Filling the gaps: science and technology companies, scale-ups and patient capital - the FCA's discussion paper on the UK's primary markets landscape
Published on 28th Mar 2017
The FCA has published a discussion paper looking at the continued effectiveness of the UK’s capital markets. The FCA’s aim is to “prompt a broad discussion about the effectiveness of the UK’s primary markets landscape, looking in particular at access to capital for issuers and investment opportunities for investors.”
Scope of the discussion paper
The discussion paper covers three core issues:
- revisiting the unloved standard segment of the Main Market and whether redrawing the lines between premium and standard segments might improve market effectiveness and sentiment towards the standard segment
- identifying gaps in the UK’s market framework, and in particular the effectiveness of the primary markets in providing capital for early stage science and technology companies
- the listing of debt securities and facilitating retail access to the debt markets
It is this second element of the discussion paper which is particularly eye-catching as the FCA looks to assess the role of primary market structure and regulation in encouraging scale-up and patient capital in those sectors.
Supporting the growth of science and technology companies
The changing role of IPOs and potential regulatory impediments to early stage investment
The FCA is aware of concerns that the UK’s primary equity markets “are proving less effective at what many think should be their central role” – to provide capital for a company’s further growth and development. Instead, there is a concern that IPOs are principally undertaken to provide an investment exit for later stage companies, with companies accordingly staying private for longer. Whilst the data included in the discussion paper paints a mixed picture in terms of the exit/capital raising dynamic, the FCA thinks this is a policy areas “where further reflection would be valuable“, and looks in particular at the problems of primary market access to “scale-up” and “patient” capital for early-stage science and technology companies.
In doing so, the FCA is looking to explore whether regulatory change could offer solutions to these problems, but also looking more broadly at whether the binary risk presented by early stage investment (“high return or a total loss of investment“) should mean that primary market regulation should confine that binary investment risk to private capital until companies have reached an appropriate stage of development – a question that goes “to the heart of defining the role of public securities markets and the authorities responsible for regulating them.”
Scale-up capital
The FCA is keen to understand whether the primary markets could offer a solution to the problem of access to scale-up capital. Whilst acknowledging the generally supportive conditions in the UK for start-ups and early stage companies, it notes the problems faced by scale-up companies looking to access capital to help them develop into “large, established businesses“. Scale-up companies are defined in this context as companies having average employee headcount or revenue growth exceeding 20 per cent per annum over three years, starting with a minimum of 20 employees.
The FCA poses the following question: are investors generally unwilling to fund this stage of a company’s growth, and could changes in primary market regulation could address that reticence? It notes evidence that later stage VC deals are significantly larger in the US and the UK, and that UK technology companies are disproportionately targeted for M&A transactions compared with their international peers, suggesting a lack of willingness by external investors to meet the capital needs of scale-up companies.
The FCA is seeking views on:
- the factors that adversely impact the effectiveness of the UK’s public equity markets in providing scale-up capital
- what potential enhancements to the primary market regulatory framework could contribute to improving the provision of scale-up capital
- whether science and technology companies should reach a certain stage of business maturity before accessing public equity markets, and if so, how that stage of maturity should be defined
Patient capital and alternative market structures
The FCA is also seeking views on whether (and if so how) to address the continued problem of short-termism in the capital markets; two policy areas specifically raised are the continued prevalence of (now voluntary) quarterly reporting and the impact of market abuse rules on suppressing dialogue, and therefore the prospect of effective stewardship, between companies and their investors. The FCA notes feedback that, unsurprisingly, early failures or disappointments are seen as being “unduly punished by a market focused on short-term targets and metrics“, reducing scope for further primary issues or from accessing public markets at all.
Given the difficulties in encouraging access to long term capital within the current regulatory framework, the FCA asks whether a fundamentally different model is required for companies with the need for long-term pre-revenue financing – perhaps one that (radically) separates the primary (securities issue) market from a continuous secondary (securities trading) market. The FCA draws a parallel with the success of the equity crowdfunding model which, to date, does not have a full secondary market.
The FCA is requesting comments on the Discussion Paper by 14 May 2017.
Osborne Clarke comment
The FCA’s discussion paper is in some respects an ambitious document, but (as the FCA itself acknowledges in its introduction) it is perhaps difficult to see how primary markets regulation – in and of itself – would be sufficient to being about the changes in investor sentiment and strategy that the FCA clearly identifies as necessary in order to full some of the structural problems in access to capital for UK business.
In reality, larger policy levers will need to be pulled to bring about effective change (most obviously tax policy which was fundamental in shaping, at least in part, some of the success of the AIM market). Whilst the start of the FCA’s thematic review of the capital markets pre-dated the Brexit vote, it is possible that leaving the EU may well present itself as the political opportunity and catalyst on which to base ambitious and far-sighted structural change in the UK’s capital markets.
