LSEG Budget Submission - London Stock Exchange

Jobs, innovation and investment:
A strategy for sustainable growth
London Stock Exchange Group plc
2011 Budget Submission
The London Stock Exchange is Europe’s largest and most liquid equity
market. Since 2007, London Stock Exchange Group also operates the
Italian equity market and, through its subsidiaries, offers post-trade
services and has a majority interest in MTS, Europe’s leading market for
trading government debt.
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Jobs, innovation and investment:
A strategy for sustainable growth
Four years after the start of the credit crisis, there is a strong consensus
of the causes and the lessons to be learned. It is very clear that we
need to work together to build a rebalanced economy with deeper
personal savings, a re-equitisation of our funding environment, and a
renewed focus on the growth opportunities provided by our world class
SMEs. The last of these is crucial. If each of the 4.8 million UK SMEs
adds one job, we could end unemployment.
The London Stock Exchange has been working hard to find ways to
meet these goals, building on our experience as the operator of the AIM
growth market, and working closely with investor and business groups. We recognise the
fiscal constraints on the Government. This submission offers sixteen detailed
recommendations that are deliverable with minimal legislative or spending implications. The
majority of our recommendations are entirely revenue neutral.
Making the equity funding ladder work for UK SMEs – smaller businesses will be the
drivers of our future growth, especially the innovative ‘three tech’ sectors - high, clean
and bio – in which we have global leadership. We need to build a funding ladder which
can support them at each stage of their development. We have suggested a number of
polices which could have a real impact, and we believe that the targeted abolition of
stamp duty on AIM quoted shares would be a particularly low cost, effective intervention
on behalf of these key drivers of growth. Growth markets like AIM account for only
around 5 per cent of Stamp Duty revenues, and research by KMPG shows that abolition
would increase GDP growth, replacing lost revenues.
Boosting UK corporate access to fixed income finance - Last year, we launched the
UK’s first retail accessible bond market, which we hope can unlock a new pool of finance
for UK businesses and medium sized companies in particular. We suggest a number of
policies to support the market with little or no fiscal implications, such as introducing a
dedicated ISA allowance specifically for bond investment, and a demonstration of
support by the Government, to increase the visibility of this high-potential asset class.
Capital markets – a tool for policy makers - The green economy, university innovation
spin outs, and even public sector spending projects could all be addressed by
harnessing private finance through transparent, efficient markets. In this submission we
outline areas where the investment industry could work with Government.
The 2011 Budget is an opportunity to lay the foundations for transformative change in the
UK economy. As policy makers and industry professionals, our ambition has to be to build
a sustainable funding environment where the blue-chips of tomorrow can thrive today. We
believe that the policies suggested in the submission can make a strong contribution.
Xavier Rolet
CEO
London Stock Exchange
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Our Recommendations
Making the equity funding ladder work for UK SMEs
1. Increase funding to growth companies by removing stamp duty from AIM shares.
Stamp Duty is a direct cost to investors, and reduces liquidity. Abolition would enhance
the equity funding ladder by improving ability of investors to sell their holdings at a
reasonable return. KPMG have demonstrated that the measure would be revenue
neutral in the long term as a result of higher economic growth following greater
investment in business, and in the short term cost only 5 per cent of the total stamp duty
revenues.
2. Introduce a principles-based test for tax incentives to make sure tax incentives are
targeted as effectively as possible without increasing the regulatory burden. The
Exchange stands ready to coordinate an industry group to assist the Government in
implementing this.
3. Improve the CGT regime for investment in quoted companies to encourage investors to
re-invest their gains into smaller companies. Introducing roll-over relief for capital gains
on investment in companies on growth markets would not only boost liquidity but also
encourage investors to re-invest their gains into smaller companies creating a more
vibrant market for the longer term.
4. Allow Venture Capital Trusts to invest in the secondary market providing urgently
needed support for growth companies through funds that are already accounted for by
the Treasury. This would help alleviate the ongoing depressed valuations of many
smaller companies which has made it extremely difficult and costly for these companies
to raise further equity capital.
5. Increase the ceilings on the size of companies that VCTs can support. We
recommend increasing the gross assets limit for VCTs from £7 million to £15 million and
the employee test limit from 50 to 250 employees. In the medium term, increasing the
limits will make AIM VCTs more attractive to their ultimate investors and help restore the
ability of AIM VCTs to raise funds, with clear benefits for the UK economy. VCT
managers can be an asset in delivering government policy, through the expertise and
support they offer growth companies.
6. Defend the regulation of the UK growth market in the EU. The regulatory burden on
AIM effectively balances investor protection and the needs of SMEs. To ensure the
existing regulatory framework of the UK’s growth markets is preserved, we would
encourage the Government to offer a strong voice in Europe on the regulation of growth
markets.
7. Encourage direct investment in growth companies by UK corporates. The
Government should seek to enhance existing tax incentives and investigate new other
policies to encourage larger firms to provide financing and support to smaller companies.
As an example, the investing firm could receive a full first year corporation tax relief
equivalent to the size of their investment in the smaller business. To ensure that this
relief is properly targeted, the Government could introduce criteria based on the size of
company receiving the investment, how the funds are used, and restriction to companies
within their sector and with direct technological relevance. British Gas and Ceres Power
is an excellent example of how this system could work.
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Boosting UK corporate access to fixed income finance
8. Provide Government backing to encourage high street banks to promote retail
bonds. The Chancellor of the Exchequer or Secretary of State for Business, Innovation
and Skills could lead an initiative to encourage existing providers to offer access to retail
bond trading. The explicit leadership of the Government would strongly support the
development of these access routes, and the London Stock Exchange would be
delighted to support such an initiative.
9. Recommendation – Encourage trading in listed products on a regulated market -
We believe that the Government should encourage greater transparency in relation to
trading venue and should require stockbrokers to make clear to their clients whether or
not their trade is conducted on a regulated market, ensuring a full choice for investors
and greater confidence in the investment process.
10. Introduce an additional £2000 ISA savings level for bonds to kick start’ interest in the
asset class, enhancing access to non-bank finance and encouraging a savings and
investment culture. This policy is likely to have limited fiscal impact.
11. Remove tax barriers to issuance of corporate inflation-linked bonds - We
encourage the Government to review the tax treatment of inflation-linked instruments
and to offer a level playing field in the tax treatment of gilt and corporate inflation-linked
securities.
12. Improve the transparency of bond issue documentation to promote wider access
for private investors. The regulator should support market driven initiatives to increase
transparency. Furthermore, we ask the Government to work with the industry to clarify
areas of uncertainty in relation to the UK interpretation of the EU Prospectus Directive.
Encouraging transparency and investor protection
13. Introduce a level playing field between listed, exchange-traded products and
financial spread betting products. The tax system should not encourage investment in
unlisted products which are not admitted to a regulated market or spread betting to the
detriment of on-Exchange, listed securities. The tax treatment for tradable listed
products should be at least equivalent to that available for products not admitted to a
regulated market.
Capital markets – a tool for policy makers
14. Support investment in the clean tech sector by helping us to build on our Low Carbon
Indexes to develop equity investment products. The Government could support a
working group to launch the world’s first clean technology retail investment products. Our
indices offer a tailored solution for clean technology companies, and a retail accessible
investment fund could greatly increase the profile and amount of funding they receive.
15. Create a listed equity fund to invest in university spin outs, supporting UK
leadership in university based science and engineering innovation. The fund could raise
an initial raise £150 - £300 million of private investment to support the commercialisation
of university innovations.
16. Launch government bonds to fund public sector spending projects, such as the
Dover Port hospitals, road projects or schools. We would be delighted to bring together
a working group of Government, officials, and investors to deliver a mechanism for
funding spending in this way.
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A strategy for sustainable growth
Index
A strategy for sustainable growth .......................................... 6
1. Making the equity funding ladder work for UK SMEs ................ 7
1.1 Introduction – the equity funding ladder and the role of growth markets........... 7
1.2 Improving tax policy for SMEs ........................................................................ 10
1.3 European regulation – preserving a framework for growth ............................. 13
1.4 Direct investment in smaller peers.................................................................. 14
2. Boosting UK corporate access to fixed income finance ............15
2.1 Widening access for retail customers ............................................................. 15
2.2 Removing barriers for small to medium sized firms to debt capital markets ... 17
3. Encouraging transparency and investor protection.................18
4. Capital markets – a tool for policy makers............................19
4.1 Funding low carbon companies ...................................................................... 19
4.2 Supporting high technology innovation at the UK’s universities...................... 20
4.3 Funding public sector expenditure.................................................................. 20
Appendix A: AIM Factsheet..................................................21
Appendix B: Fixed income and the retail bond market ...............27
Appendix C: Fiscal incentives available to AIM companies ...........30
Appendix D: Rationale for an EU framework for growth markets ...33
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A strategy for sustainable growth
The most pressing economic and public finance challenges the UK faces will need to be met
through policy makers and the private sector working together. In this Budget submission,
we set out a number of targeted policies which we believe can be very effective in creating
and supporting sustainable long term growth.
Economic recovery – and the ability to address the deficit – can only be secured by
harnessing the growth and innovative nature of smaller companies, especially in the high
technology industries which increasingly dominate the global economy. 12% of Total Early
Stage Entrepreneurial Activity in the UK is in high or medium tech sectors, compared to
6.3% in China. The prize on offer is hugely significant. By helping each of the 4.8 million
SMEs in the UK to add just one net job, we could end unemployment.
And it is clear that we need to achieve a fundamental rebalancing of the economy away from
an excess of bank finance, towards a more stable financing system for UK business built on
diverse sources of funding including equity and non-bank lending channels. These
alternative finance streams, for example in the form of bonds, can offer a much needed
economic ‘spare tyre’, providing capital when bank lending is reduced.
Capital markets can also offer a powerful tool for meeting a number of key government
infrastructure ambitions. Clean technology, university spinouts and public infrastructure are
all areas where private sector funding and expertise could be harnessed to support
Government policy.
We stand ready to work with the Government to secure change in these areas.
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1. Making the equity funding ladder work for
UK SMEs
1.1 Introduction – the equity funding ladder and the role of growth
markets
The 2011 Growth Budget is an opportunity to lay the foundations for transformative change
in the key area of UK SME financing.
Smaller, growing businesses are major contributors to job creation across the UK. During the
three years leading to the crisis they contributed an average 2.1% year on year job growth 1 ,
and they are also twice as likely to innovate as their larger peers and account for 40% of live
patents. The innovation and enterprise of these companies creates spillover benefits as new
knowledge, technology and skills are transferred to other industries, raising the level of
productivity across the UK economy.
The equity funding ladder is crucial to supporting these companies throughout their
development, from seed capital, business angels, venture capital and public markets. For
the ladder to work, each level of investor must be confident that they can sell their holding at
a later stage and reinvest in the next generation of promising entrepreneurs.
At the top of this ladder is the AIM growth market, which since being launched 15 years ago
has helped over 3,170 companies raised £70 billion at admission and through further
fundraisings. This includes over £16 billion raised by more than 1800 smaller UK
companies 2 . As at 31 December, there were 1,194 companies on AIM with a total market
value of £79.4 billion, of which 965 were UK incorporated with a market value of £48 billion.
A Grant Thornton report 3 published earlier this year found that in 2009, UK AIM companies
directly contributed £12 billion to UK GDP and supported 250,000 jobs. They contributed a
further £9 billion to UK GDP and supported 320,000 jobs indirectly through the supply chain
and multiplier effects. AIM companies continue to experience significant growth in turnover
and employment in the years after admission, with the highest levels experience in the first
year post admission (with an average of 37% increase in turnover and 20% in employment –
see figure 1 below).
1 Business Innovation and Skills statistics, Statistical Press Release (October 2009)
2 Smaller UK Companies are UK incorporated companies that had a market capitalisation of under £25 million at
the time of admission.
3 Grant Thornton, Economic Impact of AIM and the Role of Fiscal Incentives, (2010)
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Figure 1: Turnover and employment growth in AIM companies, by period since admission
40%
35%
30%
25%
% annual average growth in turnover
% annual average growth in employment
20%
15%
10%
5%
0%
1 year since
listing
2 years 3 years 4 years 5 years
Source: Thomson Reuters and Grant Thornton analysis 4
Note: Weighted by size of company
However, existing data clearly indicates that equity finance is underused by companies of all
sizes, with the problem particularly acute amongst SMEs who make far greater use of short
term debt finance such as credit cards and bank overdrafts. In fact, research conducted by
the University of Warwick shows that the percentage of UK SMEs using equity finance
remained broadly unchanged over the period 2001 to 2008 (see Figure 2 below).
Figure 2: Percentage of SMEs using financial products (2006-2008 vs 2001-2004)
Source: Warwick Business School, Small Firms in the Credit Crisis: Evidence from the UK Survey of
SME Finances, (2009)
There is no single barrier to companies of any size, and SMEs in particular, accessing equity
finance. However, there are various factors that influence a company’s decision to access
external funding and an equity investor’s interest in investing in an SME. Companies are
willing to seek access to public equity markets on the basis that the benefits of being on
market outweigh the costs. Ultimately this is measured through increased investor interest
(i.e. liquidity – the number of buyers and sellers in a market) and a reasonable cost of
capital.
4 These figures are compound annual growth rates.
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A company’s cost of capital is the return investors demand for their investment in the
company. The cost of capital therefore increases with costs borne by the investor which
include due diligence costs, any upfront or future taxes on investment and uncertainty over
exit options.
Due to the higher costs of due diligence associated with investing in earlier stage and
smaller businesses, SMEs face both a higher cost of capital than their larger peers, and a
number of funding gaps throughout the development cycle. In the current economic climate,
the supply of bank finance remains limited and the equity gap has widened. As a result,
investors willing to provide capital to SMEs demand an even higher rate of return, leading to
an increase in the cost of capital for these companies. These issues are more pronounced in
key sectors such as technology where ventures need significant capital injections prior to
revenue generation.
Info box: Why liquidity matters
Investor willingness to support a company is influenced by how certain investors are of
their ability to sell their investment later. Any uncertainty over exit options is therefore
incorporated in the price an investor pays for a stock at issue; this is also known as the
‘liquidity risk premium’. Therefore, the less liquid an asset, the less assurance an
investor has over his ability to trade in and out of the investment – as a result the investor
demands a higher rate of return therefore increasing the company’s cost of capital.
Illiquidity is measurable as the ‘spread cost’ between the buy and sell prices – for
instance 2000 liquid FTSE100 shares bought for around £11,000 and immediately sold
would incur a ‘spread cost’ of £2 whereas a similar sized deal in a relatively illiquid stock
on FTSE250 would incur a spread cost of £130. The smaller and less liquid a stock, the
higher this spread cost can be.
Investors factor this loss between the price they buy and the price they sell into the
amount that they are willing to pay for the shares when they are first issued. The
‘liquidity’ of the secondary market therefore directly impacts on the amount of funding the
issuing company receives.
We therefore strongly welcome fiscal and regulatory policy designed to broaden the set of
investors at the retail and institutional levels willing to invest in smaller companies at the
time of new share issues (i.e. in the primary market) and once they are on market (i.e in
the secondary market). This would bring liquidity in smaller company securities and help
reduce the cost of capital for such companies.
We recognise that the Government feels it is currently unable to support the inclusion of
AIM shares in ISAs as a mechanism for achieving this goal, but in this paper we outline a
number of alternative solutions which we believe would promote increased investor
participation and liquidity for SMEs.
While there is no single solution, we believe the UK funding environment could be supported
by targeted regulatory and fiscal policies to attract a wider set of investors to smaller,
growing businesses, helping to create a virtuous circle of investment and growth in the
longer term.
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1.2 Improving tax policy for SMEs
Arguably the most significant barrier to efficient access to equity funding for companies of all
sizes is the tax treatment of equity. The existing behaviour-altering fiscal structure creates an
unnecessary disincentive for investment and issuance of equity. While other asset classes
such as bonds and cash are subject only to income tax, equities are taxed at purchase,
dividend and sale, in addition to the corporation tax paid on company profits, as indicated in
Table 1.
Table 1: Tax treatment of equity and fixed income
Equities Tax Rate
Tax on purchase Stamp Duty/SDRT 0.5% on purchase of shares in UK companies
Tax on company
paying dividend
Tax on dividend
income
Corporation Tax on
profits
Dividend Tax
21%/28% depending on size
10%/32.5% depending on income (offset by a
10% tax credit)
Tax on sale Capital Gains Tax 18%/28% rate depending on income
Gilts/Bonds 5 Tax Rate
Tax on interest Income Tax 20%/40%/50% (at income tax rate)
These taxes are in addition to the underlying risk associated with equity that investors take
on, i.e. the risk of no compensation in the case of a company failure.
Fiscal incentives therefore play a central role in encouraging investors to include smaller,
earlier stage, growth companies in their investment strategy rather than simply focusing on
larger companies and securities that are perceived to carry a lower risk. We believe that
fiscal incentives targeted at such companies should aim to promote entrepreneurialism as
well as attract as wide a set of investors as possible to boost liquidity and help lower the cost
of capital. It is however important to recognise that no one single incentive scheme can
achieve these objectives.
Stamp Duty - a tax of 0.5 per cent on the trading of shares - discourages investors from
investing in equities. In 2010 KPMG published a report supported by the London Stock
Exchange which outlined the effect of the tax on capital raising for UK business and the
wider economy. The report found that Stamp Duty increases the cost of raising equity
capital for UK business by an average of 7.5–9% and for technology companies by 10–
13%6.
The report also found that Stamp Duty reduces the total value of UK listed companies by
over £133 billion and the total amount of UK capital investment by up to £7.5 billion a year.
Perhaps most interestingly, KPMG modelled the effect of abolition of Stamp Duty on the
economy. The report found that as a result of higher economic growth following enhanced
investment in business, abolition of Stamp Duty would be revenue neutral to the Exchequer
within the lifetime of a parliament. It would increase the total amount of capital investment by
up to £7.5 billion a year, and deliver a jump of 7.7 per cent in the stock market on the day it
is announced.
5 In addition, interest on debt re-payments is tax-deductible for companies.
6 KPMG, Building a Sustainable recovery (2010)
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Recommendation - Remove stamp duty from AIM shares - We ask the Government to
phase out or abolish Stamp Duty shares on AIM and other growth markets as part of the
five year corporate tax strategy to further boost the efficiency of equity markets for UK
companies, savers and investors. We estimate that Stamp Duty revenues from AIM
securities account for under 5 per cent of total Stamp Duty revenues from share trading
activity.
In times when there are severe pressures on public spending, tax incentives need to
demonstrate that they offer value for money, and that they effectively meet the public policy
challenge for which they were designed.
We understand the concerns of policy makers and the market that fiscal incentives such as
the VCT and EIS schemes mentioned below in this chapter are sometimes used to make
investments that are not directed to the businesses that most need them and are therefore
not delivering maximum value to the UK economy.
We would be pleased to work with the Government to refocus tax incentives to their intended
target. Although further restrictions are likely to have an adverse impact on smaller
businesses seeking scarce development capital, we would strongly support the introduction
of a principals based test for investors using these incentives.
Recommendation - Introduce a principles-based test for tax incentives - A new
approach to address concerns that fiscal incentives are sometimes not being directed
effectively, could be to develop a principles-based test governing the use of the VCT and
EIS schemes. Investors making use of tax incentives could be asked to demonstrate
how their investment is addressing the funding gap the incentive has been designed to
reflect, for example through their annual tax return or through the VCTs’ annual financial
statements. However, it is imperative that such a measure does not become a regulatory
burden or overly prescriptive.
Investors in smaller companies expect to make gains when they exit their investment, rather
than relying on dividend payments as such companies often do not have the profits and/or
cash flows to maintain dividend payments. The current capital gains tax (CGT) rate of 28 per
cent would significantly reduce such returns and is therefore a deterrent for investors.
Furthermore, investors with current holdings in smaller companies may be less likely to exit
their investments to prevent the associated CGT liability to arise. As a result, liquidity is
reduced because investors are not recycling their capital.
We believe that reducing the tax rate on capital gains made from direct and indirect (for
example through an SME investment fund) investment in smaller companies would also help
to boost liquidity as it would help attract more investors. This can be achieved through a
lower CGT rate for companies on growth markets such as AIM, through roll-over relief or
alternatively through an upfront reduction in the CGT rate.
Recommendation - Improve the CGT regime for investment in quoted companies –
We ask the Government to introduce roll-over relief or a reduced CGT rate for capital
gains made on direct or indirect investment in companies on growth markets. This would
not only increase investor interest, therefore boosting liquidity, but also encourage
investors to re-invest their gains into smaller companies. This would ensure a more
vibrant market supporting growing businesses over the longer term.
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The below chart indicates the significant fall in the proportion of AIM VCT fund raising
following the Finance Act 2006 reduction in the gross asset limit from £15 million to £7
million and the limit on number of employees to 50 in the following year. We believe these
restrictions are putting artificial caps on growth as they may prevent businesses from
recruiting more staff or expanding through acquisition because, in many cases, they become
ineligible for investment by the VCT managers that have provided their initial funding.
Furthermore, we have received anecdotal evidence that some companies have made people
redundant in order to remain eligible for VCT funding – a perverse and unnecessary
outcome of fiscal incentive designed to encourage growth. The current complexity of the
VCT rules can also cause companies to have to restructure fundraisings and conduct
multiple placings, resulting in unnecessary cost and uncertainty.
Figure 3: AIM VCT fundraisings as a percentage of total VCT fundraisings (tax years 1998 –
2010)
900
100%
Funds raised (£millions)
800
700
600
500
400
300
200
100
Gross Assets
test reduced
from £15 million
to £7 million
50 Employees
limit introduced
90%
80%
70%
60%
50%
40%
30%
20%
10%
AIM VCT fundraising as a % of total VCT fundraisings
0
1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10
0%
AIM VCT fundraisings
Generalist VCT fundraisings
AIM VCT fundraisings as a % of total fundraisings
Source: HMRC, London Stock Exchange
The London Stock Exchange strongly supports policies to ensure that these incentives are
clearly targeted towards their intended purpose, and changes to investment rules to reflect a
post-Rowlands Review understanding of the equity gap.
As outlined above, liquidity in the secondary market has a direct impact on capital raising
throughout the equity funding ladder. VCTs are currently restricted from making investments
in the secondary market, reducing potential secondary market liquidity and making it difficult
for VCTs to re-orientate their portfolios towards those companies with better prospects. This
hampers the VCT’s own performance and attractiveness to end investors.
Recommendation - Allow Venture Capital Trusts to invest in the secondary market -
As the Grant Thornton research shows, fiscal incentives are a cost-effective mechanism
for promoting secondary market liquidity. Allowing VCT participation in the secondary
market would provide urgently needed liquidity through funds that are already accounted
for by the Treasury. This would help alleviate the ongoing depressed valuations of many
smaller companies which have made it extremely difficult and costly for these companies
to raise further equity capital.
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To ensure that VCTs continue to play their core role of funding companies in the primary
market, their ability to invest in the secondary market could be restricted to a certain
percentage of their overall fund. Currently, VCTs are required to hold 70 per cent of their
funds in qualifying investments while the remaining 30 per cent is usually split between cash
and non-qualifying investments. If VCTs were to participate in the secondary market, the
rules could be altered to require 75 to 80 per cent in qualifying investments of which onethird
could be in the secondary market.
Recommendation - Increase the number of companies that VCTs can support - To
make investment capital available to a wider pool of SMEs as defined within EU State
Aid rules, we recommend increasing the gross asset ceilings for VCTs from £7 million to
£15 million and the employee test limit from 50 to 250 employees. In the medium term,
increasing the limits will make AIM VCTs more attractive to their ultimate investors and
help restore the ability of AIM VCTs to raise funds, with clear benefits for the UK
economy.
1.3 European regulation – preserving a framework for growth
A core part of the success of growth markets such as AIM and PLUS-quoted has been the
ability to offer a carefully tailored regulatory framework, strongly informed by European
policy, that balances the needs of growth companies with appropriate levels of investor
protection and is able to evolve in tandem with market developments. These markets have
distinct identities around which companies, investors and intermediaries can align, hence
fostering an infrastructure that supports smaller businesses.
However, as these exchange-regulated growth markets are not formally recognised in the
EU’s Financial Services Action Plan (FSAP) Directives, they fall subject to regulations that
are often inappropriate or burdensome. There remains a risk that future changes to FSAP
could reduce the ability of exchanges to effectively operate such markets and retain their
differentiation from regulated main markets. We believe to allow these markets to
continue supporting growing companies, there could be benefits arising from the
introduction of a distinct framework within FSAP, tailored to the needs of such
businesses.
Indeed, the EU Commission’s consultation of the Markets in Financial Instruments Directive
(MiFID) announced on 8 December 2010, includes questions on whether there is a need for
a new and separate regime for SME markets and the potential eligibility criteria for such
markets.
We believe any such framework or regime should ensure flexibility at a Member State and
market operator level to enable domestic growth markets to account for local market
practices. A properly constructed framework could allow SMEs to raise equity capital more
efficiently and, importantly, could include appropriate exemptions from State Aid rules,
provide a framework for fiscal incentives and facilitate investment in smaller companies
However, we remain concerned that the consultation places undue focus on simply reducing
regulation for issuers and does not tackle the important issue of extending the base of
investors willing and able to invest in SMEs. It is also vital that any debate on reduced
regulatory requirements ensures appropriate levels of investor protection remain in place.
Additionally, introducing restrictive eligibility criteria around SME markets and inadequate
flexibility at the local level would undermine the ability of growth markets such as AIM to
attract appropriate companies and investors and could reduce investor confidence in SMEs
as an asset class.
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We therefore believe the focus needs to broaden to how an SME market framework could
make investment in SMEs more attractive to a wider set of investors and should not seek to
impose restrictive eligibility criteria on European growth markets.
Recommendation - Preserve the regulation of UK growth markets - We believe that
the current regulatory burden on AIM effectively balances investor protection and the
needs of SMEs. In light of the ongoing MiFID consultation, we encourage the
Government to offer a strong voice in Europe on the regulation of growth markets and to
ensure appropriate flexibility at a Member State and market operator level when setting
out a separate regime for such markets. This would help support and boost the SME
growth and economic contribution over the longer term.
1.4 Direct investment in smaller peers
Equity capital raised through growth markets could be complemented by direct investment
by larger firms with whom they have a technological affinity, for example a leading blue chip
in the same sector. Ceres Power are an AIM quoted company who have attracted significant
investment in this way, raising £20 million from British Gas in addition to their £100 million
fund raising on AIM. The funding, which came through an equity investment, allowed Ceres
to develop a new heating technology and gave them a guaranteed customer for the finished
product.
The visibility, funding and confidence provided by their AIM quotation helped to secure the
additional investment from a larger peer. Tax incentives to encourage direct investments of
this sort could strongly support the development of UK-based technology.
Recommendation -Encourage direct investment in growth companies by UK
corporates - The Government should seek to enhance existing tax incentives and
investigate new policies to encourage larger firms to provide financing and support to
smaller companies. As an example, the investing firm could receive a corporation tax
relief equivalent to the size of their investment in the smaller business. To ensure that
the relief is properly targeted, the Government could introduce criteria based on the size
of company receiving the investment, how the funds are used, and restriction to
companies within their sector of with direct technological relevance.
14

2. Boosting UK corporate access to fixed
income finance
It is clear from the crisis that the UK needs to address an over-reliance on bank lending,
which has proved highly susceptible to bubbles and periods of contraction. A new,
sustainable corporate financing ecosystem needs to be built on diversity across a number of
funding streams, able to meet the needs of differing businesses and provide access capital
throughout the economic cycle.
A major area for development is the non bank lending market, which has the potential to
offer a financing alternative for medium-sized companies – effectively a spare tyre for
periods of economic contraction. Retail bond investment in particular is an untapped source
of business funding, and a long term savings opportunity.
We have already taken steps to make this happen. In February 2010, the London Stock
Exchange launched its Order book for Retail Bonds (ORB) as a means of driving change.
Previously, retail customers were unable to access retail bonds on a transparent electronic
order book on a regulated exchange.
ORB offers a solution. But in practice, customers are still unable to access retail bonds
through the channels they are most comfortable with. For example, high street banks do not
include the asset class in either their in-store leaflets or provide access through their own
share dealing portals.
We would strongly welcome support from the Government to overcome these barriers.
2.1 Widening access for retail customers
Debt capital markets in the UK have traditionally only been accessible to the largest
companies. The London Stock Exchange believes that it is possible to widen this access to
medium sized companies, offering a more sustainable alternative to bank finance for these
companies. For companies below this size, the costs associated with issuance will make
capital debt markets a less practicable means of fundraising.
We believe that a crucial step to increasing access for medium sized businesses will be to
expand the investor pool. This could be achieved through enhanced retail investor access to
corporate debt, supported by the development of a liquid, transparent secondary market.
The London Stock Exchange launched its Order book for Retail Bonds (ORB) in February
this year as a means of driving change. Further detail about this market can be found in
Appendix B.
Market transparency and private investor education are key to developing retail confidence
and investment in the corporate debt markets. UK investors have less confidence investing
in debt than in equity, and our experience as a market operator suggests that the lack of
information and education available about investing in debt products is a critical factor.
Currently, it is not possible for a retail customer to access retail bonds via a transparent
order book on a regulated exchange through the investment channels they use most
frequently. For example, high street banks do not include the asset class in either their instore
leaflets or provide access through their only share dealing portals. This represents a
significant barrier for investors.
15

Recommendation - Encourage access to retail bond trading through high street
banks - The Chancellor of the Exchequer or Secretary of State for Business, Innovation
and Skills could lead an initiative with high street banks to encourage existing providers
of retail savings products to offer access to retail bond trading on a regulated exchange,
by advertising these instruments in their savings and investments brochures and by
providing access to trading to the electronic order book through their online share
dealing portals. The explicit leadership of the Government would strongly support the
development of these access routes, and the London Stock Exchange would be
delighted to support such a launch.
Bond investment in the UK is limited by lack of transparent and accessible market structure,
in comparison to US and European markets which have a greater level sophistication and
participation throughout all levels of investors.
The new Order book for Retail Bonds service developed by the London Stock Exchange is
designed to address these issues. However, Over-The-Counter (OTC) methods of execution
still predominate even for retail customers. In many cases, private investors may not be
made aware that their trade is being dealt OTC and without reference to order book prices.
OTC handling of private investor trades is prevalent in retail trading of all asset classes,
including equity shares.
Recommendation – Encourage trading in listed products on a regulated market -
We believe that the Government should encourage greater transparency in relation to
trading venue and should require stockbrokers to make clear to their clients whether or
not their trade is conducted on a regulated market, ensuring a full choice for investors
and greater confidence in the investment process.
Direct investment in corporate bonds has a lower risk profile than investing directly in equity
from the same company. Private investors can hold corporate bonds within the stocks and
shares component of an ISA if the bonds have 5 years or more until maturity on date of
purchase. However, direct investment in corporate bonds is often overlooked in favour of
investment in bond funds. There is very low awareness that corporate bonds can be held
directly within ISAs and SIPPs and many ISA managers do not provide access to these
instruments.
Recommendation - Introduce additional £2000 ISA savings level for bonds – We
propose that the Government introduces an additional £2,000 tranche of ISA savings
specifically for direct investment in corporate bonds, which could ‘kick start’ interest in the
asset class, enhancing access to non-bank finance and encouraging a savings and
investment culture. This policy is likely to have limited fiscal impact.
Inflation-linked bonds are a particular area of interest for investors. Index-linked gilts are
available on the ORB but there is growing demand for similar instruments from company
issuers. Index-linked gilts however offer greater tax efficiency as they are not subject to tax
on the uplifted principal amount. This tax exemption is not in place for similarly index-linked
bonds from corporate issuers. The current tax treatment has therefore made such securities
less viable for investors and has resulted in the issuance of corporate inflation-linked bonds
where only the coupon is uplifted for inflation and not the principal amount.
16

Recommendation - Remove tax barriers to issuance of corporate inflation-linked
bonds - We encourage the Government to review the tax treatment of inflation-linked
instruments and to offer a level playing field in the tax treatment of gilt and corporate
inflation-linked securities.
2.2 Removing barriers for small to medium sized firms to debt
capital markets
There are a number of barriers unrelated to investor demand to entry for small to medium
sized firms, particularly in relation to the costs involved in issuing debt on the public markets.
The European Prospectus Directive that requires additional disclosure requirements in
relation to retail bond issuance is often cited as a barrier to entry. Our consultations with
issuer and advisory groups indicate that the additional requirements are not significantly
onerous in comparison to other costs which must be met to successfully access debt capital
markets. However, perceptions that the obligations and costs inherent in pursuing retail bond
issuance are higher than is the case may be acting as a barrier to retail issuance in the UK,
particularly in relation to the interpretation of requirements in the Prospectus Directive
A key area of uncertainty is the responsibility of an issuer to maintain a prospectus
throughout the offer period. This period is likely to be longer for bonds issued to retail rather
than wholesale investors and therefore carries greater risk of having to publish
supplementary prospectuses at additional cost. Advisors must be comfortable with the
requirements and liabilities for their clients before they can promote the retail bond market as
an alternative to wholesale.
Although the additional disclosure requirements for a retail prospectus may not pose a
significant burden for larger, established corporate issuers when accessing the debt capital
markets, these requirements can pose a barrier for smaller to medium size companies who
do not have the resources to fulfil the documentation and continuing disclosure obligations.
To support greater access for smaller and medium size companies to the retail bond market,
we encourage the regulator to work with the industry to promote greater standardisation in
relation to retail bond documentation.
In addition, we have also identified local authorities as a potential new source of retail bond
issuance in the coming years. As these bodies seek alternative sources of funding for local
development projects, the retail bond markets, offering a private investor base engaged in
funding projects in their own region, may prove of great interest. For these issuers however
the ongoing financial reporting obligations (required to IFRS rather than GAAP) may prove a
deterrent. We urge the Government to review how local authority bonds might be afforded
exemptions similar to those in place for sovereign issuance and the corporate bonds which
were issued under HM Treasury’s Credit Guarantee Scheme.
For retail investors, ease of access to information such as that contained in the bond
prospectus is vital to encourage wider participation. This information is not always readily
available to bond investors and most investor relations websites will only have details of the
company’s equity and very little information (if any) for bond holders.
Recommendation - Improve transparency in relation to bond issue documentation -
We believe that the regulator should support market driven initiatives to increase
transparency around retail bond documentation and to promote wider access for private
investors. Furthermore, we ask the Government to work with the industry to clarify areas
of uncertainty in relation to the UK interpretation of the EU Prospectus Directive,
particularly in relation to the issue of retail cascade for bond issues.
17

3. Encouraging transparency and investor
protection
Financial spread betting, which allows private investors to replicate features of trading in
listed products, is tax free, but the listed equivalents of these spread betting instruments are
subject to taxation. Listed products such as covered warrants are subject to capital gains tax
and in some cases income tax which encourages investors to utilise unlisted products which
do not benefit from the same high levels of transparency, regulatory oversight and ongoing
disclosure as do listed products on a regulated market. The tax treatment for tradable listed
products should be at least equivalent to that available for products not admitted to a
regulated market.
The tax free status of spread betting has clearly incentivised the growth of this market.
Following the removal of betting tax in 2001, betting increased sevenfold and total annual
consideration for spread betting is now estimated to be in the region of £120 billion 7
The UK market for listed structured products and securitised derivatives has not benefitted
from similar growth trend. Total consideration on the London Stock Exchange’s market for
these products annualised for 2010 was £2.8 billion and the average monthly number of
trades on this market in 2010 has shown growth at half the rate of that seen in spread
betting.
In other developed European markets, where spread betting has not been established as
the cheapest mechanism for gaining exposure to financial and where no tax incentive exists,
activity in listed products far surpasses that seen on the London market. Taking average
monthly figures for 2010, the number of trades on London was 1.85K compared to 56K on
the Swiss market and over 420K on the German market. Similarly, total value traded on
London was €2.8 million compared to €1.5 billion on the German market and over €3 billion
on the Swiss market.
Recommendation - Introduce a level playing field between listed, exchange-traded
products and financial spread betting products -The tax system should not encourage
investment in unlisted products which are not admitted to a regulated market or spread
betting to the detriment of on-Exchange, listed securities. The tax treatment for tradable
listed products should be at least equivalent to that available for products not admitted to
a regulated market.
7 Source: White Paper on Spread Betting, Chris Brady and Richard Ramyar, Cass Business
School, 2006.
18

4. Capital markets – a tool for policy makers
The UK’s capital markets can be a powerful tool for meeting a number of important public
policy goals, and the London Stock Exchange would be delighted to work with the
Government to find ways of harnessing that power. The Government’s strategy for
improving national infrastructure investment could be built on the potential private sector
financing capability of the UK’s equity and fixed income markets.
In particular, capital markets offer an opportunity to fund clean technology and universitybased
innovation through equity investment, and to fund public sector improvement
programmes through hypothecated government bonds.
4.1 Funding low carbon companies
Clean technology can offer the UK a potential source of economic growth, and the ability to
meet wider public policy challenges. The investment community has traditionally found it
difficult to identify companies that have a significant involvement in environmental / low
carbon sectors, which has reduced the amount of financial support that these companies are
able to secure.
In June 2009, we launched the FTSE UK Environmental Opportunities Indices in response
to this challenge. The indices offer a way for companies in the fast growing environmental
and clean technology sectors to attract investment. The indices enable investors to easily
and efficiently identify and track the performance of a group of companies that have not
previously had a way to achieve vital profiling. They also assist the companies in their
communication with investors.
The indices track the share prices of companies that have significant involvement in one or
more of the following six sectors; renewable & alternative energy, energy efficiency, water
infrastructure & technologies, pollution control, waste management & technologies, and
environmental support services.
To qualify for the indices, a company must have at least 20 per cent of its business derived
from these sectors. Currently there are 35 Main Market companies in the FTSE UK
Environmental Opportunities Index, and 66 AIM companies in the FTSE Environmental
Opportunities UK AIM Index.
The next stage in the development of this project is to develop investment products such as
a tracker fund to allow investors to access these companies in a diversified way, just as an
investor might invest in the FTSE100.
The London Stock Exchange continues to work towards achieving this, and would greatly
appreciate the support of the Government in doing so.
Recommendation - Support investment in the clean tech sector - by helping us to
build on our Low Carbon Indexes to develop equity investment products. The
Government could support a working group to launch the world’s first clean technology
retail investment products. Our indices offer a tailored solution for clean technology
companies, and a retail accessible investment fund could greatly increase the profile and
amount of funding they receive.
19

4.2 Supporting high technology innovation at the UK’s universities
The UK enjoys global leadership in high technology innovation. Our early stage businesses
are more than twice as likely to be invested in high technology sectors as in China 8 . High
technology and advanced engineering expertise is often clustered around universities, with
specialist investors looking to areas such as Cambridge or Southampton for potential
investment opportunities.
However, we have been informed by issuers that the UK funding environment is less able to
meet the funding requirements of university spinouts than other economies such as the US.
To support the commercialisation of this university innovation, the London Stock Exchange
proposes that the Government support a private sector backed investment fund which would
invest in university spin outs.
The fund could seek to raise an initial raise £150 - £300 million on our AIM market, and
develop partnerships with a range of universities to help them commercialise intellectual
property originating from their various research teams.
We would be delighted to support this project, bringing together the universities and
investment community, with Government, and to support a launch.
Recommendation - Create a listed equity fund to invest in university spin outs – A
listed investment vehicle floated on the AIM growth market could provide a mechanism
for encouraging private sector investors to support university spin outs, with the
confidence that the fund is well managed, diversified and subject to the AIM regulations.
4.3 Funding public sector expenditure
The capital market for fixed-income could offer a transparent way of funding public sector
spending projects through private sector funds. Local authorities have successfully raised
funds on the market, which we expect to be a developing trend. Government at national and
local level could issue bonds with the purpose of funding a specific project, such as a road
building programme, or a series of hospitals or schools.
As these bodies seek alternative sources of funding for local development projects, the retail
bond markets, offering a private investor base engaged in funding projects in their own
region, may prove of great interest. For these issuers however the ongoing financial
reporting obligations may prove a deterrent. We would be pleased to work with the
Government to overcome these barriers.
Recommendation - Launch government bonds to fund public sector spending
projects - such as hospitals, road projects or schools. We would be delighted to bring
together a working group of Government, officials, and investors to deliver a mechanism
for funding spending in this way.
8 12% of Total Early Stage Entrepreneurial Activity in the UK is in high or medium tech sectors, in Italy 12.5%, in
China 6.3%. Taken from Levie, Jonathan and Mark Hart (2009), United Kingdom 2008 Monitoring Report, Global
Entrepreneurship Monitor
20

Appendix A: AIM Factsheet
AIM is the London Stock Exchange’s market for smaller, growing companies. Over the 15
years of its existence, AIM has grown from ten UK companies worth £82 million in six
sectors to over 1200 companies worth £60.5 billion operating in 94 jurisdictions across 40
sectors.
Snapshot as at 31 December 2010
Number of companies 1194
- UK incorporated 965
- International incorporated 229
Aggregate market value
£79.4 billion
Number of admissions in 2010 102
Capital raised 2010
£6.8 billion
- New funds £1.2 billion
- Further fundraisings £5.7 billion
Number of Nominated Advisers 62
Since inception in June 1995
Total number of AIM admissions 3200
- UK incorporated 2656
- International incorporated 544
Total capital raised
£72.6 billion
- at admission £34.1 billion
- through further fundraisings £38.5 billion
Transfers to the Main Market 148
Contribution to the UK economy
• In 2009, UK incorporated AIM companies contributed £12 billion in GDP to the UK
economy and £1.8 billion in tax revenues.
• Fundraisings by UK SMEs
Over £16 billion (out of the total £68 billion) has been raised by UK incorporated
companies each with a market value under £25 million at the time of admission (£4
billion of this was at admission and £12 billion through further fundraisings).
• Turnover
Historic performance of AIM companies indicates that companies average 35% growth in
turnover one year after joining the market.
UK incorporated AIM companies had an aggregate turnover of over £38 billion in 2009.
21

• Employment
Historic analysis indicates that AIM companies average 20% growth in employment one
year after joining the market.
As at 30 June 2010
Number of
companies
Number of
employees
UK incorporated companies 1005 252,000
Companies with predominantly UK
operations
Companies with predominantly UK
operations AND market
capitalisation

• Regional analysis – as at 31 May 2010
Region
AIM companies
as at 31 May
2010
Number of
employees
(‘000)
Aggregate
Market Value
(£ million)
East Anglia 72 20 2,357.1
Ireland 2 0 97.6
London 451 102 16,004.4
Midlands 54 15 1,234.8
North West 118 29 4,659.1
Scotland 31 4 1,040.8
South East 89 25 2,618.4
South West 36 9 1,602.0
Wales 12 5 352.0
Yorkshire & North East 64 23 1,291.4
Channel Islands 75 18 5,546.3
Isle of Man 6 1 241.2
UK Incorporated companies
total 1,010 252 37,045.1
Impact of current economic conditions
• Admissions and further fundraisings
Recent economic conditions have impacted AIM as witnessed by the decrease in number of
admissions – 87% decrease in admissions in 2009 compared to 2007.
2010 2009 2008 2007
Total funds raised (£million) 6,821 5,512 4,312 16,184
Total new funds raised (£million) 1,219 740 1,108 6,581
Number of admissions 102 36 114 284
Further funds raised (£million) 5,738 4,861 3,214 9,602
• Cancellations
Smaller businesses are experiencing reduced investor interest. On AIM this is witnessed by
the increased number of UK smaller companies choosing to leave the market.
2010 2009 2008 2007
Total cancellations 199 292 259 224
Companies choosing to leave market 52 113 54 17
- of which companies with predominantly UK
operations and market value of

• Secondary market (Trading activity)
Investor confidence has also impacted the secondary market of AIM securities.
Total value traded of AIM securities decreased by 56% in 2010 compared to 2007 (55%
reduction in 2009 and 32% reduction in 2008 when compared to 2007). Only part of this
decrease is attributable to the reduction in number of companies; removing the impact of
movement in company numbers indicates that value traded in AIM securities dropped by
33% in 2008, 47% in 2009 and 42% in 2010 when compared to 2007.
Year
Value
traded (£
million)
Movement
in value
traded
from 2007
Number of
companies
at year
end
Average
number of
companies*
Estimated
value traded
(adjusting for
change in
number of
companies) in
£millions**
Movement in
value traded
compared to
2007 (adjusting
for change in
company
numbers)
2007 75,031 1,694 1,664 56,093
2008 49,246 -34% 1,550 1,622 37,769 -33%
2009 33,670 -55% 1,293 1,422 29,466 -47%
2010 32,717 -56% 1,194 1,244 32,717 -42%
* based on number of companies at the start of the year and at year end - assuming an
even movement during the year.
** assuming average number of companies has been at 2010 levels
Investor profile
AIM is supported by institutional and retail investors.
Most influential institutional investor by value of investments
Rank
Most Active Institutions by Value
of investment
Value of
Investment
(£m)
No. of
Investments
1 BlackRock Merrill Lynch Investment 772.06 107
2 Invesco 675.05 69
3 Citivic (Nominees) 486.16 4
4 CDS & CO (Nominees) 432.39 9
5 Prudential Group 432.33 39
6 Lloyds Banking Group 426.81 82
7 Fidelity International 421.48 97
8 Capital Group Companies 290.24 37
9 Artemis Investment Management 273.75 93
10 Schroders 262.53 64
24

Most influential institutional investor by number of investments
Rank
Most Active Institutions by
Number of number of
investments
Value of
Investment
(£m)
No. of
Investments
1 Pershing Keen (Nominees) 203.84 121
2 BlackRock Group 772.06 107
3 HSBC (Nominees) 226.28 106
4 AXA 189.66 101
5 Henderson Group 204.25 98
6 Fidelity International 421.48 97
7 Gartmore Investment Ltd 215.17 97
8 Artemis Investment Management 273.75 93
9 F&C Group 210.60 90
10 Barclays 82.95 85
Source: GCI Institutional Investors in AIM survey 2009
LSEG initiatives
We continue to introduce initiatives, enhance our product offering and develop solutions for
the companies coming to AIM to ensure that businesses are able to gain access to finance
in an efficient environment.
Some of our recent initiatives include:
Promoting measures to reduce information asymmetries associated with SMEs,
specifically:
o
o
o
The requirement for AIM companies to maintain up to date and readily accessible
investor information on the company website
Working to increase the availability of equity research through the development of
PSQ Analytics and promotion of equity research offered by other providers
Publishing an Investor Relations guide and held regional roadshows to
emphasise the importance of good IR and assist companies in their IR activities
Working closely with the market making community to provide the most appropriate
trading platforms, tariff & rules to maximise available liquidity in SME companies
Lobbying at the European level and providing specific evidence to support specific
amendments to the Prospectus Directive, to allow smaller companies to raise capital
more cost efficiently
Development of indices together with FTSE to provide visibility to specific sectors (e.g.
launch of FTSE Environmental indices)
25

Initiatives to work with businesses across UK regions
The following are examples of recent regional initiatives, particularly for smaller businesses
that may be seeking to come to our markets or which are already on our markets:
UK wide programme of PLC Forums which bring together senior management of listed
and quoted companies to discuss equity capital markets and corporate related topics,
including investor relations best practice
4 Regional Advisory Groups (Birmingham, Leeds, Manchester, Edinburgh) - part of the
Exchange's formal consultation group mechanism, comprise a cross-section of advisers,
issuers and investors that meet three times a year
Various IPO-education briefings with third parties across the UK to provide insight into
how to access funding via an IPO is delivered
AIM Roadshow events including issuer/adviser/NOMAD briefings
Growing Company Investor Days - UK wide programme designed to bring together
senior management of listed and quoted companies with private client brokers and
regional pension funds
University/incubator focused activities – presentations to key Universities and incubator
networks.
Local Access to Finance events – such as an event in Liverpool with Sir Terry Leahy and
Xavier Rolet in September 2010
26

Appendix B: Fixed income and the retail bond
market
Order book for Retail Bonds
The London Stock Exchange launched the Order book for Retail Bonds (retail bond market)
on 1 February 2010, providing corporate debt issuers direct access to retail investors for the
first time, through a cost effective and transparent electronic market. The service also offers
retail brokers (and therefore end investors) access to electronic order book trading and
increases the availability of prices and information on retail-tradable corporate bonds and
gilts.
The new market provides a venue for UK issuers to take advantage of an increase in
demand for retail denominated corporate bonds, which offers the potential opportunity to
lower the cost of issuing debt by widening the investor base.
The key characteristics of the new market are:
o
o
o
A mechanism for distribution via the order book, offering issuers the potential to raise
capital more cheaply and efficiently
An EU-regulated market with full market supervision and monitoring of pricing activity
to promote transparency and investor protection
A flat per-trade pricing structure for simplicity and cost-efficiency
The order book is supported by five market makers, and participants include retail brokers,
corporate issuers and a Gilt Edged Market Maker. Six new bonds have been issued on the
market since launch by RBS, Provident Financial and Lloyds TSB. The issue by Lloyds TSB
was heavily subscribed and actually raised £75m against a £50m target. Recent issues by
RBS have responded to growing retail demand for inflation-linked bonds, however given the
current tax treatment between gilt and corporate-issued inflation-linked bonds, are structured
such that investors are only able to gain inflation uplift on the coupon amount rather than the
invested principal. Although the current selection of bonds is dominated by blue-chip
corporations this is primarily due to the small selection of existing retail denominated debt.
The London Stock Exchange is committed to developing the range of issuers accessing this
service to raise capital from the retail market.
Prices are available for each instrument throughout the trading day, increasing pre-trade
transparency. The model for trading is an open order book, encouraging the concentration of
liquidity in these instruments and allowing participants to submit their own prices. Feedback
from market participants in both the on-book and off-book markets has clearly shown that
the introduction of a transparent, open order book has already brought about a reduction in
corporate bond bid/offer spreads for retail customers which effectively reduces the cost of
investing in these products. Details of all trades are published immediately to the market to
provide a record of trading activity in each instrument.
Expectations for growth
Through our experience of operating the Italian retail corporate bond market (MOT) we
anticipate that the new UK retail bond market will lead to an increase in demand for retail
denominated bonds and will deepen liquidity in these securities. MOT is Europe’s largest
electronic retail corporate bond market with over 600 tradable bonds, trading on average
over €1 billion per day.
27

We believe that there is significant potential within the UK market to develop a thriving and
liquid retail bond market, to match or exceed that already achieved in Italy. Some cultural
and structural constraints will affect the time required to develop this market (see below) but
the London Stock Exchange is commited to engaging all participants to deliver a liquid and
active retail corporate debt market as soon as possible. This new market will increase capital
raising opportunities for issuers and the choice and availability of debt instruments for UK
based investors.
Development of primary market
Regulatory environment
Current perceptions of the obligations and costs inherent in pursuing a retail bond issuance
may be acting as a barrier to retail issuance in the UK, particularly in relation to the
interpretation of requirements in the Prospectus Directive. We do not believe that the level
of corporate transparency is onerous for retail bond issues, however it is necessary to
emphasise the disparity between perceived costs and actual costs to companies and
advisors.
Advisory services
It is clear from recent issues that there is a willing investor base for retail denominated
bonds, however very few bonds are available such sizes. A structural shift is required by the
advisory and broker communities to encourage issuers to consider non-bank lenders as a
viable market for debt, and to educate companies on the opportunities available to issue
debt to UK retail investors.
Ratings
The lack of an alternative credit rating process for smaller companies has been highlighted
as a potential barrier to the development of this market, both for non-bank investors and to
making public debt offering more attractive to SMEs. The established credit rating agencies’
rating methodologies often penalise companies on size, thus reducing the ability of a smaller
company to raise funds through a bond issue. We understand that there is also concern
expressed in some quarters that the current commercial agencies tend to be owned by large
media groups which increasingly demand a high level of information in return for ratings.
A standardised process from an agency, providing ratings based on company quality rather
than size, while protecting investors by making the size of the company clear, might also be
more attractive to issuers and may be more valuable for investors.
Development of secondary market
Investment culture
UK investors have less confidence investing in debt than investing in equity, and our
experience suggests that the lack of information and education available about investing in
debt products is a critical factor.
Market driven education of investors and businesses is key, to understand how bonds
operate, how to access these instruments and how to build them into a portfolio. The
London Stock Exchange is committed to working with retail brokers as partners to develop
interest and understanding of opportunities for investment in the bond market.
We believe there is already demand from sophisticated UK investors and savers to be able
to access the relatively high yields available from corporate debt products, particularly while
basis interest rates are low, however access is limited due to the tendency for such issuers
to issue in wholesale denominations. The retail market is more likely to be attracted to
28

higher yield products than institutional investors such as pension funds and insurers so may
provide an alternative investor base.
Transparency
Bond investment in the UK is also limited by lack of transparent and accessible market
structure. US and European markets have a greater level sophistication and participation
throughout all levels of investors than the UK. The new platform developed by the London
Stock Exchange addresses these issues, however a substantial number of retail brokers still
rely Over-The-Counter (OTC) methods of execution, such as the Retail Service Provider
(RSP) network. The London Stock Exchange is working with its member firms to encourage
broader use of the order book.
These methods of execution do not provide full transparency of pricing or liquidity making it
much harder for investors to track the value of their investments. As trading takes place
away from a Regulated Market, investors do not benefit from the supervision and monitoring
which covers on-Exchange trades.
In addition, information and prospectuses for debt issuances are not easily available to
investors, even for large corporations. Most investor relations sites will only have information
on equity and very little information (if any) for bond holders.
It would be useful if companies issuing retail bonds were to dedicate a section of their
website specifically to bond investors. This would be similar to the AIM Rule 26 for
companies, which stipulates that each company must maintain a website on which certain
specified information (e.g. description of the business, names and biographies of the
directors) should be available, free of charge. We believe this change would best be
achieved through changes in market practice and best standards, rather than through
regulatory intervention.
29

Appendix C: Fiscal incentives available to AIM companies
The table below provides detail on fiscal incentives currently available to AIM companies as well as additional incentives that we believe if
implemented would help companies to attract a wider set of investors and boost liquidity in the secondary market.
Incentive Policy Aims Details Key Benefits Eligibility Uptake/ Effectiveness
INCENTIVES CURRENTLY AVAILABLE TO INVESTORS IN AIM COMPANIES
Venture
Capital
Trusts
(VCTs)
VCTs encourage
individuals to invest
indirectly in a range of
small higher-risk
companies, by
spreading the
investment risk over a
number of companies.
Through this system,
investors in VCTs can
gain access indirectly to
a professionally
managed portfolio of
unquoted investments,
including shares in
qualifying AIM
companies.
VCTs are collective
investment vehicles.
Investors acquire shares
in a VCT which then
invests in trading
companies.
VCTs gain an equity
stake in the business in
return for their
investment, therefore
becoming shareholders
in these companies.
Their return is dependant
on the profitability and
growth of investee
companies, and will be
gained when the VCT
sells its shareholding to
another owner.
Investors into VCTs may be
entitled to various forms of
tax relief. These include:
Dividend relief: exemption
from income tax on dividends
from ordinary shares in VCTs.
Income tax relief: for shares
in VCTs for which were
subscribed to a maximum of
£200,000 issued in that year.
At 30 per cent of the amount
subscribed for shares issued
provided the shares are held
for five years.
Capital gains tax (CGT)
relief or disposal relief, where
investors do not have to pay
CGT on gains made when
they dispose of their VCT
shares.
VCTs must be
approved by HMRC,
for which they must
meet certain
conditions. A VCT's
investments must,
after three years, be
at least 70 per cent in
qualifying unquoted
trading companies.
In 2009 there were 29 AIM
VCTs with net assets of £330
million 9 .
Since 1994, AIM VCTs have
raised over £800m,
contributing significantly to
the supply of long term
finance to support SME
growth. The value of
qualifying investments in AIM
companies is £205 million -
representing ~20% of the
value of the relevant
population of companies.
Generalist VCTs also hold
investments in AIM
companies, representing
~10% of the value of the
relevant population of
companies.
However, the changes in
VCT investment criteria
9 Based on latest audited annual financial statements of each AIM VCT.
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introduced in 2006 and 2007
have disproportionately
impacted AIM VCTs in
comparison to Generalist
VCTs.
Enterprise
Investment
Scheme
(EIS)
This scheme was
designed to attract
individual investors to
small higher risk
companies to grow their
businesses.
A range of tax reliefs for
investors. Investments
can be made either
directly or through EIS
funds
Income tax relief: 20 per
cent relief on the investment
leading to a maximum of
£100,000 reduction on
income tax liabilities
CGT exemption: relief on
gains arising on disposal of
EIS qualifying shares
CGT deferral relief : deferral
of the capital gains tax charge
on a capital gain that is
reinvested in an EIS
qualifying company
All must be qualifying
investments up to
£500,000. For income
tax relief and CGT
deferral, the
investment must be
held for three years.
Over 1,000 new companies
have obtained EIS funding
each year.
In 2008 EIS investment
levels were around £600
million per year.
Companies receiving
investment through EIS and
VCTs exhibit enhanced
growth indicators
Loss relief: if the shares are
disposed of at a loss, that can
be set against income of that
year, instead of being set off
against any capital gains.
Business
Property
Relief
Provides longer term
liquidity for companies
and improves investor
confidence
Relief from an individual’s
IHT liability
100 per cent relief from
Inheritance Tax (IHT) on
investments in qualifying AIM
companies
Investment must be
held for a minimum of
two years. Qualifying
AIM stocks must be
'trading companies' to
qualify.
Promotes longer term
liquidity due to the two year
minimum holding period
In 2007, the leading IHT
funds alone held £530 million
in AIM companies.
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INCENTIVE PREVIOUSLY AVAILABLE FOR INVESTMENT IN AIM COMPANIES
Capital
gains tax –
Business
Asset Taper
Relief
(BATR)
Targeted at attracting a
wider set of investors to
smaller companies,
boosting medium to
longer term liquidity
Taper relief available to
individual investors and
trustees to reduce CGT
liability
Shares in qualifying AIM
companies were classed
as ‘business’ assets
50 or 75 per cent BATR
available for capital gains on
sale of AIM shares depending
on number of years an
investment was held
AIM shares could be
purchased in the
primary or secondary
market. Qualifying
AIM shares had to be
‘trading companies’ to
qualify.
This relief, previously
available for holdings in AIM
securities, was abolished in
Finance Act 2008.
Prior to abolition an
estimated 680 AIM
companies with a combined
value of £30 billion qualified
as business assets for the
purposes of taper relief. As
~50 per cent of shares were
estimated to be held by
institutions at the time, over
£16 billion of AIM securities
(24 per cent of the total
market value) potentially
qualified for BATR.
A London Stock Exchange
survey at the time revealed
that 90 per cent of retail
investors considered the
CGT BATR to be a
significant factor in their
decision to buy AIM shares.
Over two-thirds planned on
selling all or part of their
qualifying AIM shares before
April 2008.
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Appendix D: Rationale for an EU framework
for growth markets
There is wide recognition of the significant contribution of the estimated 20 million SMEs
across the EU to economic growth, employment, innovation and social integration 10 .
However, these enterprises often face a higher cost of capital than their larger peers
when seeking funds from external sources and a gap in funding between initial seed
capital and later stage development capital 11 .
Over the years, equity markets have developed across Europe (in parallel to fully listed
and regulated markets for larger issuers) to provide smaller, growing companies with a
platform for fundraisings, not just at IPO but through periodic further fundraisings (referred
to as “growth markets” hereafter). Since 2008, over €3 billion has been raised by
companies admitting to Europe’s growth markets and over €12 billion through further
fundraisings 12 . For many SMEs, these growth markets are an important stepping stone
and a precursor to listing on a Regulated Market.
Growth markets have an increasingly important role to play in facilitating SME access to
finance as they provide:
• long term capital to companies, especially to those that do not have short term
revenue streams to service debt finance;
• an essential exit route for earlier stage investors and private equity backers;
• a tailored regulatory framework that balances the needs of such companies with
appropriate investor protection principles;
• a platform for companies to increase their profiles with the widest range of
stakeholders, with external validation by equity analysts, enabling access to new
markets;
• the benefit of the expertise and support of advisers and investors that understand the
specific needs of growing companies;
• the benefit of continuously updated and transparent valuation, providing currency for
growth by acquisition;
• the ability to incentivise key employees through share option schemes; and
• a stepping stone towards regulated markets, allowing companies to develop public
company accountability, reporting systems and governance structure.
However, as these markets are not specifically provided for in the European regulatory
framework, they are often subject to regulation that is burdensome or inappropriate for
smaller companies, for example by seeking to provide investor protection via
unnecessarily complex requirements. This undermines their potential attractiveness /
benefits to SMEs that may be forced to seek capital outside EU equity markets.
10 http://ec.europa.eu/enterprise/policies/sme/index_en.htm
11 Recent research suggests that this funding gap is permanent rather than cyclical – Rowlands Growth
Capital Review, November 2009 - http://www.berr.gov.uk/files/file53698.pdf
12 The funds raised statistics correspond to money raised 14 key growth markets in Europe for which data
available.
33

We believe there could be benefits arising from the introduction of a distinct
framework for European growth markets that would allow SMEs access to growth
capital at a reasonable cost without compromising investor protection principles.
Europe’s growth markets generally have regulatory frameworks that are based on the
principles of the directives that form FSAP. They have specific rule books, regulatory and
monitoring functions, direct relationships with issuers and the ability to take disciplinary
action and impose sanctions. The market operator rather than the competent authority
(except in the case of a public offer) serves, in the relevant areas, as the primary
regulator.
The regulated market framework, designed to ensure a level playing field for larger, more
established companies operating across Member States, is also not always appropriate
for smaller companies because:
• it does not take into account the disproportionately higher cost of capital experienced
by smaller companies and the challenges such companies face in raising finance;
• the costs of compliance (including time costs) for such companies exceed the
intended regulatory benefits at IPO and on an ongoing basis;
• the involvement of the competent authority may deter companies from considering a
public listing, as it adds to cost and impacts the ability of SMEs to act quickly and as a
consequence increases the uncertainty over the success of a transaction.
We believe creating a ‘smaller company’ regime within the regulated market framework
may result in investor confusion, reduced investor protection, lower credibility for smaller
companies and consequently reduced investor appetite. A separate regime for growth
markets would ensure a clear distinction for companies and investors, providing
confidence and ultimately attracting a wider set of investors to SMEs. However, such a
regime must allow for flexibility at Member State and market operator level to enable
markets such as AIM to account for local market practices and should not introduce size
criteria of eligibility to such markets.
Taking steps through European legislation to further develop and support growth markets
would provide a proportionate and harmonised framework for smaller and growing
European companies to access finance. There would also be advantages in terms of
visibility, as having markets specifically for smaller and growing companies would in
aggregate raise the general visibility of these companies to investors.
Such a framework would help increase investor confidence, bringing a wider set of
investors to smaller companies. It will also provide Member States that currently do not
have such markets with a framework to develop such markets to cater for their small
business finance needs.
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