What Europe needs is a more dirigiste stock market

Well, at least that's what Georges Ugeux seems to think. In his recent op-ed in the Financial Times (Exchange battles mask Europe's silence), Ugeux suggests that the European Commission is falling down on the job by allowing U.S. stock exchanges to buy up Euronext and the London Stock Exchange instead of (subsidizing? mandating? prohibiting the alternatives?) a true pan-European exchange to compete with the U.S. Ugeux asks, since the profits of the London Stock Exchange, Euronext, and Deutsche Börse are higher than NASDAQ or the New York Stock Exchange, why is the exchange merger impetus coming from the United States instead of Europe? He also asks why U.S. stock exchanges are trading at price/earnings ratios of 50:1 while European p/e ratios are closer to 20:1. All of which leads the this conclusion:

It is extraordinary that neither the European Commission nor Ecofin, the committee of European finance ministers, have encouraged the European exchanges to get together. Is it no matter to Europe that two of its largest equity markets will be owned by US stock exchanges? Would this not affect the internal market? Does the CME-CBOT merger not threaten the European derivatives market?

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There is certainly a risk of US dominance on the regulatory front. The absence of consideration for the basic rules of international private law led to regulatory overreach beyond US borders. The Sarbanes-Oxley Act of 2002 extended its jurisdiction to non-US companies. It might happen again.

It happened before. In the 1950s, America’s interest-equalisation tax dried up the US foreign bond markets, which shifted from New York to London in the same way listings have been affected by SOX. The law changed, but the bond market never returned to New York. The European teams of the US investment banks years ago ceased promoting the US capital markets. They have used SEC Regulation S and Rule 144a to reach US institutional investors without registration with the Securities and Exchange Commission.

Will the efforts of Hank Paulson, the US Treasury secretary, convince the Congress in time to avoid a structural lack of competitiveness in the US capital markets?

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The eurozone badly needs deeper and more fungible pools of liquidity if it wants to compete effectively with the US. That is why the silence of European authorities on what is in effect a fundamental policy issue is so loudly heard. Could this be a wake-up call?

Granted, I cut out some stuff in the middle, but if you read the article you can tell I didn't cut out much of substance. Which means either the FT did a hatchet job editing Ugeux's article, or he can't string together a coherent argument to save his life. (And that's putting aside his line about how the Sarbanes-Oxley Act violates basic rules of private international law. I don't see how a law violates these "rules" when it only effects issuers deliberately participating in a jurisdiction's market.)

First, if the Americans have screwed up their regulation so badly, why is Europe at risk of being dominated by U.S. exchanges and U.S. regulators? Second, don't you think there's a reason that U.S. exchanges trade at a substantial premium to their European competitors? Rather than "financing their own takeover," doesn't it seem more likely that European exchanges are trading so cheaply because investors believe they are poorly run or have comparatively low future prospects? And, third, if the Eurozone badly needs deeper and more fungible pools of liquidity, how is a EU-subsidized exchange going to create that liquidity? Liquidity is created by investors. Exchanges are just the platforms upon which the liquidity crystalizes. Even as U.S. exchanges seek merger partners, they are also facing new competitors as electronic communications networks (ECNs) and alternative trading systems (ATS's) spring up. If anything, this has seemed to increase liquidity on the U.S. market.

Ugeux's article only makes sense (and even here I'm being kind) if you believe that the government must play a central role in promoting and guiding capital markets, rather than acting as a policeman to make sure nobody cheats. And it's precisely that kind of dirigiste thinking that has Europe playing catch-up today.

NYSE and Euronext to vote on merger today

The New York Stock Exchange and Euronext announced today that they had formally agreed to a merger. (Euronext's press release can be read here. The NYSE's website announced it as a "merger of equals" -- much like the merger of British Petroleum and Amoco and Daimler Benz and Chrysler were mergers of equals as well...)

This was supposedly a done-deal for the past several weeks, notwithstanding some recent maneuvering by various European governments to extract a few more concessions out of the deal. (See Norma Cohen's and Ian Bickerton's FT article, Dutch seek control of NYSE body. A copy of the Dutch Finance Minister Gerrit Zalm's letter to Euronext and the NYSE can be found here.)

Which brings to mind this question: is the NYSE buying itself another Airbus? The recent Dutch push isn't just an attempt to protect against American "regulatory creep". That's been a red-herring from the very beginning. What it is, rather, is an attempt for the Dutch finance ministry to remain relevant. In addition to a promise that there would be no "spill-over" of U.S. financial regulation into Europe (something that would not be possible without the consent of European governments at any rate), Zalm's letter demands:

-- Safeguards for the local operation of Euronext NV and Euronext Amsterdam NV, to be ensured (among others) by the availability of adequate resources; and

-- Safeguarding proper and effective supervision by local supervisors on the securities exchanges in the Netherlands.

So, basically, the Dutch want to make sure that the New York Stock Exchange won't consolidate the Amsterdam exchange or render the Dutch AFM (the Netherlands financial regulator) irrelevant. But this, fundamentally, is not a US-Europe issue. It's a intra-European issue. Europe right now has dozens of small stock exchanges and dozens of small financial regulators, at a time when the pressure to consolidate, converge and harmonize has just gotten a whole lot more pressing. How relevant will individual European financial regulators remain, when overarching regulatory policy is now set in Brussels?

More importantly, what happens next? Despite the SEC's honest assurances that the United States has no intention of "exporting" its regulation to Europe, European regulators are already greatly affected by what goes on in the U.S. (See, for example, this post about how much of Europe has already adopted significant provisions of the Sarbanes-Oxley Act, even as they have criticized SOX as excessive.) What would happen if the SEC were to adopt some kind of "mutual recognition" model (as the European Union regularly demands), but this model were based on some type of regulatory convergence? Would the EU insist on "going its own way," if "importing" certain U.S. provisions were to give European financial firms more direct access to the enormous U.S. investor base?

Second, what now happens in London? The London Stock Exchange continues to fight against NASDAQ's hostile onslaught. (See Norma Cohen's LSE rejects Nasdaq approach.) Will it still try to hold out, now that it is no longer the most significant stock exchange in Europe? Will UK financial regulators attempt to lower their regulatory requirements even further, to make the London market even more attractive to foreign issuers (even if this approach has recently backfired with the LSE's Alternative Investment Market)?

Third, what happens now with the United States' own Chicago-based derivatives exchanges? Last October, the Chicago Mercantile Exchange and the Chicago Board of Trade merged to form the world's largest derivatives exchange. The CME and CBOT have studiously avoided any talk of buying out one of America's smaller equities exchanges, so as to avoid falling under the jurisdiction of the SEC. (The SEC's smaller cousin, the Commody Futures Trading Commission, seems so much easier to deal with...) But now the CME Group faces NYSE Euronext, which, because it owns Liffe (the London derivatives exchange), has a foot in both worlds. Will this put pressure on the CME Group to get into the equities business? (If the CME does, will this be enough to finally push a combination of the SEC and CFTC? And what would such a beast look like?)

It all looks like it will be an interesting New Year.

SEC Chairman Cox meets with Euronext regulators

Securities and Exchange Chairman Christopher Cox met on Tuesday with the heads of the Portuguese, Dutch, Belgian and French financial regulators, along with the head of the United Kindom's Financial Services Authority's division of market regulation. The meeting was designed to demonstrate to Europe that regulatory issues regarding a proposed merger between Euronext and the New York Stock Exchange are all under control. In particular, Cox's venture to Lisbon was a signal that the SEC has no intention of imposing SEC regulations or the Sarbanes-Oxley Act on European stock exchanges.

The make-up of the meeting was very interesting, and indicative of the shape of this merger. Euronext is a pan-European stock exchange, a combination of the former Paris, Brussels, Amsterdam and Lisbon stock exchanges, plus the London derivatives market LIFFE. The New York Stock Exchange is the world's largest stock exchange, by several times. Within Europe, Euronext is a smaller competitor to the London Stock Exchange (which rank 5th and 4th in the list of the world's largest stock exchanges, following NASDAQ, Tokyo and New York in the 3, 2 and 1 spot.) Euronext formed precisely in order to compete with London and other large stock exchanges, both in Europe and the rest of the world. Yet these mergers have yet to give it the critical size it feels it needs to be competitive.

Consequently, the rest of this saga reads like a Jane Austin novel.

Euronext currently has two suitors — the NYSE and the Deutsche Börse in Frankfurt (currently tied in the number 6 spot with Toronto). The NYSE originally had its eyes on London, but NASDAQ (that low-class rogue) swept in and bought a controlling share of the LSE by borrowing to the hilt. However, the LSE wants to remain independent and unmarried, particularly where the likes of an American are involved. Miss Euronext, by contrast, has been pursued very persistently by Mr. Deutsche Börse, to the point where his offer, on paper at least, appears the better — €600 million better, in fact.

Nonetheless, Miss Euronext is taken by Mr. New York. His offer is cheaper, but he's huge (umm... maybe I should rephrase that.) His parents, the SEC, have a nasty reputation, but they live far far away. And Mr. New York is just so nice. He's promised to let his lovely wife have the European villa to redecorate in any way she sees fit. Mr. Deutsche Börse, by contrast, is well-known for his Teutonic domineering attitude, and his parents live way too close for comfort. In fact, Miss Euronext already has five parents (she comes from an "alternative lifestyle" family — but she's European, so what do you expect) and all she needs are the Germans to be added into the Porto-French-Belgi-Dutch-Brit mix. I mean, please! Aren't there enough inbred impoverished European aristocratic families out there already? As inlaws, the SEC, by contrast, could be interesting. Miss Euronext knows that her own parents hate them (one of the reasons why her French parent, the Autorité des Marchés Financiers, has been encouraging Mr. Deutsche Börse). But this fact may well play into her hands, since it just means that much fewer tense family get-togethers she must attend.

Mr. New York, on the other hand, sees Miss Euronext as the perfect way to enter upper European society. He's rich, but his overbearing parents (and his positively God-awful half-uncle, Eliot Spitzer) have been driving business to Europe. With Miss Euronext, he can have a foot in both worlds — his puritanical, but extremely profitable home in New York, but also a relaxing, almost libertine estate in Europe.

The fly in this ointment are the British. Everyone knows that the London Stock Exchange has been the FSA's favorite daughter, particularly since LIFFE went off and hooked up with those Continental types. Now, a Euronext-NYSE merger poses a direct threat to the LSE, and may even give those damned Frenchies an opportunity to lord it over their British betters. Even worse, it might just drive the LSE into the waiting, grubby arms of that cowboy, NASDAQ. Intolerable!

But, at this point, there isn't much they can do about it. The British spread innuendo at every turn ("did you hear that those Yanks intend to force Euronext into a Sarbanes-Oxley corset?") And they certainly won't be a party to any of this dowry discussion (which is why the UK FSA sent a relatively junior director to Lisbon, while everyone else, including the SEC, sent their chairmen). But, still, at the moment, they grumble and pray that those damned Americans make a faux pas — maybe drink directly out of the punch bowl like a horse. One can only hope...

A Euronext-NYSE merger will prove interesting. It will create enormous competitive pressures on both NASDAQ and the LSE, while also creating for the NYSE a two-tiered market — a high-regulation market in New York, and a comparatively low-regulation market in Europe. This way, if it proves that US regulation is excessive, money is still to be made on the Continent. If, however, investors place a premium on a highly regulated market, the NYSE makes money on that, too. On the other hand, it will prove extremely expensive for the NYSE, and Euronext's Continental regulators, while weak, are not exactly as "hands off" as their UK counterparts. NYSE faces the daunting task of turning Euronext into a truly global brand, while London is already there and has been for quite some time.

That said, it will be interesting to see what happens next. Pressure to further integrate Euronext and the NYSE will come, from both investors and broker-dealers. How will the SEC respond to this brave new world?