Listing Rules Reform: UK Debt Capital Market Set for a Boost?

Published: February 14, 2024

The Financial Conduct Authority (FCA) is embarking on the most significant set of reforms in the UK capital markets in a generation, the aims of which include improving investor access to non-equity securities (i.e. bonds).

If implemented, these could see retail investors being able to access regulated and typically investment grade bonds on the primary and secondary markets for the first time since 2005, unlocking a significant amount of capital to UK bond issuers.

TMI readers with an interest in raising capital, particularly debt capital via bond issuance onto the London Stock Exchange’s (LSE’s) Main Market (typically populated by investment grade issuers), could find these proposed regulatory changes, poised to take place in early 2025, intriguing.

Following the UK Listing Review by Lord Hill published in 2021, and subsequently the UK government’s Edinburgh Reforms (aimed at enabling the UK to be the “world’s most innovative and competitive global financial centre”), the FCA published a series of engagement papers in 2023. The fourth engagement paper focused on ‘non-equity’ securities (i.e. bonds) and outlined the FCA’s desire of “facilitating broader access to listed debt”. The FCA published a summary of the feedback to this consultation in December 2023 . Its proposals were broadly supported and two looked particularly interesting:

1. A proposal to introduce a single disclosure standard for all bonds irrespective of the bond’s denomination – under the current regime, bonds with denominations of less than €100k require more onerous disclosure
   
2. A proposal to incentivise a reduction in denomination size by allowing less disclosure (even from current wholesale levels) for seasoned issuers that reduce denomination size to a level that enables retail participation

Nick Dilworth, Vice Chair of the Investor Access to Regulated Bonds (IARB) Working Group and Head of Compliance, Winterflood Securities, commented that these are “…material and positive changes for both issuers and investors…we and the retail investment community look forward to seeing the proposals in due course and their timely implementation.”

The current ‘illogical’ scenario

The reason why this is of significance to those raising sterling bond capital on the LSE Main Market is the oft underestimated difference to liquidity (and thus pricing) that this regulatory change could make. UK retail AUM have grown over the years to an astonishing £2.7tr. value . Due to current regulation and attitudes, most of these assets are invested in equities.

It is difficult to estimate the quantum of capital that will shift to the UK’s regulated bond market, but anecdotes from retail wealth managers suggest that, if a blue-chip investment grade bond issuer ‘retail-enabled’ a bond issuance (by reducing denomination size to £1,000 or less), £200-300m could be filled, within a time frame commensurate with wholesale execution.

To put this into context, a current benchmark issue by an investment grade bond issuer in the UK market, is in the region of £250m+. While books for popular bonds are often oversubscribed, the reality is that books can be padded by investors attempting to get better allocations. Arguably such padding is not incremental demand whereas the demand from wealth managers, retail intermediaries and individuals is. An additional and not immaterial pool of sterling in a post-Brexit world should benefit issuers.

At a time when some investment grade issuers are saying that the UK debt capital markets have in recent years become more difficult compared with others and dominated by a handful of institutions, this must be of significance – not least to those issuers who have a natural need for GBP.

Rather than raising those funds overseas in, say, USD and EUR and swapping to GBP using a derivative, they would have the ability to raise funds directly in GBP at a competitive price. Other benefits from ‘retail-enabling’ bond issuance include: diversification of funding sources; improved liquidity in the secondary market (important for pricing); and the opening-up of niche funding possibilities.

Dilworth commented: “Certain issuers that face ‘retail’ as part of their business operations, such as listed high-street retailers or certain utility companies, may feel that lower-denomination issuances with specific use of proceeds will provide them with an opportunity to engage with their customer base through a different lens.”

Indications from the market are that there is pent-up demand – particularly in the current higher interest rate environment – from investors seeking to provide for their futures and build an income stream, as well as achieving a well-balanced portfolio. The current status quo of it being easier for a UK individual to invest in crypto, bet on a horse or invest in penny AIM stocks, than it is to invest in a UK-regulated investment grade bond, is clearly illogical.

Request to engage and comment

The FCA plans to construct detailed proposals during 2024, with implementation intended in early 2025. It will be interesting to see how plans evolve. Issuers, investors, and other counterparties are urged to engage and comment when they have the opportunity – the FCA has said that it is very keen to hear from the market about the proposals (contact: POATR@fca.org.uk). Current concerns among UK issuers, aside from actually digesting the existence and implications of the proposed regulatory change, include: how the proposed disclosure framework will align with global capital markets; and what the new single-format disclosure requirements will be. Guidance from the FCA is that the new standard will be based on the existing wholesale format that issuers prefer.

As a background to this, the EU-driven Prospectus Directive (PD) was implemented in the UK and across EU member states in 2005. The PD bifurcated the bond market into retail bonds, being those with denominations of less than €50,000 or equivalent and wholesale bonds, with denominations of more than €50,000 or equivalent. The issue was that retail bond disclosure, designed to protect investors, required additional formatting and disclosure whereas wholesale bonds benefitted from a lighter regime. Consequently, issuers and advisers simply switched to the wholesale disclosure regime.

The result was immediate. Prior to the PD’s implementation, about 67% of non-financial sterling investment grade issuance was in denominations of £2,000 or less (i.e. retail-enabled) but in 2005, the amount of low denomination issuance fell to 18% and by Q3 2023, this figure stood at less than 3%.

Next steps

If you are interested and/or impacted, keep an eye out for updates throughout 2024 which will come through relevant channels such as TMI and the UK Association of Corporate Treasurers (ACT). Opportunities to engage should emerge. Please reach out to the FCA to express your views (POATR@fca.org.uk) or to the ACT (technical@treasurers.org). Alternatively, feel free to contact the author for an informal discussion (james.leather@coriumtreasury.com).

• Financial Services: The Edinburgh Reforms - GOV.UK (www.gov.uk)
• Engagement feedback on the new public offers and admissions to trading regime (fca.org.uk)
• The denomination threshold was set at €50k (or equivalent in another currency) in the first version of the Prospectus Directive and was subsequently increased to €100k (or equivalent in another currency)
• UK Capital Markets Building on Strong Foundations.pdf (ukfinance.org.uk)