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Soul-searching over U.S. competitiveness: much attention and hand-wringing have come over U.S. capital markets' perceived loss of stature. Committees are studying the issue and considering change, but the evidence of a swoon is far from conclusive.

A global economy has always seemed like a good idea, and the best part was being at the center of the universe, so to speak--in the U.S., or, depending on your point of view, in New York City, the financial capital of the world.


But something's been happening. The uniquely immense American capital markets have recently begun to lose their domination over global finance. In 2000, half of the value of global initial public offerings was raised in the U.S. Just six years later, it was down to 5 percent.

Of the world's 10 largest IPOs in 2006, only two were American companies, and only one--the second smallest--listed first on a U.S. market. Ten years ago, more than 40 percent of the capital raised in the top 10 countries was raised in the U.S. Today, that share is under 30 percent.

If New York City Mayor Michael R. Bloomberg and Sen. Charles E. Schumer (D-N.Y.) weren't already worried about melting glaciers flooding Wall Street, they're now worried about whether it matters. Concerned that "The City" was going to see its second-strongest industry (after real estate) become a historical has-been, the mayor and senator commissioned a report on weaknesses in the U.S. markets and the strategies that will help them compete with the growing global tide.

The findings were less than encouraging. Though the migration of IPOs hardly constitutes a stampede, the movement is apparently in a direction other than toward New York. With a chill that just might refreeze those glaciers, Bloomberg and Schumer wrote in the introduction to their report, "... if we do nothing, within 10 years, while we will remain a leading regional financial center, we will not longer be the financial capital of the world."

The fear of being reduced to mere regional leadership is widespread but hardly unanimous. Thomson Financial has analyzed the trend over the past 20 years and found "little evidence that foreign issuer IPOs have been shying away from the U.S. market" since the enactment of the Sarbanes-Oxley Act. The study found that foreign IPOs accounted for 16 percent of all IPOs in the U.S. last year, the highest proportion in the 20-year review. It also found that foreign IPOs represented 23 percent of IPO volume in the country last year, the highest level since 1994.


In contrast to Thomson's optimistic report, various concerned institutions, ad hoc commissions and prominent individuals have looked into the matter and produced reports shorter on positive news and longer on dread. They see American competitiveness waning as European and Asian markets wax. And, as they try to identify the causes, three words pop up often enough to sound like a bad poem: globalization, regulation, litigation.

Raising Alarms

Among the organizations raising alarms is the U.S. Chamber of Commerce. The Chamber has inaugurated a Center for Capital Markets Competitiveness (CCMC), an entity dedicated to "making U.S. capital markets the most fair, efficient, transparent and attractive in the world."

Michael Ryan, executive director and senior vice president of the CCMC, says that some foreign capital markets--most notably London and Hong Kong--are achieving what many in the U.S. have been calling for: improved infrastructure, better regulation and more enforcement.

"What we've been advocating for a long time has come to fruition," Ryan said. "That calls for us to respond and recognize the capacity of those markets, and our legal and regulatory framework needs to keep pace. You have one framework when you're the only game in town, and another when there are alternatives. We need to worry about how to respond to that. What worked in the past won't necessarily work in the future."

Ryan suggests a convergence of the world's capital market regulations as a means of helping corporations raise capital in various markets. The CCMC plans to implement the key recommendations found in reports produced by the Chamber's Commission on the Regulation of U.S. Capital Markets in the 21st Century, the Committee on Capital Markets Regulation (CCMR)--a blue-ribbon body formed last fall to examine existing regulation and recommend changes--and the Schumer-Bloomberg initiative.

The report from the Chamber's commission noted that "the competitive position of our capital markets is under strain." It identified the causes to be "increasing competitive international markets and the need to modernize our legal and regulatory frameworks."

The commission's recommendations ranged from specific to optimistic: Make the Sarbanes-Oxley Act part of the Securities Exchange Act of 1934, giving the U.S. Securities and Exchange Commission (SEC) the power to address implementation issues; increase retirement saving plans by connecting groups of 21 or more employees without retirement plans to a financial institution offering such plans; and allow audit firms to raise capital from shareholders other than partners.

On the less specific (and more optimistic) end: Modernize the federal government's regulatory approach to financial markets; convince public companies to stop issuing earnings guidance or quarterly earnings-per-share numbers (some have already done so); call on domestic and international policy-makers to consider proposals to address auditors' risk of litigation; and enhance the portability of retirement accounts through simpler, consolidated 401(k)-type programs.

The Center will also be implementing the recommendations in an interim report issued by the Committee on Capital Markets Regulation. That report identifies changes that would cut the cost of capital, while reducing excessive risk aversion among managers, auditors and directors.

The Lure of the 144a Market

Hal Scott, director of the CCMR and a professor of international financial systems at Harvard Law School, says that companies outside the U.S. are seeking investment in three main places: the public markets in London and Hong Kong and the private market in the U.S., the so-called 144a market that works outside the SEC's jurisdiction.

The 144a market is strictly for big players, companies that can navigate in that less-regulated realm and institutional investors savvy enough to know what they're dealing with.

In the 144a market, the cost of raising capital is higher because the market is smaller and secondary trading of stock is less liquid. Nonetheless, raising capital on the private market can be more cost-effective--and often just plain easier--than the effort needed to qualify for listing on a public exchange.

"You have to ask yourself," says Scott, "Why are foreign companies raising money in the United States [in the 144a private market], with its higher cost of capital?" He says, "The answer is, they don't want to be subject to Sarbanes-Oxley, and they don't want the litigation risk they would have as a public company."

At the same time, companies that go public on foreign markets are obviously finding support from investors not scared off by markets unprotected by Sarbanes-Oxley and the SEC. Those markets have apparently found a comfortable balance that satisfies investors and issuers. That balance, Scott says, is what seems to be missing in the U.S., and aggravating the imbalance is what he calls "a deficit in shareholder rights."

"If you go to the U.K., you have much less regulation and almost no litigation, but more shareholder rights," Scott says. "That's who we're competing with." Indeed, shareholders in the U.S. have fewer rights than those in the U.K. with respect to voting on takeovers, making shareholder proposals and advisory votes on such things as executive compensation.

The CCMR report recommends that the SEC move to a more risk-based regulatory process, weighing the costs and benefits of new rules. It called on the SEC to clarify the rules on litigation, shield board members who must rely on audited financial statements and adopt a more reasonable materiality standard. It also suggested that if the commission could not adopt better guidance on Sarbanes-Oxley Section 404, it should consider exempting smaller companies from its requirements.

Treasury Secretary Henry M. Paulson Jr. has also weighed in on the issue. In a speech delivered to the "Capital Markets Competitiveness Conference" at Georgetown University in March, he suggested changes in three areas: the regulatory structure, the accounting industry and the legal/corporate governance environment.

The forum in March also included such luminaries as former Federal Reserve Chairman Alan Greenspan, former SEC Chairman Arthur Levitt and investment guru Warren Buffett.

On regulation, Paulson said, "We should assess how the current system works and where it can be improved, with a particular eye toward more rigorous cost-benefit analysis of new regulation." On accounting, he said we should consider "whether our system is producing the high-quality audits and attracting the talented auditors we need, whether there is currently enough competition in the accounting profession and the desirability of moving toward more principles-based accounting standards."

On governance and the law, he said, "In my judgment, we must rise above a rules-based mindset that asks, 'Is this legal?', and adopt a more principles-based approach that asks, 'Is this right?' And we should consider whether our legal system appropriately protects investors or gives too much latitude to unscrupulous lawyers."

Yale Law School Deputy Dean Jonathan Macey wrote in an op-ed in The Wall Street Journal that "the U.S. has lost its first-mover advantage" and that there is "no longer any fear that investors will think a company desiring to go public necessarily has something to hide if it chooses to avoid the litigation burden and SEC compliance issues in the U.S."

Macey also argued that the CCMR report proves that companies are staying private "rather than face the dreaded one-two punch of the U.S. plaintiffs' bar and the SEC's regulatory juggernaut."

FEI: 'Reduce Complexity'

Financial Executives International (FEI) has called for strengthening U.S. capital markets by reducing regulatory complexity. The organization has made four key recommendations: 1) that the SEC and the Financial Accounting Standards Board (FASB) coordinate with the stakeholders in financial reports to end the proliferation of detailed rules; 2) that Congress consider meaningful class-action reform; 3) that the SEC and the Public Company Accounting Oversight Board (PCAOB) develop a framework of principles-based regulation; and 4) that stakeholders form an independent "Committee on Complexity."

Not everyone, however, sees a cause-and-effect link between regulation and competitiveness. Arthur Levitt has expressed concern about the loss of competitiveness by U.S. capital markets, but he sees the weakness not in over-regulation but in reporting that is less than ideally transparent.

In an op-ed in The Wall Street Journal, Levitt warned that special interests--corporations and their client CPA firms--prevent the FASB from writing solid, simple accounting standards. "[I]ntense interest-group lobbying has delayed action and severely compromised stock-option expensing, pension accounting rules, and now threatens lease accounting," Levitt wrote. "When FASB falls prey to these compromises, the resulting standards can end up being overly complex and confusing."

As a result, he wrote, "standards fail to provide investors with transparent, comprehensive and understandable measures of resources or performance." Those compromised standards lessen the premium placed on securities sold in the U.S.--giving companies one less reason to seek investment on U.S. markets.

Goldman, Sachs & Co. has also questioned the link between regulation and competitiveness. In a report issued in February, the firm said, "Legal and regulatory factors probably do matter, and policy reform might strengthen New York's competitiveness. Nonetheless, we do not see them as the critical drivers behind the shift in financial market intermediation, even in the aggregate. Quite simply, economic and geographic factors matter more."

In other words, London's rising success may be determined to a great extent by its time zone; Hong Kong's success may be partially explained by the fact that it's in Asia; and New York remains the financial capital of the world because that's where the money is. Regulation and litigation may cause trepidation, but at least they don't rhyme with Enron. The U.S. can certainly learn a thing or two from other successful capital markets. It just shouldn't forget what it has already learned the hard way.

GLENN ALAN CHENEY ( writes on finance, business and accounting issues and is a frequent contributor to Financial Executive.


* At first glance, the statistics seem to show a worrisome shift of capital markets activity away from the U.S. and into a few foreign exchanges.

* In recent months, various concerned institutions, ad hoc commissions and prominent individuals have made ominous announcements about U.S. competitiveness.

* Recommendations about regulatory change in the U.S. have been coming with some frequency, along with questions about the fundamental goals that should be addressed.
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Title Annotation:CAPITAL MARKETS
Author:Cheney, Glenn Alan
Publication:Financial Executive
Date:Jun 1, 2007
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