The City needs an intervention

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Craig Coben is a former global head of equity capital markets at Bank of America and now the managing director of Seda Experts, an appraisal firm specializing in financial services.

In 1888, Antofagasta (Chili) and Bolivia Railway Company listed on the London Stock Exchange to finance a railway between the port of the same name in northern Chile and the capital of Bolivia, La Paz. Antofagasta, the oldest stock listed on the LSE, recalls London’s central role at the frontier of capital markets financing.

Today it is not the Andean railways, but climate technology, artificial intelligence and life sciences that are applying for funding. But by all accounts, this generation’s Antofagastas are dodge from London, also (especially) homegrown companies.

City policy makers and stakeholders are alarmed that London appears to be losing stature and relevance. The result was a slew of official reviews, including the Review of wholesale marketsTHE UK listing reviewTHE Kalifa review by FinTechand the UK secondary capital raising review. The City of London Corporation has launched a “radical overhaulof UK financial services regulation, while the London Stock Exchange has launched a task force for the UK capital markets industry to “maximize the impact of capital market reforms.”

And it’s not just talk. The UK government announced a list of measures last December, dubbed the “Edinburgh Reforms”, to improve the competitiveness of the financial sector. Meanwhile, the Financial Conduct Authority announced earlier this month detailed proposals to streamline the listing process, such as eliminating the premium listing segment and easing the rules for related party transactions. This comes on top of FCA measures in 2021 to reduce free float requirements and allow for dual class share structures.

Amidst this barrage of revisions and reforms, the UK’s trade finance body and EY have released a great relationship last week on the UK capital markets. It offers a balanced and comprehensive survey of the landscape and debunks many myths which portray London as a lagging behind and lackluster place.

The 66-page document notes, for example, that London outperforms other European stock exchanges on nearly every metric, including the number of companies listed, amounts raised, market capitalization and the size of the investor base. Furthermore, LSE IPOs fare no worse than US ones, and any valuation discount with US markets is more a function of industry composition than geographic location. Indeed, the report makes clear that the vast majority of UK companies would gain no benefit from avoiding their home exchange to list overseas.

London is in a funk right now, but it’s not a backwater. Coincidentally, last week’s report was released the same day as an overnight placement of £2.7bn ($3.4bn). in London Stock Exchange Group shares for Thomson Reuters and Blackstone, nearly double the largest equivalent US placement so far in 2023. This is proof positive that the UK market can mobilize huge amounts of capital around listed names.

The UK Finance/EY report recommends various measures to increase the attractiveness of London. These range from tax incentives for issuers and investors to support for SMEs to increased digitization of ‘plumbing’ capital markets to facilitate investor participation.

Reviving UK capital markets requires a multi-pronged approach. Reforms must first address what I would call supply-side challenges, in particular how to make London a less burdensome place to raise capital and get a company listed. This is to some extent the easy partbecause the reform and rationalization of the listing rules are apparently under the control of the authorities.

Clearing out the regulatory undergrowth it may be necessary but it is not sufficient. The real challenge is on the demand side, namely how to incubate attractive companies and attract capital from domestic and foreign investors to provide liquidity to the market and finance further growth. And this is where the UK needs to go big or go home.

This challenge is not unique to the UK. Delisting ea scarcity of public offers they are ruining stock markets around the world, even as many stock indexes are nearing all-time highs. Look no further than this year’s dangerous IPO market in continental Europe, where the paltry number of deals has poorly executed. As I argue about this week IPO Stories Podcastthe European IPO market suffers from limited investor depth and parched post-sale liquidity.

So, to some extent, the de-equitisation witnessed in London represents a wider phenomenon which – in the absence of a renewed enthusiasm for growth or stockpiles of concepts – no amount of tweaking the rules can counteract. But the malaise of the list matters more to the UK because of the outsized role of the financial sector and the totemic importance of the London Stock Exchange as a sort of national champion.

The authors of the report are diplomatically circumspect the B word, but like Banquo’s ghost it haunts every initiative to rehabilitate the City as a global financial center. In negotiating Britain’s exit from the European Union, the British bureaucracy left the City in the lurch. As reported by MainFT in January 2022:

The post-Brexit trade deal concluded in late 2020 included very few provisions for financial services, and Brussels has since refused to offer London anything resembling the same market access agreements – or equivalence – enjoyed by the financial centers including New York, Tokyo or Hong Kong.

The Sunak government has since somewhat buried the hatchet with the EU, signing just last week a declaration of intent on regulatory cooperationbut it is anything but equivalence.

It is in this context that the recommendations of UK Finance / EY can be understood. The report reads as a call for robust industrial policy, making strong pushes – if not vigorous pushes – to prop up UK capital markets. Conditioning higher tax breaks for research and development on a national listing – as the report suggests, for example – is its own kind of protectionism. The same is true of providing financial incentives to investors for owning UK listed shares. Similarly, supporting Solvency II reforms to invest in UK equities means that regulation takes into account a wider range of interests than just the safety of policyholders.

The report justifies this call for government intervention on the grounds that UK capital markets are a viable business whose success eliminates a number of positive externalities:

The role of capital markets goes beyond the world of finance and investment and its social contribution is significant. From creating jobs and wealth and developing skills and talent, to fostering innovation, the criticality of dynamic and well-functioning capital markets to the overall health and prosperity of the UK cannot be underestimated.

This is not just the municipality employs many people and pay a lot of taxes; the financial intermediation it offers channels savings into productive investments which in turn benefit the whole of society.

The problem is that the primacy of the UK’s capital markets is under existential threat after Britain’s withdrawal from the single market, as market share and (payment of the increased rate) talent disperses to other financial centres. Brexit is not to blame for slow IPO volumes or low retail holdings of shares. He did, however, make efforts to arrest the city’s decline much more difficult – and more urgent.

The question now is whether Brexit offers the legal and political space for some sort of direct government intervention that would have been unthinkable within the single market. For the Square Mile it’s more a consolation prize compared to sunny plateaus promised by the Leavers, but you must play the cards you are dealt.

Plagued by structural challenges and drifting away from European markets, the city needs active and proactive official support to regain its momentum and mojo. This means more dirigisme and no more laissez-It does not matter. The government now has to decide how much it wants to restore the luster of a trophy industry that past policies have damaged so much.

Further reading:
— Diagnosis of London quotation miasma (FTAV)
— A farewell to Arm (FTAV)
— Why Silicon Valley has failed (so far) to break the circus of IPOs (FTAV)