Exactly ten years ago, the London Stock Exchange (LSE) proudly held the third place globally for raising money through Initial Public Offerings (IPOs). But today, it has fallen to eighteenth place.
Meanwhile, countries you might not expect to be in the spotlight, such as Malaysia, Luxembourg and Poland, have surged ahead. Australia and Saudi Arabia have established themselves as the hubs for IPOs. Then there’s Oman’s Muscat Stock Exchange. Despite being a small market, barely 1% the size of the UK, it has overtaken London.
So what’s going on?
First, the UK economy is going through a tough time. Borrowing costs have skyrocketed, reaching levels not seen since the 2008 Global Financial Crisis (GFC). For the government, this means paying investors much higher interest rates on borrowings, such as bonds it issues.
Now, this sets off a chain reaction. First, a larger portion of the government’s budget is being eaten up by debt servicing. In the last financial year alone, more than 8% of government spending went to servicing debt. Second, the fiscal deficit, or the gap between what the government earns and what it spends, has widened further.
This means the government is having to rethink its approach. It is now reluctant to borrow more just to meet day-to-day expenses. There is talk of raising taxes to plug the gap, which could leave people with less money to save and spend. Less spending means slower economic growth. This is a red flag for investors. They then choose to park their money elsewhere, in markets like the US, which they see as having brighter prospects.
When investors start pulling out, companies take notice. Why would they raise funds or list their shares on the LSE if the market is not attracting the money they need?
To put things into perspective, auditing giant EY found that 88 companies exited the LSE or moved their primary listings elsewhere last year. This is the highest number of companies to leave the exchange since the GFC, and is certainly a troubling sign for what was once a thriving financial hub.
Now, we know what you’re thinking. The US isn’t exactly in perfect financial health either. Its debt is over 120% of GDP, while the UK’s is close to 100%. Its fiscal deficit is also a whopping 7%, compared to the UK’s 4.5%.
So why are investors still flocking to the US over the UK?
One big reason for this is how the UK manages its debt. In 1981, it introduced something called inflation-linked government bonds. These are government bonds where both the principal and interest payments increase with inflation. At the time, this seemed like a smart move, especially when inflation was low. But today, with inflation rising, these bonds have become a financial headache.
Worse still, around a quarter of the UK’s government debt is tied to inflation, the highest rate of any major economy.
You can imagine that this doesn’t exactly mean stability for investors. They are concerned about the UK government’s rising costs and the strain on its finances. On the other hand, the US, despite its own problems, seems like a safer investment with a more predictable system.
When investors pull their money out of the UK, this puts the LSE in a difficult position. Fewer investors mean that companies listed on the LSE have a harder time raising funds.
But there’s more to the story, because what I’ve told you so far is just the broader picture or the basis of why the LSE has lost its shine.
Take liquidity, for example. When investment on the LSE declines, liquidity on the exchange dries up. Fewer stocks are bought and sold, making it harder for investors to make quick returns. Fund managers, whose performance and fees depend on results, don’t wait any longer. They reallocate more of their clients’ money to markets like the US, home to big guns like Nvidia and Apple.
This shift away from the LSE creates a vicious cycle, making it a classic example of a vicious cycle. Less liquidity leads to more investors pulling out, which dries up liquidity even more.
The problems don’t end there. Low liquidity is also affecting the market value of companies listed on the LSE. According to Bloomberg, UK shares are currently trading at a staggering 40% discount to their global peers, making them great opportunities for foreign companies waiting to buy. In fact, M&A activity targeting UK companies has increased by 80% this year to over $160 billion.
As a result, companies are leaving the LSE at a rapid pace. Around 45 companies have exited the exchange this year alone, a 10% increase on last year and the highest since 2010. It’s another domino to erode the LSE’s position on the global stage.
But the LSE is not entirely at the mercy of these external factors. It is also partly responsible for the IPO drought and the wave of companies leaving it.
Tech companies in particular have long complained about the company’s strict listing rules and lack of flexibility. For example, the old rules were tough – requiring a shareholder vote on certain transactions and banning dual-class shares, which gave founders or key investors extra voting rights. These made it difficult for companies to consider London as a home base for listings, especially when other global markets such as New York or Singapore offer more attractive options.
But now the UK government and the LSE appear to have caught on and have recently revamped their listing rules.
First, the LSE has simplified its listing categories. Gone are the confusing ‘premium’ and ‘standard’ categories that treated companies differently according to corporate governance and regulatory standards. Now, there is a listing category for shares in trading companies, making the process easier and less bureaucratic.
Then, disclosure requirements for major deals have been relaxed. Companies no longer need shareholder approval for transactions exceeding 25% of their assets or value. They simply need to notify the market, which is much quicker and less cumbersome.
Perhaps the biggest challenge they’ve solved is dual-class shares. Previously, only founders or directors could hold these shares. But now, institutional investors such as pension funds or investment companies can also hold them for up to 10 years.
So yes, these reforms do give the LSE a chance to get back into the game and compete with its global stock market rivals.
But let’s be realistic. This is just one piece of the puzzle. It may persuade companies considering listing in London, but if the LSE really wants to win back investors, the UK government has a bigger problem to deal with – turning the economy around.
Can they do that? We’ll have to wait and see.