Today’s Finshots explains why the London Stock Exchange appears to be losing its appeal, and explores how things can turn around.
But before we get into it, we wanted to let you know about an exciting announcement we shared in Sunday’s newsletter. If you missed it, check it out here.
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Exactly 10 years ago, the London Stock Exchange (LSE) was the world’s third largest raiser of initial public offerings (IPOs). However, as of today, it has dropped to 18th place.
Meanwhile, countries you wouldn’t expect to see in the spotlight, such as Malaysia, Luxembourg and Poland, are booming. Australia and Saudi Arabia have solidified their status as IPO hotspots. and Oman’s Muscat Stock Exchange. Despite being a small market, only 1% of the UK, London is lagging behind.
So what’s going on?
First, the British economy is in a difficult situation. Borrowing costs have soared to levels not seen since the 2008 global financial crisis (GFC). For governments, this means paying much higher interest rates on borrowings such as bonds issued to investors.
Now, this sets off a chain reaction. First, a larger portion of the government’s budget will be eaten up by debt payments. In the last financial year alone, more than 8% of government spending went toward debt servicing. And second, the budget deficit, the gap between government revenues and expenditures, will widen further.
This means governments need to rethink their approach. They are now reluctant to borrow more just to cover day-to-day expenses. And there is talk of raising taxes to fill that gap, which could leave people with less money to save and spend. Lower spending means slower economic growth. And that’s a red flag for investors. And they choose to park their money in markets such as the United States, where they believe the prospects are brighter.
And when investors start pulling out, companies take notice. Why would they raise money or list their shares on the LSE if the market doesn’t have the money they need?
To put things into perspective, auditing giant EY found that a staggering 88 companies delisted from the LSE or moved their primary listing elsewhere last year. This is the highest number of companies leaving stock exchanges since the global financial crisis, and is certainly a worrying sign for a region that was once a thriving financial hub.
Now, I know what you’re thinking. The United States is by no means superior in terms of fiscal health. Its debt is over 120% of GDP, compared to the UK’s close to 100%. The budget deficit is also quite high at 7%, compared to 4.5% in the UK.
So why are investors still flocking to the US rather than the UK?
Well, a big reason is how the UK handles its debt. As you know, in 1981 something called inflation-indexed gold coins was introduced. These are simply government bonds, and both the principal and interest payments increase with inflation. And at the time, it seemed like a smart move, especially when inflation was low. But with inflation soaring, these bonds have become a financial headache.
To make matters worse, around a quarter of the UK’s government debt is linked to inflation, which is actually the highest proportion of any major economy.
And as you can imagine, this doesn’t exactly scream stability for investors. They are concerned about the increased costs to the UK government and the strain on public finances. Conversely, the United States, despite its own problems, appears to be a safer option because it has a more predictable system.
And when investors pull their money out of the UK, the LSE will find itself in trouble. Fewer investors means companies listed on the LSE are struggling to raise funds.
But there’s more to the story, as what we’ve talked about so far is only the big picture or basis of why LSE is losing its luster.
Let’s take liquidity as an example. As investment in the LSE declines, liquidity on the exchange dries up. Fewer stocks are being bought and sold, making it difficult for investors to make quick profits. And fund managers whose performance and fees depend on delivering results aren’t really waiting. They are reallocating more of their customers’ money to markets like the United States, home to powerful companies like Nvidia and Apple.
And this transition away from LSE creates a vicious cycle, a classic example of a destructive loop. When liquidity declines, more investors withdraw their funds, which further depletes liquidity.
That’s not the only problem. Reduced liquidity also affects the market value of companies listed on the LSE. British stocks are currently trading at a staggering 40% discount to their global peers, looking like a bargain for foreign companies waiting to be acquired, according to Bloomberg. Indeed, merger and acquisition activity targeting UK companies has soared by 80% this year, reaching more than $160 billion.
As a result, companies have left the LSE in droves. About 45 companies have been delisted this year alone, an increase of 10% from last year and the highest since 2010. It’s yet another domino in a loop of doom that will chip away at LSE’s place on the world stage.
However, LSE is not completely at the mercy of these external factors. This is partly to blame for the IPO drought and wave of companies exiting the market.
Tech companies in particular have long complained of its strict listing rules and lack of flexibility. For example, the old rules were strict and included requiring shareholder votes on certain transactions and banning dual-class shares that gave founders and major investors additional voting rights. These have made it difficult for companies to consider London as their home for listing, especially when other global markets such as New York or Singapore offer more attractive options.
But now the UK government and LSE seem to have woken up to this and have recently revised their listing rules.
Firstly, the LSE has simplified its listing categories. The confusing “premium” and “standard” categories that treated companies differently based on corporate governance and regulatory standards have been eliminated. There is now only one listing category for the shares of commercial companies, making the process easier and less bureaucratic.
Second, disclosure requirements for large transactions have been relaxed. Companies no longer require shareholder approval for transactions involving more than 25% of their assets or value. All you need to do is notify the market, which is much faster and less cumbersome.
And perhaps the biggest problem they solved was the dual-class stock problem. Previously, only founders or directors could hold these shares. But now institutional investors such as pension funds and investment companies can also hold them for up to 10 years.
Yes, these reforms are aimed at getting the LSE back into the competition and competing with its global stock exchange rivals.
But let’s be real. This is only part of the puzzle. It may persuade companies considering listing in London, but if the LSE really wants to win back investors, the UK government needs to tackle a bigger problem: rebuilding the economy.
Will they be able to pull it off? We’ll just have to wait and see.
Until then…
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