The markets have gone global, and U.S. regulators ought to catch up if they want keep American exchanges competitive, allowing investors, particularly institutional, greater access, said participants during a roundtable discussion hosted by the Securities and Exchange Commission in Washington last week.
"Regulation needs to find its way through and get ahead of this game, rather than follow it," said Meyer "Sandy" Frucher, chairman and chief executive of the Philadelphia Stock Exchange.
Addressing the trend of cross-border trading is inevitable, said SEC Chairman Christopher Cox. The question is how to best execute it.
Later this year, the SEC expects to introduce new rules reflecting such "mutual understanding" among regulators and exchanges at home and abroad, potentially making trading foreign securities simpler.
Global markets, Cox said, are "opportunities, not dangers."
In 2000, the amount that U.S. investors funneled into foreign securities was $1.6 trillion, and that swelled to $4.6 trillion last year, said Ethiopis Tafara, director of international affairs at the SEC. The majority of that sum comes from mutual funds, followed by American depository receipts and private placement agreements.
Twenty percent of the London Stock Exchange is held by U.S. investors. Again, the biggest investors are mutual funds, said Jonathan Howell, executive director and director of finance at the LSE.
Fund companies like Vanguard of Malvern, Pa., and American Funds investment advisor Capital Research and Management Company in Los Angeles already have direct access to foreign exchanges. In the case of Capital, which has been investing overseas for more than three decades, that means desks at exchanges in London, Tokyo and elsewhere. At Vanguard, which has been actively investing in non-U.S. exchanges for nearly seven years, these trades are sometimes executed electronically straight from desktops in Malvern, but at other times with traders abroad.
Still, not all investors, retail or otherwise, have the capacity to open desks abroad or gain access here. With 84% of the initial public offerings in 2006 being made on non-U.S. exchanges, that means millions of U.S. investors could be missing out on investment opportunities.
What's worse, American reporting regulations, including Sarbanes-Oxley, have been deemed by some companies to be too cumbersome, spurring them to de-list from domestic exchanges, said Catherine R. Kinney, president and co-chief operating officer of NYSE/Euronext. Since the start of April, 20 companies have announced plans to pull themselves off of the NYSE, she said.
Even for sophisticated institutional investors, investing abroad can be costly, because U.S. brokers need "chaperones," or brokers locally licensed to execute trades.
Allowing brokers to deal directly, chaperone-free might shave a few basis points off the price of a fund share. Direct access might also mean more immediate research and information about foreign stocks, and allow smaller fund companies to better compete, said Stephen E. Bepler, senior vice president and director at Capital.
More competition is always welcome, said Vanguard Principal Duane Kelly. Not only might trading costs go down, but exchanges that wished to attract more international investors might tighten their oversight of member companies and electronic access, while companies themselves may make efforts to be more transparent, Kelly said.
But others worry that allowing American investors and foreign brokers direct access to one another could lead to an erosion of investor protection. Harold Evensky, a certified financial planner and principal with Evensky & Katz in Coral Gables, Fla., warned of large companies registering funds overseas, where the requirements may be more lax, and then selling them back to U.S. investors.
The SEC would only ink mutual understanding agreements with exchanges that had "substantially similar" protection and oversights in place, SEC officials said. "This whole process at the very least provides certainty, structure and a more user-friendly place where risk can be better understood and measured," Howell said.
As such, U.S. investors would be able to pursue the same type of legal recourse here as if they had bought an American security on a U.S. exchange.
David Grayson, managing director at Auerbach Grayson, a brokerage in New York, likened the screening system to that used by the federal government to determine from which countries visitors need visas. Another suggestion offered was for only certain qualified investors, for example institutional investors, to be allowed to trade in a cross-border system.
But Citigroup Investment Banking General Counsel Edward F. Greene disagreed that such a division would be effective. There is no clear line between institutional and retail, sophisticated or not, he argued.
Former SEC Chairman Harvey Pitt, now the chief executive at Washington-based Kalorama Partners, said that "substantially similar" must be just that: similar, not identical.
David Ruder, a law professor at Northwestern University, in Chicago agreed. Ruder was involved in an attempt to codify accounting standards worldwide at the beginning of the decade. "I don't think convergence is the best way to go," he said. The SEC should compare and contrast other exchanges' rules and methods, make investors aware of them, and not impose their own, he said.
At the same time, it is important that any organization with which the SEC reaches an agreement has not only the rules in place, but the resources to enforce them, Grayson said.
Back home, Evensky said he wasn't sure that U.S. investors who bring cases against foreign exchanges may have standing. "We will be debating standards we don't know," he said. "We will be standing in court trying to say that [an issuer] didn't meet the suitability standards of the United Kingdom or Japan," he said. Then there are the legal fees to consider.
Bepler dismissed concerns that open foreign markets mean chaotic ones. "There was absolutely no disclosure when I started doing this, " he said.
Regulators can look to the standards of sophisticated investment companies like his to determine which exchanges are comparable and which are crapshoots, he said. The key is to begin the process of opening now, he and other panelists said, because, sooner or later, investors eager enough to go overseas will find a way to do so whether SEC sanctions it or not.
"The capital markets are accessing U.S. investors already, just in a way that doesn't flow through our economy," Bepler said.
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