Does London need a stock exchange?

There’s been a lot of hand wringing this year about the state of the capital markets Europe vs the USA. In particular, the hugely divergent fortunes of the equity markets in both regions has provided fodder for endless commentary about what Europe (incl. the UK) can and should do about it.

A couple of excellent articles I read this week got me thinking about the current state of equity listings in the UK and Europe. 

The FT chronicles the LSE’s response which has been a full-fledged evolution from an exchange into a data conglomerate over the past 5 years. This comment from Global Capital offers an interesting solution, suggesting that what the European IPO market needs is the equivalent of a “ratings agency” for IPOs.

As exemplified by Arm’s decision to choose New York over London for its listing in September, the UK is under pressure to fight back against its transatlantic rivals. But what can the LSE do?  

Short of options 

Making UK equity listings more attractive is high on this year’s UK political wish list. In July, the Chancellor, Jeremy Hunt, presented his series of Mansion House reforms that, amongst other aims, sought to make the UK more attractive for companies wanting to list shares.

Whilst many of his suggestions were inventive and positive, as the FT article points out, the current sentiment is one of near-capitulation when the UK is compared to international rivals: 

“Chip designer Arm, a rare British large tech company, earlier this year chose New York to float, valuing it at $51bn, lured by its larger pool of capital and more tech-savvy investors. London-based commodity broker Marex and UK pollster YouGov are among the companies considering abandoning their London listings in favour of New York, following in the footsteps of the world’s largest building materials group CRH and packaging company Smurfit Kappa. Earlier this week, Glencore’s chief executive Gary Nagle said the company would list its planned coal mining spin-off in New York, even though natural resources companies have traditionally been one of London’s strengths.”

And whilst that’s bruising for London’s ego as it vies to remain the financial capital of the globe, when reading around the subject, it struck me that, given the climate, there seems to be little that UK politicians and regulators, or even the LSE, can do to stem the tide in equity markets. 

Equity instincts

Those proposing minor reforms, such as reducing the governance requirements for a listing, or even the more outlandish proposals, such as the creation of a “Ratings Agency,” miss the point about some of the fundamentals of investing in equities. 

Equity prices (despite what you learn in business school) are almost entirely driven by animal spirits. Hence, when a company comes to market, it knows that listing in New York will (more than likely) derive a higher valuation (higher multiple of price to earnings) purely because of the stronger sentiment (animal spirits) among the US investing community. As hard as the UK tries, it will never be able to compete on this front. 

The drivers of those stronger US animal spirits are numerous. For starters, stronger growth over the past 10 years has led to much more wealth creation across the pond. Secondly, I believe it’s fair to say that there are different cultural attitudes to wealth creation vs preservation in both regions that are deeply embedded and span generations. American wealth tends to be more newly created, so there is a greater risk appetite when seeking investment opportunities. European wealth is much more generational, and investment attitudes and risk appetites are more prosaic.

The forces behind FOMO

But, I think the most important reason that animal spirits are stronger in the US is due to the prevalence of numerous success stories. This drives a sense of FOMO amongst US investors. 

While most remember the 1990s dot-com boom for its subsequent bust, from the ashes of that period, the most successful companies in history (Google, Amazon, Facebook) were born. The growth of the 2000s and 2010s preys on the minds of all investors today, and it is this fear of missing out on the next big thing that drives US IPOs to perform so well. UK investors don’t suffer from FOMO because they haven’t “missed out” on any equity success stories of the same magnitude.

The reasons for the lack of a major European “big tech” champion warrants a post of its own, but the point remains: as long as the US is where the biggest companies are created – and thus where the greatest sense of FOMO prevails – that is where valuations will continue to be higher. Inevitably, this makes it a more attractive listing venue for any successful company.

Consolidate to accumulate 

That brings us to the options for exchanges like the LSE, now firmly in the shadow of its US rivalss. Where do they go from here? What can they do to compete? Or survive? 

One option is consolidation and, for exchanges, this is nothing new. 100 years ago, there were vibrant exchanges in San Francisco, Chicago, Amsterdam, Milan, Paris, Stuttgart, Vienna, and, of course, London and NYC. In the past century, the benefits of consolidated liquidity resulted in most of these closing down, with listings consolidating in London and New York. 

Despite recent isolationist rhetoric to the contrary, the world continues to globalise. So one could argue that we are just witnessing the same trend continuing apace in the financial exchange sector. Even if the world “splits” into bipolar or multipolar “spheres of influence,” it's clear that Europe and America will continue to be bonded by politics, economics, financial services, and technology. So, we may just be witnessing the final chapter of exchange consolidation, with New York emerging as the undisputed financial capital of the Western Hemisphere.

Some politicians may hate the idea, especially those fighting to whip up the populist vote. But to me, the LSE’s transformation from an exchange to a data company looks even wiser and more prescient. Data is global, sits across asset classes, and its revenues command much higher multiples than exchange trading. As CEO David Schwimmer tells the FT:

“In 2018, LSEG was a collection of great assets largely focused on Europe, largely focused in terms of execution, on equities, and an important but relatively niche provider of data and analytics. Today, we are a leader in multiple asset classes, including fixed income and foreign exchange, which are the two largest traded asset classes. And we are a leader in data and analytics on a global basis. I think we are going through a re-rating. The market has historically thought of us as a markets company and is now thinking about us more like an information services company.”

As Microsoft CEO, Satya Nadella once said, “Every business will be a software business.” LSEG has been very wise to identify this trend and lean into it - hats off to them.