2021 April-May Analysis

New routes open up for Georgian SMEs as IFIs move to diversify financing options

IFIs in Georgia are moving to attract entrepreneurial finance for SMEs, passing on along the way a much needed boost to Georgian capital markets

It is all-hands-on-deck for Georgian capital markets as International Financial Institutions (IFIs) have been rallying to the call to diversify the money on offer to small and medium-sized enterprises (SMEs)—the key to Georgia’s economic growth—over the past several months.

Involved are the European Bank for Reconstruction & Development (EBRD), USAID, the Asian Development Bank (ADB), European Investment Bank (EIB), the World Bank, as well as the Georgian Ministry of the Economy and Sustainable Development (MoE) and National Bank of Georgia (NBG), to name a few.

Their aim is to widen the range of sources of corporate funding beyond just bank borrowing, increasing Georgian companies’, and particularly SMEs’, access to long-term international money and domestic funds. Vital is that this will attract investors who can take greater risks than banks. The plans, IFIs hope, will speed-up the development of Georgia’s capital markets, which has been a slow process for several years now.

Over the coming months, Georgian SMEs are going to find themselves on the receiving end of instruction on how to appeal to foreign frontier funds, how to present their financial profiles to investors; they will learn about EU requirements on governance and financial transparency and how to set up private pensions schemes to incentivize key staff. They will be invited to consider non-bank financing in the form of bonds or shares. Starting with a select few, they could be helped with mentoring and maybe also funding to cover the issuance costs to raise money directly from international and domestic investors of all sorts.

In the view of investment bankers Galt & Taggart and TBC Bank, both of whom have international investor clients, foreign investors should be attracted to the Georgian companies in the IFIs’ line of sight because of the relatively high level of Georgia yields in the current global ultra-low-yield environment.

The TBC Bank deputy CEO of Corporate, Investment Banking and Wealth Management, George Tkhelidze, believes that once more potential investee companies become available—the IFIs stress that chosen candidates will need to have strong cash flows and earnings—international funds will be drawn in. Domestically, new funds should join them, as legislation for private equity and venture capital funds is on the NBG’s action list, and company pension funds could follow.

The scope of Georgia’s domestic markets is currently too small to attract international institutional funds, but it could be boosted by activity from the country’s recently established state Pension Fund, believe both TBC Bank and investment bankers Galt & Taggart. There should also be very useful expansions in size and activity on the entry of promised privatisation via the stock market of state-owned enterprises, which could help the whole market.

“The Government has recently announced intentions to privatize a number of Georgian corporates. It’s crucially important for the development of capital markets that these privatizations be carried out through local capital markets (a path of development taken by a number of Eastern European peers),” said Otari Sharikadze, Managing Director at Galt & Taggart.

Currently, he says, the pace of development of Georgia’s capital markets is “significantly lower compared to our Eastern European peers.” There has been a little recent activity at the smaller end of the market in that Galt & Taggart listed two companies on the Georgian Stock Exchange in 2020—Metro Euphoria and Green Insurance. These were rare events, because of the lack of trading and hence liquidity at the exchange. But with prospects of increasing IFI support in the background, Galt and Taggart is “looking for interesting companies to be listed that could trigger investors coming to the market.”

The much-needed catalyst of more intermediaries (brokers and investment banks) and traders to pull in clients, groom prospective issuers, and create a more dynamic capital market is still a work in progress. USAID and other international agencies are hoping to help with this. Without them, although regulations are going into place, the situation is described by Sandro Bibilashvili at BGI Legal as “having building structures but no occupants.”

Active international trading to create a dynamic stock market in Tbilisi in local bonds and shares is not something currently on the IFI’s short-term agenda. First, they want to prepare the companies. So for now, any SME bond or equity issuances, brokers believe, are likely to be placed directly with small groups of investors.

Oft consulted by IFIs is George Loladze, who now runs broker Caucasus Capital. Loladze was the founding chairman of the Georgian Stock Exchange (1999-2014) and active in its predecessor, the Caucasian Exchange. Advising on the basis of one of the longest market experiences in the country, he says that, “To get a long-term sustainable outcome, if they really want to develop a local capital market, the donors should concentrate their efforts on capacity building of the key entities of any stock market, local (non-bank-subsidiary) investment banks/brokerage companies.”

“This could take a year and a half or so, then they would, in turn facilitate the process, educate potential issuers and investors on a (permanent) sustainable basis—the business model followed in developed markets.”

For its part, the EBRD says it will “assist the NBG with the design and implementation of support mechanisms facilitating access to capital markets—both debt and equity—for local corporates, including SMEs. Targeted support will enhance Georgian companies’ preparedness for capital markets, broaden their funding sources and help attract financing from domestic and international investors. Companies can receive tailor-made advisory services and technical support to improve their corporate governance, transparency and credit rating to source investments across capital markets.”

The program will offer this “capacity building” to “objectively selected companies” and “targeted support to prepare for the issuance process.” More details will be published when the program is officially launched, and market expectations are that it will be an 18-month programme.

Catarina Björling Hansen, EBRD Regional Director for the Caucasus, says, ‘’The pandemic and its economic impact have created a new reality for the private sector and now is the time to rethink, re-educate, reskill and restart. We are delighted to be joining forces with the European Union again to support businesses, jointly fostering digital transformation, driving green growth and assisting companies to access much-needed funding from diverse sources.’’

USAID has stated that “a functioning, diverse financial market is a crucial underpinning for economic growth” and is providing (to the tune of $10 million‒$24.9 million) the money to “establish additional funding sources” and financial innovation for SMEs. Potential areas for the USAID plan do include enabling the intermediaries essential for markets. Others are development of diversified financial products and services tailored for SMEs and stimulating private equity to invest in them. Also to be provided are “support to improve the capacity of SMEs to access fit-for-purpose financing; and incorporation of appropriate financial technology into the local capital market ecosystem.” This is all part of its drive to “build a modern capital market” so that Georgian companies can “access diversified sources of capital.”

The pace of effort to augment the supply of funds from banks is being driven at a faster rate. Work on Georgia’s capital markets has been protracted over many years. While the Caucasian Exchange was created and traded in 10 companies back in 1991, its updated re-incarnation, established with the aid of USAID, the Georgian Stock Exchange, has listed 350 companies and has been active from 2000. However, local markets have been pushed aside for SME funding in recent years. Banks and microfinance groups have largely taken over the role as suppliers of finance, dominated by the Bank of Georgia and TBC Bank, both limited on risk-taking by London Stock Exchange listings. These banks also own the major brokers.

Non-bank finance in Georgia has come mainly through large denomination bonds issued by the IFIs and major corporates, although the latter have often preferred overseas rather than domestic stock markets. The position for smaller companies has attracted concerned comment from the IFIs. As the EIB has commented, “Banks dominate the financial system in Georgia. Banking sector assets to GDP reached an all-time high of 96% in January 2019.”

In its look at SME enterprise policy in Georgia last year, the OECD states that “Georgian banks have lent larger amounts to smaller numbers of corporate clients (e.g. loans of USD 1 million+) rather than focusing on smaller-scale SMEs in the Georgian context.”

It added that at that time, though conditions were improving in late 2019, “in general, lenders regard the SME sector as being relatively high risk.” Thus, “[b]urdensome collateral requirements are a significant barrier. In terms of collateral, banks may sometimes demand more than 130% of the total loan value (usually in the form of real estate or land). For many SMEs, this is challenging as their fixed asset base may be relatively small, or their value proposition based around intangible assets.”

“High interest rates, especially in local currency, also create significant barriers for many SMEs in Georgia to access finance […] reflecting the relatively high levels of perceived risk. Rates are significantly higher for borrowers using microfinance structures. Often maturities are relatively short. They may not reflect the potential payback periods needed for profitable capital investment (e.g. renewable energy or energy efficiency).” As a result, the OECD states, “SMEs face a significant financing gap. ”Likewise, the EIB notes that “a noticeable level of loan rejections and credit-constrained firms characterize the Georgian market.”

Yet, the OECD pointed out, this segment of the economy provided “59% of total production value, 53% of turnover, 62% of value added (2017) and 62% of the total number of employees in the business sector and 50% of the country’s exports in 2018 […].” Hence, moves by the EBRD, USAID, ADB and others to bring in more funds to help growth.

It is not, as the OECD comments, that Georgian conditions for SMEs are any worse than in most developing countries. Plus, the IFIs and government have been trying, as it says, “to address barriers to access finance; targeted programmes aim to provide access to credit under the SME support programmes previously identified. These programmes provide a range of instruments. Some provide grants, while others subsidise the interest rate for SME beneficiaries.”

For several years now, the NBG has been building a regulatory framework to attract international investors and widen the range of available financial instruments, though much that has been passed by the legislators has targeted the top end of the financial sector.

Indications, brokers believe, are that future bonds of SMEs could be in smaller units—$1,000 equivalents—than the daunting size of those currently being issued in tens or hundreds of thousand-dollar units by major groups, perhaps, even enabling access by local retail investors. Bonds are still by far the preferred means of financing. As Sandro Bibilashvili says, while he sees no reason why current legislation could not also support the issuance of equities by SMEs, their founders may not want to dilute ownership or like the increased reporting and governance requirements.

The NBG has been very active in building the framework for capital markets. It has been creating attractive tax regimes for investment funds, in line with EU practice. It sees access to investment in SMEs for venture capital and private equity funds as vital to “improving funding conditions/growth opportunities for domestic companies.” It believes the entrance of the state Pension Fund and then these funds will speed up capital market development as “[…] usually investment funds act as intermediary entities, and also trigger future capital market transactions by exits from the funds.”

Auditing requirements have been introduced by legislation, which has been helping companies improve their financial statements and their accounting standards, the NBG says. Medium-sized companies are already complying, and this will help them present better to investors

The NBG is now expanding the range of investment instruments, including plans for covered bonds (where investors are protected by collateralizing a bond against a pool of assets). These can be used by domestic credit institutions and a draft law could be launched this year.

The MoE has joined in with NBG to help diversify Georgia’s financial offerings. Giorgi Gurgenidze, a lawyer who is leading the Ministry’s team of Georgian commercial corporate lawyers working on capital markets, says they are looking at, among other reforms, laws to allow more asset-backed securities, as well as at securitization and private pensions.

However, as TBC’s George Tkhelidze notes on the EBRD plan to bring more companies to investment markets, the banks are anxious to stay in touch with their medium-size corporate clients who are eligible for the IFI’s funding program, and to help.

“Bond issuance preparation includes setting up an advanced corporate governance system and choosing a sustainable structure for a board of directors. Our experience allows us to guide mid-corporates in the qualification process for international rating companies as well. In addition, TBC helps mid-size companies structure their finances and debt/equity ratio in a way that makes companies more attractive for investors and additional funding sources,” Tkhelidze says.

Gains from the IFI’s program, he says, go beyond SME financing .

“Developed local capital markets will further benefit the country by improving access to local currency and reducing FX [foreign exchange] dependence. Furthermore, companies can have access to a diversified investor base, thus decreasing the concentration risks, which is beneficial for the overall economy.”

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