Public markets have shown their worth during the crisis, we need to sustain them

By Stuart Andrews, Managing Director at UK financial services firm and broker finnCap

Despite their many detractors, the public markets have proved their worth for both corporates and investors alike since the pandemic struck, with up to £16bn so far being raised in the UK. Nevertheless, the fact remains that the number of quoted companies has dwindled, we have seen limited numbers of IPOs and the general liquidity pool is slowly evaporating for growth companies. While the reasons are many, government tax policies and regulations designed to protect investors are key areas that have contributed to this – but there is a way to address these concerns and it is now time to do so as public markets are critical for funding growth.

Public markets on the wane?

Given the amount of column space devoted to the decline of publicly listed companies, you could be forgiven for believing that the public markets were now redundant and listed status a quirk of an evolving capitalist system. This is particularly true of the smaller end of the market where growth companies are largely unnoticed by the mainstream press unless there is a corporate mishap. We often hear about declining volumes of shares traded and the availability of vast amounts of private capital, while the statistics that between 1996 and 2016 the number of listed companies in the United States fell from 7,300 to just 3,600 or that AIM has fallen from 1650 to 863 companies between 2007 and 2020 seem to be wielded at will.

The last few months should prompt a serious rethink of this overarching narrative. Many companies have had a pressing need to raise capital given such dire economic conditions, and those that are publicly listed have been able to do so, accessing more capital, more quickly, than has proved possible in the private market. It is not an exaggeration that, for many, being publicly listed has represented a real competitive advantage. And it is not just companies in distress who have benefited, those looking for funds to develop Covid-19 related products, or who are strengthening balance sheets to capitalise on future opportunities have done so as well.

Benefits for investors, both institutional and retail

Alongside corporates benefiting from public markets, investors are granted access to liquidity and transparent pricing which allows capital to be released for new issuance and deployed effectively whenever opportunities arise. Investors also benefit from levels of disclosure and protection enshrined in UK law or in the rules of the exchange that ensure that the pricing of liquidity is fair to all concerned. And strikingly, it has not only been institutional investors who have been keen to invest: in recent weeks retail investors have represented over 20% of the volume on the FTSE All-Share, with 60-74% of this being buy orders. UK stockbroking platforms are also reporting over threefold increases in new account openings.

Tax policies and regulation inhibit growth companies – plotting a path forward

So why, despite the benefits of public markets to raising capital and investing, are we not seeing more IPOs and greater liquidity in growth companies? It is a complex area, but government tax policies and regulations designed to protect investors are both combining to make the public markets not as easy as they should be for smaller companies and investors alike.

Change is needed to make companies consider turning to public markets first, and to reverse the fact that more companies are leaving public markets than joining.

Capital structure ownership – limit the amount of interest that is tax deductible

Given that interest is tax-deductible, private equity that owns the whole capital structure is at an advantage compared to a passive equity investor that only owns the equity and therefore has less appetite for leverage. The effect of this is to lower the cost of capital to private equity, allowing much higher valuations for businesses ideally suited to the public markets. There should therefore be a rethink of this tax benefit to limit the amount of interest that is tax deductible, so costs of capital are more comparable.

Review regulation that results in the need for larger funds

As regulation has grown, funds have had to become larger to be run profitably, leading to industry consolidation and larger portfolios. Additionally, private client funds are increasingly run on a model portfolio, which also increases the unit size of these funds and limits discretion.  A fund can only sustain a limited number of positions, and so the larger the fund, the larger the companies in which it must invest. Savings are therefore increasingly exposed to the same pool of larger companies, which is a disservice to the underlying clients. Hence by reviewing regulation for institutional fund managers and retail investors, the overall market could benefit – with the risk profile for the individual retail client remaining unchanged.

Democratise access to research and corporates

A key contributor to market liquidity is the private individual. Yet, ironically, they are being increasingly locked out of public markets by regulations designed to protect them. This locks them into exposure to large corporates or execution-only accounts and penalises companies that do deal with them. The City of London therefore revolves around institutional stockbrokers that act on behalf of corporates but are reluctant to deal with retail clients, putting individuals at a disadvantage when it comes to research and corporate access. It is why initiatives such as PrimaryBid and Investor Meet Company are important – they help level this playing field and create equal access to all market participants.

Raise Prospectus Regulation limit

Finally, a significant bottleneck on liquidity is that it is not currently possible to include private investors in fundraises to a quantum higher than €8m without producing a time-consuming prospectus. Issuance is therefore increasingly spread over limited institutions while pre-emption rights have largely been eradicated. Little investor detriment seems to have come from increasing the Prospectus Regulation limit from €2m to €8m, so it is time to consider increasing this again to €20m. Indeed, after Brexit, this decision will rest in the hands of the UK Government and can be denominated in Pound Sterling.

Conclusion

Getting tax policy and regulatory oversight right is a tricky, but necessary, balancing act. Yet, as it stands, some are acting to the detriment of growth companies and investors on public markets that have truly shown their worth during the pandemic. It’s time for a rethink so the growth companies that will drive the recovery get the funding they need.