Report: The wider context on UK public equity markets
January 2021 • Capital markets • by William Wright
One of the biggest challenges and opportunities for UK capital markets is how to reinvigorate the new issue market and to make listing in the UK more attractive to UK and international companies alike.
Our latest paper ‘The wider context on UK public equity markets’ is our submission to the UK listings review, being led by former European Commissioner Lord Hill. We are delighted to have hosted two events this week with Lord Hill to debate the wide range of range of perspectives on one of our favourite topics with different market participants.
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The report provides a wide-ranging and long-run analysis of the shifting trends in the UK, US and global public equity and new issue markets. It shows that while the listings process and regulations in the UK can always be improved, the causes of the relative decline in public equity markets and new issues over the past 25 years are more structural – and will therefore require a wider strategic response.
The paper is in the form of a slide presentation with notes and has a lot more charts than words. It updates and expands our report from 2019 on ‘What are stock exchanges for? And why should we care?’ that we published in collaboration with Pension Insurance Corporation.
Here is a 10-point summary of our paper on the UK public equity and new issues market:
1) Why public equity markets and IPOs matter: without equity there is no other finance. Equity markets drive growth and investment by providing long-term risk capital to companies; they fuel innovation and productivity growth; they democratise wealth creation; they set standards in governance and accountability; and they support the social licence for business and finance. Post-Brexit the UK can build on its position as the dominant market in Europe for IPOs and the second biggest market globally for international IPOs.
2) A structural decline: over the past 25 years, public equity markets in developed economies have been in structural decline. While stock markets are bigger, deeper, and more liquid and more efficient than ever, the number of companies listed on them in developed economies has roughly halved, the value of new issues has fallen by two thirds, and the number of new issues has dropped by three quarters.
3) The international context: the UK has the largest stock market in Europe and one of the deepest stock markets (relative to GDP) in the world. It has more than twice as many listed companies as the next biggest market in Europe. It also has the largest and deepest IPO market in Europe, and relative to GDP IPO activity in the UK is slightly higher than in the US (in the three years to 2019).
4) So, what’s the problem? Over the past 20 years the number of listed UK companies (including the main market and AIM) has nearly halved (-44%), the value of new issues has fallen by around two thirds in real terms to about £5bn a year, and the number of new issues has dropped from over 400 a year at its peak to less than 100. A small but significant number of high growth UK companies have opted to list in the US instead of London.
5) The main drivers: we think there have been three main drivers of this decline in developed markets:
- the rise in alternative sources of capital, particularly private equity and venture capital, and abundant cheap debt
- the perceived and real increase in regulation, disclosure and governance requirements for listed companies and the ecosystem supporting them
- a structural shift in the banking and finance industry towards scale and technology, which has created a hyper efficient market for larger companies but made listing much less attractive for smaller companies and the ecosystem that supports them.
6) The US and UK new issue markets: there are a number of key differences between the IPO market in the US and the UK:
- A different path: since 2015 the value of IPOs in the UK (by UK and overseas issuers) has declined by more than 55%, while the market in the US has more than quadrupled. Last year, the US market was more than 20 times larger than the UK: as recently as 2015 it was just twice as big.
- The SPAC surge: 60% of the growth in the US market since 2015 has come from SPACs (special purpose acquisition companies or cash shells), which last year accounted for half of all IPO volumes in the US. In the UK, the tighter regulatory process for SPACs has limited activity: since 2015, SPACs account for just 6% of IPO activity in the UK, compared to a third in the US.
- Growth companies: the US IPO market is a growth company IPO machine. Over the past decade technology and growth companies have accounted for just over half (52%) of the value of all IPOs in the US (compared with 26% in the UK) and nearly 60% by numbers (27% in the UK).
- Scale: the UK IPO market is dominated by smaller companies. Adjusted for inflation, 65% of all IPOs in the UK raised less than $100m in the past decade, while 62% of US IPOs raised more than $100m (there have actually been more IPOs in the UK raising less than $50m than in the US).
- Capital raising vs exiting: the UK IPO market is geared more towards existing shareholders exiting their investment while the US market is more about raising new capital to invest in the business. Over the past decade, 86% of funds raised in the US IPO market were new shares, compared with just under 60% in the UK.
- Private equity: since the financial crisis, private equity and VC firms have accounted for a significantly higher percentage of IPO activity in the UK than in the US (although this gap has closed in the past few years). Private equity firms in the UK sell a significantly higher chunk of their investment in the IPO than they do in the US, and a high proportion of new shares is used to pay down high levels of debt.
- Dual class shares: the number of IPOs in the US by companies with dual class share structures has more than doubled over the past 20 years to over 20%. This has been driven by tech IPOs, where more than a third of companies in recent years have dual class structures. In the UK, just 4% of the stock market has dual class structures.
- Free floats: US companies have a significantly lower free float on listing than their UK counterparts. The median free float for UK IPOs over the past decade is 43% compared with 26% in the US. Less than a fifth of UK IPOs have a free float of less than 25%, compared with half of all US IPOs.
7) The international picture: the UK is the second largest market for international IPOs after the US with a global market share of 17% (compared with 67% for the US): since 2015 around 90 overseas companies have IPOd in London raising $18bn. The US dominates the market for international tech IPOs with half of all IPOs by number (144) and two thirds by value ($33bn): that’s five times bigger than the UK’s share of international tech IPOs.
8) The opportunity ahead: there is a significant opportunity for the UK to increase listings in at least four specific areas:
- make listings more attractive for all UK companies by rethinking the wider listings framework and the tax treatment of equity.
- reduce the ‘leakage’ of high growth companies from the UK to the US market: since 2015, 32 UK companies have raised more than $5bn listing overseas. More than two thirds of these companies listed in the US – all of them were tech or biotech companies, or SPACs.
- a specific focus on sectors where the UK has a clear advantage, such as fintech and advanced manufacturing. For example, the UK dominates the European market for unicorns, with 28 out 63 companies worth an estimated €53bn (out of a European total of €128bn)
- target regions where the UK already has a strong share of international listings such as Europe (UK share of 46%) and the Middle East, Africa, and Central Asia (UK share of 57%), where local markets may not be able to accommodate bigger companies.
9) Rethinking the listings process: we think there is scope to explore tweaks to the listings requirements in the UK. Any changes would obviously need to be carefully balanced with the needs and concerns of investors. The UK could explore the following:
- allow a defined group of tech / growth companies with dual class share structures to list on the premium segment with a three to five-year sunset clause
- allow slightly lower free floats for tech / growth companies in the premium segment with a three to five-year sunset clause
- simplify and reduce the prospectus requirements for follow-on issues
- in conjunction with a) and b), perhaps include a minimum proportion of new shares in IPOs, to reduce perceived ‘dumping’
- potentially review the SPAC regime
10) Recalibrating the wider framework: in addition to rethinking the listings framework, there is scope to address the more structural factors that act as a drag on public equity markets and new issues:
- rethink the differential tax treatment of debt and equity finance (perhaps experiment with equity tax credit / notional interest deduction as used in Belgium);
- reduce the disclosure gap between private and public companies;
- encourage a longer-term approach to investing through the chain (by asset managers, asset owners, investment consultants and companies themselves)
- and for the industry and policymakers to work together to rethink the IPO process and set up industry-wide initiatives to support smaller companies.