Wednesday, January 10, 2007

Global stock exchanges and the future of the SEC

The press reported today that the New York Stock Exchange has agreed to buy a significant portion of India's National Stock Exchange (see NYSE buys into Indian bourse, NYSE, Others Buy 20 Pct Stake in India's NSE Bourse). This, of course, follows on the planned merger of the NYSE with Euronext, and an agreement in the works for a link-up between the NYSE and the Tokyo Stock Exchange (Tokyo Exchange Is Close to NYSE Agreement, Japan Minister Says).

None of this is surprising, given the relatively recent demutualization of U.S. stock exchanges and their foreign brethren. Whereas once stock exchanges were owned by "members" who alone had the priviledge of trading on the exchange floor, demutualized stock exchanges are now public companies existing in not only a more globalized environment, but (more importantly) a more competitive environment, too. Not only do they face competition from foreign exchanges (i.e., all the hub-bub between New York and London), but also from upstart ECNs and ATS's -- new computer networks that match buyers and sellers away from the stock exchanges, and often faster and and lower prices.

But that raises an interesting issue, from a regulation perspective. When, in the past, stock exchanges had a certain public utility-like quality about them, there could be expected a certain degree of symbiosis between the exchanges and the regulators. The exchanges had a priviledged position that limited the competition, and, in return, the exchanges could be counted on to police their members in ways that regulators, with their limited resources, simply could not. Now, however, exchanges are losing their guild-like qualities. In the United States, this has led the NYSE and NASDAQ to formally shed their self-regulatory functions into a combined regulator. This will allow the exchanges to focus on business, rather than regulation, and eliminates some conflicts of interest. At the same time, it also heralds the end of this cosy regulatory relationship between the SEC and the exchanges.

But does this also herald a change in the SEC's mindset towards the exchanges? In the past, the European Commission, in particular, has accused the SEC of working as guardian of U.S. stock exchanges against foreign competition. This may or may not have been true, but if it was true, it might have been justified on the basis that the SEC relied on the exchanges so heavily to police the U.S. market. (All those fancy computers that notice strange trading patterns and lead to insider trading investigations belong to the exchanges, not the SEC. The SEC's own market monitoring room is basically two guys, a few Bloomberg terminals, and a hotline to the exchange floors.) Now, however, that reliance must change.

Will that change the SEC's own approach to foreign stock exchanges and foreign market participation? I think it will, one way or the other. And if not this year, than a few years down the road. U.S. stock exchanges and its financial industry might not be the world's most nimble, but it is by far the largest. That means it can bring to bear the biggest guns, and win through attrition, if nothing else. The SEC can also be a surprisingly nimble regulator, when it has to be (as when Congress passed the Sarbanes-Oxley Act). Finally, despite the recent gains by London, Hong Kong and other markets, the U.S. market is second-to-none for "quality" listings. For this reason alone many foreign government pension funds place a surprisingly large amount of their investments in the United States (which, incidentally, is what this letter to SEC Chairman Christopher Cox is all about.) Add this altogether, and the U.S. financial services industry is one of America's largest export industries, and the SEC won't kill the goose that lays the golden eggs. It will open up the U.S. market to foreign competition, if only as a way to push reciprocity abroad.

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