Stuart Andrews,Managing Director, finnCap
Much has been written over the last few years about the slow destruction of the quoted plc as a mainstay of the western capitalist system. Barely an article on the public markets has gone by that has not mentioned the dwindling number of quoted companies around the world. Take the US, for example. Between 1996 and 2016, the number of listed companies in the country fell to 3,600, down from 7,300. Similarly, we often hear about declining volumes of shares traded and the availability of vast sums of money from private equity and unicorn hunters.
At the end of the market that most interests us, it is taken as an established truth by many commentators that the AIM market is dying – “only” 863 companies remaining, an increased regulatory burden and far greater rewards available under private equity ownership. You could be forgiven for believing that the market was no longer required in some people’s eyes.
If this is true, then the last three months should prompt a serious rethink – both of our view of the public markets as well as how they benefit the UK economy.
We have witnessed the greatest disruption to business in peace time, with vast swathes of the economy shut down by centralised government decisions and equally unprecedented intervention to sustain wages. To respond to these conditions, many companies have had a pressing need to raise capital. Those that are publicly quoted have been able to do so, accessing a far larger pool of capital than any private organisation can muster, and with a speed that cannot be bettered in the private market. It is not too much to say that being quoted at this point has been a distinct competitive advantage.
However, it is not just those that have experienced a sudden need for capital that have benefitted. So have those seeking capital to develop products related to Covid-19, or who are preparing their balance sheets to take advantage of the opportunities to come. UK-listed companies have raised more than £10bn since the pandemic struck and the speed of access to such a deep pool of capital that more than offset some of the “red tape” that comes with being listed.
On the other side of the coin, investors in the public markets are granted:
- Access to liquidity and transparent pricing – This allows capital to be released for new issuance and deployed effectively whenever opportunities arise
- Levels of disclosure and protection – Some of these are enshrined in law and others in the rules of the exchange. They ensure that the pricing of liquidity is fair to all parties
Retail investors have demonstrated that they are keen to invest alongside institutions. In recent weeks they represented over 20% of the volume on the FTSE All Share, with 60-74% of this volume being buy orders. UK stockbroking platforms are also reporting over threefold increases in new account openings.
But if the public markets are such a good place to raise capital and invest why are we not seeing more companies IPO and greater liquidity in growth companies?
The answers, in our view, are multiple but some of the most obvious come down to the twin pillars of government tax policy and regulation designed to protect investors. Both have combined to make the public markets a hostile environment for smaller companies and investors alike.
With evidence of the usefulness of public markets and renewed private investor interest, I hope many more will be tempted to list publicly. I also hope that we can consider some radical changes to make this a first thought for companies and to reverse the direction of travel with more companies joining the public markets than leaving. Set out below are some of the key areas that we see as current challenges and ways to address them.
1) Capital structure ownership
Challenge: Interest is a tax-deductible item, benefiting private equity that owns the whole capital structure compared to a passive equity investor that only owns the equity and therefore has less appetite for leverage. The effect is to lower the cost of capital to private equity, allowing much higher valuations for business’ ideally suited to the public markets.
Solution: Rethink this tax benefit to limit the amount of interest that is tax deductible resulting in more comparable costs of capital.
2) Reduce the need for funds to get bigger and bigger
Challenge: As regulation has expanded, funds have had to become larger to be run profitably, leading to industry consolidation and larger portfolios. Additionally, private client funds are increasingly run on a model portfolio to ensure fair treatment, which also increases the unit size of these funds and limits discretion. A fund can only sustain a limited number of positions, and so the larger the fund, the larger the companies it which it must invest. As a consequence savings are increasingly exposed to the same pool of larger companies representing a disservice to the underlying clients.
Solution: Reversing the red tape for institutional fund managers and reducing protections for retail investors is likely to benefit the overall market whilst not changing the risk profile for the individual retail client.
3) Democratise access to research and corporates
Challenge: A key contributor to liquidity is the private individual, but they are being increasingly locked out of public markets by regulations designed to protect them. The legislation locks them into exposure to large corporates or execution-only accounts and penalises companies that do deal with them – the financial services compensation scheme being a particular example. The City therefore revolves around institutional stockbrokers that act on behalf of corporates but are reluctant to deal with retail clients, putting individuals at a disadvantage when it comes to research and corporate access.
Solution: At finnCap, we are supportive of initiatives like PrimaryBid and Investor Meet Company that help level this playing field and make our own research available to all market participants.
4) Raise Prospectus Regulation limit
Challenge: A significant bottleneck on liquidity is that it is not currently possible to include private investors in fundraises to a quantum higher than €8m without producing a time-consuming prospectus approved by the relevant regulator. Issuance is therefore increasingly spread over limited institutions and pre-emption rights have, to a large extent, become a quaint historical artefact.
Solution: There seems to have been little investor detriment from increasing the Prospectus Regulation limit from €2m to €8m. It is time for to consider increasing this again to €20m – but post Brexit it can be denominated in £ and become a choice for the UK Government.