Transnational capital markets challenge US, European regulators

As global financial markets become integrated and cross-border capital flows become easier, securities regulators are struggling to maintain investor protection while encouraging international foreign direct investment.

One example, experts say, is the creation of transnational exchanges. The New York Stock Exchange (NYSE) group plans to join with Euronext NV, a pan-European, Paris-based stock exchange with subsidiaries in Belgium, France, the Netherlands, Portugal and the United Kingdom, to create the first global securities exchange with a combined market capitalisation of around $27 billion.

In a press release, Christopher Cox, chairman of the Securities and Exchange Commission (SEC), which regulates US securities business, last month welcomed the deal as "a notable step in the continuing globalisation of the world's capital markets".

Such integration, he said, can be achieved without giving up national regulatory controls. When multinational exchange Euronext was created in 2000, the regulating agencies of several European countries created a "college" to jointly oversee the exchange's activities.

On January 25 the college signed a non-binding memorandum of agreement with the SEC on "consultation, co-operation and the exchange of information related to market oversight". The practical details of this co-operation, however, have yet to be worked out.

To many financial experts the NYSE-Euronext case illustrates both the opportunities and the problems of international capital markets integration.

In a January 24 address to the 34th Annual Securities Regulation Institute in Coronado, California, Mr Cox said such integration drives down transaction costs, directs capital "to its highest and best uses" and accelerates economic growth "for everyone on the planet".

According to Daniel S. Hamilton, director of the Centre for Transatlantic Relations at Johns Hopkins University, the relatively free flow of investment capital between the US and Europe already plays a predominant role in the two countries' economic relations.

Over the first half of this decade, Europe accounted for more than half the total US direct investment outflows and three-quarters of inflows. In 2005, US foreign-affiliate income from Europe reached $106 billion.

Mr Hamilton estimates that full integration of trans-Atlantic financial markets could boost trading volume significantly. Among the obstacles, experts say, are regulatory requirements still established and enforced mostly by national boards and commissions.

Many international investors, for example, find dealing with different corporate governance and reporting standards in different countries expensive and cumbersome.

Mr Cox said that investors look closely at regulatory environments before committing their assets. "After all, if investors find the regulations of a particular jurisdiction to be either so onerous as to diminish returns, or so weak as to fail to protect property rights, they will take their money somewhere else," he said.

One suggested solution is gradual "synchronisation" of financial regulations, possibly leading to the creation of a single, international securities authority.

This is apparently the direction preferred by German Chancellor Angela Merkel, a strong proponent of trans-Atlantic economic integration. Speaking on January 24 at the World Economic Forum in Davos, Switzerland, she called for creating uniform regulatory "structures similar to those of an internal market".

In 2005, the European Union adopted the International Financial Reporting Standards (IFRS), which are compatible with the Generally Accepted Accounting Practices used in the United States. The so-called Norwalk Agreement of 2002 commits two standard-setting bodies, the US Financial Accounting Board and the International Accounting Standards Board, to gradually remove the differences between their respective regulations.

But some experts doubt full synchronisation is possible, or even desirable. They say it is more important that standards be clear and fairly applied.

Mr Cox pointed out that regulatory variations "reflect differences in culture, legal systems and market structure" and that some people believe full integration of capital markets to be impossible.

He said that national regulators will remain important, although they will have to work with like-minded counterparts to find new ways of performing their duties.

Although they differ in specific recommendations, experts on both sides of the Atlantic predict that regulatory barriers to cross-border investment will gradually come down and that regulatory co-operation will be an important part of the process.

They also expect that financial integration will soon extend to areas beyond the Atlantic region. Mr Cox predicted that in a short time "the structure of the planet's exchanges and trading platforms will be completely rebuilt".

This perspective, he said, brings both opportunities and new threats - of fraud, unethical trading, market manipulation - and it is the job of national regulators to protect investors while promoting market integrity.

The full text (www.sec.gov/news/speech/2007/spch012407cc.htm) of Mr Cox's speech is available on the SEC Website, as is the memorandum of understanding (www.sec.gov/news/press/2007/2007-8.htm) between the SEC and the College of Euronext.