updated on 31 October 2023
QuestionWhat are capital markets and what’s going on at the moment?
Capital markets are a staple of the global economy and a key arena for many law firms and central areas of business activity. In simple terms, they’re where funds are exchanged (or traded) between suppliers of capital (such as financial institutions and other investors) and those seeking capital to finance projects, investments or for other working capital purposes (such as businesses and/or individuals).
On a practical level, capital markets move money from a source that has it to those who need it for productive use. For example, high-growth companies will require capital to finance their expansion plans and may rely on the capital markets for access to this.
The markets are used to trade financial instruments, including equity and debt securities. Equities, such as shares, are financial assets that represent ownership in a company. Debt securities are investments that represent the borrowing of capital that’ll be paid back later (often with interest), such as bonds. Some people trade pieces of companies, and others trade borrowed money that they'll get back later with a little extra (interest).
The most common capital markets are the stock market (equity capital market) and the bond market (debt capital market).
The capital markets can be accessed on a primary or secondary basis. A primary issuance of securities is where a company directly issues the securities in exchange for capital – where new capital is raised via a new issuance of shares or bonds. This is where companies raise money by listing themselves and issuing public securities for the first time – for example, via an initial public offering (IPO). Primary issuances are strictly regulated and focused on large institutional investors and occasionally retail investors. There’s also a secondary market where existing securities (ie, those already listed) are traded between investors in a transaction that’s separate from the issuing company.
Lawyers are key players in capital markets transactions. They advise issuers (ie, the companies issuing the relevant securities) and the investment banks on legal and regulatory matters, draft and negotiate key transaction documents and obtain approvals from various external parties such as regulators and rating agencies.
Different markets have historically been associated with particular industries, capital structures and risk appetites, therefore attracting different types of companies. The New York Stock Exchange (NYSE) boasts deep pools of capital (with securities trading at a high volume) which entices both companies and investors. The US markets are typically less risk averse than continental European markets. US markets offer big tech firms proximity to competitors and investors, substantial coverage, favourable valuations and, in some instances, less onerous regulatory requirements when compared with the London Stock Exchange (LSE).
Comparatively, the LSE typically attracts more established businesses with records of profitability and prospective dividend streams. The LSE is attractive for investors because of its diverse investor base, global visibility, and high disclosure and corporate governance requirements, which provide companies with credibility and investors with confidence in the companies on the market. Companies listing on the LSE are also attracted to London's global financial hub and established financial infrastructure of financial services, legal expertise and professionals.
Generally, the LSE is also seen as being less costly and less litigious than US markets. In recent times, the Financial Conduct Authority in the UK has progressed its plans to reform the UK listing regime to broaden access to listing and simplify the regime. While the reforms intend to maintain high standards of disclosure, the UK listing regime will be closer to that of the US.
Global market activity fell to its lowest level in more than a decade in the first quarter of 2023. Both the US and the UK have been experiencing a listing drought because of turbulent trading conditions. So far in 2023, ongoing geopolitical and macroeconomic uncertainty have had a collateral impact on capital markets and global market activity, which has dropped to a 10-year low.
The UK has seen $2 trillion worth of M&A activity so far in 2023, which is down 28% against the same period in 2022, and the lowest since 2013. This puts dealmaking in the UK at a 14-year low (source: London Stock Exchange Group Deals Intelligence). Similarly, in the US, the IPO market was virtually closed in 2022 and investors remain cautious.
UK chip designer Arm launched its US IPO in September. This was shortly followed by Instacart's listing in New York, which was anticipated to deliver a welcome boost to market optimism for venture-capital-backed start-ups in both the UK and the US. However, both firms' choppy debuts dampened near-term hopes for tech listings globally as the predicted resurgence failed to materialise and IPO numbers remained flat.
In the wake of the war in Ukraine, price volatility, high inflation, rising interest rates and fears of recession are undercutting business confidence and taking their toll in the form of eye-watering financing costs for firms. High interest rates are particularly painful for unprofitable or cash-intensive private start-ups by making it incredibly expensive for firms to borrow to fund growth. These factors have slowed global economic growth and encouraged tight monetary policy in both the UK and US. Additionally, high geopolitical tensions have created a "divergent global economy" (Paul Go, Ernst & Young Global IPO Lead). The conditions have stopped many deals in their tracks and encouraged firms to postpone upcoming announcements.
However, strong players are unperturbed and have not wavered in their decisions to list. In recent months, as inflationary pressures ease, markets remain cautiously optimistic in the longer term for a greater resurgence to come.
Megan Eaton is a trainee solicitor at Taylor Wessing.