Speech by SEC Staff:
A Global View: Examining Cross-Border Financial Services
Erik R. Sirri
Director, Division of Market Regulation
U.S. Securities and Exchange Commission
Whistler, BC, Canada
August 18, 2007
Thank you. I am delighted to have this opportunity to join you today. Before I begin my remarks, let me remind you that the views I express are my own and not necessarily the views of the U.S. Securities and Exchange Commission, the individual Commissioners, or my colleagues on the Commission staff.1
The topic of this year's conference — "Growing" Global — is of great interest to me. I have spent much of my current tenure at the Commission thinking about the continuing trend of cross-border financial services, and its impact on the markets, on investors, and on regulation. Indeed, when thinking about financial services today, we all must have a "global view." These developments present both new challenges and opportunities for the U.S. and Canadian securities markets.
Current Trends in Capital Markets
As the markets have evolved, innovations in technology have eliminated many physical barriers to market access. As a result, financial participants worldwide have pursued alliances and mergers in order to more effectively participate in global business. Today, few would dispute that the capital markets are becoming increasingly global.
U.S. investors invest heavily in foreign securities. Between 2001 and 2005, U.S. investor holdings of non-U.S. securities nearly doubled, from $2.3 trillion to $4.6 trillion. U.S. investor holdings of Canadian securities increased from $205 billion in 2001 to $419 billion by 2005.
Foreign investors also have shown appetite for U.S. securities. As of June 2006, foreign holdings of U.S. securities measured $7.8 trillion, up from $4.3 trillion as of June 2002. Canadian investor holdings of U.S. securities increased $208 billion in 2001 to $381 billion in 2006.
Global business is not limited to issuers. We have seen this trend play out for broker-dealers and exchanges. For example, in February of this year, the NYSE Group and Euronext merged their businesses under a U.S. holding company — NYSE Euronext — to create the first trans-Atlantic equities market. Shares of NYSE Euronext are now listed on the NYSE trading in U.S. dollars and on Euronext Paris trading in Euros. The U.S. headquarters of NYSE Euronext is in New York, and its international headquarters are in Paris and Amsterdam. The combined company comprises seven exchanges in six countries. Each of NYSE Euronext's markets, however, continues to be regulated in accordance with local requirements. Its European exchanges are overseen by the relevant European regulator, and the Commission continues to regulate NYSE and Arca, the U.S. exchanges.
In addition, Nasdaq has acquired a substantial minority interest in the London Stock Exchange and recently announced an agreement to buy the Nordic stock-exchange operator, OMX. Further, Eurex — the European derivatives exchange — has agreed to acquire the U.S.-based International Securities Exchange.
I have no doubt that the trend of cross-border alliances and mergers will continue, and that financial participants worldwide will continue to seek opportunities beyond their borders.
Factors that Precipitated Globalization
I believe a number of factors precipitated the recent trend of increased cross-border financial transactions. In recent years, most U.S. exchanges have demutualized, usually by creating parent holding companies, and a number of those parent holding companies are now public companies. As a result, many U.S. exchanges have access to new sources of capital and the means to consider mergers that would expand their businesses globally.
In addition, the demand for global exchanges has grown as more and more investors, both large and small, have begun to look beyond their own countries' borders for investment opportunities. Today, for example, nearly two-thirds of all U.S. equity investors hold foreign equities through ownership of individual stock in foreign companies or ownership of international or global mutual funds.
And finally, developments in technology and reduced communication costs have driven the markets to become largely electronic — making geographic boundaries much less relevant. This, of course, has made it easier and less expensive for investors to conduct cross-border securities activity.
Regulation in the Increasingly Global Market Place
Globalization of the capital markets will continue to present challenges and opportunities for regulators in the U.S. and abroad. The Commission has had occasion to consider many of these complex issues, recently adopting changes to the rules that govern when a foreign private issuer may terminate the registration of a class of equity securities, and when it may cease reporting obligations regarding a class of equity or debt securities. Also, the Commission recently published for public comment a proposal to eliminate the current requirement that foreign private issuers filing their financial statements using international financial reporting standards also file a reconciliation of those statements to U.S. GAAP.
Some regulatory issues faced by the Commission have been relatively modest, such as the proposed transactions involving U.S. exchanges that preserve their separate operation under a holding company structure. With NYSE Euronext, for example, the NYSE Group and Euronext markets continue to operate as separate liquidity pools in their respective jurisdictions. The creation of a single holding company for these markets, in and of itself, does not raise substantial U.S. regulatory issues. In essence, the Commission reviews the proposed governance and ownership structure of the new holding company to determine whether the Commission continues to have adequate tools to effectively oversee a U.S. exchange that is controlled by an entity not fully subject to its jurisdiction. Over time, however, I expect the global exchange groups will seek to further integrate their markets, whether through a consolidation of technology platforms, the provision of trading screens in each other's jurisdictions, or linking their liquidity pools. Depending on the scope of the integration, a wide range of core U.S. regulatory issues could be implicated, including those surrounding exchange registration, broker-dealer registration, and listed company registration.
Impact on Capital Markets and Investors
Global financial services initiatives may very well promote competition and the efficiency of cross-border capital flows, and thus have the potential to benefit the markets and investors in the U.S. and abroad. A core mission of the Commission is to protect U.S. investors, so as we approach these difficult global regulatory issues, we must be vigilant in our efforts to ensure adequate disclosure and regulatory oversight for U.S. investors. At the same time, another core mission of the Commission is to foster capital formation, and we are mindful of the fact that today capital increasingly is being raised internationally, with securities trading on various exchanges.
Over the years, a number of foreign markets and jurisdictions have questioned whether registration of foreign exchanges and broker-dealers in the U.S. is essential to investor protection if the foreign jurisdiction affords regulation comparable to that in the U.S. Some countries have complained that the U.S. "investor protection" mandate is used to protect the interests of domestic institutions and firms.
The Commission's response has generally been that our statutory mandate requires a high level of investor protection, while at the same time fostering capital formation, and that foreign exchanges and broker-dealers are welcome to do business here if — like their U.S. counterparts — they register, or for broker-dealers, if they comply with Rule 15a-6.
We recognize, however, that we can do more to reduce the costs and frictions of trading foreign securities in the U.S. without jeopardizing the protection of U.S. investors.
Opportunities and Challenges Ahead
The Commission has begun exploring possible approaches to facilitate global market access — a cooperative approach to mutual recognition. In June, the Commission hosted a Roundtable on Mutual Recognition, where distinguished representatives of U.S. and foreign exchanges, global and regional broker-dealers, retail and institutional investors, and others shared their views on the possible approaches to facilitate our global market place.
We are grateful for the sharing of ideas from the Roundtable as we press forward. Based on the input we received at the June roundtable, we are developing a mutual recognition proposal that would allow broker-dealers and exchanges from "recognized" jurisdictions to conduct limited operations in the U.S. without being subject to U.S. regulation.
Under the current U.S. regime, foreign broker-dealers that induce or attempt to induce trades by investors in the U.S. generally must register with the Commission and at least one SRO. Similarly, a foreign exchange that conducts business in the U.S. — by placing its trading screens directly with U.S. broker-dealers — must register the exchange and the securities trading on the exchange with the Commission. The Commission has, however, provided exemptions to foreign broker-dealers that engage in a limited U.S. business, such as effecting transactions with U.S. institutional investors with the participation of a U.S.-registered broker or dealer. In addition, within the current regulatory framework, a number of U.S.-registered broker-dealers today provide electronic access to foreign exchanges for their U.S. clients.
One possible approach involves use of the Commission's broad general exemptive authority. In 1996, Congress provided the SEC with greater flexibility to regulate the marketplace by giving the SEC broad authority to exempt any person from any of the provisions of the Exchange Act and impose appropriate conditions on their operation.2 This exemptive authority, combined with the ability to facilitate a national market system, provides the SEC with the tools it needs to adopt a regulatory framework that addresses the global realities without compromising its dual mandate of investor protection while promoting competition among exchanges.
Although the details of a viable mutual recognition approach are still developing, one possible approach could permit foreign exchanges and broker-dealers to provide services and access to U.S. investors, subject to certain conditions, under an abbreviated registration system. This approach would require that the Commission make certain findings, and would depend on these entities being supervised in a foreign jurisdiction that provides substantially comparable oversight to that in the U.S.
A mutual recognition regime would consider — for example, under what circumstances foreign broker-dealers that are subject to an applicable foreign jurisdiction's regulatory standards could be permitted to have increased access to U.S. investors without need for intermediation by a U.S.-registered broker-dealer. Some key issues in developing this approach include the types of investors and securities, the "foreignness" of a foreign broker-dealer's business; and the standards for recognizing other jurisdictions. Mutual recognition would also consider under what circumstances foreign exchanges could be permitted to place trading screens with U.S. brokers in the U.S. without full registration.
While this approach could reduce frictions associated with cross-border access, it would not address the significantly greater custodial and settlement costs that are incurred today when trading in foreign markets.
To satisfy the Commission's mission of investor protection and fostering capital formation, these exemptions from registration would depend on whether the foreign exchange and the foreign broker-dealer are subject to comprehensive and comparable regulation in their home jurisdiction. To make this determination, the Commission would need to engage in detailed conversations with the regulator(s) in the foreign jurisdiction to explore the regulatory regime, considering whether it adequately addresses such things as: investor protection, fair markets, fraud, manipulation, insider trading, registration qualifications, trading surveillance, sales practice standards, financial responsibility standards, and dispute resolution.
Other requirements may also be appropriate. For example, a path permitting mutual recognition may be limited — at least initially — to trading in foreign securities, so as to address concerns about the impact of this approach on U.S. market activity. Similarly, exemptions could be limited to trading with market professionals and certain large sophisticated investors, who could be expected to more fully appreciate the risks of trading directly with foreign markets and intermediaries.
Finally, this approach could require that the home jurisdiction of the foreign exchange and the foreign broker-dealer provide reciprocal treatment to U.S. exchanges and broker-dealers seeking to conduct business in that country.
At the direction of Chairman Cox, and drawing upon the valuable input received at the Roundtable on Mutual Recognition, my staff is developing a proposal regarding mutual recognition for Commission consideration. I expect the staff to have completed its initial work by the fall. In essence, the goal is to develop a regulatory approach that strikes a balance between securing the benefits of greater cross-border access to investment opportunities, while vigorously upholding the Commission's mandate to protect investors, foster capital formation, and maintain fair, orderly, and efficient markets.
The increased demand for worldwide financial services challenges us to continue to view our markets, not in isolation, but rather as a part of the larger global marketplace. Globalization has the potential to provide great benefits for U.S. markets and investors. At the same time, the Commission must make sure that it has identified and appropriately addressed the risks of liberalized access by foreign markets and market participants to U.S. investors, so that the U.S. regulatory regime is not undermined, and our statutory responsibilities relating to U.S. investors and the U.S. markets are fulfilled.
Through greater communication and cooperation between the Commission and our colleagues in other nations, as well as dialogue with industry participants, a degree of harmonization may result that produces stronger protections for all investors. At the same time, this approach offers the promise of reducing the costs of trading around the globe.
Thank you for the opportunity to join you in beautiful Whistler, Canada, for your gracious hospitality, and for the opportunity to share with you some of my thoughts on our ever-increasingly global financial market.