by Dr Bobby Reddy, Fellow, Cambridge Endowment for Research in Finance
Whichever way you look at it, the London Stock Exchange is in secular decline. The number of companies listed on the exchange’s Main Market has fallen from over 4,400 in the early 1960s to less than 1,200 now. One could argue that a similar pattern is evident in the US. However, unlike the US, the London Stock Exchange’s total market capitalisation has also plummeted relative to the size of the UK’s economy over the last 20 years. Notably, the FTSE 100 has significantly underperformed the US’s S&P 500 and the blue chip indices in Germany and Japan over the same time period. In recent years, the decline of the London Stock Exchange has attracted regulatory, media and public attention, and the future of the exchange is now front and centre in the minds of policymakers.
In a recent co-authored paper with Professor Brian R Cheffins, in The Modern Law Review, we first consider the merits of prioritising strong equity markets in the UK before evaluating whether recent changes by the Financial Conduct Authority to the Listing Rules, which govern London Stock Exchange Main Market-listed companies, will successfully resuscitate the exchange. With the plethora of private capital available to companies, the argument in favour of strong equity markets is not a slam dunk. The prospects for retail investors, though, are substantially impaired by a weak stock exchange. Moreover, wider economic benefits can stem from a strong exchange, especially in the context of developing a robust tech-industry ecosystem, and the shadow of Brexit looms large with some tying the fortunes of the London Stock Exchange to the self-confidence of the City. It is not therefore surprising that policymakers have sought to rejuvenate the exchange, with Listing Rules reform seemingly a material part of the solution.
The recent changes to the Listing Rules include a more permissive environment for ‘dual-class shares’ that enable company founders to list their companies and divest of a majority of their equity while retaining voting control. The reforms also include provisions intended to attract special purpose acquisition companies (SPACs), which are listed cash-shells established purely for the purpose of acquiring private companies, giving those companies a potentially streamlined pathway to listing. Finally, changes to the Listing Rules reduce the minimum ‘free-float’ of equity that Main Market-listed companies must maintain in public hands. On their face, these changes could increase the numbers of initial public offering (IPOs) on the London Stock Exchange. However, in our paper, we note that a lack of ambition in relation to dual-class shares and the free-float rules will likely encumber the allure of the exchange to high growth, innovative, early-stage companies that have many other options for growth. In relation to SPACs, the dynamics that will develop from the new regulations mean that there can be no assurances that more UK-listed SPACs will result in numerous good quality SPAC-acquired operating companies listing on the London Stock Exchange. Those very dynamics also potentially create hazards for unsophisticated investors, and the danger exists that promoting SPACs in the UK could conversely damage the reputation of the London Stock Exchange. Ultimately, the Listing Rules reforms may spur an annual increase in IPOs at the margins, but the results will certainly not move the needle.
Even if our assessment of the capacity of the Listing Rules reforms to increase IPOs proves to be overly pessimistic, simply focusing on the Listing Rules will not resuscitate the London Stock Exchange. Two deeper-seated issues endure. Firstly, over-regulation can deter companies from seeking listings on the London Stock Exchange. Companies face a cosier existence remaining private rather than succumbing to the extensive disclosure and governance requirements to which Main Market-listed companies are subject. Second, depressed share prices on the Main Market dissuade companies from listing on the London Stock Exchange. With depressed share prices, the perception exists, especially in the tech industry, that companies will be undervalued when they undertake an IPO on the London Stock Exchange. Such a perception can lead investors in private companies to the warm embrace of private capital, corporate acquirors and flotations on overseas exchanges when they seek to grow their companies or simply exit their investments.
Furthermore, a sole focus on IPOs may be misguided. In our paper, we show that exits from the Main Market routinely outstrip IPOs. It is those exits, rather than a dearth of IPOs, that have primarily impacted the market capitalisation to UK gross domestic product ratio of the London Stock Exchange. Although financial distress sometimes leads to de-listings, the principal cause of exits is acquisitions by other companies or private equity. To truly resuscitate the London Stock Exchange, policymakers need to be sensitive to the drivers of the relentless leak of companies from the market. For example, easing the governance burden on listed companies in a sensible manner may not only have a sizeable impact on IPOs, but could also stem the exodus of companies from the exchange. The onerous requirements of the Main Market can become draining for boards and stymie company innovation, making de-listing attractive. Additionally, as well as deterring IPOs, depressed share prices post-IPO can make Main Market-listed companies easy prey for, often overseas, corporate raiders. We have canvassed some of the areas for future research on improving share valuations. Although the Brexit-related currency shocks that contributed to undervaluations are not easy to reverse, encouraging British institutional investors, who have been forsaking the UK equity markets in recent times, to invest in Main Market-listed companies could materially improve flagging share prices. Policymakers should holistically reassess the regulatory package applicable to British pension funds and insurance companies and the incentives that derive therefrom.
The fresh impetus displayed by policymakers to revitalise the UK’s equity markets is welcome. However, policymakers must coherently evaluate the qualities of the market as a whole rather than focusing on individual elements isolated from the bigger picture. Although the new Listing Rules reforms may encourage some positive stock market activity, the regulators have a long way to go to resuscitate the London Stock Exchange.
This article originally appeared on the Oxford Business Law Blog on 1 June 2022.
Cheffins, B.R. and Reddy, B.V. (2022) “Will listing rule reform deliver strong public markets for the UK?” The Modern Law Review.