New rules for the UK’s equity markets

UK regulators have finally begun the process of reforming London’s ailing capital markets, beginning with updates to the listing rules.

Announced yesterday, the new rules will take effect on 29 July. The full list can be found here but, in summary, the key changes are to: 

• Simplify the regime by merging the premium and standard segments into a single “commercial companies” category
• Permit issuers to have dual class share structures which can confer greater voting rights on certain parties such as founders, institutions and sovereign wealth funds
• Abolish requirements for shareholder approvals on significant transactions and related-party transactions
   

What does this mean for markets and shareholders? Merging premium and standard segments removes unnecessary complexity and confusion for companies and investors alike, so is a welcome upgrade.

Permitting voting rights to be weighted in favour of certain shareholders will essentially benefit bigger, more powerful shareholders at the expense of smaller holders such as retail investors, wealth managers, and smaller boutique funds.

Abolishing requirements for shareholder approval on significant or related party transactions makes it easier for listed businesses to cut deals with minimal fuss and delay but also allows for deals that may not be in the best interest of the wider shareholder base to be pushed through. Company management could, for example, set up a relationship that favours another company under their ownership to the detriment of the listed business.

This loosening of the rules in the favour of company owners and managers may very well help to attract more companies to list in the UK. However, it may also make our stock market especially attractive to companies with intentions that are not entirely pure. If the changes did make for an influx of poor-quality businesses, it could erode the market’s essential quality of trust, causing investors to look elsewhere as a home for their money.

Furthermore, the key issue preventing London listings is not our strict regulations, as the US already has a more demanding regulatory environment. Capital outflows from UK equities have been the key long-term issue, exemplified by the fact that only 4% of the capital within UK funds is allocated to UK equities now; a huge fall from 44% in 1998.

This outflow has naturally resulted in the suppression of valuations. UK companies trade on lower average price earnings ratios than their US counterparts and this has been the key reason for companies choosing New York ahead of London. If we can address this issue liquidity will improve, valuations will rise and more companies will be tempted to list on the UK market, without the need to loosen shareholder protections and risk damaging trust in the market.

There has been a myriad of suggested solutions to help improve the situation, some examples of which include:

• Mandating pensions and certain life funds to place a minimum percentage of their funds in listed and unlisted UK equities. This may not be entirely feasible, as fund managers’ responsibilities should be to those whose money they manage rather than UK corporates. However, the government provides these funds and pensions with considerable tax breaks which could be removed or reduced for investments made abroad
• Abolishing the MiFID 2 measure that banned buying research through commissions on trades. This laudable development was introduced to provide transparency for clients who could then see what research they were paying for. However, brokers were then forced to absorb these costs and reduced the amount of research they paid for leading to less quality research in the market and ultimately less liquidity
• Abolishing or reducing stamp duty on UK share purchases. Similar to the above point of removing tax breaks for investing abroad, greater tax incentives could be provided for investing in UK equity, whether in the form of reduced stamp duty or capital gains taxes. An additional £5k annually of CGT exempt ISA allowance is now available for investing in UK stocks but this is a drop in the ocean in comparison to the potential impact pension funds could provide
   

Although yesterday’s reforms don’t fully address the issue of capital outflows they are, ultimately, a step in the right direction. The UK’s capital markets desperately need a course of medicine, and this is a welcome first dose.

While these moves have been led by the FCA, they align with the wider agenda of the new government to revive the UK's capital markets. The Chancellor, Rachel Reeves has pledged to take the previous government’s Edinburgh Reforms further and undertake a comprehensive review of how UK pension funds invest in UK markets and productive assets.

Hopefully, this is a signal that the government is determined to get on with the job and do whatever it takes.  With these reforms in the bag, they can hopefully now begin looking at some of the more impactful suggestions mentioned above.