How much is reputation worth to a national stock exchange?
The government of Saudi Arabia is shopping. What do Britain’s Financial Conduct Authority, the London Stock Exchange - and indeed the City of London itself - have to sell? Two things: size and prestige.
The Saudis are looking for a place to list a 5 per cent stake in their state oil company, Saudi Aramco. They aim for a $2tn valuation for the whole enterprise ( others take a more modest view). That would make the stake sale the biggest public offering ever. The size shortens the list of exchanges that could accommodate the deal. New York and London are the main candidates. Hong Kong, Tokyo, Singapore and Toronto are also possible.
The initial public offering poses challenges. Public investors will be a tiny minority at the mercy of a majority owner that also happens to be an absolute monarchy. They will have no control and, possibly, limited information about the controlling shareholder and its strategy. The kingdom needs a venue with a sterling reputation to reassure investors and minimise the discount the shares will receive relative to those of private oil companies. The pressure to minimise the discount is all the more acute with Brent crude under $50 a barrel - half its level of three years ago - and electric car technology improving.
The question for London, then, is the degree to which reputation is like cake. It is universally agreed that cake cannot be both had and eaten. Can reputation be both had and sold? For exchanges technical excellence is part of reputation, but share quality is too. An exchange is a distributor. If it moves shoddy goods its legitimacy is endangered, and for stocks quality is a matter of corporate governance.
To accommodate Aramco, however, the FCA will have to loosen its governance rules, mainly the strictures on “related-party transactions”. These were tightened a few years ago following governance fiascos at resource groups with dominant shareholders. The rules require minority consent for deals that change company structures. A state entity such as Aramco is loath to give such power to outsiders.
The FCA’s proposed solution is creating a class of shares for sovereign-owned companies. The distinction may provide some warning to investors that shares in the new category leave them with diminished rights. It is also an exercise in reputation management. Fashion labels who wish to sell to the masses while retaining elite brand cachet create different labels for different price ranges. So, for example, the British clothier Burberry once had Brit (affordable), London (classics) and Prosum (high fashion) lines. That the FCA describes the new class as a subset of its “premium” listings, which are for companies that “choose a higher standard”, is pure marketing. The new class is there to allow the LSE to distribute a lower-quality product line safely.
What costs this change in standards will have - whether London’s reputation can be both had and sold - remains to be seen. Aramco shares will be, in essence, a perpetual Saudi sovereign bond, a promissory note from the kingdom. The Saudis, in an increasingly delicate financial position, will work hard to protect their “credit rating”. Another factor is who might follow the Saudis under the lowered bar. Much depends on how much is disclosed in the shares’ offering documents and in future financial reports.
London has been a destination to global capital of imperfect provenance for centuries. Its reputation has survived. But the world is changing. After Brexit, Britain will face more questions about how best to open itself to the world. Much depends on the choices it makes.
