Monday, September 18, 2006

It's not SOX; London is just better

Clara Furse, chief executive of the London Stock Exchange, has an op-ed in the Financial Times today ("Sox is not to blame – London is just better as a market") adding to the transatlantic pissing match between the London Stock Exchange/H.M. Treasury/UK Financial Services Authority and the New York Stock Exchange/NASDAQ/Securities and Exchange Commission. Nothing is more fun to watch than regulators and finance firms in a cat fight, huh? Huh?

Even so, as I keep telling all you doubters out there, this really is a high-stakes game for both countries, even if it does seem so dreadfully boring. (To give it some context, think about how much the Iraq war has cost the United States so far--maybe $300+ billion? The total market capitalization of all the companies trading on just the New York Stock Exchange is $21.2 trillion. That's with a "t". $7.9 trillion of that are foreign companies. You skim 1/10th of 1 percent off just those foreign listers in terms of fees, etc. and you've practically paid for a full year of Congressional "Emergency Supplemental Appropriations".)

At any rate, Furse makes the following argument:

At one level, it has been suggested that international companies listing outside America want to avoid submitting themselves to the highest standards of regulation. As the head of one US exchange put it: “By setting the bar so high in the US, Sox has had the unintended consequence of triggering a ‘race to the bottom’ by stock markets and companies.”

This line of argument may reflect a combination of sour grapes and a tendency to believe that bigger must mean better; that in creating the world’s heaviest rulebook the US has also created the most effective and trusted regulatory environment. However, this view does a disservice to both the international companies that are coming to London and the world-class standards of regulation to which they aspire.

Indeed, London’s principles-based regime, rather than a more prescriptive rules-based approach, continues to prove itself as a model that facilitates pro-competitive innovation in a tough but sensible regulatory environment. All the important independent corporate governance surveys confirm that the UK is number one for corporate governance standards.

At a more practical level, US market participants do recognise the strength of the negative sentiment towards Sox, in particular from smaller companies for whom the cost – in time, dollars and legal risk – represents a serious disincentive to growth via initial public offerings. These participants are hopeful that, with some minor modifications to the law, US markets will once again attract the lion’s share of international listings.

This hope underestimates the attractions of the City of London and its competitive pedigree. The truth is that Sox has become a convenient focal point for explaining away the success of London’s financial district. It is easy to forget that the City has a strong track record in competing for international listings. At the end of 2000, long before Sox, there were 532 international companies on the LSE compared with 488 on Nasdaq and 433 on the NYSE.

London’s competitive advantage is clear: it has the world’s deepest pool of international liquidity; it has a wide range of institutional emerging market investors; it has broad analyst coverage; it offers an unrivalled choice of markets on which to list; it is the gateway to a budding eurozone; and, critically, the City promotes world-class regulation and corporate governance standards. This is why the profile associated with an LSE listing provides real value. London offers a highly competitive product to companies who seek to join the global economy, enhancing growth prospects around the world, helping to build new economies and providing hope through prosperity.

Furse makes some interesting points. She also claims some absurdities.

First, it is probably accurate that London has a cheaper, more efficient market. You can list in London and pay less in transaction costs than you can in New York, where investment bank underwriters will charge you so much to hawk your IPO that some companies (such as Google) have decided to go it on their own through a Dutch Auction. That is a serious concern for New York, and one they will have to address in this increasingly competitive global capital market. And the Sarbanes-Oxley Act has nothing to do with it.

But the other claims are disingenuous. London does have a largely principle-based regulatory regime which, as opposed to the supposedly "rules-based" American approach, sets out broad objectives (such as "be honest") and lets you figure out what that means. There is nothing theoretically wrong with this approach. After all, God Himself gave Moses only 10 "principles". And the UK goes one step further by making most of these principles "comply or explain" (sorta like me saying, "God, I am not going to comply with your "Thou shalt not steal" provision because I can imagine myself being in a Les Miserables-type situation where the need to steal a loaf of bread might arise...") The problem with a principles-based approach, of course, is that it is meaningless if not backed up by a strong enforcement mechanism and some kind of respected judging mechanism. (God, of course, being omniscient and infinitely just, can pull this off. But, as I discuss here, the UK FSA, with its 12 enforcement cases per year, probably can't.)

Second, Furse points to the UK's corporate governance system as an example of how the LSE's regulatory standards are world-class. This brings up two interesting points. The UK's corporate governance standards are world class, but (except for the comply-or-explain provisions), they are also hardly principle-based. In fact, the UK expressly prohibits a wide range of corporate governance activities (such as staggered boards of directors and other anti-takeover devices) that are permitted in the United States. The UK corporate governance rules are far more proscriptive than Delaware's (which really are principles-based, to the point where they let you get away with anything). At the same time, corporate governance is just one aspect of securities regulation. In other areas, the UK takes a decidedly hands-off approach to regulating even clearly problematic issues, such as the transparency of bond markets and securities analyst conflicts of interest.

Third, given the size of the LSE, I don't quite understand how Fruse can make the claim that the London Stock Exchange has the "deepest pool of international liquidity". What does this mean? As a general matter, how can a market with a $7 trillion market cap have deeper liquidity than a market with a $22 trillion market cap? She seems to be confusing foreign issuer representation on a stock exchange, with overall investor participation. (Or am I missing something here?) And what is the difference between "liquidity" and "international liquidity"?

Fourth, "gateway to the budding eurozone." Is the UK part of the Eurozone? Since that's a rhetorical question (it's not), why is it a gateway?

Granted, I'm being a bit nitpicky here, but, really, the fundamental question is not what do issuers want, but what do investors want. Do they want transparency or not? Do they want a strong securities market cop or not? If they don't, the LSE will prosper. If they do, trading on the LSE will be more volatile. The LSE may still do well for itself, but it will tend to attract lower-quality, more speculative-grade issuers.

In that regard, the LSE's censure of the investment bank Durlacher (a firm since bought by Panmure Gordon) is telling. (See the FT's Henry Tricks, "LSE’s rebuke signals Aim clampdown" and Lombard's "Mixed messages for naughty nomads".) Basically, in the middle of a private placement, Durlacher's client, Prestbury Holdings (a company listed on the LSE's "Alternative Investment Market"), found its financial performance was likely to fall significantly short of market expectations. Prestbury provided Durlacher with a draft press release announcing this fact, but Durlacher sat on it until May 26, after the placement was finished, and a day after a sharp fall in Prestbury’s share price. (Had the information come out during the private placement, the company would not have raised nearly as much capital and Durlacher's profits probably would have been lower.)

In most countries, this is the kind of activity that would spark a major investigation, and significant fines (if not a suspension of the underwriter's ability to conduct business). But in the UK, the "light touch" apparently goes beyond just regulating. My favorite quote in the FT articles is from Nick Bayley, head of trading services at the LSE, who said this was the first time an AIM adviser had been publicly censured, and this is a message to advisers “to do their jobs properly”. “I hope it will send a strong message,” he said.

Given that this "strong message" goes out to a firm no longer in existance, I'm sure it will come across loud and strong.

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