Our views on AIM market reforms

As an analyst who is looking to FTSE AIM as a long-term new source of income, it’s slightly concerning that two of my most popular articles over the past few months are entitled:

• Is the AIM market an unregulated mess? – November 2023
• Is the small cap market broken? – March 2024

Now, I want to be clear, as before, that there are many good macroeconomic reasons why the small cap market is suffering. I’ve gone into these before; it is cyclical, rates remain elevated leaving risk-free money tied up in savings accounts, the risk cash is all in the large caps due to the AI boom, AIM is having to share risk money with crypto allocations, yada-yada.

But this does not explain the state of the market. Over the past 12 months, 70 companies left AIM by choice or by collapse, leaving the index with 738 firms at the end of March. That’s nearly a 10% fall, and far more than the 25 companies that left in the comparable period of the year before.

There were more than 1,700 firms on AIM before the 2008 Global Financial Crisis. Just 10 companies listed in 2023 — and so far in 2024, we’ve had one IPO. That company was MicroSalt — a business I covered in depth.

But as we all know it’s not just the small caps. Shell’s Wael Sawan is considering leaving London for New York because, he argues, the oil major is undervalued compared to stateside rivals. This is nonsense, as Shell is actually valued lower due to its significant investment into green energy.

US-listed oilers haven’t, by and large, bothered.

I don’t think Shell will leave. It’s beyond easy for American investors to buy the stock already, and if it were to go, Sawan would have some explaining to do when the share price refused to budge. And these warnings have been made several times before.

But still, ARM listed in New York, refusing to contemplate even a dual listing that it had enjoyed prior to going private. CRH upped sticks, as did Ferguson. And Ocado is apparently under pressure to seek fame and fortune on a US exchange whose investors can properly appreciate it as the tech stock it is.

Then you have the takeovers, both successful and failed. Hotel Chocolat, Currys, Direct Line, Gresham House…the list continues to grow. There is a pervasive and persuasive argument that London simply does not value companies properly — and that given the smaller size of AIM stocks, the damage this causes is correspondingly magnified.

But instead of complaining, this time I’ve come up with some proposals to reform the small cap end of the market. I’m not saying every idea is excellent — but waiting for the FCA to come up with their own ideas and implement them will take forever.

We need change now. I’d rather start a conversation than continue to complain.

1. Reduce IPO prospectus requirements from hundreds of pages to a maximum of 40. Reduce listing fees to a maximum of £200,000 and ongoing annual fees to as low as practically possible.
2. Return auditing and ESG guidelines to their prior status. These reforms have hindered rather than helped.
3. Reform insider information guidelines to make communication between management and shareholders freer flowing.
4. Spin-off ownership of AIM off LSEG and into a separate entity, which is actually incentivised to attract new listings.
5. Apply a new venture capital scheme to AIM shares, boasting similar tax incentives as those offered to investors in private companies.
6. No capital gains tax or dividend tax for investors who buy shares in AIM companies which sport a market capitalisation under £50 million at the point of investment.
7. Create a tax credit scheme for pension funds, to subsidise some of the losses incurred from investing in small cap risk assets.
8. Companies looking to place shares have to suspend the stock until the placing is concluded, with a maximum discount of 20% to the most recent closing price.
9. Create a new account type, whereby investors can hold 10% of the value of their shareholding, and this cash gets preferential treatment for any placing undertaken.
10. Maximum spread of 5% applied to all AIM shares.
11. Ban on shorting for companies with a market capitalisation under £25 million, and then staged limits thereafter.
12. Raise the TR1 disclosure limit to 5%.
13. Executive managers who deliberately break market rules publicly named and shamed, and banned from being a director of any listed company for life.
14. Impose a maximum cash salary for directors, with additional pay beyond this only to be in a pre-set number of shares.
15. Marketing services, both formal and informal, to provide clear information on their success rate.

Broadly speaking, there are two key though interrelated issues plaguing companies listed on the AIM market — financial problems and regulatory struggles.

This has been highlighted in pretty gory detail in recent weeks — C4X discovery and Redx both delisted specifically because they think (rightly) they can raise more money as private companies. Scirocco Energy is also going, primarily because of the ongoing expense of remaining listed.

Launching an IPO and remaining listed on the index needs to be much, much cheaper. The cost of listing is circa £500,000 and annual costs also run into the hundreds of thousands every year. With many AIM shares sporting microcaps, it is very difficult to justify these fees — when staying private is free. The trade-off used to be that companies could better access finance on decent terms, but as we all know, this is no longer the case.

As part of the IPO process, you are expected to produce a prospectus running to hundreds of pages long. Nobody in the history of investing has ever read this document — you look for the 

key five pages or so and the rest might as well be an old Argos catalogue.

In terms of ongoing regulatory requirements, new reporting obligations around both auditing and new ESG guidelines are twin disasters. Private companies don’t need to faff around with this nonsense, and the reason why so many companies keep getting suspended for missing earnings deadlines is that auditing the finances now takes much longer. There aren’t enough auditors for the increased workload, and the ones there are, now have to charge more.

Listing on AIM is meant to be cheap, and less regulated than the main market — and it does feel that it is relatively expensive, and that the regulation is in place only where not wanted or needed.

For context, listing on AQSE costs half that of listing on AIM, and it’s getting the IPOs. And then we come to the communications problem; NOMADs and CEOs are effectively gagged by the regulator from effectively communicating their strategies, aims and objectives — or at the very least, many management figures feel that they simply cannot be completely open with investors.

Now, yes, there is the concept of inside information — but the balance has shifted too far the other way. I work with several private businesses and can have lengthy, in-depth chats with management on virtually every aspect of the company/assets, because typically I am unable to offload my shares until a liquidity event.

Of course, private companies can be a double-edged sword as you essentially have to 100% trust the management team because there can be effectively no disclosure. But the liquidity issue is starting to change; services like JP Jenkins are going to get more popular as they are using tech from the likes of InfinitX to display real-time pricing of private assets, while also 

executing trading by matching buyers and sellers via its broker network.

Now there’s talk of NASDAQ buying AIM off LSEG. Of course, LSEG only cares about its revenue golden goose (the data and analytics service has been rebranded from the widely known Refinitiv to LSEG Data & Analytics — presumably after an overpaid consultant had one too many martinis at lunch).

On that note, LSEG CEO David Schwimmer (not Ross) is set to become one of the highest paid executives in the UK after 89% of shareholders voted for his maximum pay to double to £13 million. Again, investors looking on bewildered need to understand; LSEG does not care about the health of the market.

It doesn’t give a damn about listed companies it is supposed to have some kind of responsibility for, and a new proprietor may well be a great idea. The problem is that NASDAQ running the show would also be terrible — listen to investors in US small caps and you will realise the grass is not greener.

However, NASDAQ does have more than 1,000 companies on its European exchanges and had previously attempted to buy LSEG itself. Given that LSEG doesn’t care about the index, and NASDAQ wants the growth, this could well happen if there is any truth to the rumours.

On the other hand, as I type, Smart Metering Systems has announced it’s gone, taken out by Bidco. Death by a thousand cuts seems apt.

Why does the US do so much better at encouraging risk assets? Partly, it’s structural. Americans have to save to pay hospital bills and up front college tuition fees — an anathema to Europeans and Brits, where the deal is higher taxes in exchange for these services being taxpayer-funded.

This means our stateside cousins get the investing bug ingrained into them from birth and have the timescales to increase their exposure to risk; the general wisdom being that you should reduce your risk profile as you age.

But on top of this, in the US, you can offset $3,000 of capital losses against your income tax bill every year and roll it over if not used. This means almost everyone in the US has a ‘free’ $3k to invest in high-risk growth stocks, because if it goes to 0, it’s a tax write-off.

The small cap market needs a similar incentive in the UK. Additional tax breaks need to be brought in that are currently only applied to private companies through the various venture capital schemes. A big part of the reason why being private is more appealing is because individual investors are incentivized to invest in you through the tax system.

How about this? No capital gains or dividend tax for investors who buy shares in AIM companies which sport a market capitalisation under a certain figure at the point of investment.

Then there’s the pension funds — Mansion House reforms, sure, but what you need is a wholesale cultural change as fund managers refuse to invest in anything lossmaking (which rules out hundreds of AIM shares). Pension funds need a new tax credit scheme to claim back some money on failed small cap investments, subject to a cap.

I also think it’s worth looking to the ASX, as Australians have a far healthier small cap market. In the junior resource sector, you are not meant to share photos or details or any ongoing programs before an RNS — avoiding the typical rampy nonsense you get on AIM. In general, the rules are stricter as mining is such a massive part of the ASX and having more investors in a specific sector tends to create more incentive to get it right.

But more widely, the big things the Australians do well, and we should copy, is that as a soon as a company decides it wants to conduct a placing, the stock is suspended for several days. This prevents the typical forward selling endemic in the UK. And a further (though looser rule) is that discounts offered in a placing are limited to a certain percentage.

What would be the immediate impact on AIM? To start with, dozens of terrible companies are alive solely because only forward sellers are prepared to buy in their placings. These zombie businesses would die in short order.

Then, companies which cannot acquire capital without offering a massive discount will either be forced to delist, or collapse entirely. This would again see more businesses go — but introduce far higher levels of confidence for investors who know that they will not suffer from mass dilution at a moment’s notice.

Of course, what would happen once this was implemented is that share prices would slowly decline to a point where they get to a place where they can raise funds at a 20% discount (because we can all calculate a cash runway), but this gives investors an escape hatch in the meantime. It would also mean that the gains would be slower, but far more sustainable.

Placings themselves need to be more accessible to current shareholders. Not just to the family and friends of management at a discount (this is fine, as long as everyone gets a bite of the apple). But a common tactic is to offer retail a placing with a deadline 3 hours later when all the brokers have gone home for the day. It feels very much like free money for insiders and needs to change.

Perhaps investors can choose to hold some cash in a nominated account, with this money getting preferential treatment for any placing undertaken. It would be up to you to keep the money in there. At the moment, brokers must underwrite the raise before they can let retail know, but this feels like a better system. It would also make it less necessary for management to lie about the fact they are raising.

Yes, this would all initially accelerate delistings. But perhaps cutting off the gangrenous limbs would be good news over time — more cash would be spread over the remaining companies — and you would have a healthier market for new businesses to launch IPOs.

Further, the spread on all AIM shares needs to also have a maximum. The argument goes that many companies are very illiquid, so you have to make the spread for some AIM stocks large enough to make an order worthwhile for the market maker. But these spreads then themselves become the source of the illiquidity, as nobody wants to be 15% down immediately after clicking the buy button.

Better to apply a mandatory maximum spread of 5% of the share price — and if nobody wants to deal in the stock, it becomes effectively delisted.

Now a pet peeve. Why, in 2024, do we not know whether a trade is a buy or a sell? Just synch the prints to the RSP — or force market makers and brokers to verify the trade. This should be easy —and don’t say they are recorded correctly, as we have all placed a large trade that is recorded the other way.

Then we come to a seriously contentious issue. Shorting. There are plenty of people clamouring for an outright ban, but I think this would be a mistake. While shorting can kill healthy companies, it is also necessary in a market where equity bubbles can quickly form due to overexuberant investors.

A middle ground might be found, where only a certain percentage of a company’s shares can be shorted — or alternatively, where new shorting positions are banned when a business has a market capitalisation under a certain figure — say £25 million. Of course, this could create a cliff edge of businesses at the £25 million mark, so perhaps you could again limit the percentage of the float that can be shorted from this point.

It’s worth noting that shorting is banned on AQSE, but that it hasn’t really stopped any of the usual shenanigans.

Now, reforms will only work where they are actually enforced. Here’s a scenario: a high net 

worth investor buys shares in a small cap, brings themselves over the 3% limit, and should promptly declare TR1 status. They decide they would rather not, as they then come under fire from other investors if they decide to sell — and sometimes, just prefer their privacy.

Often, it’s a genuine mistake. Many HNWs float just under the 3% limit, and a share buyback or regular monthly buy can tip them over without realising.

But regardless, the rules are the rules. There must be some kind of penalty for late/no disclosure. And as it stands, the current punishment is that they need to bring a cake into the FCA next time they’re in London.

Personally, I would increase the TR1 limit to 5% to encourage more buying among the people with the financial firepower to do so — but the underlying principle of any rule is that it only exists if it is enforced.

Of course, late declaration of a TR1 is child’s play compared to the lunacy many CEOs get away with. What is actually needed is for management who openly break the rules to suffer — publicly named and shamed, and banned from being a director of any listed company for life.

Just pick one CEO. There are plenty to choose from. Throw the book at him/her and watch the rest fall into line. Of course, what the FCA is proposing at present is to name companies and management at the point of investigation, rather than when found guilty. As per usual, lunatics run the asylum!

Then there’s a question of skin in the game. Should there be a minimum amount of shares each board member should hold? Should individuals paying themselves in cash for 17 different non-executive director gravy trains instead only have to take shares — or perhaps be limited to a certain numbers of roles?

Of course, many competent managers need a cash salary to pay the bills, so there needs to be a trade-off. And high risk companies don’t always pan out. But it seems to me that there needs to be a financial alignment of interests. Perhaps a basic wage and then all further wages in shares?

In terms of marketing — both FCA regulated and informal — I have a very simple idea. All CFD providers have to disclose the success rate of their traders (typically 75% of people lose money). 

Similarly, all marketing services should have to disclose the ongoing share price performance of their clients from the moment they take them on, alongside historical data of the performance of past clients.

However, for this to work, it would need to universally apply to everybody, as some companies and services will simply sign NDAs to circumvent the rules.

At some point, you need to stop complaining and start fixing the problems. These proposals may be radical, and perhaps impractical in terms of cost. I just want to start the conversation.

But tax incentives for growth tend to pay off — and if you want a small cap market, you need to reward investors taking the risks.