How the US is crushing Europe’s domestic exchanges

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The writer is the author of several books on the City and Wall Street

A hundred years ago, the UK had more than a dozen stock exchanges. London was the biggest but Aberdeen, Cardiff, Leeds and Edinburgh were among the provincial centres with their own flourishing exchanges raising and recycling capital for local businesses. Within 50 years they were all gone, merging with the London Stock Exchange in 1973 as access to the City’s deep pool of capital proved irresistible to companies seeking to raise funds.

The staggering success of this month’s Arm flotation — a British company listing in New York and five times oversubscribed — leads me to wonder whether something similar is under way today but on a transatlantic scale. Is New York this century’s irresistible force, set to marginalise and perhaps consume European exchanges just as the City did to its provincial rivals last century? If so, what can policymakers do about it?

Investment bankers report that most sizeable Europe-based candidates for initial public offerings are contemplating a Nasdaq or NYSE listing. A significant factor is that despite their European base, their ownership is concentrated in US venture capital. For those VC firms, Nasdaq and the NYSE are the markets of choice and where they feel most comfortable in owning their residual public market positions post-IPO.

They are the markets of choice because they are the largest. US equities account for nearly 70 per cent of the MSCI World index; the next five largest — in Japan, UK, France, Canada and Germany — total less than 20 per cent. The top 10 constituent equities of the MSCI World index, which are all US companies including Apple at number one and ExxonMobil at number 10, aggregate to more than 20 per cent.

To put it bluntly, the 10 most valuable US equities are larger than the market capitalisations of Japan, UK, France, Canada and Germany combined.

Such market dominance is partly built on the faster economic growth of the US relative to the EU and UK since the great financial crisis, enhanced at the corporate earnings level by share buybacks. Investors have recognised this, trebling the value of the S&P 500 since the crisis while the Euro Stoxx 50 is up less than 75 per cent over the same period.

The US has become the world’s stock exchange. Using data and estimates from multiple sources, non-US investors own $14tn of US equities.

In effect, the US has scaled up the largest companies in the world in its own public markets, creating a colossal pool of recyclable equity capital residing in domestic and non-US investor portfolios. This has created a virtuous cycle of new listings from US and overseas issuers attracted by the depth and liquidity of that equity pool.

Only a collapse in US corporate earnings relative to other developed markets would reverse that cycle. What is to stop the US growing its 70 per cent of the MSCI World index to 80 per cent over the next decade?

Until this question is answered, US domination of new issues and capital raising for big international companies is the harsh reality. Policymakers are right to fight tooth and nail to retain big international companies on their home exchanges but boards and investors are fully aware of US valuations. Loss of prestigious deals to New York is inevitable and should not be a matter for nationalistic breast beating.

Rather than grieving over the inevitable, effort should be made to nurture domestic markets in small and medium-sized companies, headquartered and listed locally. This requires a sophisticated suite of policies — perhaps with tax credits — to encourage domestic investment by pension funds, measures to encourage analyst coverage and market liquidity, and minimal bureaucracy in the listing process itself.

The UK government’s Edinburgh reforms, together with Financial Conduct Authority proposals to simplify the listing rules are not unhelpful. But we must not start a race to the bottom: investors need to be able to rely on robust regulation and accurate prospectuses. The British authorities are walking a fine line.

This is a pan-European issue. London, Paris, Amsterdam and Frankfurt are not yet this century’s equivalent of the exchanges in Aberdeen, Cardiff, Leeds or Edinburgh, doomed to be crushed by an all-consuming power.

But unless there is a recognition that their future lies as subsidiary markets to New York, accompanied by proactive public policies that make them attractive as regional and domestic exchanges, they risk a similar fate.

Richard Wyatt, chair of equity advisory at Rothschild & Co, contributed to this article