Securities Sandbox – a step forward to facilitating the development of the Latvian capital market

09.08.2022
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Edmunds Rudzītis, Chief Supervisory Expert of the Financial Instruments Market Supervision Department of the FCMC

In 2021, the Financial and Capital Market Commission (FCMC) developed a 10-step programme for the development of the Latvian capital market, including activities that will also focus on expanding the possibilities of issuers. Within the scope of implementation of the 10-step programme, the FCMC announced the establishment of a Securities Sandbox in April this year. This blog discusses why the Sandbox is necessary and what its benefits to potential issuers could be.

It is no secret that the development of the Latvian capital market lags behind Western European countries substantially, and also among the neighbouring countries we currently only stand out with the fact that, according to various capital market indicators, the Latvian capital market holds the “honourable” last place in the Baltics. There are several reasons for this, one of which is the decreasing tendency of the number of issuers and the lack of new quality issuers in the Latvian capital market. The lack of quality issuers, in turn, undermines the investors’ interest in the Latvian market and adversely affects the stock exchange turnover.

Capital market instruments as an alternative to bank financing

The development of companies requires investments, and traditionally, companies in Latvia have mainly been using bank loans as the main source of financing, while capital market opportunities in the attraction of financing remain untapped. However, during recent years the situation has changed, and several successful examples can be seen in Latvia where companies have attracted financing in the Latvian capital market by public offerings of financial instruments and shifting the attracted financing to corporate expansion projects. Such examples can be found both with regard to the initial placement of shares and the successful issue of debt securities (bonds), thereby increasing the number of stock market participants.

However, such examples are still relatively rare in Latvia, and for most of the companies the issue of financial instruments has basically not been an alternative to bank loans. Still, the interest in the capital market is increasing; during recent years, there have been issues of shares and bonds of several companies in Latvia, and also the listing of these shares and bonds on stock exchange has started; however, for more rapid growth of the Latvian economy and the capital market, more active participation of companies would be required while also considering alternatives to the financing of development projects, especially those that provide input to reaching the companies’ emission (climate) targets.

Proper setup of companies as a precondition for entering the capital market

In a survey of potential issuers carried out a few years ago, seeking to find out the potential difficulties that a company would face if it wanted to become an exchange issuer, insufficient interest of investors in the company to be quoted, costs connected with regulatory requirements and a lack of information about possibilities in capital markets were among the factors mentioned.

Reducing the perception that the attraction of financing in capital markets is costly and that only large companies can afford it, and raising the companies’ awareness of the potential costs and benefits of the attraction of financing and presence on the capital market, are factors that would encourage companies to capture the opportunities provided by the capital market.

For a company to be able to successfully issue its shares or bonds in the capital market, it has certain homework to do first. Planning of attraction of financing in the capital market requires a company to look at itself from the investors’ point of view, i.e., to arrange its internal processes, increase the transparency of the company, introduce or supplement corporate management principles and implement best practice in company management.

Proper setup of a company increases its attractiveness, not only in the eyes of investors, but also in the entire finance sector; hence, the company’s issues might gain more success – the company can raise more financing from the issue of its shares or bonds. For companies that would be willing to raise financing in capital markets, it is not always clear what to start with in order to successfully engage in the capital market. Considering the above, the FCMC has created a Securities Sandbox.

Support mechanism for entering the capital market

The Securities Sandbox is targeted at companies that want to raise financing in the Latvian capital market, and participation in it allows the potential issuer to receive non-financial advice. Not only representatives of the FCMC but also participants and experts of the Latvian capital market who represent banks and the stock exchange, certified advisors from the Baltic exchanges, etc., take part in the advisory process.

As opposed to regulatory sandboxes which are mainly targeted at innovative products or companies and where market participants test such products or processes under the supervision of a regulator, no given products-securities are tested in the Securities Sandbox.

The Securities Sandbox is a support mechanism – it can be viewed as a type of place where advice is given to companies by means of a test, which allows the company to understand how ready it is for entry to the Latvian capital market and what should be done to implement financing attraction plans.

Both private companies and state and local government capital companies can apply for participation in the Securities Sandbox. Also, there are no limitations as to what kind of financial instruments (shares or bonds) the potential issuers would like to use; companies that want to issue and offer their shares to investors, as well as companies that would rather choose the issuing of bonds to raise financing can apply for advice. It is also possible to choose which market is more suitable for the company – whether it is the regulated market with more stringent regulatory requirements or the alternative market where the regulatory burden is smaller.

Application and duration of the process

In order to apply for participation in the Securities Sandbox, a company should fill in an application form that can be found on the FCMC’s website and that should be accompanied by the documents listed – the set of documents to be submitted is almost identical irrespective of the market selected. The only difference is that, if a company seeks to enter the regulated market, it should submit its audited annual reports which have been prepared in accordance with IFRS (International Financial Reporting Standards).

When the company has submitted the necessary documents, the FCMC’s experts examine them and, within 10 days, provide a reply on admission to the support mechanism and ask the company to provide additional information, if needed. A cooperation agreement is then concluded with the company, and within 30 days from the time of submission of the documents (the last document) an assessment is prepared for the company. In making the assessment, several bodies which operate in the working group of the support mechanism are involved, and during the assessment the potential issuer can be invited to an interview with the authors of the assessment to provide additional information.

Benefits of participation in the Securities Sandbox

What are the benefits for the potential issuer? First, an indicative assessment of the company’s preparedness to enter the capital market. Secondly, the potential issuer receives recommendations as to what should be improved in order for the company to successfully start operating in the Latvian capital market. Also, a binding offer can be made to the issuer – a participant of the working group of the support mechanism, or a company representing it, makes an offer to the potential issuer regarding a service for the company to complete the issue process and assumes obligations for work with the potential issuer.

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