Italy’s Capital Markets Reform Puts Investor Protection at Risk

In March 2024, Italy’s so-called Capital Law entered into force. Among other things, it delegates to the government the power to adopt a far-reaching reform of capital markets and company law, with the declared objective of making the Italian stock market more attractive.

A draft legislative decree implementing this delegation is now before Parliament. It contains several technical adjustments that will do little to achieve that goal. But embedded in its many pages is a set of reforms that, if enacted as proposed, will seriously weaken investor protection and, in practice, sideline parliamentary (and stakeholder) scrutiny of future changes to corporate law. 

The draft decree identifies two categories of companies to which a special, more flexible regime will apply:

• IPO companies, or issuers of any size that will do an IPO after the decree enters into force; and
• Small and medium enterprises (SMEs), as defined in the Testo Unico della Finanza (TUF), a category that covers the large majority of listed firms by number, but only less than 10% of total market capitalisation. 

Both IPO companies and SMEs will be allowed, by charter amendment, to opt out of key protections that have been built into Italian listed company law over the last thirty years. These include:

• board representation for minority shareholders;
• core safeguards on related-party transactions; and
• the super-majority (two-thirds) requirement for extraordinary shareholders’ resolutions, including charter amendments and mergers. 

Some degree of flexibility for IPO companies and SMEs does make sense. For IPO companies, the argument is that, if they disclose ex ante that they will not be subject to certain governance rules, investors can price that risk and either walk away or demand a discount. In turn, corporate governance mandates affect SMEs differently than larger firms because fixed costs represent a proportionally greater burden for smaller firms than for blue chips. And institutional investors are little invested in SMEs, because of a lack of analyst coverage and/or their absence from stock indexes. Hence, the chances are lower that anyone will exercise the rights the law grants to minority shareholders (with lower corresponding benefits).

In both cases, the argument runs, the law should allow deviations from the standard regime, provided that informed investors can react accordingly—ideally with some form of majority-of-the-minority approval to protect pre-existing minority shareholders. 

From flexibility to a maze of opt-outs

The draft decree, however, deviates from the choices this rationale would justify and does so arbitrarily.

For IPO companies, the key feature is a ‘gateway’ opt-out: if the company opts out of even a single optional rule before listing—potentially one that investors may not object to—this unlocks, for the entire future life of the company, the ability to adopt additional opt-outs by ordinary majorities for special-meeting resolutions (or the lower majorities the company may have opted into at the IPO stage), without any majority-of-the-minority (MOM) requirement. 

This arrangement has at least two implications:

1. It weakens the signalling function of pre-IPO choices. Investors cannot simply observe the IPO-time governance package; they must also factor in a credible risk that controlling shareholders will subsequently strip away further protections without their consent.
2. It creates an unjustified asymmetry between IPO companies and already-listed firms that cannot access the same degree of flexibility, even when they are otherwise comparable.

For SMEs, the design is even more convoluted. SMEs that, within two years from the entry into force of the decree, opt out of at least one eligible rule following MOM approval acquire a permanent licence to make further opt-outs thereafter, but at that point without MOM approval. By contrast:

• a listed company that becomes an SME after the two-year window has closed is barred from using the regime altogether;
• an SME that ceases to be an SME (for example, because its market capitalisation grows) keeps the benefits of the special opt-out regime acquired during the two-year window. 

The result is an incongruous patchwork of privileges and exclusions. Companies that are similarly situated in terms of size, ownership structure and market relevance would be treated very differently depending on whether they happened to cross the SME threshold—or to exercise a first opt-out—within a narrow, arbitrarily chosen time frame.

Equality, constitutionality, and a ‘correction’ mechanism

Under the Italian Constitution, the legislature may not treat similar situations differently without a reasonable justification. The design just described offers no such reasonable basis. It is difficult to see why, for example, an SME that qualifies as such three years after the decree’s entry into force should be systematically denied the flexibility accorded to those that already fell within the definition during the first two years—and why a firm that ceases to be an SME should be allowed to retain the benefit of previously exercised opt-outs. 

As several commentators have already noted, this exposes the regime to serious doubts as to its constitutionality. Blue chips would have plenty of reasons for pressuring the government to extend the new opt-outs to them.

And that is where Article 19(4) of the Capital Law may come handy. It authorises the government, within twenty-four months of the implementing decrees’ entry into force, to issue ‘corrective and integrative’ decrees, again in reliance on the original delegation criteria. Crucially, this corrective power is drafted without an explicit cross-reference to the provision that currently requires submission of draft decrees to Parliament for prior scrutiny. 

Now the picture is complete:

• The government enacts an opt-out regime so internally inconsistent that constitutional challenges are all but inevitable.
• Once issuers and commentators notice the unreasonableness of the opt-out regime described above and the former lament the unequal treatment they are subject to, the government itself invokes the need to ‘correct’ its own decree.
• The ‘correction’ then consists in extending the opt-out regime—possibly even without any MOM requirement—to all listed companies, including Italy’s large-cap issuers representing about 90 per cent of total market capitalisation. 

Formally, the corrective decree would still be said to pursue the original goal of promoting capital market attractiveness. In substance, it would enable a generalised rollback of precisely those governance safeguards that had brought Italian listed company law closer to international investor expectations between the early 1990s and mid-2010s. 

Those familiar with Italian legislative practice will recognise that this kind of institutional sleight of hand is well-precedented.

A better way: targeted flexibility, credible minority protection

If Parliament wishes to promote IPOs and lighten the regulatory burden on smaller issuers, there are less risky and more coherent ways to do so. Drawing on more detailed analysis submitted to the parliamentary committees by one of us, three elements seem particularly important. 

First, if any special opt-out regime is to be introduced, it should be limited to genuine SMEs, irrespective of whether they are already listed or become listed later, and without arbitrary time-windows. When companies grow beyond SME size (for three consecutive financial years), the benefits of the regime should cease.

Second, each individual opt-out should be permanently subject to a robust majority-of-the-minority requirement, along the lines of US-style enhanced MOM votes:

• the resolution should be voted on separately;
• only truly disinterested shareholders should be counted; and
• minority shareholders should receive full information and face no coercion.

This is particularly important where opt-outs concern institutions that have proven especially effective in protecting investors in Italy’s institutional context, such as list voting, the two-thirds super-majority in extraordinary meetings, and the related-party transaction regime. 

Third, opt-outs should be subject to a sunset clause: every five years, a resolution approved by a majority of minority shareholders should be required for the opt-out to remain in effect. 

Fourth, Parliament should obtain a formal commitment from the government that any use of Article 19(4) of the Capital Law will be subject to parliamentary scrutiny of the draft decrees. At a minimum, corrective and integrative decrees should not become a vehicle for far-reaching changes to investor protection that escape public debate. 

Conclusion

Italian equity markets are small compared with those of other major economies. Regulation is not the only, or even the main, cause. But the credibility of the legal framework for listed companies is a necessary condition for attracting—and retaining—domestic and international investors.

The current draft decree moves in the opposite direction. It weakens exactly those governance mechanisms that have proved most effective in protecting minority shareholders in a system characterised by controlling shareholders, a slow and unspecialised judiciary, and limited enforcement. 

If the government chooses to proceed along this path in the name of ‘competitiveness’, the consequences—for investor confidence, valuation levels and the reputation of Italian markets—will be entirely predictable. There is still time for Parliament and market participants to insist on a different approach.

Renzo Costi is Emeritus Professor of Business Law at the University of Bologna. 

Luca Enriques is Professor of Business Law at Bocconi University.

This post was drafted with the help of ChatGPT, also based on an op-ed published in the Italian daily Il Domani.