Mingyi Huang, PhD candidate, School of Law, University of Strathclyde, Glasgow.

13 August 2024.

Cite: Mingyi Huang, The Evolution of Listing Rules and Initial Public Offerings: Evidence from the UK (1871 to 1985), The Global South Network Blog, 13 August 2024, https://globalsouthnetwork.com/the-evolution-of-listing-rules-governing-equity-initial-public-offerings-ipos-in-the-self-regulation-era-uk-evidence-from-1871-to-1985/

Introduction

As part of a plan to strengthen the UK’s position as a leading global financial centre, the UK’s Listing Rule is undergoing reforms following the UK Listings Review on 19 November 2020. This study briefs the development of securities regulation from the perspective of share initial public offering admission in the UK during the self-regulation era. It traces the evolving magnitude of tightness in the market entry threshold for equity listing and investigates the rationale behind each major rule change. It contributes to broader research about how the past regulatory framework connects to the present approach. Also, it aims to provide historical insights into the ongoing Listing Rule reform in the UK.

Legal history, socio-legal, and legal-philosophy methods are employed in this research. The study examines the development of listing rules, with the support of other relevant archives such as The Economist in the same period. Secondary sources on the UK’s corporate ownership and control evolution offer further insight. Additionally, research focusing on stock exchange stories, including institutional design, membership, and market development, provides an important context for the study.

Throughout the 19th and 20th centuries, the London Stock Exchange (LSE) was in a dominant position in the UK Stock Market. Hence, this study uses the LSE’s rules and regulations as a proxy to assess how tight UK listing rules were during that time. By examining these changes, it reveals insight into the evolving regulatory landscape for equity listings in the UK. The following sections are thus divided according to the different levels of stringency in regulating share initial public offerings (IPOs) over time.

II. 1871-1914: Light Touch

The choice of 1871 as the starting point is mainly due to its historical significance. This date marks a pivotal moment in the financial history of the UK when the securities market began to assume a central role in allocating financial resources. [1] From 1871 to 1914, companies could get their shares traded by the investing public either through pathways of ‘Special Settlement’ (SS) or ‘Official Quotation’ (OQ). [2]

There is a notable difference in regulation tightness between the SS and the OQ. The SS was largely unregulated[3] and became even less restrictive during this period.[4] In contrast, the LSE gradually raised the threshold for OQ.[5] However, the LSE was not concerned with the quality of the securities the market handled, leaving its members free to deal in whatever financial instruments they chose.[6] As a result, the admission control in this period is overall characterised as ‘laissez-faire’. [7]

The background is a fast expansion of the stock market. This was marked by an influx of foreign and domestic large enterprises seeking financing via the LSE. [8] A properly functioning stock market benefits the LSE, companies seeking capital, investors, and the government. At the same time, a growing number of securities became less actively traded due to a relatively limited capital pool. Such a situation increased the cost of matching orders by the LSE members.[9] Once the costs outweighed the benefits brought by the increasing number of listed shares, the LSE was incentivised to restrict market access. [10] For instance, in 1879, the updated listing criteria made it clear that only corporations of “significant magnitude and importance” could access the stock market. [11] Behind this scene, The LSE’s goal was to benefit its members by selecting large companies with the potential for active investor trading. The resultant improved investor protection in this process was a by-product, rather than the goal itself (e.g., non-action in response to the 1901 crisis [12]).

To dig deeper, in the face of tension between increasing IPO needs from companies and the LSE’s self-interest in maximising its profits, would it be possible not to lead to raising market entry conditions? The answer could be ‘yes’ if there was always sufficient capital to accommodate an increasing number of newcomers. It is because such a situation means more business and profits for the LSE. However, the pace of the rising number of IPOs outweighed the increase in investor participation in the market. This was evidenced by an increasing number of listed shares not generating any trading volume. Additionally, the government during this period lacked incentive to intervene due to a lack of public outcry. Moreover, the stock market worked as an important channel of government funding. Consequently, the LSE opted for narrowing market access. Notably, the change towards more strictness only applied to the OQ pathway and did not go far. A plausible explanation is due to its competitive landscape with provincial exchanges [13] and foreign stock exchanges [14]. It can be foreseen that investor protection was unlikely to be prioritized by the LSE, unless its own interest was at risk caused by the absence of such safeguard. This became evident in the following period when the lack of investor protection threatened the LSE’s position.

III. 1914-1945: From Formality Compliance to Quality Compliance

During this period, listing regulations shifted from a ‘laissez-faire’ approach to a more regulated framework within the LSE. This change was driven by factors like government control during the world wars, intervention in the post-war reconstruction, financial scandals such as the Hatry scandal and the 1929 crisis, and the boom of shares issues by riskier companies in the mid-1930s. [15] The LSE tightened admission conditions to either prioritise government-related funding or to rebuild and maintain investor confidence in its market.

In essence, the emergence and development of two new contradictions brought momentum for updates in admission rules during this period. The first contradiction lies in the government’s growing need for capital to fund wars and post-war rebuilding. This competes with the funding needs of both domestic enterprises and international borrowers. The other tension lies between the demand for investor protection and the LSE’s self-interest in maximising its profits. Still, the competitive pressure from provincial and international stock exchanges would limit how high the London LSE was willing to set its market entry thresholds.

When analysing the ‘possibility’ of listing rule development: competition for capital between the government and companies during war and post-war recovery could, in theory, be eased if there were a large enough savings pool available. Unfortunately, this was not the case. As witnessed, The government used its power to aggressively intervene in the market, reducing the share of scarce capital for entities that didn’t align with its policy goals [Actuality]. Given the frequent scarcity of capital, especially during economic downturns, it was likely that government intervention would continue for an extended period. Moreover, the government’s successful past interventions, especially during the war, along with the rise of Keynesian theory, likely created a path dependency. This made it more probable that the government would continue controlling the securities market to achieve broader policy goals [Necessity].

As for the tension between investors and the LSE, it could have been eased if the LSE, as both market provider and rule maker, had maintained a more neutral stance. [Possibility] This is similar to the ‘neutral technocracy’ concept by Berle and Means in Modern Corporation and Private Property.[16]

Nevertheless, the nature of the self-regulatory body in power had an inherent incentive to maximise its gains rather than prioritise investor protection. Consequently, the tension escalated until it finally erupted following the 1929 crisis. [17] This led to a shift towards more investor-focused regulation in the new rules, aiming to restore public confidence in the market [Actuality]. It can be forecasted that investors were to be protected at most to a suboptimal level under the sole governance of the industry’s self-regulatory body [Necessity].

IV. 1945-1985: Increasingly Stringent Regulation

Most of the time during this period, the stock market admission rules appeared to become stricter and more prescriptive. For instance, the LSE closed the option of going public by way of ‘Permission to Deal’ in 1946, [18] demonstrating even less acceptance of small and young companies. This cautious attitude was maintained until 1981 when the Unlisted Securities Market (USM) was created to accommodate those riskier companies.[19] Likewise, more conditions were required to be met in seeking OQ, especially after the federation and merger of the London LSE with provincial exchanges. [20] An exception to this trend occurred after the 1974 banking crisis when it slightly relaxed some of the requirements to support enterprises’ capital needs.[21]

The background is that the LSE had been recognised as an important element in the capital market since World War I. [22] The LSE’s long-standing cooperation with the government led the public to see it as the authority for handling complaints about company misconduct. [23] The public now expected the LSE to oversee the securities it listed. If stocks were found to be worthless or fraudulent, there would likely be calls for stricter government regulation which would threaten its freedom. [24]

Under these phenomena, it can be suggested that the newly emerged tension between the Exchange’s fear of losing self-regulation due to public outcry and companies’ need for IPOs likely drove the rule changes during this period. This explains why the LSE tightened its listing rules in most of the years but reopened to riskier companies once the new government appeared to be less interventionist after 1979.

In light of this new contradiction, there were a few potential alternatives to alleviate it. On the one hand, it could be addressed if smaller or younger companies could raise sufficient capital conveniently outside the LSE at low cost, or if they simply became less risky. However, the higher risk associated with this group of enterprises is inherent and thus unlikely to change. Additionally, the available alternative trading mechanisms for securities at the time were not perfect. For example, the Over-the-counter (OTC)⑦ market suffered weaknesses in transparency and efficiency compared with the market provided by the LSE. [25]

On the other hand, the tension could be reduced if: (i) the LSE better differentiated companies by risk instead of focusing on size and age, (ii) the government was less interventionist, or (iii) the LSE gained statutory power, becoming more independent and able to balance stakeholders’ interests while resisting external, especially government, influence. Although the first proposal was possible, it was not an easy task for the LSE; otherwise, it would have been applied in the past decades. However, the second and third conditions did come true in the 1980s. The LSE launched the USM in 1981 and was recognised as the competent regulatory body. According to the Financial Services Act 1986, the LSE was responsible for promulgating and enforcing listing requirements for companies with publicly traded shares. [26]

Looking to the future, having an independent statutory regulator focused on public interest could reduce tensions between the LSE and other market stakeholders. This would leave only the conflict between companies seeking easier capital access and the need for investor protection [Necessity]. However, the LSE was unlikely to be completely free from government interference, as coordination between institutions was necessary to achieve their shared national goals. For instance, in the case of another national emergency necessitating the government to raise tremendous capital, relevant market restrictions imposed by the government would appear again.

V. Conclusion

The study illustrates that despite periodic changes to the rules favouring either companies or investors, the overall trend in regulations governing share floating became increasingly stringent over time. Before 1914, a ‘laissez-faire’ approach prevailed. However, starting from 1914, government intervention or influence began to vary in strength throughout the ensuing decades until 1979. A shift towards greater emphasis on investor protection emerged following the 1929 crisis, becoming even more pronounced from 1946 onwards. From 1871 to 1985, it is argued that LSE’s self-interest primarily drove regulatory changes. The ongoing tensions between the LSE and companies seeking IPOs or investors ultimately led to the end of the pure self-regulation model.

VI. Glossary

①Special Settlement – This refers to a designated day set by the Stock Exchange Committee when all transactions in a company’s newly offered shares must be settled. This process grants the company official recognition on the stock market. It allows securities to be traded within the exchange before they are fully issued or officially listed.

②Official Quotation – It refers to the listing of a company’s shares or the scrip or bonds of a loan in the Official List by order of the Stock Exchange Committee, a status that can only be obtained after fulfilling certain required formalities.

③Keynesianism – It is an economic theory proposed by the British economist John Maynard Keynes in his 1936 publication ‘The General Theory of Employment, Interest, and Money’. Keynesianism advocates for government intervention during economic downturns through fiscal policies such as increased public spending and tax cuts to stimulate demand and create jobs, aiming for economic recovery. This theory provided a theoretical foundation for arguments against laissez-faire economics and in favour of government intervention in the economy.

④Neutral Technocracy – It is a concept developed by Berle, Adolf A. Jr., and Means, Gardiner C. in ‘Modern Corporation and Private Property’. They argue that for the corporate system to survive, the control of large corporations should evolve into a neutral technocracy. This system would balance the interests of different community groups and distribute income based on public policy, rather than private greed.

⑤Permission to Deal – Between 1919 and 1945, the Stock Exchange forced brokers to ask permission to deal in any new issue of securities before creating a market for it on the stock exchange floor.

⑥Unlisted Securities Market – It was a market on the London Stock Exchange, established in 1981 and discontinued in 1996, for trading in shares of smaller companies that did not wish to comply with the requirements for a full listing.

⑦Over-the-counter market – This refers to a decentralized market where securities are traded directly between two parties without being listed on formal exchanges.

References:

Ranald Michie, ʻThe London LSE and the British Economy, 1870–1939ʼ, in J. J. Van Helten and Y. Cassis (eds.), Capitalism in a Mature Economy (Aldershot 1990) 99.
B. E. Spencer, The Law and Practice of the Stock Exchange (William Clowes and Sons 1897) 27.
Burhop C, Chambers D and Cheffins B, ‘Regulating IPOs: Evidence from Going Public in London, 1900-1913’ (2014) 51 Explorations in Economic History 60.
Rules and Regulations of the Stock Exchange, 1879, 1902, 1911.
Rules and Regulations of the Stock Exchange, 1879, 1902, 1906.
George R. Gibson, The Stock Exchanges of London, Paris and New York: A Comparison (1889), 35.
Cheffins BR, Corporate Ownership and Control: British Business Transformed (Oxford University Press 2008) 75-76.
Michie R, The London Stock Exchange: A History (Oxford University Press 2001) 92-3.
Michie R, The London Stock Exchange: A History (Oxford University Press 2001) 95-97.
The Economist, 30 May 1885.
Rules and Regulations of the Stock Exchange, 1879.
FRANCIS CHISWELL, Key to the Rules of the Stock Exchange (Effingham Wilson 1902) 133-134.
Davis LE and Gallman RE, Evolving Financial Markets and International Capital Flows : Britain, the Americas, and Australia 1865-1914 (Cambridge University Press 2001) 191.
Michie R, The London Stock Exchange: A History (Oxford University Press 2001) 140.
Michie R, The London LSE: A History (Oxford University Press 2001) 270-72, 280-82.
Berle, Adolf A. Jr.; Means, Gardiner C. Modern Corporation and Private Property. New York, Macmillan Co., 1933. 356.
Klein M, ‘The Stock Market Crash of 1929: A Review Article’ (2001) 75 Business History Review 325-351.
Rules and Regulations of the Stock Exchange, 1946.
Michie R, The London Stock Exchange: A History (Oxford University Press 2001) 531-34, 572.
Cheffins BR, Corporate Ownership and Control (Oxford University Press 2008) 332-33.
Michie R, The London LSE: A History (Oxford University Press 2001) 536.
Michie R, The London LSE: A History (Oxford University Press 2001) 354-58.
Michie R, The London LSE: A History (Oxford University Press 2001) 354-58.
Michie R, The London LSE: A History (Oxford University Press 2001) 416.
Randall Dodd, ‘Financial Markets: Exchange or Over the Counter’<https://www.imf.org/en/Publications/fandd/issues/Series/Back-to-Basics/Financial-Markets> accessed 20 March 2024.
Financial Services Act 1986, ss. 145(b), 153.