Speech by SEC Commissioner:
Remarks Before the Securities Industry and Financial Markets Association Annual Meeting
Commissioner Annette L. Nazareth
U.S. Securities and Exchange Commission
Boca Raton, Florida
November 9, 2007
Good morning. I am delighted to be here in beautiful Boca Raton for your annual meeting. In fact, this is such a lovely setting that I will attempt to avoid all references to the recent unpleasant market difficulties and focus my remarks today on more upbeat business opportunities. Before I begin my remarks, let me remind you that the views I express are my personal views and not those of the Securities and Exchange Commission or other individual members of the Commission or its staff.1
Over my nine years at the Commission, I have always appreciated the insights and collaboration of SIFMA's members on the issues facing the securities industry. You have shared generously your knowledge of the markets and the impact of regulation on your businesses. This interaction has been essential, particularly as your businesses have developed and evolved over time. Certainly one of the biggest changes in your operations has been the expansion of your efforts offshore. Over the years, many of your members have built operations across the globe and have achieved a significant presence in foreign locales. SIFMA itself recognized this internationalization of its members' operations by opening offices in London and Hong Kong, to help promote the growth and development of capital markets around the world and to facilitate the integration of SIFMA members into the global financial system.
Today I would like to talk about some of the regulatory challenges you face as your businesses have become more international, and what I hope will be the Commission's response to your evolving needs and the needs of the marketplace as a whole. Given the exponential growth in international activity, the time for action is now. Action is particularly pressing given our heightened attention to promoting highly efficient and competitive U.S. markets.
II. Globalization and the Need for Foreign Access
Cross border activity is at an all time high. In 2006, companies in the S&P 500 derived approximately 44% of their 2006 revenues from abroad. This compared to only 32% in 2001. And there has been staggering growth in U.S. investment in foreign securities over the past 25 years. Between 1980 and 2005, U.S. gross trading activity (purchases and sales) in foreign securities grew from $53 billion to $7.5 trillion.2 This dramatic expansion was fueled by several factors, including advances in communications and technology, the increased prominence of foreign companies, and the desire to diversify investment portfolios. Foreign trading activity in U.S. securities likewise has exploded during this period, growing from $198 billion in 1980 to $33 trillion in 2005.3
Virtually all major U.S. financial services firms have foreign affiliates. Many foreign firms have U.S. affiliates. For the first time we are seeing some U.S. firms earn more of their revenues from foreign activity than from their U.S. operations. On the exchange side we have seen tremendous international consolidation. It seems as though literally every week the Wall Street Journal has an announcement of another completed or proposed market consolidation — NYSE with Euronext, Nasdaq and Borse Dubai with OMX, Eurex Frankfurt with ISE, to name a few.
Despite all of this cross border activity, regulatory impediments to cross border trading remain. These rules are historical remnants of a time when trading occurred almost exclusively within a domestic market and generally occurred in a single physical location — a trading floor. Thus virtually all securities regulation has a national, and not an international, focus. Finding ways to preserve the national standards that have served our markets well, while accommodating the business and economic opportunities of cross border trading, has historically been a challenge for regulators.
But we must adapt. The telecommunications revolution has created a world in which borders have almost no relevance. After all, computers know nothing of borders — and money flows without regard to geography. In a fully electronic trading world, one can appreciate the difficulty of maintaining high national standards in a borderless trading environment.
Our securities regulatory regime has constrained, to some degree, the ability of our investors to access foreign markets and foreign securities seamlessly and cost effectively. For example, foreign markets currently are unable to directly access customers in the U.S. But certainly greater familiarly with foreign markets and marketing efforts would spur even greater cross border activity.
To cater to the demands of their customers for foreign securities, some large investment firms have resorted to rather inefficient "work-arounds" to comply with restrictions under the current regime. Inherently more costly and cumbersome, many of these restrictions have outlived their usefulness. Some "work-arounds" involve "pass through" access by U.S. broker-dealers to their foreign affiliates. Clearly, trading would be more efficient and cost effective if some of the current requirements were relaxed.
This is a particularly opportune time to address this issue. The growing international consensus among securities regulators of what constitutes a highly developed, well-functioning marketplace has strengthened the regulatory and enforcement programs in several developed markets across the globe. Disclosure standards have been raised in many foreign jurisdictions. And we have witnessed significant progress toward the adoption of high quality global accounting standards. We now have greater comfort than ever before that certain regulatory regimes may be "comparable" to our own. As a result, the time has come to assess whether exchanges in these "comparable" jurisdictions should be permitted to offer certain products to investors in the U.S. without being subject to full U.S. registration.
III. Mutual Recognition Approach for Exchanges
Currently, securities exchanges — including foreign exchanges who wish to place their screens in the U.S. — are required to register with the SEC. These foreign exchanges already are subject to regulation in their home jurisdiction. So, the question is whether we should grant a foreign exchange some sort of exemption from U.S. exchange registration, subject to certain conditions, if the foreign exchange is subject to "comparable" regulatory oversight. In return, we could expect the foreign jurisdiction to afford comparable treatment to U.S. markets, that is, allow U.S. markets to operate in the foreign jurisdiction on comparable terms. This "mutual recognition" would represent a very positive step forward and would present significant opportunities for U.S. investors and firms.
Procedure, Principles and Standards
To facilitate mutual recognition, I believe that the Commission should either adopt a procedural rule or issue a policy statement that clearly lays out the terms under which a "comparability" analysis of the foreign market would be conducted on a reasonably expedited basis. Under this framework, a foreign exchange that demonstrates that it achieves certain regulatory principles and standards would be deemed "comparable" and would receive an exemption from U.S. exchange registration. By clearly defining at the outset what constitutes "comparability" the Commission would be articulating the principles and standards that it believes are essential for a well-functioning market.
What kind of comparability assessment should the Commission conduct? What would be the elements on which comparability would be judged? I certainly believe this review should not establish prescriptive requirements. Rather, it should be based on the key principles on which our domestic markets operate. It should assess how the foreign jurisdiction and the foreign market achieve those regulatory principles and standards. I would envision a dynamic, two-way dialogue with our foreign counterparts. We would be prepared to evidence how our U.S. regulatory system also achieves the goals set forth in our high level principles. And we would look forward to hearing how our foreign counterparts do so as well. I would not expect the foreign jurisdiction or the foreign exchange to have exactly the same rules as the U.S. Clearly, there are many ways of achieving these key regulatory principles and standards.
So what would these regulatory principles and standards be? None should shock you. I would anticipate broad acknowledgment among securities regulators in the most developed markets that our requirements are sound. Some examples would include: (1) prohibitions against fraud and manipulation, (2) transparent, fair and efficient pricing, (3) fair treatment of customers and (4) fair access to all market participants. In addition, investors would have access to material information — including periodic disclosure documents and audited financial statements — so that they could make informed investment decisions.
Some may ask why it is important to focus on principles and standards, and why it isn't sufficient to focus solely on the results a foreign regulatory regime has achieved. I believe the principles and standards that guide our markets must be articulated clearly and substantively. To the full extent possible, we should be clear and transparent as to what we expect and what our assessment process will entail. We should not create unrealistic expectations nor should we compromise the integrity of our markets through this process. The U.S. securities laws have principles and standards based on a rock solid platform of investor protection and fair and efficient markets, which has served our investors, our markets and our economy well. We must assure that this platform remains strong. Simply looking at results would not, for example, be adequate. Results are important but they can be driven by good fortune rather than concerted effort, and they do not tell the whole story. They do not tell us how the foreign regime will handle shocks to the system. They also do not provide sufficient confidence that the foreign regime has rules or processes to protect investors or to assure a well-functioning capital market, if circumstances change.
We will also have to be sensitive to the fact that competition must remain fair. In permitting foreign markets to offer products directly in the U.S. under the rules applicable in their foreign jurisdictions, regulatory arbitrage will inevitably result. Some regulatory disparity is inevitable. But we will need to be sensitive to the fact that we have set high regulatory and compliance standards for U.S. regulated entities and foreign competitors should not have a competitive advantage due to application of disparate standards. We must avoid any potential race to the bottom as U.S. firms seek to compete with others who are subject to different rules. This is a terribly important issue that we will have to get right. If we get it wrong, we may inadvertently put pressure on our own firms to move their operations offshore in an effort to evade U.S. law. The impact on the U.S. markets and the U.S. economy potentially could be devastating.
Enforcement, Inspections and Examinations
Rules are meaningless if they are ignored. Thus, a foreign regime's enforcement program is critical to our review of whether an exchange should be deemed "comparable." The scope of the foreign regulator's inspection or examination processes and resources also must be considered. In addition, since the SEC reviews registered company periodic reports, it is consistent that the foreign regime have this type of review of issuer reports as well. These types of reviews are not unique to the U.S. Canada has a very active issuer review program. And in the United Kingdom, the Financial Reporting Council reviews issuer financials.
Regulatory cooperation also is critically important. Of course, securities fraud knows no boundaries. If fraud were conducted, in whole or in part, using a foreign exchange's trading systems, the U.S. would need to obtain the relevant books and records and witness statements, in order to prove our case. Other issues could include restrictions on information flow and insider trading and barriers in foreign law. Many of these issues could be resolved with a foreign exchange by execution of a Memorandum of Understanding. We should also facilitate ongoing consultations and cooperation with foreign regulators to share regulatory issues, inspections, and risk assessments.
Review of Comparability
Finally, I believe that our review should not end once we determine that a particular foreign regime or a particular foreign exchange has "comparable" regulation. There should be a process for reviewing "comparability" at regular intervals, as the relevant facts and circumstances may change over time.
If a foreign exchange is found to be comparable, we could grant an exemption from full exchange registration. But, given the importance of this exercise and our desire to make progress responsibly in order to assess the results, certain conditions might be appropriate. For example, we might provide that:
- the foreign exchange only provides access to foreign securities on the foreign exchange.
- the foreign exchange only be permitted to provide access to equity securities of foreign issuers that have been public for a certain number of years and that have a global public float above a certain threshold amount.
- the foreign exchange has adequate procedures in place to protect against unregistered distributions of securities in the United States.
These conditions and possibly others would be designed to encourage access by U.S. investors to comparable foreign markets and high quality foreign issuers, without creating an un-level playing field to the full extent possible. The conditions could vary depending on the circumstances and as the Commission gains more experience with a mutual recognition approach.
IV. Mutual Recognition Approach for Broker-Dealers and Rule 15a-6
My remarks thus far have focused primarily on a mutual recognition approach for exchanges. I hope I have conveyed sufficiently my enthusiasm for the potential benefits of such an effort. I would now like to turn to the topic of mutual recognition of broker-dealers.
I have several reservations concerning a mutual recognition approach for broker-dealers. I believe we can effectively address the needs of institutional customers through reform of our own rules by modernizing Rule 15a-6. To provide that foreign broker-dealers could solicit U.S. retail investors under a mutual recognition approach will undoubtedly raise serious investor protection concerns. The task of ensuring comparability of protection for retail investors would be daunting. Our sales practice regulations, disclosures and suitability requirements are critical to protecting retail investors and are in my view a bedrock set of protections to which U.S. investors are entitled. But by definition, a broker-dealer mutual recognition approach would pre-empt FINRA and state securities law oversight. And in addition to serious retail investor protection issues, such an approach could also raise competitiveness issues for domestic U.S. brokers who operate under a very robust set of important sales practice standards. These highly developed requirements were crafted in response to years of experience in a marketplace with high individual investor participation. Indeed, given the Commission's recent concerns about protecting our ever-aging population from abusive and unscrupulous sales practices, it strikes me as ill advised to embark on a mutual recognition regime for brokers that could result in potentially diminished or compromised investor protections.
In my view, the most straightforward and achievable way to improve access for foreign broker-dealers is to amend our Rule 15a-6. That Rule, which is admittedly quite difficult to comply with in its present form, sets forth a process by which a foreign broker can access certain U.S. customers without full registration with the Commission. The Rule is quite restrictive today. Its requirement that investors have at least $100m of assets is too high, for example. A lower threshold — perhaps $25 million for institutions — may be more appropriate. In addition, I believe we should consider eliminating or loosening some of the current rule's chaperoning and back office requirements. Indeed, these types of reforms are very long overdue.
Progress has been stalled for years pending the "deeper think" on mutual recognition of exchanges. Since I question whether mutual recognition of brokers is even achievable on a realistic time frame, I believe that it is imperative that reforms to Rule 15a-6 not now become enmeshed in concerns over investor protections that might be raised by full broker-dealer mutual recognition. Thus Rule 15a-6 reforms should be de-linked from the mutual recognition rulemaking. Separate consideration may allow much-needed reforms to Rule 15a-6 to proceed at a faster pace, even if the mutual recognition approach for brokers ultimately is delayed.
The Commission has a tremendous opportunity to articulate what is essential to a well functioning securities market and to foster deeper cooperation with our fellow regulators through the mutual recognition process for exchanges that I have outlined. Such a process could expose us to different yet equally effective ways of achieving our regulatory principles. By requiring a foreign market to evidence that it meets the standards we articulate as requiring comparability, we also will help assure that investor protection and market integrity standards are not compromised and that U.S. firms can compete on fair terms. This approach will recognize markets that have already embraced high quality regulatory standards and provide incentives to those who currently have not. This approach also may provide an increased incentive for all markets to continue to work towards convergence of high quality regulatory standards.
If we get this right, we will reduce costs and increase the opportunity for cross border activities in a more cost effective and efficient way. We will further the goal of having capital directed to its highest and best uses across the globe. On the other hand, if we get this wrong, we may expose U.S. investors to heightened risk and place U.S. firms at a competitive disadvantage.
Given the importance of this effort and the need to achieve the right result for U.S. investors and our markets, I strongly encourage you to continue your involvement as the Commission continues to refine its thinking on this issue. I hope that you will continue to offer your comments, your insights and your analysis on this and other important issues.