Speech by Nikhil Rathi, our Chief Executive delivered at the Global Investment Management Summit.
Speaker: Nikhil Rathi, Chief Executive
Location: Global Investment Management Summit, Guildhall, London
Delivered: 29 March 2023
Note: this is the speech as drafted and may differ from the delivered version
Highlights
- The FCA set out proposals to reform the UK framework for asset management to ensure its proportionality, continued alignment to high global standards and to better support innovation.
- Proposed ESG labelling regime for investment products will build trust in the growing sustainable investment category.
- While recognising that regulation is only one element to encouraging firms to list in the UK, the FCA will always play a full part and is open-minded about reform.
The Smokey Bear effect
In the early 20th Century, swathes of land in the American southwest were designated as national forests and parks. A ban on fires was imposed. A sensible and welcome move. Who wouldn’t want parks and forests protected from fires?
However, no one had realised that banning controlled fires would lead to a more intense and destructive force – that of wildfires. And no one had thought how acres of forests and parks could be tinder for those wildfires. They had ignored the wider ecosystems.
These wildfires wreaked far more devastation over larger areas of habitat than the controlled fires that had been used as a preventative measure previously.
This unintended consequence was called the Smokey Bear effect[1], after the forestry’s mascot.
Smokey the Bear was a victim of his own success and the forest service now advocates controlled fires to replenish the ecosystem.
It is important to keep that Smokey the Bear lesson in mind as we think about the policy trade-offs and consequences, intended and otherwise, in what can be vigorous discussions about the wider ecosystem of capital markets.
Boosting asset management
Asset managers play a fundamental role in our capital markets ecosystem.
Please engage in our review of asset management[2]. We want our framework for asset management through targeted reforms to be better at supporting innovation, and be proportionate, whilst taking account of global standards.
We have made good progress when we work in dialogue with the Government, Bank of England and investors including in creating our regime for Long Term Asset Funds (LTAFs)[3] which addresses some of the challenges in deploying long-term capital in Defined Contribution schemes.
We recently approved the two first LTAFs[4] giving investors another option to invest in long-term infrastructure. More will follow.
We recognise there is a tough market environment and significant regulatory reform agenda and your input will help us prioritise to focus on the next reforms that can have the biggest impact.
We could take measures to simplify the regimes, to take away some of the complexities in rules that apply to different types of managers or funds. We could cater more explicitly for institutional business.
We know technological innovations can help us grow our markets and support innovation so we are exploring whether there are regulatory barriers that hinder creative use of technology. Our sandboxes[5] allow experimental use of technology and we will launch a Financial Market Infrastructure sandbox over the next year.
Green shoots and growth
One area we have been participating actively in the global debate is ESG.
We received around 240 responses to our Sustainability Disclosure Requirements consultation[6], which garnered broad support and also gave us some constructive feedback. We will reflect and publish a policy statement later this year.
Our labelling suggestions come in response to what consumers have been asking for. Our Financial Lives survey of nearly 20,000 consumers found that 81% of adults would like the way their money is invested to do some good as well as provide a financial return.
And our consumer behavioural research[7], with around 15,000 participants, found that by introducing a simple labelling regime, consumers could better understand sustainable products compared to when they only received the Key Investor Information Document.
We want to help build the trust on which the growth of this sector is dependent. That is why regulators across the world are undertaking the same policy thinking we are.
Clearer definitions and labelling will, we hope, bolster confidence in investments. As will a clearer regulatory regime for ESG data providers. We want everyone – investors, firms, regulators – to be able to see the wood for trees.
Our Capital Markets Ecosystem and Equity Markets
When I opened, I set out that as policy makers we need to be mindful of trade-offs and consequences, intended and otherwise, as we propose reform. That is vital as we engage in a vigorous discussion about the wider ecosystem of capital markets.
Recent decisions by some UK-based corporates to seek alternative or additional pastures to raise capital or list their equity have focused minds.
In many cases, these decisions flow from a shift in the geographic sources of revenues and future focus of the companies concerned. Rather than simply lamenting these decisions or insisting that a few regulatory levers would change the outcomes, it is important to recognise that there has not until now been a fundamental discussion about the entire ecosystem. Nor has this been a priority area for public policy for decades.
That lack of systemwide focus has come at a time, when the shape of the global economy – and our share of it - has also changed dramatically. The sharpest growth in the number and size of listed companies has unsurprisingly been in China, which now has two of the largest stock exchanges in the world.
India has moved up to eighth place. Enormous and relatively fast-growing economies like China and India, with a spirit of entrepreneurialism buoyed by burgeoning middle classes, will generate growing companies hungry for domestic capital from a huge domestic retail investor base.
While we have maintained a strong equity capital markets specialism in London, we have grown faster in other asset classes and services. We are a preeminent centre for fixed income, currency and commodities. Our investment managers guard and grow over £11 trillion in assets[8].
Our capital markets supported 126 IPOs in 2021[9], raising £16.3bn, before last year’s economic headwinds, which impacted nearly all jurisdictions. In 2020, UK equity markets saw £34.3bn of new secondary capital[10] for UK-quoted companies, secured at pace and following flexibilities provided rapidly by the FCA. The markets and your institutions were there for companies when they needed support most. And new technology has been adopted to enable timely retail investor participation. 2022 was a tougher year.
Over the last 5 years, global multinationals have increasingly unwound dual holding or similar structures.
In a number of those cases the UK has won the competition to be the chosen location for domicile and primary listing - including RELX, Shell and Unilever and Mondi.
There are plenty of advantages that commend the UK and supported these choices, including the depth and expertise of our investor base and rigour of our regulatory and legal framework. They include our openness, too.
More than ever investment is a global business. Technology makes it far easier for investors wherever they are in the world to access investment opportunities across borders.
There are more versatile globally oriented investment products.
Globally funds now make up 60 trillion dollars of Assets Under Management, double the amount of a decade ago. Exchange traded funds comprise 9 trillion dollars of this, having grown from around 2 trillion 10 years ago.
In the UK in 2003, global equity funds held £20bn under management[11]. Domestic equity funds held were £95bn. By 2021, more investors’ money was held in overseas equity funds (£272bn) than those specialised in homegrown equities (£269bn).
The UK is a global centre of excellence for investment management and managing products such as these. Global investment strategies make sense for many investors as they help diversify risk exposures and provide access to more opportunities. UK based sellside firms also advise companies from around the world on raising capital globally.
Home is where the bias is?
We pride ourselves in openness and on an approach that supports competition, domestic and global. We are a global financial centre after all. But in the area of equity markets taking such a stance does result in a number of asymmetries. We need to be clear-eyed about these and their cumulative impact and constantly work to ensure a level playing field through regulatory cooperation and market access discussions.
Some jurisdictions require a listing presence in their home jurisdiction or restrict direct overseas listings.
Others place restrictions on where firms they consider of strategic importance can raise capital or where shares can be traded.
In some markets delisting can be complicated; our approach has been to prioritise issuer and investor choice.
Understandably many emerging markets, such as in the Middle East, which are undertaking large scale privatisations use those programmes to bolster their domestic capital markets too.
India does not permit overseas direct listings of Indian companies, although there has been a lively debate on this topic.
Beyond emerging markets, some argue that US legislation has the effect of incentivising US issuers to retain a capital markets anchor in their home jurisdiction.
The EU has a share trading obligation which means euro-denominated shares of EU issuers cannot be traded on UK trading venues, which are currently not deemed equivalent.
In the UK we have tended to prioritise free movement of capital cross-border so have not put in place similar requirements.
When BHP consolidated[12] in Australia and moved the UK to a secondary listing, it came on the back of Australian government intervention[13]. The Australian government deemed the company to be of national importance so made clear it would rely on its powers to keep the company anchored to capital markets in Australia.
By contrast, when ARM was taken over in 2016, no post-offer undertakings in relation to retention of a UK capital markets nexus were sought.
Tax regimes are different. In the UK, stamp duty has been levied for centuries, now payable at half a percent of transaction value on UK shares traded on UK markets. Trading on the shares in many overseas markets is not taxed in the same way.
Retail investor access is often subject to more specific regulation. In Switzerland, for example, to access Swiss retail investors, ETFs must be[14] listed on a Swiss stock market.
UK savers are able to invest in a large number of stock markets around the world, including through tax advantaged savings vehicles such as ISAs and SIPPs, whilst other jurisdictions sometimes place more restrictions in their analogous vehicles.
Role of UK pension funds
Aside from different jurisdictional requirements, there has been a focus in recent commentary on the sharp decline in UK pension and insurance funds investment in UK equities.
Reasons for a fall in defined benefit allocations from over 50% in UK equities in 1992[15] to less than 2% today range from changes in the treatment of dividend tax to accounting rules to global economic shifts. Overseas investors now own a majority of the UK[16] equity market – this can be both a cause of celebration and, in some quarters, concern.
With many more fully funded defined benefit schemes bought out and ending up on insurers’ books, this will change the availability of capital over the next decade. You in this room play an important role in how that capital is deployed.
At the other end of the spectrum, over 90% of those employed outside the public sector save into direct contribution schemes and, by 2029, the British Business Bank estimates workplace DC schemes assets under management will reach £1trn[17], double what it was in 2019.
The case for pension fund consolidation seems clear cut to enable greater economies of scale, deeper expertise and capacity in investing in a wide range of assets on behalf of UK savers.
Ultimately, investors and those acting on their behalf will go where they can get the best returns to meet their objectives, including investing sustainably with appropriate risk diversification and taking account of business environment and currency volatility. The UK has to compete for this investment, including from UK pension funds, and cannot just assume it will flow in our direction. That competition is about far more than regulation.
Regulation is only part of the answer
Regulation – at least alone – cannot create companies of scale in sectors of the future. Nor can it help investors better understand how these companies work and their value. Nor can it conjure a culture in which success is lauded just as readily as failure is criticised.
A company’s decision on both whether to list and, if so, where, is driven by a range of factors, including whether staying private or non-listed markets can provide more efficient access to capital. We want the full spectrum of capital raising possibilities to be functioning well from private to public markets. If a company does decide to go public, its choice of listing location may be driven by valuations, depth and liquidity of capital markets and breadth of investor base, comparable peers, investor / analyst expertise, taxation, director remuneration requirements, indexation, founder preferences, location of main operations, customer base or competitors now and in the future, political support and media coverage, among other things.
Real change requires both financial and an ongoing sustained commitment from all parts of the ecosystem, infrastructure that controls exchanges, trading, clearing, settlement, corporate advice, buyside and research. Firms that control the ecosystem are now part of global groups that have so many competing priorities. So getting this aligned commitment is challenging, but achievable.
Asset managers need to keep investing in capacity to undertake investment analysis. In some markets, national exchanges fund equity research for SMEs.
Sell-side firms have to be convinced to recommend the UK market when advisory fees for transactions elsewhere can be very significantly higher.
Settlement infrastructure needs to constantly invest in new technology and products to improve efficiency – and we’re ready to support moves to faster settlement and also reduce frictions on retail investor access.
Other factors are more sensitive, including political and investor debates about executive remuneration. We at the FCA and the regulatory regime we oversee are one part of a much wider debate, one part of a much wider ecosystem, all of which needs to be aligned and pulling in the same direction.
Listings regime reforms
We will always play our full part and we are open-minded about reform. At the end of 2021, we implemented significant reforms - lower free float levels, a more permissive approach to dual class share structures for premium listed companies and introducing digital financial reporting.
We will publish a blueprint for further reform of the listing regime soon, following our discussion paper launched last year.
Some market participants have told us that premium listing standards are burdensome and deter some companies, even when allowing for the benefits of UK index inclusion.
Feedback has also indicated that the incremental investor protections that they provide compared to other international capital markets is not viewed as significant to the choices made by investors deploying capital across those markets.
Further feedback indicates that while the standard listed segment offers greater flexibility, it is less well understood and seen as an inferior ‘brand’.
Our rules have evolved over decades, including in response to previously damaging market episodes.
They are a reflection of investor preferences and cultural and other business norms in the UK present at the time but the global market has now evolved.
To reform these rules, we need a wide-ranging consensus across issuers, investors, politicians and market participants.
We are mindful that it is not as straightforward as taking rules that apply in other jurisdictions and copying them into our rulebook. The US for example operates a far more litigious environment, including class actions, not prevalent in the UK. Following the Sarbanes Oxley legislation, they have a different system for internal controls in listed corporates.
A significant strength of the UK capital market is the predominance of sophisticated and deeply knowledgeable institutional investors, both domestically and internationally based.
We can see the value in allowing experienced investors the flexibility to form their own judgement in making investment decisions based on issuers’ disclosures and rely on their considerable negotiating power.
Index providers can set criteria to deliver outcomes required by their users and further influence listing decisions.
Our proposals will consider all these factors. Crucially we will need your engagement on the detail to determine a regime that is fit for the future and a UK capital market that continues to deliver for companies, investors and the economy.
We plan to propose replacing our current standard and premium listing segments for shares in commercial companies with a single listing category with one set of requirements.
The change to a single segment and a focus on transparency would lead to a significant reform of our rule book – specific changes would include:
- the removal of eligibility rules requiring a three-year financial track record as a condition for listing, not always easy for fast growing start-ups to meet
- a more permissive approach to dual class share structures
- the removal of compulsory shareholder votes for large transactions and for related party transactions, whilst maintaining a disclosure regime
We would intend to retain:
- a streamlined sponsor regime
- a single set of Listing Principles and
- rules to protect shareholders from the solvent cancellation of a listing without takeover offer or approval by a super majority of investors.
Drawing out the principles of our thinking
Underpinning this debate are two elements that are particularly important and key to how we consider our market integrity objective.
First, how do we approach conflicts of interest?
For example, in the UK we tend to prefer strong boards with a degree of independence and separation between the CEO and Chair.
Our related party rules and rules around Directors’ transactions were put in place due to historic governance failures. What is our collective appetite to the greater risk of such problems in the future?
Conflicts management is embedded in the UK’s approach to management of client assets, ringfencing of banks, remuneration practices, roles of Risk and Audit Committees.
It underpins the approach on research commissions to ensure investors focus on best execution when directing trading flow not other inducements. We will work closely with Rachel Kent’s review which will look specifically at these issues and see what further evidence emerges.
We avoided some of the challenges with respect to the Gamestop episode as we have had, for a number of years, far stricter rules on payment for trading order flow. The US is now debating a far-reaching set of reforms to its market structure.
Second, what is the attitude to risk going to be in the UK market? How far should investors be in charge of their own risk appetite and move away from ex-ante regulatory rules? Should we rely more on disclosure and situations where investors, such as those represented here today, use their market power to exercise discipline and control over companies?
Is disclosure the answer in all cases? Investor documents can be lengthy and hard to penetrate. Financial information can often require sophisticated accounting expertise to be understood. Lack of ex-ante controls can also lead to something of a cult around perceived star investors or founders.
Lengthy disclosure is even less effective for retail investors. Is there a better route?
And, if we move down this route, there will need to be clear acceptance that some investors, even those who do read and understand every word of the disclosure, will lose money, not just uninitiated retail investors.
And this will be as a result of risks inherent in investing. When these events happen, there can be no question of compensation for those investors left nursing losses on the grounds of perceived regulatory failure – the assumption has to be that retail investors take a portfolio approach to investing and do so in the knowledge that they may lose as well as profit from their investments.
Are we ready for such an approach? Politically and culturally.
And is this an approach which would secure an enduring market consensus in the UK including the support of the UK and global investor community?
These are the questions I would urge you to consider as we aim to move our work forward at pace in the coming months. We stand ready to play our part, but we are only one part of a much wider debate and we need to be realistic about how impactful these reforms in and of themselves will prove to be without wider concerted action and in a world where regulatory home bias remains a feature of equity markets even as investing has become increasingly global.
Conclusion
Whether it is a framework for asset management that is fit for the future, listing reforms or building investor trust through clear disclosure, open debate is vital. We need your engagement. Consultation not as a legal nicety but a means to improve reforms and ensure inherent policy trade-offs are recognised, discussed, agreed.
Ultimately – if we are to embrace risk but stamp out wildfires, we must all – regulators, industry and government - align behind a commitment to growth, a commitment to innovation and a commitment to underpin our entire ecosystem with global ambition, high standards and proportionate regulation.