Dual-class share structures are the wrong answer to the UK listings problem

There has been extensive discussion amongst UK policymakers about how to fix the recent decline in IPOs as the current government looks for ways to boost economic growth in the wake of the pandemic.

These include the May 2023 FCA proposals in CP23/10: Feedback to DP22/2 and proposed equity listing rule reforms. Proposed changes include taking “a more permissive approach to dual-class share structures” (DCSS) as well as relaxing rules around shareholder votes on related party and significant transactions. The stated rationale for DCSS specifically is that it would allow “a full range of company models to list in the UK” and appeal to tech firms in particular, with the FCA paper noting a “higher prevalence of DCSS particularly among companies in the technology sector.”

This proposal was unexpected, given that previous relaxation of the rules around dual-class share structures had only come into force 18 months previously. Also unexpected was the lack of evidence demonstrating that a key reason high-growth companies list elsewhere is the UK’s shareholder rights regime.

In our response to the FCA, and in light of the issue’s complexity, Railpen – which is overweight UK listed equities (versus the major global indices) and has an extensive history as an early-stage, pre-IPO investor in UK companies – opted for a “first principles” approach. This required us to examine the assumptions inherent in the current policy debate and review the evidence[1] regarding i) what creates healthy capital markets, ii) what attracts companies to list in a given jurisdiction and iii) why investors choose to invest in a specific company. Our research suggested the proposals would not support the thriving capital markets we all want to see but would instead exacerbate the problem, damaging the UK’s longstanding USP as the world’s “quality” market.

Healthy capital markets

A 2023 UK Finance/EY report argues that capital markets operate in a circular fashion: companies want to access a large and liquid pool of high-quality investor capital, while investors seek access to dynamic companies that can generate long-term sustainable financial returns.   It is therefore clear that any reforms proposed need to make UK capital markets attractive to both companies and investors.

How companies choose where to list

Lord Hill, in the 2021 UK Listings Review that preceded the FCA’s current proposals, noted that factors considered by pre-IPO companies in choosing where to list include “…the wider business ecosystem; the visibility of companies and IPOs; the presence of a pro-investment culture; and the prestige [of a] market.”

UK Finance/EY also found that the top five factors considered by companies were (in order): access to a strong investor base; valuation and research coverage (of technology companies); liquidity; comparable companies and the “ease and cost of being publicly traded”. This echoes Railpen’s own conversations, with one IPO adviser noting that governance practices (including DCSS specifically) were “a marginal consideration, if at all” for their clients. It also aligns with our own analysis of the UK-based companies that have chosen to list in the US since 2017: of the 12 companies that gave reasons for doing so, only one (Endava) cited governance rules. The others mentioned liquidity, access to capital and the quality and nature of the investor base.

We can therefore infer that reducing corporate governance safeguards and shareholder rights would have minimal impact on companies’ decisions regarding listing jurisdiction.

The importance of shareholder rights to investment decisions

Robust shareholder rights (including the right to exercise a meaningful voice through the vote) are vital if a company’s shareholders are to be able to effectively (and appropriately) influence corporate behaviour on material issues and in support of long-term performance; the FCA itself noted in its 2019 paper the clear link between meaningful, well-targeted stewardship and financial performance[2].

Railpen votes with its feet on companies where there are insufficient shareholder rights, including dual-class share structures, through our governance-focused exclusions process and bottom-up active investment decisions. We are not the only investors to do so, with recent examples of companies that listed with dual-class share structures at IPO and traded at a discount including Deliveroo and The Hut Group. This micro-level evidence aligns with macro-level academic research showing that strong shareholder protections mean “suppliers of capital are more willing to…provide investment[3]”, leading to “more dynamism[4]” in capital markets.

It can therefore be inferred that reducing shareholder protections makes investors more reluctant to allocate capital to companies in a given jurisdiction, unless it is in return for a higher risk premium (leading to a greater cost of capital for the company).

Conclusions – a vicious UK capital markets cycle?

We think UK policymakers currently underestimate the extent to which robust investor protections helped make the UK the global financial powerhouse it is today and have not fully explored the problem through both a company and an investor lens.

The CP23/10 proposals would do nothing to tackle the actual barriers to a UK listing cited by companies, including the relative lack of tech expertise amongst the investor base. In fact, we think they could exacerbate the situation: investors could become more reluctant to invest in UK-listed firms because our reputation for strong investor protections has been damaged, meaning companies would look elsewhere for their liquid, high-quality pool of capital. This in turn risks creating a vicious UK capital markets cycle that will leave investors, companies and beneficiaries worse off.

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Author’s notes

This article draws upon the evidence and research carried out for Railpen’s response to CP23/10, which can be found here.

By Caroline Escott, Senior Investment Manager, at Railpen and Chair of the Investor Coalition for Equal Votes (ICEV), an over $2 trillion and growing coalition of US and UK pension funds and asset managers whose mission is to promote the adoption of equal voting rights.