Why are SPACs currently such a hot topic?
UK investor circles are increasingly interested in the potential impact of SPACs on private and public markets, and whether the SPAC bubble will turn into a longer-term structural game-changer. SPACs are experiencing a boom in the US. Over 200 SPACs were launched in the US in 2020 and 143 SPACs have already launched there in 2021 so far. In 2020, more was raised through SPACs in the US than through traditional IPOs. This has sparked a worry in the investment industry that the UK is losing out on listing activity as SPACs raised a mere £30 million in the UK in 2020. This in turn could affect the UK’s attractiveness as a place for doing business for financial services companies, with the potential for a drain on talent and jobs from London. There is also a worry that US-listed SPACs could snap up UK companies, effectively meaning that they become US-listed companies, further draining business from the UK, and squeezing out UK private equity firms from deals.
This has fed into demands from some industry figures for the UK to adjust its listing rules so that more SPACs can be launched in the UK. The key barrier to UK SPACs is that trading in SPAC shares must be suspended once a deal is announced. This means that those investors who do not support the proposed takeover cannot exit their investment until the deal is complete, meaning their money is locked up for months. A review into UK listing rules set up by the government and led by Lord Hill has recommended this suspension rule be removed to make the UK a more competitive place to list SPACs
Is a change to the rules likely?
The Financial Conduct Authority (FCA) controls UK listing rules. To make changes to SPAC listing rules, it would have to undertake a consultation on any proposed changes before implementing them. This is in itself no issue, with many industry stakeholders likely to back the changes. However, increasing the competitiveness of the UK financial services system is not a formal regulatory objective of the FCA, unlike regulators in Australia, Singapore and Hong Kong, for example. The FCA’s objectives are to protect consumers, protect and enhance the integrity of the UK financial system and promote competition in consumers’ interests. Therefore, the FCA’s priority is managing risks in the system to keep it functioning well and protect consumers. This does not necessarily align with demands to increase the UK’s international competitiveness.
Given the impact SPACs could have on the UK investment environment and on investors’ interests, the FCA may be reluctant to ease regulations. The listing costs of SPACs are significantly higher than traditional IPOs. A forthcoming paper in the Yale Journal on Regulation estimates that the median cost of a SPAC deal, relative to the cash delivered to the company in the deal, is a staggering 50.4%, almost double the paper’s estimate of IPO costs to companies going public. Furthermore, these costs are generated precisely because many investors exit the SPAC just before the deal takes place. Under US SPAC rules, investors who exit the SPAC regain their initial investment plus interest but retain their warrants (right to buy further shares at a fixed price). Therefore, they can buy more shares at an often-reduced price. This process dilutes the shareholding of other investors while providing little extra cash to the SPAC, creating costs for the listing.
These high costs are often then reflected in the poor performance of the post-deal share price, with the median return for investors 12 months post-deal for US SPACs being negative 65.3%, meaning investors in the SPAC are normally the ones who suffer from high costs. Adding to these potential woes is the incentive for SPACs’ sponsors to reach a deal, even a bad one, before the time limit for making a deal (normally 2 or 3 years after the SPAC listing) ends. This is because SPAC sponsors tend to do very well out of deals, making a median return of 32% in the US after 12 months and very few making a loss. Therefore, the FCA has reason to be cautious about opening the UK to a SPAC boom by removing the requirement to suspend trading in shares because, as the regulations stand in the US, SPACs often benefit sponsors at the expense of investors.
Perhaps more likely is a change as a result of the Financial Services Future Regulatory Framework Review, currently at the consultation stage. This a wider review of UK financial regulation in the context of the UK’s increased powers post-Brexit. Lord Hill’s Listing Review advocates using this opportunity to give the FCA a target of making the UK financial services industry more competitive, which could then incentivise an easing of rules on SPACs. However, HM Treasury is sceptical of the benefits of a competitiveness objective for regulators in the consultation paper, saying that it risks undermining the objective of a stable financial system.
The government and the FCA are unlikely, therefore, to seek to replicate the US regulatory system for SPACs anytime soon. Any loosening of regulations is likely to be cautious and come with greater investor protections. This reflects the thinking in government that a stable financial system is also an attractive one to the financial services industry. This position is likely to guide the government through changes to financial regulation in the years ahead meaning a SPAC boom is unlikely to reach the UK.