OPINION OF THE WEEK: Fixing London's Sluggish Stock Market

Tom Burroughes Group Editor London 7 June 2024

OPINION OF THE WEEK: Fixing London's Sluggish Stock Market

Whether it is enabling entrepreneurs to efficiently exit a business (creating new HNW individuals) and allowing the public to easily win a stake in the economy, a thriving stock market is a must. While not the only stock market to be under a cloud, there appears to be a chorus of concern about London's famous market, and what to do about it.

The UK equity market is suffering from poor relative performance compared with its global peers, firms are de-listing or heading to foreign homes such as the US Nasdaq. Both major UK political parties appear to want to squeeze wealthy foreigners such as resident non-doms. However one tries to spin it, the UK isn’t sending out lots of friendly vibes for domestic or international business. (And let's not even get into the state of the country's airports.)

At a breakfast briefing in London this week with Pictet Asset Management, your correspondent noted that while Japanese equities (yes, really!) delivered total returns of 15.5 per cent per annum over the past five years (MSCI, local currency terms), the UK was less than half of that, at 6.7 per cent. Over the next five years, Pictet has returns (in dollars) of 6.7 per cent for the UK. The highest placed, by the way, are Swiss equities, at 11.3 per cent.

With voters due to vote on 4 July – continuing a busy year of elections around the world – the state of the UK stock market and “UK Plc” might not yet register as high a concern as potholes in roads, high net migration, long health service waiting lists or low crime clear-up rates. As I said in a previous column, the “Overton Window” of what is politically discussable has regrettably shifted Leftwards – more government intervention, more tax, and more regulation. For some, this goes counter to what Brexit was supposed to be all about.  

But because it is now outside the European Union and in an increasingly (sadly) protectionist world, the UK needs to work harder than ever before to prove its competitive edge. I think so far it is coming up short.

True, there are some signs of progress. The UK Financial Conduct Authority is considering bringing back research “bundling” so that asset managers and other buy-side firms – including wealth managers – could pay for research in a package covering other services. Under the MiFID II reforms introduced (January 2018) when the UK was still an EU member state a few years ago, this packaging of services was stopped. “Unbundling” of research was designed, so the argument went, to weed out bias, kickbacks of commissions and to protect investors. But the culling of analyst coverage of stocks, particularly among small and medium-sized firms, has hit stock market activity and liquidity. It also, arguably, hit the ability of investors to efficiently execute on some ESG ideas. A classic case of the Law of Unintended Consequences. 

Other measures, such as the Senior Managers Regime, GDPR privacy regulations under the EU and tighter domestic UK rules about non-executive directors, can all be individually justified as protecting market resilience and good conduct. Inevitably, however, they collectively raise the cost to firms of doing business. Barriers to entry become more severe. And with listed firms having far more disclosure requirements than for unquoted ones, it’s not surprising that more businesses are getting snaffled up by private equity. The latter trend, one seen around the world, explains in part why there’s so much focus on private market investing these days. It’s where the action is.

Jeremy Hunt, UK Chancellor of the Exchequer, and his opposition shadow, Rachel Reeves, want to play the patriotic card by trying to fix these issues. In his March budget, Hunt came up with the idea of launching a British ISA, or “BRISA,” which would encourage investors to support UK-based firms. In Reeves’ case, she wants to create a framework that will allow insurers and pension funds to invest alongside the British Business Bank. Another possibility is changing tax rules and other laws to stimulate equity holdings. The specifics aren’t clear. One idea doing the rounds on the newswires is creating a sort of UK sovereign wealth fund, a bit like the SWFs that operate in Norway or Singapore. The London-based think tank Turning the Page (source, Bloomberg, 4 June) suggests selling the state’s stake in NatWest Group and reinvesting the proceeds in a SWF seeded with small and mid-sized UK stocks. 

Another idea from the think tank is pension tax breaks contingent on partial allocation of fund assets to the UK. Mention of pension funds is also a reminder that under UK accounting rules, final-salary pensions (admittedly a dwindling group) must hedge expected liabilities with AA-rated sterling debt. This meant that, for the past 20-plus years, pensions have shifted allocations from stocks to bonds. That was a nice way for the Treasury to sell its gilts, but not so good for the equity market. 

So far, while some politicians have talked about how the City of London financial market has a problem, there isn’t the kind of high-volume commentary on it to suggest that it will be a big priority for whoever is in power from 5 July. PIMFA, the UK trade association for wealth management, possibly spoke for a lot of wealth managers by urging the next government to focus on removing barriers to investment rather than creating new products like the BRISA. 

“PIMFA does not consider that historic underinvestment in the UK represents a market failure which can be addressed through the creation of yet another ISA wrapper. In its response it suggests the next government could stimulate UK investment further by abolishing Stamp Duty of UK share purchases or reversing the gradual erosion of investment allowances such as the capital gains tax and dividend thresholds,” it said in a statement yesterday. 

“We do not believe the UK ISA represents a compelling market opportunity for firms. Feedback from our members suggests only marginal value can be found as an additional £5,000 annual top-up if it corresponds with the client’s risk appetite. This would benefit a maximum of 7 per cent of ISA savers that reached their maximum ISA allowance in 2023/24,” PIMFA said. 

Another problem with Hunt’s ISA idea is that it could fall foul of the new Consumer Duty regime that went live at the end of July 2023, PIMFA said. The “British” ISA would have a highly restricted universe of equities to hold – at odds with ideas about diversification of risk and other requirements that regulators usually insist on.

Of course, there is nothing wrong in principle in using tax-advantaged structures, but I agree with PIMFA that it makes more sense to lighten regulatory burdens and cut taxes than create yet more structures – and add to the complexity of the tax code. It is true that other countries can set rules to steer capital into domestic markets, as Singapore has done with revised family office regulations, to give one example. 

One suspects that, given the state of public finances and the political convictions of Reeves – who on current opinion polls seems most likely to be the next finance minister – we are unlikely to see PIMFA’s wish list on tax cuts come to pass. (Well, you never can say never, I guess). But radical action of some kind will be needed to put fizz back into the City. 

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