In today’s Finshots, we tell you why the London Stock Exchange seems to be losing its charm and explore how it might turn things around.

But before we dive in, we wanted to let you know about an exciting announcement we shared in Sunday's newsletter - check it out here if you missed it!

The Story

Exactly a decade ago the London Stock Exchange (LSE) proudly held the third spot globally for raising money through Initial Public Offerings (IPOs). But cut to today, and it has fallen all the way down to eighteenth place.

Meanwhile, countries you wouldn’t expect to steal the spotlight, like Malaysia, Luxembourg, and Poland have zoomed ahead. Australia and Saudi Arabia have cemented their places as IPO hotspots. And then there’s Oman’s Muscat Stock Exchange. Despite being a tiny market, barely 1% the size of the UK’s, it too has left London trailing in the dust.

So, what’s going on?

To begin with, the UK’s economy has hit a rough patch. Borrowing costs have shot up, reaching levels not seen since the Global Financial Crisis (GFC) of 2008. For the government, this means paying much higher interest rates on its borrowings like the bonds it issues to investors.

Now, this sets off a chain reaction. First, a bigger slice of the government’s budget gets eaten up by debt payments. Last financial year alone, over 8% of government spending went towards servicing debt. And second, the fiscal deficit or the gap between what the government earns and what it spends, widens further.

This means that the government has had to rethink its approach. It’s now reluctant to borrow more just to cover day-to-day expenses. And to plug the gap, there’s talk of increasing taxes, which could leave people with less money to save and spend. Less spending means slower economic growth. And that’s a red flag for investors. They then choose to park their money elsewhere, in markets like the US, which they see as having brighter prospects.

And when investors start pulling out, companies take notice. Why would they raise funds or list their shares on the LSE if the market isn’t attracting the money they need?

To put things in perspective, auditing giant EY found that a staggering 88 companies either delisted from the LSE or shifted their primary listings elsewhere last year. That’s the highest number of companies leaving the stock exchange since the GFC and undoubtedly a troubling sign for what was once a thriving financial hub.

Now, we know what you’re thinking. The US isn’t exactly stellar in terms of financial health either. Its debt is over 120% of its GDP, while the UK’s is closer to 100%. Its fiscal deficit too runs a hefty 7%, compared to the UK’s 4.5%.

So why are investors still flocking to the US instead of the UK?

Well, a big reason lies in how the UK handles its debt. You see, back in 1981, it introduced something called inflation-linked gilts. These are simply government bonds where both the principal and interest payments rise with inflation. And it seemed like a smart move at the time, especially when inflation was low. But today, with inflation soaring, these bonds have become a financial headache.

What’s even worse is that about a quarter of the UK’s government debt is tied to inflation, which is actually the highest proportion among major economies.

And you can imagine that this doesn’t exactly scream stability for investors. They’re worried about the rising costs to the UK government and the strain on its finances. On the flip side, the US, despite its own issues, looks like a safer bet with a more predictable system.

And when investors pull their money out of the UK, it leaves the LSE in the lurch. Fewer investors mean companies listed on the LSE struggle to raise funds.

But then there’s more to the story since what we’ve told you so far is just the broader picture or the foundation of why the LSE is losing its sheen.

Take liquidity, for instance. When investments in the LSE dwindle, liquidity on the exchange dries up. Fewer stocks are being bought and sold, making it harder for investors to make quick returns. And fund managers, whose performance and fees depend on delivering results, don’t really wait around. They reallocate more of their clients’ money to markets like the US, home to heavyweights like Nvidia and Apple.

And this shift away from the LSE creates a vicious cycle, making it a classic example of a doom loop. Less liquidity pushes more investors to pull out, and that further dries up liquidity.

The problems don’t end there. Lower liquidity also impacts the market values of companies listed on the LSE. According to Bloomberg, UK equities are now trading at a staggering 40% discount compared to their global peers, which makes them look like great bargains for foreign companies waiting to acquire others. In fact, merger and acquisition activity targeting UK firms has skyrocketed by 80% this year, hitting over $160 billion.

The end result is that companies are leaving the LSE in droves. About 45 delisted this year alone, a 10% jump from last year and the highest since 2010. It’s yet another domino in the doom loop, chipping away at the LSE’s position on the global stage.

But hey, the LSE isn’t entirely at the mercy of these external factors. It’s also partly to blame for the IPO drought and the wave of companies leaving it.

Tech companies, in particular, have long complained about its rigid listing rules and lack of flexibility. The old rules, for instance, were tough ― things like requiring shareholder votes on certain transactions and banning dual-class shares, which give founders or key investors extra voting rights. These made it harder for companies to consider London as their home base for listings, especially when other global markets, like New York or Singapore, were offering more attractive options.

But now, the UK government and the LSE seem to have woken up to this and have recently revamped their listing rules.

First off, the LSE has simplified its listing categories. Gone are the confusing ‘premium’ and ‘standard’ categories, which used to treat companies differently based on their corporate governance and regulation standards. Now, there’s just one listing category for equity shares in commercial companies, making the process easier and less bureaucratic.

Next, the disclosure requirements for large deals have been relaxed. Companies no longer need shareholder approval for transactions over 25% of their assets or value. They just need to notify the market, which is much faster and less cumbersome.

And the biggest challenge they’ve solved, perhaps, is that of dual-class shares. Before, only founders or directors could hold these shares. But now, institutional investors like pension funds or investment firms can hold these too, for up to 10 years.

So yeah, these reforms are the LSE’s shot at getting back into the game and competing with its global stock exchange rivals.

But let’s be real. This is only one part of the puzzle. It might convince companies thinking about listing in London, but if the LSE really wants to win back investors, the UK government has to tackle the bigger issue ― turning around the economy.

Can they pull it off? We’ll just have to wait and see.

Until then...

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