The UK’s equity market is facing significant challenges with declining numbers of listed small
companies and capital outflows. Addressing this requires regulatory reforms and encouraging
pension funds to invest in UK equities to support economic growth.
Charles Hall
Head of Research at Peel Hunt
As a nation, we have a proud culture of stock markets and equity investment. Today, share trading is synonymous with London, but during my lifetime, regional markets did play a vital role in helping local businesses raise capital – the Northern and the Scottish Stock Exchanges to name just two.
Manchester’s own exchange came about with the birth of the cotton industry in 1836 and remained open until the 1960s. It was the desire for deeper trading pools and the increasing internationalisation of finance that led these markets to be merged with London. But when the common perception is that finance and trading is something done in gleaming glass towers in London, we should recall those regional roots – and remember that London’s equity market doesn’t just serve a small district of the capital, it is an engine room for our entire economy and its regions, playing a vital role in connecting the funds of savers with growth businesses.
Unfortunately, that engine has been misfiring badly of late. The number of listed smaller companies has been declining relentlessly in the past five years, down 30 per cent. There’s been a flurry of takeovers, and scarcely any listings to replace them. At the current pace, there won’t be a small cap index left by 2028, due to this “doom loop” of low valuations and lower liquidity.
Around £18 billion was pulled out of UK equity funds last year, depressing share prices and reducing the UK’s share of global markets. Lower valuations mean a higher cost of capital for companies and a competitive disadvantage compared to other markets. That, in turn, means little desire to IPO in London, and so the whole vicious spiral begins again. Even worse, we are now seeing companies choosing to move overseas to access a broader network of investors and higher valuations. This is currently a trickle, but it would become a flood if companies like Shell depart these shores.
Essential Regulatory Reform and the Importance of Growth
At Peel Hunt, we’ve been working with politicians, regulators, and the industry on how to fix this issue. There is a huge reform effort underway, which started with Lord Hill’s review in 2020. The prize is a simplified, competitive regime to encourage IPOs while reducing the complexity and red tape around fundraising for those companies who are already listed. At the same time, efforts are being made to revitalize research into listed companies and unlock the billions in funding from pensions and retail investors.
We have much, much more to do, however. City reform may not be a vote winner, but every politician worth their salt is interested in growth and the revenues that come with it to spend in all four corners of the UK. A thriving domestic equity market is a crucial element in super-charging a healthy UK economy – and my goodness, we certainly need that.
Encouraging UK Investment for UK Companies
Turning this around requires bold changes. This is why we are major advocates for a UK ISA, to encourage domestic investment. At the moment, UK savers are enabled to invest up to £20,000 overseas tax-free. People should of course be free to put their money anywhere they like, but it seems perverse to incentivise them to do so at our own detriment and expense. That’s especially true when there is no stamp duty to pay on the purchase of US shares, compared to over here where we have the second highest rate in the world.
The proposal for an additional allowance of £5000 to direct investment towards UK stocks is a good start – we think it could help raise at least £4 billion of investment – but we could go even further. Making the UK ISA free from inheritance tax, like AIM shares, would also encourage a culture of equity investment. So too would ending the situation where gains on gilts – the safest investment there is outside cash – are exempt from CGT, whereas those on shares are not. It’s hardly the way to encourage a more risk-taking, growth-orientated culture.
But these changes also need to come with a shift in attitude from our major investors, the pension funds. Our portfolio managers are creating global portfolios and putting their money elsewhere in the world, pushing their weighting of UK shares down from 44 per cent to just 4 per cent in the past 25 years. Individually, it might be a sound decision, but collectively, it’s disastrous.
We are very good at exporting our capital, but we’re not getting the benefits of other countries sending their own funds in our direction. AustralianSuper invests heavily in Australia and shouts from the rooftops about its contribution to the Australian economy. Contrast that with Nest, the UK’s largest workplace pension scheme, which is silent on its contribution to UK society and the economy.
The Chancellor has committed to introduce a reporting regime for pension schemes to disclose their allocations to UK equities, and not before time. But what we need to do is restore a sense of national pride. This is economic common sense, not flag-waving. Our UK investors are strong at early-stage seed and venture funding, but the truth is that the majority of big funding rounds are led by foreign investors. That’s why the Mansion House Compact, getting pension funds to invest 5 per cent of their funds in growth companies, is so vital to keep the future crop of listed companies coming through.
We speak to small- and medium-sized businesses all around the country. We want to float them here, so they employ more people here, invest here and generate tax here. With some smart policy and a change of attitude, we can turn a vicious circle into a virtuous one.
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