The future of smaller company capital markets in the UK

This report argues that rebuilding a vibrant market for smaller listed companies is a vital part of the wider reform of UK capital markets to help drive long-term investment and growth. It paints a stark picture of the burning platform over the past few decades and how smaller companies have been hit harder than the wider market, highlights the unique role they play as a source of funding for UK plc, and outlines a vision to reverse their decline.

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The past few decades have been pretty brutal for public equity markets in the UK but smaller listed  companies have been hit hardest of all. On virtually every metric - the decline in the number of listed companies and new issues, the collapse in demand from retail and institutional investors, or the reversal in performance - smaller companies have fared worse than the wider market. In the active debate around reforming the UK market over the past few years there is a risk that the unique dynamic of the smaller company end of the market gets lost in the noise. On many issues, such as the shift by UK pensions to a global equities allocation model, the specific impact on smaller listed companies has not been reflected in the debate.

Many of the challenges facing smaller companies are common across the wider market: stemming the exodus of pensions from UK equities; re-engaging retail investors; resetting risk culture and the balance between risk, growth, and stability; or addressing governance and regulatory hurdles. But there is a world of difference between the issues facing a big tech company like Arm Holdings (valued at £110bn) it its decision to list in the US, and its smaller cousin Raspberry Pi (valued at £725m) which listed in London this year. And there is a world of difference between Raspberry Pi and a £75m tech company listed on AIM.

In this report, we use a broader definition than usual of ‘smaller companies’ and include any UK listed company with a market capitalisation of less than £1bn. This is a deliberate decision to try to capture the dynamic of all smaller companies and to avoid getting too bogged down in a specific debate about AIM (which only accounts for a third of smaller listed companies by value). For our analysis of trends over the past 20 years, we have adjusted all market values for inflation into 2023 money.

It can be tempting to think that smaller companies don’t really matter: they only represent 8% of the combined value of the UK stock market and there are bigger fish to fry. We think this is would be a mistake: smaller companies have a strong local footprint in every corner of the UK and make a big economic contribution to jobs, investment, and growth. Smaller company capital markets provide a big source of funding for UK plc and help provide a funding escalator for the bigger companies of tomorrow: one third of listed UK companies with a market value of more than £2bn today have been a smaller company on our definition at some point in the past 20 years and have since more than doubled in value in real terms.

The good news is that there is nothing inevitable about the decline in smaller listed companies: there are plenty of examples in markets like Australia, Canada, and Sweden where smaller listed companies have been thriving. This shows that with a concerted effort across government, regulation, and the industry, we can reverse the ‘doom loop’ and revitalise what should be a vibrant component of UK capital markets.

Here is a 10-point summary of the report:

1. A focus on smaller companies: in the active debate on UK public equity markets over the past few years there is a risk that the unique dynamic of smaller listed companies - which account for over 80% of all listed companies in the UK - is lost in the noise. This report focuses specifically on the challenges facing UK smaller companies in the context of the wider reform of UK capital markets.

   
   

2. A burning platform: it has been a pretty brutal few decades for the UK stock market but on virtually every metric, smaller listed companies have been hit hardest of all. The number of smaller listed companies has dropped by nearly a third; the number of new issues had fallen by 80%; share price performance has halved; and the ecosystem of smaller company brokers and asset managers is struggling to stay afloat.

   
   

3. An engine of growth: while smaller listed companies only represent 8% of the stock market by value, they have a strong local footprint across the UK, have raised nearly £250bn in real terms over the past 20 years, and play an important role in supporting jobs, investment, and growth in every corner of the country.

   
   

4. The big companies of tomorrow: many of today’s smaller companies will grow into the big companies of tomorrow. Half of all listed UK companies with a market capitalisation of more than £1bn - and a third of companies worth more than £2bn - have been a smaller company with a market value in real terms of less than £1bn at some point in the past 20 years.

   
   

5. A collapse in demand: the biggest driver of this decline has been a breathtaking collapse in demand by institutional and retail investors. UK smaller company funds have just recorded their 36th consecutive month of outflows, and the number of local authority pension schemes with a dedicated allocation to UK smaller companies has fallen from 18 to just one over the past decade.

   
   

6. A negative feedback loop: the danger is that smaller listed companies have fallen into a self-fulfilling ‘doom loop’ of lower demand, lower valuations, lower performance, higher governance and regulatory requirements, and higher cost, which makes the market less attractive for issuers and investors.

   
   

7. Some good news: the good news is that there is nothing inevitable about the decline in UK smaller listed companies. There are plenty of examples in markets like Australia, Canada, and Sweden where smaller companies have been thriving. A concerted effort by government, regulators, and the industry can set smaller companies back on track.

   
   

8. Rethinking tax and incentives: ahead of the budget, we think it would be dangerous to abolish the tax reliefs on AIM stocks today. Instead, there is a strong case for proving longer-term certainty about these reliefs and the rates of tax, for extending the exemption from stamp duty on share trading from junior markets to all stocks outside the FTSE 100; and for perhaps introducing a lower differential rate of CGT and dividend tax for UK companies as is the case in Australia and Canada with dividends.

   
   

9. Rethinking demand: the priority in increasing demand should be to get more money into the system rather than focusing on channelling more money specifically into smaller companies, on the basis that a rising tide will lift all boats. Pension contributions need to urgently increase, stock and shares ISAs could be simplified and reformed to channel an additional £10bn a year into UK equities, and pension fund providers that have pledged under the Mansion House compact to invest more money in unlisted equities could allocate some of this to smaller companies.

   
   

10. Rethinking risk culture, regulation, and market infrastructure: wider reforms to reverse the culture of risk aversion, revitalise UK capital markets, recalibrate regulation and governance requirements, digitise the UK’s archaic and anti-competitive shareholder framework, and adopt a digital first approach to capital markets would help reverse this doom loop and turn it into a virtuous circle of growth and investment.