The Lex Newsletter: Shell’s mooted City exit should spur reform

Dear reader,

Miserabilists have been painstakingly charting the City of London’s slow decline. But is the pessimism overdone? News that Shell’s top brass considered moving the Anglo-Dutch group’s listing and headquarters to the US in 2021 is a case in point. The UK’s largest company thought a move could be construed as a measure of London’s weakness. But, instead, the Anglo-Dutch group consolidated its base and stock market listing in the UK capital. Glass-half-full types would see that as a sign of strength.

Unilever went further in drawing up plans to leave the UK in 2018. But they were abandoned following pressure from shareholders. Two FTSE 100 companies — miner BHP and plumbing group Ferguson — have indeed moved their primary listings out of the UK. But they moved to countries — Australia and the US respectively — where they did most of their business.

Similarly, the US is now Flutter’s biggest market. So the Dublin-headquartered gambling company’s recently announced plans for a US listing are not hard to justify.

To be clear, there are push as well as pull factors at work. UK equities are cheap by international standards. When Shell considered a possible move, its valuation gap with its US-quoted rivals must have been a significant consideration. Exxon and Chevron are valued at about six times their cash flow, twice the multiple for Shell.

The valuation gap between UK equities and those of other markets has opened up since 2016. Despite the recent outperformance of banks and energy companies heavily represented in the FTSE 100, the London market trades at an 8 percentage point discount to that of the US.

Index composition accounts for some of the gap between UK multiples and those of the rest of the world. UK-listed companies typically have lower margins and growth prospects. Many UK-listed companies still think their businesses are undervalued. That, together with a relatively weak pound, makes them vulnerable to takeovers.

A majority of FTSE 250 bosses believe that UK-listed companies will be targeted by foreign predators this year, according to a survey by broker Numis. The M&A uptick may have already started. In recent weeks, two UK-listed companies — events business Hyve and energy services company Wood Group — reported approaches by US private equity funds.

Departures would not be a problem if newcomers were taking their place. London had some grounds for optimism on this score before the shutters came down with last year’s market downturn. In 2021, 126 companies raised £16.9bn through initial public offerings, making London the largest centre for new listings after the US and China.

But there is little cause for complacency. London only accounted for 5 per cent of IPOs globally between 2015 and 2020. If London is to reverse its decline, it needs to do better.

One issue is a shortage of homegrown capital to help small companies bulk up. Overseas pensions groups invest far more in venture capital and private equity in the UK than domestic counterparts. The UK pension funds’ risk aversion can partly be blamed on a lack of scale. The industry is highly fragmented, with thousands of relatively small schemes.

Another reason is that private sector defined benefit schemes are now mostly closed. Accordingly, they have shifted towards bonds and out of equities. In 2000, about 40 per cent of the shares on the London Stock Exchange were owned by pension funds; now their share is about 4 per cent.

Reformers have suggested changes. Consolidating pension schemes would make it easier for them to hold riskier assets that offer higher long-term returns. Structural pensions reforms are among the proposals put forward in the government’s “Edinburgh reforms”. These aim to drive growth in the financial services sector. There is also a plan to rejig rules on investment research that made coverage of smaller companies uneconomic. Many other reform plans are afoot.

If the City fails to reverse its decline, it will not be for want of reviews, consultations, task forces and calls for evidence. Though success may prove elusive, the effort is more constructive than hand-wringing. Departures, or the threat of them, are a warning signal. The City needs to find replacements if it wants to have a healthy stock market.

Enjoy the rest of the week.

Vanessa Houlder
Lex writer