The Decline of Stock Markets in the UK: Is Regulation to Blame and Deregulation a Fix?

In recent years, the London Stock Exchange (LSE) has faced significant challenges, marked by declining IPOs, a shrinking number of listed companies, and prominent firms opting for US markets. The prevailing narrative suggests that regulatory burdens have stifled UK market competitiveness, prompting policymakers to pursue sweeping reforms regarding the listing regime, audit and corporate governance and capital raising. However, in my article, ‘The Decline of Stock Markets in the UK: Is Regulation to Blame and Deregulation a Fix?’, forthcoming in the Journal of Corporate Law Studies, I argue that (over-)regulation was not the cause of the travails of LSE and deregulation will not be a fix.

The article first contextualises the current reform efforts by investigating the UK financial market developments and the importance of LSE for UK policymakers. The UK enjoys a vibrant and innovative business environment and counts itself among the top countries in terms of most active unicorns and also overall value, funding and start-up numbers. Yet, LSE does not reflect this picture: it is dominated by the old economy firms and has long suffered from declining IPOs and number of listed firms, with firms preferring the US market in an attention-grabbing way. Its market value stagnated as well, with a notable fall in its ratio to GDP. Remarkably, while policy documents and regulatory measures are full of such facts, there is no indication of a funding gap for UK firms, suggesting that they are able to satisfy their financing needs via other ways (private capital, debt finance or overseas IPOs or acquisitions). This did not stop UK policymakers and regulators from starting one of the biggest overhauls of the regulatory regime in decades. The aim seems to make LSE, which was the world’s leading stock exchange at the beginning of 20th century, ‘the global capital for capital’ again and attract high-growth technology firms (what the railway companies were a century ago) to list on LSE.

Regardless of whether policy goals behind the recent reform are sound, there is a shift in the regulatory paradigm the UK espoused. The role of regulation in capital markets development has been one of the perennial debates in the literature. One view sees regulation supported by credible enforcement as attracting investors and reducing cost of capital, thus enhancing funding opportunities and financial markets. The other view, however, sees regulation as potentially costly and inefficient, trusting market mechanisms (such as pricing) to achieve optimal outcomes. The UK had long adopted the first view with gold-plating EU rules with super-equivalent premium listing regime, seeing itself as a paragon of high corporate governance standards and investor protection which it thought made London and LSE highly attractive as a listing destination. With the recent overhaul, however, the UK has come to endorse the second view with important deregulatory measures. While regulatory competition was a significant driver, it depends on one’s view of the merits of old vs new rules whether it is a race-to-the top or race-to-the bottom. In any case, the article argues that it is highly unlikely that (over-)regulation was the cause of the status quo, and that deregulation will help policymakers achieve their goals regarding LSE. This is supported in turn by two analyses.

First, a comparative analysis to the US ecosystem shows that it provides a functionally equivalent strict regime, if not stricter, to what the UK regime has been pre-reform. In addition, there has been none-to-little evidence that UK regulatory measures affected firms’ listing choices, especially in cases where clear differences with the US regime existed (like the availability of dual-class share structures).

The UK reform efforts range from the overhaul of the listing regime and capital raising to watered-down audit and corporate governance requirements. While it has remained unscathed so far, executive remuneration has also been a major discussion point. Most important changes concerned reversing the ban on dual-class share structures and effectively abolishing the significant transactions and related party transactions regime, which gave shareholders important information and approval rights. Under the new single-segment regime, firms can adopt a flexible dual-class share structure during IPOs. Previously, Class 1 transactions (25% or more under class test ratios) required shareholder approval and an FCA-approved circular, but they now only require market notification under the enhanced market notifications regime. Class 2 transactions (5% to 25%) no longer require separate disclosure beyond existing UK Market Abuse rules. For related party transactions (RPTs), the old regime mandated disclosure and a fairness opinion for small transactions (0.25% or more) and (minority) shareholder approval for large ones (5% or more). The new rules eliminate requirements for small RPTs, while large RPTs now only need a fairness opinion and simple (disinterested) board approval.

While the US regime (Delaware law and stock exchange rules) overall grants shareholder fewer formal rights regarding these matters, it has strong enforcement of fiduciary duties, active securities litigation and shareholder activism which achieve functionally equivalent results in curbing corporate insiders. As a striking example, one of the CEOs that had a significant pay rise after leaving a UK company for a US one—and was therefore used as an example of transatlantic gap in terms of the attractiveness of UK and US regimes for firms and insiders—was recently sacked by the board due to poor performance after significant activist shareholder pressure. The US regime also goes further in some governance requirements (SOX-liability regime) and reporting requirements for companies (quarterly reporting), imposing further costs and liability risks. Regardless of the merits of these rules, the narrative of the UK market being overregulated in comparison to the US does not hold scrutiny. While a clear difference existed regarding the availability of dual-class share structures during IPO, very few UK-incorporated firms went stateside to utilise them.

The UK’s investor protection regime has now become weaker than its US equivalent in key areas. While both allow dual-class share structures, the US enforces stricter controls through fiduciary duties and procedural safeguards to prevent value diversion by insiders. In contrast, the UK now permits dual-class shares but provides weak restrictions for RPTs, relying mainly on disinterested board approval. Additionally, enforcement through derivative actions in the UK has been historically weak. Although investors are expected to account for governance risks through pricing and negotiation, potential abuses could undermine the UK market’s appeal.

Secondly, an analysis of the UK market ecosystem reveals certain deficiencies as well, which strengthens the point that (over-)regulation was not a root cause and deregulation will not be a fix unless they are addressed. There is a significant degree of misdiagnosis regarding the UK market ecosystem which, if left unidentified, might lead to false cures. It seems doubtful that investor composition and behaviour play an important role in making UK markets unattractive while liquidity and relatedly valuation indeed seem to have certain adverse effects. UK markets do not offer as deep and liquid markets as the US ones. Increasing money flows to UK markets which were so far shunned by UK domestic investors including pension funds and insurance firms, would go some way of increasing liquidity and (thereby) lifting valuations. Current deregulatory reforms do not address this concern while UK government’s recent proposals of disclosure of UK asset allocation by pension funds and consolidating pension fund industry do not offer the carrot and sticks necessary to achieve this.

Overall, the UK’s latest and dramatic changes to its legal regime concerning capital markets grounded upon a mission of saving the LSE in a regulatory competition (toward top or bottom?) provides a cautionary tale that a powerful narrative—in this case, that regulation and certain market factors play a significant role in the travails of the LSE—is more compelling than the underlying evidence and can lead policymakers astray.

Alperen A. Gözlügöl is Assistant Professor of Law at the London School of Economics.