Does London’s Alternative Investment Market deserve its tax breaks?

London’s Alternative Investment Market (AIM) enjoys tax breaks that can suck in unwary investors. Created as a lightly regulated junior Exchange, it is failing to live up to its promise of fostering enterprise. Scandals in the market have seen some AIM shares fall over 90% in the past year. Yet, the market enjoys tax privileges that might draw-in the unwary; investors least able to take risks. Without action, London’s reputation risks being tarnished. It is time for regulators to re-assess the AIM experiment.

AIM will reach its 20th anniversary in June, and it claims to have helped more than 3500 companies raise equity for growth, totalling almost £90bn. While the intended emphasis has been high growth areas such as technology, in practice it has attracted many oil and gas explorers, junior miners, and an assortment of Chinese companies – some via British Virgin Islands vehicles. This may partly explain poor performance. The AIM market average has lost more than 20% of its value over the past 12 months, compared to a flat performance by the average smaller listed company. Over the last 10 years, AIM has significantly lagged the UK listed averages.

Why has AIM disappointed? It was meant to attract entrepreneurs and early stage, but not unproven, businesses. The London Stock Exchange Group (LSE) markets AIM as representing some of the UK’s most ambitious, dynamic and innovative companies. Free-float requirements are undemanding, allowing the issue of just a small minority of equity. Founders can retain control, and also issue more equity for acquisitions at lower cost. There is no trading record requirement, and no prior shareholder approval for most transactions.

Instead of a stockbroker, companies appoint a Nomad (Nominated Adviser) such as legal or accounting firms, although many Nomads are also recognised brokers. Standards on AIM rely a great deal on companies working closely with their Nomad to ensure their actions are fair and reasonable for shareholders. There are rule books both for companies and Nomads. The risks of lower free-floats, combined with limited research and scrutiny deterred some investors, but many institutions and private investors jumped aboard. Despite this poor average performance, there have been a few notable successes. The companies that have delivered for investors tend to be those that do not have such large founder interests, enjoy bigger free floats, and have not been acquisitive.

The AIM market gets a lot of official encouragement, via tax breaks. In April 2014 stamp duty on shares admitted to AIM was abolished. And, investors enjoy capital gains tax gift relief on share transfers. Many AIM companies also offer entrepreneurs’ relief, inheritance tax savings and Enterprise Investment Scheme benefits, giving good reasons for normally cautious investors to be drawn-in. Unfortunately, less sophisticated investors may focus on tax planning rather than investment prospects.

Even for professional investors, the risks may not be fully understood. On terminals such as Bloomberg, there is little that clearly distinguishes AIM stocks from those with full listings. Similarly, investment fund reports do no more than add asterisks and footnotes for the AIM holdings. While investors are advised that all shares can go up or down, there is little additional specific risk warning in fund reports on AIM. As a result, AIM percentages in portfolios can creep up, without a clear red flag.

The lower free-floats have created additional liquidity problems, with volatile share prices exaggerating any changes in prospects. Quindell plc, for example, was once the biggest AIM company, capitalised at almost £3bn at its peak in February 2014. Since then its shares have fallen more than 80%.

Quindell’s fall illustrates two features of the recent AIM market problems. In their desire to cash-in, a number of AIM founders and directors took advantage in 2014 of a financing arrangement, which involved pledging shares. Although, this typically meant a share sale, reporting to the market was confused in some cases. The resulting loss of confidence when corrections were announced, triggered sharp share price falls. Some Nomads subsequently resigned, and one of the larger Nomads has withdrawn entirely from this role. This has left some AIM companies still looking for new advisers. Both these factors have hit confidence.

The tax breaks and flexible regime have not just helped British entrepreneurs. A number of overseas companies, particularly Chinese, have taken advantage of AIM’s light touch. For example, wooden door manufacturer, Jiasen International, floated in July 2014 to become the 10th largest Chinese company trading on AIM, taking the total number to 50. But by the end of the year it had more than halved. Equity issued was just £2.3m on a capitalisation of £100m, leaving little free float.

Earlier this month Chinese sportswear group, Naibu Global, suspended trading in its shares, despite strong profits and cash forecasts. Lack of independent research on AIM companies is a factor in disappointments and share collapses. Many companies do not maintain websites with their accounts, prospectuses and market announcements. The City Code does not apply to companies incorporated outside the UK, the Channel Islands and the Isle of Man.

What the LSE calls a “balanced approach” to regulation now looks simply too light. For the companies involved, AIM is meant to offer a heightened public profile. But is association with some of the recent headlines the exposure that good companies want? It does not even look like publicity that regulators wish. Investor trust seems to have broken-down over the past year. LSE should not be afraid of tightening the rules; there are some excellent companies on AIM, who might benefit if investors were reassured.

The AIM market and its participants may be lightly regulated, but are still covered by key financial regulations. These include the Prospectus Directive, MiFID and market abuse. So there is scope for intervention, which might focus all involved in the market in better practices. A characteristic of many financial failures is that unwary investors have been drawn-in. The range of tax incentives for AIM might help Chinese door manufacturers and Zambian beef businesses, but it is not clear there are proportionate benefits to the UK. Indeed, London has much to lose reputationally if it all goes wrong. A re-assessment of AIM is overdue.

A version of this article was published as the Op-Ed in Financial News on 19 January 2015.

Disclosure: The opinions expressed in this article are my own, and may not represent the views of any firm or entity with which I am affiliated. I have no investment position in or business relationship with any company mentioned in this article. The information presented in this article has been obtained from sources believed to be reliable; however, I make no representation as to their accuracy or completeness and accept no liability for loss arising from the use of the material. Articles and information do not represent investment advice. At the time of writing neither I nor my employer’s clients had interests in any stock mentioned and had no plans to initiate any positions.

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