Fears for UK small and mid-cap liquidity

Feb 12, 2020
Mifid II weighs on UK-based smaller firms as sharp fall in coverage leads to muted investor appetite

A growing number of issuers and investors in the UK have reported a decline in the amount of research produced on small and mid-caps as Mifid II has gradually fed into the financial markets since January 2018.

More than 80 percent of investors saw a decrease in the availability of research for small and mid-cap companies in 2019, blaming the European regulatory regime for the reduction in coverage, according to a study published by broker Peel Hunt and the Quoted Companies Alliance.

The study surveyed 155 UK-based fund managers and 110 small and mid-cap companies finds 48 percent of investors noticed a drop in the amount of research produced on small and mid-caps in 2017. In 2018, more than 60 percent of investors noticed a decline. The current report follows on from a similar study conducted in 2017 and 2018.

As for companies, since the introduction of Mifid II, 54 percent of UK-based small and mid-caps have faced a sharp decline in the volume of research produced, finds the report.

The expectations of investors and smaller companies regarding coverage for the next 12 months remain gloomy, with 77 percent of investors and 78 percent of companies surveyed estimating a further fall in research quantity.

Decline in research increases small and mid-cap risk
The study suggests that the curtailing of small and mid-cap coverage means a greater risk for shareholders, preventing them from investing in small and mid-cap shares. More than half of shareholders (51 percent) mention risk in relation to a decline in the research in 2019, up from 46 percent in 2018, according to the report.

‘With less research being undertaken, there are greater unknowns with a stock, which could easily be overlooked,’ warns one of the surveyed investors. ‘Also, access to company management is likely to be less, which means investors are not necessarily able to ask management the right questions.’ 

Due to the negative impact of Mifid II on small and mid-cap research, just over 40 percent of investors point to an opportunity in the market for larger investment firms with significant in-house analysts in 2019, compared with 35 percent in 2018.

‘In the right circumstances it can provide larger rewards for those investors prepared to do their own research,’ adds another survey respondent.

Companies’ liquidity drying up
Investor fears combined with the regulatory change feeding deeper into the system appear to be leading to a drying up of small and mid-cap liquidity.

The UK stock market is now two years into Mifid II and the percentage of shareholders saying the European legislation plays a role in pulling liquidity out of small and mid-caps has increased from 63 percent in 2018 to 79 percent in 2019, according to the report.

More than 60 percent of investors believe appetite for private companies to list on the UK public markets has decreased as a result of the far-reaching financial regulation. Last year, 30 percent of those surveyed said this appetite had plummeted.

An unfolding de-equitization crisis
The survey suggests the regulation’s negative impact on small and mid-caps adds to an already growing de-equitization trend in UK stock markets. In 2019, 75 percent of companies and investors raised concerns over the de-equitization, the study notes.

‘I would exempt AIM companies from Mifid II research rules. Under Mifid II, access to research for smaller companies has declined substantially – this in turn impacts market liquidity,’ recommends one respondent to the survey.

Reasons for the trend also include UK political uncertainty and global trade tension. According to the report, there were only 10 IPOs on AIM in 2019 and the number of companies listed on the junior market shrank from 923 in 2018 to 863 in 2019. The London Stock Exchange also reduced in size, seeing just 26 IPOs last year.

The investors and firms surveyed have called on the UK government to halt the UK stock market’s de-equitization, and proposed further steps to make. More than two thirds (68 percent) of companies call for reduced regulation for IPOs and maintaining listings. 

Investors’ top three recommendations for increasing the flow of private companies to list on UK markets are reducing costs (41 percent), allowing dividends to be tax-deductible (41 percent) and simplifying corporate tax rates (34 percent).


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