The debate about the UK stock exchange is heating up. The FTSE All-Share Index of London’s largest public companies, which has a discount on its global peers that spans decades, is under attack. Private equity investors are trying to grab UK-listed companies that are not loved by equity investors. The 2016 Brexit vote was the catalyst for this malaise, but there are also well-founded concerns that the negative sentiment toward Britain’s stock markets has been entrenched by savers. What can be done to stop the decline?
First, it is important to note that both the government and the financial regulators are aware that there is an enormous problem. The government, the opposition and financial services regulators have all acknowledged that there is a significant problem. The British economy has many cogs and capital is its grease.
The numbers are not the whole story, but they help illustrate the magnitude of the problem. The number of UK-listed companies has dropped to under 2,000. In 2015, there were over 2,400 companies. It’s not just about the number of firms, but also their size. The UK stock exchange is just marginally bigger than Apple, the largest company in the world. Flutter (the gambling group) and Arm Holdings (the semiconductor designer) have recently chosen America as their main listing, after previously raising capital in Britain. The UK’s fastest growing private companies are looking into this, and their advisers are trying to convince them to raise money and scale on the London Stock Exchange.
Government-commissioned reviews into listing rules, independent company research, the bespoke requirements of the technology sector and more agile and competitive regulation have been welcome, but these are unlikely to be game-changers. Rachel Reeves is the shadow chancellor . She has talked up the prospect for a £50 billion UK Growth Fund, which would mandate UK-based funds to hold at least a certain amount of clients’ savings as UK assets. Pensions industry has reacted with a cool reception to this.
Jeremy Hunt will explain in his Mansion House Speech this Summer how his “Edinburgh Reforms”, of the financial industry, can change the narrative about investing in Britain’s publicly traded companies. The chancellor must consider three suggestions that are based on sound economics and aimed at boosting growth and productivity.
First, UK listed investments would qualify for Isa relief. Currently, the tax system in the UK offers the same incentives to savers as it does for those living in the United States or Europe. The positive impact on domestic employment and growth is much lower when foreign companies are given growth capital. Even though Times readers might balk at an unfair playing field, a quick glance at The Inflation Reduction Act of the US and The EU’s Green Deal Industrial Plan shows that the race to fund investment in domestic companies has already begun. Britain doesn’t want to be that friendly, open economy at the end of that race.
Second, British public pension schemes would be required to invest a minimum of their capital in UK-listed or UK domiciled investments. Some debate exists on whether this mandate should include all UK investment schemes, but it is argued that it is best to limit the mandate to public sector pensions. The beneficiaries of these schemes — ex-public sector employees — receive a guaranteed return. The wider taxpayer is responsible for the investment risks, not the members. These funds should therefore be viewed in terms of how they support UK growth, where the benefits are returned to the same taxpayers. Private schemes, on the other hand, are largely influenced by the investment decisions. The state cannot dictate what assets should be invested in.
Flutter Entertainment, which owns Paddy Power and other brands, turned to the United States for capital.
Thirdly, and perhaps most controversially, there are increasing arguments for a tax increase on passive investments. Passive investment is simply tracking indices like the FTSE 100. While these investments are cheap for investors, they do little to contribute to the social function of the financial markets, which is to funnel capital to the most innovative and productive companies. It is called “price-discovery” and is the major social benefit of a healthy financial market. By discovering prices, it directs capital to the most innovative and productive companies.
Passive investing does not make a contribution to this. It simply allows the largest and most established firms to gain a relative advantage over smaller companies that aren’t part of established indexes. This shift towards passive investing is largely responsible for the persistent discount on Britain’s fastest-growing and smallest companies. The rapid growth of passive investments creates barriers to the flow of finance to disruptors. This can stifle competition. A transaction tax on passive investments listed both in the UK as well as overseas can be used to seed fund a UK sovereign funds. A fund of this kind can be used to provide financial support for growing businesses in the UK, and help fuel the energy and technology transitions currently underway.
These eye-catching reforms can change perceptions of Britain’s economy as an ideal place to start a business, innovate, and expand the nation’s narrow tax base. It is not time to waste.