A quarter century of damaging reforms

May 10, 2024

Some of the root causes of the problems confronting the UK equity market, including AIM, can be traced back over twenty years, and some are of a more recent vintage. Here, I want to highlight two major problems that have had a very negative impact. The first of these was a series of changes to pension accounting rules that were first mooted in the late 90s and introduced in the early 2000s. 

Disclaimer: this is a long article. Don't feel bad if you don't make it to the end – I asked ChatGPT to give you a summary and as you can see, it's a lot to read!

Screenshot from ChatGPT reads: Neil Woodford critiques the damaging reforms over the past 25 years that have reshaped the UK equity market, focusing on the effects of pension accounting changes (FRS 17), MiFID 2 regulations, and Brexit. These reforms dramatically reduced UK pension funds' equity holdings, hindered UK companies' ability to raise capital, and left the market vulnerable to foreign takeovers. It’s a long story of regulatory missteps — so lengthy, even ChatGPT needed a breather to summarise it!

The introduction of FRS 17

Before I focus on the damaging implications of these changes, which were highlighted during consultation before this new accounting standard was introduced, I need to walk you through what this accounting reform entailed as painlessly as possible.

FRS 17 replaced a pre-existing accounting standard under which actuaries were able to estimate defined benefit pension costs based on the investment strategy of the underlying scheme. Most UK pension schemes held around 60-70% of their portfolios in equities, so this allowed actuaries to anticipate the higher expected returns of equities relative to bonds to be considered when calculating pension costs.

FRS 17 is far more prescriptive and measures pension liabilities by reference to AA-rated corporate bond yields on one specific day. Based on an AA bond discount rate, the difference between the market value of the assets and the liabilities then gives rise to a surplus or deficit. The surplus or deficit goes straight to the corporate sponsor’s balance sheet, net of deferred tax. Under the previous rules, any surplus or deficit was spread over the future working life of the employees, which was usually about 15 years, and this was included in the corporate sponsor’s P&L, not the balance sheet. Under FRS 17, there is no spreading, and the measurement is marked to market. The direct result of this was that FRS 17 hugely magnified the importance of the company’s pension scheme in the sponsor’s accounts.

In summary, the new accounting standard deposited very large assets and liabilities, which in some cases were larger than the sponsor’s non-pension assets and liabilities, directly onto the company’s balance sheet. Because the FRS 17 measurements were calculated by reference to market conditions on one day and because 60-70% of the typical scheme’s assets were invested in equities, this exposed the sponsor’s balance sheet to unmanageable volatility. Large surpluses one year could quickly become large deficits the next simply because of the inherent near-term volatility of the equity asset class. These large swings naturally created an intolerable situation for corporate sponsors. Another characteristic of FRS 17 is that the full cost of any benefit improvements delivered by the company to scheme members had to be recognised (as a cost) in the year the award was granted. Under SSAP24, those improvements were spread. Hey presto, and at a stroke, that was the end of benefit improvements.

Despite the many warnings that were delivered at the time, this new pension accounting standard was introduced. Unsurprisingly, this happened to defined benefit pension fund asset allocation in the aftermath of this damaging regulatory reform. In the space of just over twenty years, DB pension funds UK equity holdings went from over 50% of their total assets to virtually nothing.

Chart showing the evolution of UK defined benefit pension fund allocation and how allocation to UK equities has dropped from a peak of around 50% to virtually nothing since the mid 1990s.

Looking at it another way, pension funds owned 32.4% of the UK equity market in 1992, and now they own about 1.5%. (Insurance and pension funds together owned 46% of the UK equity market in 1997, and together they now own just 4%.) As these pension funds progressively sold down their UK equity holdings, they significantly increased their holdings of government and corporate bonds, such that they now comprise more than 63% of their total assets.

Again, to help put this into perspective, total private sector DB assets in the UK are now over £1.5tn, and the total value of shares listed in London is approximately £2.57tn.

In summary, this accounting change forced the biggest single, long-term, patient capital owner of the UK equity market to almost completely disinvest from the UK equity asset class.

Quite why these DB pension funds’ asset allocators were persuaded that international equities, private equity, infrastructure and real estate, allocations to which were either maintained or increased during this time, were so much more attractive than UK equities is not a question I have seen a sensible answer to other than that these alternatives offered diversification benefits that UK equities were deemed not capable of delivering. However, this wholesale disinvestment has had a profound and obviously damaging influence on the UK equity market over the last twenty years.

Unfortunately, it is hard to precisely quantify the damage done by this change, partly because, of course, there is no counterfactual. However, to start with, I would point to the prolonged underperformance of UK equities against all peers as an obvious symptom of this harm.

The first chart below shows the FTSE 100 against its peers from 2010 to today. This protracted underperformance has consequently left the UK market on a rating that is now completely detached from that in the US and, in some cases, significantly lower than its peers across Europe as shown in the second chart.

Chart showing how the UK stockmarket has significantly underpeformed its peer group since 2010.

Chart showing cyclically adjusted price to earnings ratio

But this change didn’t just lead to an underperforming index. It has had a much more insidious impact on the structure of the UK market, leaving it incapable of fulfilling one of its primary functions.

The implications of the DB pension fund exodus

As these funds exited the asset class, so listed businesses found it progressively harder to find investors from whom they could raise additional capital either for investment or acquisitions and as their stock market ratings declined, so the economics of paper transactions (issuing shares to fund deals) became harder to justify and execute. Also, as these companies’ share prices derated, or at least underperformed peers listed on other exchanges, so they have become more vulnerable to foreign takeovers. And, of course, companies seeking a listing via an IPO found it increasingly difficult to find enough long-term patient capital investors who were prepared to back a newly listed business. 

Eventually, this resulted in the situation we now confront in the UK, where the equity market is incapable of fulfilling one of its two primary functions, namely, its role as a capital-raising venue for listed businesses or those seeking a listing. A stock market is ultimately the mechanism via which surplus capital generated by mature companies in an economy can be recycled to those companies that need it to grow – the technology-focused companies of the future.

By implication, the UK is economically disabled because it cannot grow its thriving but small technology sector into viable, scaled commercial enterprises that generate profits and provide knowledge economy jobs and tax revenues. This is a very serious long-term problem for the UK economy that has been increasingly visible over the last ten years, and its roots lie in the damaging pension accounting reforms introduced over two decades ago. 

For those who doubt these conclusions or disagree with this diagnosis, I wanted to provide some evidence to back them up. 

IPO activity

First to IPOs. Here is a self-explanatory graphic showing UK IPOs from 2007 through to 2023. At its peak in 2006, the London Stock Exchange (LSE) accounted for nearly 18% of total global IPOs by value.

Chart showing IPOs in the UK which peaked in 2006 at $45Bn and which are now at $972m

To help you put this into perspective, over the last three years, Saudi Arabia’s stock exchange, the Tadawul, has recorded more than 120 IPOs, which have enabled issuers to raise more than $100bn.

Listed companies

The London stock market lost 44% of its listed companies between 1997 and 2019, a dramatic decline that appears to be accelerating.

Chart showing the number of companies trading monthly on the LSE dropping from 2429 in 2015 to 1900 in 2023.

Follow-on transactions 

In 2023, listed companies raised £18.8bn in 327 follow-on transactions. One might think this reflected a different narrative in which the London market was finally emerging from this prolonged period of contraction. Unfortunately, when compared with listed company ordinary dividends of £90bn and an additional £57.4bn of share buybacks in 2023, it looks altogether more feeble.


Takeovers of UK-listed companies are also shrinking the UK market. The number and value of these transactions is a volatile series (see below), but more recently, in 2023 and during the first four months of 2024, the number and size of transactions have increased considerably. Here is a list of only some of the most recent:

Graphic showing some of the most recent takeovers of UK listed companies from 2023 and 2024 so far including Wincanton, Currys, Virgin Money, Redrow, DS Smith, Spirent, Direct Line, Mattioli Woods, Lok'n Store, Hipgnosis, Tyman, Darktrace, AngloAmerican.

And just in case you thought that UK companies were marauding around international exchanges buying up companies left, right and centre, well, think again. Apart from a spike in activity in Q3 2021, the number and size of these transactions, not surprisingly, remains very subdued.

Chart showing the value of inward and outward M&A

In summary so far...

I said this was a complicated story, and I am still only part of the way through it, but I hope you can now see why the UK stock market has had such a difficult twenty or so years. In some ways, it is remarkable that it has survived this act of regulatory self-harm as well as it has. Not surprisingly, I am still not at all sure why this change was imposed or why the asset allocators at these funds decided that UK equities were so toxic compared to almost every other type of asset, including international equities, property and private equity. If I were an asset allocator based in any other part of the world and observed that UK pension funds were happy to own almost any financial asset other than UK equities, it would make me think twice about owning them, even if they were incredibly cheap.

Of course, it is also hard to understand why, when what many in the fund management industry had forecast came to pass, the government, the regulator, or the Treasury didn't intervene to stop it. It is also almost impossible to imagine any other competitor nation (take the French, for example) standing by and allowing this much damage to be done to what was the world's leading international equity market, comprising 10% of the global equity index (at its peak) and a once dynamic, thriving and essential component of the UK economy. And let's not forget that the DB and DC pension industry has, and continues to receive billions of pounds in tax subsidies, ultimately paid for by all UK taxpayers, corporate and individual, whether they have a pension or not (fewer than one in five self-employed workers are saving in a pension).

Another inevitable outcome of this imposed regulatory change was that 90% of all DB schemes subsequently closed to new members, depriving younger employees of businesses with corporate pensions the risk-sharing benefits that were a key part of these schemes. In the new DC schemes that replaced the DB structures, although there is greater flexibility for members, all the investment risk is carried by the employee. And, to add insult to injury, as the closed DB funds were forced into liability-matching investment strategies, which entailed a massive increase in the exposure of these funds to low-returning bonds, so the investment return potential of these funds was undermined, something that is hard to reconcile with the interests of the funds’ beneficiaries.

So, in summary, the pension accounting reforms that were imposed over twenty years ago not only undermined the structure, function, status and performance of the UK equity market but also damaged the financial interests of the millions of members of these schemes and deprived future generations the benefits of shared investment risk-taking with their employers. By comparison, in the US, pensions have largely disappeared from the private sector and been replaced by employer-sponsored schemes such as 401(k)s. However, most public sector workers in both state and local government have them (from what I can establish, these are almost entirely DB plans), and very interestingly, based on the latest information from the Public Fund Survey, the average public pension fund asset allocation has just over 47% in public equities.

One final thought on this section is for the constituency of readers who remain convinced that allocating away from UK equities was the right decision because they have underperformed their rivals for so long. This argument fails to acknowledge the fundamental point that the selling of UK equities by pension funds was the principal cause of this underperformance. There is no other plausible explanation, and to illustrate the point, imagine a parallel universe in which a £1.5tn domestic asset pool announced that it would be increasing its asset allocation to UK equities from about 2% to more than 45%. How bullish would you be then about UK equity performance?

Compound damage

FRS 17, while hugely important, is only part of the story. However, its legacy meant the UK equity market was much more vulnerable to the following two events that further undermined it. In both cases, the damage was more severe than it might have been.


The first of these was the Brexit vote in the summer of 2016. By this time, international investors had already replaced UK DB pension schemes as the largest single owners of the UK equity market (approximately 50% of the market was foreign-owned in 2016). It was this constituency that was especially vulnerable to the apocalyptic warnings politicians and the media issued at the time about the economic consequences of a decision to leave the EU. These dire warnings never came to pass, unsurprisingly, but the damage was done. Although the percentage of international ownership of the UK market has continued to rise after 2016, the foreign institutional selling of the UK equity market that followed the Brexit vote outcome certainly damaged the relative performance of the UK index vs its peers.

Chart showing the beneficial owners of UK quoted shares have dramatically shifted overseas


The second event that administered the coup de grace to the already ailing market was another piece of imposed regulatory nonsense, namely MiFID 2, the consultation on which started in 2010. MiFID 2 was finally implemented in January 2018. This was a piece of EU legislation that was designed, I believe, to both harmonise the regulation of financial services across the EU and to increase competition and investor protection. But as someone once said about good intentions:

“People who, with the very best intentions, establish laws, rules and policies to govern others’ behaviour in order to protect potential victims and vulnerable people from harm, do not give sufficient attention to the predictable, negative consequences of their laws, rules or policies.”

This sums up MiFID 2 perfectly and, I think, pension accounting reform, too. I will not bore you here with a list of MiFID 2’s measures or bold ambitions. Suffice it to say that its implementation in the UK did not benefit the structure of the UK equity market, liquidity, market participation, or, in my opinion, lead to better investor protections or outcomes. Instead, what we now have is a market in which liquidity has been fragmented and reduced, there is less transparency, small and medium-sized businesses cannot raise capital (more on this below), and despite lower transaction costs (albeit stamp duty remains at 0.5%) individual participation in it continues to fall.

The single most damaging aspect of MiFID 2, which regulators were warned about years before implementation, was that it severely restricted (effectively ended) fund managers’ ability to buy investment research on companies listed in London with commissions on trades executed in the market on behalf of their clients (fund investors). Regulators had long seen this arrangement as potentially corrupt, and I would not be so naïve as to believe that it was not open to abuse by the unscrupulous. However, vitally and in the vast majority of cases, it formed the basis of the pivotal and healthy relationship between active fund managers, managing funds on behalf of their investors, stockbrokers who represented, supported and promoted the interests of their client companies, and the listed businesses themselves. This symbiotic relationship benefitted all parties and, most importantly, the ultimate fund investors because it created more transparency. Investors knew more about the businesses they were investing in because experienced and knowledgeable analysts authored high-quality, independent, insightful research. In turn, fund managers could make better-informed investment decisions on behalf of their clients.

Listed companies also benefitted, especially small and medium-sized businesses, because they could cultivate close relationships with their informed institutional investors via their broker, which improved understanding and knowledge of the business in the market. This encouraged longer-term patient capital investing, which created an environment in which raising additional capital for investment was feasible. (It’s now virtually impossible) It was also an environment in which companies looking to IPO could approach a broker who could promote the business to an appropriate investor audience and who would support the capital raise. It was not a perfect system, but it was tried and tested and worked for investors, companies, fund managers and brokers. That resulted in a healthy, liquid stock market that could fulfil its vital roles for the economy and, critically, one in which companies could raise capital. 

Now, over six years after MiFID 2’s full implementation, we have a reduced UK equity market. There is less liquidity; companies cannot raise capital; the number of listed companies is collapsing; many leading businesses are looking to relist on other markets, and, as a result of the damage inflicted on it, the skills and talent of the professionals who were employed in and around it have been irreversibly lost.

By way of comparison and for those that might still think MiFID 2 addressed an inherently dishonest equity market infrastructure in the UK, in the thriving US equity market, the regulator (the SEC) allows commission dollars to be set aside to pay for research-related costs incurred by fund managers and advisors. There, companies are raising billions of dollars in secondaries and IPOs, and it is the number one destination for companies seeking to delist from the UK equity market. Enough said.

In conclusion

If you made it this far, well done.

In summary, the UK equity market’s decline in terms of performance, prominence and vitality, and arguably most importantly, in its ability to fulfil its key functions for the UK economy, was the direct result of two acts of unnecessary regulatory self-harm and a third political event, whose impact was more significant than it should have been because of the damage done by the other two.

The key question is: can the UK equity market recover? I'll address that point next week but, as we saw this morning, as optimistic as I am about the future of the UK economy, even I underestimated Q1's GDP growth figures...

Disclaimer: These articles are provided for information purposes only. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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