UK listing reform is too important to be stalled by small stakeholders
Dual-class struggles
In postwar Paris, signs above kitchens often declared that the owner eats his own cooking, attesting to the cook’s confidence in the dishes amid the era’s food rationing.
This phrase springs to mind in the debate over proposed UK listing rules reforms. Corporate governance bodies and pension funds are mounting a co-ordinated, last-ditch bid to thwart changes that would allow dual-class share structures (DCSS) with no mandatory sunset clause and remove the need for shareholder approval for significant and related-party transactions.
In their letters to the UK Financial Conduct Authority, the International Corporate Governance Network and a coalition of UK pension funds pull no punches. They argue that the rule changes could deter investment in UK-listed shares, hike up the cost of capital for British firms, and erode London’s status as a financial centre — a triple whammy of woe for beleaguered Britain.
The pension funds state that the proposals (Alphaville emphasis):
. . . will make the UK less appealing as a destination for capital, exacerbating the current issues by making UK-listed companies less attractive to the kinds of high-quality, long-term investors that both our pre- and post-IPO companies . . . are looking for. In turn, this could raise the cost of capital for UK-listed companies as investors require a higher return for the increased risk.
Similarly, the ICGN’s letter — co-signed by shareholder and governance groups from Portugal, Italy, Canada, and Australia — argues that the UK’s high standards set it apart and draw in investors from all over the world. Relaxing them could scare away the foreign investors vital to the London market (our emphasis again):
The UK’s reputation for high quality listing and governance standards and resultant overseas investor confidence is both a competitive advantage and a positive differentiator for the UK market in a global context. According to the . . . Office for National Statistics, the proportion of shares in UK companies listed on the London Stock Exchange (LSE) held by overseas investors increased to a record high of 57.7% of the value of the UK stock market in 2022 . . . [B]eing listed on the UK premium segment is a powerful signal that the company adopts the highest governance standards and is well-placed to thrive over the long-term . . . [M]arket integrity is something that must be preserved, and not diluted.
The language carries an implied, but unmistakable, threat to divest from the UK.
The merits of the reforms are finely balanced and have been hotly debated. The ICGN cites studies suggesting that the benefits of dual-class share structures vanish after seven years, though the letter stops short of alleging any outright detriment. In fact, it’s not difficult to find counterexamples, and indeed the area is an academic minefield, with various studies struggling to find any link between governance and corporate performance. Whether long-term DCSS empowers visionaries or entrenches subpar management depends on myriad factors that fund managers have elsewhere been free to assess for themselves.
Whatever the pros and cons, two issues overshadow the arguments from the conscientious objectors. First, their investment choices belie their statements. Most of their equity portfolio is invested in companies and markets whose governance practices they decry. Second, their assumption that high standards attract investment is unsubstantiated and likely erroneous in the UK context.
For starters, the institutions represented by ICGN seem to have few qualms about investing in markets with less stringent standards, such as the US and various European countries. Its membership roster includes some of the largest investors in dual-class share structures and in markets that don’t require shareholder approval for significant and related-party transactions. Presumably, the corporate governance is good enough in those other venues to make their listed stocks investible.
So there’s a clear discrepancy between the governance groups’ advocacy and investment teams’ actions. The ICGN’s letter doesn’t address the inconsistency or explain why the UK should maintain uniquely tougher standards than the other markets in which its members happily invest.
UK pension funds, meanwhile, have largely forsaken the domestic stock market, accounting for four per cent of total holdings. Pension funds have rotated much of their assets out of listed equities, and to the extent they are still invested, they barely hold any UK shares. Take this snapshot from lead letter author Railpen’s factsheet on its Global Equity Fund:
Or the disclosed allocation of the “Global Investments (up to 100 per cent shares) Fund” of cosignatory People’s Partnership:
And the top 10 holdings are all American and include companies with multiple classes of shares:
It’s a similar story with another signatory, Brunel Pension Partnership. The top 20 holdings of each of its four non-regional “Active Equity” funds include only one UK-listed stock; the 80 names are predominantly American and include dual-class share structures and even some Chinese firms.
This is not a criticism of their investment decisions. Quite the opposite: multiple-class share companies like Alphabet and Meta have been phenomenal stocks to own! But the critics’ investment choices mean their implied threat to pull their money out of the London market rings hollow. British pension funds have, as HSBC analysts recently pointed out, “nothing left to sell.”
With so little skin in the (listed UK) game, the pension funds can scarcely be described as having “vested interests”. More like “uninvested interests”.
Similarly, it is difficult to give much credence to the groups’ claim that London’s gold-plated standards attract investment and thus result in a lower cost of capital. The commenters don’t cite any studies to substantiate this assertion; nor do they try to reconcile it with the bargain-basement rating and perennial underperformance of UK stocks.
Even as the ICGN and UK pension funds warn that lowering governance standards could deter investment, their own investment practices suggest a more nuanced reality. It’s probably more accurate to say that once governance reaches a threshold-acceptable level, other factors take precedence. Overly rigorous standards may not attract investment and may even be counterproductive by distracting management or discouraging companies from listing there.
The proposed listing reforms are the first, baby steps in the campaign to rehabilitate London as an equity market after a torrid period marred by delistings, reduced liquidity and an IPO drought. Much more will need to be done, especially around pensions, insurance and tax, and these efforts will attract scrutiny, debate and opposition from various interests. It would bode ill for the City’s revival if the UK couldn’t even amend its listing rules to align them with the rest of the world.
It is a fine line between being principled and priggish, and the UK has derived little benefit from wearing the hair shirt of its stricter standards.