- The UK has a problem – the pace of companies leaving the market has accelerated, but the hopper is not being refilled. Even worse – more UK companies of scale are undertaking IPOs in the US than the UK.
- Reforms will help – the FCA is changing and recognising that a functioning market is essential, rather than just concentrating on regulation and reducing risk. The new focus on growth and international
competitiveness is fundamental to ensuring regulation is supportive to the performance of markets.
- Looking for solutions – to find a solution, it is necessary to realise the scale of the problem. Increasingly we see the government and opposition wanting to engage to understand the issues. This is encouraging, but concerted action is required to maintain the health of the UK equity market and ensure that it provides the necessary growth capital for companies.
In this article we look at the scale of the issue, the reasons for it and a number of suggestions for improvement. However, it is important to recognise that increasing fund flow into the UK is central for sustained improvement. The good news is that concerted action could deliver material improvement in a short time period, which would stimulate investment and the equity market to the benefit of all stakeholders.
Asleep at the wheel – for many years there has been an over-riding sentiment that markets can operate successfully with limited input from the government. As a result, the focus has been on regulation and control rather than growth. It should be clear by now that the UK equity market has a major issue, which will result in steeper decline if not addressed. Are we really resigned to the notion that many companies in the UK aspire to float in the US rather than the UK? Are we happy that the market cap of the entire UK market is now the same as Apple?
The equity market matters – this should be well understood but needs repeating.
- Equity is permanent capital that does not require refinancing. It provides capital to invest in growth opportunities in assets, people and R&D. We have a large number of great companies in the UK and access to capital is vital to enable them to prosper.
- Listed companies lead the way in numerous areas, such as sustainability and disclosure, as well as being subject to a far higher level of analysis and scrutiny. This adds cost but is of clear benefit to wider society. Compare and contrast the BP and INEOS annual reports.
- Listed companies generally pay a full tax contribution, whereas many private companies are structured to avoid/reduce tax.
- A strong equity market helps to stimulate economic growth, a more prosperous population and higher tax revenue. It provides both a growing store of savings, as well as income in the form of dividends.
- There is a broad ecosystem around listed companies, including accountants, lawyers, advisers, bankers and investment funds. These are core specialities in the UK and a healthy equity market pulls in material
additional revenue for the UK.
- Equities have broad ownership and are available to all.
- Listed companies generally have lower leverage than their privately backed counterparts, which ensures greater capability to manage economic and interest rate volatility and higher free cash flow to invest in growth.
An impetus for change – as discussed above, there is now a recognition that change is required. There is no silver bullet, but a number of policy initiatives would make a material difference. Regulatory reform is important but should only be the start of the changes. Government and regulators have plenty of levers to ensure that London returns to a leading position for IPOs, which would not only stimulate greater activity in the UK, but also drive inward investment. The UK historically has had a vibrant small & midcap market, which is where the majority of IPO activity occurs. This has dwindled at an alarming rate, but we believe concerted action would reverse the decline and return the UK to its previous standing as a leading destination for growth companies.
Peel Hunt suggestions
We see a number of potential changes that we believe would collectively drive a meaningful improvement.
- Increase demand. It is essential to reverse the negative fund flow in UK equities, which has now lasted for 30 consecutive months. It is highly unlikely we will ever have a vibrant IPO market if fund managers do not have funds available to invest in new companies. This is particularly true for small & midcap companies as these see limited appetite from overseas investors given scale and liquidity. It is relatively straightforward to increase demand, through encouragement of pensions, insurance companies and retail investors, but positive action is required.
- Increase attraction of being listed. There are numerous benefits to the UK from having a vibrant listed market and yet listed companies have to endure higher costs, increased scrutiny and significantly enhanced regulation. Introducing corporation tax incentives would enhance the attraction of being listed and improve economic growth. Improving equity schemes (eg SAYE and options) would improve the perception of being listed and enhance employees’ motivation. Enhancing the tax treatment for entrepreneurs and employee shareholders of listed companies would encourage companies to list.
- Reduce cost. Preparing for an IPO is expensive and time consuming. Companies need to be encouraged to undertake this process given the overall benefits to the UK. The costs for an IPO are typically around 5% of funds raised given the spend on lawyers, accountants, bankers etc. These costs could be made tax allowable, which would defray a meaningful cost. We would expect this to be overall tax positive for the government given that profits are generated by the advisers as well as incremental tax revenues post IPO (eg stamp duty). This change has been made in Poland and Italy, so there is international precedent. A further improvement would be to make VAT on IPO fees recoverable.
- Improve IPO process. There are a number of regulatory changes in flight, which will improve the system. However, we see a number of other areas to address as the rules and regulations seem to be based on arcane and outdated concepts (eg the six-day rule) and do not serve to improve the outcome for the company and the investors. Some of these are US driven, but there is plenty of opportunity to improve the process.
- Improve after-market. The UK has gained a reputation for poor performance post IPO. This becomes self-fulfilling after a period with IPOs targeted by short sellers and investors wary of IPOs. This could be addressed through changing short-selling rules for a period and by encouraging immediate index inclusion (as happened recently for the float of Hidroelectrica in Romania). Changing the post IPO blackout period for research would also help after-market activity. New companies are particularly vulnerable to short sellers given the limited track record and information flow, with the potential for additional volatility and undermining the initial perception of the business. A respite from short sellers in the early stages of being listed (say the first six months) would enable investors to get to know the business in a more considered environment.
- Encourage active fund management. The inexorable trend to passive investment is squeezing out active management. This is being driven by a focus on cost, effective marketing by passive funds, attitude to risk and historic performance. Passive investing is fine per se, but the growth is highly detrimental to the IPO process given that it is active managers that invest in IPOs and support the growth of companies.
- Enfranchise retail investors. The historic regulatory approach appears to be characterised by risk and protection rather than enabling investment and growth. Effectively retail investors are excluded from a wealth of information ‘for their own good’. The IPO is a classic example of information asymmetry where professional investors get access to analyst research and to presentations from management and analysts, whereas retail investors have to make do with public documents. In our view, this is just the worst form of regulation and the playing field has to be levelled in terms of information access (see the recommendations of Rachel Kent in the recent Investment Research Review). It could also be mandatory for all companies undertaking an IPO to have a retail offer (as happens in Hong Kong). Discounts for retail investors could make IPOs materially more attractive (for example there was a 3% discount for retail investors in Hidroelectrica).
- Improve attraction of secondary listing. There was a trend for secondary listings in order to tap into pools of additional demand in overseas markets. However, the reduction in liquidity in the UK makes this less attractive (as shown by TUI). A remedy would be to relax rules for secondary listings to be eligible for index inclusion. Ireland changed its rules to encourage companies to retain secondary listings. ARM may well have considered a secondary UK listing more seriously if there was index inclusion.
- Direct government action. The National Security and Information Act is in place to enable the UK to control acquisitions of strategic companies by overseas acquirors. A similar mechanism could be established to ensure effective ownership does not move overseas. The lack of tools to persuade ARM to list in the UK was clearly apparent. There could be a mechanism where approval for certain businesses to list overseas is required or at least a secondary listing in the UK is put in place. Longer term, we should be looking to drive UK investment to establish and support the growth of UK companies. It makes no sense for these to then list overseas.
- Address executive awards. This is a contentious subject but it is a major issue. The reality is that executive pay for UK-listed companies is consistently below international levels (particularly the US) and less remunerative than pay-outs potentially available in private equity businesses (as well as being less tax efficient). The UK has an obsession with executive pay that inevitably penalises UK companies given the increasingly global market for executives. Investment managers need to adopt global policies when considering pay rather than looking at the UK as an island. It is very noticeable that the same fund managers are happy to support pay and incentive packages in the US that they would vote against in the UK.
- Non-Executive pay & incentives. Similar to executives, NED pay is generally materially lower in the UK-listed environment than the US. We increasingly hear of listed companies finding it hard to find well-qualified candidates, particularly as the level of personal liability and time commitment has increased. This needs to be addressed. In addition, consideration should be given to share-based remuneration. Again, this is contentious given that the central role of NEDs is to provide independent oversight of a company’s management. However, NEDs should also be aligned with the owners of the company (ie the shareholders) rather than merely having a focus on risk and being incentivised to constrain growth. The proposition for NEDs is noticeably different in the US.
- Regulatory change. There is considerable momentum on the regulatory side already, which will improve the relative perception of listing in London vs other markets, as well as address some of the competitive disadvantages of being listed vs privately-owned companies. Many of these will land during 2024. We believe these changes have been well thought through, but of themselves will not change the fundamental issues in the UK both in terms of desire and ability to list/raise capital and attraction of being listed.