in conformity with the “Guidelines for SME Access to Finance Market Assessments” (GAFMA) developed by the European Investment Fund (EIF)11. Aligned with the preamble of the Common Provisions Regulation (CPR) adopted on 17 December 2013, it is meant to establish “evidence of market failures or sub-optimal investment situations and the estimated level and scope of public investment needs, including types of Financial Instruments to be supported”12.

Specifically concerning Malta, this ex-ante market assessment results from the desire of the Managing Authority (MA) - the Priorities and Planning Coordination Division within the Ministry for European Affairs and the Implementation of the Electoral Manifesto (MEAIM) - to enhance and improve its portfolio of Financial Instruments in order to address difficulties which SMEs are currently facing. The present AFMA study is aimed at supporting the MA in preparing its investment strategy for the design and implementation of FIs that will facilitate access to finance for SMEs in Malta in the next programming period, through European Structural and Investment Funds (ESIF) as well as investment returns to the Joint European Resources for Micro to Medium Enterprises (JEREMIE) Holding Fund (HF). According to the Coordination Committee of the Funds (COCOF) Guidance Note on Financial Engineering Instruments13, these JEREMIE funds shall be allocated to the same type of actions for the benefit of SMEs

9 See Annex 1 for details (Common Provisions Regulation adopted on 17 December 2013). 10 In that framework, the present AFMA study is aligned with the European Court of Auditors (ECA)’s recommendation to base future ERDF operations on a “sound assessment of the financing gap”, including its quantification. 11 European Investment Fund (2014). Guidelines for SME Access to Finance Market Assessments (GAFMA). Working Paper 2014/22. 12 See Common Provisions Regulation adopted on 17 December 2013 (Article 37 in Annex 1). 13 European Commission – Directorate-General Regional Policy (2012). Revised Guidance Note on Financial Engineering Instruments under Article 44 of Council Regulation (EC) No 1083/2006. COCOF_10-0014-05-EN.

and used beyond the end of the current programming period (i.e. 2007 – 2013) until exhaustion. Following the GAFMA methodology14, the main activities conducted for the present financing gap analysis in the field of access to finance for SMEs in Malta have been: • The analysis of demand and supply of SME finance by type of financial product taking into account nationwide specificities; including a link with the 2014-2020 Operational Programme (OP) currently prepared by the Managing Authority; • The identification and - where feasible - the quantification of the financing gap per financial product as well as per category of SME size.

2.2 Relevant regulation The Common Provisions Regulation lays down provisions for the ESIF. According to these provisions, ESIFs may be used to support Financial Instruments under one or more Programmes to be implemented during the programming period 2014-2020. FIs are consequently becoming necessary tools for the successful implementation of Common Strategic Framework (CSF) policies as well as for achieving the Europe 2020 Strategy objectives for smart, sustainable and inclusive growth. They are seen as a valuable complement to traditional grant schemes and are meant to leverage existing experience with the use of Financial Engineering Instruments acquired during the programming period 2007-2013.

Member States (MS) and MAs will be allowed to use FIs for all the 11 Thematic Objectives covered by CSF programmes and part of the future Cohesion Policy (CP) for the new programming period 2014-2020. As a result, the structure of CSF programmes will have to be aligned with the Thematic Objectives, including the third Thematic Objective aimed at […] enhancing the competitiveness of small and medium-sized enterprises, the agricultural sector (for the EAFRD) and fisheries and aquaculture sector (for the EMFF)”15.

According to the adopted CPR for the future Cohesion Policy 2014-2020, FIs shall be set up on the basis of ex-ante assessments that address the local needs and potential of SMEs.

2.3 Structure of the report This report is structured so as to bridge recent trends with foreseeable developments in access to finance for SMEs in the country and draw specific conclusions on the market financing gaps. The report begins with the presentation of the methodology (Chapter 3) that details the approach taken in collecting and analysing relevant

14 European Investment Fund (2012). Guidelines for SME Access to Finance Market Assessments. June 2012. Mimeo. 15 See Common Provisions Regulation adopted on 17 December 2013 (Article 37 in Annex 1).

data. The methodology is followed by the description of the market environment in Malta (Chapter 4). It consists of the overview of the economic situation and detailed description of the SME market, including a snapshot of the institutional and legal framework. Subsequently, the report describes the existing SME financing instruments available in the Maltese market, including the Financial Instruments (Chapter 5) and provides an overview of the existing government support schemes and the historical use of Structural Funds. In Chapter 6, the report presents the policy priorities of the Managing Authority (the Ministry for European Affairs and the Implementation of the Electoral Manifesto) for SME financing during the next programming period 2014-2020.

In Chapter 7, the supply of SME finance is analysed for each category of financial product and each category of SME size. The analysis then focuses on the demand side, by category of SME size. It also provides insights on the demand for financing in the future per financial product and category of SME size. SMEs have been categorised by size according to their number of employees, taking into account the EU’s SME definition; namely from 0 to 9 employees, 10 to 49 and 50 to 249 employees. This categorisation is important in order to highlight several characteristics of the Maltese market such as the dominant presence of micro- enterprises. The categorisation by company size is an additional tool used to distinguish the different problems and related needs within the SME population in the country. Following this description, in Chapter 8, financing gaps have been identified and analysed for each of the above categories and lessons learned from previous initiatives are summarised so as to draw conclusions on the needs of SMEs in terms of financing and substantiate recommendations for a Proposed Investment Strategy to be developed for the Managing Authority.

3 Methodology of the study Various data sources on the financing of SMEs in Malta were used: • Literature review, including the analysis of SME-specific indicators developed in various previous studies; • Interviews with key stakeholders in SME finance in Malta. Three groups were defined: financial institutions and supply side representatives, policy-makers and actors representing the demand side; • An online survey conducted among SMEs in the country.

3.1 Literature review A literature review was conducted, aimed at gathering the majority of the existing information on SME financing in Malta to identify and analyse: • Information on the economic and political environment of Malta; • Insights on the policy priorities of the Managing Authority for the next programming period 2014-2020; • Information on the regulatory environment relevant for SMEs and FIs in Malta; • Existing indicators and information on SME financing (on both the demand and supply sides) in Malta; • Insights on the successes, failures and lessons to be learned about the use of FIs in the past.

The documentation used for the literature review is indicated in Annex 3. The literature review enabled the sourcing of qualitative and quantitative indicators that were used to analyse the context and situation of SME financing in Malta. These indicators, along with their sources and definitions, are presented in Annex 7.

3.2 Stakeholder interviews

A total of 1816 face-to-face interviews with stakeholders involved in SME financing were carried out to complement the literature review. When selecting the relevant stakeholders. Three groups of stakeholders were identified: • Financial institutions and supply side representatives (such as commercial banks, financial institutions and investment managers); • Policy makers; and • Demand side representatives (such as representatives of professional associations representing Maltese SMEs).

Specifically, this includes representatives of finance suppliers, such as commercial banks, financial institutions and investment fund managers, as well as representatives of professional associations representing Maltese SMEs.

3.3 Online survey

An online survey among Maltese SMEs, consisting of 22 questions17, was launched on 22 May 2014 and closed on 09 July 2014. A questionnaire was sent to a sample of SMEs covering 2.8% of the total SME population in Malta with a stratification corresponding to the nationwide SME population in terms of sectors18. In an effort to ensure a robust response rate the questionnaire was further distributed to over 10,000 SMEs in Malta which are members of the Malta Chamber of Commerce, Enterprise and Industry and of the General Retailers and Traders Union (GRTU)19 and beneficiaries of grant schemes (funded by the EU) that were administered by Malta Enterprise (ME), the Tourism and Sustainable Development Unit (TSDU) and the Department for Social Welfare Standards (DSWS). Overall, more than 580 SMEs answered the online survey, of which 217 SMEs provided valid answers that were used for the analysis of the present AFMA study. The distribution of respondents is aligned with the overall Maltese SME population to the largest extent possible, as shown in Annex 220.

3.4 Data analysis All the data and information collected through the literature review, stakeholder interviews and the online survey was used and assessed in order to validate the study’s findings. The methodology used is based on the principles of triangulation which ensures that all findings presented in the AFMA report are supported, to the largest extent possible, by evidence from these three data sources. Information obtained through these data sources has been compared in order to identify trends or contradictions in the findings. The principle of triangulation is illustrated in Figure 1 below.

17 The questionnaire used for the online survey is presented in Annex 8. 18 According to the OECD definition, stratification consists of “dividing the population into subsets (called strata) within each of which an independent sample is selected” (OECD, 2013). The stratification conducted for the AFMA study divides the SME population of Malta into sectors. A detailed presentation of the sampling methodology used for the AFMA study is provided in Annex 2. 19 The Malta Chamber for SMEs. 20 The methodology conducted for the stratification of the Maltese SME population and the distribution of respondents to the online survey are presented in Annex 2.

Figure 1: Principle of triangulation

Literature

Findings

Online Interviews survey

Source: PwC.

The above-mentioned approach enabled tendencies for access to finance to be identified amongst SMEs in Malta.

4 The market environment This chapter presents a snapshot of the market environment relevant to SMEs in Malta. A more elaborated description of the market environment is provided in Annex 4.

Over the last few years, despite the turbulence experienced in the global and European economic environment, Malta has maintained a degree of stability and avoided many of the difficulties experienced by some other EU countries. This is partly due to the nature of the Maltese economy which remains isolated from external influences and has limited SMEs exports. The banking system remained strong and liquid while the continuous efforts of government and policy makers to maintain the pace of economic performance have also resulted in sustained positive market conditions and no fundamental issues were observed for Malta’s SMEs. Except for 2009, the Maltese economy recorded growth rates above the EU- average, amounting to a total Gross Domestic Product (GDP) of EUR 6.8bn in 2012. One of the critical success factors of Malta is its ability to attract Foreign Direct Investments, especially from the EU.

With regard to the business population in the country, there were 40,573 active SMEs and 61 large enterprises in Malta in 2012. This implies that 99.8% of the total active companies were SMEs of which 95.1% were micro-enterprises, which is slightly above the EU-28 average of 92.2%. Small and medium-sized enterprises account for 4.0% and 0.9% of the total SME population respectively. Further analysis of the SME distribution by region shows that 93% of the SMEs in the Maltese islands are concentrated in Malta, while the remaining 7% operate from Gozo, the second largest island.

Close to 70% of SMEs are active in six sectors. The three activities with the highest number of SMEs are “Wholesale and retail trade, repair of motor vehicles and motorcycles” (26.0% of SMEs), “Construction” (10.9% of SMEs) and “Professional, scientific and technical activities” (9.8% of SMEs). However, SMEs operating in the largest sectors do not necessarily contribute towards higher employment. Even though the wholesale and retail sector does in fact account for the most employed persons (24.6%) within the SME population, the accommodation and food services and manufacturing sectors employ 11.9% and 11.6% of the SME workforce respectively. Overall, Maltese SMEs employ 80% of the total workforce, which is higher than the EU average of 66.5%. This highlights the importance of these enterprises in terms of their contribution to economic activity and economic growth.

Despite the global financial crisis, the Maltese banking sector remains resilient due to its strong capital base and bank liquidity. The World Economic Forum rated Malta’s banking sector as the 12th soundest in the world out of 144 countries, and placed Malta at number 15 for financial market development. The banking sector in Malta consists of 26 credit institutions, of which three are owned by Maltese shareholders

exclusively. The Maltese banking sector appears to be a dominant financing source for Maltese enterprises21.

Regarding access to finance, the World Bank “Doing Business report 2014”, despite the strong banking sector in the country, ranked Malta 180th out of 189 countries with respect to getting credit. This is the effect of the dominance of the banking sector and the lack of other specialised institutions that could be more focused on SME financing. Moreover, according to the Central Bank of Malta (CBM) in January 2014, Malta had the fifth highest rate of bank lending interests after Cyprus, Greece, Portugal and Slovenia, thus increasing the cost of finance for SMEs. Lending to SMEs declined by 3.1%, following an increase of 5.6% in 2012, while the ratio of Non- Performing Loans (NPLs) from resident non-financial corporations increased from nearly 9% in 2009 to almost 16% in the first half of 2013. This increase is mainly due to the fact that only specific companies and sectors are eligible for bank loans in the country which often leads to an over-indebtedness of some companies while other companies have no access to financing. Moreover, a slowdown of the construction and real estate sectors contributed almost 50% to this increase of NPLs. Nevertheless, the overall amount of disbursed loans increased substantially during the first 6 month of 2014.

According to the 2013 Maltese Small Business Act (SBA) fact sheet, certain indicators measuring SMEs’ access to finance in Malta demonstrated that overall, Malta scores below the EU average. This is above all the case for the legal environment and the share of EU structural fund financing reserved for SMEs. It is furthermore a challenge for SMEs to attract financing from alternative funding sources outside the traditional banking sector, with only 19% being fully successful in applying for non-bank finance as compared to a near 80% average for the EU-28 (SAFE survey, 2013).

In Malta, a friendly legislative environment has attracted investment funds in the country. Relevant stakeholders observed that even though there is a number of investment funds registered in Malta, their focus is to invest in larger external markets, especially given the lack of deal flow in the local market. Therefore, such investment funds do not tend to provide Venture Capital, which is necessary to support the needs of innovative companies. The absence of legislation, of organised networks and public intervention schemes that could motivate private investors to invest are missing in the country. Such initiatives would protect and motivate investors to support local SMEs.

21 The SAFE survey confirms the predominance of the banking sector in SMEs’ access to finance in Malta: 67.7% of interviewed SMEs indicated that they used bank products, far above the EU average (51.5%). According to the SAFE Survey, no respondent has seen his credit application rejected (12.6% on average in the EU). Banks rather appear to leave room for negotiation of the amount: only 55.6% of applicants got the entire amount they requested (64.5% in the EU), whereas a significant proportion (27.6% against 7.3% on average in the EU) got a limited part of it. This shows that Maltese banks try to adjust an intermediate credit proposal in line with their risk profile rather than rejecting a demand.

With respect to Malta’s overall legal framework and fiscal policy, the Government has introduced a series of legislative frameworks to improve competitiveness, cut red tape and reduce the costs of regulation on enterprise. Nevertheless, these reforms might still be not sufficient for SMEs. When asked about the five most important factors limiting further business growth, unfair competition and the regulatory framework were named among the most limiting factors in the short-, middle and long-term 22 . In the longer term, regulatory and tax reforms at the European or global level could potentially erode Malta’s competitiveness as its dependence on sectors such the financial and gaming industries, which have greatly benefitted from a business-friendly tax and regulatory regime in the past, allowing them to offset a corporation tax rate of 35% which is otherwise among the highest in Europe.

Malta’s innovation performance, over the last decade has been very poor, mainly as a result of insufficient Research and Development (R&D) spending, along with the almost non-existent linkages between research and the needs of the productive sector. As indicated during stakeholder interviews, there are a number of SMEs that have come up with an innovative product/service but experience difficulty in taking the product to market. A further concern in Malta is the lack of an effective Intellectual Property (IP) rights framework, which has been identified by the market as a necessity for incentivising investment in R&D. In this light, initiatives and policies were recently introduced in Malta to create linkages between research (specifically the University of Malta), market needs and the country’s innovation system.

Malta’s market environment is also influenced by its changing demographics. Demographics affect most domestic social indicators, and may have an impact on the local business environment, and the development of SMEs. On the one hand, the wide availability of a well-educated labour force represents a competitive advantage for the country, serving as a lever to attract investment. On the other hand, the ageing population is a cause for concern for the long-term prospects of SME development in the country.

In conclusion, despite the favourable economic growth rates, SMEs are still exposed to several challenging factors, in terms of market conditions and regulation, high interest rates as well as demographics, including an ageing population and a low participation rate of women in the labour force. The lack of alternative financing sources, increasing levels of corporate debt and the tightening credit conditions remain two of the main factors undermining business confidence which are expected to influence the growth of SMEs.

22 In fact, the survey conducted for the present AFMA study showed that SMEs perceive price competition/small margins as the most limiting factor for further business growth in the short-, middle- and long-term. The SAFE survey shows the same result as competition was chosen as the most pressing problem for SMEs in Malta.

5 Existing SME financing instruments Throughout the present report, the market environment related to the financing of SMEs, and the analysis of supply and demand, highlight the dominant position of the banking sector in the country. As there are currently no alternative potential financial intermediaries for FIs, this limits the potential of public sector intervention and Malta has implemented FIs in the past that are adapted to the banking system, namely in the form of loans (including micro-credit) and guarantees. Other FIs in the form of equity or microfinance have not been implemented yet. In recent years, financing tools in the form of grants have been widely used. These include direct grants, interest rate subsidies, and tax subsidies. In this chapter the existing FIs and grant schemes will be presented as well as a presentation of the historical use of structural funds in the country.

5.1 Financial Instruments available for SMEs in the country This section presents the Financial Instruments available for SMEs in Malta, financed by European and national funds. The main FIs in Malta are implemented by the JEREMIE initiative and Malta Enterprise.

a) EU funded Financial Instruments The paragraphs below describe the FIs implemented in Malta under the 2007-2013 programming period.

The JEREMIE Initiative in Malta The JEREMIE initiative was designed in Malta with the purpose of increasing awareness of the use of FIs and improving access to finance for SMEs. In this context, the Maltese authorities created a Malta JEREMIE Holding Fund, managed by the EIF and funded by Operational Programme I (OPI) “Investing in Competitiveness for a Better Quality of Life”.

Currently one product is fully operational under the JEREMIE initiative in Malta, namely the First Loss Portfolio Guarantee (FLPG) instrument which guarantees up to 75% of loans to SMEs. At the inception of the guarantee instrument, EUR 10m were allocated with the aim of creating a loan portfolio of EUR 51m. The demand for these guarantees was significant, leading to a top-up of EUR 2m in August 2013 and increasing the maximum loan portfolio to over EUR 60m.

Table 6: Conditions and criteria for eligibility of the JEREMIE guarantee instrument

Conditions / Criteria for eligibility

Purpose Capital expenditure purposes

Maximum 10 years (minimum maturity of 1 year) loan term

Interest rate Discounts average 1%

Security 75% covered by JEREMIE. Maximum collateralisation cover at portfolio level of 37.5%

Charges No early repayment penalty

Type of Micro, small and medium-sized enterprises as per EU definition company

Scope of All SMEs except: business - SMEs in difficulty; - SMEs active in arms production and trading, gambling, tobacco, human cloning, genetically modified organisms, fishery and aquaculture sector, primary production of agricultural products; - SMEs presented in article 1 (c-g) of De Minimis regulation; and - Real estate and construction sectors

Source: BOV presentation: Local Best Practices (Financial Incentives in Malta) - JEREMIE.

As of the end of August 2014, 761 loans were granted to 649 SMEs (total loan volume committed reached EUR 62,1m, while loans disbursed reached EUR 53m) through the JEREMIE portfolio guarantee. On average, 20 loans per month were granted with an average value of EUR 1.8m per month. This initiative resulted in over EUR 100m worth of investment23, being a leverage of 5.8x.

The guarantee instrument supported SMEs of all size groups. More specifically, 75% of total facilities were taken up by micro-enterprises, 21% by small companies and 4% by medium sized enterprises and the average loans sought were less than EUR 100,000. 44% of facilities were granted to start-ups having a total value of EUR 18.2m. Under the JEREMIE initiative start-ups are defined as those SMEs that have carried out their main business for a period not exceeding 24 months24.

The loans covered by the guarantee were granted for various purposes including the setting up of premises for new catering establishments, offices and retail outlets, the purchase of tangible assets such as machinery, hardware and other equipment, and the purchase of energy efficient equipment. The SMEs were mostly active in the sectors dominating Malta’s economy: wholesale and retail, accommodation and

23 Information provided during stakeholder interviews. 24 Bank of Valletta presentation – The JEREMIE Initiative in Malta.

food service activities and the manufacturing industry. These sectors combined represent 67% of the companies supported by JEREMIE25.

Despite Malta’s limited experience with financial engineering instruments, this instrument seems to be successful in terms of absorption of funds, as it was well targeted, covering the existing, realistic needs of SMEs, especially micro-enterprises. However, it has to be noted that the guarantee covers loans originating from a single financial intermediary namely the Bank of Valletta (BoV), which was selected following a public Call for Expression of Interest. The implication of further intermediary banks has to be considered in order to increase the impact of JEREMIE in the country and take further advantage of the strong banking system.

BoV Start Plus

BoV was selected as an intermediary in the European Commission’s CIP (Competitiveness and Innovation Programme) which is implemented by the EIF and had previously participated in JASMINE. Under this scheme called “BoV Start Plus”, the BoV is providing loans in the form of microcredits that are partially guaranteed by CIP. Through this programme BoV is committed to create a portfolio of EUR 6m of microloans (i.e. up to EUR 25,000) for start-ups over a three year period. These microloans are characterised by low interest rates and lack of collateral and can support investment and working capital needs.

After Malta Enterprise under the previous programming period 2001-2006, this is the second time that a Maltese financial intermediary took advantage of centralised EU financing opportunities. BOV signed the agreement with the EIF in November 2013 and officially launched the initiative in January 2014. While the closing date was set for 16 December 2014, the major part of the funds has already been spent as of September 2014. Such interest confirms that the scheme was well tailored to the needs of Maltese start-ups.

In fact, BoV making use of JASMINE and using Technical Assistance to maximise its success can be seen as a good practice of how technical assistance supports intermediaries in branching out into new Financial Instruments/markets. This example is in contrast to the unsuccessful cooperation of Malta Enterprise and the European Commission's Multiannual Programme for Enterprise (MAP): In 2004, the EIF provided a counter guarantee covering the loan guarantee activities of Malta Enterprise (including innovative start-ups). The cooperation was planned to support the establishment of an SME loan guarantee scheme in Malta. This agreement was the first contract under the MAP facility with an intermediary in Malta, although this failed and came to an end 7 years ago. The reasons for its failure are arguably in

25 Bank of Valletta presentation – The JEREMIE Initiative in Malta.

the lack of ownership and promotion by ME, but also in the lack of interest from SMEs. Table 7: Conditions and criteria for eligibility of the BOV Start Plus programme

Conditions / Criteria for eligibility

Maximum amount EUR 25,000

Purpose To support capital investment and working capital directly related with a capital investment project

Eligible sectors All sectors excluding agriculture / fisheries (some restrictions on transport)

SME Contribution 20% of total investment

Maximum loan 5 years (minimum maturity of 1 year) term

Interest rate 4.65% (as at 13 June 2014)

Security No collateral requested

Charges No annual processing and early repayment fees

Type of company Start-up (micro-enterprises only)

Scope of business Most sectors

Source: BOV presentation: EU Financial Instruments BOV Start Plus 2014.

As at the end of June 2014, 33 microloans have been granted to 32 micro- enterprises with a total value of over EUR 480,00026.

b) National funded Financial Instruments Malta Enterprise is the national development agency with the legal basis in the Malta Enterprise Act. It is responsible for promoting and facilitating international investment in Malta by offering investors business opportunities and other services. This institution implements initiatives that promote Malta’s economic growth and attractiveness. It is also responsible for the growth and development of Maltese enterprises, especially SMEs. The institution was created with the objectives of supporting the local companies in: • Setting up their business; • Expansion of their existing operations; • Innovation, Research and Development; and • Access to international markets.

Malta Enterprise also designs and implements FIs for SMEs, financed mostly from the national budget as presented below.

26 Stakeholder interview with Bank of Valletta.

Loans

Malta Enterprise provides direct loans (often referred as soft loans) to SMEs and large enterprises offered at low interest rates. The main objective of this incentive is to support new investment projects undertaken by enterprises mostly engaged in the manufacturing industry. These loans usually cover 33% of investment expenditure and do not exceed 75% of the cost of plant, machinery and equipment. Since its inception, EUR 10m have been provided as loans to enterprises in Malta27. This is an important amount, however, and it should be noted that direct loans such as the ones provided by the Malta Enterprise fail to create leverage. By working in isolation from the market, they limit their overall impact as FIs.

Loan Guarantees

Malta Enterprise also guarantees loans provided by commercial banks through two schemes.

Micro Guarantee Scheme: This guarantee scheme was launched in 2013 and targets companies employing up to 50 employees. Companies can benefit from a guarantee between 65% and 80% (mostly depending on the sector of activity) of loans up to EUR 100,000 28 , which may be used to finance a range of business projects. The Micro Guarantee Scheme has the objective of accelerating growth by facilitating access to debt financing for smaller businesses.

The Micro Guarantee Scheme would appear to have a higher level of acceptable risk than that imposed on projects under the JEREMIE scheme. However, up to the third quarter of 2014 there has been no detailed information available since this is a new scheme and only one approval has been granted by Malta Enterprise. The reason for this poor performance is not evident and could be related to the low awareness among microenterprises and their lack of experience in seeking finance.

Loan Guarantees: This scheme is addressed to all SME sizes. The main objective of this incentive is to support new investment projects undertaken by enterprises engaged in the manufacturing sector. It is estimated that on average EUR 3m to EUR 5m of loan guarantees are issued by ME per annum. The uptake of soft loans and guarantees are largely dependent on the projects submitted as such schemes are not call driven. Moreover, these loan guarantees apply specifically to manufacturing companies. By providing a number of incentives specifically to the manufacturing industry, Malta intends to safeguard the industrial sector as a result of intense competition from developing countries such as China and India.

27 Data provided by ME during stakeholder interviews. Estimates are based on annual approvals by ME. 28 The figure provided by the institution during the interview includes guarantees provided to both SMEs and large companies.

37 Table 8: Existing Financial Instruments in Malta29

Leverage by Number of Source of Instrument Instrument Financial Budget Disbursemen Eligibility Main objective of Institution Scheme intermediary SMEs Start date End date financing name type intermediary (mEUR) ts (mEUR) criteria product (mEUR) supported EIF First Loss JEREMIE JEREMIE Bank of Support capital 1 ERDF Portfolio Guarantee 10.8 30 53 All SMEs 649 Apr 2011 Mar 2015 Holding Valletta 62.6 investment Guarantee Fund

First Loss Support capital BOV Start Bank of Micro- 2 EIF CIP Portfolio Guarantee 0.6 31 0.5 investment and 32 Dec 2013 Dec 2016 Plus Valletta 6 enterprises Guarantee working capital

All business Finance projects undertakings leading to Malta Micro Malta Commercial including start- business 3 State Funds Enterprise Guarantee Guarantee n/a n/a n/a n/a 2013 n/a Enterprise Banks ups that satisfy enhancement, guarantees Scheme eligibility growth and criteria development

Facilitate access Support new Enterprises to finance to Malta Loan investment Commercial engaged in 4 State Funds Guarantee n/a n/a n/a assist enterprises n/a n/a n/a Enterprise Guarantees projects in Banks manufacturing in the acquisition manufacturing sector of capital assets

Financing Enterprises Support Malta investments in engaged in enterprises 5 State Funds Direct loan Soft loan n/a n/a n/a n/a n/a n/a Enterprise qualifying - manufacturing through loans at expenditure sector low interest rates

Sources: BOV presentation: EU Financial Instruments BOV Start Plus 2014 and Malta Enterprise.

29 Information for EU funded financial instruments is as at June 2014. 30 Leverage of 5.8x. 31 Leverage of 10x.

5.2 Grant schemes This section presents the grant schemes available to SMEs in Malta. These include schemes supported by EU funds, namely under the Operational Programmes I and II, the Rural Development Programme (RDP) and the Fishery Operational Programme (FOP) as well as grants supported by national funds.

a) EU funded grant schemes For the 2007-2013 programming period, Malta was allocated funds through the Operational Programme I (OP I), “Investing in Competitiveness for a Better Quality of Life” and Operational Programme II (OP II), “Empowering People for More Jobs and a Better Quality of Life”. These Operational Programmes (OPs) have introduced several grant programmes in Malta, which have supported numerous enterprises, especially SMEs, in obtaining funding for specific needs and requirements. These grant schemes were introduced under priority axes 1, 2, 4 and 6, which supported SMEs through state-owned intermediaries such as Malta Enterprise (ME), the Tourism Sustainable Development Unit (TSDU) and the Department for Social Welfare Standards (DSWS). Grant schemes that are no longer available are also presented in the table below in order to highlight the previous use of grants. Table 9: Grant schemes and programmes in Malta under the 2007-2013 programme

Operational Grant Programme / Measure Status Committed Inter- Programme / Funds32 mediary Priority Axis (mEUR)

OPI / PA1 "ERDF Small Start-up Grant Scheme" Closed 1.4 ME

OPI / PA1 "ERDF Innovation Actions Grant Scheme (Innovation)" Closed 6.1 ME

OPI / PA1 "ERDF Innovation Actions Grant Scheme (Environment)" Closed 1.0 ME

OPI / PA1 “ERDF e-Business Development Grant Scheme” Closed 2.2 ME

OPI / PA1 "ERDF International Competitiveness Grant Scheme" Closed 3.9 ME

OPI / PA4 “ERDF Energy Grant Scheme” Closed 10.9 ME

OPI / PA6 “Grant Scheme for Child Care Facilities” Closed 0.5 DSWS

OPI / PA1 "Research & Development Grant Scheme". Closed 2.8 ME

OPI / PA2 “Grant Scheme for Sustainable Tourism Projects by Closed 8.9 TSDU Enterprises” OPII / PA2 “Training Aid Framework” Closed 8.8 ETC

OPII / PA3 “Employment Aid Programme” Closed 14.1 ETC

Total 60.6

Sources: PPCD – List of Aid Schemes of EU Funding through Structural Funds for OPI and OPII (updated June/July 2014).

32 Amounts include EU and national eligible public funding and exclude private contributions.

The grant schemes under the 2007-2013 programming period proved relatively successful and have yielded positive results in many areas. By the end of 2012, 259 projects were supported by Malta Enterprise, under Priority Axis 1 (OP I), with a total value of EUR 15m. In total 238 projects have been completed. The MA has published some performance indicators, as shown in Table 10 below. While several indicators exceeded targets, it is of note that the number of supported start-ups remains relatively low at 17 as compared to the target of 40. This suggests that in the new programming period more attention should be paid to fostering the emergence of new businesses, on top of supporting the existing ones. Table 10: Progress indictors under Priority Axis 1 (OP I) – Take-up of initiatives by SMEs

Indicator Target Result

No. of projects (direct investment aid to SMEs) 450 326

No. of SMEs launching new or improved product or processes 40 62

No. of SMEs improving their use of ICT for e-business 49 62

No. of SMEs improving their market penetration efforts 55 63

No. of start-up businesses supported (core indicator) 40 17

No. of SMEs assisted in environmentally sensitive technologies, 35 19 operating systems and processes

Source: PPCD Annual Implementation Report 2013, June 2014 (OPI).

Throughout the implementation of OP I during the 2007-2013 programming period, the MA identified various problems encountered in the management and administration of such aid schemes including33: • Considerable time spent on the project selection process; • Bottlenecks in the public procurement process during the selection and vetting of EU funded tenders; and • Untimely payments and verification processes.

Measures were undertaken to mitigate these problems and included among others34: • Ensuring maximum availability of the selection committee for project selection meetings to ensure that time spent on project selection is minimised to the extent possible; • Setting up a special unit to prioritise the vetting of EU-funded tenders and improving the capacity of the Department of Contracts to increase efficiency in the awarding of tenders and to reduce bureaucracy; and

33 PPCD Annual Implementation Report 2013, June 2014 (OP I). 34 Ibid.

• Simplifying templates used for payment verification purposes and increasing the workforce at the Treasury Department 35 , to improve the timeliness of payments.

Also under priority axis 2 (OP I) there were 100 projects supported by TSDU with a total value of EUR 7.1m. A further call was issued in 2013, where an additional 88 applications were submitted. Malta Enterprise has also supported 178 projects under priority axis 4 in relation to the energy grant scheme with a total value of EUR 10.7m. Approximately EUR 5.4m have been paid out to eligible enterprises36.

As at 2013, 1,569 SMEs benefitted from the Training Aid Framework, where EUR 8.8m were allocated from the ESF and targeted specific sectors such as transport, wholesale and retail, financial intermediation, real estate, manufacture of food and beverage products and post and telecommunications. In total EUR 5m has been paid out to enterprises. Another EUR 14.1m were allocated from ESF funds to the Employment Aid Programme, which was fully absorbed by enterprises aiming to improve employment37. Initially, Malta had some problems in absorbing ESF funds; however the process improved after the involvement of private enterprises in the implementation. Given that both schemes were oversubscribed, there is great potential for such funds to be fully exploited by employers if these are made available in the next programming period38.

During the same programming period, there were another two operational programmes, the Rural Development Programme (RDP) and the Fisheries Operational Programme (FOP) that were administered and implemented by the Agriculture and Rural Payments Agency (ARPA) and the Funds and Programmes Division (FPD) respectively. These operational programmes were funded by the European Agricultural Fund for Rural Development (EAFRD) and the European Fisheries Fund (EFF) and provided grants to enterprises. These programmes are presented in the table below.

35 The Treasury Department is responsible for effecting disbursements. and managing the Government’s debt portfolio. 36 PPCD Annual Implementation Report 2013, May 2014 (OPII). 37 PPCD Annual Implementation Report 2013, May 2014 (OPII). 38 Report published by Malta Business Bureau - Allocation of EU Funds in Aid of Private Enterprise: Programming Period 2014-2020, July 2013.

Table 11: Grant schemes under the 2007-2013 RDP39 and FOP40 programmes

Operational Measure Objective of measure No. of SMEs Intermediary Programme / assisted Priority Axis

“Vocational Training and Information Actions” To provide the opportunity and means for RDP / PA1 Measure 111 farmers and others involved in agricultural 5 ARPA activities and the agro-food industries to be trained. Training was limited to the managers or owners of micro-enterprises.

RDP / PA1 “Use of Farm Advisory Services” Assistance was This measure was aimed at directing indirect as a farmers, through the use of advisory result of funding Measure 114 ARPA services, to adopt sustainable practices the setup of and to facilitate access to farmers to rural Farm Advisory development measures. Services

RDP / PA1 Assistance was indirect as a “Setting up of Farm Advisory Services” result of funding Measure 115 To aid in the setting up of farm advisory ARPA the setup of services bodies. Farm Advisory Services

RDP / PA1 “Modernisation of agricultural holdings” To support farm investment and assist agricultural holdings to improve their Measure 121 390 Awarded ARPA economic performance through better use of new technologies, organic products and on farm diversification.

“Adding value to agricultural products” This measure was specifically orientated RDP / PA1 Measure 123 49 ARPA at facilitating improvements in processing and marketing of agricultural products.

“Cooperation for development of new products, processes and technologies in the agriculture and food sectors” The general aim of this measure was to increase the competitiveness of the RDP / PA1 Measure 124 6 ARPA farming sector and of the agro-food processing industry through the development of new products (goods and services), processes and technologies.

39 ARPA website: https://secure2.gov.mt/MRRA-PA/rdproj_tm?l=1. 40 FPD website: https://secure2.gov.mt/fpd/fish_results.

Operational Measure Objective of measure No. of SMEs Intermediary Programme / assisted Priority Axis

“Infrastructure related to the development and adaptation of agriculture” To facilitate the development of RDP / PA1 Measure 125 agriculture by supporting the 0 ARPA development of the necessary infrastructure to address water scarcity and farm accessibility.

“Participation of farmers in food quality schemes” RDP / PA1 Measure 132 To encourage farmers to participate in 4 ARPA Community and national food quality schemes through financial support.

“Setting up of producer groups” Support under this measure is limited to RDP / PA1 Measure 142 3 ARPA cover the setting up and administrative operation of producer groups.

“Public aid for permanent cessation of fishing activities launch 1” 13 Awarded FOP / PA1 Measure 1.1 Contributes to financing of the FPD 27 On reserve permanent cessation of fishing activities of fishing vessels. “Public aid for permanent cessation of fishing activities launch 2” FOP / PA1 Measure 1.1 Contributes to financing to financing of 6 FPD the permanent cessation of fishing activities of fishing vessels.

“Public aid for permanent cessation of fishing activities launch 3” FOP / PA1 Measure 1.1 Contributes to financing to financing of 5 FPD the permanent cessation of fishing activities of fishing vessels.

“Public Aid for Permanent Cessation of fishing activities Scheme 4” FOP / PA1 Measure 1.1 Contributes to financing to financing of 5 FPD the permanent cessation of fishing activities of fishing vessels.

“Investment on Board Fishing Vessels and Selectivity launch 1” FOP / PA1 Measure 1.3 Contributes to financing of equipment 45 FPD and the modernisation of fishing vessels of five years of age or more.

Operational Measure Objective of measure No. of SMEs Intermediary Programme / assisted Priority Axis

“Productive Investments in Aquaculture” Support investments in the construction, FOP / PA2 Measure 2.1 extension, procurement of equipment 2 FPD and modernisation of production installations.

“Aqua-environmental measures” Supports granting compensation for the FOP / PA2 Measure 2.2 use of aquaculture production methods 0 FPD that help to protect and improve the environment and to conserve nature.

“Investments in Processing and Marketing” FOP / PA2 Measure 2.3 Support investments in processing and 2 FPD marketing of fisheries and aquaculture products.

Source: ARPA website and FPD website.

b) National funded grant schemes Besides the schemes that are offered under OPs I and II, the RDP and the FOP which are principally funded through ERDF, ESF, EARDF and EFF, Malta Enterprise offers many other incentives in the form of grant schemes, interest rate subsidies, investment tax credits and other support measures. In some cases these have a special focus on SME development and growth, as described in the following sections41.

Grant schemes

Business Development scheme: The scheme is intended to facilitate typically larger, high value-adding projects that are likely to offer a significant contribution to the regional development of Malta through substantial job creation. The scheme may support various activities such as initial development phase of enterprises establishing an operational base in Malta. The total aid per enterprise cannot exceed EUR 200,000 over a period of three years. This scheme is mostly applicable to large firms but SMEs can also apply.

Network Support Scheme: Business Networks are made up of between 3 and 10 independent enterprises working together to achieve a specific business objective. Through the sharing of resources, enterprises forming part of the network can benefit

41 ME website: http://www.maltaenterprise.com/en/support.

from transfer of knowledge, combined capacity, improved business prospects and achieve higher competitiveness. Malta Enterprise is supporting approved network projects with a grant up to EUR 60,000. This scheme provides support mainly to associations and does not provide any direct assistance to SMEs.

Gozo Transport Grant Scheme: The scope of this scheme is to support manufacturing undertakings operating from Gozo by reducing the additional inter-island transport cost incurred for transporting materials, goods and finished products between Malta and Gozo. This scheme proved to be quite popular, particularly amongst SMEs. In 2012 and 2013 Malta Enterprise granted total aid of EUR 481,000 and EUR 309,000 respectively, mainly to SMEs42.

Improving Market Entry and Internationalisation of companies: This incentive is used to facilitate access to foreign markets by allowing enterprises to explore growth opportunities, establish business contacts and consolidate existing markets. This scheme provides part-financing to business undertakings that participate in international trade events, fairs and trade missions. Malta Enterprise also provides various initiatives that prepare entrepreneurs for entering new markets. The total aid that may be granted to a single undertaking is limited to EUR 30,000 in any fiscal year. Malta Enterprise may part-finance eligible costs at a rate of 50% in the case of small or medium-sized undertakings. The uptake for this scheme in 2013 was slightly over EUR 539,00043.

Innovative start-ups Programme: This scheme supports new enterprises engaged in existing markets but introducing innovative products and services and having the potential to compete in international markets and enterprises engaged in new markets, new technologies, novel products or services and in knowledge based industries that demonstrate a potential for job creation and growth. This incentive is implemented by Malta Enterprise in cooperation with the Kordin Business Incubation Centre (KBIC). The grant is available to enterprises that have submitted a business plan approved by Malta Enterprise. The maximum grant under this incentive is EUR 15,000; however, the actual value granted to a beneficiary varies according to the level of innovation of the start-up. The uptake of this scheme has varied over the years, with an average of around six start-ups per year with grants of roughly EUR 100,000 per annum. In 2013 over EUR 56,000 were provided as aid to start-ups44. This scheme is currently closed but will be revised on the basis of the updated State Aid regulation.

Royalty Income from Patents: The objective of this scheme is to encourage researchers to exploit intellectual property through the licensing of patented knowledge. The scheme should also encourage investment in research and

42 Data provided by ME during stakeholder interviews. 43 Data provided by Malta Enterprise during stakeholder interviews. 44 Ibid.

knowledge creation and exploitation of intellectual property. The incentive gives fiscal benefits to persons (individuals and enterprises) that own the rights to patented intellectual property and are receiving income in the form of royalties.

Grants for Cross-Border Collaborative Research and Development: The collaborative R&D Grant Scheme supports Maltese enterprises that carry out an industrial research or experimental development project in collaboration with other enterprises. The project should lead to the development of innovative products, processes and services based on advanced technologies. Projects may only be funded if they are endorsed by the EUREKA network or approved through the Eurostars Programme. This scheme is currently under review. The uptake of this scheme did not exceed three projects per annum. This scheme is currently closed but according to meetings held with Malta Enterprise, there is the possibility that it will be updated to re- commence in October 2014.

Interest Rate Subsidies Interest Rate Subsidies: The main objective of this incentive is to support new investment projects undertaken by enterprises engaged in manufacturing. This scheme offers grants to cover a percentage of the finance costs incurred by enterprises with the aim of reducing the effective rate of interest paid.

Refurbishment of Hotels, Accommodation Facilities and Restaurants: These grants in the form of interest rate subsidies aim to support hotels, restaurants and holiday accommodation owners in upgrading their operations. Approved projects may receive an interest rate subsidy of between 1% and 3% during the first five years of a loan period. To date EUR 800,000 in subsidies were allocated to Maltese enterprises engaged in the accommodation and food services sector45. This scheme is currently closed. According to meetings held with Malta Enterprise, due to changes in State Aid regulation, it is currently in the process of updating relevant schemes on a priority basis. Since this scheme was relatively popular amongst enterprises it is likely possibility that this well be extended.

Investment Tax Credits

Malta Enterprise also provides grants in order to subsidise the tax payments of companies or labour costs.

MicroInvest: This scheme provides tax incentives to micro-enterprises (employing fewer than 10) and the self-employed for development projects. All undertakings, with few exceptions are supported through a tax credit representing a percentage of the eligible expenditure and wages of newly recruited employees and/or

45 Data provided by ME during stakeholder interviews.

apprentices. This scheme entitles eligible companies to a tax credit equivalent to 45% of the eligible expenditure incurred (this percentage increases to 65% for undertakings operating from Gozo). The maximum eligible amount cannot exceed EUR 30,000 over a period of 3 consecutive years and these tax credits must be utilised within a period of 3 years. This scheme attracted around 2,000 applications with around EUR 7m worth of support annually. In 2013, Malta Enterprise received 962 applications (on average around 900 applications are processed annually).

Investment Aid Tax Credits: This scheme supports enterprises in investment and job creation and is one of the most popular forms of support utilised by enterprises. The scheme is mainly focused on attracting new investment projects and eligible enterprises can benefit from tax credits. The principle beneficiaries are enterprises engaged in manufacturing, ICT, call centres, pharmaceuticals, biotechnology, and audio-visual industries. Annual aid provided through this scheme reached around EUR 50m; however, this scheme is currently under review since Malta is no longer considered as an “a” area (GDP per capita <75% of the EU average) in terms of the Regional Aid Guidelines, but as a “c” area (where aid can only be granted to facilitate the development of certain economic activities). The incentives claimed by all enterprises during the last three years amounted to circa EUR 49m per annum.

Get Qualified: Get Qualified is an initiative that supports the personal development of individuals for the achievement of qualifications and certifications required by industry. The incentive is applicable to individuals following a course of studies leading to a certification, diploma, degree or post-graduate degree courses. Upon successful completion the student will benefit from a tax credit thus recovering part of the costs incurred.

5.3 Historical use of structural funds Since Malta’s EU accession in 2004, the country has been granted access to a number of EU Financial Instruments and schemes. In 2004, Malta began to implement and participate actively in the following programmes for the period from 2004 till 2006 outlined in Table 12 below. Table 12: Funding provided under the 2004-2006 programming period

(mEUR)

The Structural Funds Programme for Malta 2004-2006 63.19

The Structural Funds Community Initiative Interreg III 2.37 The Structural Funds Community Initiative Equal 1.24

The Cohesion Fund Programme for Malta 2004-2006 21.9

Total 88.7

Source: PPCD website.

For the 2007-2013 programming period, Malta experienced a large increase in its allocation, to EUR 855m in total. These funds were made up of EUR 444m under the European Regional Development Fund, EUR 284m under the Cohesion Fund, EUR 112m under the European Social Fund (ESF) and another EUR 15m under the European Territorial Cooperation Programmes.

By 2012, the EU Structural and Cohesion Funds had become the primary pool of public funding for the modernisation and improvement of Malta’s economic environment. The National Strategic Reference Framework 2007-2013 (NSRF), approved by the European Commission in December 2006, provided guidelines for the use of EU Structural Funds through two OPs namely OPI ‘Investing in Competitiveness for a Better Quality of Life’ and OPII ‘Empowering People for More Jobs and a Better Quality of Life’. These programmes were designed with four objectives in mind: • Strategic objective 1 – Sustaining a growing knowledge based competitive economy; • Strategic objective 2 – Improving Malta’s attractiveness and the quality of life; • Strategic objective 3 – Investing in human capital; and • Strategic objective 4 – Addressing Gozo’s regional distinctiveness.

a) At a glance: Operational Programmes and Structural Funds Structural Funds and the Cohesion Funds have supported SMEs mainly through grant schemes but also through the use of FIs. Malta has been using the provisions of the two EC Operational Programmes co-financed in various portions by the European Regional Development Fund (ERDF), the European Social Fund (ESF), and the Cohesion fund (CF) to ensure the availability of funding. Table 13: Funding Distribution by Operational Programme

Total Budget National Funding EU funding (EUR) As at 20/07/2013 (EUR) (EUR) ERDF ESF CF

Investing in Competitiveness for OPI 128,492,304 443,978,031 - 284,145,020 856,615,354 a Better Quality of Life

Empowering People OPII for More Jobs and a 19,764,705 - 112,000,000 - 131,764,705 Better Quality of Life

Total 148,257,009 443,978,031 112,000,000 284,145,020 988,380,060

Source: PPCD website.

Figure 2: Budget distribution by Operational Programme OPI in line with the National Strategic OPI - Investing in Competitiveness for Reference Framework (NSRF) – Budget a Better Quality of Life distribution

OPII in line with the National Strategic OPII - Empowering People for More Reference Framework (NSRF) – Budget Jobs and a Better Quality of Life distribution

Source: eufunds.gov.mt, Structural Funds and Cohesion Fund 2007 - 2013.

Table 14: Fund absorption progress by Operational Programmes I and II

Total budget Contracted % of Actually paid As at 03/06/2014 % of budget (EUR) (Grants) (EUR) budget (EUR)

Investing in OP I Competitiveness for a 856,615,355 701,600,000 82% 480,700,000 56% Better Quality of Life

Empowering people for OP II more jobs and a better 131,764,705 99,520,000 75.5% 77,800,000 59% quality of life

Total 988,380,060 801,120,000 81% 558,500,000 56.5%

Source: eufunds.gov.mt, Operational Programmes (Monitoring Committees).

Despite the numerous grant schemes implemented under the 2007-2013, the absorption rates have been moderate. As of June 2014 only 56.5% of the funds reached the beneficiaries. Fortunately, more than 80% of the funds have been contracted but it is uncertain whether these projects will be implemented.

b) OP I “Investing in Competitiveness for a Better Quality of Life” (2007-2013) On 26 June 2007, The European Commission gave the go-ahead for a major development programme in Malta for the period 2007-2013, namely the Operational Programme for "Investing in Competitiveness for a Better Quality of Life" (OP I). This scheme involved EC support with the primary objective of achieving a higher degree of convergence across Member States. The total budget of the programme was EUR 856m where Community assistance through the ERDF and Cohesion Fund amounted to EUR 444m and EUR 284m.

The Operational Programme “Investing in Competitiveness for a Better Quality of Life” was the principal programming document aimed at improving the competitiveness of the Maltese economy. Through ERDF and the Cohesion Fund, OPI aimed to develop and generate economic growth based on encouraging competitive economic activities and strengthening Malta’s physical infrastructure, leading to a better quality of life for Maltese citizens. The OP’s main objectives defined through seven priority axes:

Priority Axis 1: “Enhancing knowledge and innovation”: to promote and strengthen high value-added economic activity, including attraction of Foreign Direct Investment, support of the re-structuring process of local industry and explore the potential for renewable energy sources. Therefore, the objective for this priority axis was largely targeted at assisting SMEs in starting-up, launching new products or services, expanding or enhancing their businesses and improving their market penetration efforts.

Priority Axis 2: “Promoting sustainable tourism”: intended to promote the Maltese Islands as a prime tourist destination and improve the competitiveness of tourism and culture operators.

Priority Axis 3: “Developing the trans-European network for transport”: to improve journey-time reliability and road safety through upgrades to parts of the TEN-T road infrastructure and improve maritime accessibility (also inter-island) by upgrading TEN-T ports and related infrastructure.

Priority Axis 4: “Climate change and resource efficiency”: to improve and strengthen Malta’s mitigation and adaption measures (strategies) in response to climate change as well as measures intended to ensure the best and efficient use of available resources.

Priority Axis 5: "Safeguarding the environment": to continue with the upgrading process of the country’s environment infrastructure, particularly in the areas of solid waste management and risk prevention.

Priority Axis 6: "Urban regeneration and improving the quality of life": to safeguard and value the country’s urban heritage and promote an overall improvement in quality of life through better accessibility, enhanced education, social and health systems and increased environmental monitoring capacity.

Priority Axis 7: "Technical assistance": to facilitate the overall implementation of OPI and to reinforce the administrative capacity of the public administrations concerned.

The overall objective of this OP and the specific objectives of sustaining a growing, knowledge-based, competitive economy and improving Malta’s attractiveness and the quality of life are being measured and assessed through an overall impact indicator of increasing nominal exports of goods and services. This is based on the NSRF Strategic Objectives of Sustaining a growing, knowledge-based, competitive economy and improving Malta’s attractiveness and the quality of life. It is also based on the National Strategic Reference Framework’s (NSRF) core target and impact indicator: increasing nominal exports of goods and services by 4% over the 2007-2013 programming period.

More specifically, the goals of the OP and the seven priority axes are, amongst others, to increase Research and Development expenditure from 0.52% of GDP in 2004, up 0.85% by 2013, to increase earnings from tourism by 1% per annum over the 2007-2013 programming period, and to increase manufactured export earnings with an average rate of 2.7%46. Another important objective is to create 1,400 jobs by 2015, as a direct result of interventions financed through the ERDF and CF47.

In particular, the objectives of priority axis 1 were mostly focused on the set-up and development of SMEs in Malta. Certain schemes introduced under priority axes 2 and 4 were also targeted at helping SMEs obtain funding from available Financial Instruments, albeit to a lesser extent than priority axis 1. There were several grant schemes and FIs introduced under these axes aimed at improving SMEs’ competitiveness. The most successful initiative implemented in Malta was the introduction of the JEREMIE Fund scheme, implemented under priority axis 1, with EUR 12m in funds committed from the ERDF with an objective to facilitate over EUR 51m in investment into SMEs.

46 Baseline data 2004 (excluding extraordinary items) with an average growth calculated over a 7 year reference period. 47 Operational Programme I Cohesion Policy 2007-2013, November 2013.

c) OP II “Empowering People for More Jobs and a Better Quality of Life” (2007-2013) Operational Programme II was originally approved by the Commission on the 22nd June 2007. This was subsequently updated and approved in July 2012. 48 The programme was co-financed by the European Social Fund, through which it aimed to strengthen social and economic development by improving employment and job opportunities, encouraging a high level of employment, and more and better jobs. It supported initiatives that aim to increase employment and quality and productivity at work, promote financial inclusion and encourage disadvantaged people to join the work force.

OP II addressed the following five key priority axes agreed upon between Malta and the European Commission:

Priority Axis 1: “Improving Education and Skills”, to invest in human capital in order to increase the overall participation rates in education at all levels, thereby increasing and upgrading the knowledge and skills levels of the labour force.

Priority Axis 2, to “Investing in the Employability and Adaptability of the Workforce”: invest in human capital to ensure that the working age population and enterprises become flexible enough to respond to the needs of the economy, whilst reducing unemployment levels.

Priority Axis 3, to “Promoting an Equal and Inclusive Labour Market”: promote the uptake of stable and quality employment by persons who find difficulty in participating in the labour market.

Priority Axis 4, to “Strengthening of Institutional and Administrative Capacity”: invest in human resources development and mechanisms in order to strengthen institutional capacity and efficiency of public administrations, local government, social partners and civil society.

Priority Axis 5, to “Technical Assistance”: facilitate the overall implementation of the Programme in order to optimise the programme’s quality and efficiency, whilst ensuring effective application of regulations and procedures.

48 PPCD website.

6 Priorities and policies of the Managing Authority for SME financing The Planning and Priorities Coordination Division (PPCD) within the Ministry for European Affairs and the Implementation of the Electoral Manifesto (MEAIM) is the Managing Authority of the two OPs developed in Malta for the next programming period 2014-2020. The first OP (OP I) is entitled “Fostering a Competitive and Sustainable Economy to Meet our Challenges” and will be financed through the European Regional Development Fund (ERDF) and Cohesion Fund (CF) 49 . The second OP (OP II) is entitled “Investing in Human Capital to Create More Opportunities and Promote the Wellbeing of Society” and will be financed through the European Social Fund (ESF)50.

In May 2014, the EU Programming Unit within the MEAIM initiated a consultation process by issuing the preliminary drafts of the Operational Programmes covering Cohesion Policy for 2014-2020. The following two sections derive from the consultation documents issued by the MEAIM.

Malta has also applied for the SME Initiative proposed by the European Commission (EC), the European Investment Bank (EIB) Group and the European Council. The rationale behind the SME Initiative and the envisaged use of Malta’s future ERDF resources within the SME Initiative are presented in the last section of this chapter.

6.1 Operational Programme I for 2014-2020 OP I is focused on achieving the three funding priorities set out in Malta’s Partnership Agreement, namely to: • Foster competitiveness through innovation and the creation of a business- friendly environment; • Sustain an environmentally friendly and resource-efficient economy; and • Create opportunities through investment in human capital and improving health and well-being.

The OP outlines Government’s strategy for the measures necessary to contribute towards the Europe 2020 targets for smart, sustainable and inclusive growth.

The Operational Programme is subdivided into eleven priority axes with underlying investment priorities and strategic objectives. The table below provides an overview of these priority axes, the indicative financial allocations and the rationale supporting each priority axis.

49 Operational Programme I 2014-2020 - Fostering a competitive and sustainable economy to meet our challenges, Consultation Document, May 2014. 50 Operational Programme II 2014-2020 – Investing in Human Capital to Create More Opportunities and Promote the Wellbeing of Society, Consultation Document, May 2014.

Table 15: Priority axes of Operational Programme I

Indicative Priority Axis Financial Comments Allocation

PA 1: Investing in EUR 72m This axis focuses on Malta’s need to attain its Research and research, Innovation (R&I) targets primarily through the development technological and enhancement of R&I infrastructure. development and This priority axis also targets the promotion of R&I investment innovation within the private sector through specific financial incentives. PA 2: Consolidating EUR 38m ERDF funds are being targeted towards the private sector to investment within the increase the use of ICT and e-based solutions as a mean of ICT sector enhancing Malta’s competitive offering. This priority axis also addresses the need to strengthen public sector ICT applications covering e-government, e-health and other related e-services. PA 3: Enhancing EUR 53m ERDF funds are being envisaged for the creation of clusters Malta’s and business parks and for the enhancement of enterprise competitiveness infrastructure. To complement this, financial incentives are through investment also being earmarked to encourage start-ups and existing in SMEs SMEs to invest further in national strategic areas such as product development, internationalisation and niche tourism. PA 4: Shifting towards EUR 57m To achieve its 2020 renewable energy targets, Malta needs a low-carbon to adopt a number of measures. This priority axis focuses on economy the financial incentives to be provided to households and to the industrial and commercial sectors to invest in energy efficiency and renewable energy. These measures will also be complemented with energy efficiency and RES measures to be undertaken within the public sector. PA 5: Protecting our EUR 72m Tourism is a key economic pillar and in this regard this priority environment - axis focuses in part on the preservation, development and investing in natural promotion of cultural heritage and tourism assets of Malta. and cultural assets ERDF funds are also being earmarked towards the conservation of Malta’s natural environment. PA 6: Sustainable EUR 24m This priority axis focuses on the sustainable urban Urban Development development within the Harbour area. Through an integrated approach, interventions under this priority axis will focus on the preservation, development and promotion of cultural heritage and commercial tourism assets, cultural services for SMEs as well as housing infrastructure. PA 7: Shifting towards EUR 35m This priority axis is focused entirely on promoting and a more low carbon facilitating sustainable transport systems and mobility across transport sector the islands thereby contributing towards reduced journeys times and the increased use of greener fuels. PA 8: Investing EUR 59m An active labour market participation and economic towards a more prosperity is highly dependent on having a socially-inclusive socially-inclusive society. Investments in community based healthcare and society social infrastructure, as well as the regeneration of deprived communities will be supported under this priority axis. PA 9: Developing our EUR 33m This priority axis complements measures within OP II with a future through view to providing education, training and research facilities education, training for tertiary education and Vocational Education and Training and lifelong learning institutions.

Indicative Priority Axis Financial Comments Allocation

PA 10: Investing in a EUR 166m Two thirds of CF funds are being directed towards waste more management and the sustainable use of water resources. environmentally This is particularly relevant given the high levels of waste still friendly society being landfilled and the need to ensure the islands’ long term availability of potable water. PA 11: Investing in EUR 89m This priority axis is focused primarily on further developing the TEN-T infrastructure Trans-European Transport Networks (TEN-T) road network and maritime transport infrastructure to enhance Malta’s competitiveness.

Source: Operational Programme I 2014-2020 Public Consultation Document on the Programming of European Funds for Malta, Fostering a competitive and sustainable economy to meet our challenges, 2014.

Financial incentives for enterprises are contemplated specifically within the first four priority axes. At this preliminary stage, no specific decisions have been taken on the forms of support. The table below provides an overview of these financial incentives being envisaged for SMEs. Table 16: Details of priority axes of Operational Programme I focusing on support to SMEs

Priority Axis Investment Priority Rationale

PA 1: Investing in IP 2: Promoting business Incentivise enterprises to invest in the research, technological investment in R&I R&I sector development and innovation PA 2: Consolidating IP 1: Developing ICT products Incentivise enterprises to invest further investment within the ICT and services, e-commerce and in the use of ICT and e-based solutions sector enhancing demand for ICT PA 3: Enhancing Malta’s IP 1: Promoting entrepreneurship Foster entrepreneurship and start-ups competitiveness through investment in SMEs IP 2: Supporting the capacity of Incentivise enterprises to innovate SMEs to grow in regional, their processes in areas covering R&D, national and international environment, quality certification, markets and to engage in the resource efficiency and niche tourism innovation process PA 4: Shifting towards a IP 2: Promoting energy efficiency Incentivise enterprises to invest in RES low-carbon economy and renewable energy use in and EE measures enterprises

Source: Operational Programme I 2014-2020 Public Consultation Document on the Programming of European Funds for Malta, Fostering a competitive and sustainable economy to meet our challenges, 2014.

6.2 Operational Programme II for 2014-2020 Similar to OP I, OP II is focused on achieving the three funding priorities set out in Malta’s Partnership Agreement, namely by: • Fostering competitiveness through innovation and the creation of a business- friendly environment; • Sustaining an environmentally friendly and resource efficient economy; and • Creating opportunities through investment in human capital and improving health and well-being.

OP II also outlines Government’s strategy for the measures aiming at contributing to the Europe 2020 strategy. OP II is subdivided into four priority axes with underlying investment priorities and strategic objectives. The table below presents an overview of these priority axes, the indicative financial allocations and the rationale behind each priority axis. Table 17: Priority axes of Operational Programme II

Indicative Priority Axis Financial Comments Allocation

PA 1: Investing in the EUR 26m This axis focuses on improving the employment prospects of employability and job seekers and inactive persons and providing the adaptability of necessary support to enhance job mobility. Besides human capital addressing the overall employment rate, this priority axis seeks to increase female, elderly, and youth worker participation in the labour market. Addressing the needs of these populations is actually essential for Malta’s socio- economic development. PA 2: Towards a EUR 40m This priority axis addresses financial inclusion and combating more inclusive poverty. The first investment priority focuses on active society inclusion measures for vulnerable sectors of the population and for which EUR 35m have been allocated. The ultimate target is to lift around 6,560 persons out of the risk of poverty and exclusion. The second investment priority deals with the provision of health care and social services to vulnerable groups. Health issues are particularly pronounced within these groups, and obesity is particularly prevalent among children and adults alike. PA 3: Investing in EUR 47m Malta faces particular issues with early school leavers and people through illiteracy rates. Approximately EUR 15m of this priority axis will education, training be directed towards enhancing the education experience. and lifelong learning This priority axis also deals with lifelong learning, for which EUR 15m has also been allocated. The strategic rationale behind the priority axis is two-fold: firstly, to ensure that the workforce remains employable over time and adapts skills to a dynamic world, and secondly provides the opportunity for enterprises to enhance their competitive edge. About EUR 15m has been allocated towards lifelong learning initiatives. The priority axis also considers the tertiary education sector and the need to encourage more students to take up their studies at a tertiary or equivalent level. Lastly, there are also initiatives being considered to strengthen participation levels for vocational education and training.

Indicative Priority Axis Financial Comments Allocation

PA 4: Building the EUR 11m An efficient and cost-effective public sector is necessary for institutional Malta’s continued socio-economic development. This priority administrative axis deals specifically with strengthening the capabilities of capacity public administration.

Source: Operational Programme II 2014-2020 Public Consultation Document on the Programming of European Funds for Malta, Investing in Human Capital to Create More Opportunities and Promote the Wellbeing of Society, 2014.

Financial incentives for SMEs are contemplated specifically within Priority Axes 1 and 3. The table below provides an overview of the financial incentives being envisaged for enterprises and more specifically SMEs. Table 18: Details of priority axes of Operational Programme II focusing on support to SMEs

Priority Axis Investment Priority Rationale

PA 1: Investing in the IP 1: Access to employment for Incentivise enterprises to contribute employability and job seekers and inactive people towards achieving an inclusive labour adaptability of human market capital IP 2: Sustainable integration in Incentivise enterprises to provide the labour market of youth youths with the necessary labour market exposure PA 3: Investing in people IP 3: Enhancing equal access to Incentivise enterprises to invest further through education, lifelong learning, upgrading the in their workforce through training training and lifelong knowledge, skills and measures learning competencies of the workforce

6.3 EU programmes facilitating R&D and innovation among SMEs and Malta’s use of the SME Initiative In June 2013, the European Commission and European Investment Bank (EIB) Group submitted to the European Council an initiative to complement and utilise synergies between existing SME support programmes at national and EU level. More specifically, this refers to a joint-instrument: the SME Initiative. This initiative involves the blending of existing EU instruments available under COSME, Horizon 2020 and ESIF resources with EIB Group’s own resources, with the aim of providing additional lending to SMEs. Such initiative is set to promote faster action and achieve a significant impact on stimulating SME financing and economic growth, fight fragmentation and develop non-banking financing for SMEs.

This is a positive development, inter alia since the 2020 programme for innovation, introduced by the European Commission (Horizon 2020 - New Research Framework Programme) is set to be considerably more competitive than for the previous 2007- 2013 programming period, with SME consortia competing with consortia in other EU Member States to benefit from the EUR 80bn available for R&I. Also, SMEs will only be able to apply for funding once every two years, further reducing the likelihood of success in obtaining this funding51.

In parallel to Horizon 2020, COSME is the EU programme for the Competitiveness of Enterprises and SMEs over the 2014-2020 programming period with a planned budget of EUR 2.3bn52. COSME will support entrepreneurs and their new businesses through the promotion of entrepreneurship and entrepreneurial culture. Some initiatives to be supported by COSME include: exchanges among European educators and trainers, experts to develop recommendations on the best support for businesses throughout their lifecycles and groups such as young people and women or senior entrepreneurs to benefit from mentoring or other tailored programmes. COSME also aims to lighten the administrative burden on businesses by removing unnecessary reporting and information requirements.

In considering the indicative financial allocations in the next programming period, one needs to consider that the Government of Malta has pledged EUR 15m from its ERDF resources specifically for the SME Initiative53. The nature of possible public intervention and the level to which assistance is needed by Maltese SMEs is the focus of the next chapters.

51 Interview carried out with the Malta Council for Science and Technology (MCST). 52 See: http://ec.europa.eu/enterprise/initiatives/cosme/index_en.htm. 53 Presentation on Joint SME Initiative - European Commission, July 2013.

7 Market analysis and findings This chapter aims to identify the existing supply and potential demand of selected financial products available in Malta for micro, small and medium-sized enterprises.

Section 7.1 presents the methodology used to calculate the supply of the main financial products available in Malta. This methodology has been applied for the calculation of all financial products unless stated otherwise in the respective paragraph.

Section 7.2 provides an overview of the current supply of the main financial products. This overview focuses on supply trends observed in recent years. The section will then present a quantification of the estimated potential annual supply of these financial products in 2014. It has to be noted that the annual supply and annual demand of financing products quantified in the present report are considered as average figures that also apply for the next two years, thus 2015 and 2016. Experience with other similar AFMA studies has shown that, especially for the demand side, business owners provide similar amounts when asked to provide their financing needs for the next three years.

Section 7.3 presents the methodology used to quantify the demand of financial products among SMEs. The analysis is carried out by describing the demand needs of companies according to their size (defined by number of employees) and answers provided in the online survey carried out within the scope of this study. The methodology which will be described has been applied for the calculation of the potential demand of all financial products unless otherwise mentioned. Where data from other surveys and studies is available, it has been used for triangulation.

Sections 7.4 to 7.6 provide elements on the demand for financial products in 2014 as expressed by SMEs in Malta according to their size.

Section 7.7 provides the quantification of the demand for financial products in 2014 for both small and medium-sized companies. As mentioned above, this figure is also representative for the next two years.

Section 7.8 looks at the potential demand for equity finance in Malta for 2014. This will not be analysed by category of SME size, due to its limited application, but will rather be provided for the total population of SMEs in Malta.

Section 7.9 highlights the demand for financial products expressed by large companies In Malta. Although this study focuses specifically on SMEs some fieldwork was also undertaken with large companies to assess how these enterprises were impacted with access to finance difficulties.

Throughout the analysis, both supply and demand of financial products are presented in ranges, unless more accurate figures are possible to provide, and these refer to the potential annual supply and demand anticipated in 2014.

Finally, Chapter 8 summarises the results of the analysis. The demand for financing from “viable” SMEs meaning those that are growing but have failed to secure finance will also be taken into consideration in order to provide a quantification of the existing gaps, and to summarise the main considerations for the definition of the future investment strategy.

7.1 Methodology used to compute supply The anticipated annual supply of the main financial products available to SMEs in 2014 has been calculated based on numerous sources of information, market trends and projections, allowing for a comprehensive and complementary approach. While specificities have been highlighted for each product, including where additional factors have been used, the general approach for the calculation of supply is described in the following steps: • First, the analysis considers all the amounts provided to SMEs in Malta for the products where data is available for recent years. The supply information used only concerns SMEs, excluding large companies. • Within the supply of financial products to SMEs, amounts provided to each size category: (1) micro, (2) small and (3) medium-sized companies are also estimated. This is done by using information provided by both the literature and stakeholder interviews. • The amounts to be provided in 2014 are determined by taking into account: – Available data for 2014. When data was available for the first months of 2014, assumptions have been made to compute the total supply of financial products for the whole year of 2014; and – The market dynamics as perceived by market stakeholders, for the future, for each market has been used in order to define high and low scenarios.

This trend analysis is a necessary component of the methodology since the development of the future supply of financial products depends to some extent on the supply characteristics in the past, unless there are known or assumed reasons to believe there will be a discontinuity in the historical trend (e.g. exceptional growth in financial intermediaries due to market liberalisation, strong new industry development, and other shocks) that can be identified or predicted. Economic growth is also taken into account as an important indicator of the economic performance of Malta.

Finally, the perception of the market developments provided by the interviewed stakeholders is a more subjective element. Insights from relevant financial institutions have been used to estimate the growth of their finance offer.

7.2 Supply side analysis The analysis of the supply side is divided into two parts. The first part presents an overview of the current supply of various financial products. The second part presents the quantification of the anticipated supply of key financial products in 2014 in Malta.

a) Overview of financial product supply The paragraphs below give an overview of the supply of the following financial products in Malta: • Microfinance; • Loans (including short-, medium and long-term loans, credit lines and overdrafts); • Leasing; • Factoring; • Bank guarantees; and • Business Angel investing, Venture Capital and Private Equity.

Microfinance

The EU definition describes microfinance as loans up to EUR 25,000, offered specifically to micro-enterprises, entrepreneurs and other individuals who may encounter difficulties when applying for a conventional loan. Microfinance is, therefore, an important incentive to encourage the development of micro- enterprises as well as job creation. Moreover, the efficient provision of microfinance tends to play a crucial role in mitigating the effects of financial and economic crises.

In Malta, the concept of microfinance is still underdeveloped with an absence of microfinance providers. This absence of specialised institutions that would be able to provide microfinance is an important market failure in Malta that has to be taken into account. In the present report, the computation of supply of microfinance includes the financing scheme “BoV Start Plus” provided by BoV. However, a distinction has to be made between micro-credits provided by a commercial bank and microfinance provided by a specialised institution. Under normal circumstances these micro-credits would not have had been considered as microfinance products. However, because of the dominance of the banking sector and the lack of MFIs in Malta, and taking into account the fact that these micro-credits are guaranteed by CIP, they are included in the supply for analytical reasons.

As shown in Section 5.1, BoV Start Plus is partially guaranteed by CIP and provides loans under the amount of EUR 25,000 to start-ups. Admittedly, the bank does not demand collateral under this scheme and loans are only provided to companies which have no credit history with the bank. But as a purely commercial loan only

bankable projects are financed. As at the end of June 2014, 33 micro-loans have been granted to 32 micro-enterprises with a total value of over EUR 480,000. The BoV anticipates disbursing approximately EUR 1.3m of loans until the end of the year 2014.

Recently a growing interest in Malta for the supply of microfinance has been observed, mostly originating from charitable organisation, but the current legislation framework hampers the development of such supplying organisations. Even non- profit organisations are legally registered as limited liability companies with the Malta Financial Services Authority (MFSA) and as such subject to high licence fees. The limited access to the banking system combined with increasing social needs to support the less fortunate, has created a new niche for short-term, unsecured financing which could be provided by specialised institutions if the legal context for microfinance organisations and social enterprises can be improved54.

An example is Microfinance Malta Ltd. In November 2013 MicroFinance Malta was registered with the MFSA and issued its first loans. This institution is wholly owned by St Andrew’s Scots Church and is a not for profit company55 and will give interest free loans up to a maximum of EUR 2,400 to disadvantaged persons (with particular emphasis on women and migrants) to start income generating projects 56 or to provide advances to pay a deposit, initial operating or to acquire training in a trade and buy a set of tools to work as a skilled tradesman.

The company is about to issue its first two business loans of ca. EUR 800 each. If the issues are successful it is estimated that in one year around 20 loans will be issued at an average of EUR 1,000 each. As these plans are indicative and as the total amounts will not have a relevant impact in the market even if realised, the amounts will not be considered for the calculation of microfinance supply in 2014.

Loans (short, medium, and long-term loans57)

Currently, the banking sector in Malta consists of 26 credit institutions, three of which are owned by Maltese shareholders exclusively. However, at present, the banking

54 For more information and suggestions on how Malta has the opportunity to develop its model of social enterprise respecting its unique characteristics of a small market economy and its tradition in the social volunteering sector see: APS Consult Limited, Social Enterprise Project, MFEI, 2012. http://mfin.gov.mt/en/home/social-enterprise/Documents/Social%20Enterprise%20Initiative%20- %20Final%20Report.pdf. 55 The institution is funded by the World Communion of Reformed Churches and the Church of Scotland Guild project "Out of Africa into Malta”. 56 The company only charges an arrangement fee on each loan granted. This is currently a fixed fee of 12% for one year business loans (27.18% APR) and trade loans (26.75% APR), and 6% on six month rent loans (23.83% APR), the fees being payable at the time the loan is approved. 57 In the present report it is considered that short term loans also include bank overdrafts and credit lines. Short- term loans comprise tenors of up to one year, while medium and long-term loans comprise tenors of over one year.

sector is dominated by Bank of Valletta and HSBC Bank, which have the majority of market share in relation to retail and commercial lending activities.

Figure 3 below indicates the outstanding loans to all companies in EU countries as a percentage of GDP (without non-performing loans) in order to establish a comparison of loan supply. Outstanding loans in Malta correspond to 83% of GDP, which is significantly higher than most other EU countries. If Figure 3 includes loans provided to both SMEs and large companies, because of the dominance of SMEs it nonetheless indicates the extent to which companies - including SMEs – are already indebted in the country. This may cause difficulties for them to negotiate with banks and obtain further loans, either for working capital needs or investment. Figure 3: Total loans outstanding as a percentage of GDP among EU countries

Source: DG Enterprise, 2013.

Short-term loans are defined as loans to be repaid in one year or less and most commonly used to finance working capital needs. In the present report, it is considered that short-term loans include credit lines and bank overdrafts. Credit lines are defined as maximum loan amounts approved by a bank to a company where interest is charged only to the used part of the loan. Overdrafts are an extension of credit from a bank when an account reaches zero thus allowing a company to continue withdrawing money even if the account has no funds. These financial products are usually characterised by smaller collateralisation than longer- term products. Nonetheless, collateral remains a key concern both for banks (in terms of the value of collateral required) and SMEs (due to lack of assets that could be collateralised). Medium and long-term loans have maturities longer than a year and usually finance investment.

Nearly all commercial banks in Malta offer short-term loan products, mainly to small and medium-sized enterprises. The supply of medium and long-term loans is boosted by financing facilities from public institutions, particularly Malta Enterprise which have significantly facilitated bank financing, collateral requirements and overall attractiveness. The JEREMIE facilities, BOV Start Plus, Loan Guarantee Schemes, soft loan products, and other national and EU funded grant schemes have all improved access to debt financing for SMEs. In addition, Malta’s resilience in the face of financial turmoil, economic recession and debt crisis has strengthened its position as a global financial services centre and the banking sector in Malta remained robust, retaining adequate liquidity, capitalisation and profitability levels. However, this sector is being faced with tougher regulatory and capital requirements emanating from the implementation of the new European Union directives.

Information on the total new loans issued to resident non-financial corporations was provided by the Central Bank of Malta for the period 2011 up until May 2014, and was not publically available.

A break-down of these new loans in terms of repayment period and size of business is also not available from public sources, thus information on outstanding loans issued by the Central Bank of Malta was used as a proxy. This gave a ratio of 27 / 73 of short-term loans (maturity < 1 year) to medium/long-term loans (maturity > 1 year) for 2011 and 2013. This number is consistent with the loans and advances to corporations found in the financial statements of the two main local commercial banks58.

The total amount of loans provided by Maltese banks to non-financial corporations is presented in Table 19, along with the estimate for 2014. As illustrated, the provision of loans in 2014 is expected to increase for both short-term loans and medium/long- term loans by around 26% and is in line with the volatility of the market during the last years. They will be more deeply analysed in the following Section 7.2 b.

58 These two banks are the two main national commercial banks and are key financial players in the country. They are “core domestic banks” (as described in Annex 4). Those loans and advances that were repayable on call and at short notice were used to represent short-term loans whereas term loans and advances were used to represent medium and long-term loans.

Table 19: New loans to all non-financial corporate entities with the year-on-year change

Loan Type 2011 (mEUR) 2012 (mEUR) 2013 (mEUR) 2014 (e)59 (mEUR)

Short-term (up to 1 year) 331 388 361 454 y-o-y % - 17% -7% 26% Medium/Long-term (more than 1 year) 879 1,044 955 1,199 y-o-y % - 19% -9% 26%

Total 1,210 I,432 1,316 1,653

Source: Central Bank of Malta, PwC analysis, 2014.

To analyse the data further, the short-term and medium/long-term categories of new loans were further broken down into loans relating to SMEs and large companies. No data is available on the level of new loans provided exclusively to SMEs in Malta. In order to consider exclusively the amount of new loans to SMEs, assumptions on the percentage of new loans to SMEs of total loans was made based on information available on outstanding loans. The outstanding loans to SMEs as a percentage of total outstanding loans was applied to determine the split between new loans to SMEs and those to large companies. From information gathered on outstanding loans from the CBM and local banks, the percentage of outstanding loans to SMEs stood at 78% and was consistent over 2011 and 2012. The portion of new loans provided to SMEs may consequently be considered as 78% of total new loans.

The new loans provided to SMEs then have to be further analysed into new loans to micro, small and medium-sized enterprises. Information provided by two local commercial banks60 revealed that 25% of loans are provided to micro-enterprises, 32% are provided to small enterprises and 43% are provided to medium-sized companies. As a whole, small and medium-sized enterprises consequently obtain 75% of the loans provided by banks in Malta. These percentages are applied to both short-term loans on the one hand and medium/long-term loans on the other hand (Table 20).

59 Estimates for 2014 are based on actual data until May 2014 and were pro-rated to project figures until year end 2014. 60 These two banks are the two main national commercial banks and are key financial players in the country. They are “core domestic banks” (as described in Annex 4).

Table 20: Estimate of loan disbursements to SMEs

Financial product 2011 (mEUR) 2012 (mEUR) 2013 (mEUR) 2014 (e) (mEUR)

Short-term loans to SMEs 257 301 280 335 - 370

Micro-enterprises 63 74 69 82 - 91 Small enterprises 83 97 91 108 - 120 Medium-sized enterprises 111 129 121 144 - 159

Medium and long-term loans to SMEs 682 810 741 884 - 977

Micro-enterprises 168 199 182 218 - 240 Small enterprises 221 262 240 286 - 317 Medium-sized enterprises 293 348 319 380 - 420

Source: Central Bank of Malta, PwC analysis, 2014.

From information acquired in conducting stakeholder interviews and other information provided by the Central Bank of Malta it appears that although SMEs constitute the majority of businesses, accounting for 99.8% of enterprises in Malta, only 78% of new loans relate to SMEs. Moreover, Table 20 above indicates that, micro-enterprises, which account for 95.1% of SMEs in Malta, only receive 25% of loan supply. In parallel, small and medium-sized companies which represent a smaller fragment of the total population of SMEs would benefit from a very significant part of the total supply. Consequently, the loans supplied to micro- enterprises appear low compared to their share among SMEs.

Leasing

Leasing is the method of acquiring goods by making instalment payments over time. Under this type of contract, the buyer is leasing the goods and does not obtain ownership until the full amount stipulated in the contract paid.

In Malta, unlike most other EU countries, no leasing products are currently provided by local financial institutions but instead leasing and hire purchase is used to acquire equipment, machinery, IT and vehicles directly from the respective suppliers.

According to interviews held with financial institutions, sale-and-leaseback is seldom provided by financial institutions. It may also be unpopular with SMEs due to restrictive legislation, unattractive tax implications and high costs to enterprises.

Factoring

Factoring is the use of company receivables to finance current working capital needs. This instrument is used mostly in a supply chain environment by SMEs that suffer from delayed payments from clients.

Due to its small market size, business in Malta is conducted in a traditional style, where the relationship between buyer and seller is personal and more focused on sales and the relationship with the customer, rather than on collections or risk assessment. Effective payment terms are long and often with significant delays after the due date. Standard credit terms in Malta tend to be of around 60 to 90 days but many payments are effected between 90 to 120 days, and even longer in certain industries such as tourism or certain government institutions. As a result, companies are forced to acquire further debt financing in the form of overdrafts and other short terms loans to finance the necessary day-to-day expenditure.

Although factoring remains at an early stage of development in Malta, the results being achieved are positive and this financing product is slowly gaining popularity. Since 2006, when factoring services were first introduced, volumes have been rising consistently. In 2011, the factoring industry in Malta continued to grow, with global turnover increasing by 48% on the previous year, reaching EUR 201m. The boom in factoring volume can be primarily attributed to businesses increasingly turning to factoring as an alternative to traditional bank loans61.

The uptake of factoring solutions has received a boost as a result of the presence of more multinational companies on the island. International companies tend to be more aware of factoring’s advantages and consequently adopt factoring as an alternative financial solution from the outset. Ultimately, the adoption of factoring in Malta as a mainstream financing option is down to awareness and confidence in the product. Factoring is covered by local legislation, and providers of factoring services must be registered as financial institutions, which are in turn regulated and supervised by the Malta Financial Services Authority.

In Malta, recourse62 business is the norm, representing 89% of total factoring business. However, where export business is concerned, the proportion of non-recourse 63 factoring doubles to 22% of the total. This reflects customers’ increasing attraction to the extensive advantages of factoring risk protection covers, together with those of international collection services.

With a representation of a bit more than 3% of GDP, factoring still has good prospects for growth in Malta. On the product side, one can see the potential development both in the domestic and the export markets of the supply chain

61 Article from the Times of Malta: Factor It In, 2014. (http://www.timesofmalta.com/articles/view/20120314/business-news/Factor-it-in.411104). 62 In recourse factoring, a company selling an invoice to a factor bears full risk of non-payment of the invoice by the debtor. Since it is more risky to a company than non-recourse factoring explained below, the amounts lent by factors are also higher. Recourse factoring resembles a loan: a company receives certain amount from a factor in return for an invoice. If the factor is not able to collect the invoiced amount in full, they can demand the outstanding amount from the company. Recourse factoring is a desirable financing solution when a company knows its clients well and the repayment is highly probable. 63 In non-recourse factoring, the risk of non-payment of the invoice sold is borne by a factor who can be compared to a buyer of financial assets (accounts receivable). In comparison with recourse factoring, amounts received by a company are smaller and risk protection higher.

finance/reverse factoring offer, following on the trend established in other European countries where factoring generally represents more than 10% of GDP.

Bank guarantees SMEs in Malta are gradually embracing the use of bank guarantees. Entrepreneurs and managers have developed better knowledge of these financial products in recent years and awareness of their benefits. A combination of the overall liquidity problems of companies and the delayed, or failed, collection of the receivables has made these financial securities more attractive than before. Credit institutions in Malta offer a comprehensive range of bank guarantees, which include:

Payment Guarantees: This form of guarantee provides security to a supplier for goods or services provided and applies mostly to import and export business.

Tender Guarantees: These guarantees apply to companies tendering for services, works or supplies and guarantee compensation should a company fail to accept award of tender.

Advance Payment Guarantees: This guarantee mostly applies to companies that make advance payments for goods or services and provides protection to the importer when trading on open account terms. Therefore, this product guarantees repayment of an advance payment in the event that the supplier fails to deliver.

Performance Guarantees: This product is suitable for companies wanting to expand their business and supports their ability to perform in accordance with contractual obligations. Therefore a performance guarantee secures claims by the buyer on the seller arising from default.

Shipping Guarantees: This product is suitable for importers whose goods have arrived prior to shipping documents. A shipping guarantee will enable a business to take control of goods arriving by shipment, in the absence of shipping documents.

Guarantees securing a credit facility: These guarantees enable businesses to secure their liabilities and secure claims by the lender on the borrower, in respect of a credit such as a loan or bank overdraft.

To quantify the supply of bank guarantee products in Malta the balance of commitments from the principal five credit institutions that operate in the local market was analysed from public financial statements. The five credit institutions considered were HSBC Bank, Bank of Valletta, Banif Bank, Lombard Bank and APS Bank. In 2013, the total amount of guarantees issued by these credit institutions to third parties amounted to EUR 291m (EUR 293m in 2012).

Business Angels - Venture Capital - Private Equity

In Europe between 2007 and 2011 more than 20,000 SMEs64 have benefited from equity investments made by Private Equity Funds (PEs), Venture Capital Funds (VCs) and Business Angel Investors (BAs). These three categories of investors have different and specific goals, preferences and investment strategies; however, together they provide financing in order to nurture expansion, new-product development, or restructuring of the corporate operations, management, or ownership.

PE funds often target established and mature companies to invest in and at times they acquire majority stakes in these companies. PE Funds usually are generalist; therefore they are investing in various industry sectors, and/or various geographic locations.

On the other hand, VC funds and BAs typically invest in young, growing or emerging companies, and rarely obtain majority control. In terms of sectorial orientation VC funds are usually specialist (specialising in a few industry sectors where the management of the Fund has expertise in or investing in only a limited geographic area) investors. Venture Capital funds generally: • Finance new and rapidly growing companies with scalable potential; • Purchase equity shares, i.e. become shareholders in the underlying company; • Invest in companies having innovative products or services and developing intellectual property (IP); • Assist in the development of new products or services though their expertise, contacts and knowledge; • Add value to the company through active participation alongside the senior management; • Take higher risks with the expectation of higher rewards and thus are able to finance companies which banks would never consider; and • Have a pre-defined period within which they want to liquidate their investment.

The different types of equity financing, namely BA, VC, and PE can be categorised according to five stages of company development, although these definitions will vary within the industry: • Seed stage, i.e. first stages of the life of a company, which is mostly financed by Business Angels, family, friends, microfinance. • Start-up stage refers to the start of revenue generation, often financed by Business Angels and Venture Capital. • First success stage corresponding to the set-off of the company, usually financed by Venture Capital.

64 “The little book of private equity”, European Venture Capital Association (EVCA), 2012.

• Growth stage when the company expands, targets new products and/or markets, provided most often by later-stage Venture Capital funds and Private Equity funds. • Buy-out when a company is sold for the new development.

The positioning of each type of capital with respect to the company lifecycle and needs is presented in Figure 4 below. Figure 4: The ladder of equity financing according to the development stage of companies

Capital needed (single ticket) Higher risk EUR 50m Growth funds Buy-out funds Private Equity funds Banks EUR 10m

Investment funds

EUR 1m Business Angels Venture Capital funds (public and private) Banks EUR 500k Lower risk Family and friends Seed funds Business Angels Start-up funds EUR 5k Time Seed Start-up First success Take-off Sustainable growth/ Early growth Maturity

Source: North East Access to Finance65, PwC Analysis, 2014.

In Malta, the equity market is underdeveloped compared to other EU Member States. Furthermore, there is very little information available on the formal supply of equity. Interviews with key stakeholders indicate that few SMEs in Malta are financed by equity and there is little awareness on how to pursue such avenues of financing. While on one hand, the small market size of the Maltese market itself is limiting investment possibilities, Maltese business owners, on the other hand, tend to be risk averse and prefer using funding sources they are familiar with. Stakeholders commented however that private placements are common in Malta when business owners find it difficult to obtain funding from financial institutions. But these private placements are more often limited to friends and family. The culture of equity funding from third party investors is not a common practice locally, and may be most relevant only for young, high growth companies.

The sub-index on access to equity finance of the SME Access to Finance Index shows that the Maltese equity finance environment ranks above the average of the Eurozone and the European Union. While the EU sub-index value is 98 in 2012, Malta attained a value of 103, which is close to the score of Latvia (104) and Hungary

65 See: http://www.nea2fguide.co.uk/wp-content/uploads/2012/11/NEA2F-Guide-Funding-Ladder-for-illustrative- purposes.pdf.

(101). However, this is not representative of the local equity market for Maltese SMEs, as this merely reflects high density of investments funds in the country. Figure 5: SMAF Sub-index on access to equity finance per country (2012)

Source: SME Access to Finance Index (SMAF), 2013.

Research and interviews indicate that at present there are no formal Venture Capital funds or Business Angel networks in Malta. Furthermore, at present there are no formal Venture Capital funds or Business Angel networks which could support innovative start-ups.

Set out below are a number of initiatives and schemes that were introduced in Malta to encourage enterprises to seek alternative measures to finance their business. Several attempts were made to set up formal Venture Capital schemes, with the intention of filling a perceived financing gap that was present in Malta and to encourage Maltese enterprises, especially start-ups and companies in the development phase of the business cycle to finance their operations using equity, rather than traditional forms of financing. However, the take up of these schemes was not sufficient and the funding schemes were eventually liquidated.

Possible reasons for the very limited success of these Venture Capital initiatives may include among others66: • Targets and investments from Government were too high; • Lack of interest from Maltese entrepreneurs (the provision of equity seems not enough to guarantee take-up); • Company structure not ideal;

66 MBB report on Market gaps in access to finance and the feasibility of new financing instruments in the EU addressing the credit needs of Maltese business and Stakeholder interviews.

• Lack of willingness to dilute ownership of business; • Maltese culture is not conducive to facilitating formal approaches to Venture Capital; and • Administrative difficulties within the fund set-ups.

These schemes are listed below.

Investment Finance Bank (IFB 1991-1993): During this period the IFB managed a EUR 4.7m loan facility (provided by the EIB) for venture capital initiatives in Malta. The objective of this financing instrument was for preference shares to be offered to the bank, which in turn would have been given representation on the Board of Directors. At the time a few projects had benefitted from this facility.

Technology Venture Fund (TVF 2001-2003): This fund was set up by the Maltese Government through the Malta Development Corporation to support the development of technology and innovation for SMEs. The objective of the fund was to partly finance the setup of innovative enterprises to improve their rate of success during the start-up phase of a business in selected sectors, such as biotechnology, ICT, multimedia, software development, e-Business and waste management, among others. EUR 2.3m was allocated by the Government with further funding planned from the EU and private sector. Apart from seed funding, another objective of the fund was to assist SMEs in negotiations with banks and share potential credit risks with them. Initially, approximately ten applications from potential start-ups were received; however, only a few of these were actually assisted through this fund due to problems with administration. Between 2004 and 2005, efforts were made to stimulate this fund which was renamed the Technology Innovation Fund providing seed capital for start-up businesses.

Malta Business Angels Network (MBAN 2003): In 2003, a network was set-up through an initiative from the private sector to promote informal equity investment in Malta. The network’s main function was to introduce new Maltese entrepreneurs to established business owners who actively seek to invest in new, innovative businesses with growth potential. The network has had limited activity.

Malta Venture Capital plc (2006): In 2006, the Maltese Government set up a venture capital fund through its investment arm Malta Investment Management Company Limited (MIMCOL), with the intention of licensing it as a collective investment scheme. The objective was to assist entrepreneurs to find the required finance to develop new projects. It also aimed to encourage the Maltese private sector to provide finance on a small scale to regenerate Maltese private enterprise, and provide finance for innovative ideas and new technologies. Government initially committed approximately EUR 2m, with the intention of obtaining more funding from private investment. It appears that this initiative never materialised.

Research, Innovation and Development Trust (2012): As an early example of crowd funding, the University of Malta set up this EUR 0.5m Trust in 2012, to allow individuals and companies to donate money to the fund, either by channelling their donations to particular projects or allowing the Board of Trustees to manage the funds67.

Equity Financing Programme: In 2009, Malta Enterprise intended to launch an Equity Financing Programme to support local businesses, in particular local SMEs with the development of their business proposals and to help with their initial investor search. Despite talks held about the launch of this programme, this never took-off for reasons which are unknown.

Although the Malta Stock Exchange has been set up since the early 1990s, only a few companies to date have gone public and listed their securities – a characteristic which can be observed in most of the European markets due to the lack of liquidity. As at August 2014, there were 22 companies, that have equity listed on the Malta Stock Exchange and 22 companies with listed corporate bonds. However, when applying the European Commission SME definition, the majority of these companies do not classify as SMEs and six of these companies are financial institutions engaged in the financial and insurance services sector.

Fifteen years ago, the Alternative Companies List was introduced at the Malta Stock Exchange to give companies the opportunity to issue equity that did not fulfil all the conditions for an Official List Admission, namely having three-year track record to participate in the Maltese market (Second Tier Market securities). This could be an attractive source of financing for SMEs, which are in the initial stages of the business lifecycle. However, it is under-used and currently, only one entity is listed on the Alternative Companies list, which is primarily engaged in the ICT industry and another two companies have corporate bonds listed on this platform.

Last but not least, crowd funding has been gaining momentum as an alternative funding opportunity in other European countries that could be explored for start- ups68. The idea behind it is to use a web platform to collect funding from the general public in the form of loans, equity investment or donations. In making investment decisions, the lenders follow their own judgment. Financed projects are most often entrepreneurial (in particular, with a solidarity dimension), innovative or artistic.

The small size of Malta makes it an ideal environment for crowd funding to work as it is usually carried out on a regional level in other countries. In this way, start-ups

67 See:http://erawatch.jrc.ec.europa.eu/erawatch/opencms/information/country_pages/mt/ supportmeasure/support_0032. 68 At the international level, crowdfunding has been growing exponentially. Globally collected amounts increased from EUR 380m in 2009 to EUR 2.1bn in 2012 (“Observatoire des entrepreneurs” French observatory of entrepreneurs, “PME Finance” Finance SME, 2014). Out of these, the American market accounts for 60% as compared to 35% in Europe (“Observatoire des entrepreneurs” French observatory of entrepreneurs, “PME Finance” Finance SME, 2014).

which come up with a product or service would be able to pitch their ideas in a simple yet effective manner. In Malta various fund-raising campaigns have been held in the past for different reasons that could be considered as a form of crowd funding, most of which were held to raise money for various non-profit making/ social initiatives. However, the number of experiences of equity funding through this mechanism for private sector initiatives remains limited.

Overall, the equity financing market in Malta is weak. Consulted stakeholders in the financing market clearly stated that without the assistance of public institutions and Government intervention the equity market in Malta will not change. Increasing the availability of financing options would help in addressing the financing needs of local enterprises. So far, only loan guarantees have been adopted under JEREMIE in Malta whereas JEREMIE instruments in other EU Member States also provide for seed loans and equity guarantees.

b) Quantification of the expected supply of financial products in 2014 As described in Section 7.1, the quantification of the expected supply of financial products takes into account: • The current supply trend of each product under consideration; • Available data for 2014. When data are available for the first months of 2014, assumptions have been made to compute the total supply of financial products for the whole year of 2014; • The perception of the development of each market expressed by market stakeholders during interviews. These perceptions are used to define high and low scenarios for each financial product for the future; and • Any new funds in place such as for micro-finance and equity.

Table 21 below provides a summary of the last years and for 2014.

Table 21: Supply of financial products to SMEs in the previous years and estimate of the annual supply in 2014 in Malta

EUR (million)

Financial product Estimate of annual 2011 2012 2013 supply for 2014

Microfinance - - n/a 1 Short-term loans, credit lines and overdrafts 257 301 280 335 - 370 Medium- and long-term loans 682 810 741 884 - 977 Leasing n/a n/a n/a n/a Business Angels n/a n/a n/a n/a Venture Capital n/a n/a n/a n/a Private Equity n/a n/a n/a n/a

Source: Central Bank of Malta, PwC analysis, 2014.

Based on these estimates, the supply of each financial product is further broken down by size of company. This split has been based on the information provided by stakeholders on their current supply to, micro, small and medium-sized companies.

Microfinance To date, microfinance supply is non-existent in the country. Nevertheless, and as explained above, the BoV Start Plus micro-loan scheme is considered as microfinance supply in 2014. As at the end of June 2014, 33 microloans have been granted to 32 micro-enterprises with a total value of over EUR 480,000. The BoV anticipates disbursing approximately EUR1.3m of loans until the end of the year 2014.

However, there is a growing awareness of the need for this type of financing, and in November 2013 the first microfinance organisation operating independently and locally was set up. It plans to disburse an indicative amount of EUR 20,000 in business loans during the next year. As these plans are indicative and as the total amount will not have a relevant impact in the market even if realised, the amount will not be considered for the calculation of microfinance supply in 2014.

Short-term loans, overdrafts and credit lines Interviews with stakeholders indicated that commercial banks are becoming more risk averse when considering project financing. This is consistent with banking views across Europe.

This report considers only the loans to non-financial corporations.

Figures for the supply of new loans to micro, and small and medium-sized enterprises over the short-term and long-term were determined for 2014. Since actual data for

new loans, provided by the Central Bank of Malta, was available for the first five months of 2014, in order to establish the total supply of new loans for the whole year the figures were pro-rated and a range was set at plus or minus 5%.

Based on the computation methodology, the supply of short-term loans for 2014 will range between EUR 335m and EUR 370m. The computation has taken into account the supply of short-term loans to SMEs for January to May 2014. Since the supply of short-term loans to SMEs over the first five months of 2014 represented about 42% of the overall supply during this year, the supply of short-term loans provided to Maltese SMEs between January and May 2014 was pro-rated to estimate to total supply of this financial product for the whole year 2014.

Interviews indicated a shared perception that there are no specific constraints foreseen in the future that could limit loan supply (short, medium or long-term loans). This perception has been translated in the calculation with a variation of the supply between -5% and +5%.

This supply of short-term loans for SMEs has been broken down into supply for micro- enterprises on the one hand and for small and medium-sized companies on the other hand, using information provided by commercial banks. Since the Central Bank of Malta does not provide a split between the three sizes of companies, it was determined based on the feedback received from key players in the market. As a result, 25% of short-term loans were assigned to micro-enterprises, 32% to small companies and 43% to medium-sized companies. Table 22 below provides an overview of the resulting supply of short-term loans to SMEs per company size in Malta.

Table 22: Estimated annual supply of short-term loans to SMEs in 2014 in Malta69

Supply of short-term loans to SMEs (e) 2014 (mEUR)

Total supply to SMEs 335 - 370

Total supply to micro-enterprises 82 - 91 Total supply to small enterprises 108 - 120 Total supply to medium-sized enterprises 144 - 159

Source: PwC analysis, 2014.

Medium and long-term loans

The estimate of the supply of medium and long-term loans in 2014 has been calculated by applying the same approach as for short-term loans. The computation is based on the supply of medium and long-term loans provided

69 Differences between the sums of supply provided to micro, small and medium-sized companies and the total supply provided to SMEs result from rounding errors.

between January and May 2014. Also, to translate the lack of specific constraint to supply of medium and long-term loans perceived by bank stakeholders, a variation of the supply between -5% and +5% has been applied.

The range for medium and long-term loans supply for SMEs in Malta in 2014 is estimated to range from EUR 884m to EUR 977m.

Similar to short-term loans, the supply of medium and long-term loans to SMEs has been broken down into supply for micro, small and medium-sized enterprises, using a similar split. Table 23 below provides an overview of this supply. Table 23: Estimated annual supply of medium and long-term loans to SMEs in 2014 in Malta70

Supply of medium and long-term loans to SMEs (e) 2014 (mEUR)

Total supply to SMEs 884 - 977

Total supply to micro-enterprises 218 - 240 Total supply to small enterprises 286 - 317 Total supply to medium-sized enterprises 380 - 420

Source: PwC analysis, 2014.

Leasing

The estimate of supply of leasing in 2014 could not be calculated due to the lack of publicly available information. However, analysis indicates that this source of supply is very limited.

Equity

The estimate of the supply of equity in 2014 could not be calculated due to the lack of publicly available information. The analysis indicates that this source of supply is very limited in Malta.

Summary of expected supply of financial products All the estimates made for the supply of finance in Malta for 2014 are summarised in the table below and used in the next sections so as to analyse - and when feasible quantify - the financing gaps of SMEs in the country.

70 Differences between the sums of supply provided to micro, small and medium-sized companies and the total supply provided to SMEs result from rounding errors.

Table 24: Estimate of the annual supply of financial products in 2014 in Malta

Estimates of annual supply in 2014 (mEUR)

Financial product Medium-sized Total SME Micro-enterprises Small enterprises enterprises

Not relevant for small and medium- Microfinance 1 1 sized enterprises Short-term loans, overdrafts, 335 - 370 82 - 91 108 - 120 144 - 159 credit lines Medium- and long-term loans 884 - 977 218 - 240 286 - 317 380 - 420 Leasing n/a n/a n/a n/a Business Angels n/a Split by category size is not relevant Venture Capital n/a Split by category size is not relevant Private Equity n/a Split by category size is not relevant

Total - - -

Source: PwC analysis, 2014.

The amount of the future supply for SMEs from financial institutions is estimated between 23.1% and 25.0% of the GDP of Malta (roughly in line with an average of 20.2% in the last three years).

7.3 Methodology to quantify the demand for finance The methodology developed to assess the demand for financing from Maltese SMEs relies on the sampling strategy used for the online survey. A questionnaire was provided to a sample of Maltese SMEs according to sector and with a breakdown by size into micro, small and medium-sized companies 71 . The SMEs consulted reported their financing experiences in the past and needs in the future (in euros)72. They provided information for various financial products, including: short-term loans, medium and long-term loans.

Given the random arrangement of the SMEs composing the sample and the number of responses obtained, the demand figures provide a reasonable estimate for each of the categories of SMEs sizes in Malta.

The quantification of the demand for funding has been performed for micro- enterprises on the one hand and for small and medium-sized companies on the

71 See Annex 2 for a complete note on the methodology used for the sampling of the online survey. 72 For this computation, results provided in Question 19 have been used (see Annex 8 for the questionnaire used for the online survey). Answers considered are from 75 micro-enterprises, 29 small companies and 28 medium-sized companies. In total, 132 SMEs provided an answer to that specific question. As a reminder, 217 SMEs answered the online survey. SMEs may have decided not to provide an answer because they have no vision of their future needs and consequently the financing amounts they will need in the future, because they do not make a clear distinction between the different financial products or because they do not want to provide this information.

other hand to increase reliability through a larger sample size. Moreover, interviews with representatives of SMEs and commercial banks (see Annex 5 for list) have highlighted that financing demand from small and medium-sized companies are often similar in Malta. Various financial products have been considered for the analysis. For the two categories of SMEs considered and for each type of financing, the answers provided by companies with amounts they expect to require in the future have been computed73. The computation has been conducted by using the following approach: 1. The “outliers” from the sample are left aside, i.e. where some firms indicated EUR 0 amounts or extremely high financing figures for a particular type of financing. In order to avoid a situation where a few responses severely skew the global estimate of the demand, these answers are taken out. 2. The average of the remaining amounts is calculated. This step is conducted for each financial product and each category of SMEs considered (micro- enterprises on the one hand and small/medium-sized companies on the other hand). 3. The final calculation of the demand for the entire population of each category of companies is conducted as follows: – The total number of companies of the specific size category is computed74. – This computed number is multiplied by the average amount to be sought in 2014. – A variation of -5% and +5% around the result computed previously is applied to generate a reasonable approximation of the potential demand.

In order to illustrate the computation method described above, the following box gives an example of estimating demand for short-term loans from micro-enterprises.

73 The amounts used for the computation are estimated needs from SMEs for 2014, but they might also be requested in a later moment. 74 The micro-enterprise population has been computed differently, with a correction for those for whom financing is deemed not applicable, as explained in Box 1. This correction has been applied for computing demand for loans. For microfinance, only 0 employee companies were considered, as shown Section 7.4 b).

Box 1: Example of a calculation of demand estimate for short-term loans from micro-enterprises

Step 1: Outliers. The amounts above EUR 100,000 have been removed from the computation as these amounts, for short-term loans, are likely to have resulted from an overestimation of the funding needs by the respondents, or from their misunderstanding of the questionnaire question. Observations of the EUR 0 funding amounts have also been removed, as they are an indication that no funding is needed for the future. By doing so, the micro-enterprises which indicated the EUR 0 amounts are considered the same as those that did not answer the question.

Step 2: Calculating the weighted average amount of the sample. The average amount of the whole sample is EUR 31,964 and corresponds to the demand for short-term loans by a single micro-enterprise that is intending to seek finance.

Step 3: Computing the potential demand from the population of micro-enterprises. The total population of micro-enterprises in Malta is 37,23275. First, the 0 employee companies are removed. They correspond to 9,293 enterprises76. Second, the micro-enterprises that do not intend to raise finance in 2014 are filtered out. According to the SAFE survey, 78.1% of enterprises prefer loan finance as an external source of financing to finance their growth ambitions 77 . Consequently, the remaining micro- enterprise population considered is of 21,820. Third, the obtained number is multiplied by the proportion of micro-enterprises which used short-term loans in 2013 as a proxy for the type of finance that will be sought in the future. This proportion is 31.0%78. Following these adjustments to the calculation, the population of relevant micro-enterprises is 6,772, computed with the following formula: (37,232 – 9,293)*0.781*0.31 = 6,77279

The volume of the potential demand for short-term loans from micro-enterprises is then computed as follows: 31,964*6,772 = 216,456,88680

75 For the purpose of the computation of demand for loan products for micro and small/medium-sized enterprises, the sectors “Financial and insurance activities” (NACE K according to rev.2 classification) and “Activities of households as employers; undifferentiated goods- and services-producing activities of households for own use” (NACE T) have been excluded since the present study focus on non-financial corporations. 76 This is based on the assumption that 0 employee companies have different needs than companies with employees. These 0 employee companies are considered for microfinance only and not for short-term loans. This assumption is based on the fact that commercial banks preferably finance more structured companies, which tend to have employees. The total number of 0 employee companies stood at 10,263 in 2012 in Malta however 0 employee companies engaged in NACE K and NACE T sectors according to rev.2 classification have been removed since the present study focus on non-financial corporations. Data according to the latest NSO data (August 2014). 77 This result derives from SMEs’ answers to Question 20 of the SAFE survey: “If you need external financing to realise your growth ambitions, what type of external financing would you prefer most?” 78 This result derives from micro-enterprises’ answers to Question 6. 79 The result of this calculation is EUR 6,764 but contains rounding errors and the actual result is EUR 6,772.

A variation of -5% and +5% around this volume is then calculated to take into consideration the potential fluctuation. The lower end of the estimated range is calculated as follows: 216,456,886*(1 - 0.05) = 205,634,042

The higher end of the range is calculated as follows: 216,456,886*(1 + 0.05) = 227,279,731

As a conclusion, the demand for short-term loans from micro-enterprises represents EUR 206m at the lower end of the estimated range, and EUR 227m at the higher end.

The same methodology is applied to long-term loans (with 24.1% instead of 31.0%).

The results obtained for each financial product thus correspond to potential total demand for this specific product, within a reasonable margin of tolerance. Consequently, the potential demand is an estimate of the amounts that companies might want to obtain, but which they would get only if they (1) convert their intention to seek finance to action (many may be discouraged) and (2) met the conditions set by finance suppliers81.

To ensure that the sample of SMEs was as representative as possible, the online survey conducted for the study canvassed SMEs from different sectors. It is important to remember that their answers are largely based on their perception of their own business needs and expectations for the economy (GDP growth) and the overall business climate. These perceptions and expectations are formed in the current climate where the market operates within a relatively low-growth environment. Both these factors exert pressure on the SMEs and will be further discussed in the section on the analysis of the estimates of demand, based on the “viable” companies’ unmet need methodology described in Section 8.1.

80 The result of this calculation is EUR 216,460,208 but contains rounding errors and the actual result is EUR 216,456,886. 81 For instance, 12.4% of the SMEs which applied to bank overdraft and credit lines were rejected (compared to 10.4% at the EU-28 level), 0% of those which applied to bank loan were rejected (compared to 12.6% at the EU- 28 level) and 19.1% of those which applied to other external financing (including loans from other lenders, equity, leasing, and factoring) were rejected (compared to 5.5% at the EU-28 level) (European Commission, SME’s Access to Finance survey, 2013).

7.4 Demand for financing from micro-enterprises a) Financing micro-enterprises in Malta Micro-enterprises (companies having between 0 and 9 employees) represent more than 95% of the SME population in Malta 82 . Assessing and improving micro- enterprises’ access to finance would consequently affect the largest part of the SME population including its economic performance and social impact, particularly in the sense of employment creation. Figure 6: SME population in Malta according to the size of companies

Source: National Statistics Office of Malta, PwC analysis 2014.

As shown in Table 25 the number of micro-enterprises decreased from 40,083 in 2009 to 38,592 in 2012. This represents a compound annual growth rate of -1.3%. The largest decline in the number of micro-enterprises occurred between 2011 and 2012 (by 4%). However this decline is not necessarily linked to the closing of enterprises. Recently, a new law was introduced whereby companies are no longer required to register for VAT purposes if their turnover does not exceed EUR 7,000 in one year. Therefore, between 2011 and 2012 the data on the number of companies registered in Malta was revised to reflect this change in legislation. Table 25: Number of micro-enterprises in Malta

2009 2010 2011 2012 Number of % of total % of total Change % of total Change % of total Change Number of Number of Number of Number of companies SME SME over SME over SME over companies companies companies companies population population 2009-2010 population 2010-2011 population 2011-2012

Total SME 41,910 42,607 1.7% 42,131 -1.1% 40,573 -3.7% population

Total micro- 40,083 95.6% 40,686 95.5% 1.5% 40,183 95.4% -1.2% 38,592 95.1% -4.0% enterprises

Source: National Statistics Office Malta, PwC analysis, 2014.

82 The share of micro-enterprises among all SMEs in Malta is higher than the EU-27 average of 92.1% (European Commission, 2013). Conversely, the share of small enterprises is smaller by 1.9 percentage points. It should be noted that the SME sector is particularly important when comparing the number of employees. While on average in EU-27 66.5% of the total workforce is active in the SME sector, the share is 80% in Malta (36% for micro- enterprises In Malta and 28.7% in EU-27).

Results of the online survey indicate that only 8.8% of SME owners in Malta identify their company to be in the initial stages of the development lifecycle (initiation and creation). The results also indicate that about 17.5% of micro-enterprises consider that their company is in a post-creation phase, as illustrated in Figure 7. Both of these could have considerable potential to grow and create further job opportunities. A third of all micro-enterprises believe that their business is still developing and 29.4% believe they have reached a maturity stage, which could still produce growth but likely at a lower level.

Figure 7: Development stage of micro-enterprises in Malta83

Source: PwC, SME online survey among Maltese SMEs, 2014.

Figure 8 below illustrates that most of the micro-enterprises interviewed used retained earnings, short-term loans, bank overdrafts and credit lines (maturity < 1 year) and medium to long term loans (maturity >1 year) to fund their businesses over the last 3 years (2011-2013).

Around 12% of all micro-enterprises seeking finance indicated that they used microloans from microfinance institutions as a funding source. Since microfinance institutions are not present in the country, it is assumed that these answers are provided under a misperception of the definition of microfinance and most probably these loans represent short or medium to long term loans provided by banks up to EUR 25,000.

Capital contributions of shareholders and public grants are only used respectively by 12% and 10% of micro-sized enterprises. No respondent used factoring, equity from national or foreign institutions, buyout capital or corporate bonds.

In the survey, companies were asked to state which financial products were relevant to them and to what degree these were sufficiently accessible. 44% of

83 The number of micro-enterprises having provided an answer: 126.

micro-enterprises stated to have sufficient access to short term loans (including bank overdrafts and credit lines), followed by medium to long term loans with 41%84.

Micro-enterprises perceived loans provided with interest rates subsidies (32%) and loans guaranteed by public or private entities (31%) as the most inaccessible products but relevant to their business85. The accessibility of short-term loans and medium and long-term loans remains difficult for approximately a quarter of respondents but with these products remaining the most relevant to the micro- enterprise segment. The least relevant sources for micro-enterprises are mezzanine financing, factoring, buyout capital, corporate bonds and technology transfer funds where between 79% and 80% of respondents indicated that these financial products are not relevant to their financing needs86.

Financial sources to fund start-ups are considerably different than funding sources used by established enterprises. In the case of start-ups, according to associations interviewed, enterprise owners used their own savings as financial resources to start their business. Other informal sources like savings and credits from friends and family members are also a common source of financing when starting up a business. This highlights the lack of institutions in the country that would be specialised in seed financing, such as microfinance institutions and seed funds, and the dominance of the banking sector that is not generally equipped to support such financing.

84 The number of micro-enterprises having provided an answer: 108. 85 The number of micro-enterprises that provided an answer: 99 in the case of loans provided with interest rate subsidies and 100 in the case of loans guaranteed by a public or private entity. 86 The number of micro-enterprises that provided an answer: 94, 95, 96, 96 and 97 respectively for each type of financial product.

Figure 8: Sources of funding used by micro-enterprises between 2011 and 201387

Source: PwC, SME online survey among Maltese SMEs, 2014.

According to a large proportion of micro-enterprises, support from public or private institutions is perceived as limited. According to the survey, even those companies that are looking for finance do not seek such support. Moreover, when companies did seek assistance, they frequently felt they lacked it. In particular, micro- enterprises stated they were not supported by commercial banks (36% as opposed to 24% not lacking support) and the State (26% and 12% respectively). Informal support originating from friends and family proved to be among the most supportive since 32% of the respondents felt supported by them. An even more important role is played by other professional networks like accountants, tax or financial consultants with 37% of the respondents being satisfied with their assistance as illustrated in the Figure below.

87 The number of micro-enterprises that provided an answer: 116.

Figure 9: Feeling of lack of support among micro-companies when seeking finance88

Source: PwC, online survey among Maltese SMEs, 2014.

88 Number of micro-enterprises that answered this question: 126.

Simultaneously however, the majority of micro-enterprises in Malta feel discouraged when looking for finance. According to the online survey conducted for this study, 62.7% of micro-enterprises in Malta felt always (10%), often (21%) or sometimes (31%) discouraged in seeking finance89 over the last three years. Since this share includes companies that sought finance in addition to those that did not, it reveals that access to finance is a key concern for micro-enterprises. This may be attributed to micro-entrepreneurs not having sufficient time to look for financing. Due to the limited material and human resources of their companies, they perform several roles (operating day-to-day business, tax and accounting, developing business strategy) at the same time. For the same reason, i.e. an absence of financially-trained employees and insufficient time to gather information, micro-entrepreneurs may lack the knowledge to seek finance and complete related administrative formalities. Moreover, once denied finance, micro-enterprises may feel reluctant to apply again and also deter other micro-enterprises that have not applied yet.

15.1% of respondents attributed the difficulties to the financial situation of their business and 11.9% indicated that difficulties arose as a result of high costs of obtaining financing. In fact, according to stakeholders from business associations interviewed, costs of financing, in particular bank charges incurred by micro- enterprises for administrative purposes, create barriers for such enterprises when applying for bank financing. Moreover, the charges are reported to have worsened in 2011-2013 by over one quarter of the respondents (5.6% think they deteriorated significantly and 19.8% observed just deterioration). On the other hand, 47.6% of micro-enterprises indicated that they did not experience difficulties in obtaining financing.

89 The number of micro-enterprises that provided an answer: 126.

Figure 10: Reasons for the difficulties for micro-enterprises in accessing finance over 2011-201390

Source: PwC, SME online survey among Maltese SMEs, 2014.

Indeed, when specifically asked about debt financing, 52.4% of micro-enterprises stated that they faced difficulties. The main difficulties identified as barriers can be linked to two factors; the willingness of banks to provide micro-enterprises with financing and the effort required applying for financing. In the survey, 23.0% of respondents identified the willingness of banks to provide them with financing as the main barrier, while 16.7% implied that the effort made or burden experienced when applying for financing is usually a cause for difficulties faced in obtaining financing. In addition, a significant part of the respondents are of the opinion these difficulties intensified in 2011-2013. It is of note that 30.2% of the respondents stated willingness of banks to lend deteriorated during this period (9.5% noted strong deterioration and 20.6% deterioration).

90 The number of micro-enterprises that provided an answer: 126.

Figure 11: Perception of change in the conditions of debt financing in 2011-2013 by micro-enterprises in Malta91

Source: PwC, SME online survey among Maltese SMEs, 2014.

Overall, 36.5% of companies stated to have faced obstacles in accessing debt finance92. Figure 12 below shows that lack of own capital was identified as the most recurring obstacle for micro-enterprises (11.9% of micro-enterprises). Another major difficulty identified by companies is the high interest rates with 7.1%.

Figure 12: Obstacles to loan financing reported by micro-enterprises93

Source: PwC, SME online survey among Maltese SMEs, 2014.

91 The number of micro-enterprises that provided an answer: 126 92 The number of micro-enterprises that provided an answer: 46. 93 The number of micro-enterprises that provided an answer: 126.

Despite the abovementioned difficulties in getting loans, those of the respondents that did receive them, received on average 83% of the amount sought (EUR 50,428 out of EUR 60,983). This rate is much higher than in the case of equity products (56%) and even grants (78%). However, it is of note that successful loan applications require collateral. As illustrated in the figure below, 50% of surveyed micro- enterprises stated to have relied on their own assets for loan collateral or on family and friends (11.1%). Only 17.5% relied on company assets and. The fact that such a large number of enterprise owners had to rely on their own assets to guarantee their loan is again an indication of the lack of other institutions that would support micro- enterprises especially in their inception phase instead of the banking system that normally requires collateral. As debt finance is the most important funding source in the country, the findings indicate that, micro-enterprises lacking assets would most probably be excluded from any formal financing.

Figure 13: Type of collateral provided for debt financing by micro-enterprises94

Source: PwC, online survey among Maltese SMEs, 2014.

Regarding the purpose of financing, the survey highlighted that the financing obtained by micro-enterprises was primarily used for working capital (32.2% of reasons to seek financing). The launch of new products and services accounted for only 14.6% of reasons given, which is less than acquisition of machinery and equipment and the purchase or rental of land and buildings with over 17%. Only 3.9% of purposes for financing were to expand operations in new markets abroad and only 2.4% was for export sales. It has been indicated that the local market is limited and saturated, with limited opportunities for growth. Therefore the unwillingness or inability of micro-enterprises to expand their business scope or export their products and services is a crucial indication. The Maltese Government and authorities such as Malta Enterprise have recently introduced new programmes, such as the Gateway to Export Programme and the Go Global Programme, to assist micro and small enterprises by providing them with an assessment of export readiness to determine if they are ready to venture into new

94 The number of micro-enterprises that provided an answer: 126.

9 0

markets through their exports95. Such initiatives should be further supported in order to motivate micro-enterprises to seek new opportunities.

Figure 14: Use of funding by micro-enterprises in 2011- 201396

Source: PwC, online survey among Maltese SMEs, 2014.

The online survey also investigated future needs of micro-enterprises, which shared their intentions for future funding sources for the year 2014. Results on the products that micro-companies intend to seek are presented in Figure 15. Similar to the past, traditional banking products such as loans, represent the main source of finance to be used in the future. Particularly, short-term loans are to be sought by micro- enterprises (42.7%) followed by medium and long-term loans (25.3%).

This is expected due to the lack of alternative finance providers in the country. Equity funding from corporate bonds or rescue / turnaround and buyout, and even mezzanine and hybrid finance is not mentioned as a future financing source by the micro-enterprises who responded to the questionnaire.

While some Maltese micro-enterprises believe they lack support from commercial banks, they still consider them as their main finance suppliers in the future. Moreover, a large majority of micro-enterprises do not expect to have different needs or uses of finance in 2014, therefore many of them expect to face the same challenges as they currently have.

95 Malta enterprise website: Programme overview – Gateway to Export. 96 The number of micro-enterprises which provided an answer: 126.

Figure 15: Expected sources of funding in 2014 indicated by micro-enterprises97

Source: PwC, online survey among Maltese SMEs, 2014.

Uses of funding are also likely to remain the same as in the past, as underlined in Figure 16. Funding will be required for financing working capital (24.8% of reasons given), for purchasing machinery and equipment (15.5%) and for launching new products/services (12.4%). As indicated by respondents, 7.5% and 4% of the reasons to seek finance is to develop international activities and finance export sales respectively. These rates seem to slightly increase compared to the period 2011 and 2013. This is a positive indication that micro-enterprises’ appetite to expand their operations in international markets is increasing.

97 The number of micro-enterprises that provided an answer: 75.

Figure 16: Expected use of funding of micro-enterprises in 201498

Source: PwC, online survey among Maltese SMEs, 2014.

b) Quantification of potential demand for financial products from micro-enterprises in Malta in 2014 Demand from existing micro-enterprises has been considered for two categories of companies: • Micro-enterprises with no employees; • Micro-enterprises with between 1 and 9 employees.

It is assumed, to facilitate analysis and quantification of demand, that the most suitable financial product for micro-enterprises without employees is microfinance. Similarly, micro-enterprises with employees are expected to require more conventional loans (short-term or medium and long-term). The survey did not provide information on other products at this level of detail. Equity products are considered as a whole for the three main categories of SMEs in Section 7.8.

In the case of micro-enterprises with no employees, demand has been considered for both existing and companies that do not yet exist in order to provide insights on financing demand for financial inclusion.

The assumptions on the desirability of financial products depending on the type of micro-enterprise are illustrated in Figure 17 below.

98 The number of micro-enterprises that provided an answer: 126.

Figure 17: Categorisation assumptions for financial products for micro-enterprises and financial inclusion

Source: PwC 2014.

Demand from micro-enterprises with employees is considered first.

Quantification of demand for loans

The methodology behind quantifying micro-enterprise demand for financing is provided in Section 7.3. The information provided by SMEs in the online survey was used in estimating demand for the following financial products: • Short-term loans, bank overdrafts and credit lines; and • Medium and long-term loans.

The average amount in short-term loans sought by micro-enterprises is EUR 31,964 and EUR 73,133 for medium and long-term loans.

To calculate micro-enterprises’ total demand for the selected financial product, the total population of micro-enterprises has been identified on the basis of the following considerations: • First, the number of 0 employee companies is removed (9,293) as they tend to have different needs than established companies. • Second, the obtained number is multiplied99 by – The rate of enterprises that prefer bank loans as a type of external financing as a proxy for companies seeking finance in the future: 78.1% for short-term loans and for medium and long-term loans as indicated in the ECB’s SAFE survey of 2013100; and

99 The use of proxies in these calculations is intended to provide a more realistic size sample of population. These proxies originate from different sources in order to reinforce the triangulation process, and reveal a behavioural pattern of companies related to their choices of financing either in the past or the future. It has to be noted that different approaches could have been used to obtain a similar result; however, the information provided by the SAFE survey and the survey conducted for the present report, provide strong indications on the financing choices of SMEs, thus allowing to reduce the population size based on these choices. As a result of the use of proxies, the population is reduced to a number of companies that is more likely to seek a specific financial product, thus allowing a more realistic computation of demand for this product. 100 This result derives from SMEs’ answers to Question 20 of the SAFE survey: “If you need external financing to realise your growth ambitions, what type of external financing would you prefer most?”

– The rate of micro-enterprises that used the financial product in 2013 as a proxy for their respective likely uptake among those seeking finance in the future: 31.0% for short-term loans and 24.1% for medium and long- term loans.

In order to estimate the total demand from micro-enterprises, the average amount is multiplied by the total population (6,772 micro-enterprises for short-term loans and 5,267 micro-enterprises for medium and long-term loans). A variation of -5% and +5% around this volume is then calculated so as to take into consideration the potential fluctuation of demand.

This method is applied for 2014 for the two financial products. The results by product are presented in Table 26 below. Table 26: Annual demand for financial products among micro-enterprises in Malta in 2014

Average finance sought by a single Finance sought by the total micro-

micro-enterprise (mEUR) enterprise population (mEUR)

Short-term loans, bank 0.032 206 - 227 overdrafts and credit lines Medium and long-term loans 0.073 366 - 404

Source: PwC analysis, 2014.

The demand figures listed in the table above appear to be consistent with the business environment in Malta and the projected real GDP growth of 2.3% in 2014 and 2015.

Micro-enterprises usually consider using long-term loans in order to update their equipment and machinery. However, they are also willing to secure their financing over the next few years, especially for working capital purposes. In fact, micro- enterprises seem to not clearly distinguish the purpose of loans depending on different maturity periods when looking for financing. For example, and as illustrated in other surveys, SMEs in Malta use more bank overdraft and credit lines than average in the EU-28101 (SAFE survey, 2013). They however use less bank loans than the average in EU-28 (25.0% of SMEs as compared to 31.6%)102.

101 65.7% of the SMEs in Malta used bank overdraft and credit line over the last 6 months prior to the survey conducted for the European Commission and the European Central Bank, when they were 38.8% for the EU-28 (European Commission, SME’s Access to Finance survey, 2013). The survey was conducted over the second half of 2013. 102 25.0% of the SMEs in Malta used bank loan over the last 6 months prior to the survey conducted for the European Commission and the European Central Bank, when they were 31.6% for the EU-28 (European Commission, SME’s Access to Finance survey, 2013).

It seems that micro-enterprises in Malta intend to use short-term loans for medium- term investments and may also use long-term loans to cover their working capital needs and finance their day-to-day business or to cope with their existing debt.

The sense that Maltese micro-enterprises may not make a clear distinction between the uses of loans with various maturities is also consistent with the observations on microfinance that are highlighted later on in the present section and that illustrate the extent to which microfinance products are not clearly defined neither by micro- enterprises, nor by financial services providers in the country.

Quantification of demand for microfinance

Demand for microfinance has only been considered for 0 employee companies in Malta. This is done since microfinance is mostly used for financial inclusion and social entrepreneurship purposes. As already established in this report, most newly created companies are micro-enterprises. Two calculations have been made: • Demand for microfinance from existing micro-enterprises; and • Demand for microfinance from potential micro-enterprises (financial inclusion).

Demand for microfinance from existing micro-enterprises The average amount of microfinance intended to be sought in 2014 by micro- enterprises has been computed with the methodology described in Section 7.3, except in this case, the average amount of microfinance being sought by micro- enterprises was derived from the average amount expressed by respondents from the online survey, who stated their intention to seek amounts of short-term and medium to long-term loans of EUR 25,000 or less. The average amount is EUR 15,857. As already mentioned, the perception of microfinance in Malta is different than other countries, since it is mostly associated with bank loans below EUR 25,000. Thus, if microfinance institutions did exist, these companies would most probably seek this financing from these institutions.

For the survey, 21 micro-enterprises provided an appropriate answer (between EUR 1 and EUR 25,000), with 17 micro-enterprises requesting short-term loans and 4 medium to long-term loans respectively. This average of EUR 15,857 is higher when compared to a survey conducted by the European Microfinance Network103 (EMN), where the EU average for business loans provided by MFIs is EUR 9,960.

However, according to the same survey, there seems to be wide differences from country to country regarding the average loan amounts, ranging from very low amounts of below EUR 1,000 to high amounts reaching EUR 20,000. No figure is available on the demand side of microfinance in Malta specifically to conduct

103 EMN 2014, Overview of the microcredit sector in the European Union for the period 2012-2013.

triangulation. Finally, information provided by the supply side of microfinance is of limited support since the first microfinance institution in Malta was set up less than one year ago, which means that until very recently, no supply for this type of financing was available.

For these reasons, the following quantitative analysis uses an average amount of EUR 15,857 for microfinance to be sought by an existing micro-enterprise in 2014 in Malta and the population considered for computation is 7,258 micro-enterprises with 0 employees104.

The computation of demand for microfinance has been made for 2014. The results are presented in Table 27 below. Table 27: Annual demand for microfinance in Malta in 2014

Average finance to be sought by a Finance to be sought by the total

single micro-enterprise (mEUR) micro-enterprise population (mEUR)

Microfinance 0.016 109 - 121

Source: PwC analysis, 2014.

Micro-enterprises in Malta may not yet be familiar with the purposes of microfinance and the actors of this market. Also, micro-enterprises in Malta may not clearly make a difference between the sources of financing they require, but the amounts indicated for short-term loans express a clear need for short-term financing.

Demand for microfinance from potential micro-enterprises (financial inclusion) Microfinance can be used for financial inclusion to help people at risk of poverty to create their own company.

Since there is no available data on demand for microfinance in Malta and that there is a no information on the supply of microfinance in the country, the average amount to be sought by a micro-enterprise for financial inclusion in 2014 may be considered at EUR 15,857, i.e. the same as the average amount to be sought by an existing micro-enterprise.

The population at risk of poverty, who might be the population who might seek this type of finance, consists of people with very different profiles, such as: (1) young people with no qualification, who have never worked and have difficulties finding a job, (2) people with disabilities, (3) people from unprivileged populations, (4) people

104 9,293 micro-enterprises with 0 employees exist in Malta. As for the computation of demand estimate for short- term loans, enterprises which do not intend to raise loan finance in 2014 are filtered out. As 78.1% of enterprises prefer loan finance as an external source of finance to finance their growth ambitions (SAFE survey, 2014), 7,258 enterprises are considered for the calculation.

living in difficult areas with high rates of unemployment or (5) experienced people who are unemployed for a long period and have difficulty in adapting and finding a new job.

This population may create their own business, if properly supported.

To determine the number of people aged 15-64 years old at risk of poverty that may create their own business. With this approach, the following steps are conducted: • Consider within the population of 15-64 years old in Malta in 2012 (184,500 people), the people at risk of poverty (15% according to 2012 figures). This population represents 27,675 people. • Among these people, consider the percentage of people that prefer to be self-employed to exploit a business opportunity. This percentage among the overall Maltese population is 8%105. The population obtained is 2,214. • Among this population, consider the people who think that starting a business is a desirable career choice but do not have enough capital/financial resources to be self-employed. This represents 17% of the respondent to the Eurobarometer survey conducted in 2012 106 . The population obtained represents 376 people. • Multiply this population of companies by the estimated average amount of microfinance to be sought by a micro-enterprise for financial inclusion in Malta in 2014: EUR 15,857.

The results are presented in Table 28 below and yield a need for microfinance of EUR 6m may be expressed by new business creators who currently face social exclusion and may be willing to initiative a business if better supported in their access to finance. Table 28: Annual demand for microfinance for financial inclusion in Malta in 2014

Average finance to be sought by a Finance to be sought by the total

single micro-enterprise (mEUR) micro-enterprise population (mEUR)

Microfinance 0.016 6

Source: PwC analysis, 2014.

It has to be reminded that this demand is indicative as Malta has a strong tradition of informal financing originating from the family and social environment rather than specialised institutions.

105 Q6 in Flash Eurobarometer 354, 2012: Why would you prefer to be self-employed rather than an employee? 106 Q8 in Flash Eurobarometer 354, 2012: Why would it not be feasible for you to be self-employed within the next 5 years?

7.5 Demand for financing from small enterprises in Malta Overall, small enterprises (companies with 10 to 49 employees) have easier access to finance than micro-enterprises as evidenced by proportionately higher use of it. Loans are the primary financial product used by small enterprises as their larger asset base facilitates collateralisation. Unlike micro-companies, small enterprises favour medium and long-term loans over short-term loans as their investment needs are comparably higher. Demand for financing from small enterprises is further detailed in the paragraphs below.

Small enterprises represented 3.9% of the total SME population in Malta in 2012. The number of small enterprises increased between 2009 and 2010 by 6.3%, remained stable in 2011 and increased by a further 2.0% in 2012. Therefore small enterprises increased year on year by 2.7%. Small enterprises seem to grow in line with GDP growth. Table 29: Number of small enterprises in the Malta

Total SME 41,910 42,607 1.7% 42,131 -1.1% 40,573 -3.7% population

Total small 1,491 3.6% 1,585 3.7% 6.3% 1,583 3.8% -0.1% 1,615 3.9% 2.0% enterprises

Source: National Statistics Office Malta, PwC analysis, 2014.

Figure 18 shows that a significant share, namely nearly half of all respondents (48%), believe that their business is in a development stage of its life cycle, indicating that they expect further business growth and an increase in their employees. The survey also revealed that around 38% of respondents see their business in the maturity stage, meaning that they do not envisage significant growth within their company. 14% see their company to be in the reorganisation stage of its lifecycle.

Figure 18: Development stages of small enterprises in Malta107

Source: PwC, online survey among Maltese SMEs, 2014.

When seeking finance, small companies most frequently look for support from commercial banks (70% of respondents), accountants, tax experts and financial advisors (48%) and the State (42%). The State is perceived by small companies as the least supportive actor. With 30% of the respondents, the rate is similar to the one declared by micro-enterprises (26%).

Commercial banks are second least supportive actor (18%). However, at the same time, they are seen by small companies as the most supportive actor, which is in sharp contrast with micro-enterprises (52% and 24% respectively). Comparably closer and more trusting relationship between small companies and banks can be linked to larger asset base, credit history and experience in dealing with financial institutions of the former. It is explored in detail in the paragraphs below.

Finally, unlike micro-enterprises, relatively few small companies declared having sought help from family and friends (22%). This can be explained by the fact that small companies have higher financing needs which cannot be addressed by informal financing sources.

107 The number of small enterprises that provided an answer: 50.

100

Figure 19: Feeling of lack of support among small enterprises when seeking finance108

Source: PwC, online survey among Maltese SMEs, 2014.

108 The number of small enterprises that provided an answer: 50.

101

Analysing the most-frequently used sources of finance, Figure 20 shows that small companies depend heavily on short-term and medium and long-term financing sought from banking institutions, with 62.5% and 56.3% of them having used medium to long-term loans and short-term loans, bank overdraft facilities and other credit lines respectively. Unlike micro-companies, small enterprises prefer medium and long-term loans to short-term loans, which illustrates their greater investment needs.

Similar to micro-enterprises, about one third of small companies finance their operations and investment needs through retained earnings; however, small enterprises naturally rely much more on formal sources due to their higher needs in financing than micro-companies. A quarter of respondents have had recent experience in using bank guarantees, while 14.6% claimed to have used capital contributions from shareholders. Since small enterprises have easier access to formal funding sources than micro-enterprises, it allows them to diversify their financial sources. A further 12.5% of respondents indicated they used loans provided with interest rate subsidies and grants and fewer than 10% of respondents indicated they used other financing products such as leasing, microloans, and factoring amongst others. No respondent used forms of private equity financing such as Venture Capital, Business Angels and technology transfer funds among others.

Figure 20: Sources of funding used by small enterprises between 2011 and 2013109

Source: PwC, online survey among Maltese SMEs, 2014.

109 The number of small enterprises that provided an answer: 48.

102

The survey further queried on the perception of sufficient access to finance for different products. Approximately 81% of small enterprises seeking financing stated to have sufficient access to medium to long-term loans, while 73.8% felt they had sufficient access to short-term loans, bank overdrafts and credit facilities110. These two financial products are also the most relevant forms of financing to small companies, with 88.1% and 83.3% of respondents indicating their relevance. 44.4% of respondents also felt there is sufficient access to bank guarantees including export guarantees111. On the other hand, small companies feel that there is a lack of access to loans provided with interest rate subsidies (36.1%)112. The least relevant forms of financing to small enterprises included loans obtained from the parent company, technology transfer funds, mezzanine financing and private grants and donations among others.

Regarding obstacles in accessing financial resources, under two thirds of enterprises (62.0%) stated that they did not experience any difficulties when seeking financing. Small companies identified the cost of obtaining financing (16.0%) and other terms and conditions of financing (14.0%) as the two major obstacles in accessing financial measures. The views of the respondents are in line with the perception in the market, where rather than access to finance being an issue, the problem lies more with the affordability of the loan.

Indeed, between 20% and 25% small enterprises are of the opinion that willingness of banks to lend (24%), cost of financing (24%) and administrative burden of loan applications (20%) deteriorated in 2011-2013. While these proportions are lower than among micro-enterprises, they are a visible signal that credit market in Malta remains tight and is not becoming more accommodating to SMEs. This is further confirmed by high percentage of respondents who did not perceive any change in the above conditions: 36% with respect to financing cost, 50% for financing burden and 42% for willingness of banks to lend. Simultaneously, as much as 56% of the respondents declare that financial situation and turnover of their small companies improved in the same period. While a positive signal, it poses a question of where the seemingly flourishing companies will finance in the future if the financing market remains very conservative.

Figure below illustrates how small enterprises perceive changes in loan financing.

110 The number of small enterprises that provided an answer: 42. 111 The number of small enterprises that provided an answer: 36. 112 Ibid.

103

Figure 21: Perception of change in the conditions of debt financing in 2011-2013 by small enterprises in Malta113

Source: PwC, online survey among Maltese SMEs, 2014.

Figure 22: Reasons for the difficulties for small enterprises in accessing finance over 2011-2013114

Source: PwC, online survey among Maltese SMEs, 2014.

The above evidences that small companies have fewer difficulties in accessing finance than micro-companies. This translates into a lesser feeling of discouragement of small enterprises. 40% of them felt discouraged from seeking

113 The number of small enterprises that provided an answer: 50. 114 The number of small enterprises that provided an answer: 50.

104

finance in 2011-2013 (8% always, 10% often and 22% occasionally) as opposed to 62.7% of micro-companies. Figure 23: Feeling of discouragement from seeking finance among small enterprises in Malta115

Source: PwC, online survey among Maltese SMEs, 2014.

When focusing on debt financing, 72.0% of small companies did not encounter problems or did not ask for loans. For the companies that faced problems, the most serious problem raised was the cost of obtaining finance (12.0%), followed by lack of own capital (8.0%) and insufficient collateral or guarantee (8.0%). When asked about collateral provided for loan financing, 60% of respondents used business assets (only 17.5% in the case of micro-enterprises).

115 The number of small enterprises that provided an answer: 50.

105

Figure 24: Obstacles to loan financing reported by small enterprises116

Source: PwC, online survey among Maltese SMEs, 2014.

Small companies were also asked to identify the reasons why they sought financing. More than one third of their financing was used to finance working capital and 13.4% of financing was used to launch a new product or service. Over 11% of financing used was allocated to investment needs, e.g. the acquisition of machinery and equipment and the purchase or rental of land and buildings. Only a small proportion of reasons referred to the financing of R&D, innovation and developing and entering new markets; 5.2% between 2011 and 2013. This confirms the reluctance of companies to invest in R&D as shown in Chapter 4. Moreover, only 4% of indicated purposes for seeking financing by small companies targeted export sales. This percentage is rather low, especially when considering that expansion within the local market is limited and growth largely depends on access to other markets abroad. It is noticeable that the same figure for micro-enterprises is even lower at 2.4% for the period between 2011 and 2013, confirming the insularity of the Maltese economy and the reliance of SMEs on the domestic market, as mentioned in Chapter 4.

116 The number of small enterprises that provided an answer: 50.

106

Figure 25: Use of funding by small enterprises over 2011-2013117

Source: PwC, online survey among Maltese SMEs, 2014.

Small enterprises plan to seek similar products in 2014 when compared to the past as indicated in Figure 26, especially, medium and long-term loans (48.3%) and short- term loans, bank overdrafts and credit lines (37.9%). Equity funding from Business Angels, investment funds, technology transfer funds or rescue / turnaround and buyout, mezzanine and hybrid finance, corporate bonds are not mentioned as a potential financing source. Also other forms of financing such as loans guaranteed by public or private entities, or loans provided with interest rate subsidies are not selected.

Figure 26: Expected sources of funding in 2014 indicated by small enterprises118

Source: PwC, online survey among Maltese SMEs, 2014.

117 The number of small enterprises that provided an answer: 50. 118 The number of small enterprises that provided an answer: 29.

107

7.6 Demand for financing from medium-sized enterprises in Malta Medium-sized companies find access to finance even less restricted than small enterprises. However, unlike the latter, they quote a lack of willingness of banks as the main obstacle in obtaining finance. This would suggest that, despite larger asset bases, medium-sized companies in Malta may already be significantly indebted. Similarly to small enterprises, medium-sized companies have preference for medium- and long-term loans. Interestingly, though, medium-sized enterprises use a significant proportion of their financing on improvement of energy efficiency, which is not the case for other SME sizes. These trends are further detailed in the following paragraphs.

As illustrated in Table 30 below, medium-sized enterprises (companies with 50 to 249 employees) accounted for 366 entities, representing only 0.9% of the total SME population in the country (2012). This proportion was stable over the last few years. Table 30: Number of medium-sized enterprises in the Malta

Total SME 41,910 42,607 1.7% 42,131 -1.1% 40,573 -3.7% population

Total medium 336 0.8% 336 0.8% 0.0% 365 0.9% 8.6% 366 0.9% 0.3% enterprises

Source: National Statistics Office Malta, PwC analysis, 2014.

Figure 27 shows that more than half of all respondents (56.1%) believe that their business is in a mature stage of its life cycle. The survey also indicated that around 24.4% of respondents see their business in the development stage and another 17.1% in the reorganisation stage.

Figure 27: Development stages of medium-sized enterprises in Malta119

Source: PwC, online survey among Maltese SMEs, 2014.

119 The number of medium-sized enterprises that provided an answer: 41.

108

Interestingly, medium-sized companies find access to finance slightly more challenging than small enterprises. 49% of the respondents felt discouraged from seeking finance, as compared for 40% in the case of small companies. One of the reasons for this may be an already significant indebtedness of medium-sized companies, which makes banks more reluctant to lend. It is however of note that discouragement was most often only occasional (37%). Figure 28: Discouragement of medium-sized companies in Malta from seeking finance120

Source: PwC, online survey among Maltese SMEs, 2014.

As is the case with other companies, medium-sized enterprises use mostly short-term loans, overdrafts and credit lines (57.5%) and medium to long-term loans (47.5%) as a means of obtaining external financing. No respondent indicated using mezzanine Venture Capital funds or Business Angel financing. In comparison, the total SME population used short term (30.5%) and medium and long term loans (24%) to a much lesser extent than medium/sized companies, demonstrating that larger companies have easier access to these products.

The survey also queried the perception that companies have regarding their access to different products. 73% and 67.6% of medium-sized enterprises stated have sufficient access to medium and long-term loans and short-term loans, bank overdrafts and credit lines respectively121. Loans provided with interest rate subsidies were relevant for 51.5% of the respondents. However, 30.3% stated not to having sufficient access to them122. Bank guarantees also seem to be equally relevant to medium companies (48%) as to small companies (44%), but less so for micro- enterprises (34%).

120 The number of medium-sized enterprises that provided an answer: 41. 121 The number of medium-sized enterprises that provided an answer: 37. 122 The number of medium-sized enterprises that provided an answer: 33.

109

Figure 29: Sources of funding used by medium-sized enterprises over 2011-2013123

Source: PwC, online survey among Maltese SMEs, 2014.

When analysing the obstacles in accessing finance, 29.3% of the medium-sized enterprises answered that the willingness of banks to provide finance had been the main difficulty during the period from 2011 to 2013. The second most widespread difficulty was other terms or conditions of finance, indicated by 19.5% of the respondents. While 12.2% of medium-sized respondents noted that the cost of financing was an issue, this proportion amounted to 16% among small enterprises that responded to the survey.

In fact, even though the majority of medium-sized enterprises are successful in raising the (loan) finance sought, the obstacles identified suggest that their access to finance is not all plain sailing.

123 The number of medium-sized enterprises that provided an answer: 40. Note: Other sources of funding are: microloan from a microfinance institution, factoring, venture capital funds, business angels, technology transfer funds, equity from national, regional or foreign institutions, rescue / turnaround and buyout capital, mezzanine or hybrid financing, private grants or donations and external capital contributions.

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Figure 30: Reasons for difficulties for medium-sized enterprises in accessing finance over 2011-2013124

Source: PwC, online survey among Maltese SMEs, 2014.

According to Figure 31 below, medium-sized enterprises had difficulties in receiving loans as a result of their existing debt (9.8%), insufficient potential of the business or project being financed (9.8%), and insufficient collateral or guarantee (9.8%). When asked about collateral provided for loan financing, 58.5% of medium-sized enterprises stated to have used their company’s assets and the owner’s assets (41.5%)125.

124 The number of medium-sized enterprises that provided an answer: 41. 125 Ibid.

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Figure 31: Reasons referred to as difficulties by medium-sized enterprises in receiving loan financing126

Source: PwC, online survey among Maltese SMEs, 2014.

Overall, the majority of the respondents had the opinion that the financing conditions remained mostly unchanged and financial situation of their companies improved in 2011-2013. This is illustrated in the Figure below. Figure 32: Perception of change in the conditions of debt financing in 2011-2013 by medium-sized enterprises in Malta127

Source: PwC, online survey among Maltese SMEs, 2014.

Medium-sized enterprises indicated that financing working capital (27.6%) was the main purpose for the funds raised, while improving energy efficiency represented the second largest reason of using finance by medium-sized enterprises (18.4%).

126 The number of medium-sized enterprises that provided an answer: 41. 127 The number of medium-sized enterprises that provided an answer: 41.

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Since medium enterprises are larger they incur higher administrative costs, especially utility costs, which are especially high in Malta. On this basis, more effort is made to invest in energy efficient equipment. In the case of micro and small enterprises only 6.3% used the funding sought for improving energy efficiency. The third most common purpose with 17.1% of responses was to fund other needs such as acquiring machinery and equipment or acquiring or renting land and buildings.

Figure 33: Use of funding by medium-sized enterprises over 2011-2013128

Source: PwC, online survey among Maltese SMEs, 2014.

When asked about the financial products to be sought in the future, medium-sized enterprises identified virtually the same products used to date. According to the survey, medium and long-term loans will be sought by just over 46% of respondents, followed by short-term loans (39.3%), which presumably reflect the medium-sized companies’ greater relative interest in investing in the business.

Equity funding from existing shareholders or family and friends or national / foreign institutions, Business Angels, Venture Capital funds, or rescue / turnaround and buyout, technology transfer funds, and even mezzanine and hybrid finance attracted no responses. This lack of responses indicates also in the case of medium- sized companies a very low awareness of such financing sources and the relative sufficiency of the banking infrastructure for their needs. Also, other forms of financing such as loans guaranteed by a public or private entity and corporate bonds did not attract any responses from medium sized companies.

128 The number of medium-sized enterprises that provided an answer: 41. Note: no respondent answered: transfer ownership.

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Figure 34 Expected sources of funding in 2014 indicated by medium-sized enterprises129

Source: PwC, online survey among Maltese SMEs, 2014.

According to the online survey, as shown in Figure 35, most of the medium-sized enterprises anticipate using funding for acquiring machinery and equipment (24.6% of total funding being sought) and for financing their working capital (21.7%). It is interesting to note that 10.1% of respondents indicated that funding sources would be used to develop international activities. This response indicates that medium enterprises may be more optimistic about growth prospects in the near future than their smaller counterparts. Figure 35: Expected use of funding of medium-sized enterprises in 2014130

Source: PwC, online survey among Maltese SMEs, 2014.

129 Number of medium-sized enterprises that provided an answer: 28. 130 Number of medium-sized enterprises that provided an answer: 41.

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7.7 Quantification of potential demand for financial products from small and medium-sized enterprises in Malta in 2014 The quantification of demand for financing for small and medium-sized enterprises has been calculated for the two size categories together. Interviews with representatives of SMEs and commercial banks have also confirmed that financing demand from small and medium-sized companies are often similar in Malta. The following quantification of demand from these companies uses the methodology described in Section 7.3 for the following financial products: • Short-term loans, bank overdrafts and credit lines; and • Medium and long-term loans.

Similar to micro-enterprises, small and medium-sized companies have not indicated amounts that can be appropriately used for the quantification of the potential demand for other financial products, such as leasing and factoring.

After implementing all the steps of the methodology for 2014, the average potential demand from a single small or medium-sized company for each product is provided. For short-term loans, the average demand amounts to EUR 170,833. Despite the fact that average amounts of short-term loans are not available, this amount seems consistent with the business reality of Malta also based on international experience and the size of these companies. A respective amount was also computed for medium and long-term loans (EUR 282,667), as presented in Table 31 below. Table 31: Annual demand for financial products by small and medium-sized enterprises in Malta in 2014

Average finance to be sought Finance to be sought by the total by a single small or medium- population of small and medium- sized enterprise (mEUR) sized enterprises (mEUR)

Short-term loans, bank 0.171 175 -193 overdrafts and credit lines Medium and long-term loans 0.283 284 - 314

Source: PwC analysis, 2014.

In order to estimate the demand in the total population of small and medium-sized enterprises, the average amounts were multiplied by the number of companies and a variation of -5% and +5% was applied.

It was described in the previous sections that the banking sector is dominant in Malta and nearly the only formal source of financing for companies. As a result, small and medium-sized companies are the natural clients of banks and therefore access to finance is easier for these companies. The later seem to have experience with banks and they seem to be more aware of the different financing products

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associated to different uses. According to the findings, these companies will seek funding through medium and long-term loans, in order to support their businesses.

7.8 Potential demand for equity financing from the SME population in Malta The Maltese equity market portrays an unusual paradox. As presented in the supply side analysis, the country seems to attract equity funds due to a friendly legislative framework. However, these equity funds have no interest in the local market as its small size does not seem to match portfolio requirements of private investment funds. On the other hand and as described in the demand side analysis, SMEs have limited experience or even awareness of equity funding and how this funding could benefit their businesses. As explained below, factors like moderate innovativeness and insularity of the market, very small size and family character of many businesses leave few Maltese companies interested in financing innovation or significant growth. Hence, new equity would not automatically trigger high-quality demand as shown by several similar attempts in the past.

The estimate of demand for equity financing in Malta will mainly remain qualitative since it is recognised that quantifying demand for equity may depend on many contextual factors, such as: capacity of the SME to present its project and attract investors, ability of the SME to be well supported by a network and interest of investors in the sector. However, an indicative quantification will also be provided for consistency reasons and in order to provide an indicative financing gap.

In contrast to debt products that can support a very wide range of potential companies in terms of size and sectors with their working capital and investment needs, equity financing is only appropriate for a small subset of companies. Despite the fact that demand for equity financing could originate from different sectors, sizes and company profiles, a realistic approach in describing demand is actually to define the profile of companies where the type of demand would materialise that would be of interest to investors.

In the AFMA survey conducted for this study, a few companies expressed the willingness to use equity financing in the future. These investments could be attractive for equity investors but only if other conditions are met first. For this reason it is important to define the prerequisites sought by investors. For early stage financing the profile of the entrepreneur and his or her educational or professional background are important, as well as the viability and scalability of the business. As Malta is a small market and rather saturated, a targeted company would have to consider developing its operations in international markets. The level of innovation deriving from the business is also a priority along with defining growth perspectives before considering the size of the company or even the sector. It was shown that the percentage of companies willing to expand their business to new markets is

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slightly increasing compared to the past, thus equity financing could be relevant to those companies.

SMEs were asked to provide the amounts of equity financing they sought and obtained over 2011-2013, but as only a very limited number of enterprises clearly stated their needs, estimating the financing need is not representative. The survey showed that the ratio of equity financing obtained over equity financing sought increases with the size of the SME. Micro-enterprises have indicated that they only obtain 56% of the amount sought while small and medium-sized enterprises specified that they managed to obtain 95% and 65% of equity financing sought respectively 131 . It has to be noted that this equity financing received does not necessarily originate from the local market.

As mentioned in Chapter 7.2, Business Angels in Malta are not coordinated, or rather there have been attempts to coordinate them that have failed, and only few individual investors are active in the country. Moreover, VC funds would need to be incentivised to focus their attention on Maltese companies, and particularly if they are to develop local operations, given the risk of limited high quality propositions.

In parallel, interviews with financial stakeholders and SME representatives are confirming the findings of the survey as they stated that investment from private sector has declined in recent years and few SMEs are being funded by equity financing. In fact, between 1% and 5% of SMEs intending to seek funding in 2014 are looking for equity financing from various external equity sources132, which is in line with other regions in Europe.

A large proportion of SMEs are owned by a single person (20.6%) or are family businesses (60.7%) (SAFE survey, 2013). Reluctance in seeking and obtaining equity financing may consequently be linked to the existing mentality of SMEs’ owners who are not willing to share its management.

As illustrated in the online survey133: • For Venture Capital: 70% consider they do not need it, 27% consider the access is not adequate and only 2% consider their access as adequate; • For mezzanine financing: 82% consider they do not need it, 18% consider the access is not adequate and only 1% considers their access as adequate; and

131 These figures should however be taken with precaution since the amounts provided by the companies for equity financing sought may vary from EUR 3,000 to EUR 2m, illustrating very different financing needs and/or a poor estimation of the actual needs of the company. That is why focusing on ratio provides more insights than only considering the amounts given by the SMEs in the survey. 132 This is confirmed by the SAFE survey: When asked “If you need external financing to realise your growth ambitions, what type of external financing would you prefer most?” 5.1% of enterprises state equity investment (including Venture Capital or Business Angels). 133 The number of SMEs that provided an answer: 135.

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• For Business Angels: 73% consider they do not need it, 23% consider the access is not adequate and 3% consider their access as adequate.

Overall, only between 1% and 7% of SMEs in Malta considers their access to equity and quasi-equity financing as adequate. However, the fact that circa 25% of companies feel that there is an inadequate supply of early stage finance suggests that there may be a sufficient latent demand.

Even though information on Venture Capital in Malta is limited, an example of an SME having received equity financing in the last few years is illustrated below.

As mentioned in Annex 4 of the report, the University of Malta (UOM) has recently launched a business incubator called TAKEOFF, which has been operational for the last year, offering facilities (office and communication facilities and mentorship) for start-ups. Through financing received from the Government of Malta, UOM launched the Seed fund award as part of the TAKEOFF programme where funds were awarded to nine applicants. The total request by the participants to this Seed Fund was EUR 400,000 meaning that there was a strong interest in the programme. Eventually, one of the start-ups, DiscountIF has managed to raise EUR 190,000 through angel investors in the United Kingdom.

This initiative raised some awareness on the opportunities for young entrepreneurs in launching an innovative start-up. Although there have been some initiatives in the past year to further raise awareness on equity financing, the overall demand for equity financing is limited. This demand is also often not well formulated by the entrepreneurs who lack financial knowledge and experience with VC funds. This lack of knowledge and experience is faced by all sizes and all maturity stages of SMEs. It is likely to be one of the main barriers for seeking equity financing in Malta.

The challenges for the future will be to assist SMEs in the commercialisation process and helping them to attract more customers during the early stages of the development of their business. Due to its small market size, Malta does probably not produce enough start-ups to support the portfolio requirements of a privately managed venture capital investment fund. Hence, the challenge would be to incentivise investors, through public funding and assistance, to focus on the Maltese market. For this to be done successfully, government needs also to be the catalyst to drive the demand for equity financing.

Several stakeholders have voiced their opinion on the need to introduce tax incentives if investment funds were to invest in local projects. Interviewees specified that some forms of tax exemptions such as investment tax credits, tax exemptions on dividend payments and exemptions from tax on the sale of underlying companies could be introduced to attract foreign or local high net worth individuals, as is done in other EU Member States.

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Stakeholders recognise the importance of encouraging high-technology and knowledge-intensive industries. As highlighted in the analysis of innovation in Malta, a considerable lack of funding instruments for innovative companies to finance growth exists particularly in the critical development stages. Equity finance is potentially the most appropriate form of financing to promote innovation in the country as anticipated by national strategies. Nevertheless, increasing innovation does not only depend on adequate financial sources, but a stimulating environment supported by stronger links and interactions between universities, research institutes and innovative SMEs. The AFMA survey conducted for this study revealed that most SMEs did not request support from the innovation framework (approximately 78%) and infrastructure in the country such as incubators, innovation centres, technology parks and clusters, further confirming that there might be lack of awareness of the presence of such institutions, but also reflecting the limited appetite for innovation among companies. Strengthening this environment in combination with the involvement of BAs and VC funds in such interactions would benefit young innovative SMEs.

Quantification of demand for equity financing

The average amount of equity financing to be sought by SMEs in Malta in 2014 is estimated to be EUR 116,485134; however, this sits in a range of between EUR 5,000 and EUR 500,000 reflecting the wide scope of potential types of businesses and their development stages.

For the calculation of the total demand of SMEs, the total population has been identified on the basis of the following considerations: • First, only micro-enterprises with employees are taken into consideration as even start-ups will need to have a team in order to be able to raise seed finance. They are 27,939 micro-enterprises. • Second, all small and medium-sized companies are taken into consideration: 1,897 enterprises. • Third, the obtained number is multiplied by the proportion of SMEs that are interested in seeking equity financing in 2014. As already mentioned, the lower end of the range may be estimated at 1% and the higher end of the range may be considered at 5%.

The number of SMEs that may seek equity financing in Malta in 2014 is between 298 and 1,492 (Table 32).

134 Amounts used for the computation of the average includes: “capital contribution of shareholders”, “external capital contributions (family or friends)”, “Business Angels”, “investment funds”, “Venture Capital funds”, “technology transfer funds”, “rescue/turnaround funds and buyout capital”, “other private investors”, “mezzanine or hybrid capital”, and “equity from national, regional and foreign institutions”. The average amount is computed by adding all the amounts given by SMEs for the above-mentioned financial products. Amounts that are above EUR 500,000 have been considered as outliers since they may be only relevant to a limited number of companies.

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Table 32: Annual demand for equity financing in Malta in 2014

Average finance to be sought by a Finance to be sought by the total

single SME (mEUR) SME population (mEUR)

Equity financing 0.121 35 - 174

Source: PwC analysis, 2014.

This range of demand for equity financing should be considered with caution, particularly as equity investment can be applied to different needs. There is a wide range of amounts sought: small amounts could illustrate a capitalisation need in order for SMEs to stabilise and/or solidify their capital structure as well as to have better access to debt financing and large amounts could illustrate SMEs’ willingness to secure future investments for the launch of new activities and the implementation of their growth strategies.

The equity market mainly depends on the capacity of matching supply and demand and the ability of stakeholders to coordinate. Such coordination needs considerable improvement in Malta to be more effective and to be able to raise relevant investment projects for BAs, VC and PE funds. This coordination implies investment funds, Chambers of Commerce, business clusters and incubators, for instance. Coordination efforts have improved considerably in the past year or two with the University of Malta teaming up with other incubators such as the Microsoft Innovation Centre. However, these efforts need to be strengthened, especially among the Government and its agencies, and other initiatives that may be launched in the future by other institutions.

Notwithstanding the above, supply-side representatives are at times not willing to meet the demand, even if they are able to. For instance, SMEs looking for equity finance may be in an inappropriate stage of development, e.g. seeking VC financing while PE would be more appropriate. Another example is SMEs looking for PE financing when they should seek equity for turnaround investment. This highlights lack of SMEs’ ability to define their equity financing needs and their timing as well as non-recognition of the need to build contact with appropriate providers. Targeted technical assistance and awareness-raising could tackle these issues, resulting in more robust demand for equity. Nevertheless, the number of companies as preferred investment targets by VC funds will be limited, as mainly high growth potential companies with global aspirations are targeted.

It is worth noting that by indicating an amount for equity financing, Maltese SMEs also express their need for support from business clusters and investors to help them structure and implement their growth strategies. This support does not only cover the provision of financing, but also the skills support and mentoring that SMEs may need to develop.

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8 Financing gaps, conclusions and recommendations This chapter provides the calculations of the financing gaps per company size and per financial product in order to draw conclusions and present recommendations to be used for the development of a future investment strategy for the use of Financial Instruments. The chapter is set out as follows.

Section 8.1 outlines the methodology used to calculate the financing gaps. The first part of the analysis provides estimates of the financing gaps based on the estimated existing supply and the potential demand per company category and per financial product. The financing gaps are then calculated based on a recent approach elaborated by the European Commission135 which takes into account the unmet demand for financial products from viable SMEs in Malta.

In Section 8.2 the financing gaps based on both potential and “viable SMEs” demand are presented and analysed. The analysis is carried out by segment of company size and by financial product.

Section 8.3 provides an overview of the supply, demand and financing needs of large companies in Malta.

Section 8.4 provides conclusions and main findings of the AFMA study, including lessons learned from previous initiatives.

Section 8.5 presents the recommendations for the future investment strategy in Malta.

8.1 Rationale behind financing gaps and methodology to compute them In order to provide a greater perspective of the SMEs’ needs in Malta, two different methodologies have been used to define the financing gaps: one that provides the total amount that SMEs would ideally like to seek compared to the total supply, and the other that takes into account the pressing issue of viable, growing companies that have failed to obtain finance. In the following paragraphs, the rationale behind the use of financing gaps is provided to define the context and understanding of the gaps. The two methodologies are subsequently elaborated upon. Furthermore, it has to be reminded (as mentioned in Chapter 7) that the computation provide gaps for 2014, but these gaps are average annual gaps that expand in a period of the next one to two years (2015 and 2016). For reasons of simplification the gaps are referred as gaps for 2014.

135 European Commission (2013). Ex-ante assessment of the EU SME Initiative. Staff Working Document, November 2013.

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a) Rationale behind financing gaps The estimated supply of financial products presented in Chapter 7 was based on market trends, information provided by the Central Bank of Malta and estimates of market stakeholders. As a result, such supply figures can be considered as robust and objective due to the fact that information is collected by the Central Bank of Malta from financial institutions, and market stakeholders have the expertise to provide such insights based on the liquidity and overall conditions of the institutions they represent.

The estimated demand is based on the online survey answers provided by SME owners or managers and is related to their knowledge of their respective markets and the perspective of their company. Unlike figures provided for the last years which represent disbursed amounts, the expressed figures shown by the survey show the SMEs’ real demand preferences independent from real market constrains. In the present report, financing gaps are first calculated by subtracting existing supply from potential demand. Nevertheless, the following points have to be taken into account when assessing the financing gaps based on potential demand.

• Potential demand may not actually translate into action. SMEs express their expectations and intentions when answering the online survey. These intentions may however not translate into action in the coming months or years for several reasons. SMEs may be discouraged to ask for finance, because of requirements (collateral, interest rates) or because of their difficult financial situation. They may also change their growth strategy and decide to postpone their investments.

• Specific nature of the economy in Malta. Malta is a relatively small country compared to the EU with some specificities that have to be taken into account when reading the gaps. Although this island economy is dominated by the banking sector, the banks are very cautious when lending, which is reflected by one of the highest interest rates in Eurozone. At the same time these banks are only willing to lend to enterprises with sufficient assets, and strong credit history. As a result, a considerable part of enterprises, particularly among micro-enterprises has to rely on informal sources of financing or on the personal assets of the business owner to be used as collateral. Especially for micro-enterprises, this environment nurtures a conservative mentality toward financing needs and some figures may be understated because of this mentality. Regarding small and medium sized enterprises, these aspects also have to be taken into account. The fact that these companies are dependent solely on the banking sector for financing implies that most companies that are growing in size depend on assets of the owners or shareholders. In that sense, even if these companies have access to finance, the dependence on the banking sector has to be perceived as a market failure and taken into account, even in the absence of financing gaps.

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• Total lack of supply for certain financing products. In the case of Malta, there are cases of financing products such as microfinance and equity where the supply is non-existent. Despite this, gaps are provided in order to support policy makers in case these products are introduced in the future. It has to be taken into account however that the total absence of supply also implies a very low awareness of these specific markets from the demand side. As such the demand expressed for these specific products should not necessarily be considered realistic since the respondents have no relevant experience seeking these products.

• Limited knowledge of financing sources and products. SMEs may not be aware of all the financing sources available on the Maltese market. SMEs may consequently keep seeking debt financing without envisaging other funding sources, such as for example factoring. Demand for debt products provided by the banking system may consequently remain high, while more sophisticated products could be more appropriate to SMEs’ actual needs.

• The absence of financing gaps does not mean that companies have an easy access to financing. Small and medium-sized companies in Malta are often asset-based and may not experience difficulties to provide collateral to commercial banks. On the other hand, the omnipresence of banks in the country and the lack of other financing sources may prevent smaller enterprises to access bank financing because of a lack of collateral. For that reason, it may also indicate a difficulty for smaller companies to grow and develop since they do not have the assets and collateral required by banks.

• Larger companies often have a clearer vision of their future financing needs. Small and medium-sized enterprises often have more time and skills to define their growth strategies and clarify their financing needs. They also request higher amounts to finance providers, in comparison with micro-enterprises. The larger companies may consequently have a clearer perception of their financing needs when answering the online survey and provide higher amounts. This does not mean that micro-enterprises do not have financing needs but that they may encounter difficulties or lack time to clearly define these needs and/or answer the online survey. One consequence may then be that a higher proportion of small and medium-sized companies answer the specific question related to future needs in the online survey and provide higher amounts. This may influence the average amount calculated when the total SME population is considered, such as for equity financing.

These market conditions create a tendency for SMEs to underestimate or overestimate their financing needs or to request financing which is needed for more than one year. As a result, the financing gaps calculated with potential supply and potential demand should not be perceived by policy makers as amounts that

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should be covered in a single year or as gaps that have to be bridged by Financial Instruments in order to facilitate private financing for SMEs. On the other hand, the lack of gaps also should not be perceived as an indication that FIs are not needed, since market failures can still exist in qualitative aspects. Overall, gaps are an indication of financing needs in the overall economy of Malta, according to the methodologies described in the report and market constraints experienced by SMEs in the country136.

In order to give the analysis of financing gaps a more operational focus for the design of Financial Instruments, the report also provides viable financing gaps (VFGs). These gaps express a more targeted approach for identifying needs of SMEs which experience growth but do not have access to finance. Nevertheless, it has to be taken into account that these needs do not necessarily reflect a realistic view of the market, but only a minimum existing gap for the following reasons: • The definition of a viable company (as described later on in Section 8.1.c)) is a limiting factor. SMEs which have deteriorating financial standings due to external reasons are not taken into account, nor are newly created SMEs which should be a target of Financial Instruments. • SMEs which are viable but do have access to finance could be in a process of experiencing financing constraints which do not allow for the further development of their activities or for their expansion to international markets. These SMEs create important added value and should be taken into account when analysing financing gaps. • Especially in Malta, companies may be experiencing growth but not seeking finance from the formal banking sector due to their inexperience or lack of awareness and thus would not recognise their lack of access to finance. • SMEs which have difficulties restructuring their existing debts are also not included. These companies could become viable if supported in their process to renegotiate their terms on existing loans, and consequently if their access to finance is supported by Financial Instruments. However, the impact of these companies on financing demand is difficult to estimate. • Potential financing demand of SMEs that do not yet exist is not taken into account (due to lack of data availability); however, most companies start out as micro-enterprises and many of them do not seek finance over the first years of existence or have very limited needs. • Some companies not included in this group may have received funding, but less than they sought out to obtain.

136 Financial Instruments are one of the solutions to reduce the identified financing gaps and need to be considered in a complementary manner with other financing tools, such as grants. The latter may be of particular interest for instance in the case of R&D financing or financing support to financial intermediaries or final beneficiaries for capacity building and training.

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Both of the above-mentioned methodological approaches to calculating financing gaps provide useful information to policy makers. They define maximum needs from the potential demand and minimum needs from the viable financing gaps.

The methodologies used to compute the financing gaps are detailed in the following paragraphs.

b) Methodology to compute financing gaps with estimated supply and potential demand The first methodology to calculate the financing gaps uses the estimated supply and the range of potential demand calculated in the previous sections of the report for each category of SME and each financial product.

For each financial product considered per category of SMEs, two steps have been followed: first, the minimum estimated supply is subtracted from the lower figure of the potential demand (as calculated in Chapter 7). Second, the maximum estimated supply is subtracted from the higher figure of the potential demand.

For each of the subtractions, when a positive number is obtained, a financing gap is identified. If a subtraction provides a negative number, it means that, under certain circumstances, the supply in 2014 may cover the potential demand for the considered financial product.

This computation methodology is followed for two categories of SMEs (micro- enterprises on the one hand and small together with medium-sized companies on the other hand) and two financial products: short-term loans and medium and long- term loans.

c) The viable SMEs methodology to compute financing gaps A second methodology is used to estimate financing gaps for loans. It follows the approach based on “viable SMEs” that was suggested by the European Commission in a recent report137, and the gaps estimated by using this method will be henceforth referred to as Viable Financing Gaps or VFGs. The methodology used by the EC estimates financing gaps by using two elements: • The identification of the percentage rate of financially viable SMEs that were unsuccessful in obtaining loan finance in Malta; and • The calculation of a loan financing gap by using an average loan amount that would have been requested by these companies.

137 European Commission (2013). Ex-ante assessment of the EU SME Initiative. Staff Working Document, November 2013.

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In the EC report, viable SMEs are defined as SMEs that have registered positive growth in terms of turnover in the last six months. The proportion of viable SMEs that were unsuccessful in obtaining loan finance is considered in the EC report as the share of SMEs that (1) applied for a bank loan but were rejected by the bank (bank rejection); (2) refused the bank’s proposed loan because of high interest rates (SME refusal); and (3) did not apply for a loan for fear of rejection (SME discouragement). For Malta, the EC report estimates the proportion of viable SMEs that were unsuccessful in obtaining loan finance at 6.3%.

In order to compute a viable loan financing gap for SMEs in Malta which is in line with the EC report’s assumptions, the following methodology has been used in the present report.

The proportion of financially viable SMEs that were unsuccessful in obtaining loan finance has been estimated for the two categories of SMEs. The number of SMEs defining their turnover as better or much better between 2011 and 2013 has been taken from the online survey data. Among the viable SMEs, the share of companies that were unsuccessful in obtaining loan finance has been calculated. On this basis, 10.2%138 of viable micro-enterprises were unsuccessful in obtaining loan financing. In considering small and medium-sized companies, one notes that all companies were successful in obtaining loan financing. These percentages are applied to the population figure used to calculate the potential demand previously 139 . These percentages also indicate the difference between micro-enterprises, who have difficulties despite an increasing turnover on the one hand, and small/medium-sized companies on the other hand which do not seem to face difficulties to access loan financing.

For micro-enterprises, the calculation of the financing demand from a single company is multiplied by the share of viable unsuccessful SMEs in the micro- enterprise population. A variation of -5% and +5% is then applied so as to take into consideration the potential fluctuation.

In order to illustrate the methodology presented above, the following box provides the calculation used to estimate the financing gap of viable micro-enterprises that were unsuccessful in obtaining short-term loans.

138 As per the online survey 6 micro-enterprises out of 59 were unsuccessful in obtaining financing despite experiencing an improvement in turnover. In opposite to the ratio of 6.3% (SAFE survey) which captures the last 6 month, this figure covers the period of the whole last year and is, hence, higher. 139 Specifically, 6,772 micro-enterprises for short-term loans, 5,267 micro-enterprises for medium and long-term loans and 1,078 small and medium-sized companies taken together for short-term loans and 1,056 for medium and long-term loans.

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Box 2: Example of calculation of a viable financing gap (VFG) for short-term loans for viable micro-enterprises

Step 1: Calculating the share of viable micro-enterprises that were unsuccessful in obtaining loan finance The percentage of micro-enterprises that define their turnover as better or much better between 2011 and 2013, but are unsuccessful in obtaining short, medium and long-term loans, represent 10.2%140 of all micro-enterprises in Malta. This percentage corresponds to the micro-enterprises who sought finance and were unsuccessful in obtaining short, medium or long-term loans between 2011 and 2013 (using Question 5 on turnover and Question 7 on the satisfaction on financing sources; these two questions are present in the questionnaire in Annex 8). The percentage is computed based on the micro-enterprise population which perceive their turnover as better or much better between 2011 and 2013. Among this population, only those which were unsuccessful in receiving short, medium or long-term loans were taken into consideration. Following the same approach, there is no small or medium-sized enterprise in this situation. As already mentioned, the difference between these percentages illustrates the difference in access to finance between micro- enterprises on the one hand and small/medium-sized companies on the other hand. The absolute number of micro-enterprises is 689 for short-term loans.

Step 2: Computing the average short-term loan sought by a single micro-enterprise This computation provides the average demand of short-term loans for micro- enterprises. The average amount is EUR 31,964.

Step 3: Multiplying the average amount by the number of viable micro-enterprises that were unsuccessful in obtaining loan finance The formula is the following: 689*31,964 = 22,012,565141.

Step 4: Estimate of a reasonable range for the viable financing gap Based on the calculation in step 3, a viable financing gap is obtained. In order to take into account of the variation of the demand around this viable financing gap, a variation of -5% and +5% is applied, giving a viable financing gap between EUR 21m and EUR 23m. The same approach is applied to the other category of SMEs and to medium and long-term loans.

140 This percentage corresponds to the micro-enterprises that perceive their turnover as better or much better between 2011 and 2013, who sought finance and were unsuccessful in obtaining short, medium or long-term loans. The respective percentage for small and medium-sized enterprises is 0%. This illustrates again the difference in access to finance for micro-enterprises and small/medium-sized companies. 141 The result of this calculation is EUR 22,023,196 but contains rounding errors and the actual result is EUR 22,012,565.

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8.2 Financing gaps The analysis in this section, based on the two methodologies described above, presents the financing gaps computed according to the potential demand for financial products as well as the viable financing gaps (VFGs) based on viable demand.

a) Financing gaps for micro-enterprises Micro-enterprises in Malta represent the vast majority of companies in the country. On the one hand, commercial banks do not consider these companies as potential clients unless their collateral requirements are met, on the other hand many micro- enterprises can provide private collateral (owner’s assets and family and friends) to access formal loan financing. The dominance of the banking sector excludes in this sense micro-enterprises which are not able to provide sufficient collateral, which is consolidated by the lack of specialised institutions such as microfinance providers that could support these companies. The analysis also highlighted two important points. One is that micro-enterprises could be discouraged from seeking bank financing due to their lack of collateral but also due to their inexperience in dealing with banks and their limited technical skills in applying for loans and presenting business plans. The second point is that a third of micro-enterprises consider that guarantees which are provided in Malta by JEREMIE and Malta Enterprise are inaccessible to them. This has to be taken into account when designing FIs in the future and especially guarantee instruments.

Financing gaps for microfinance As mentioned previously, the microfinance market in Malta is practically non- existent except for some initiatives more directed toward charity and support of sensitive social groups and less toward business microfinance. The quantitative estimate of the financing gap for microfinance presented in the table below is based on potential demand from existing micro-enterprises in Malta. Table 33: Potential financing gap for microfinance for micro-enterprises in 2014

Range of potential Estimated supply (mEUR) Financing gap (mEUR) demand (mEUR)

Microfinance 109 - 121 1 108 - 120

Source: PwC analysis, 2014. See Boxes 1 and 2 for detailed descriptions of the methodology.

This financing gap for 2014 based on potential demand from existing micro- enterprises is estimated to range between EUR 109m and EUR 120m. This financing gap arises mainly from: • The difficulties that micro-enterprises (especially 0 employee companies) experience when seeking financing from financial institutions, and especially commercial banks;

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• The fact that the microfinance market is very limited in Malta. This financing product, if available, is implemented by commercial banks (BoV), but not by specialist MFIs; and • Microfinance products are not well identified by their potential beneficiaries in the country.

Given the current estimated gap for microfinance, one can envisage that as supply for microfinance is expected to increase over the coming years, awareness of these financial products will also increase. In addition, the number of 0 employee companies in Malta also tends to increase implying a potential increasing demand of microfinance in the coming years.

Moreover, a need for microfinance for financial inclusion has been computed in the previous section. This need is estimated at EUR 6m. It corresponds to the financing amount of microfinance that would be needed by new business entrepreneurs who currently face social exclusion and may be willing to launch a business if they were better supported in their access to finance.

Table 34 below indicates the total financing gap for microfinance, including microfinance needed for financial inclusion. It ranges between EUR 114m and EUR 126m. Table 34: Potential financing gap for microfinance for micro-enterprises in 2014, including financial inclusion

Financing gap for existing Financing gap for financial Total financing gap for

micro-enterprises (mEUR) inclusion (mEUR) microfinance (mEUR)

Microfinance 108 - 120 6 114 - 126

Source: PwC analysis, 2014. See Boxes 1 and 2 for detailed descriptions of the methodology.

Financing gaps for loans

Many micro-enterprises in Malta, especially start-ups, are experiencing problems in accessing the banking system, which is nearly the only source of corporate funding in the country. Access to mainstream banking products tends to be limited to those micro-enterprises with a good credit history of the owner, larger turnovers and lower levels of debt financing and sufficient equity invested according to banks’ standards. Micro-enterprises which cannot fulfil the bank’s requirements seek financing from informal sources (family and friends) because they lack credit history, lack collateral while not being aware of the existing Financial Instruments providing guarantees and lack knowledge of banking procedures.

The quantitative estimate of the financing gaps based on potential demand for micro-enterprises in Malta is summarised in the tables below.

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Table 35: Potential financing gaps per financial product for micro-enterprises in 2014

Range of potential Estimated supply (mEUR) Financing gap (mEUR) demand (mEUR)

Short-term loans, bank 206 - 227 82 - 91 123 - 136 overdrafts and credit lines Medium and long-term loans 366 - 404 218 - 240 148 - 164

Total 572 - 632 300 - 331 272 - 300

Source: PwC analysis, 2014. See Boxes 1 and 2 for detailed descriptions of the methodology.

These gaps are subject to the limitations described in the previous paragraphs but they provide an indicative view of the total potential financing needs of micro- enterprises in the country.

For 2014, the financing gap for short-term loans is between EUR 123m and EUR 136m and is an indication of a need for working capital finance for micro-companies. The quantification of these gaps seems consistent with the interviews carried out, since stakeholders underlined the need for working capital financing for micro-enterprises.

Financing needs for investment are also highlighted by the financing gaps for long- term loans for 2014 (where the financing gap ranges between EUR 148m to EUR 164m). One should note that the financing gap for medium to long-term loans is very similar to the financing gap for short-term loans indicating that the demand for short-term loans is much higher than the supply when compared with the ratio of demand and supply of medium to long-term loans. This further confirms the importance of short-term financing for micro-enterprises, since this provides the means to finance the day-to-day running of their business.

The demand analysis in Chapter 7 demonstrated that micro-enterprises may not be trying to access the right kind of finance for their desired use. This should be an indication that micro-enterprises would benefit from customised products in terms of amount, maturity, and collateral requirements. The absence of specialised MFIs enhances the shortcomings in loan products for micro-enterprises. With regard to the heterogeneous nature of micro-enterprises, mainly with 0 employees, and start- up micro-enterprises, a better supply of targeted products, such as microfinance products, is a crucial success factor in closing the financial gaps since such micro- enterprises currently rely heavily on informal sources and need support to cover their funding needs.

Overall, micro-enterprises’ problems in accessing finance may also be explained by their difficulties in defining their needs and formulating a clear business plan for the future. This factor highlighted during interviews with financial institutions is probably due to the lack of managerial skills that entrepreneurs have when launching their activity. In order to cope with these challenges, business owners may need support

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to define the most appropriate financing sources and products for their development.

In order to provide a more targeted view of these gaps, the present report has also calculated a gap range for the loan products (short-term loans, overdrafts and credit lines, and medium and long-term loans) based on the viable demand as described in Section 8.1. These gaps (VFGs) are presented in Table 36. Table 36: Viable financing gaps for micro-enterprises concerning loan products in 2014

Range for viable financing gap (mEUR)

Short-term loans, bank overdrafts and credit line 21 - 23 Medium and long-term loans 37 - 41

Total 58 - 64

Source: PwC analysis, 2014. See Boxes 1 and 2 for detailed descriptions of the methodology.

For 2014, the calculation has identified a VFG for short-term loans ranging between EUR 21m and EUR 23m. For long-term loans, the VFG ranges between EUR 37m and EUR 41m. The VFGs refer to financing needs of micro-enterprises, which are viable but still have no access to finance. These companies should become a policy priority for future public assistance, since by improving their access to finance this would create a stronger business environment in the market and will also help companies expand and develop in other markets locally or abroad.

For 2014, the total viable gap for loan products ranging between EUR 58m and EUR 64m is an indication that the obstacles for the financing of micro-enterprises are not only linked to the viability of the business plans but also to other constraints, such as the lack of funding at the launch of the business, the lack of financial knowledge, the lack of experience with and relation to financial institutions (often leading to discouragement to seek finance) and the lack of collateral. The range of the viable financing gap for total loan products (EUR 58m - EUR 64m) also seems to be consistent with the gap identified for SMEs in Malta in the ex-ante assessment of the EU SME Initiative142, which is between EUR 18m and EUR 61m. The VFG computed in the present AFMA study is in line with the gap identified in the ex-ante assessment of the EU SME Initiative since there is no viable financing gap for small and medium sized enterprises, as detailed in the following section. Therefore, the total viable financing gap is essentially the viable financing gap for micro-enterprises.

The total viable financing gap computation also illustrates a prudent and conservative banking sector resulting from an overall attitude of the banking system

142 European Commission (2013). Ex-ante assessment of the EU SME Initiative. Staff Working Document, November 2013.

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toward micro-enterprises and new regulations on banking risk management (mainly resulting from the implementation of Basel II and III regulations).

In this context, the further development of guarantee products in the country and/or funding products that would better incentivise the existing commercial banking sector to support micro-enterprises would improve their access to bank financing. It would also help to avoid the difficult period that micro-enterprises experience when they need to invest and grow if they have no credit history and lack relations with banks and experience with the banking sector in general.

Both potential financing gap and viable financing gap for micro-enterprises are illustrated in the following figure for 2014 to show their relative size. Figure 36: Potential financing gaps and viable financing gaps for micro-enterprises for 2014

Source: PwC analysis, 2014.

b) Financing gaps for small and medium-sized companies Small enterprises represent a much smaller segment of the SME population than micro-enterprises in Malta. The number of small companies has been slightly increasing since 2009 signifying that companies are growing within the local market pushed by the growth in GDP. According to the findings presented in previous chapters, small companies have access to bank financing. They are perceived by banks as clients of interest and have the experience and knowledge to apply for loans. The majority of small enterprises indicated that they did not face obstacles when seeking finance; however, some indicated that costs of financing and other terms and conditions imposed by financial institutions are a growing cause of concern to them. Moreover, as the majority of these companies are in a development stage, their financing needs will be increasing in the coming years. This has to be taken into account by policy makers, since the banking system will always request collateral and it is not evident that existing assets will be sufficient for small companies to implement their growth strategies.

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Medium-sized enterprises represent an even smaller segment of the SME population. Like other sizes of SMEs, medium-sized enterprises have favoured short-term loans to medium and long-term loans over the past few years. However, they have faced even fewer difficulties than small companies.

The quantitative estimate of the financing gap for small and medium-sized companies based on potential demand in Malta is summarised in the table below for 2014. Table 37: Potential financing gaps per financial product for small and medium-sized enterprises in 2014

Range of potential Estimated supply (mEUR) Financing gap (mEUR) demand (mEUR)

Short-term loans, bank 175 - 193 252 - 279 - overdrafts and credit lines Medium and long-term loans 284 - 314 667 - 737 -

Total 459 - 507 919 - 1,016 -

Source: PwC analysis, 2014. See Boxes 1 and 2 for detailed descriptions of the methodology.

According to the table above, financial institutions seem to be addressing the demand for loan products from small and medium-sized enterprises since the supply for both medium and long-term loans and short-term loans exceeds the demand in 2014.

This result is confirmed by the opinions expressed by the stakeholders interviewed who believe that financial institutions appear to be meeting the demand for loan products from small and medium sized enterprises. This observation is also reflected through the literature review carried out143, which indicated that: • Consolidated debt from non-financial corporations in Malta is estimated at nearly 82% of GDP, which is higher than the EU-28 average (69.4%); • Maltese enterprises tend to have large proportions of debt in their balance sheets compared with equity (high levels of gearing); • Eurostat states that persons in Malta own more immovable property (82%) as in other Member States (70% EU-27 average), which is the most used form of collateral according to the survey conducted for this study; and • The SBA Fact sheet states that the percentage of rejected loan applications and unacceptable loan offers in 2011 was 0% in Malta as compared to the EU average of 15%.

These points confirm that financial institutions generally meet the demand for loan products and as many stakeholder confirmed, banks in Malta have excess liquidity

143 See Annex 4 for a detailed presentation of the market environment en Malta.

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making it easy to finance enterprises, especially when it comes to companies having previous credit history and a good relationship with the banks.

For 2014, the calculation reveals that there are no viable gaps for short-term and medium to long-term loans. This is because no small or medium sized company, which experienced an improvement in turnover, indicated that they were unsuccessful in obtaining loan financing for either short-term or medium to long-term loans (as indicated by the SAFE survey).

However, the lack of gaps can be misleading. Indeed, the banking system focuses on small and medium-size enterprises, because they have assets and are more suitable clients than micro-enterprises; however, the dominance of the banking system that appears as the only financing source for SMEs has to be considered as an important market failure. As already mentioned, the limited choice of financing products, and the complete lack of equity financing or mezzanine financing, causes SMEs to collateralise their assets and damage their balance sheets. Moreover, the complete dependency on banking financing makes the market sensitive to external shocks related to the banking environment, as was experienced in other EU countries.

This dependency on the banking system may also prevent micro-enterprises in areas of activities were tangible assets are not required, from growing. Micro-enterprises that are not asset-based and cannot provide collateral are consequently excluded from banking finance. This situation is even more emphasised by the lack of alternative financing sources for the developing micro-enterprises. The characteristics of this market failure may not be quantified in a financing gap. The smaller percentage of small enterprises among all SMEs in Malta in comparison with the EU average is however a strong indication for it.

In addition to these weaknesses of the Maltese banking sector, small and medium- sized enterprises have also limited knowledge and awareness of existing FIs which could support them in reducing costs and probably allow them to secure funds without tying up their assets. This is despite the experience with banks that small and medium-sized enterprises may have acquired over the years.

It also has to be noted that, those companies that have assets and are perceived as attractive clients by commercial banks, are often encouraged by banks to receive higher amounts than the ones initially applied for. Although qualitative information is not provided by the survey to support this argument, the market experience in Malta reveals this reality. Overall, the reliance of business owners and entrepreneurs on assets that can be collateralised is an important market failure since it limits business activity to specific social groups or redirects business activities toward asset based types of companies with the danger of excluding non-asset based enterprises from the financial market.

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c) Financing gap for equity financing The analysis conducted in Chapter 7 revealed that the investment funds present in Malta do not invest locally and that the overall equity financing market in the country is weak. This is despite a perception of the banks that Maltese SMEs are under-capitalised. In the meantime, most of SMEs in Malta do not know the functioning of an equity market and do not tend to seek equity financing and/or do not perceive a need to strengthen the equity structure of their company. The need for equity financing expressed by SMEs in the online survey result from the most structured companies and those having the stronger history with finance providers. That is why the potential gaps for equity financing illustrated in the table below needs to be considered with caution. When a financing gap exists for equity financing in Malta, it results from a lack of investors willing to invest in the country and a lack of knowledge and habit from SMEs of all sizes to seek equity financing. This financing gap is consequently mainly indicative and illustrates the extent to which the equity market in Malta requires better structuring. It also indicates the SMEs’ expectations for stronger support from business clusters and investors to help them define and implement their growth strategies for the future.

Table 38 below provides the quantitative estimate of the financing gap for equity financing in Malta. Following the analysis conducted in the present AFMA study, this gap may be considered as the potential demand for equity financing expressed by SMEs in the country. Table 38: Potential financing gap for equity financing for all SMEs in 2014

Range of potential Estimated supply (mEUR) Financing gap (mEUR) demand (mEUR)

Equity financing 35 - 174 - 35 - 174

Source: PwC analysis, 2014. See Boxes 1 and 2 for detailed descriptions of the methodology.

The potential financing gap for equity financing illustrated in the table above is mostly an indication that the equity market needs to be more developed in Malta. The development needs to be twofold: of the volume supplied and of the products offered as the demand figure above comprises many different individually demanded amounts which cannot be all addressed by the same equity product. This would require a public intervention that would increase investor confidence and trust in the local market.

8.3 Access to finance from large companies in Malta Large companies represent only 0.15% of all companies in the market. These companies have an easier access to banking finance and an alternative financing

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source namely the stock market 144 . Following a request from the MA, large companies were included in the analysis which is presented in the section below.

a) Supply of financing for large companies As highlighted in Section 7.2 and in Table 39 below, new loans to all companies in Malta amounted to EUR 1.2bn in 2011, increasing to EUR 1.3bn in 2013. In 2014, the estimated amount of total new loans is expected to amount to EUR 1.7bn, based on actual figures until May 2014. Table 39: New loans to all non-financial corporate entities with the year-on-year change

2014 (e)145 Loan Type 2011 (mEUR) 2012 (mEUR) 2013 (mEUR) (mEUR)

Short-term (up to 1 year) 331 388 361 454 y-o-y % - 17% -7% 26% Medium/Long-term (more than 1 year) 879 1,044 955 1,199 y-o-y % - 19% -9% 26%

Total 1,210 I,432 1,316 1,653

Source: Central Bank of Malta, PwC analysis, 2014.

No data is available for new loans provided exclusively to large companies in Malta. In order to consider the amount of new loans issued to large companies, assumptions on the percentage of new loans to large companies of total loans were made based on information available on outstanding loans. CBM data revealed that even though large companies in Malta represent only 0.1% of total active companies, approximately 22% of the total value of outstanding loans of non-financial corporations resident in Malta arises from short-term and medium to long-term loans to large companies.

Once the supply of bank loans to large companies was defined, data for the supply of loans was categorised into short-term loans (maturity < 1 year) and medium/long- term loans (maturity > 1 year) using the ratio of 27 / 73, as defined previously in Section 7.1. This split was determined based on public available information issued by the Central Bank of Malta on outstanding loans to non-financial corporations.

Table 40 below provides the estimates of the supply of short-term and medium to long-term loans to large companies based on the abovementioned data and assumptions.

144 As of 2014, there were approximately 10 large companies listed on the Malta Stock Exchange. 145 Estimates for 2014 are based on actual data until May 2014 and were pro-rated to project figures until year end.

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Table 40: Estimate of loan disbursements to large companies

Financial product 2011 (mEUR) 2012 (mEUR) 2013 (mEUR) 2014 (e) (mEUR)

Total 295 321 271 352 - 389

Short-term loans 81 88 75 97 - 107 Medium and long-term loans 214 233 197 255 - 282

Source: Central Bank of Malta, PwC analysis, 2014.

Stakeholders in the banking sector indicated that the supply of short and long-term financing to large enterprises is not perceived to be an issue as for smaller enterprises since large enterprises would typically have stronger and more enduring business relationships with commercial banks.

Apart from bank financing, large companies also have easier access to alternative financing avenues, such as the issue of corporate bonds on the local stock market. Larger enterprises would typically attract stronger investment from the market, given their size and reputation. In fact over the years, bond issues have become more popular among large companies as a means of financing large real estate projects.

Large companies are also eligible to apply for funding under a number of grant schemes and Financial Instruments available through both EU and national funding. Clearly large companies are well positioned to use their resources, knowledge and expertise to tap such funding.

b) Demand for financing from large enterprises Since the business environment in Malta is restricted and the size of most local enterprises and the scale of their operations is much smaller than that of enterprises in other EU Member States, the views of large companies (companies employing 250 persons or more) on access to finance were also obtained via the online survey. 10 companies provided their views, which means that numerical results need to be treated with caution, but it does represent ca. 18% of the population of large enterprises.

Large enterprises represented 0.15% of the total companies in Malta in 2012. The number of large enterprises increased between 2009 and 2010 by 3.6% and remained stable in 2011, increasing by a further 5.2% in 2012. Therefore large enterprises increased year on year by 2.9%.

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Table 41: Number of large enterprises in Malta

2009 2010 2011 2012 Number of % of total % of total Change % of total Change % of total Change Number of Number of Number of Number of companies companies companies over companies over companies over companies companies companies companies in Malta in Malta 2009-2010 in Malta 2010-2011 in Malta 2011-2012

Total companies 41,966 42,665 1.7% 42,189 -1.1% 40,634 -3.7% in Malta

Total large 56 0.13% 58 0.14% 3.6% 58 0.14% 0.0% 61 0.15% 5.2% enterprises

Source: National Statistics Office Malta, PwC analysis.

In order to identify if there were any problems among large enterprises regarding the accessibility of financing in Malta, a survey was distributed to 25 large companies. Ten respondents completed the survey thus representing 16.7% of the total large enterprise population in Malta.

Figure 37 shows that 60% of all respondents, believe that their business is in a maturity stage. The survey also revealed that around 20% of respondents see their business in the development stage, indicating that they expect growth within their company while another 20% see their company to be in the reorganisation stage of its lifecycle. Figure 37: Development stages of large enterprises in Malta146

Source: PwC, online survey among Maltese large enterprises, 2014.

Analysing the most-used sources of finance, Figure 38 highlights the extent to which large companies depend on short-term and long-term financing sought from banking institutions (60% for each type of financing), as well as loans obtained from their parent company and financing through retained earnings.

The survey further queried on the perception of sufficient access to finance for different products. 78% of large enterprises stated to have sufficient access to short-

146 The number of large enterprises that provided an answer: 10.

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term loans, bank overdrafts and credit facilities and medium to long-term loans147. Two third of respondents also felt there is sufficient access to loans obtained from their parent company148. On the other hand, one third of large companies feel that there is a lack of access to public grants and external capital contributions149. The least relevant forms of financing to large enterprises included several forms of equity financing such as, technology transfer funds, investment funds, Venture Capital, Business Angels, equity from national or foreign institutions and buyout capital.

Figure 38: Sources of funding used by large enterprises between 2011 and 2013150

Source: PwC, online survey among Maltese large enterprises, 2014.

Half of the large enterprises stated that they did not experience any difficulties when seeking financing. Large companies identified the financial situation of their business (40% of respondents) as the major obstacle in accessing finance. One fifth of the respondents also feel that there is a lack of willingness from banks to provide them with financing and believe that their debt / turnover ratio is another reason why they find difficulty when seeking financing. This observation is line with higher debt ratios in comparison to the EU average.

147 The number of large enterprises that provided an answer: 9. 148 Ibid. 149 Ibid. 150 The number of large enterprises that provided an answer: 10.

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Figure 39: Reasons explaining difficulties of large enterprises in accessing finance151

Source: PwC, online survey among Maltese large enterprises, 2014.

When focusing on debt financing, 58% of large enterprises did not experience any difficulties in obtaining loans or did not request any. For those companies facing problems, the most serious barrier related to their existing debts (17% of respondents faced such a difficulty) meaning that these companies are typically highly geared. When asked about collateral provided for loan financing, 67% of respondents used company assets indicating that these companies have much more security to offer compared with SMEs. However, it is interesting to note that 17% of respondents stated they used the owners’ assets as collateral, indicating that even large companies might not have enough collateral from business assets to satisfy the bank’s requirements for providing security.

Figure 40: Obstacles to loan financing reported by large enterprises152

Source: PwC, online survey among Maltese large enterprises, 2014.

151 Ibid. 152 The number of large enterprises that provided an answer: 10.

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Large companies were also asked to identify for what reason they sought financing. Figure 41 below illustrates that, similarly to SMEs, large companies tend to use the financing for diverse purposes. Of all the purposes stated for using finance, more than one third was working capital and nearly 16% was launching a new product or service. Approximately 11% of times, the financing was used to develop activities in new markets, including international markets. R&D, innovation and improvement of energy efficiency accounted for only a small proportion of destinations of financing: 5.3% between 2011 and 2013. 21.1% of needs financed were other needs such as the acquisition of machinery and equipment, rent or purchase land and buildings.

Figure 41: Use of funding by large enterprises over 2011-2013153

Source: PwC, online survey among Maltese large enterprises, 2014.

Large enterprises plan to seek similar financial products in 2014 as indicated in Figure 42, especially short-term loans, bank overdrafts and credit lines (43%) and medium and long-term loans (43%). 29% of respondents indicated they will be seeking leasing products, which may be used to finance the hire of machinery and other equipment or vehicles used by the company. No large company intends to finance its operations through equity financing other than one respondent who indicated that the company will be seeking financing from private investors.

153 The number of large enterprises that provided an answer: 10.

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Figure 42: Expected sources of funding in 2014 indicated by large enterprises154

Source: PwC, online survey among Maltese large enterprises, 2014.

c) Conclusions for large companies Overall, large companies in Malta do not face any difficulty with access to finance. Results from the online survey indicated that only 11% of the respondents stated to have insufficient access to short-term loans, bank overdrafts and credit facilities and medium to long-term loans155.

Large companies in Malta can be categorised into three broad groups. The first category of large companies includes export-oriented manufacturing companies. These mainly consist of subsidiaries of foreign-owned companies, which set up subsidies in Malta in the 1970s to benefit from certain advantages such as low labour and operational costs and an English-speaking skilled workforce. These companies do not experience many difficulties in accessing funding since such decisions are made at group level and financing is usually obtained from the parent company. In fact, it transpired that 50% of large companies in the online survey sought funding in the form of loans from the parent company156.

Another category of large companies could be classified as that including family- owned businesses, which, at holding level are considered large and are three to four generations old. Such companies generally have very strong relationships with local commercial banks therefore are more likely to obtain financing. In addition, these companies have easier access to equity markets because of their size. Some

154 The number of large enterprises that provided an answer: 7. 155 The number of large enterprises that provided an answer: 9. 156 The number of large enterprises that provided an answer: 10.

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are listed on the Malta Stock Exchange and many trade corporate bonds on the same Stock Exchange. On the other hand, regulatory capital requirements for credit and financial institutions, currently being implemented across the EU, may end up also restricting access to finance for large companies.

Over the last two years it has become increasingly difficult to fund large projects, especially those related to real estate activities. The third category of large companies in Malta includes construction companies, which currently have problems with funding as a result of the stagnation of the construction and real estate market in Malta. In fact, the 11% of respondents who stated they do not have access to short, medium and long-term loans were engaged in the construction industry. As identified in Chapter 4, the construction and real estate sectors contributed to almost 50% of the rise in non-performing loans as a result of overvalued properties, low levels of sales and the oversupply of real estate.

8.4 Conclusions and main findings The objective of the analysis conducted in the present study was to identify the main characteristics of SMEs’ access to finance in Malta, to draw a picture of the current situation, identify the major constraints and analyse any existing financing gaps. In this framework, the overall objective has been to consider market failures, suboptimal investment situations and financing needs in the SME sector. The goal of this analysis is to contribute to the formulation of an investment strategy for Financial Instruments for SME financing that would use the European Structural and Investment Funds, and more specifically ERDF resources157. This analysis also draws from the experience of the current use of the Financial Instruments already in place in Malta.

The analysis conducted in the present study revealed that the Maltese economy remained resilient during the crisis and that SMEs have largely contributed to this resilience. This resilience is also mainly attributable to the strength of the domestic banking system, the intervention of Government, which provided temporary assistance to companies engaged in the manufacturing and tourism sectors (these industries were mostly impacted by the financial crisis in Malta). It has to be noted however that this resilience also derives from the fact that the Maltese economy and especially SMEs do not have a tradition of exporting activities and thus are more protected from shocks in the external environment.

In the current environment, characterised by reduced availability of credit and tighter lending standards, the financing needs of SMEs, especially micro-enterprises,

157 Financial Instruments are one of the solutions to reduce the identified financing gaps and need to be considered in a complementary manner with other financing tools, such as grants. The latter may be of particular interest for instance in the case of R&D financing or financing support to financial intermediaries or final beneficiaries for capacity building.

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have to be given specific attention. The tightening of credit standards across the EU has impacted SMEs in all Member States; however, Maltese SMEs were impacted to a lesser extent. This is mostly related to the fact that banking financing is only available to those SMEs with sufficient assets while other companies have learned to rely on informal sources of financing. It is important to mention that while lending to SMEs decreased in 2013158 during the first 6 month lending increased substantially and is expected to continue during the next month.

SMEs represent almost the entire population of enterprises in Malta (99.8%). They also account for 78.6% of the total national employment. Among the total population of SMEs, 95.1% are micro-enterprises. These micro-enterprises represent 32.3% of the overall employment which is above the EU average. Meanwhile, the numbers of SMEs tend to remain stable while the number of 0 employee companies is in constant increase since 2009. According to these trends, SMEs in Malta seem to be adapting to their environment irrespective of whether they have access to the banking system or not. Micro-enterprises are the companies that face the main difficulties accessing finance due to their lack of collateral, credit history and technical expertise in seeking and negotiating with financial institutions. Many micro-enterprise owners consequently have to rely on informal sources for collateral or also financing. Larger companies do not encounter particular difficulties to receive financing.

The analysis also highlighted the public Financial Instruments that have contributed, and keep contributing, to the improvement of SMEs’ access to finance in Malta. These Financial Instruments only partially cover the scope of current SMEs’ needs and allow room for improvement. There seems to be a focus on guarantees which are very relevant to the needs of SMEs but the awareness of their existence is still limited and their visibility needs to be enhanced. The analysis also highlighted that networks and relationships between actors in the country need to be set up and/or strengthened so as to propose a more efficient and comprehensive support grid to SMEs. These networks are meant to communicate and inform existing and newly created SMEs about the existing financing products available and the Financial Instruments at their disposal in Malta. However, the information is not always clearly diffused among SMEs.

Overall, the existing Financial Instruments supported by public interventions have positively impacted the financing conditions and environment of the national market thanks to the development and promotion of guarantee products and loans.

The present study concludes that the positive impact of existing Financial Instruments could be increased with the use of ESI Funds into existing or new

158 CBM Annual Report, 2013.

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Financial Instruments. This use would enable the development of financing products currently not available to SMEs, such as microfinance products, and support the structuring of an equity market that would invest in local SMEs in view of supporting their development and favouring innovation.

The following paragraphs summarise the findings and conclusions per financial product, lessons learned from prior use of Financial Instruments and present recommendations for the formulation of a future investment strategy.

a) Microfinance Demand for microfinance covers both existing SMEs and people currently unemployed and/or at risk of poverty who see themselves as potential business creators if their access to finance was facilitated (financial inclusion).

In the case of Malta, the potential financing gap for microfinance for existing micro- enterprises in 2014 ranges between EUR 108m and EUR 120m. Concerning microfinance for financial inclusion, a gap has been estimated of EUR 6m.

On this basis, a total financing gap for microfinance may be considered between EUR 114m and EUR 126m. As already mentioned, the microfinance financing gap may be explained by the lack of a supply market and the unclear definition of microfinance for micro-enterprises, despite there being a clear need for short-term financing for these companies and financing support for business creation. Table 42: Potential financing gap for microfinance for micro-enterprises in 2014, including financial inclusion

Financing gap for existing Financing gap for Total financing gap for

micro-enterprises (mEUR) financial inclusion (mEUR) microfinance (mEUR)

Microfinance 108 - 120 6 114 - 126

Source: PwC analysis, 2014. See Boxes 1 and 2 for detailed descriptions of the methodology.

b) Short-term loans, overdrafts and credit lines SMEs of all sizes have needs for working capital financing in Malta. On the supply side, the analysis has highlighted that commercial banks do not face liquidity issues but still apply higher than average interest rates on SME loans. These higher interest rates illustrate a conservative approach toward financing SMEs of commercial banks. According to the stakeholders interviewed most of Maltese SMEs are under- capitalised when compared to their EU counter-parts.

On the demand side, the analysis indicates that SMEs give particular prominence to the availability of working capital to manage their day-to-day business activities.

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The study reveals viable financing gaps for short-term loans for micro-enterprises, but not for small and medium-sized companies, as illustrated in the table below. Table 43: Viable financing gaps for short-term loans, overdrafts and credit lines in 2014

Viable financing gap Viable financing gap for Viable financing gap for micro-enterprises small and medium-sized for SMEs (mEUR) (mEUR) enterprises (mEUR)

Short-term loans, bank 21 - 23 - 21 - 23 overdrafts and credit lines

Source: PwC analysis, 2014. See Boxes 1 and 2 for detailed descriptions of the methodology.

VFGs indicated in the table above indicate that the financing market falls short when it comes to assisting micro-enterprises. This is mainly because micro-enterprises pose higher risks. Stakeholder interviews indicated that over the past few years very few business start-ups were approaching banks for financing and preferred seeking financing from more informal sources and often start their activities under- capitalised. It appears that commercial banks are catering for larger SMEs and many of their clients are well-established, have credit history and can provide collateral.

c) Medium and long-term loans All sizes of SMEs use medium and long-term debt financing in Malta. These loans are sought to finance investment and business expansion and are crucial for the enterprises’ future development and sustainability. In the short run, micro, small and medium-sized companies intend to continue investing in their equipment and machinery as well as launch new activities.

Viable financing gaps were calculated and are presented in the table below. Table 44: Viable financing gaps for medium and long-term loans in 2014

Viable financing gap for Viable financing gap for Viable financing gap small and medium-sized micro-enterprises (mEUR) for SMEs (mEUR) enterprises (mEUR)

Medium and long- 37 - 41 - 37 - 41 term loans

Source: PwC analysis, 2014. See Boxes 1 and 2 for detailed descriptions of the methodology.

Table 44 presents a viable financing gap for medium and long-term debt. As is the case for short-term loans, one notes that the VFG arises mainly from the reluctance of the banking sector to support micro-enterprises. Likewise, demand side constraints primarily concern micro-enterprises, which have difficulties to meet the collateral requirements and also find it complicated to apply for loan financing. Bridging this gap would foster investment and job creation in Malta.

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d) Equity The financing gap for equity financing in Malta results from the lack of local investment from investment funds located in the country and from the lack of knowledge of the smaller SMEs of the functioning and purposes of equity financing.

A potential financing gap was calculated for equity financing for all SMEs in Malta, and needs to be taken indicative only for reasons explained previously. The table below presents the financing gap for 2014. Table 45: Potential financing gap for equity financing for all SMEs in 2014

Financing gap for equity financing (mEUR)

Equity financing 35 - 174

Source: PwC analysis, 2014. See Boxes 1 and 2 for detailed descriptions of the methodology.

The analysis conducted in the present AFMA study highlighted that equity financing should be considered as key for the support of SMEs in their future access to finance in view of supporting their growth strategies. However, in the design of any FI, consideration needs to be given to the presence of a sufficient critical mass in demand from specific targets for equity investment, their attractiveness to private investors and the ability of the financial intermediary to leverage existing networks and stakeholders (incubators, Chamber of Commerce) to facilitate matchmaking and provide mentoring and support to SMEs in the country. Especially the last point has to be highlighted as a growing equity market does not solely depend on sufficient supply, but on an adequate equity environment – particularly given previous attempts which have created only limited impact in the market.

e) Lessons learned from the use of FIs in Malta Malta has a limited experience in the use of FIs and as a result also SMEs have a low awareness of the benefits of FIs. Even though legislation regulating the provision of FIs by the State has been in place since the 1990s FIs have only been used in in recent years. The EU-funded JEREMIE guarantee Financial Instrument became available in Malta in 2011 and in 2013 another guarantee instrument, the Guarantee Facility under the CIP (supporting the BoV Start Plus loan product) was also introduced. The JEREMIE initiative has proven to be successful as it was well marketed and appropriately targeted at different sectors. Also it is important to note that despite the limited experience of micro-enterprises with the banking system, they received the majority of guarantees, thus generating genuine additionality.

Throughout the AFMA report, the existing FIs are analysed and lessons learnt are being highlighted through information provided by interviews and desk research. A summary of lessons learnt from the use of FIs is provided below:

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• The JEREMIE initiative in Malta provided funding assistance to a number of SMEs in various sectors. Sectors dominating Malta’s economy such as wholesale and retail, accommodation and food service activities and the manufacturing industry accounted for 67% of the total sanctioned amount of loans159.

• The financial intermediary BoV allocated substantial resources to ensure the successful implementation of the guarantee scheme and the achievement of the agreed targets. The financial intermediary also brought in a good knowledge of the SME lending market and targeted industries and was equipped with a good understanding of EU rules. In fact, BoV making use of JASMINE and using Technical Assistance to maximise its success, can be seen as a good practice example of how technical assistance supports intermediaries in branching out into new Financial Instruments/markets.

• In addition, with the help of the EU Research department, the financial intermediary made various efforts to implement its communication strategy. This involved the organisation of over 40 information sessions with SMEs and stakeholders, the printing of brochures, several one-to-one meetings, phone enquiries, billboards and television adverts which enabled them to reach many SMEs160.

• A number of EU funded Financial Instruments (JEREMIE, JASMINE and CIP) were implemented through a single financial intermediary, which has its disadvantages. Since Maltese entrepreneurs like to retain the relationship with a particular bank or bank manager, the need to switch banks may have been an obstacle to being able to benefit from the JEREMIE initiative. With more than one financial intermediary offering funds to SMEs there could have been a greater outreach to SMEs across Malta and Gozo. Given experience in the JEREMIE Call for Expression of Interest, other good quality institutions may be willing to engage with FIs.

• The use of many intermediaries, especially concerning guarantee schemes has proved elsewhere to increase awareness for the use of FIs and the competition between the intermediaries often improves the overall lending conditions for SMEs. Nevertheless, the unsuccessful cooperation of Malta Enterprise and the European Commission's Multiannual Programme for Enterprise has to be taken into account when designing new schemes.

159 Bank of Valletta presentation – The JEREMIE Initiative in Malta. 160 Research paper – JEREMIE – Joint European Resources for Micro to Medium Enterprises.

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• The current JEREMIE initiative focuses mainly on capital investment and does not provide for working capital loans. The most popular financing product among SMEs in Malta is the use of short-term loans and overdrafts to finance their working capital needs. In fact the BOV Start Plus loan product, which benefits from a more recent guarantee programme undertaken by BOV and financed through the CIP, supports capital investment and working capital directly related to a capital investment project. This initiative is however only available to start-up micro-enterprises and is not available to established SMEs.

• Equity financing in Malta is almost non-existent. Despite the substantial inflow of FDI in the country and despite the fact that a number of initiatives were introduced to try boost the equity funding culture, these have not been able to motivate private investors to support SMEs in Malta.

• The concept of microfinance in Malta is non-existent. This is due to the lack of microfinance institutions. As a result, there is a perception in the market that microfinance is similar to microcredit provided by banks, which tend to be standard bank loans and not necessarily capped at EUR 25,000. Any new microfinance initiative should ensure that the distinction is clearly articulated.

• A lack of training and technical skills of entrepreneurs and employees in general has also been identified, causing concerns about the level of technical knowledge that these new business owners will have. While some FIs in access to finance are being implemented, none to date have been used for training and mentoring purposes in order to support more technical aspects of running a business like creating a business plan, or applying and negotiating with financial institutions.

Below, a non-exhaustive SWOT analysis (Strengths, Weaknesses, Opportunities and Threats) is provided regarding access to finance for SMEs as a general overview leading to the recommendations provided in the next section.

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Table 46: SWOT analysis regarding access to financing for SMEs in Malta

Strengths Weaknesses Opportunities Threats Commercial  Strong presence of  Conservative approach toward  Stable economic  Instability of the financial system banks commercial banks SMEs and especially micro- outlook for the in Europe in the country enterprises. future161  Rising levels of NPLs mainly in the  Liquidity and  Relatively high interest rates  Increasing use of construction and real estate solvency are well FIs sectors above current  New programming  Overreliance on real estate regulatory period providing market requirements new opportunities  The implementation of the new  Well diversified asset for the use of FIs CRD IV/CRR Framework (Basel holding through banks III) (limitations to support SMEs)  Reliance on  Even for banks with large domestic financing market share, the total scope of avoiding exposure SME finance needs may not to external shocks provide sufficient critical mass on financial markets for some instruments.  Poor credit history among SMEs and especially micro-enterprises  High indebtedness of those SMEs that have access to finance  Lack of technical skills of business owners to apply for banking products and present business plans  Saturated economy. Further economic development highly dependent on SMEs’ ability to engage in export activities

161 Eurostat European Economic Forecast Spring 2014.

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Strengths Weaknesses Opportunities Threats Equity  Strong regulatory  Negligible presence of venture  The Alternative List  Limited technical skills of SME investors framework within capital and Business Angel market where owners to interact with equity the financial networks in Malta companies can funds services sector  Size and nature of the local have limited  Many SMEs are family owned  Strong presence of market is not conducive to trading history and by nature averse to investment fund attracting an adequate deal  The new external equity investors managers, flow for VC programming  Low level of innovation in the administrators and  No interest from investment period and country other professional funds domiciled in Malta in opportunities for  Limited technical skills of services firms, investing locally introducing FIs investors for dealing with although they are  Illiquid stock market related to equity Maltese SMEs. not focused on VC investors  Momentum associated with the creation of TAKEOFF + Microsoft Innovation Centre+ BioMalta Life Sciences Park Financial  Success of JEREMIE  Low awareness of FIs among  New EU regulation  Limited technical skills of SME Instruments  Malta Enterprise has SMEs promoting the use owners and knowledge to apply a track record in  Negligible FIs for non-bankable of FIs for such instruments designing recycling SMEs  Willingness of the  No interest by equity investors to forms of financing  Publicly funded FIs limited to a country to invest locally single financial intermediary promote the use of  Non-existence of microfinance  Poor diversity of FIs. Existing FIs FIs institutions adapted to the banking sector  Continued  Confusing perception of exploitation of BOV microfinance in the market Start Plus for micro-  Lack of technical skills of enterprises business owners to apply for  Strong banking financing products and present sector business plans

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Strengths Weaknesses Opportunities Threats SMEs  Resilience of SMEs  Limited technical skills of SME  New EU regulation  Scarcity of skilled labour force in during the crisis owners promoting the use certain sectors  SME sector  Weak credit history of FIs  Decline in SME investment expanded over the  Weak export tradition in the  New programming appetite over the last couple of past five years in country period years number of firms and  Lack of customised FIs (to  Lack of interest from equity 162 employees different SME sizes, different investors in the local market  Relatively high development stages and success rates in various needs) obtaining finance  High indebtedness of companies those companies that have access to finance

162 SBA Fact Sheet Malta, 2013.

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8.5 Recommendations The use of Financial Instruments is relatively recent in Malta. In recent years some initiatives to implement FIs and support business enterprises through loan guarantees and direct loans have been introduced, primarily though Malta Enterprise and JEREMIE.

However, the specific nature of the Maltese economy and more specifically the dominance of the banking sector have created some limitations to the use of FIs that need to be overcome.

The key recommendations from the analysis conducted in the present AFMA report are detailed below: a. Support and expand the implementation of JEREMIE or similar instruments. The implementation of the JEREMIE guarantee instrument during the 2007-2013 programming period was successful and demand for the product will continue. It stands to reason that this instrument should be further supported during the upcoming EU programming period.

The Managing Authority should consider expanding, the allocation of EU funds for the next programming period towards this instrument, given that the new instrument would span the full duration of the programming period. The JEREMIE initiative could also implement other instruments in the forms of risk sharing facilities and equity instruments, subject to further investigation and the prerequisites mentioned in Recommendation e). Especially the latter could motivate investors, help generate demand and help build an equity ecosystem over time, although the small size Maltese business base will continue to be a limiting factor. Within JEREMIE, there could be more need specific instruments rather than the generic guarantee instrument offered today. Such instruments would cater for specific needs of specific companies like start-up or micro- enterprises and would increase awareness of the use of FIs but increase the

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perception that FIs are relevant to all SMES and not only those that already have access to finance.

In implementing JEREMIE instruments going forward, it is also important to consider appointing more than one financial intermediary, recognising that a certain critical mass will be required for each, particularly for low-leverage instruments such as risk sharing loans or equity. This approach is likely to allow a much deeper penetration amongst SMEs who may have been reluctant in the previous period to consider JEREMIE, given their existing banking customer relationship. b. Consider developing specific guarantee instruments or complementing the existing instruments to facilitate access to short-term debt for working capital purposes and long-term debt for investment purposes. The analysis conducted for the present report has revealed that financing gaps exist for short-term and medium and long-term loans for micro-enterprises. Moreover it was established that an increasing need for working capital financing is appearing in the market. The main barrier for the access to debt financing for SMEs, especially micro-enterprises, is related to the collateral requirements imposed by commercial banks locally. The analysis for this study has identified that micro-companies have a greater need to seek funding especially for financing working capital. Taking into account the lack of microfinance institutions in the country, Financial Instruments in the form of guarantees and other risk-mitigation products to support micro-enterprises without collateral could be developed or could complement existing guarantee products. c. Consider the introduction of a risk sharing loan facility. Besides the need for guarantee schemes and collateral support, Maltese SMEs could also benefit from a Financial Instrument which would target a reduction in the cost of lending. It was highlighted in the analysis that interest rates, including bank charges and fees in Malta are high thus affecting the overall cost of financing. With the introduction of a risk sharing loan facility, for example, SMEs and especially small and medium-sized companies willing to expand, could benefit from reduced interest rates.

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properties, as collateral. The promotion of a microfinance facility provided by a non-banking institution, to support existing and potential entrepreneurs should be considered. In lack of such a specialised institution, the provision of (collateral- free) microfinance through a risk sharing scheme with commercial banks could also be considered. e. Create the conditions for the development of an environment that will support equity financing and an active Business Angel community. The equity market and business angel environment in Malta have a very weak presence. Early-stage investments in the technology and knowledge-based sectors in Malta are scarcely financed. The investment gap is particularly apparent for companies in their start-up phase, where risk and uncertainty are at their highest.

However, in the design of any FI, priority should be given to develop an adequate business environment as an efficient equity market does not solely depend on sufficient supply – particularly given previous attempts in Malta which have created only limited impact in the market. An experienced approach combing knowledge and reputation of JEREMIE might create the necessary synergies and confidence among stakeholders to develop the equity market. f. Consider an appropriate combination of grants and FIs for investment purposes or mentoring and training support to SMEs. Malta has implemented several grant programmes in recent years that have proved successful. A combination of grants and FIs for investment purposes could help SMEs complement their financing with banking loans and facilitate the implementation of their business plans. A combination of grants and FIs could also be envisaged in initiatives to mentor SME owners. It has been mentioned in the analysis that SMEs do not have experience in negotiating with financial institutions and in preparing business plans. Mentoring initiatives would support SMEs in applying to banks but also to grant programmes. When setting up such initiatives it is vital to keep the balance between tailoring them to the needs of

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SMEs and maintaining a scope sufficiently broad to ensure a reasonable take- up. As illustrated by several unsuccessful grant schemes in the programming period 2007-2013 (e.g. on vocational training of farmers or development of new farming products), too specific a programme, however well-meaning, may be inefficient, with only a handful (if any) SMEs using it.

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Annexes

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Annex 1 – Article 37 (2 and 3) of the Common Provisions Regulation n°1303/2013 adopted on 17 December 2013163

Support of Financial Instruments shall be based on an ex-ante assessment which has established evidence of market failures or sub-optimal investment situations, and the estimated level and scope of public investment needs, including types of Financial Instruments to be supported. Such ex ante assessment shall include:

(a) An analysis of market failures, suboptimal investment situations, and investment needs for policy areas and thematic objectives or investment priorities to be addressed with a view to contribute to the achievement of specific objectives set out under a priority and to be supported through Financial Instruments. This analysis shall be based on available good practice methodology;

(b) An assessment of the value added of the Financial Instruments considered to be supported by the European Structural and Investment Funds, consistency with other forms of public assistance addressing the same market, possible State Aid implications, the proportionality of the envisaged assistance and measures to minimise market distortion;

(c) An estimate of additional public and private resources to be potentially raised by the Financial Instrument down to the level of the final recipient (expected leverage effect), including as appropriate an assessment of the need for, and level of, preferential remuneration to attract counterpart resources from private investors and/or a description of the mechanisms which will be used to establish the need for, and extent of, such preferential remuneration, such as a competitive or appropriately independent assessment process;

(d) An assessment of lessons learnt from similar instruments and ex-ante assessments carried out by the Member State in the past, and how these lessons will be applied in the future;

(e) The proposed investment strategy, including an examination of options for implementation arrangements within the meaning of Article 38, financial products to be offered, final recipients targeted, envisaged combination with grant support as appropriate;

163 The present AFMA study is addressing point (a) and an assessment of lessons learned from similar instruments in the country as per (d).

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f) A specification of the expected results and how the Financial Instrument concerned is expected to contribute to the achievement of the specific objectives set out under the relevant priority including indicators for that contribution;

(g) Provisions allowing for the ex-ante assessment to be reviewed and updated as required during the implementation of any Financial Instrument which has been implemented based upon such assessment, where during the implementation phase, the managing authority considers that the ex-ante assessment may no longer accurately represent the market conditions existing at the time of implementation.

The ex-ante assessment may be performed in stages. It shall, in any event, be completed before the managing authority decides to make programme contributions to a Financial Instrument.

The summary findings and conclusions of ex-ante assessments in relation to Financial Instruments shall be published within three months from their date of finalisation.

The ex-ante assessment shall be submitted to the monitoring committee for information purposes in accordance with Fund-specific rules.

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Annex 2 – Note on the sampling methodology of the online survey The online survey was been conducted in Malta, where 40,573 SMEs are operating (National Statistical Office, as per requested information in August 2014).

The SME population in Malta was defined and stratified on the basis of three dimensions: • Sectors, using the NACE rev.2 classification; • Location, using the 2 macro-regions in Malta (NUTS level 3); • Size of companies (micro, small, medium-sized), using NSO figures as per requested information due to unavailability of public data. The most updated NSO figures of the SME population for 2012 were obtained in August 2014.

Starting from this stratification, a suitable sample of the SMEs in Malta was by using the member databases of the Malta Chamber of Commerce, the Enterprise and Industry and of the General Retailers and Traders Union (GRTU) and beneficiaries of grant schemes (funded by the EU) that were administered by Malta Enterprise (ME), the Tourism and Sustainable Development Unit (TSDU) and the Department for Social Welfare Standards (DSWS). A total of 11,000 invitations to participate in the survey were sent and 271 companies provided valid responses, in line with expectations for an online B2B survey.

The questionnaire used for the online survey included 22 questions and is presented in Annex 8. The survey was sent out on 22nd May 2014 and closed on 09th July 2014.

Responses were monitored and the survey was closed when the respondent population had achieved a representation of each stratum, based on the three dimensions, with a sufficient degree of freedom to implement a relevant statistical analysis.

Table 47 below provides a detailed description of the stratification with: • The number of SMEs per size of enterprise, per region and per sector at the national level; along with the related percentage compared to the total SME population in Malta. • The number of SMEs that answered the online survey (respondents) per size of enterprise, per region and per sector. The related percentages are also provided.

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Table 47: Stratification of respondents to the online survey for AFMA in Malta compared to the population of SMEs in the country

SME population in Malta Respondents

Number Percentage Number Percentage Size of enterprise Micro-enterprises 38,592 95.1% 126 58.1% Small enterprises 1,615 4.0% 50 23.0% Medium-sized enterprises 366 0.9% 41 18.9%

Region Malta 37,684 92.9% 198 91.2% Gozo 2,889 7.1% 19 8.8%

Sector

A AGRICULTURE, FORESTRY AND FISHING 2,889 7.1% 3 1.4% B MINING AND QUARRYING 54 0.1% 0 0.0% C MANUFACTURING 2,526 6.2% 40 18.4% D ELECTRICITY,GAS,STEAM AND AIR CONDITIONING SUPPLY 171 0.0% 4 1.8% E WATER SUPPLY; SEWERAGE, WASTE MANAGEMENT AND REMEDIATION ACTIVITIES 4,416 0.4% 1 0.5% F CONSTRUCTION 10,550 10.9% 10 4.6% G WHOLESALE AND RETAIL TRADE;REPAIR OF MOTOR VEHICLES AND MOTORCYCLES 1,645 26.0% 34 15.7% H TRANSPORTATION AND STORAGE 2,508 4.1% 6 2.8% I ACCOMMODATION AND FOOD SERVICE ACTIVITIES 1,253 6.2% 20 9.2% J INFORMATION AND COMMUNICATION 1,448 3.1% 8 3.7% K: FINANCIAL SERVICES AND INSURANCE COMAPNIES 1,773 3.6% 13 6.0% L REAL ESTATE ACTIVITIES 3,964 4.4% 5 2.3% M PROFESSIONAL, SCIENTIFIC AND TECHNICAL ACTIVITIES 1,831 9.8% 12 5.5% N ADMINISTRATIVE AND SUPPORT SERVICE ACTIVITIES 2,889 4.5% 5 2.3% P EDUCATION 985 2.4% 13 6.0% Q HUMAN HEALTH AND SOCIAL WORK ACTIVITIES 934 2.3% 6 2.8% R ARTS, ENTERTAINMENT AND RECREATION 1,321 3.3% 9 4.1% S OTHER SERVICE ACTIVITIES 2,303 5.7% 26 12.0% T ACTIVITIES OF HOUSEHOLDS AS EMPLOYERS; UNDIFFERENTIATED GOODS AND SERVICES PRODUCING ACTIVITIES OF HOUSEHOLDS FOR OWN USE 2 0.0% - 0.0% U ACTIVITIES OF EXTRATERRITORIAL ORGANISATIONS AND BODIES 0 0.0% 2 0.9%

Source: National Statistics Office, PwC analysis, 2014.

The distribution of respondents by sector and location is closely aligned with the total population. For the size categories, it was more important to obtain sufficient responses by category size than to match the population, because these categories are examined separately in the analysis.

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Annex 3 – Bibliography

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 MFSA (2002). Policy Document on the Regulatory Provisions for the Undertaking of Lending Activities by Institutions Authorized under the Financial Institutions Act 1994.

 MFSA (2012). Annual Report.

 MFSA (2013). Annual Report.

 Malta Microfinance website. [Online] Available from: http://www.maltamicrofinance.com/

 Malta Today (2014). Maltese Banks Charging High Interest Rates on Lending. [Online] Available from: http://www.maltatoday.com.mt/news/national/33286/maltese-banks-charging-high-interest-rates- on-lending-20140120#.U_xVv_m1ZcQ

 National Statistics Office. Labour Force Survey: Q4/2009. [Online] Available from: http://www.nso.gov.mt/statdoc/document_view.aspx?id=2686&allEditions=true

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 National Statistics Office (2010). Access to Finance 2007-2010. [Online] Available from: http://www.nso.gov.mt/statdoc/document_file.aspx?id=3103

 National Statistics Office (2012). Census of Population and Housing, Preliminary Report. [Online] Available from: http://www.nso.gov.mt/statdoc/document_file.aspx?id=3424

 National Statistics Office (2011). Research and Development in Malta: 2009-2011. [Online] Available from: http://www.nso.gov.mt/statdoc/document_view.aspx?id=3575

 National Statistics Office (2013) Registered Unemployed.

 National Statistics Office (2013). Malta in Figures, Publication. [Online] Available from: http://www.nso.gov.mt/statdoc/document_view.aspx?id=3640

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 National Statistics Office (2014) Business Demographics 2008-2013. [Online] Available from: http://www.nso.gov.mt/statdoc/document_view.aspx?id=3769

 National Statistics Office (2014). Number of Enterprises in Malta.

 National Statistics Office (2013). Gross Domestic Product as published in News Release No. 110.

 National Statistics Office (2014). Direct Investment in Malta and abroad January-June 2013.

 North East Access to Finance (2012). [Online] Available from: http://www.nea2fguide.co.uk/wp-content/uploads/2012/11/NEA2F-Guide-Funding-Ladder-for - illustrative-purposes.pdf.

 Operational Programme I Cohesion Policy 2007-2013 (2013). Investing in Competitiveness for a Better Quality of Life. [Online] Available from: http://eufunds.gov.mt/en/Operational%20Programmes/Structural%20Funds%20and%20Cohesion%2 0Fund%202007%202013/Operational%20Programme%20I%20- %20Priority%20Axis/Documents/Operational%20Programme%20I%20-%20March%202014.pdf

 Operational Programme I 2014-2020 Public Consultation Document on the Programming of European Funds for Malta (2014). Fostering a competitive and sustainable economy to meet our challenges.

 Operational Programme II 2014-2020 Public Consultation Document on the Programming of European Funds for Malta (2014). Investing in Human Capital to Create More Opportunities and Promote the Wellbeing of Society.

 Pharmaceutical-technology.com (2014). BioMalta Life Sciences Park, San Gwann. [Online] Available from: http://www.pharmaceutical-technology.com/projects/biomalta-life-sciences-park/

 Planning and Priorities Coordination Division (2014). List of Aid Schemes of EU Funding through Structural Funds for OPI. [Online] Available from: https://eufunds.gov.mt/en/Operational%20Programmes/Operational%20Programme%20I%20Appro ved%20Projects%20and%20Beneficiaries/Documents/Approved%20Projects%202014/Approved%20S chemes_OPI%2031.07.2014.pdf

 Planning and Priorities Coordination Division (2014). List of Aid Schemes of EU Funding through Structural Funds for OPII. [Online] Available from: https://eufunds.gov.mt/en/Operational%20Programmes/Operational%20Programme%20II%20Appro ved%20Projects%20and%20Beneficiaries/Documents/Approved%20Projects%202014/OP%20II%20Sc hemes_30_06_2014.pdf

 PPCD Annual Implementation Report 2013, June 2014 (OPI). [Online] Available from: https://eufunds.gov.mt/en/Operational%20Programmes/Monitoring%20Committees/Documents/M C.OPI.06.14%20Presentation_on_Annual_Implementation_Report.pdf

 PPCD Annual Implementation Report 2013, May 2014 (OPII). [Online] Available from: https://eufunds.gov.mt/en/Operational%20Programmes/Monitoring%20Committees/Documents/Pr esentation%20on%20Annual%20Implementation%20Report.pdf

 SANT, (2014) Research paper (2014) – JEREMIE – Joint European Resources for Micro to Medium Enterprises.

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 Rural Development Programme for Malta 2007-2013. [Online] Available from: https://secure2.gov.mt/mrra-ma/downloads-links

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 Think Small First - A Small Business Act for Europe (COM (2008) 394 of 23.6.2008).  The Malta Independent (2013). Three payday loan companies licensed in Malta. [Online] Available from: http://www.independent.com.mt/articles/2013-10-12/news/three-payday-loans-companies- licensed-in-malta-2860482564/

 Times of Malta (2012). ‘Development Bank is Essential for Malta’. [Online] Available from: http://www.timesofmalta.com/articles/view/20121215/local/-Development-bank-is-essential-for- Malta-.449618

 Times of Malta (2009). Some realities on microfinance. [Online] Available from: http://www.timesofmalta.com/articles/view/20091104/opinion/some-realities-on- microfinance.280200

 Times of Malta (2014). Factor It In. [Online] Available from: http://www.timesofmalta.com/articles/view/20120314/business-news/Factor-it-in.411104

 Times of Malta (2014). GRTU in defense of cheaper financing for small businesses.

 Times of Malta (2013). Malta’s private debt: a cause for concern? [Online] Available from: http://www.timesofmalta.com/articles/view/20131212/business-comment/Malta-s-private-debt-a- cause-for-concern-.498688

 Times of Malta (2014). MCST launches R&I programme. [Online] Available from: http://www.timesofmalta.com/articles/view/20140615/business-news/MCST-launches-R-I- programme.523482

 World Bank (2014). Doing business report 2014. [Online] Available from: http://www.doingbusiness.org/~/media/GIAWB/Doing%20Business/Documents/Annual- reports/English/DB14-Full-Report.pdf

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Annex 4 – Detailed analysis of the market environment of Malta This section presents the market environment for Maltese SMEs. Insights provided by the online survey complement the existing data. Over the last few years, despite the turbulence experienced in the global and European economic environment, Malta has consistently maintained a degree of stability and avoided many of the difficulties experienced by some other EU Member States. The continuous efforts of government and policy makers to keep up this performance have resulted in the maintenance of positive conditions within the economic market. Nonetheless, SMEs are still exposed to several challenging factors, including demographics - such as an ageing population and low participation rate of women in the labour force - and market conditions – such as GDP growth, volatility of interest rates and inflation - that impact their growth perspectives. These elements are analysed in the sections below.

Characteristics of the economy and demographics Important indicators such as Gross Domestic Product (GDP), GDP growth rate, inflation rate, and political and regulatory matters (e.g. fiscal conditions and tax policies), which for the most part define existing market conditions (e.g. investments, consumption and export growth) ultimately affect the overall profitability of SMEs. Furthermore, social indicators and conditions (e.g. the quality and cost of human resources) and the overall outlook of the demographics also remain crucial components of Maltese SMEs’ competitiveness. Malta’s map and key figures are shown in Table 48 below.

Table 48: Malta – Map and key figures

Indicator Value Date

Population 421,364 2012

GDP EUR 6.8bn 2012

Real GDP 0.9% / 2.4% 2012 / 2013 growth

Inflation 2.8% / 1.0% 2012 / 2013

Employed 172,701 2012 population

Source: NSO Malta in Figures 2013, CBM 2013 annual report.

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a) Economic and political overview of Malta Since the country joined the European Union in 2004, and despite the still fragile external environment, the Maltese economy has outperformed the Eurozone average in recent years. Real GDP growth accelerated to 2.4% during 2013, from 0.9% in the previous year (Eurostat, 2014). One of the critical success factors of Malta is its ability to attract Foreign Direct Investment (FDI) in specific sectors. Recent regulatory frameworks implemented in the country continue to improve the local business environment, especially within the gaming, financial services and ICT sectors. However, the Eurozone’s unstable economic situation, and the political situation in neighbouring North African countries continues to create uncertainty on the ability of Malta to thrive. Special attention is therefore made to monitor external market conditions.

Political Context As a republic and full Member State of the EU, Malta enjoys political stability at both a national and international level. The Maltese government is democratically elected for a 5-year mandate whereby last elections were held in 2013 and the coming elections to be held in 2018. There are two principal political movements on the island, the Centre Right Nationalist Party and the Centre Left, the New Labour movement. Malta enjoys well-established relations with European countries and, due to its geographical location, also has good relations with countries in the Middle-East and North Africa.

Macroeconomic overview Over the period 2005-2008, before the peak of the global crisis, the Maltese economy reported considerable progress and sustained positive real GDP growth rates, ranging from 2.6% to a record 4.1% in 2007, below those observed in Cyprus and Luxembourg, but above the EU-28 average since 2007 (Figure 43). In 2009, Malta’s real GDP contracted as a result of a substantial decrease in the manufacturing industry, and to a lesser extent in the construction, wholesale and retail, tourism and transport sectors. This is illustrated in the figure below.

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Figure 43: GDP growth rates in Malta according to Eurostat forecasts

Source: Eurostat, European Economic Forecast, Spring 2014.

Since the decline observed in 2009, the country’s economic performance experienced a sharp recovery in 2010, 2% above the EU-28 average, followed by modest growth in 2011 and 2012. 2013 has seen economic recovery, bringing growth rates to levels prior to those of the recession. This growth can be explained by household consumption coupled with a decline in import activities (Eurostat, 2014).

Real GDP growth is projected to remain largely unchanged, averaging 2.3% in 2015, converging with Luxembourg and the EU-28 average (Eurostat, 2014). Labour market participation is set to remain on an upward path, largely reflecting higher activity by women and older workers. The job market is expected to be able to fully absorb this inflow and the unemployment rate is set to decline slightly. Favourable labour market conditions and the positive impact of the announced reduction of electricity tariffs are projected to support a further improvement in household consumption.

The recovery is however to be considered rather cautiously, in an environment of higher interest rates, as compared with the Eurozone (see paragraph below on interest rates and bank lending). Improving domestic demand is expected to boost imports, but overall net exports are projected to continue to contribute positively to real GDP growth and the current account is forecast to remain in surplus over the forecast horizon.

From 3% of GDP in 2013, the budget deficit is expected to decrease to 2.7% of GDP in 2014. The 2014 budget includes mostly revenue-increasing measures, including higher indirect taxation (mainly excise duties), a new programme to grant Maltese citizenship to foreign individuals and families (against the payment of a fee and

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investments in the country) and the introduction of a new tax regime for rental income.

On the expenditure side, the budget envisages some restrictions on recruitment. Overall, the current revenue ratio is projected to increase by 0.2 percentage point of GDP, while primary current expenditure is forecast to stabilise.

Foreign Direct Investments Interviews with stakeholders revealed that throughout the past few decades, Malta has upheld a very good record in attracting foreign investors to Malta, who re-invest in their production and service facilities on the island. This has been achieved by moving from a labour-based industry towards knowledge-based, which resulted in attracting Foreign Direct Investment from countries like the UK, Germany, Italy, France, Spain and the United States. Malta’s favourable industrial climate and pro- business policies have been the basis on which foreign companies have built their success.

As at June 2013, FDI in Malta was estimated at EUR 11.4bn, with 79.1% originating from financial and insurance activities. Geographically, EU Member States were the largest contributors to Malta’s inward Foreign Direct Investment, with EUR 8.4bn, or 73.2% of total FDI (NSO, 2014).

Inflation

In 2009, the Harmonized Index of Consumer Prices (HICP) plummeted from around 4.75% to less than 2%, but showed a relative resilience to the crisis, as compared with the EU-28 average (1%) and the near-to-zero inflation observed in Cyprus and Luxembourg. In 2013, inflation for Malta came in slightly below expectations at 1% for the year as a whole, slowing down from 3.2% in 2012, 0.5 percent below the EU- 28 average, but twice as high as in Cyprus. Deceleration resulted from lower prices for services being offered by restaurants and hotels. Energy prices also declined slightly, in line with developments in international markets. This trend is illustrated in the figure below.

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Figure 44: HICP inflation for Malta including Eurostat forecasts

Source: Eurostat European Economic Forecast, Spring 2014.

In 2014, the reduction in electricity tariffs is projected to offset a rebound in services inflation and keep overall price inflation at a relatively moderate rate (by Malta's historical standards) of 1.2%. With the output gap estimated to have closed in 2014, the HICP is forecast to accelerate further to 1.9% in 2015, above the Eurozone average of 1.5% (Eurostat, 2014).

Financial sector and interest rates

The legal framework of Malta’s financial sector requires official licences from the Malta Financial Services Authority (MFSA) for any type of credit and financial activities. As a result, only legally registered institutions can provide financial services. The MFSA is the authority responsible for the licensing, regulation and supervision of credit institutions, electronic money institutions and financial institutions. It carries out its functions as the competent authority through its Banking Unit.

Credit institution licenses The banking sector in Malta consists of 26 credit institutions. Three of these institutions are owned by Maltese shareholders exclusively, while 23 institutions are foreign- owned. The number of banks setting up in Malta over the last 6 years increased from 22 to 26, representing a growth of approximately 3% (MFSA, 2013).

Credit institutions in Malta are classified as “core domestic banks”, “non-core domestic banks”, or other banks. Core domestic banks are those institutions, which have strong links with the domestic economy. These banks have a widespread branch network, provide a vast range of banking services and are core providers of credit and deposit services in Malta. These banks mainly include HSBC Bank and Bank of Valletta. The “non-core domestic banks” are institutions which have a more restricted role in the domestic economy, since the volume of operations and the

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banking services they offer to residents are limited, while other banks are those which cater for the international market.

Most credit institutions in Malta possess broad licences allowing them to engage in consumer lending, leasing, factoring and other financial services. Loans remain the most popular form of financing by SMEs in Malta, and cover the whole scope of available loan products including standard loans (short-, medium, long-term and revolving loans), bank overdrafts, credit line and conditional loans.

Most often, loan products are provided against collateral and, as a result, banks tend to design and offer asset based products such as mortgage business loans, quick loans for micro-enterprises and mortgage loans for hotel and restaurants. Bank guarantees and letters of credit are offered by most commercial banks in the country and usually take the form of payment guarantees, bid bonds, performance bonds and advance payment guarantees. These products are however rarely used by SMEs.

Factoring products are mostly provided by commercial banks. Types of factoring products include factoring with recourse, which is the financing of current operational needs of a company, based on the credit sales of the company without the need of any collateral and factoring without recourse - protection of credit sales along with the collection and management of the underlying receivables. Also, in this case no collateral is required. Export and import factoring are two other financial products offered by commercial banks where collection is carried out by a correspondent factoring company in the country of the importer / exporter. Import factoring is rarely provided by financial intermediaries in Malta164.

Legislation allows leasing facilities to be provided by commercial banks through their branches or specialised subsidiaries. Alternatively, legislation also allows financial intermediaries in Malta to offer leasing products, including financial leasing products, operational leasing and fleet management (a leasing product used for transportation and logistics companies that have large fleets of motor vehicles).

According to stakeholders interviewed, leasing and hire purchase facilities have become more popular among SMEs over the past few years, but the leasing is predominantly provided within the supply chain. No data is however available to estimate this trend165.

164 Presently the Central Bank of Malta does not collect data on the supply of factoring products in Malta from commercial banks. 165 Presently the Central Bank of Malta does not collect data on the supply of leasing products in Malta from commercial banks.

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Financial institution licenses In Malta, 28 institutions are licensed as financial institutions under the Financial Institution Act (FIA) 1994. The FIA is a law which emerged from the Banking Act. The key difference between credit and financial institutions is that a financial institution licence covers institutions that undertake certain activities but are not funded through deposits of the public. Therefore, the FIA regulates companies carrying on activities such as lending (including personal credits, mortgage credits, factoring and financing of commercial transactions), leasing, Venture Capital, money transmission services, issuing and administering means of payment (e.g. credit cards, travellers’ cheques), providing guarantees, trading for own account or for account of customers in money market instruments, underwriting and participation of share issues and money broking.

Bank lending and interest rates Despite the economic downturn, which is still being felt in many Member States of the European Union and is still having repercussions on the lending market across Europe, the Maltese banking sector remains resilient thanks to its strong capital base and bank liquidity. The World Economic Forum rated Malta’s banking sector as the 12th soundest in the world out of 144 countries, and placed Malta at number 15 for financial market development (Malta Financial Services Authority, 2012).

However, bank lending to private Non-Financial Corporations (NFCs) declined at a fast pace during 2013, falling by 4.9%, after a drop of 0.7% in 2012. The reduction in loans to private sector NFCs was broad-based, but stemmed mainly from reduced borrowings by firms in the construction and wholesale and retail trade sectors. For the first time since the onset of the global financial crisis, loans to private NFCs in Malta during the second half of 2013 contracted at a faster annual pace than in the Eurozone as a whole. Despite this development, disbursed loans in the first half of 2014 increased strongly in comparison to the same timeframe in 2013, indicating an overall increase for the year 2014.

Lending to SMEs declined by 3.1%, following an increase of 5.6% in 2012. Loans to SMEs, which have been facilitated by targeted EU loan guarantee programmes, comprised more than three-fourths of those granted to all private NFCs resident in Malta during 2013 166 . Contributions to growth in loans to private non-financial corporations are presented in Table 49 below.

166 Central Bank of Malta, Annual Report 2013.

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Table 49: Contributions to growth in loans to private non-financial corporations

All private NFCs SMEs

Dec 2012 Dec 2013 Dec 2012 Dec 2013

Accommodation and food service activities 0.2% -0.2% 0.1% 0.3%

Construction -1.8% -3.4% -0.1% -4.5% Manufacturing 0.7% -0.3% 0.5% 1.1% Real estate activities 0.1% 0.6% 3.1% -0.6% Transportation and storage -0.4% -0.4% 0.0% -0.9% Wholesale and retail trade -0.5% -1.2% 0.3% -1.5% Other 0.9% 0.1% 1.7% 3.0% Total -0.7% -4.9% 5.6% -3.1%

Source: CBM, Annual Report 2013.

In the future, Maltese banks, similar to banks in other Member States, may face tougher regulation, higher capital requirements and, perhaps, also scarcer funding. The small size of the domestic market, moreover, will require them to be more innovative, exploiting the opportunities of the Single Market and of Malta’s strategic location on the EU’s southernmost frontier. The future challenge for the banking sector is to remain competitive.

According to a presentation published by the Central Bank of Malta (CBM) in January 2014, Malta has the fifth highest rate of bank lending interests after Cyprus, Greece, Portugal and Slovenia. These interest rates may be considered as high for SMEs to get credit and expand operations. In parallel, banks have higher interest margins than the Eurozone average.

Credit growth in Malta has slowed down since the financial crisis in 2008, almost approaching the zero level in 2013 - such is the caution exercised by banks in the face of Non-Performing Loans (NPLs) and other defaulters, especially in the construction industry. In fact, according to the CBM, the construction industry suffers from the highest weighted average interest rates, followed by the real estate activities sector and the wholesale and retail sectors. In 2009, the difference in the interest rates set by the European Central Bank (ECB) and those offered by Maltese banks was 2.8%, and in 2013 this climbed to 4.8% while for countries like Luxembourg this difference has remained stable (Times of Malta, 2014)167.

The associations that provide support to SMEs and have been interviewed believe that local banks impose excessive charges and interest rates and believe that lending rates and bank charges in Malta are among the highest in the Eurozone.

167 Article in Malta Today (21 January 2014): Maltese Banks Charging High Interest Rates on Lending.

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They also commented on the high level of bank fees charged since these may discourage SMEs from seek financing (Times of Malta, 2014) 168.

Interest rates for loans up to EUR 250,000 and between EUR 0.25m and EUR 1m in the Eurozone for 2012 are shown in Figure 45. Interest rates for overdrafts in the Eurozone for 2013 are shown in Figure 46. Figure 45: Interest rates for loans up to and including EUR 0.25m and between EUR 0.25m and EUR 1m (January to July 2013)

Source: European Commission, 2013.

168 Article in Times of Malta (24 April 2014): GRTU in defense of cheaper financing for small businesses.

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Figure 46: Interest rates for overdrafts in the Eurozone in 2012 (January to September)

8 7.74 7.07 6.78 7

6 5.38 5.3 5.28 5.13 4.96 5 4.51 3.97 3.86 4 3.41 3.19 3.14 3 2.56 2.53 2.41 2.04 2

Source: European Commission, 2013.

Corporate indebtedness According to Eurostat, consolidated loans of non-financial corporations as a percentage of GDP were estimated at nearly 81.5% in Malta in 2012. Malta’s level of corporate debt was as high as in Slovenia and close to the levels of corporate debt in the Netherlands and Belgium. Even though Cyprus, Ireland and Luxembourg have higher corporate debt levels than Malta, Malta’s corporate debt level is higher than the EU-28 average of 69.4% of GDP169.

The high level of debt of non-financial corporations may have a negative impact on the capacity of the companies to further access finance. They may be restricted from further investment and instead concentrate on paying off loans170.

The Financial Stability Report Update issued by the Central Bank of Malta reported that during 2013 the total Non-Performing Loans (NPLs) ratio, as a percentage of total outstanding loans disbursed by core domestic banks, increased from 8.2% to 9%, mainly because of a deterioration in the quality of resident corporate loans (Figure 47). The ratio of NPLs from resident non-financial corporations increased from nearly 9% in 2009 to almost 16% in the first half of 2013. The construction and real estate sectors contributed to almost 50% of the rise in NPLs as a result of overvalued properties, low levels of sales and the oversupply of real estate, while the

169 Eurostat: Private debt as a percentage of GDP - consolidated - annual data. 170 Article from Times of Malta, December 2013: Malta’s private debt: a cause for concern?

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accommodation and food services sector contributed to around 25%. Despite this increasing trend, the level of NPLs compared to the total outstanding loans disbursed does not constitute an alarming factor for the Maltese economy and SMEs’ access to finance since it concerns SMEs which have access to finance and the NPL level remains at an acceptable level. Figure 47: Non-Performing Loans as a percentage of total gross loans issued by core domestic banks

Source: Central Bank of Malta, 2013.

b) Characteristics of the demographics Malta’s changing demographics have an extensive influence over most domestic social indicators, and may have an important impact on the local business environment, and the development of SMEs. The wide availability of a well- educated labour force represents a competitive advantage for the country, serving as a lever to attract investment. On the other hand, the aging population is a major cause of concern for the long-term prospects of SME development in the country.

As of 2012, Malta’s population amounted to 421,364 people (0.1% of the total EU population). Malta ranked 1st as the most densely populated country in the EU with approximately 1,333 inhabitants per square kilometre (NSO, 2012). Compared to 2011, total population in the country has increased by 0.9% (NSO, 2012). However, substantial falls in the population size are forecast by 2060 (Figure 48). According to estimations by the NSO, the population of Malta is expected to reach 429,000 persons by 2025 and down to just over 350,000 by 2060. According to such estimates, by 2060, children and youths under 20 will decrease from 90,705 to around 59,300 – a drop of 35% as a result of less births. Therefore overall it is

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envisaged that the rate of births will decrease and will not be enough to offset the number of deaths.

Figure 48: Projection of the total population of Malta in the long-term171

500 450 421 427 429 416 400 378 352 350 300 250 200

150 Ppopulation (1,000) 100 50 0 2012 2015 2025 2035 2050 2060

Source: NSO Demographic Review 2010, Census 2011.

Aging and working population

According to Eurostat data, the number of people above the age of 65 years old represented 15% of Malta’s population in 2009. In 2012, the number of people in this age group had increased from 2.2%, to 17.2% of the total population, when compared with the results for 2009. The average age of the Maltese population stood at 40.4 years, whilst in Gozo this was slightly higher at 41.7 years (NSO Census 2011, 2014).

At EU level, Malta ranks at the 17th place in terms of aging population. In 2012, the EU-27 average level of population above 65 years old was 18.2%. Furthermore, children aged 15 years old and below represented 14.6% of the total population in Malta in 2012.

The decreasing population of working age is a major cause for concern for the Maltese business environment. As at the end of 2012, the population of working age according to NSO figures included 358,785 people, or 85.2% of the total population (Labour Force survey Q4/2013, 2014). Aligned with the increasing retirement age, the working population has increased by 2.2%, in comparison with 2009 (Labour Force survey Q4/2013, 2014).

Also, Malta is still experiencing very low rates of female participation in the workforce, when compared to the rest of the EU. NSO figures show that the majority of inactive persons forming part of the working age population are females with a rate of 61.6% inactive relative to 34.7% for males. This situation also results in the fact

171 Basis: end 2010 estimates of the total population.

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that Malta lags behind the other EU Member States when it comes to women pursuing careers.

Therefore, an aging population and the result of low female participation in the workforce are tangible causes of concern for the future development of SMEs in terms of human resources availability and the potential loss of entrepreneurial talents.

Regional population distribution

Malta is composed of two islands. The main island is also called Malta while the second one is Gozo, also comprising another very small island, Comino. In 2012, approximately 7.4% of the total Maltese population resided in Gozo. Covering a land area of 67 km2, Gozo is one of the smallest NUTS III regions in Europe in terms of population size. The island is rural in character, and compared to Malta, less developed. Around one in five persons in Gozo live in Victoria. The population of Gozo has remained stable over the years. When considering land use and land cover, residential areas account for approximately 12% whilst agriculture and natural areas account for about 78% (European Commission, 2012)172. This reflects the predominance of agriculture in the Gozitan economy.

The number of inhabitants per region as at 2012 is provided in Table 50 below. Table 50: Number of inhabitants per region as of 2012

Regions Population Share (%)

Malta 389,906 92.5% Gozo and Comino 31,458 7.5%

Source: National Statistics Office, StatDB 2012.

Labour Force The labour force is one of Malta’s main competitive advantages. Malta is known for having a highly skilled labour force, together with lower average salaries when compared to many other EU Member States. Malta’s highly skilled labour pool is one of the main reasons why many foreign companies engaged in the financial services sector and other professional service lines set up their operations in Malta, thus encouraging foreign capital investment in the country. The estimated labour hourly cost for 2012 is shown in Figure 49 below.

172 European Commission report on the economic and social situation of Gozo (Malta) 19/10/2012.

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Figure 49: Estimated hourly labour cost for 2012

Source: Eurostat, 2013.

In Malta and Gozo approximately 40% of the population aged 15 and over has completed its education up to lower secondary level, while 13% have completed their education up to tertiary level. This is shown in Figure 50 below. Figure 50: Population aged 15 and over by highest level of education successfully completed, 2011

Source: NSO, Census 2011.

Following this, the Maltese workforce can be viewed as highly skilled and competent in areas such as social science, business and law, followed by health and welfare. The percentage of graduates completing their studies in these two last areas is higher than that of the EU-27 area. The percentage of tertiary education graduates by type of subjects studied is indicated in Figure 51 below.

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Figure 51: Tertiary education graduates by type of subjects studied

Source: Eurostat, 2012.

A series of policy initiatives have been introduced by the Ministry of Education to ensure high levels of education attainments of the Malta student population. These include improving literacy, providing better community access in deprived areas and providing incentives for students to stay in school longer. Furthermore, the government is introducing and widening childcare facilities to allow working mothers to enter the labour market. There are also initiatives to open schools earlier and provide support for longer hours to help working parents with childcare. There are also programmes being launched aimed at continuing to retain the existing workforce, updating their skills and increasing labour force participation. To complete these initiatives, reforms are currently under way with respect to the National Curriculum Framework, Early School Leaving Strategy and the National Literacy Strategy.

In addition, the government remains committed towards raising the number of persons in tertiary education through the development of new scholarship schemes that complement ongoing programmes. The government will also be launching a Lifelong Learning Strategy, which coupled with the ongoing and new training programmes, shall contribute towards raising the skills and competences of the labour market.

The government is also introducing changes in the tax-benefit system intended to make work pay, alongside labour activation programmes, through the launch of the Active Ageing Strategy (Economic Partnership Programme, 2013).

Overall, Malta is facing demographic challenges similar to those faced by other European Member States with an aging population. However, these challenges do not directly concern the development of local SMEs which have access to a well- educated population. In addition, Malta is a competitive and friendly destination for

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foreign businesses with its well-educated labour force and advantageous climate conditions.

Unemployment The latest Labour Force Survey estimates indicate that in 2013, total unemployed persons in Malta stood at 6.4% (12,131persons) relative to 6.5% in the fourth quarter of 2012. In 2013, out of the total unemployed of 6.4%, 27% (3,274) were between the ages of 15 and 24 and 73% (8,857) were over the age of 25. This is relative to 29.9% for those between the ages of 15 and 24 and 70.1% for those over the age of 25 years old in 2012 (Labour Force Survey, 2014).

In addition, according to NSO statistics, the total number of registered unemployed stood at 7,401 persons in 2013, compared to 6,811persons in 2012. The majority of persons registering for unemployment in 2013 were in the service workers and shop and market sales workers occupation category, which includes travel attendants, housekeep and restaurant service workers, personal care service workers, other personal services and protective services workers (21.5%), followed by clerks (17.2%), technicians and associate professionals (12%) and craft and related trade workers (12%) (NSO, Registered Unemployed, December 2013). This indicates that occupations of service workers that are of lower paying salaries are the main people suffering from unemployment in Malta.

SME characteristics and environment a) Characteristics of Maltese SMEs According to NSO statistics there were 70,538 SMEs registered in Malta in 2012 (Business Demographics 2008-2013, 2013). However, results from stakeholder interviews and data obtained from NSO show that a large percentage of the registered SMEs remain actually inactive. Therefore, of the 70,538 SMEs, 40,573 were active companies and a further 61 were classified as large implying that 99.8% of the total active companies were SMEs, of which 97.2% were micro-enterprises. Further analysis of the SME distribution by regions shows that 93% of the SMEs in the Maltese islands are concentrated in Malta, while the remaining 7% operate from Gozo (Table 51).

The business structure in Malta has remained largely unchanged until 2010. On the other hand, in 2011 the number of active SMEs declined by 1.1% and 2012 this figure further declined by 3.7%. In the meantime, new regulations173 came into force in 2011 which excludes SMEs reporting less than annual turnover of EUR 7,000 from

173 Value Added Tax Regulations, 2010 (Exemption from Registration), coming into force on 1 January 2011, as notified in the Legal Notice 524 of 2010.

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collecting VAT. Thus, this apparent decline in the number of active SMEs is not an actual decline but is the result of the abovementioned amendment174. Table 51: Absolute number of active SMEs per region across 2009 to 2012 and percentage change year-on-year

2009 2010 2011 2012 Number of Change As % of Change Number of Number of Number of Change over Number of companies over 2009- total SME over 2011- companies companies companies 2010-2011 companies 2010 population 2012 Total SME 41,910 42,609 1.6% 42,131 -1.1% 40,573 -3.7% population Malta 38,678 39,373 1.8% 38,953 -0.1% 37,684 92.9% -3.3% Gozo and 3,232 3,236 0.1% 3,178 -1.8% 2,889 7.0% -9.1% Comino

Source: NSO Malta, 2014.

The Table 52 compares the stratification of SMEs in Malta, by size, with that of the EU- 28 countries, and also compares the percentage of persons employed in each category, depending on the size of the company, with the share of EU employment. In Malta, the percentage of micro-enterprises is higher than the EU-28 average (95.1% compared with 92.2%) and this is offset by the number of small companies (4% of total companies in Malta), which is 2.5 percentage point lower than the EU-28 average. The largest share of persons within the working population in Malta is employed by micro-enterprises (32.2%), as opposed to the EU-28 share, where the majority of people are employed by companies employing 250 persons and over (32.8%). Each other company size in Malta (small, medium-sized and large enterprises) employ approximately 22% of the total workforce. As a whole, Maltese SMEs employ 79% of the total workforce in Malta. This is higher than the EU average of 67.2%, showing that SMEs in Malta employ a significant proportion of workers. It highlights the importance of this company size in terms of their contribution to economic activity and economic growth. Table 52: SME distribution by size of class of employment and number of employees175

Number of Enterprises Employed Malta and Gozo EU-28 Malta and Gozo EU-28 Number Share Share Number Share Share Micro-enterprises 38,592 95.0% 92.2% 48,102 32.3% 29.5% Small enterprises 1,615 4.0% 6.5% 32,919 22.1% 20.5%

Medium-sized enterprises 366 0.9% 1.1% 36,050 24.2% 17.1%

SMEs 40,573 99.8% 99.8% 117,089 78.6% 67.2%

174 Business Demographics: 2007-2012. 175 Data from NSO was provided for 2012.

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Number of Enterprises Employed Malta and Gozo EU-28 Malta and Gozo EU-28 Number Share Share Number Share Share Large enterprises 61 0.2% 0.2% 31,812 21.4% 32.8% Total 40,634 100% 100% 148,901 100% 100%

Source: NSO Malta, Eurostat, 2014.

When considering SME employment for each company size (NSO, 2013): • Micro-enterprises faced an overall decline in employment of 2.4% between 2009 and 2012, with the largest decline being observed in the period between 2011 and 2012; and • Small enterprises registered an increase in overall employment of 2.9% between the period 2009 till 2012, with the largest year on year increase being between 2009 and 2010; and • Medium-sized enterprises registered the highest increase in employment of the three company sizes between 2009 to 2012 with a 3.1% increase, the largest increase being between 2010 and 2011.

Table 53 presents the number of active enterprises by sector in Malta. Close to 70% of the enterprises can be classified in six sectors. The three activities with the highest number of SMEs are “Wholesale and retail trade, repair of motor vehicles and motorcycles” (26.0% of SMEs), “Construction” (10.9% of SMEs) and “Professional, scientific and technical activities” (9.8% of SMEs).

Moreover, figures presented in Table 53 show that despite having the majority of SMEs operating in the three above-mentioned sectors, this does not necessarily reflect SMEs contribution to employment. The largest numbers of employed persons by SMEs, apart from mostly being within the “wholesale and retail trade, repair of motor vehicles and motorcycles” sector, are then in the manufacturing sector and in the accommodation and food services industry. Hence, this implies that the SMEs operating in the largest sectors do not necessarily contribute towards high level of employment in these sectors.

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Table 53: Enterprise distribution by sector and number of employees

Economic activity Value added Number of Enterprises Employed (Industry sector) (mEUR) Total Total up to 9 10-49 50 - 249 % 250+ % Total Total176 % SMEs SMEs

A AGRICULTURE, 2,877 11 1 2,889 7.1% 0 3,301 2.8% 3,301 96 2.0% FORESTRY AND FISHING B MINING AND 44 10 0 54 0.1% 0 278 0.2% 278 QUARRYING C MANUFACTURING 2,262 215 50 2,527 6.2% 14 13,627 11.6% 21,695 D ELECTRICITY,GAS,STEAM AND AIR CONDITIONING 0 0 0 - 0.0% 1 - 0.0% 1,583 782177 16.2% SUPPLY E WATER SUPPLY;SEWERAGE, WASTE 162 9 0 171 0.4% 1 458 0.4% 1,520 MANAGEMENT AND REMEDIATION ACTIVITIES

F CONSTRUCTION 4,286 111 19 4,416 10.9% 2 9,053 7.7% 9,825 262 5.4%

G WHOLESALE AND RETAIL TRADE;REPAIR OF MOTOR 10,037 448 65 10,550 26.0% 3 28,799 24.6% 29,643 VEHICLES AND MOTORCYCLES H TRANSPORTATION AND 1,268 26.2% 1,540 90 15 1,645 4.1% 6 5,455 4.7% 9,861 STORAGE I ACCOMMODATION AND 2,288 158 63 2,509 6.2% 7 13,946 11.9% 16,256 FOOD SERVICE ACTIVITIES J INFORMATION AND 1,164 70 19 1,253 3.1% 4 4,870 4.2% 6,485 382 7.9% COMMUNICATION K FINANCIAL AND 1,358 65 19 1,442 3.6% 3 4,286 3.7% 7,447 493 10.2% INSURANCE ACTIVITIES L REAL ESTATE ACTIVITIES 1,757 16 1 1,774 4.4% 0 1,612 1.4% 1,612 354 7.3%

M PROFESSIONAL, SCIENTIFIC AND 3,799 151 17 3,967 9.8% 2 9,086 7.8% 10,047 TECHNICAL ACTIVITIES 613 12.7% N ADMINISTRATIVE AND SUPPORT SERVICE 1,695 103 33 1,831 4.5% 11 7,548 6.4% 11,712 ACTIVITIES P EDUCATION 893 60 32 985 2.4% 2 5,219 4.5% 5,745 n/a n/a Q HUMAN HEALTH AND 889 31 14 934 2.3% 3 3,301 2.8% 5,043 n/a n/a SOCIAL WORK ACTIVITIES R ARTS, ENTERTAINMENT 1,263 43 15 1,321 3.3% 1 3,566 3.0% 3,854 AND RECREATION S OTHER SERVICE 2,276 24 3 2,303 5.7% 1 2,682 2.3% 2,995 ACTIVITIES T Activities of households as employers; undifferentiated goods- 589 12.2% 2 0 0 2 0.0% 0 2 0.0% 2 and services-producing activities of households for own use U Activities of extraterritorial 0 0 0 - 0.0% 0 0 0/0% 0 organisations and bodies

TOTAL 38,592 1,615 366 40,573 100% 61 117,089 100% 148,904 4,838 100%

Source: NSO Malta.

176 Figures for value-added are total figures for the industry and do not distinguish between SMEs and large firms; however it is assumed that since 99.8% of enterprises are SMEs this could be used as a proxy for value added generated by SMEs. Also, total value added for sectors O to Q (EUR 1,163m) is not included in this analysis. Therefore, total value added generated by the Maltese economy amounted to EUR 6,001m. 177 Total figure for sectors B to E, of which EUR 753m relates to sector C (Manufacturing).

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b) Innovation in Malta According to the stakeholders interviewed, Malta’s innovation performance over the last decade has been poor, mainly because of insufficient Research and Development (R&D) spending, along with the almost non-existing linkages between research, usually performed at the University of Malta, and the needs of the productive sector.

A major concern in Malta is the commercialisation gap during the process of launching a product onto the market. In Malta, there are a large number of SMEs, which have come up with an innovative product/service but have experienced difficulty in taking the product to market, mainly due to lack of adequate support.

In the past, there have been several attempts by the government and other public and private institutions to set up Venture Capital funds, Business Angel networks and other platforms, which were created to promote research, innovation and development of enterprises, in particular, SMEs in Malta. These networks and funds, were not successful, since they generated little interest from the industry (see Section 7.2).

Table 54 shows the innovation performance of Maltese firms relative to the EU-28 average. In terms of “Business R&D expenditure,” Malta stands at 0.5% of GDP compared to the EU-28 average at 1.3%178, illustrating the room for improvement of spending for innovation in the country. Table 54: R&D expenditure in 2012 as a percentage of GDP relative to EU-28

Type of expenditure Malta EU-28

Business R&D expenditures 0.50% 1.31% Public R&D expenditures 0.33% 0.75%

Source: EC Innovation Union Scoreboard 2014.

Table 55 presents the level of expenditure on Research and Development stemming from the private sector, the government and higher education institutions such as the University of Malta and other institutions of post-secondary education such as the Malta College of Arts, Science and Technology (MCAST). In 2011, the business community invested EUR 31.5m in R&D, while higher education institutions spent about EUR 14.2m and the Maltese government spent EUR 1.7m. In total R&D expenditure in Malta, in 2011 accounted for 0.72% of GDP, which is much lower when compared with the average of the EU-28 countries.

178 Gross Domestic Product as published in NSO News Release No. 110/2013.

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Table 55: Total R&D expenditure in Malta as a percentage of GDP

Type of expenditure 2009 (mEUR) 2010 (mEUR) 2011 (mEUR)

Business R&D expenditures 20.12 26.16 31.52 Public R&D expenditures 1.50 1.55 1.69 Higher Education R&D expenditures 10.13 14.29 14.24

Total R&D expenditure 31.76 41.99 47.44

As a % of GDP 0.53% 0.66% 0.72%

Source: NSO – Research and Development in Malta: 2009-2011.

As illustrated in Figure 52 below, Malta falls within the “moderate innovators group” among EU Member States. This is the group where Member States perform below the EU average in areas related to innovation and R&D.

According to the EC Innovation Union Scoreboard, innovation performance in Malta improved until 2010 after which it strongly declined. It improved once again in 2013 to a level comparable with that in 2008. Malta displays a clear weakness in certain indicators of innovation performance, for example recent Ph.D. graduates, but also has relative strengths such as its performance in Community trademarks, non-R&D innovation expenditures and employment in knowledge-intensive activities. Declines in growth are observed for Malta’s performance in sales share of new innovations and licenses and patent revenues from abroad. Figure 52: Malta’s innovation performance compared with other EU Member States

0.800

0.700

0.600

0.500

0.400

0.300

0.200

0.100

0.000 BG LV RO PL LT HR MT SK HU EL PT ES CZ IT CY EE SI EU FR AT IE UK BE NL LU FI DE DK SE Modest innovators Moderate innovators Innovation followers Innovation leaders

Source: EC Innovation Union Scoreboard, 2014.

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In terms of the number of patent applications filed in Malta under the Patent Cooperation Treaty, Malta lags behind most of its counterparts within the EU, with 0.82 applications filed per billion GDP, compared with 1.98 in the EU. Table 56: Number of patent applications filed under the Patent Cooperation Treaty (PCT), in 2010 per billion GDP in comparison with the EU-27

Type of expenditure Malta EU-27

PCT patent applications 0.82 1.98

Source: EC Innovation Union Scoreboard 2014.

A key concern in Malta is the lack of an effective Intellectual Property (IP) legal framework, which has been identified by the market as a necessity for incentivising investment in R&D. Such a framework would include regulations removing the risk of rapid imitation, and ensuring ownership over the knowledge to the entity that created it. It would also organise the dissemination of new technological knowledge in the society (World Bank, 2013).

Recent initiatives and policies were introduced in Malta to create linkages between research, market needs and the country’s innovation system. The main focus is set on providing financial incentives for stimulating research and creating new research organisations and institutions more aligned with market needs. In 2014, the MCST launched “Fusion: The R&I Programme”. This programme aims to support local enterprises to develop and commercialise new technologies. Fusion offers two programmes. The first is a voucher programme covering IP checks and commercialisation viability and the second programme supports the actual technology development, thanks to funds ranging from EUR 50,000 to EUR 200,000. The voucher programme enables SMEs to obtain vouchers that can be redeemed for consulting and advisory services, as well as other non-financial support measures. The programme is open to SMEs and researchers from academic institutions 179 . Fusion is supported through Malta’s government funds managed by the MCST and will run from 2014 to 2020.

The University of Malta (UOM) has also recently launched “TAKEOFF”, which is a Business Incubator that offers facilities (office and communication facilities as well as mentorship) to startups who pay a subscription fee for the use of TAKEOFF and the UOM reserves the right to take a small stake in the equity of the start-ups should the company be successful and go to market. The UOM has also launched the “Seed Fund award”, which is financed by the government, whereby EUR 100,000 are shared between participants who are successful in securing funds for an innovative start-up idea. There were 30 applicants for this Seed Fund and eventually 9 applicants were awarded funds which ranged between EUR 5,000 and EUR 18,000.

179 Article from Times of Malta – MCST launches R&I programme, 15 June 2014.

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The demand for this Seed Fund programme was very high, with approximately EUR 400,000 requested by applicants. Therefore, the programme was able to satisfy only 25% of the demand.

Apart from the TAKEOFF programme, the UOM has also set up the “Centre for Entrepreneurship and Business Incubation” (CEBI), which was established to educate and support graduates in the creation of successful knowledge-based and knowledge-intensive business ventures. It started delivering its first post-graduate programmes in July 2014. This initiative mainly aims to stimulate and support the growth and development of entrepreneurship in, inter alia, science, technology, engineering, media and creative industries in Malta at practical, strategic, educational, and research levels.

The Malta Information Technology Agency (MITA), acting as the central driver of Government’s ICT policy, programmes and initiatives in Malta is also supporting a number of initiatives that promote ICT. One such initiative is the “MITA Innovation Hub”, which provides a support platform and collaborative environment for the digital community. The “Digital Outreach” initiative is committed to sustaining a digital-economic mindset, which is essential to retaining a strong national competitive position. Amongst others, MITA also supports e-Government through which public information is made available electronically to households and businesses mitigating the information gap.

The “PwC EUR 1m Start up Fund: Promoting Entrepreneurship and Innovation” is a further initiative whereby PwC Malta is dedicating up to EUR 1m per annum worth of pro bono services to assist entrepreneurs in nurturing their business during the critical stage of starting-up and growing a new business. The purpose of this fund is to ease the financial burden of new entrepreneurs, as well as to contribute to new businesses being set up with proper financial and management structures, which will be of particular relevance to SMEs. Services provided through the PwC EUR 1m Start up Fund are in-line with the needs of entrepreneurs, comprising of assistance in: the preparation of business plans; the raising of bank finance; the set-up and registration of companies; compliance with tax matters; the design and implementation of accounting and IT systems; the set-up of employee share option schemes and staff training in financial management related areas. For this initiative, PwC Malta is collaborating with two key local institutions, the University of Malta and Times of Malta.

In addition, Malta Enterprise is also supporting the “Business Advisory Services Scheme” aimed at providing business undertakings operating in Malta with advisory services that suit their respective circumstances and aim to support undertakings with identifying their strengths and overcoming their weaknesses in specific areas. In offering this scheme, Malta Enterprise established a team of business consultants that have the capabilities to address the needs of undertakings at different stages of business development. A range of business advisors services are available and

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every effort is made to match the right advisor to the specific needs of the applicant. Aid under this incentive may be granted to all enterprises that wish to benefit from the scheme.

The Microsoft Innovation Centre (MIC) of Malta was launched in 2013 and is a million dollar investment (EUR 758,922) by Microsoft and its partners to support the local IT industry, with a focus on innovation, entrepreneurship and technology learning. The start-up programme is offered to all entrepreneurs however with specific focus at the early stages of development. These incentives are targeted at relieving initial costs such as office space, hardware, and technology skills. Furthermore, a core aspect of the programme is an in-depth business course from accounting to marketing. The MIC is also the home of the largest IT community in Malta where technology experts, most from within Microsoft, provide workshops and learning sessions on the latest technologies.

The government of Malta is funding a life sciences centre which will be completed in 2014, named the BioMalta campus. It is being developed to foster the growth of the country's life sciences industry. The life sciences centre will provide laboratory space to new and existing companies and will also extend business advisory services, financial incentives and tangible support to companies intending to set up operations. The BioMalta campus will initially consist of four buildings comprising of 10,000m² of laboratory space (representing 61 lab units) and 3,500m² of business incubation facilities (representing 11 incubation units)180.

c) Legal framework and fiscal policy The Maltese government has introduced series of legislative initiatives to improve competitiveness, cut red tape and reduce the costs of regulation on enterprise. Reforms in the judicial system also aimed at increasing transparency and reducing the invisible costs of bureaucracy.

In the short-term, the government of Malta is planning to introduce a number of economic and fiscal initiatives to improve the sustainability of public finances, which will in turn support local enterprises, in particular SMEs, by improving administrative competitiveness in the market and reducing administrative burden, experienced by many companies in Malta and highlighted during interviews with the stakeholders.

The Maltese government is also committed towards enhancing efficiency in revenue collection through the consolidation of the various government revenue departments into one single authority.

180 BioMalta Life Sciences Park: http://www.pharmaceutical-technology.com/projects/biomalta-life-sciences-park.

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The Maltese government is also dedicated to reducing bureaucracy in an effective manner. In this regard, the government has a set objective to reduce 25% of existing bureaucratic procedures. Initiatives are at present underway to reduce the length of public procurement procedures. The holistic justice reform is also expected to contribute to the competitiveness of Malta by enhancing the quality of the business environment by containing administrative burdens and hence reducing administrative costs.

In addition, the government is working on specific policy initiatives, including the diversification of energy sources in Malta and the restructuring of Enemalta Corporation, the main provider and distributor of energy in Malta, incorporating the importation and distribution of petroleum products as well as the generation and distribution of electricity in the country181. These initiatives are expected to result in lower energy costs for SMEs, which are one of the highest among the EU, and increased cost savings, enhancing competitiveness182.

The Maltese economy, including the financial and gaming sectors, have greatly benefitted from a business-friendly tax regime. Greater fiscal integration of EU Member States and potential harmonisation of tax rates could erode some of these benefits, with consequences on employment, output, and fiscal revenues. On the other hand, with Malta’s growth model increasingly dependent on financial and niche services such as remote gaming, measures to broaden competitiveness would help diversify the economy. In 2013, the International Monetary Fund (IMF) reported that Malta should ensure better alignment of wages and productivity at the enterprise level, promote foreign investment, improve the judicial system, and promptly implement structural reforms. This is particularly important at a time when many of Malta’s trading partners - notably EU Member States - are undergoing fiscal consolidation and structural reforms to restore their competitiveness. More generally, these reforms would make the economy less vulnerable to specific sectors and more resilient to a potential harmonisation of tax rates at the EU level183.

In Malta, the corporate tax rate is a 35% flat rate, which is the highest among other European Member States (Figure 53). In addition, the World Bank ranks Malta among the lowest countries within the EU and lower than many non EU countries in the overall business environment (Malta being at the 103th place) and also much lower when it comes to ease of starting up a business (161st place) (World Bank, Doing Business report, 2014).

181 http://www.enemalta.com.mt. 182 Ibid. 183 Malta – 2013 Article IV Consultation Concluding Statement: http://www.imf.org/external/np/ms/2013/051313b.htm.

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Figure 53: Corporate tax rate across countries in 2014

40% 35% 34% 35% 33.30% 31.40% 30% 29.60% 30% 26% 25% 25% 25% 19.70% 20%

15%

10%

Source: PwC Worldwide Tax Summaries – Corporate Taxes 2013-2014.

However and as mentioned earlier, Malta is known for being an attractive location for Foreign Direct Investment which motivates new business in sectors such as financial and insurance activities, remote gaming and ICT due to highly favourable tax incentives for foreign companies setting up subsidies in Malta. Thus, Malta’s accession into the European Union in 2004, followed by a number of tax incentives introduced, have improved the country’s attractiveness for tax planning and corporate relocation.

Malta’s attractive corporate tax systems and specialised incentives targeted at the gaming sector have made it a popular destination for companies working in this sector. Malta’s gaming tax is one of the lowest and most flexible and its corporate tax is unique within the EU as it provides an effective corporate tax rate of only 5% on the distribution of dividends to shareholders. In addition, with a view to attracting even more gaming companies, Malta has enacted a flat income tax rate of 15% for certain highly qualified persons employed within the gaming industry. This allows such gaming companies to retain any additional revenue from their operations184.

Similarly, to encourage further economic activity, enterprises that set up in the financial services sector also benefit from specific tax incentives. In particular, investment funds that are resident in Malta are, as a general rule, exempt from Maltese income tax subject to the satisfaction of certain conditions. The legal framework of investment funds in Malta and the particularities of the equity financing market in Malta are further developed in Section 7.2.

184 Remote Gaming, Update 2013, LGA.

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Annex 5 – List of interviews Stakeholders interviewed for the present AFMA study in Malta are indicated in the table below. Table 57: Interviews conducted with the different stakeholder groups for the AFMA study in Malta

Stakeholder group Institution interviewed

Bank of Valletta HSBC Malta plc Lombard Bank Malta plc Banks and financial institutions APS Bank plc Banif Bank Middlesea Valletta Malta Chamber of Commerce, Enterprise and Industry Malta Chamber of Small and Medium Enterprises (GRTU) Associations Gozo Business Chamber Malta Business Bureau Malta Enterprise

Public Administration and State Planning and Programmes Coordination Division (PPCD) Managing Authorities Funds and Programmes Division (FPD) National Statistics Office The Malta Council for Science and Technology (MCST) SmartCity Malta Accelerators / incubators University of Malta (Center for Business Entrepreneurship and Business Incubation) Equity investment providers Valletta Fund Management

Source: PwC, 2014.

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Annex 6 – Glossary

Common Strategic Common Strategic Framework translates the objectives and Framework (CSF) targets of the EU strategy for smart, sustainable and inclusive growth (Europe 2020 Strategy) into key actions for the CSF Funds (also called ESI Funds). CSF Funds Common Strategic Framework Funds for the next programming period. This includes: European Regional Development Fund (ERDF), the European Social Fund (ESF), the Cohesion Fund (CF), the European Agricultural Fund for Rural Development (EAFRD) and the future European Maritime and Fisheries Fund (EMFF). They are also called European Structural and Investment (ESI) Funds. Ex-ante assessment Identifies “market failures or suboptimal investment situations, and investment needs” as established under Article 32 of regulation n°1303/2013 (Common Provisions Regulation). Member States / Managing Authorities are required to conduct ex-ante assessments prior to supporting Financial Instruments, including: rationale / additionality against existing market gaps and demand / supply, potential private sector involvement, target final recipients, products and indicators. FEI Financial Engineering Instruments in programming period 2007-2013 as established under Article 44 of Council Regulation (EC) 1083/2006 and as amended. FI Financial Instruments in programming period 2014-2020 as established under Article 32 of regulation n°1303/2013 (Common Provisions Regulation). GAFMA Guidelines for SME Access to Finance Market Assessments. This is a methodology developed by the European Investment Fund to be used to prepare market assessments to identify market failures, suboptimal investment situations and investment needs for SMEs. Guarantee A guarantee offers commitment by a third party called the “guarantor” to pay the debt of a borrower when the latter cannot pay it himself. The guarantor is liable to cover any shortfall or default on the borrower's debt under the terms and conditions as stipulated in the agreement between the guarantor, the lender and / or the borrower. Holding Fund Holding Fund is as defined in Article 44 of Council regulation (EC) 1083/2006 and as amended. It is a fund set up to invest in several equity funds, guarantee funds, loan funds, or other incentive schemes providing equity, loans, guarantees for repayable investments or equivalent instruments for SMEs.

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JEREMIE Joint European Resources for Micro to Medium Enterprises, is an initiative of the European Commission developed together with the European Investment Fund. It promotes the use of Financial Instruments to improve access to finance for SMEs via Structural Funds. Managing Authority Managing Authority, as defined in the Community regulations (MA) regarding Structural Funds. Operational As referred to in Part Three of the Common Provisions Programme (OP) Regulation and in the EMFF Regulation, and “Rural Development Programme” referred to in the EAFRD Regulation. Document approved by the European Commission comprising a set of priorities which may be implemented by Structural Funds or other Financial Instruments. Specific Fund In the context of JEREMIE, refers to loan, guarantee or equity / Venture Capital funds investing in enterprises. Thematic Objectives supported by each ESI Fund in accordance with its Objectives mission in order to contribute to the Union strategy for smart, sustainable and inclusive growth (See Article 9 of the Common Provisions Regulation).

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Annex 7 – List of indicators used for the AFMA study

Table 58: Indicators used to perform the AFMA study in Malta

Indicator Definition Source Analysis

Macroeconomic indicators GDP Gross Domestic product NS0 2012/13 Historical analysis Gross Domestic Product divided by GDP per capita Eurostat 2012 Comparison analysis the total population Year-on-year change in GDP Real GDP Growth Eurostat 2012/13 Historical analysis adjusted for price changes Retail Price Index – Change in the Inflation (RPI) price level of a market basket of NSO 2012/13 Historical analysis goods and services purchased Inflation (HICP) Harmonized Index of Consumer Prices Eurostat 2014 Forecast analysis

Level of corporate tax rate as set by Historical analysis Corporate tax rate World Bank 2013 the law Comparison analysis Market indicators R&D expenditures as Research and Development NSO 2009-2011 Comparison analysis % of GDP expenditures divided by GDP Malta’s innovation performance Malta’s innovation EC Innovation Union compared with other EU Member Comparison analysis performance Scoreboard 2014 States Number of patents applications filed EC Innovation Union Patents applications Comparison analysis under PCT Scoreboard 2014 Growth in loans to Growth in loans to non-financial Central Bank of Historical analysis NFCs and SMEs corporations and SMEs Malta 2013

Outstanding loans to Outstanding loans to non-financial Central Bank of Comparison analysis NFCs corporations resident in Malta Malta 2014 Gap Analysis

Outstanding loans to Outstanding loans to SMEs resident in Central Bank of Comparison analysis SMEs Malta Malta 2014 Gap Analysis Loans to NFCs as a % Loans to non-financial corporations as Eurostat 2012 Comparison analysis of GDP a percentage of GDP Annualised agreed (interest) rates for AAR for overdrafts Central Bank of revolving loans and overdrafts and Historical analysis and long-term loans Malta 2014 short and long-term loans Interest rates on Interest rate on loan products up to European Comparison analysis Loans EUR 1m in the Eurozone Commission 2013 Interest rates on Interest rate on overdrafts in the European Comparison analysis Overdrafts Eurozone Commission 2013 Non-performing loans as a NPLs as a % of total Central Bank of percentage of gross loans issued by Historical analysis gross loans Malta 2013 core domestic banks Financial Volume of Volume of guarantees provided by Historical analysis statements of credit guarantees provided product and by SMEs institutions 2013 Comparison analysis

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Indicator Definition Source Analysis

Social indicators Historical analysis Population Population NSO 2012/13 Comparison analysis Projection of the Maltese population Projected population NSO Census 2011 Forecast analysis in the long term

Average age of Average age of population in Malta Historical analysis NSO Census 2011 Maltese population and Gozo Comparison analysis Working population (non-working Employment & Historical analysis population) divided by the NSO 2012/13 Unemployment rates population in working age Comparison analysis Share of labour force employed in Labour force in SMEs NSO 2012/13 Comparison analysis SMEs Population attaining Population aged 15 and over by highest level of highest level of education successfully NSO Census 2011 Comparison analysis education completed Number of students attending higher Students in higher Historical analysis education institutions by different Eurostat 2012 education institutions areas of specialisation Comparison analysis People at risk of poverty or social Share of population at risk of poverty Eurostat 2013 exclusion by age Historical analysis and sex Population on 1 Number of people divided in age January by five years Eurostat 2014 Historical analysis groups age groups and sex Comparison analysis

Source: PwC, 2014.

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Annex 8 – Questionnaire for the online survey The questionnaire used for the online survey, conducted for the AFMA study in Malta, is presented below.

1. In which territorial area is the main business activity of your company based? (Please select from the list below) o Malta o Gozo

2. In which sector does your business primarily operate? (Please select from the list below) o Agriculture, forestry and fishing o Mining and quarrying o Manufacturing o Electricity, gas, steam and air conditioning supply o Water supply; sewerage, waste management and remediation activities o Construction o Wholesale and retail trade; repair of motor vehicles and motorcycles o Transportation and storage o Accommodation and food service activities o Information and communication o Financial and insurance activities o Real estate activities o Professional, scientific and technical activities o Administrative and support service activities o Public administration and defence; compulsory social security o Education o Human health and social work activities o Arts, entertainment and recreation o Other service activities o Activities of households as employers; undifferentiated goods- and services-producing activities of households for own use o Activities of extraterritorial organisations and bodies

3. Over the last three years (2011, 2012, 2013), on average how many full-time staff or full-time staff equivalent (“FTE”) were working in your company? (Please select from the list and answer for each year)

1 - 9 employees 10 - 49 employees 50 - 249 250+ employees employees 2013 o o o o

2012 o o o o

2011 o o o o

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4. At which growth phase would you currently position your company / activity?

o Initiation [business model is created, no commercial activity] o Creation [commercial activity initiated, product not marketed] o Post-creation [activity has begun, no profit] o Development [profitable growth phase] o Maturity [stable activity with frail or stagnant growth] o Reorganisation [implementing or planning future restructuring processes in order to become profitable] o Takeover / transfer to new ownership/ buy-out

5. How did the following factors change between 2011 and 2013, in your opinion? (Please indicate your answers in the fields provided below)

Much Worse Unchanged Better Much No Worse Better Opinion The financial situation of your o o o o o o business Turnover o o o o o o

The cost (interest and other) of o o o o o o obtaining finance for your business The debt/turnover ratio of your o o o o o o business Other terms or conditions of finance o (e.g. loan maturity, collateral levels, o o o o o etc.) The burden or effort to obtain o o o o o o finance for your business The willingness of banks to provide o o o o o o finance

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6. Over the last three years (2011, 2012, 2013), which source(s) of funding has your company used? (Please indicate all the sources of finance you have used)

o Micro-loan from a micro-finance institution (< 25.000 euros) o Short-term loans, bank overdrafts and credit lines (< 1 year) o Medium and long-term loans (> 1 year) o Loans guaranteed by a public or private entity o Loan provided with interest rate subsidy o Loan obtained from parent company o Leasing o Bank guarantees (including export guarantees) o Factoring o Investment funds o Venture capital funds, i.e. capital provided by investors acting together in a fund set up for the purpose of providing finance to start-up and small businesses o Business Angels i.e. individuals investing in start-ups and entrepreneurs and often providing mentoring o Technology transfer funds o Equity from national, regional or foreign institutions o Rescue / turnaround and buyout capital o Mezzanine or hybrid financing i.e. combining loans and equity o Public grants o Corporate bonds o Other private investors o Private grants or donations o Retained earnings o Capital contributions of shareholders o External capital contributions (family or friends) o Other financing sources

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7. How successful were you in obtaining each type of the products listed below over the last three years (2011, 2012, 2013)?

Please indicate the level of success for each of the following sources, where “partially successful” refers to not getting the requested amount or receiving it with unsatisfactory terms.

Whatever was not ticked in Q6 should be ticked as ''N/a'' in this question

Successful Partially Unsuccessful N/a Successful Micro-loan from a micro-finance institution (< 25.000 euros) o o o o

Short-term loans, bank overdrafts and credit lines (< 1 year) o o o o

Medium and long-term loans (> 1 year) o o o o

Loans guaranteed by a public or private entity o o o o

Loan provided with interest rate subsidy o o o o

Loan obtained from parent company o o o o

Leasing o o o o

Bank guarantees (including export guarantees) o o o o

Factoring o o o o

Investment funds o o o o

Venture capital funds, i.e. capital provided by investors o o o o acting together in a fund set up for the purpose of providing finance to start-up and small businesses Business Angels i.e. individuals investing in start-ups and o o o o entrepreneurs and often providing mentoring Technology transfer funds o o o o

Equity from national, regional or foreign institutions o o o o

Rescue / turnaround and buyout capital o o o o

Mezzanine or hybrid financing i.e. combining loans and o o o o equity Public grants o o o o

Corporate bonds o o o o

Other private investors o o o o

Private grants or donations o o o o

Retained earnings o o o o

Capital contributions of shareholders o o o o

External capital contributions (family or friends) o o o o

Other financing sources o o o o

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8. For what purpose did you seek finance in the last three years (2011, 2012, and 2013)? (Please select one or more options from the list below)

o Finance working capital

o Ensure debt consolidation

o Acquire another company

o Rent machinery / equipment

o Launch a new product / service

o Develop international activities / enter a new market (geographic expansion)

o Finance export sales

o Finance R&D and innovation

o Transfer ownership

o Acquisition of an intangible asset

o Improve energy efficiency of your company

o Other needs

9. During the last three years (2011, 2012, 2013), in your opinion, what were the reasons for any difficulties in obtaining finance that you experienced? (Please indicate one or more options from the list below).

o The financial situation of your business

o The cost (interest and other) of obtaining finance for your business

o The debt / turnover ratio of your business

o Other terms or conditions of finance (e.g. loan maturity, collateral levels, covenants, guarantee, conditions, duration, etc.)

o The burden or effort to obtain finance for your business

o The lack of expertise of your team to find or negotiate the best option

o The limited availability of equity investors

o The difficulties related to file the application

o The willingness of banks to provide finance

o Corruption

o Not applicable: Our company did not experience any difficulties

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10. Over the last three years (2011, 2012, 2013), have you ever felt discouraged from seeking finance? (Please indicate one or more of the options listed below)

o Never

o Rarely

o Occasionally

o Often

o Always

11. Over the last three years (2011, 2012, 2013), what type of guarantee did you provide for your loan(s)? (Please indicate one or more of the options listed below.)

o Owner’s assets

o Family and friends

o Company assets

o Business partners

o Mutual guarantee schemes such as cooperatives

o Other guarantee schemes (Private, public, national or regional)

o Other institution

o Not applicable: Our company did not use loan financing or did not need to provide collateral

12. Over the last three years (2011, 2012, 2013), which do you believe were the reasons for being unsuccessful - or partially unsuccessful - in receiving loan financing? (Please indicate one or more of the options listed below)

o Poor credit rating

o Lack of own capital

o Insufficient collateral or guarantee

o Insufficient potential or too high a risk (of the business or project)

o Already too much debt

o No credit history

o Poor credit history

o No reason given

o Interest rates were too high

o Other conditions of the loan were unacceptable (e.g. maturity, covenants)

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o Not applicable: Our company did not request loan financing or was successful in receiving loan financing over these years

13. Did you experience changes in bank financing terms and conditions over the last three years (2011, 2012, 2013)? (Please indicate any changes per option provided)

Increased Decreased Unchanged Interest rates o o o Other costs related to the loan (other than interest rate) o o o Amount of the loan / credit line available o o o Maturity of the loan o o o Collateral requirements o o o Contractual issues related to the loan / Information o o o requirements, etc.

14. Over the last three years (2011, 2012, 2013), what sources of equity finance did you use? (Please indicate all the equity sources you have used for the time period 2011 - 2013)

o Existing shareholders

o Directors in your company who were not previously shareholders

o Other employees of your business

o Family, friends or other individuals

o Venture capital funds i.e. capital provided by investors acting together in a fund set up for the purpose of providing finance to start-up and small businesses

o Business angels i.e. individuals investing in start-ups and entrepreneurs and often providing mentoring

o Mezzanine or hybrid financing i.e. combining loans and equity

o Initial Public Offering (IPO) or other stock market offerings i.e. the first issue of shares by a private company to the public in order to generate capital

o Banks

o Other financial institutions e.g. subsidiaries of banks

o Other companies

o Public equity funds

o Other equity finance source

o Not Applicable: Our company did not seek for equity finance in these years

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15. What amount of loan and equity funding did you SEEK during the last three years? (Please provide an estimate in thousands of Euros of the financing amount sought for loan and equity)

2011-2013 (thousands EUR) Debt (all types of loan or credit) Equity finance (all types of equity and quasi- equity financing) Grants or subsidies

16. What amount of loan and equity funding did you OBTAIN during the last three years? (Please provide an estimate in thousands of Euros of the financing amount obtained for loan and equity)

2011-2013 (thousands EUR) Debt (all types of loan or credit) Equity finance (all types of equity and quasi- equity financing) Grants or subsidies

17. Do you feel you have sufficient access to the following financing sources in Malta?

Yes No Type of financing not relevant for me Micro-loan from a micro-finance institution (< 25.000 euros) Short-term loans, bank overdrafts and credit lines (< 1 year) Medium and long-term loans (> 1 year) Loans guaranteed by a public or private entity Loan provided with interest rate subsidy Loan obtained from parent company Leasing Bank guarantees (including export guarantees) Factoring Investment funds Venture capital funds Business Angels Technology transfer funds Equity from national, regional or foreign institutions Rescue / turnaround and buyout capital Mezzanine or hybrid financing Public grants Corporate bonds Other private investors Private grants or donations Retained earnings Capital contributions of shareholders External capital contributions (family or friends) Other financing sources

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18. Please select the FIVE forms of financing you prefer.

o Short-term loans, bank overdrafts and credit lines (<1 year)

o Medium and long-term loans (> 1 year)

o Loans guaranteed by a public or private entity

o Loan provided with interest rate subsidy

o Loan obtained from parent company

o Leasing

o Bank guarantees (including export guarantees)

o Factoring

o Investment funds

o Venture capital funds

o Business Angels

o Technology transfer funds

o Equity from national, regional or foreign institutions

o Rescue / turnaround and buyout capital

o Mezzanine or hybrid financing

o Public grants

o Corporate bonds

o Other private investors

o Private grants or donations

o Retained earnings

o Capital contributions of shareholders

o External capital contributions (family or friends)

o Other financing sources

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19. What amount of each of the following financing sources have you already requested or do you intend to request in 2014 (Amount in thousands of Euros)? (If not applicable leave blank)

(thousands EUR) 2014 Short-term loans, bank overdrafts and credit lines (< 1 year) Medium and long-term loans (> 1 year) Loans guaranteed by a public or private entity Loan provided with interest rate subsidy Loan obtained from parent company Leasing Bank guarantees (including export guarantees) Factoring Investment funds Venture capital funds Business Angels Technology transfer funds Equity from national, regional or foreign institutions Rescue / turnaround and buyout capital Mezzanine or hybrid financing Public grants Corporate bonds Other private investors Private grants or donations Retained earnings Capital contributions of shareholders External capital contributions (family or friends) Other financing sources

20. For what purpose is this funding being sought? (Please indicate one or more options)

o Finance working capital

o Ensure debt consolidation

o Acquire another company

o Acquire land / building

o Rent land / building

o Acquire machinery / equipment

o Rent machinery / equipment

o Launch a new product / service

o Develop international activities / enter a new market (geographic expansion)

o Finance export sales

o Finance R&D and innovation

o Transfer ownership

o Acquisition of an intangible asset

o Other needs

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21. When looking for finance, do you feel you lacked support from:

Yes No Did not ask for support from this organisation Your city State authorities Guarantee funds Public Investment funds Venture capital funds Business angels Commercial banks Chamber of Commerce and Industry Social Media (Facebook / Twitter…) Support networks Your accountant or an accounting, tax or finance consultant Innovation infrastructure such as incubators, innovation centers, technology parks, cluster Your social environment such as friends, family

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22. Please RANK the following factors limiting business growth in Malta by importance:

Please rank the FIVE most important factors in the short-term, medium-term and long-term (up to 1 year, from 1 to 3 years, from 3 to 5 years)

1 = least important factor; 5 = most important factor

o Limited demand in foreign markets

o Limited availability of suitable new personnel

o Loss of existing personnel

o Business transfer problems e.g. inheritance

o Cost of labour increasing

o Inability to finance necessary investment into equipment

o Products getting outdated (R&D necessary, product lead time)

o Difficulty keeping up with technological change

o Change in the competition (as new entrants in the market)

o Price competition / small margins

o Unfair competition, e.g. dumping

o Regulatory framework (related to issues such as labour code, public procurement procedures, tax regulation)

o Lack of fiscal incentives

o Not enough supply of financing

o Available financing not appropriate to your need

o Corruption

o Do not see constraints (nothing ticked above)

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Annex 9 – Interview guide Below is presented the interview guide that was used to interview stakeholders. When each interview was conducted this guide was fine-tuned and adapted according to the interviewee’s experience and knowledge related to SMEs’ access to finance in Malta.

A - Your investments in Small and Medium-sized Enterprises 1. Could you briefly describe the three key solutions that you are currently offering to SMEs? a) What is the volume invested for each solution and your capacity for the next three years? b) What are the eligibility criteria for each solution? c) Are you adopting a single or multi-player approach? If Yes, which actors do you involve in the process (co-investment)?

Please, find below options for answers:

Description Volume Eligibility criteria Key challenges and obstacles Approach

e.g. size of investment Equity, debt, and company, sector, e.g. cost, market acceptance, Single or hybrid, Present | Future location, type of legal complexity, expectations multi-player guarantee, other investment (target for guarantees, risk profile activities / objectives)

2. What are the key Strengths, Weaknesses, Opportunities and Threats of your current funding offer to SMEs? 3. What are some of the reasons why you declined to make investments from your side (e.g. related to management, product, commercial considerations, etc)? 4. What specific obstacles do you face as a Venture Capitalist / bank / promotional bank / agency investing in Malta (e.g. cost, market acceptance, legal complexity, expectations for guarantees, risk profile, better conditions outside Malta)?

B - Market trends and challenges 5. How would you assess the market demand for financing SMEs in your country? How many companies in your territory fit into your potential pipeline?

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6. Which sectors would you say are most likely to experience a growth in demand in Malta? What would be the most likely objectives or target areas for investment? 7. What are the key challenges for funding SMEs? 8. What are the emerging trends in SME financing Malta in terms of: a) Instruments from the private sector b) Instruments and mechanisms from the public sector c) Policy framework 9. Have you ever considered using the securitisation of loan portfolios / lease portfolios to SMEs? 10. Is market demand higher than the current supply? Is there a funding gap in Malta?

C - Prospective solutions 11. Which are the most effective models to fund SMEs? 12. How do you see the role of public sector funding for supporting SME funding? 13. Is there a market need in Malta for SMEs?

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Annex 10 – Minutes of the interviews

The minutes of the interviews are attached in a separate document.

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