The vast majority of businesses in the UK are small or medium-sized – some 99% of them account for 60% of all private sector employment. How does an ambitious, growing company from this vast sector go public in search of investors? The London Stock Exchange (LSE) is not always the most suitable home. 

There are smaller alternatives to the LSE and other major stock exchanges that have almost become part of common parlance. They are to be found in all corners of the world, from tropical locations such as Bermuda and the Cayman Islands, to small countries in Europe like Malta and Cyprus. There’s even a securities exchange in the Faroe Islands.  

It is not just companies wishing to list that might be casting their eyes in the direction of less well-trodden paths, either. Investors, tiring of the low interest rate regimes around the world and the uncertainty over regulation and geopolitics, are also interested in what the so-called small stock exchanges may have to offer.
Defining smallAccording to the World Federation of Exchanges, a small exchange has a domestic market capitalisation of less than $100bn. That may seem a big figure, but the definition of a mid-sized exchange is a market cap of between $100bn and $1,000bn and a large exchange has in excess of $1,000bn. There are around 25 prominent small exchanges dotted around the globe. Some of these, such as Mauritius, Bermuda and Malta, have been used to provide a facility for sophisticated structures such as special purpose acquisition companies or special purpose vehicles.
  
These are known as ‘technical listings’, which are primarily set up for the purpose of regulatory requirements or tax reasons in order to facilitate the distribution of these more complex products, legitimately plan for tax efficiency or to provide offshore domiciled securities with a more robust route to market.

The Channel Island Stock Exchange (TISE) has a market capitalisation of around £400bn. A typical TISE client could be a real estate investment trust, a high-yield issuer (Netflix was a recent example), a special purpose acquisition company or a small to medium-sized enterprise (SME). 

Jon Moulton, the exchange’s chairman, is naturally an advocate of smaller exchanges. He believes that, generally, they play an important part in the financial ecosystem, and “offer a more flexible option to the larger exchanges”.
Helping SMEs to growFundamentally, though, what makes the small exchange concept so compelling is the platform they provide for companies at a crucial stage of their growth trajectory. “Smaller companies wishing to make that first foray into public listing find small exchanges very compatible with their objectives,” says Dale Acton, head of trading & market making at Channel Islands-based broker Ravenscroft, which works with TISE. 
"We have raised money successfully at every event"It’s a view shared by Frazer Thompson, CEO of English wine producer Chapel Down Group, which initially listed on the PLUS exchange, now known as NEX. Its share price has risen impressively since launch and Thompson says that listing on NEX has clearly benefited the growth of the company. “The discipline of the results and reporting process are good preparation for an ambitious management team and we have not encountered any significant barriers from being listed on NEX rather than the Alternative Investment Market [AIM] – we have raised money successfully at every event.” 
Cost benefitsPatrick Birley, the chief executive officer of NEX, says that economics are at the heart of the appeal of a small exchange. “The costs of being a member and listing on NEX are much lower than those associated with large exchanges like the LSE – around 75% lower. Obviously, this is an important consideration for smaller, growing companies.” 

AIM, which Patrick names as the main competitor for NEX, has established itself as the LSE’s little brother. It has been in operation for 22 years and caters for smaller, expanding companies. 

One direction might be to list on AIM, which costs around £350,000. In comparison, listing on NEX is roughly a quarter of the price and Patrick wants it to be even lower than that. 

NEX has a simple strategy in that it focuses on two things: issuers and investors. What NEX aims to do goes back to the very roots of the stock market ethos; one that allows the exchange to understand precisely what its clients are trying to achieve. Patrick says: “We have what is very much a traditional structure, but this means we can intensify our efforts around these two areas. We are able to fit what we offer around the requirements of our clients, be they IT companies, traditional family companies or international organisations. In some cases, a company might not want to issue too much equity and might want tighter control – we try to make that happen as seamlessly as possible.” 

Small stock exchanges, which are not always representative of the local business environment, can also play a role in bringing global capital to a relatively small market. The Bermuda Stock Exchange, for example, works with the Bermuda Business Development Agency to attract more business to the country. Bermuda’s remit appears to be quite broad and now includes instruments such as catastrophe bonds and insurance-linked securities.
The role of regulationFor exchanges such as Bermuda, Cayman Islands and other markets that provide offshore listing facilities, the regulatory environment has traditionally been less draconian than in mainland markets. Although this may mean a more nimble operating space, it can also raise doubts about reputational risk. At the same time, too rigid a regulatory framework can frighten off potential investors. 

Regulations such as the Alternative Investment Fund Managers Directive (AIFMD), the Foreign Account Tax Compliance Act (FATCA) and Dodd-Frank have certainly changed the landscape for offshore exchanges, notably in the case of the EU’s AIFMD, which looks to place hedge funds, private equity and other alternative investment firms into a regulated framework.  

In response, some offshore locations have implemented measures to improve transparency and the exchange of information, hoping that enhanced clarity will provide greater confidence around the suitability of smaller exchanges and their processes. Examples of this trend include the Barbados Stock Exchange signing the FATCA agreement with US authorities and the Cayman exchange agreeing a FATCA-style information exchange agreement with the UK.

Regulation is clearly an important element in the future development of the capital markets. While much stock market activity centres on secondary trading, the small exchanges still have the chance to reintroduce small companies and investors to the original idea of ‘coffee-house’-style stock markets. There have been various attempts down the years to provide an alternative to the behemoth exchange, but many have proved unsustainable or lacking the critical mass to keep costs realistic. Technology makes that easier to achieve today. Equity can provide a reliable source of finance, but it can also revive the process of re-engaging small and medium-sized businesses, and growth-hungry entrepreneurs, with capitalism and shareholders. Above all, small stock exchanges can demonstrate there is another way – without them, an important source of liquidity could go untapped.

This article was originally published in the Q3 2017 print edition of The Review. The print edition is available to all members who opt in to receive it, except student members. All eligible members who would like to receive future editions in the post should log in to MyCISI, click on My Account/Communications and set their preference to 'Yes'.