Britain’s financial regulator is finalising its response to a torrid few years for the country’s capital markets.
London-listed firms have proved prime targets for speculative takeover bids after years of lacklustre share price performance.
Even British businesses are shunning their domestic stock exchange in favour of more lucrative sources of funding overseas.
And impatience with London markets is not confined to giants of industry. The number of companies listed on the junior AIM market at the end of last year fell to 668, the lowest level since 2001 and around 1,000 below a 2007 peak.
The Financial Conduct Authority is looking for ways to reverse the trend, including a radical overhaul of listing rules, which it says will ‘boost growth and innovation on UK stock markets’.
It is now looking at changes that will make it easier for publicly-traded firms to issue debt and encourage ‘more flexible and cheaper capital raising’ to help them grow.
The regulator has launched a consultation on abolishing the dual disclosure requirements for corporate bonds in favour of a single standard for all issuance sizes.
But could this really be a catalyst for kickstarting the recovery of UK capital markets?
Complete change: Having once been the norm, low-denomination corporate bond issuance by UK companies is now relatively rare
What are the current rules on issuing corporate bonds?
Bonds issued on the main London markets used to be open to all investors, provided they could afford to purchase the denomination in question.
But the European Union in 2005 introduced rules that essentially split the corporate bond market into ‘wholesale’ and ‘retail’ segments, with any denomination under €100,000 belonging to the latter category and requiring separate disclosure rules.
The EU’s aim was to make it easier for firms to raise capital in other countries by standardising the rules concerning the publication of prospectuses across the bloc.
It also wanted to give investors access to clearer information to help them make informed investment decisions.
The FCA notes the differences between the wholesale and retail prospectuses are ‘relatively modest’ – more financial information is needed, though not the ‘summary’ in a prescribed format.
Yet these distinctions are widely blamed for virtually shutting out British retail investors from corporate bonds.
Small investors shut out of debt markets
Having once been the norm, low-denomination corporate bond issuance by UK companies is now relatively rare.
Research by Winterflood Securities, a division of merchant banking group Close Brothers, found that 67 per cent of regulated bonds in 2005 were issued with denominations of under £2,000, but this had plunged by 2023 to less than 3 per cent.
The number of low-denomination corporate bonds in the UK has slumped from about 1,500 two decades ago to just 30 as of this year.
‘Regulatory changes implemented 20 years ago were never really intended to exclude retail from the bond markets. But it happened,’ Winterflood said.
According to the FCA, the extra disclosure requirement costs for small-sized bonds have resulted in prospectus documents that are ‘too long and complex’ for retail investors to understand.
They have also incentivised businesses to favour high-denomination securities instead and discouraged retail investors from putting corporate bonds in their portfolios, which it believes has had two major negative consequences.
Firstly, retail investors are likelier to put their money into asset classes like investment funds with less preferential risk profiles.
Second, because issuers have seen demand for their bonds fall, the costs of raising finance will be higher, impacting their ability to raise the necessary funds.
But do the extra disclosure requirements not prevent any material harm? The FCA is not so sure; it thinks they have failed to stop harms resulting from more complex structured debt products being aimed at retail investors.
‘While we cannot attribute the low retail bond issuance entirely to the additional regulatory requirements…we consider that the current rules place disproportionate requirements on issuers when issuing low denomination bonds,’ it adds.
‘Without intervention, issuers may continue to be incentivised to issue in high denominations, and retail consumers would continue to be excluded from the market.’
Proposal: The FCA has now launched a consultation on abolishing the dual disclosure requirements for corporate bonds in favour of a single standard for all bond sizes
How would a single prospectus change the UK capital markets?
The FCA believes there is considerable demand, particularly from wealth managers, to invest in low denomination so-called ‘plain vanilla’ bonds, the most standard version of a debt instrument.
Delivering a harmonised prospectus could give listed companies a broader investor base and an extra much-needed source of raising capital.
The FCA hopes retail investors would be encouraged by the promise of attractive yields at relatively low risk levels.
Combined with other listing reforms, the FCA suggests that a larger number of companies might list or locate their operations and headquarters in the UK.
Evangelia Gkeka, senior manager research analyst at Morningstar, cautions that the regulator’s ideas are not without hazards.
‘Retail investors should still carefully study prospectuses to ensure they understand the risks involved in making investments in smaller bond sizes of smaller companies,’ she told This is Money.
On whether the FCA’s changes would make the UK corporate bond market more attractive than other markets, Gkeka believes this will depend on factors such as economic growth and future inflation and interest rates.
More pessimistically, Barclays warned in a report published last month that the FCA’s proposals could be ineffective.
Analysis by the bank estimated that for all bonds in issue as of March 2022, just eight additional businesses would be allowed to issue bonds to UK retail investors.
It said this was due to rules insisting that the issuer is both domiciled and has a premium listing in the UK, and is prevented by banks from issuing bonds.
Barclays also found that over half of bonds sold to professional investors from 2018 to mid-2024 contained ‘call features’, which permit a bond’s issuer to repurchase the asset before its maturity date. This could rule out retail investment.
The bank said: ‘We recommend that the regulatory framework needs to be reformed so that:
‘Significant barriers to including retail investors in corporate bonds issuances currently only accessible to wholesale investors are removed by reducing obligations upon issuers to the minimum necessary.
‘Nudges are introduced to encourage corporates to involve retail investors in issuance.
‘[And] responsibility for ensuring that customers are supported through the lifecycle of the bond is placed upon distributors, who have a direct relationship with retail investors.’
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