London’s markets remained open and robust in the face of COVID-19 conditions. But at the time, there were questions about how the capital markets would respond to this traumatic shock for the global economy. Over this period, these questions have been answered and vital confidence provided.

London’s experience and capabilities as a mature, adaptable and innovative international finance centre have come to the fore, providing support to growth companies and multinational corporates as they seek to strengthen their balance sheets and liquidity positions, and to sovereign nations and multilateral agencies, as they respond to the economic and social impacts of COVID-19.

Vitally, the second quarter of 2020 has been notable for the robust participation by issuers and investors. Long-term capital has been delivered with efficiency and speed. This is reflected in the remarkable range of fundraisings: from follow-on equity issues that have raised between £5m and £2bn to social bonds to tackle COVID-19; and the GDR (Global Depositary Receipt) listing of China Pacific Insurance (Group) utilising Shanghai London Stock Connect.

London has shown itself to be a market that knows how to operate, even in such a changed environment. Its unique liquidity features have been optimal for issuers and investors in these fast-moving times. And, as the ecosystem has rapidly adapted, so capital has been readily available.

In the first half of 2020, £23.7bn has been raised in London through IPOs and follow-ons. Seven of the top 20 largest European transactions since 1 March have been executed on London Stock Exchange, with deals in London accounting for 43% of total capital raised across Europe during this period.

London stands out as Europe’s capital of recapitalisation. Since 1 March, 249 follow-ons have raised a combined £17.4bn. They ranged from £5m to £2bn, highlighting the sheer range and scale of capital that could be raised in a very short time.

Capital raising has happened quickly – often taking about one week. They have been orderly and have been executed with a level-headed approach to discounts. Since 1 March, the average discount to last close for transactions above £5m has been 5.3%. The accelerated bookbuilds of some companies - such as Asos, SSP and AutoTrader – were raised at a slight premium. The subsequent average price performance of £5m+ transactions since 1 March has been positive - up 8.6%.

The effects of the pandemic will continue to reverberate. Uncertainties remain. However, companies can focus on their future with the knowledge that the public markets are robust, responsive and able to support them.

As a result, companies can begin to look further ahead. Discussions about IPOs are back on the table. Some of these plans had been put on hold as a result of the volatile market conditions. But not all. Some companies are looking at their business and assessing their capital structures and how they want to take their business forward

Companies that had previously been considering alternative sources of finance in the private markets, involving greater debt levels and time-limited exit strategies, are re-evaluating. The attractions of a permanent capital structure in the public markets has brought some to look at the IPO process.

AIM features in many of these conversations. Unsurprisingly. The most successful growth market in the world, AIM accounted for 68% of all IPO and follow-on capital raised in Europe in the first half of 2020. In total, there were 200 deals, raising £174m through IPOs and £2.8bn in follow-ons. Eight of the top 10 European growth market equity transactions over the first half of the year took place on AIM.

AIM also celebrated its 25th anniversary in June. Since its launch, it has helped over 3,800 companies raise a combined £118 billion, supporting companies throughout changing business and economic cycles. This continued access to capital is particularly important today helping to support business in the recovery from the impact of the COVID-19 pandemic as firms look not only to strengthen their balance sheets but to fund innovation and growth.

There has been a similarly strong response from London’s debt capital markets. In the first half of 2020, 521 bonds were issued, raising $358bn. This represents a three per cent increase in issuance compared to the same period in 2019.

Much of this issuance has come from international issuers, including sovereigns, corporates, financial institutions and supranational bodies. They account for 48% of the amount raised and 59% of the number of bonds issued from the beginning of March.

Strong growth has also come from UK incorporated issuers. The amount raised by these issuers grew by 23% compared to the same four months in 2019 ($112bn in 2019 vs $138bn in 2020) while the number of bonds grew by 19% (113 in 2019, 135 in 2020).

The largest UK corporates to issue bonds included Tesco, BAE, National Grid, BP, GSK, Diageo and SSE, while financial institution issuers included Bank of England, Coventry Building Society, Nationwide Building Society, L&G, Phoenix Group, Barclays, RBS, and Lloyds Bank.

The average maturity of the bonds increased as well. The bonds issued during this period in 2019 had an average maturity of nine years; that grew to ten years in 2020. Most of the bonds issued had a maturity in the three to ten-year range with a few 30-year maturity tranches as well, showing an interest in securing funding for both short- and long-term activities.

The above information was obtained from the London Stock Exchange press release of 16 July 2020.

Using the information above please answer the following questions:

1) Explain the procedure of how companies get listed on the London Stock Exchange.

2) Discuss underwriting activities of investment banks and analyse how they impact dynamics of trading on the London Stock Exchange.

3) Analyse how the market micro-structure theory aims to explain stock price formation and evaluate how it differs from the efficient market hypothesis.

4) Critically evaluate the role of credit rating agencies in the debt capital markets.

1)

1. Choose a market

Our markets are home to thousands of companies from all over the world, from start-ups to some of the world's largest corporations. Your company's size, growth objectives and funding needs will help you to decide which market is right for you. Choose from:

• AIM: the world’s most successful growth market.
• Main Market High Growth Segment: specifically designed for mid-sized, high-growth UK and European companies.
• Main Market Standard Segment: part of the Financial Conduct Authority’s (FCA) Official List; companies are subject to core European standards.
• Main Market Premium Segment: part of the FCA’s Official List and subject to the highest standards of corporate governance, providing eligible companies with inclusion in the FTSE UK Index Series.

Take a look at Compare market for listing equity page to help you decide which market is best for you.

You can also decide which type of transaction will suit your needs best. Choose from:

• Initial Public Offering (IPO)

This gives your company an opportunity to raise the widest range of capital by issuing new shares or to selling existing shares to new investors. An IPO lets the company diversify its ownership, allowing individual or institutional investors to hold shares. In attracting a broad range of investors, the company can help promote healthy liquidity in its shares while on the market. IPOs are usually followed closely by the media, which can help enhance a company’s profile and attract further liquidity after admission.

• Direct Listing

In a direct listing (also known as an introduction), a company joins our markets without raising any capital. Typically this may suit companies which have already raised capital through other means and have a diverse set of investors on their shareholder register.

2. Choose advisers

• Selecting the right external team is one of the most important steps in taking your company public. You will need to appoint a team of advisers to support your IPO, usually including: legal counsel, accountant, investment bank and any specialist sector advisers. Consulting your existing advisers, usually accountants and lawyers, is a good starting point.
• Many companies hold a ‘beauty parade’ of specialists to determine which ones have the appropriate experience and understanding of their business model. You should determine a realistic timetable with your advisers, and agree roles and responsibilities.
• When appointing advisers you should also clarify areas of responsibility in advance and negotiate costs. Take a look at our AIM Advisers and Main Market Advisers tabs to help you choose the right external team for you and your company.

3. Prepare application

• All our markets have different levels of regulation with their own respective application processes to formally admit your company. You will need to apply to the regulator to raise capital (for example, for a listing on the Main Market, this will be the FCA and for other markets such as AIM the regulatory function is carried out by London Stock Exchange) and to London Stock Exchange to be admitted to trading. Your advisers will guide you through this process.
• Appointing an appropriate adviser is essential in ensuring you meet all the market entry requirements. They can also help you to prepare an application, ensuring you produce the relevant admission documents.

4. Market to investors

• Your corporate broker will work with you to actively market your company to potential investors. They will assist the management team in preparing for a series of investor presentations as part of a formal roadshow. You may want to appoint a broker with experience of your industry, capable of stimulating investor interest both at the point of IPO and in the after-market, to enhance liquidity in your shares and maintain your company’s profile.

5. Launch and Beyond

• It is common to see a lot of trading activity on a stock’s first day on a public market and your corporate broker is permitted to conduct an over-allotment of shares at IPO, and then purchase shares in the open market if the price needs to be stabilised. Trading volume will settle towards a steady state in the weeks after the IPO, but your corporate broker will remain an important adviser beyond that process.
• Your corporate broker will continue to work with you on your engagement with the market; for example, corporate transactions, capital structure and dividend policy and supporting you at key investor events as part of a wider investor relations (IR) strategy.
• For most companies, life on the public market can be a significant development. Publishing an annual report and disclosing material, price-sensitive information to the market are two key continuing obligations for all London Stock Exchange-listed companies.

2)

The public offering of debt and equity securities is the foundation of investment banking. Although the term “underwriting” seems to imply an absolute guarantee that the managing investment bank and its syndicate members (i.e., the underwriters) will be legally bound to purchase the securities from the issuing company, the real world is more complicated. Regarding an initial public offering, there are really only two approaches that an investment bank can take: firm commitment or best efforts.

Firm Commitment

A “firm commitment” means that the managing investment bank and its syndicate will agree to buy the entire issue at a negotiated price. The underwriters will then resell these shares to its clients, making as its profits the previously negotiated “spread,” which is the difference between the “gross proceeds” paid by the public and the “net proceeds” given to the issuer. This means that the underwriters bear the entire risk of per share pricing and the amount of total proceeds raised. (It should be stressed that a “firm commitment” is often not as “firm” as it sounds. A firm commitment only becomes absolutely firm on the offering day itself (or the night before) just before the issue “goes effective,” which is the moment when the SEC gives its final approval. Until then the “firm commitment” is not firm, no matter who promises what to whom. (Even then the underwriting agreement is not perfectly firm; it has various “outs,” for market disturbances, acts of God, and the like.) Furthermore, all the marketing of the issue has already been done; the “road shows” have been conducted and the underwriting syndicate members know which of their clients are committed to buy how many shares. They know if the issue is oversold or undersold and can make final adjustments to price accordingly. The bottom line is that when investment banks give firm commitments they have little uncertainty.

Best Efforts

A “best efforts” relationship is where the investment bank uses its expertise as structurer in designing the issue and as marketer in selling the issue. This means that the underwriters bear no risk in the deal, leaving to the issuing company all the uncertainty of per share pricing and the amount of total proceeds to be raised.

The Underwriting Process

The underwriting process is a formal process involving many simultaneous functions, procedures, requirements and activities. Following are some of the critical steps: company interest and underwriter selection, preliminary analysis of issue structure and securities pricing, due diligence reviews by underwriters and their counsels, legal and accounting analysis and document preparation, preliminary compilation of the registration statement, submission of registration statement to the Security and Exchange Commission (SEC), circulation of preliminary prospectus to prospective investors, information meetings (“road shows”) in major cities for describing the company and its securities, receive and respond to SEC comments, final pricing negotiations and signing the underwriting agreement, final registration statement filed with the SEC, SEC approval declaring the issue effective, press releases and tombstone advertisement, closing and settlement.

Investment banks are at the center of business and finance, and all senior executives, irrespective of their direct responsibilities, need to understand what they do and how they do it.

The biggest deals on Wall Street and other stock markets in the world are brought to the table by investment bankers. They are virtually behind all financial transactions that move the stock markets, including security offerings, mergers and acquisitions and initial public offerings. Investment bankers operate behind the scenes which makes their functions less known to the public. However, understanding operations of stock markets begins by understanding the functions of investment bankers.

3)

Market microstructure is a branch of finance concerned with the details of how exchange occurs in markets. While the theory of market microstructure applies to the exchange of real or financial assets, more evidence is available on the microstructure of financial markets due to the availability of transactions data from them. The major thrust of market microstructure research examines the ways in which the working processes of a market affect determinants of transaction costs, prices, quotes, volume, and trading behavior. In the twenty-first century, innovations have allowed an expansion into the study of the impact of market microstructure on the incidence of market abuse, such as insider trading, market manipulation and broker-client conflict. Price formation focuses  on the process by which the price for an asset is determined. For example, in some markets prices are formed through an auction process (e.g. eBay), in other markets prices are negotiated (e.g., new cars) or simply posted (e.g. local supermarket) and buyers can choose to buy or not.

The efficient-market hypothesis (EMH) is a hypothesis in financial economics that states that asset prices reflect all available information. A direct implication is that it is impossible to "beat the market" consistently on a risk-adjusted basis since market prices should only react to new information. Because the EMH is formulated in terms of risk adjustment, it only makes testable predictions when coupled with a particular model of risk. As a result, research in financial economics since at least the 1990s has focused on market anomalies, that is, deviations from specific models of risk. The idea that financial market returns are difficult to predict goes back to Bachelier (1900), Mandelbrot (1963), and Samuelson (1965), but is closely associated with Eugene Fama, in part due to his influential 1970 review of the theoretical and empirical research (Fama 1970). The EMH provides the basic logic for modern risk-based theories of asset prices, and frameworks such as consumption-based asset pricing and intermediary asset pricing can be thought of as the combination of a model of risk with the EMH.

4)

Rating agencies assess the credit risk of specific debt securities and the borrowing entities. In the bond market, a rating agency provides an independent evaluation of the creditworthiness of debt securities issued by governments and corporations. Large bond issuers receive ratings from one or two of the big three rating agencies. In the United States, the agencies are held responsible for losses resulting from inaccurate and false ratings.

The ratings are used in structured finance transactions such as asset-backed securities, mortgage-backed securities, and collateralized debt obligations. Rating agencies focus on the type of pool underlying the security and the proposed capital structure to rate structured financial products. The issuers of the structured products pay rating agencies to not only rate them, but also to advise them on how to structure the tranches.

Rating agencies also give ratings to sovereign borrowers, who are the largest borrowers in most financial markets. Sovereign borrowers include national governments, state governments, municipalities, and other sovereign-supported institutions. The sovereign ratings given by a rating agency shows a sovereign’s ability to repay its debt.

The ratings help governments from emerging and developing countries to issue bonds to domestic and international investors. Governments sell bonds to obtain financing from other governments and Bretton Woods institutions such as the World Bank and the International Monetary Fund.