The future of world capital markets (Part 1): The Committee on Capital Markets Regulation

Several related news bits today I think highlight the deeply hidden war currently waging within the United States and between the United States and Great Britain over the future of the world’s capital markets. This war is deeply hidden mostly because it is so esoteric. The battlefield is intensely boring. You can just see most people start to slip into a coma just at the mere mention of something like “principles-based regulation” or “fair-value accounting.” Even financial reporters hate to cover these kinds of things. But this war is important because literally tens of trillions of dollars ride on the outcome. Historically, countries that control financial markets do well for themselves. (Think about how much mileage the Netherlands gets even today, just because it was a major financial center 300 years ago. How many other tiny little countries host companies as big and as powerful as ABM-AMRO, ING and Royal Dutch Shell?)

But since there are several items, I will break them up into two different entries.

Part 1

In the U.S. financial news, of course, the big announcement was the formation of a new “Committee on Capital Markets Regulation,” headed by Hal Scott, a Harvard Law School professor and co-chaired by former White House Economics Advisor Glenn Hubbard and former Goldman Sachs president John Thornton. (See the New York Times article by Floyd Norris, “Panel of Executives and Academics to Consider Regulation and Competitiveness”). It has been blogged about elsewhere (including by the Business Law Professors Blog, InsideSarbanesOxley). Very little analysis, other than by Norris, of course.

But this news is, to a degree, a side show, and a poor one at that. There are flaws with SOX, but an organization led by a group of academics and dominated by an obviously self-serving group of issuers and accounting firms is a poor tool to change it. Particularly in an election year, when: (1) the Republicans are in trouble, and don't want to look like they are just a tool of industry, (2) the two name authors of the bill are about to retire and have no intention of seeing their bill repealed this year (if ever), (3) Eliot Spitzer looks like he’s one his way to the New York governor’s mansion, and will use any attempt to repeal SOX as ammo in his campaign (and the Republicans know this), and (4) did I mention that there is a strong chance that the next Congress might not be so, shall we say, sympathetic to business?

I mean, who are these idiots?

I also particularly like Hal Scott’s statement about why this group includes no former regulators among its members—even former regulators with lots of business experience.

“We generally tried not to include regulators,” Mr. Scott said. “We would not want to put people in the position who had formulated these rules in the past. They may have a lack of objectivity. ... Anybody on this committee is in the real world and will bring with them real-world perspectives,” he said.

Coming from a Harvard Law professor, that’s just too rich! There are so many funny things in that statement (Lack of objectivity? Academics with “real-world” perspectives?), I feel like Eric Cartman when he blew his funny fuse. I may never laugh again.

But I no doubt will.

Professor Jim Cox at Duke University Law School commented on this on National Public Radio yesterday (you can listen here or see the transcript here). Cox's analysis offers some valuable insight into the real issues involved behind U.S. financial competitiveness. In particular, he points out that:

• [W]hat we found is with Sarbanes-Oxley new rules have been introduced so that the accountants are more independent, the directors are much more independent and accountable than they were in the past. As a result, they're holding management much more accountable. So, management doesn't like the new rules in the game because it's reduced something of a competitive advantage that they had in running the business or organization vis a vis the owners of the company.

• [T]he real issue here is not Sarbanes-Oxley, it's the fact that there's been a sea of change that's been underway for about a decade now in European markets that's greatly reduced the cost of doing transactions in Europe. And as a result of that, the cost advantages that were enjoyed in the United States have largely disappeared.

• If all these deals move to other exchanges, it would be a real blow to, first, the American economy. It was not that long ago where we could say that 15 percent of the GDP of New York City is largely dependent upon the financial markets that existed there, both the Nasdaq market and the New York Stock Exchange and the allied events that went around it. Second thing is, as long as you have deals occurring in the United States, we have a terrific extraterritorial impact about what happens in other places in the world. And we would lose that influence over transactions, and therefore we would lose some of the influence over our own destiny in that regard.

• Sarbanes-Oxley is something like a scapegoat for driving transactions abroad. It is the high fees that are being demanded by investment banking firms related to these deals as well as the law firms. Those fees are susbstantially lower in Europe than they are here. And unless there's some serious cost adjustment we're going to continue to see deals going away.