Share trading services have changed dramatically in the past 20 years, the catalyst being the ‘Big Bang’ reforms of October 1986. This groundbreaking legislation changed the London Stock Exchange’s (LSE’s) trading and membership rules, abolished fixed brokerage commissions and set the scene for the introduction of the SEAQ computer system. The effect was to open up the market to greater competition and to pave the way for two decades of technological, product and regulatory innovation.

A world of innovation
‘One of the most important developments of recent years was the emergence of the internet, which along with the enhancement of brokers’ trading systems has allowed retail investors to research and deal online,’ says Sophie Douglas, manager at Sharemark. ‘People now have far greater access to up-to-date investment information and pricing data, as well as lower execution costs.’

Freeing up the market has led to tremendous product innovation, with useful features like limit and stop orders now widely available. The government has also played an important role in broadening the appeal of share ownership through the creation of tax-efficient accounts such as ISAs, SIPPs and Child Trust Funds.

In November 2007, the EU Markets in Financial Instruments Directive (MiFID) gave regulatory credibility to alternative forms of trading system, and this has sparked a whole new wave of innovation. As Stephen Barber, head of research at Selftrade, points out, ‘The development of alternatives to the London Stock Exchange is positive news for investors, as it increases the competition.’

Take AIM
The first move to expand the small-cap universe was the development of the Alternative Investment Market in 1995. It was the LSE’s intention that AIM would provide a more cost-effective and flexible option than joining the main list. Since then, more than 3,000 companies have been admitted to the junior market, raising more than £60 billion in new share capital.

‘AIM gives people an opportunity to invest in a wide range of small and growing businesses,’ says Claire Dorrian from the AIM team at the LSE. ‘It is now home to more than 1,400 companies from 100 different countries spread across 39 sectors.’

Currently, the largest stock on AIM is Playtech, a software company valued at over £1 billion, although 85 per cent of its other constituents are worth less than £50 million. Investors can trade these shares through their broker in much the same way as they would a company from the main list, and although they qualify for a SIPP, they cannot be held in an ISA.

Listing less attractive
Over the years, AIM has been highly successful in attracting small companies to market, but the recession has made it very difficult for these businesses to raise new capital, and this has resulted in a record proportion of delistings.

‘The rate of cancellations has actually remained broadly the same, it’s just that the market is not being replenished at the same level as it was before because of global market conditions,’ says Dorrian. ‘It is also important to appreciate that almost half of the cancellations in 2008 were due to positive corporate activity, such as reverse takeovers.’

One of those planning to delist is Polymer Logistics, with the directors citing the high annual cost of maintaining their place, the inability to raise new funds and the fact that the lack of liquidity meant the share price didn’t reflect the inherent value of the business.

‘We have taken various steps to improve liquidity, including holding a series of Growing Company Investor Days, during which AIM companies have been able to meet private client brokers,’ says Dorrian. ‘We also supported the launch of a new equity research service called PSQ Analytics, which is designed to provide smaller companies with another tool to help them attract investor interest.’

Plus points
The only other Recognised Investment Exchange in the UK, outside the LSE Main List and AIM, is the PLUS market. This originally started out in the 1990s as OFEX, an informal share exchange founded and operated by the dealer John Jenkins. After running into difficulties it was taken over by the AIM-listed PLUS Markets Group in November 2004.

PLUS is home to a little over 200 companies with a collective market value of around
£2 billion. Investors can also trade a further 7,500 dual-listed stocks on the exchange. Business has held up reasonably well, with 42 new entrants joining in 2008, although 40 existing members delisted during the same period. So it was a big boost when, in February, PLUS announced its biggest ever new entrant, the US$900 million Kuwaiti property company Rak Real Estate.

David Battersby, an investment manager at Redmayne Bentley, says that there is only one company with a full listing that is also traded on PLUS, the social housing group Mears. ‘The rest are PLUS-quoted, which is akin to a place on AIM. PLUS hopes that over time these companies will see the cost savings and migrate from the LSE instead of retaining a dual listing.’

A light touch
Investors can buy and sell PLUS stocks through their broker in the same way as they would shares listed on AIM. Not all UK firms support this facility, but the list of participating members includes well-known organisations such as Barclays, Hargreaves Lansdown, Redmayne Bentley, Selftrade and TD Waterhouse.

AIM and PLUS are both relatively light on regulation and provide a cheaper source of share capital than the main list, but PLUS claims to have a number of competitive advantages. The most important of these is that the total cost of joining might typically be in the region of £100,000, compared with perhaps £350,000 for AIM.

‘The other so-called “stock exchanges” like Sharemark, Turquoise and Chi-X are in fact “Multilateral Trading Facilities” as defined by MiFID,’ Battersby points out. ‘These offer seamless trade routing with investors able to place their trades through their broker in the normal way. Lower fees have allowed these services to capture a growing level of business from established exchanges, but their proliferation risks fragmenting the market.’

Full marks
Sharemark was originally established in 2000 to provide an internal trading platform for investors with accounts at broker The Share Centre, but was opened for other unlisted and dual-listed companies in 2002.

‘Sharemark is suited to companies with a large shareholder base such as co-operatives, ex-mutuals and sports clubs,’ says Douglas. ‘It is also suitable for Enterprise Investment Scheme (EIS) companies, those that need to restrict trading in their shares to a defined user group, and those that are looking to move to a senior market in the future but which first want to get used to the intricacies involved with having their shares traded.’

Sharemark operates a periodic auction-based dealing facility, which works by matching prospective buyers with prospective sellers. Buyers and sellers enter their orders via their broker and Sharemark then works out the price at which supply meets demand. These volumes and prices are then displayed on its website.

The orders are used in the auction process to calculate the final price at which the trades are struck. Those wishing to sell at or below this level will then be matched with those wishing to buy at or above it. All the successful buyers and sellers deal at a single price, and as there are no market-makers, there are no bid-offer spreads.

‘Avoiding the bid-offer spread introduces a cost saving for the investor,’ says Douglas. ‘Market-makers charge a premium when they sell shares that they have previously bought. This premium is the bid-offer spread, and without market makers there is no spread.’

Liquidity and the cost of trading
By contrast, AIM and PLUS both use quote-driven trading systems supported by competing market-makers. This is designed to ensure that individual investors should always be able to buy or sell, but weak stock prices in the past couple of years have had a big impact on the number and value of shares being traded. On AIM, for example, the average daily turnover has dropped from £297 million in 2007 to just £83 million in the first quarter of 2009.

‘AIM is a more mature market than PLUS so I would expect the spreads to be tighter,’ says Kareem Khouri, managing director at broker Killik & Co. ‘Where a stock is dual listed on these two exchanges, we would always trade it on AIM.’

Accessing AIM stocks is almost as straightforward as trading a company on the main list of the stock exchange, with investors able to enter their orders in the normal way.

This is perhaps not that surprising given that some of the companies are bigger than the fledglings on the LSE. In theory, the same also applies to PLUS, but a lot of these stocks are very illiquid, so it will probably mean phoning in the order rather than placing the deal online.

Widening spreads
‘Volumes have fallen away on AIM and PLUS, and this has had an impact on the bid-offer spreads, which are naturally wider in the less liquid stocks,’ says Khouri. ‘We are seeing some real value in small-caps, but investors need to be careful because it is the liquidity that drives the share price. A lack of volume can make it difficult to buy on the way up and difficult to sell on the way down.’

It is also worth remembering that shares listed on the LSE can now be traded on rival platforms, like Turquoise and Chi-X, but there is less competition for AIM stocks because of a rule imposed by the LSE that any transactions carried out elsewhere must be reported back to it. PLUS considers this to be anti-competitive and is awaiting a High Court decision on the matter in June. Currently, just 90 AIM companies are dual traded on PLUS.

Risk and reward
Unlike the main market, companies that join AIM do not need any particular financial track record or trading history. There is also no minimum requirement in terms of size or number of shareholders. It is inevitable that a higher proportion of these early-stage companies will fail, which is one reason why AIM has underperformed the main market since its launch, with the FTSE AIM All Share index falling almost 50 per cent over the past 14 years.

AIM’s more flexible approach reflects the fact that it is designed specifically for smaller growing companies, but the ‘light-touch’ regulation could potentially expose investors to a higher level of risk. And the regulatory and accounting obligations are even more flexible on PLUS.

‘Any investment here must be classified as high risk, as they are smaller companies,’ says Redmayne-Bentley’s Battersby, ‘but I firmly believe that many of these securities are now undervalued.’

Help from the taxman
There are also various tax incentives available for anyone willing to take the risk of investing in ‘unquoted’ UK companies, such as those traded on AIM. One of the most generous measures is the Enterprise Investment Scheme (EIS). This allows those who subscribe to a new share issue to claim 20 per cent income tax relief on their initial outlay subject to a maximum investment of £200,000 per annum. If they then keep the holdings for over three years, there will be no capital gains liability on the final sale.

When held for more than two years, an investment in an unquoted company is exempt from inheritance tax under business property relief, and AIM shares are regarded as unquoted in this context. An investor can switch from one eligible AIM share to another without starting the clock all over again. They can even go into cash for up to three years before reinvesting the proceeds and not lose this valuable relief. The investor can also leave his or her AIM shares to their spouse in the knowledge that the accrued tax benefit would not be lost on the second death.