A puff of smoke arose from Throgmorton Street in the City of London last week to signal that, like rather sharper financial institutions such as the Bradford & Bingley Building Society, the London Stock Exchange intends to demutualise and incorporate itself.
It then remains to be seen whether it subsequently seeks to float itself on itself. But it won’t be required to approve itself for listing, since it has let it be known that it intends to relinquish its authority for approving company listings on the stock market and to outsource its regulatory news service if its demutualisation is successful.
It is difficult to resist the idea that the LSE – once upon a time called the International Stock Exchange and quietly just calling itself the Stock Exchange again – is occupying some sort of parallel universe. Perhaps even that is too flattering. It is more a case of Gavin in Wonderland.
Gavin Casey is the latest chief executive to live life as a dream at the LSE. His predecessor, Michael Lawrence, underestimated members’ self-serving and Luddite resistance to electronic clearing systems (they made snobby reference to his dandruff when he went).
For his part, Casey is widely toasted in the City as the man who had no cause to appear in the dock at the Blue Arrow/County NatWest conspiracy-to-defraud trial of a decade ago, when his peers and subordinates were put through the longest and least successful white-collar trial to date. It will be fascinating to see how he is greeted by institutional advisers in the tough and real environment of a plc.
Many of those I speak to are asking the question that has come back again and again over the past decade: What is the Stock Exchange for? There are those who say that it is a vital component and symbol of British power in global financial markets. But in the Big Bang of deregulation in 1986, it gave up its closed-shop trading floor and opened London’s gates to foreign institutions, which bought our banks and taught them how to play rough.
There are those who say that it retains a vital regulatory role. But, after the time and expense that has been invested in regulatory three-letter acronyms such as the SFA (for institutions) and the PIA (for investors) and the added pressures of the European regulatory initiative increasingly being taken by Brussels, you have to doubt it. And the Stock Exchange Surveillance Unit’s record on the identification of insider dealers that have led to conviction has hardly been impressive.
Then there are those who say that London won’t be able to compete with financial centres such as Frankfurt and New York unless it has its own stock exchange. Online and Internet markets are increasingly making a mockery of that view. They throw up regulatory challenges of their own, but to stand in their way is to suggest that King Canute could do as good a job as the Thames Barrier.
But probably what the fewest of even the most blindly loyal of the LSE’s adherents have to say is that it provides liquidity in capital markets. The acid test for any successful equities market must be to provide growing companies with access to public sources of capital. This the LSE has increasingly and signally failed to do.
For major FTSE stocks, in sectors such as pharmaceuticals and financial services, this has not been a problem, since they have benefited from the investment fetish of the past three years for tracker funds – institutional funds that follow the market indices with a basket of representative shares. This has distorted the market – especially so, since the indices are pushed up by the even greater fetish for Internet stocks, with the likes of Freeserve having equity capital thrown at them without the burdensome requirement of having to show a profits record.
But for the engine room of a healthy economy – the small to mid-cap sector of the equities market – the lack of capital liquidity is a disaster. Last week, a survey by Tempest Consultants for Reuters showed the depth of the problem. Perhaps most telling among the wealth of statistics that demonstrate a capital famine for smaller listed UK companies is the fact that 52 such enterprises, with a combined market capitalisat ion of £5bn, were the subject of buyouts or takeovers in the three months leading up to the survey.
We can expect some £1.5bn to be raised by the small-cap sector this year – in 1996, the figure was more than double that at £3.3bn. The investment power lies in the hands of a very limited number of huge institutional fund managers for whom passive/tracker investment models have meant that there is no need to do anything other than leave those companies that aren’t in the golden circle out to dry.
The LSE has done nothing noticeable to solve that problem. And its members probably know that to be true. When their cosy mutuality comes to an end, I expect them to take their windfall gains and disband their club. The London Stock Exchange can then pass unlamented into history.
George Pitcher is a partner of issue management consultancy Luther Pendragon