How Big Bang 2 can win back the City's crown

Almost 40 years on from UK financial services’ Big Bang, calls for a second round are growing. The 1986 reforms, made when London was struggling to compete against New York and Asia, fundamentally changed how the City operated. The old system of clubbable, protectionist finance was no more as deregulation took hold. Firms could now act as both brokers and ‘jobbers’ (market makers). Fixed commission on trades was done away with. And electronic trading was introduced, meaning fewer screaming orders in the exchange pits.

Those changes helped London re-establish itself as a major financial centre. Now, a time when critics say London is once again losing its edge, the stage is set for something similar. There are fundamental contextual differences: London has gone through both the 2008 financial crisis and Brexit, which have fundamentally altered the competitive and regulatory landscape from that seen in the 1980s. The raft of measures was outlined in last December’s proposals labelled the ‘Edinburgh Reforms’, but are seen by others as something closer to a new financial services revolution: Big Bang 2.0.

The wave of reviews and reforms are being pushed by government, financial regulators, the exchange, independent trade bodies and notable City figures in a bid to boost London’s competitiveness, spurred on most recently by the sight of several high-profile UK companies seeking to list overseas.

Some are at a more advanced stage than others. The Financial Services and Markets Bill (FSM), currently at committee stage in the House of Lords, is the government’s flagship piece of post-Brexit financial services legislation. The bill revokes and domesticates “hundreds of pieces of retained EU financial services law”. It also gives the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA) a new “secondary objective” of advancing the UK economy’s competitiveness and growth.

Alongside this comes reform of the EU Solvency II directive, which governs capital and regulatory requirements for insurers. The aim of the new domestic regime, known as Solvency UK, is to boost UK investment in long-term illiquid assets through loosening capital restrictions.

London-listed insurers such as Aviva (AV), Phoenix (PHNX) and Legal & General (LGEN), which has noted that it expects to invest more in UK-based assets because of the reform, will be impacted by the proposals. Deutsche Bank Research analyst Rhea Shah thinks that the reforms will be “only marginally positive for the UK annuity providers”, but the impact on the UK economy could be more significant.

Regulators have concerns – PRA head Sam Woods told the Treasury select committee that “the reform package as a whole increases risk” – but industry has welcomed the overhaul of the solvency regime.

Confederation of British Industry (CBI) financial services director Flora Hamilton says “Solvency UK is very important for unlocking capital in two key areas – clean energy infrastructure projects and productive finance.” The Association of British Insurers thinks the reform “can unlock £100bn for investment”.

Freeing up capital

Increasing the pools of capital available to UK businesses and UK infrastructure projects is a fundamental goal of many of the reforms. The first bullet point on the Edinburgh Reforms’ 30-strong list (see summary box) is a reform to the ring-fencing regime for UK banks. Current rules make banks with more than £25bn of retail deposits separate their retail and investment banking arms. The government plans to take banks “without major investment banking operations” out of the regime and will consult this year on raising the deposit threshold to £35bn. It is also scrapping the EU law on capping banker bonuses.

Karen Bradley MP, the chair of the all-party parliamentary group on challenger banks and building societies, said of the ring-fencing proposal that “the existing regulation effectively acts as a subsidy for big banks, making competition impossible. This move will be welcomed by challenger banks, building societies and especially mid-tier banking institutions”.

It would not be surprising if banking reform is slowed or diluted, given the current uncertainty in the sector after the collapse of Silicon Valley Bank and its reverberations. But one aim of the policy, from the government’s point of view, is similar to others: the idea is to free up bank capital for investment elsewhere.

When it comes to business investment, pension funds are also in the spotlight. A recent joint report from Tony Blair and William Hague referenced a paper from the British Private Equity and Venture Capital Association on how overseas pension funds invest 16 times as much in UK venture capital and private equity than their domestic counterparts. “The UK has continually struggled to deliver a sufficient scale and volume of patient and growth capital to the country’s start-up companies,” the report said.

There are several plans for pensions, from the Edinburgh Reforms’ aim of “increasing the pace” of defined-contribution (DC) pension scheme consolidation, seen as a key area of reform by London Stock Exchange head of equity and fixed income primary markets, Charlie Walker, to more modest changes such as excluding what the government calls “well-designed” performance fees from the pension charge cap. This “should enable pension funds to consider investing in more alternative assets including illiquid and productive assets through investment companies”, according to Association of Investment Companies chief executive Richard Stone. 

Fund structures themselves are also being overhauled. A UK long-term asset fund (LTAF) framework, designed to encourage a focus on long-term time horizons, will replace the inherited and little-used EU equivalent. The FCA authorised the first LTAF earlier this month. 

The CBI’s Hamilton said “we are very supportive of the LTAF, which should be able to encourage the trustees of DC schemes to use these funds to achieve growth through less liquid investments”.

As these shifts imply, DC schemes are seen as vital to the overarching goal of ensuring London remains a leading centre for finance and investment.

Much of the soul-searching about London markets’ health in recent weeks has focused on UK pension schemes, whose asset allocation has shifted heavily towards fixed income over the past few decades. Risk-averse defined-benefit (DB) schemes have poured their money into bonds and away from equities, lessening the UK market’s domestic investor base.

Office for National Statistics (ONS) data shows UK pension fund ownership of domestic quoted shares fell from 31 per cent to 2 per cent between 1989 and 2020. Over the same period, international ownership rose from 16 per cent to 56 per cent (see chart), and the fall-away in pension interest means foreign ownership is still on the rise on a relative basis.

Changing DB pension fund incentives will be difficult, particularly now the rise in gilt yields means many schemes are close to achieving company management teams’ long-term goals of transferring liabilities to an insurer. DC schemes, by contrast, are forecast to more than double in size to £1.3tn by 2030, and are focused on growth assets. Consolidation and long-term time horizons should pave the way for greater risk-taking in future.

Listings lagging

The trickle of companies leaving the London market – quite apart from those deciding not to list there in the first place – risks turning into a stream. Plumbing equipment supplier Ferguson (FERG) moved its primary listing to New York last year, and building materials business CRH (CRH) is planning the same. Gambling giant Flutter Entertainment (FLTR) is currently consulting shareholders about a listing in the US, while Cambridge-based tech pioneer Arm is also to be listed in the US rather than the UK by owner Softbank.

While Shell (SHEL) has opted to stay put, the latest exit rumours concern tobacco behemoth British American Tobacco (BATS) after one of its main shareholders said it “makes no sense” for the company to stay in London.

Lower valuations in London are another issue. The big premium on offer in the US is hard to ignore for boards and investors. Analysts value British American Tobacco at eight times forward earnings, while New-York-listed rival Philip Morris International (US:PM) is at 14 times.  

Given that operations are US-driven for some of these companies, a listing across the Atlantic isn’t surprising. Still, Rentokil (RTO), which has just completed a transformative US acquisition, derives more than half its revenue from the country and whose valuation still trails US rivals, said earlier this month that it had no plans to seek either a primary or secondary listing across the pond. Some simple yet irreversible factors will always help London’s attraction: analysts at RBC Capital Markets note that for global businesses such as Rentokil, having senior management located in a time zone midway between the US and Asia Pacific will always be of value to a business.

But it is not just large-caps: further down the London market food chain, biotech company Abcam (US:ABCZF) left Aim last year after 17 years, and up until last month much of the focus was on the need to ensure high-growth companies have a place on UK markets.

Netwealth chief economic strategist Gerard Lyons said that tech and high-growth companies opting to list elsewhere is “a further wake-up call for London, and has been a long time coming”.

Liquidity boost

Flutter Entertainment’s statement on its plan to investigate a US listing referenced another key matter for companies large and small – the “greater liquidity” on offer in the US. This is appealing given daily trading volumes on the FTSE have gone into reverse over the past decade.

One possible reason for the US’s more liquid market is the lack of a tax on share transactions. In the UK, investors buying shares pay a 0.5 per cent transaction tax – stamp duty reserve tax (SDRT).

UK Shareholders’ Association director Malcolm Hurlston said that “SDRT on UK shares will be a drag on subsequent liquidity [on shares after listing]. No other stock market has a similar issue and that makes the UK stock market less competitive by comparison.”

Other potential changes, ones that aim to make UK rules distinct from those on the continent, could also boost trading volumes. The Edinburgh Reforms’ review of investment research will consider the impact of the EU’s Mifid II rules around the cost of research and how professional investors pay for it. Mifid II has been blamed for a decrease in the quantity and quality of UK research, particularly when it comes to small-caps and key sectors such as tech and the life sciences. While that shortfall has arguably been of use to the canny private investor, the argument goes that greater coverage would encourage more investment.

More ambitious proposals also exist. As well as DC consolidation, the investment research review and an ongoing review of the UK listing regime (see below), LSE’s Walker sees work to trial what he described as a “world first” intermittent trading venue as a potential key reform. This initiative was set out in the government’s wholesale markets review in 2021-22 – much of which focused on possible changes to Mifid II – and raises the possibility of an exchange offering trading windows rather than continuous trading. The plan, while in its early stages, will look at “a new type of venue [that] could encourage companies to use public markets at an earlier stage and act as a bridge to companies seeking a full listing”.

It is not just equities. The Investor Access to Regulated Bonds (IARB) working group is calling for an easing of the regulatory burden around corporate bond issuances. The IARB wants the disclosure requirements for lower denomination bond programmes of under £100,000 to be simplified to encourage bond issuances in lower denominations, such as £1,000, to provide more options to private investors whilst not adversely impacting the vibrant wholesale bond market in the UK.  

Nick Dilworth, secretary of the IARB and head of compliance,markets, at Winterflood, said reform would give the London bond market access to a wider pool of investors and improve liquidity, making the City more competitive against international peers. 

“This [change] would be particularly attractive for issuers who are looking for a listing location that offers a unique proposition and true investor inclusion,” he added.

Too much or too little?

Many other reviews have also taken place already, and the government has accepted many recommendations. Lord Hill’s listing review, which called for an overhaul of the listing rules and an easing of the prospectus regime, and the Kalifa review of UK fintech have spurred on other policy assessments.

Freshfields lawyer Mark Austin’s UK secondary capital-raising review, the review of securitisation regulation, and the Skeoch review on bank ring-fencing and proprietary trading have been other notable contributions to the reform debate. And there is more to come.

The FCA is consulting on a proposal to merge the premium and standard listing segments on the main market, which would be a significant change to the rules, and the London Stock Exchange itself has launched a taskforce to “drive forward the development of the UK’s capital markets”. 

The City of London Corporation is also getting in on the action through its convening of a new initiative called Finance for Growth, which plans to release recommendations on UK financial services competitiveness in the third quarter of this year.

The list goes on, ranging from the Treasury and Bank of England’s proposal for a central bank digital currency to changes to the senior managers and certification regime (SMCR), which theoretically can fine senior financial executives for regulation failures, and an overhaul of consumer credit rules. The Priips (packaged retail investment and insurance products) retail investment disclosure framework, widely seen as burdensome, will be revoked and replaced.

But this range of initiatives also speaks to an immediate problem for the Edinburgh reforms: many of the measures relate to consultations, reviews and calls for evidence rather than solid policy proposals.

The Confederation of British Industry’s Hamilton agrees that “one concern with the Edinburgh Reforms is that there are a lot of regulations under review, but some lack timelines or prioritisation is not clear”. Chancellor Jeremy Hunt said in this month’s Budget that further proposals to make London “a more attractive place to list” were being worked on, but would not be revealed until the Autumn Statement.

More detail is also awaited on fiscal initiatives, given the way that big government subsidies and tax breaks on offer in both the US and Europe have attracted plenty of business attention in recent months.

On the regulation front, some say more time is needed. Tim Dolan, a financial services specialist at law firm Greenberg Traurig, would prefer “a bigger conversation about the scope of UK regulation more generally, rather than the government just plunging into it”. He adds “many businesses I interact with deal with both the UK and Europe, and most want one model of regulation across both so that they do not have to duplicate costs ensuring that they comply with two different regulatory regimes”.

That does not mean there is no scope for deviation. But there remains the question of how radical the changes will ultimately prove. Netwealth’s Lyons says “I don't regard the Edinburgh Reforms as a Big Bang 2.0. We also need to move away from the language of Big Bang, it has unhelpful connotations. This is an evolution in terms of measures and the approach to regulation itself rather than a revolution”. But he adds that the reforms’ broader direction of travel is positive, and acknowledges “there is a greater sense of urgency.”

The LSE’s Walker concludes that the Edinburgh Reforms “push us further along in the right direction and are a helpful step in the journey”. The consensus seems to be that the reforms package is a net positive for the London market, but it isn’t by itself a panacea.

Law firm Skadden concluded that the reforms represent “thoughtful and measured change” rather than the “genuinely transformational and iconic” reforms of the 1980s. It remains to be seen whether this considered approach will do the job of bolstering London’s traditional status as a major financial centre.