The Main Market of the London Stock Exchange (particularly the Premium Segment) is an important component of the UK financial sector. As the UK seeks to maintain and develop its post-Brexit position in financial services, it will be vital to ensure that the UK equity market remains a major global hub for equity issuance and trading. In that context, Lord Hill’s Review of the UK listing rules, commissioned by the UK Government, is extremely timely. This article provides a summary of the IoD’s contribution to that Review.
Although the UK equity market has been an essential source of funds for issuers during the pandemic, the longer-term trends in terms of the market’s competitive position are not encouraging. In recent years, the UK has slipped down the global league tables for equity issuance and IPOs – well behind the main equity markets in the US and Asia. In contrast to the situation in Asia, the number of companies listed in the UK (on the Main Market and AIM) is in long-term decline, having more than halved since the peak of the late 1990s.
Furthermore, as in other jurisdictions, many fast-growing companies – particularly from science, technology and innovation-oriented sectors – are choosing to remain in private hands for much longer than historically has been the case. Private equity funds, venture capitalists and other specialist investment vehicles (such as VisionFund) have provided an alternative to public markets in terms of risk capital financing. This has underpinned the emergence of the ‘unicorn’ phenomenon on both sides of the Atlantic – privately held companies with an imputed market capitalisation in excess of $1 bn.
These are not necessarily positive developments from a corporate governance perspective. Most developed frameworks of governance are embedded in corporate governance codes and listing requirements which are only applicable to listed companies. In contrast, even relatively large private companies continue to operate within a relatively thin governance regime. Both in the UK and US, there have been numerous examples of private companies that have become extremely large and systemically important without a commensurate evolution of their governance framework. This can and does lead to detrimental long-term outcomes for both the company itself, its stakeholders and the overall reputation of the business system.
There is hence a need to encourage more innovative firms to list on public markets – not only to obtain capital for future growth, but also as mechanism through which they can develop their governance. A public listing also provides the wider investing public with a means by which they can directly participate in the high growth phase of future technology giants – an opportunity from which they are in many cases currently excluded.
Some potential issuers are partially deterred from seeking a listing on public markets by the extra costs and bureaucracy - 6% or more underwriting fees, for example, are arguably excessive. However, a more pertinent concern for potential issuers is the exposure to market short-termism that comes with a capital market listing.
Various asset managers active in public markets demand short-term share price outperformance or significant dividend payouts from their investee companies. Those companies that are either unable or unwilling to fulfil these expectations are vulnerable to significant declines or volatility in their share price. This is in turn may be associated with unwanted attention from activist hedge funds or hostile bidders demanding restructuring of the company and/or its board of directors in favour of the delivery of short-term returns.
Such market myopia has been well documented (e.g. by the Kay Review of UK Equity Markets, 2012), and is a particular concern for high growth, innovative companies that are seeking to commercialise the latest developments in science and technology over a relatively long time horizon (e.g. 5-10 years or more). It’s also a major reason why any kind of firm undergoing a high risk phase of restructuring or development may choose to either remain private or be taken off the market by a private equity buyer.
Given the higher risk and uncertainty associated with their business models, innovative companies seeing to exploit novel scientific or technological innovations require a ‘patient capital’ approach to company ownership. There is hence an urgent need to create a more welcoming listing rules environment for innovative companies that reflects their specific needs and circumstances.
However, any changes to the listing rules must be evaluated against the need to enhance rather than diminish the UK’s reputation for world-class corporate governance. It would ultimately be self-defeating for the UK to engage in a ‘race to the bottom’ in order to win extra listings if the longer term consequence were a big increase in corporate collapses and scandals - which could cause irretrievable reputational damage to the UK as a financial centre.
The UK listing rules must hence find a way to appropriately balance the existing shareholder powers of asset managers with the emerging governance needs of innovative companies. This may imply that a ‘one-size-fits-all’ approach to listing rules within the premium listing category is no longer optimal. Slightly differing approaches may be justified for different types of issuer, depending on the nature of their business activity and/or stage of development.
Creating a discrete segment of the existing premium listing category which is devoted to innovative high-growth companies would offer a way in which to achieve this. Within this segment, innovative companies could be permitted, under strict conditions, to undertake IPOs or equity issuance with dual class share structures which deviate from the current principle of ‘one share, one vote’.
A share class with multiple voting rights (e.g. shares having 10 or more votes per share) has the potential to allow an anchor shareholder or founder to maintain control of a company for a pre-determined period (e.g. 7-10 years). This could improve the capacity of innovative companies to adopt a longer-term investment horizon for a finite period of time – with less vulnerability to the unwanted attentions of short-term oriented activist hedge funds or hostile takeover approaches.
However, such a shielding from investor activism should be time-limited and non-transferrable in nature. Such an approach would not be appropriate for more mature companies in the mainstream segment of the market – where a high level of ongoing accountability to shareholders remains a valid governance safeguard.
Regardless of shareholder structures in different market segments, certain features of the premium listing framework should remain non-negotiable and universally applicable. For example, all premium-listed companies should remain subject to the UK Corporate Governance Code. A high level of corporate transparency should be demanded of all issuers. In that context, informative issuer prospectuses, rigorous external audit and ongoing disclosure requirements remain important features of such a transparent listing regime.
The listing rules should also not compromise in terms of continuing to require independent oversight of significant and related party transactions by independent board members and independent shareholders. They should also encourage a strong business commitment to sustainability, the transition to a net-zero economy, and a culture of corporate social responsibility.
In summary, the listing rules should recognise that there is a balance to be found between the preferences of asset managers for short-term shareholder accountability and the need of innovative companies for a stable and committed ownership structure.
A listing regime which favours one perspective rather than the other will do little to maintain the position of the UK equity market or further the cause of good corporate governance.
Dr. Roger Barker is Director of Policy and Corporate Governance at the IoD