Three ideas to reinvigorate U.K. public markets
A debate over the health of the UK stock market is intensifying. At a multi-decade discount to its global peers, the FTSE All Share index of the UK’s leading public companies is under siege. High profile companies are being courted to shift their listing to the United States, whilst private equity investors are circling to pick off UK-listed companies seemingly unloved by public equity investors. Whilst the initial trigger for this malaise was the 2016 Brexit vote, there are well-founded fears are that negative sentiment towards UK stock markets has become entrenched amongst savers. So, what can be done to reverse the slide?
The first thing to note is that the Government, His Majesty’s Opposition, and the UK’s financial service regulators have twigged that there is a considerable problem. There is also a recognition that this is not solely impacting the UK’s bankers and barrow boys. The lack of a healthy capital market to raise money impacts the UK economy’s ability to scale-up investments in technology, new energy, and life sciences. The UK’s economy is a multi-cog machine, and capital is the grease that supports it.
This is a story about more than just the numbers. However the numbers do help illustrate the scale of the problem. The number of UK-listed public companies has recently shrunk to less than 2,000. There were more than 2,400 as recently as 2015. But it is also not just the total number of companies, it is also their scale. The total size of the UK stock market at £2.3tn is only marginally larger than the world’s largest company: Apple Inc. Companies like the gambling company, Flutter, the construction giant, CRH and the semiconductor designer, ARM Holdings, have recently chosen the US for the main listing, having previously raised capital in the UK. Advisers to the UK’s fastest-growing private companies, and investment companies, are looking at this backdrop and struggling to make the case for raising money and scaling on the UK stock market.
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. These are unlikely, however, to be gamechangers. The Shadow Chancellor, Rachel Reeves has been talking up the prospect of a £50bn UK growth fund, mandating UK-based fund managers to hold a minimum amount of their clients’ savings in UK assets. This has received a lukewarm reception from the pensions industry. When the Chancellor, Jeremy Hunt, delivers his long-awaited speech at the Mansion House later this summer he will lay out how his “Edinburgh Reforms” of the financial sector can change the narrative of investing in UK public companies. There are three practical suggestions – each rooted in sound economics of boosting productivity and UK growth – that he should consider.
The first of these would be reverting to UK-listed investments qualifying for ISA tax relief. At present the UK tax system is providing equal incentives for savers to fund UK growth as that in the US EU and Asia. This is despite the fact that the positive spillover into UK growth and employment is considerably lower from providing growth capital to foreign companies. Times readers may baulk at the prospect of an unlevel playing field for investing, but even a cursory glance at the US Inflation Reduction Act or EU Green Deal Industrial Plan will note that a race to fund domestic investment has begun. The UK does not want to be the friendly, open economy that comes last in that race!
The second would be to mandate the UK’s public sector pension schemes to allocate a minimum amount of their capital to UK-listed, or UK-domiciled investments. There is some debate on whether such a mandate should be widened to include all UK investment funds, but the case for limiting this to public sector schemes is more compelling. These are schemes whose beneficiaries – former public sector workers – get a guaranteed return. Members hold none of the investment risk. This investment risk is held by the wider taxpayer. The investment allocation decisions made by these funds should therefore be seen in the context of supporting UK growth where the benefits come back to these same taxpayers. This is not the case for private schemes that almost entirely see the investment decision shape saver returns. Here the state has no sensible role in mandating what assets they should be investing in, and risk replacing a market failure with a government failure.
Third, and perhaps most contentiously, there is an increasingly strong case for an additional tax on the purchase of passive investments. Passive investments are those that simply track indices such as the FTSE100, or the US S&P500. These investments, whilst cheap for savers, contribute next to nothing to the key social function of financial markets: funnelling capital to the most productive and innovative companies. This function is known as “price discovery”. It is the major social benefit of healthy financial markets – discovering prices and in doing so directing capital to the best companies. Passive investing makes no such contribution and simply enables the biggest and most established companies to gain a comparative advantage over smaller companies that are not part of established indices. The persistent discount that has now emerged on the UK’s smallest and fastest-growing companies is in large part due to this relentless shift to passive investing. A rapidly growing passive investment market creates a barrier to finance trickling down to insurgent, disruptive companies. It contributes to a stifling of competition. A transaction tax on passive investment vehicles, listed in both in the UK and overseas, can seed fund a UK sovereign wealth fund. Such a fund can use its financial muscle to support growing companies across the UK and fuel the technology and energy transitions now underway.
Three eye-catching reforms like these have the ability to change the perception of the UK economy as a place to grow a business, innovate and broaden the UK’s increasingly narrow tax base. There is little time to waste.
Author: Simon French, Chief Economist & Head of Research
Managing Director, Head of Research