A Thanksgiving Holiday of Stock Exchange Cheer

This is the Thanksgiving holiday in the U.S. this week, where I use my vacation holidays to work, like every other nervous American. Hey, you don't see the Chinese slacking off at the end of the November, watching the Packers and munching on deep-fried cheeze-whiz, do you? Unless you plan on learning Mandarin soon, I suggest you get working, too, kids. As for me --
對不起! 拜託不要解僱我!

This past week, while I was stuffing myself with roasted overgrown poultry, reporters all over the United States were waking up to the boring stock exchange battles that I've been writing about, much to the chagrin of my friends and family. Clay Risen of The New Republic writes in "Is London the world's new financial capital? The New New York" about the anti-Sarbanes-Oxley backlash developing in the United States, the Schumer-Bloomberg Wall Street Journal op-ed (see here), and the NYSE's John Thain's recent speech (see here). however, rather than piling on SOX, Risen asks:

Anti-Sarbanes-Oxley pundits would have us believe that the only thing to change in recent years, and thus the cause of London's surge, is the tightening noose of post-Enron regulations. But, while there's no doubt that reform has raised the cost of going public in the United States, a whole lot has also occurred to make going public in London--or Hong Kong, or any of a growing number of global financial centers--easier. Which raises the question: Did Sarbanes-Oxley cause the capital shift, or is something more fundamental going on here?

In particular:

...[W]hat the anti-Sarbanes-Oxley narrative really misses is that the shift to London is, in fact, part of a much larger tale: the globalization of capital. Just as the second half of the twentieth century saw manufacturing freed from its national moorings, the last few decades have seen capital become increasingly mobile, able to move in and out of markets irrespective of borders. Ironically, the globalization of capital is facilitating the regionalization of capital markets. No longer do European companies, with investors and customers centered on the continent, need to come all the way to New York, across a workday's worth of time zones, to float stock. Ditto with East Asia--for all the talk about London's financial rise, it is actually Hong Kong, with its easy access to Chinese companies, that will take first place in the size of its IPOs this year.

To be sure, capital doesn't flow completely freely, and national regulatory systems--including Sarbanes-Oxley--are still a major factor. But they are far from the only ones. Even more significant is the perception that the United States is culturally and politically averse to the international market system. It is hard to express just how offended the global finance world was by the blunt nativism surrounding the Dubai Ports World debacle earlier this year, or the rise of protectionist sentiment in Congress, or the fact that it is now much harder for international financial workers simply to move in and out of the country--a key requirement in a fluid global economy. "Just getting into America, even if you're British, is an issue,'' one headhunting executive told The New York Times. ''We've had candidates that arrived for an interview, were told they couldn't leave a room in the airport, and were put on the next plane back."

Risen concludes with something I consider obvious, but which many regulators and even industry people seem to find difficult to grasp:

The day is fast emerging when globally mobile capital will pick and choose among exchanges based on a wide set of criteria. Some will go for exchanges in countries where money is cheap and questions are few; others will go for the security that comes with weightier regulations. In a recent op-ed in the Financial Times, American Stock Exchange Chair and CEO Neal Wolkoff wrote that Sarbanes-Oxley "has effectively created an opportunity for regulatory arbitrage favouring the lowest-cost host nation." But, while Wolkoff considers this a bad thing, it is in fact a very good one--over time, national exchanges will have to compete directly for listings and, in doing so, to differentiate themselves. True, some will try a lowest-cost, lightest-regulation approach, and they will win a certain amount of attention in doing so. But market listing is hardly a commodity; with lighter regulation comes increased risk. Many companies will just as likely seek stability and accountability. Which is why the United States should stand behind, not tear down, its reputation as the best-regulated and most transparent financial sector in the world.

Next up, we have a Businessweek commentary ("London's Freewheeling Exchange: It's winning the listings war against New York, but investors can get burned"). The BW op-ed discusses the growth of the London Stock Exchange's Alternative Investment Market (Aim), which the UK holds out as a low cost/low regulation exchange for smaller start-ups (sort of a NASDAQ for really small dot.bombs.) The problem (as I've also discussed earlier in my NY-Lon post), is that returns on Aim-listed securities are dismal.

But just because London's listings are soaring doesn't mean it's doing a better job of raising capital. All major stock markets have weak companies, but the new issues in London these days seem especially so. "This is the worst dreck I've ever seen," the renowned short-seller James Chanos of Kynikos Associates declared recently in a New York speech. Chanos, who has sounded alarms about U.S. companies such as Tyco, Conseco, and Enron over a 25-year career, now maintains a London office and research staff to short-sell LSE issues.

To be sure, dependable companies like BP, HSBC Holdings, and GlaxoSmithKline still dominate London, one of the oldest and most developed centers of capitalism in the world. But when half a dozen stocks of online gambling companies plummeted recently, London's easier standards were cast in an unflattering light. The biggest loss in stock value came from online casino operator PartyGaming, one of the LSE's biggest offerings in five ears when it listed in June, 2005. Investors forked over $1.9 billion, all of which went to PartyGaming's founders instead of the company itself. (In U.S. deals, insiders take only about 15% of an initial public offering's proceeds, if any.) PartyGaming is owned mainly by an American couple who live in Gibraltar. Operating PartyPoker.com from computers in a Native American territory in Canada, the company was getting nearly 90% of its revenue from U.S. residents, where online gambling was and remains illegal.

Businessweek concludes:

But there are other signs that the bloom is off LSE IPOs. Of new issues over $100 million this year, LSE-listed stocks are up only 11%, vs. 20% for NYSE stocks, a reversal of 2005 results, according to Dealogic. The share prices of NASDAQ issues of at least $100 million beat those on London's AIM, rising 5.5%, vs. a 0.5% drop this year, and 35.2% vs. 12.3% in 2005.

The Financial Times also had an interesting article that juxtiposes some of these ideas to give a much broader picture of what is happening behind the scenes of these exchange wars. Norma Cohen, in "A clash of titans: why big banks are wading into the stock exchange fray," writes the debate over the NYSE-Euronext and NASDAQ-LSE mergers misses the larger point: stock exchanges are entrenched monopolies and investment banks and large investors are determined to inject competition into this market to limit the monopolistic fees stock exchanges have been able to extract from their customers. "Project Turquoise", the plan several of the world's largest investment banks announced two weeks ago to create an independent trading platform to compete with Europe's stock exchanges, is an example. Stock exchanges, particularly in Europe, tend to operate without competition, despite a "code of conduct" created by the European Union's Markets in Financial Instruments Directive ("MiFID"). This has led to enormous profits for the London Stock Exchange and Deutsche Börse, with trading charges remaining steady even as trading volumes have increased 50 to 75%. Marginal costs on an exchange trade are effectively zero, but exchange customers find that the more volume they direct towards and exchange, the greater the portion of their profits are absorbed by exchange fees. In this regard, this is an area where the United States, "burdened" as it is by SEC regulations designed to promote exchange competition, actually has an advantage over much of the rest of the world. (This, however, begs the question of why, if European super-profits are transitory, why is NASDAQ, in particular, willing to bid so much for the London Stock Exchange?)

The latest issue of the Economist also has an article on the subject. ("What's wrong with Wall Street") . Unfortunately, this article reads like the editor just plagarized Hank Paulson's speech from last week. (See here.) In particular, the Economist writes that the U.S. should overhaul it's corporate governance approach (which is correct, but rather unlikely -- see here), that shareholder lawsuits should be curbed (also a good idea, but even more unlikely -- see here), and that the SEC and CFTC should be merged (pretty much a no-brainer, but, again, I'm not holding my breath. See here.)

With all of that said, however, my question is, is there really a crisis with U.S. capital markets? The more oppressive aspects of Section 404 of the Sarbanes-Oxley Act will soon change. The "Roach Motel" aspect to the U.S. regulatory system ("roaches check in, but they don't check out") will also soon be changed as well. (Some call this the "Hotel California" effect, as in Todd Malan's FT op-ed ["Time to change rules at Hotel California"], but I think "roach motel" is a little more descriptive, given the activities of some issuers.) And the U.S. system is otherwise very investor-friendly and competitive. Sure, the exchanges may be getting squeezed, but as I've said before, is it really the government's job to make sure U.S. stock exchanges are the most profitable in the world? Isn't it rather government's job to see that investors get the highest returns given their risk preferences, and U.S. issuers get the lowest cost of capital given the risks they offer?