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The purpose of this study is to explore the repercussions of recession on the British Stock Market particularly expounding its impact on Alternative Investment Market. The study aims to utilise qualitative approach to examine and constitute the relative repercussions of recession upon AIM. For this, an exhaustive literature review of the London Stock Exchange is essential to gain indicative factors relevant to account for the associated risks of recession to AIM. According to research on UK firms, uncertainty shocks typically reduce the responsiveness of firms by more than half, leaving monetary and fiscal policy-makers relatively powerless (Bloom et al, 2007).
1.1 LONDON STOCK EXCHANGE
LSE is amongst the oldest stock exchanges in Europe and also the most promising out of the 22 active stock exchanges functioning in Great Britain. It was established in 1801 and has emerged as the largest stock exchanges of the world comprising of number of overseas as well as British companies (London Stock Exchange, 2005). The positioning of London city is beneficial as it let the London Stock Exchange to function during American and Asian sessions. Being a public company its shares are traded on stock exchanges and is considered to be the most international trading floor and about 50% of international transactions with shares are concluded on LSE (London Stock Exchange, 2005). The London Stock Exchange has four main quarters that include equity markets which facilitates companies from across the globe to raise capital (London Stock Exchange, 2005).
There are the four primary markets that include: ‘The Main Market, Alternative Investment Market (AIM), Professional Securities Market (PSM) and Specialist Fund Market (SFM). London Stock Exchange is a highly active market that provides range of trading services including trading in a range of securities as for example, ‘UK and international equities, debt, covered warrants, exchange traded funds (ETFs), Exchange Traded Commodities (ETCs), REITs, fixed interest, contracts for difference (CFDs) and depositary receipts’ (London Stock Exchange, 2005). It provides market data information with clarity offering real-time prices, news and other financial information to the global financial community. EDX London, established in 2003serves as a major contributor to derivatives business in order to bring the cash equity and derivatives markets closer together the London Stock Exchange.
1.2 AIM: AN OVERVIEW
London Stock Exchange reviewed the unlisted securities market in1993 during the middle of a recession and decided to close it. Quoted Companies Alliance now referred as CISCO was then born and which lead to the establishment of Alternative Investment Market in June 1995 by London Stock Exchange. With its noticeable endurance for several years; AIM has been a considerable success. Rapid growth has been observed in AIM market, commencing its operation in 1995, it has rose over £24 billion and listed over 2,200 companies, including 276 foreign companies by January 2006 listing1,408 companies from 33 industrial sectors out of which 220 were from overseas countries. Instead of offering shares to the public AIM’s 90% of flotations depends on placing the shares with institutions, venture capital trusts and private investors reinforced by European 191 Prospectus Directive (Thronton, 2009). In order to reduce the pool of capital available to buy new AIM shares, the European 191 Prospectus Directive requires that, a full prospectus must be issued in both conditions where; the company offers shares to more than 100 persons, other than qualified investors or if a private client broker proffer such shares to more than 100 of their clients (Thronton, 2009)..
Based in the city of London, AIM benefits from competitive supply of leading financial services and decently offers direct access to outsized and sophisticated shareholders. AIM has the potential to provide with all the significant financial services as required by the firm for listing, floating, reporting, auditing, broking, public relations, security analysis, printing, legalities, registering shareholders, etc. Rising higher from a percentage of 35.2% in September 2003, the institutional investors owned 40.9% by value of the shares listed on AIM in September 2005(Growth Company Investor, 2005), that consequently accounts for a very substantial institutional contribution of AIM, in small-capitalization market.
1.2.1 MARKET SIZE
The multitude of companies traded on AIM come from different parts of the world and signify huge number of industries. At present there are approximately 1500 companies from more than 26 countries that are quoted on the AIM (London Stock Exchange, 2005). There is one common trait shared by all traded companies on AIM and i.e. a dynamic corporate attitude and a strong ambition for business expansion. AIM welcomes companies of varying sizes to become part of even though it was primarily designed for smaller firms, but companies of varying sizes if possessing a desire for growth and profitability, are equally encouraged to join the Alternative Investment Market.
The operations of AIM are controlled by the London Stock Exchange, having a tendency to work ideal for companies with a capitalization and valuation from $20 million to $300 million. The costs for filings and entry are approximately $600,000, with ongoing annual costs of around $100,000. The range of capital-raising activities tends to be in between $4 million to $40 million with approximately 9 percent average cost of capital. The percentage of retail investment is higher than on the official list and the investors are largely institutional.
1.2.3 KEY STATISTICS
AIM Market Capitalisation
AIM IPOs in 2006
Capital raised since 1995*
Capital raised in 2006*
* New listings and further capital raises
1.2.4 DIVERSITY AND INTERNATIONAL DIMENSION
AIM has a diverse market spanning (Figure, 02) in approximately 39 sectors having a number of international companies and investors. The AIM is comprised of key sectors in which there is resource sector that include mining and oil & gas, financial sector includes real estate, equity investment instruments and general financial. The industrial sector of AIM is comprise of construction & materials, electronic & electrical equipment and support services whereas, the consumer services includes media and travel & leisure. Apart from US the growth in international companies on AIM is also being driven through Canada, China, India and mainland Europe.
1.2.5 MARKET CAPITALISATION
According to LSE statistics the international companies listed as UK Top Co are counted as domestic. The US investors 330 international companies are listed with a value of £36.6bn equivalent to $73.5bn and over 70 US companies listed on AIM has a value of £2.9bn that is equivalent to $5.8bn (London Stock Exchange, 2005).
It is interesting to note that the international companies on AIM are larger than UK companies, with an average market capitalisation at 31 December 2007 of £99.2 million compared with £46.9 million for UK registered companies. The market capitalisation on Alternative Investment Market is expressed in the Figure, 03. It is important to signify that AIM is not subject to more extensive regulation and therefore, it offers a wider pool of investors, and this may result in some decline in the cost of capital (Errunza and Miller, 2000).
CHAPTER II LITERATURE REVIEW
Establishing itself as the world’s most successful growth market after being launched by the London Stock Exchange (LSE) in 1995, AIM provides opportunity to raise capital and a liquid market place to trade shares for small and medium sized growing companies. Over 3000 small growth companies have listed on AIM and these companies have raised a total of over £60 billion, since the commencement of AIM. Global recession has caused complicated market conditions however; there are still some signs of recovery, such as the first major IPO of the year and on the other hand improvement can be observed in trading volumes and average; meanwhile, an improvement in fund raising conditions towards the end of 2009 and through 2010 is also predicted by the brokers and other market commentators (Thronton, 2009). In order to conserve its position in the market AIM has to become accustomed with current market conditions, ‘while not losing sight of its roots and emerge as a market focused on providing growing companies with direct access to capital’ (Thronton, 2009). The main objective of the literature review is to summarise the existing research work to gain insights on the subject area and also to assess and explain the impacts of recession. The core element of the research is to conduct an empirical study of the relative volatility, analysis of market size, allowance and liquidity ratios of AIM and determining its rate of progression during economic commotion.
2.2 AIM- FACTS AND FIGURES
The AIM’s trading began on 19 June 1995 and there were only 10 companies listed on the first day of trading. Since the opening of the Third Market in 1987, AIM was London’s first new market and it is split into two indices, the AIM 50 and AIM 100 Index where AIM 50 includes the biggest names on the junior market by attracting fresh, budding and newly expanding firms which were incapable for admittance to the main FTSE lists (London Stock Exchange, 2005). Even after facing criticism for the costs by some experts the market succeeded in making it easier for smaller businesses to raise capital. In accordance with the rules by AIM, the company’s costs rose up to 20 times higher in comparison to the earlier system. Notwithstanding the cost of raising capital was approximated to be an average of about £100,000 for an AIM company, as compared to £1m for a company on the main market (London Stock Exchange, 2005). There are now 1,276 AIM-listed companies. Liquidity among AIM stocks widely varies and the stocks having highest capitalisation and the largest free float represent comparable liquidity levels to the main market. There are a large number of illiquid stocks on the lower end of the market. AIM provides different trading platforms for different types of stock in order to improve the liquidity of the market but its volatility is not significantly diverse than other markets.
2.2.1 STOCK TRADING
Large and frequently traded stocks are listed on AIM and there are small, infrequently traded stocks also listed with it therefore; no single trading mechanism is applicable to AIM stocks. Considering the time from the institution of AIM, it has exhibited very rapid growth in trading volumes (London Stock Exchange, 2005) as represented in Table, 02. The average annual growth rates over the period of a decade starting from1996 to the year 2005 are as follows; the turnover was around 36%; number of trades was 28%; and the number of shares traded were 35% approximately. The average number of shares per trade grew by 5% per year, whereas the average value per trade grew by 6% per year, over this period. The growth of trading on AIM occurred in two phases. There was a substantial drop in stock market prices observed during 2001- 2002 where there was negative volume growth which gradually recovered in the year 2003 followed by rapid growth of trading.
2.2.2 UNDERSIZED REGULATORY LOAD
AIM regulations are designed to reduce burden for companies listing on this exchange. The admission process for AIM takes about three months, depending on circumstances (Audley, 2005) and in order to list on AIM;
There is no need for trading record and on the spot listing of start-ups and cash shells;
Smaller companies can also list as there is no minimum market capitalization;
Reduced costs and time for listing as the admission documents are not pre-vetted by AIM or the U.K. Listing Authority;
The lack of a minimum free float for preventing firms to sell off a substantial part of the business to list in AIM;
Approval from prior shareholder is not required for acquisitions that also reduces the time and cost of acquisitions.
There is an obligation to employ a Nomad at all times for each AIM-listed company. The Nomads carry out three main functions;
To make a decision that if a company should be admitted to AIM or not;
Managing the floatation process; and
Advice the company regarding rules, before and after it has been listed.
2.2.3 COSTS FOR LISTINGS
The admission fee of AIM is £4,180 with a listing fee of £4,180 per year and a value-added tax to these admission and annual fees is applied to UK companies. The total costs of admission to AIM are about £350,000 to £450,000 and a broker’s fees of 3% – 6% of any funds raised (Audley, 2005). Nomads are liable to undertake most of this process followed by any subsequent capital-raising and this keeps admission and listing costs under control.
The costs to the firm of listing on AIM include:
The initial costs to obtain the listing;
Followed by initial floatation’s costs of any subsequent capital raising; and
The annual costs of maintaining the listing.
2.2.4 THE MAIN MARKET
London Stock Exchange is one of the world’s leading stock exchanges and AIM offers a great deal of progression to it and vice versa. During a period of January 2000 to December 2004, a total of 160 companies switched between AIM and the main market. About 81% went from the main market to AIM and almost 19% went from AIM to the main market concluding that out of every company graduated from AIM to the main market, four moved in reverse course (Dufour, Sutcliffe and Wells 2005). In accordance with a survey (Baker Tilly, 2005b) 17 firms moved from the main market to AIM and their reason (Table, 03) for moving as constituted by the survey were;
Furthermore, the survey (Baker Tilly 2005b) reveals that 64% of the main market companies considered moving in and back to AIM, out of which 26% actually planned to move whereas the rest of 34% companies considered it beneficial due to lack of provisional parameters, trouble-free acquisitions, greater flexibility and tax advantages.
The following areas of tax relief are available for individual investors in U.K. companies listed on AIM (Baker Tilly, 2005a):
The business asset taper relief tends to minimise the effective tax rate of capital gains tax up to 40% – 10%. In gift relief a capital gains tax is overdue until a subsequent disposal by the recipient.
Investment in AIM trading companies leads to indemnity from inheritance tax.
Enterprise investment scheme offers relief from both income tax and capital gains tax. From the initial investment in new AIM shares about one fifth of the cost can be counterbalanced against income tax. In addition any capital gain is exempt from capital gains tax, while any capital loss (less the 20% income tax relief) can be offset against capital gains elsewhere.
Investors are exempt from tax on dividends from the Venture Capital Trusts, and capital gains on their shares in the VCT. Investors also receive an initial income tax relief equal to 40% of their investment in new VCT shares.
2.2.6 REQUIREMENTS AND LISTING PROCEDURE
Companies listed on AIM have to assign a nominated adviser to serve as their sponsor or representative and is responsible to prepare the prospectus in order to admit the issuer for trading on AIM. The function of a nomad is to assists the company in raising its initial capital provide market making and research for the issuer’s stock with the help of its brokerage and research departments. The contractual activities and correlation between the issuer and its nomad extends well beyond the initial public offering. Nomad remain active even after the initial listing on AIM so that a small issuer does not end up being left alone in a stock market crisis. New rules and regulations were instituted both for nomads and companies listed on the AIM exchange, in Feb, 2007. To provide further guidance and to illuminate the regulatory issues concerning disclosure requirements the rules for nomads and companies were put into practice. Although the changes to AIM rules are evolutionary rather than revolutionary, Nomads should not under-estimate the Exchange’s emphasis on the responsibility of nomads for preserving the reputation and integrity of AIM (Audley, 2005).
2.3 ASSOCIATED RISKS AND BENEFITS
The listing procedure is much more simplified in London Stock Exchange as there is no regulatory authority in the UK so it becomes the responsibility of the sponsoring nomad as a result of which the complete process becomes substantially quicker and inexpensive. The prospectus discloses all information that an investor needs for making an informed investment decision and it’s less comprehensive in most cases where the SEC-filed registration statement and the review process, for the most part, is absent (Audley, 2005). Therefore, the SEC governmental review process of the prospectus, the massive amount of periodic regulatory filings and compulsory financial reporting needs are eradicated by listing on AIM. The emerging growth companies are offered with very greater options by eliminating the need for underwriters that are only interested large deals so a great number of foreign companies are flocking to AIM (London Stock Exchange, 2006). Listing on AIM gives an emerging growth company the opportunity to go public and raise capital for reasonable fees and under reasonable terms and conditions.
AIM rules require not only a nominated broker but also a nominated adviser. There were companies on AIM which caused regulatory nervousness and the big guns at the DTI, Treasury and Stock Exchange focused their canon on nominated advisers. This had a knock-on effect on costs. Nominated advisers lay off their responsibilities on solicitors and accountants who duly reproduce and costs shoot up (London Stock Exchange, 2006). Professional advisers, anxious to minimise the risk of adverse criticism by the regulatory authorities, are now applying Official List standards. This has driven costs up and has damaged the purpose of AIM (London Stock Exchange, 2006).
2.4 FISCAL AGITATION AND AIM
Economic recovery is gradual but consistent followed by the recession that hit the stock markets worldwide and for London Stock Exchange, particularly AIM market; there is a need for investment by small companies. The number of companies quoted on AIM, which is the London Stock Exchange’s Alternative Investment Market, is now just 1,276 compared with more than 1,600 in the year 2007, which constitutes that, more than one company a day delists from AIM throughout last year (Northedge, 2010). It is also noticeable that notwithstanding the soaring share prices up to 66 per cent in the year 2009, outperforming the main stock market, only 36 new companies joined AIM. It is the lowest annual total since the launch of AIM in1995 and a tiny fraction as compared to the joining of 462 companies that in 2006 (Northedge, 2010). About 290 companies delisted compared with 218 in the year 2008, and others have been liquidating their assets and returning the proceeds to shareholders. Reported by (Wachman, 2009) in Guardian, ‘The number of companies having a capital under £5m or £10m has halved within two years and approximately two-thirds of AIM’s companies are capitalised at less than £25m and almost10 per cent are valued at below £2m’. Despite share prices falling, the delisting of the small firms has become a basis for the average AIM Company’s estimation twofold to £43m since the year 2006. The continued loss of small firms from AIM and some Britain’s top 200 companies remain there give rise to a fear that AIM will become another version of the main market leaving no alternative for smaller businesses to be quoted. That is already making it harder for small firms to raise capital to invest in Britain’s economic recovery (Northedge, 2010).
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