Speech by SEC Staff:
Remarks before Transatlantic Financial Market Symposium Panel, "The Road to Regulatory Convergence: Where are We and Where are We Going?"
Director, Office of International Affairs
U.S. Securities and Exchange Commission
April 27, 2005
Thank you very much Jean, and thanks also to the consortium of industry associations and government agencies that have made this conference possible. I have been involved in what is now called the "Transatlantic Dialogue" for several years now, and, with all honesty, symposia such as yours' have proven indispensable to our efforts to form practical solutions to many cross-border financial regulatory issues that, only a few years ago, seemed intractable.
But before I go further, I should give the SEC's standard disclaimer, which I imagine most of you have heard before and no doubt will hear again: The U.S. Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. These remarks express the author's views and do not necessarily reflect those of the Commission, the Commissioners, or other members of the SEC staff.
With that said and given the brevity of our panel, rather than presenting remarks, I would instead like to pose a set of questions for discussion. I'd like to do this because I believe we should not overlook the difficult issues addressed in the Dialogue with which Alex Schaub, David Wright and we in the United States have had to struggle. These issues are fundamental to our discussions on creating a seamless transatlantic financial market and their difficulty makes the success of the Dialogue that much more remarkable.
EU Internal Markets Commissioner McCreevy recently described the transatlantic dialogue as sometimes resembling a dialogue between Bart and Homer Simpson, two American cartoon characters of questionable intelligence who take turns annoying and throttling one another.
Commissioner McCreevy was describing some of the dialogue's more difficult times, of course - not the more humdrum occasions where we have been able to accomplish so much. And it is an understatement to say that the dialogue has, to date, been extremely successful. It has helped resolve a number of transatlantic regulatory issues, ranging from how to apply Sarbanes-Oxley to cross-listed European issuers, to implementation of the EU Financial Conglomerates Directive.
Nonetheless, we must be careful to continually define the lexicon of the Transatlantic Dialogue. Otherwise, rather than reminding us of Bart and Homer Simpson, discussions in which parties give different meaning to words runs the risk of reminding us more of the famous baseball dialogue between the 1930s comedians Abbott and Costello called "Who's on first." In case you haven't seen this classic, in the skit Costello is asking the coach of a baseball team about the names of the different players. Of course, the players have very unusual names - "Who," "What," "I Don't Know," "Why," "Because," and several others. Both Abbott and the coach are in complete agreement on most issues. They both know they are discussing baseball. They also both perfectly understand that they are talking about the names of the baseball players. But the comedy, of course, is that a mutual understanding about a few very key elements is missing - specifically, that "Who's on first" and "What's on second" can be statements of fact, not just questions.
We need to be mindful that the transatlantic dialogue not follow this pattern. We both know what the discussion is about. We both agree on what the central issues are. We agree on how important these issues are and that we all stand to gain from the dialogue. We know that investors today can invest abroad with relative ease, and issuers are not limited to their own countries when seeking capital. We also recognize that there still can be significant transaction costs to doing so. And regulators in the United States and Europe all agree that, everything being equal, both issuers and investors will benefit if these transaction costs can be reduced or eliminated.
We need to be sure that a misunderstanding about certain very key elements not cloud our perceptions of how successful the dialogue has been and what more we still need to discuss. And as you might expect, divergent perceptions tend to be based on different experiences.
For example, the United States has long had a very large, relatively isolated, capital market. And this capital market, with its numerous stock exchanges, has, for the past 70 years, been overseen at the national level by a single federal securities regulator and a single set of federal securities statutes. When problems arise - and, let's be honest, problems inevitably arise in this world - the US Securities and Exchange Commission and the US Congress have long been used to addressing the problem on our own, without seeing the need to consult with regulators or legislators outside our country. There are obviously advantages to this approach. After all, the Sarbanes-Oxley Act, the single most sweeping change in US securities laws in 70 years, was passed by Congress within months of the collapse of Enron.
Consequently, you can see why, in the United States, "regulatory convergence" might be viewed with some suspicion. After all, what if we get the regulations wrong? What if we need to make changes? Won't the first significant unilateral change by any jurisdiction ruin the convergence? And if jurisdictions can't make changes unilaterally - that is, quickly - won't that harm the regulatory flexibility that has made our markets so strong to begin with?
By contrast, regulatory convergence is viewed quite differently in the European Union. The EU right now is engaged in a truly momentous effort to harmonize and converge the laws and regulations of 25 different countries. Obviously, the transaction costs presented by 25 different sets of regulations are much greater than those posed by just two. Consequently, in Europe the benefits of convergence are manifest, and the downsides not quite so apparent. Further, progress on convergence within Europe to date has been impressive. And it obviously colors how Europeans view the transatlantic dialogue - after all, if the convergence of financial regulations between 25 different jurisdictions is possible, how hard can it be to converge just two?
But the EU's experience has not been easy. It has produced potentially differing legal and regulatory interpretations and applications, despite the fact that the EU now has a single overarching legal infrastructure, a single set of EU-wide directives, and a closely linked set of securities regulators cooperating through CESR. And concerns remain that even subtle divergences in member-state regulations under the relevant EU directive - not to mention enforcement - will create opportunities for "regulatory arbitrage," and different levels of investor protection in different member-states.
And this leads me to my questions, for both the European and US sides.
First, when considering how to create a seamless transatlantic capital market, do different regulatory approaches in the United States and Europe necessarily result in different regulatory costs and different levels of investor protection?
I recognize that this is a sensitive issue. After all, no regulator will admit that its approach results in less investor protection than another, or is expensive. But the European experience seems to suggest that differences do matter and to pretend that different regulations do not produce different results is to ignore reality. And different levels of cost and investor protection can result in regulatory arbitrage that could harm the integrity of all of our markets.
Within Europe, concerns about regulatory arbitrage have resulted in a push to greater harmonization and convergence and away from "mutual recognition", much to the concern of such observers as former UK FSA chairman Howard Davies, now director of the London School of Economics.
What level of regulatory convergence is necessary for a transatlantic securities market to exist? Can a transatlantic securities market really exist unless the securities regulations in both the United States and the EU are, for all practical purposes, the same - which is utopian hope, at best? Can less-than-full convergence lead to a transatlantic market without creating the impression that this market can be used by market participants to shop around for the lightest regulatory touch but have undiminished market access?
My second question, then, is, given the difficulties that Europe has faced with making such regulatory convergence a reality within the EU, despite a shared overarching legal structure, what can realistically be achieved with convergence between the US and EU, where no such overarching legal structure exists? Is real convergence possible? And if it is not, what other alternatives exist to lowering the transaction costs associated with accessing capital or investing across the Atlantic, which would not result in regulatory arbitrage?
But even assuming that regulatory convergence is possible, securities regulation is just one facet of investor protection. Investor protection also involves securities regulators with expansive enforcement and investigative powers, adequate resources, and the will to use these powers and resources. And it involves the private rights of shareholders to seek redress when they are defrauded.
So my third and final question is, even if regulatory convergence proceeds to the point where US and EU securities regulations are essentially identical, will significant legal and enforcement differences remain that, in turn, create opportunities for regulatory arbitrage? In other words, is regulatory convergence enough? Does it not also require enforcement convergence, to ensure that investor protection standards are equal on both sides of the Atlantic?
Three Questions and the Road Map
These are just a few questions that come to my mind when thinking about the steps we need to take to create a truly seamless transatlantic capital market. In practical terms, how do we answer these questions when considering, for example, the "roadmap" recently unveiled by the SEC staff of the steps needed to possibly eliminate the US requirement that financial statements prepared under International Financial Reporting Standards be reconciled to US standards in the financial disclosures of foreign companies selling shares in the United States?
Before we consider the questions in the context of the roadmap, I would like to say that the roadmap is an extremely important milestone. It represents a potential departure from the Commission's historical stance that financial statements not using US GAAP must be reconciled to US GAAP. This milestone is the result of the hard work of the IASB in developing high-quality global standards, of the foresight of the IASB and FASB in developing a convergence program and of the vision of the European Commission in adopting International Financial Reporting Standards as the standards for the European Union. All should be commended for this remarkable confluence of effort.
Now to return to the questions, as you may have heard, this roadmap states that eliminating the reconciliation requirement will first involve, among other things, a detailed analysis of the faithfulness and consistency of the application and interpretation of International Financial Reporting Standards in financial statements across companies and jurisdictions, combined with continued progress in the convergence work now being conducted by the International Accounting Standards Board and the US Financial Accounting Standards Board.
In light of the roadmap, then, we can ask:
- How much convergence between IFRS and US Generally Accepted Accounting Standards is enough? Do IFRS and US GAAP have to essentially merge into one set of standards, or can differences remain?
- Do sufficiently strong international institutions exist that will ensure that IFRS are faithfully and consistently applied across all jurisdictions that use IFRS? In other words, is there a shared overarching structure that will ensure that IFRS are universal in practice as well as on paper? And can the roadmap succeed without such a structure?
- And, finally, can the goal be achieved if different enforcement approaches to IFRS violations exist? Will jurisdictions using IFRS with less rigorous enforcement programs undermine the roadmap?
Personally, I believe convergence is essential to the elimination of the reconciliation requirement, but it need not be complete convergence. The issue will be the degree of convergence necessary.
I also believe auditors are up to the challenge of ensuring consistency of interpretation and application of IFRS across jurisdictions and sectors. Failure is not an option. Failure will simply raise the cost of regulatory compliance for their clients.
And finally, I expect regulators will have little choice but to undertake rigorous enforcement of IFRS so as not to be perceived as a haven for wrongdoing, particularly since financial statements using IFRS will be subject to the scrutiny of multiple regulators.
In closing, let me say that I believe the US-EU Financial Markets Dialogue has been an unmitigated success particularly in addressing the spillover of regulatory initiatives after fact. By this, I mean the unforeseen implications that domestic rules can have on foreign actors. For example, the Dialogue proved to be an effective forum for discussing and addressing, as appropriate, European concerns raised by the SEC's implementation of the Sarbanes-Oxley Act. The challenge now is to use the Dialogue process as a way to discuss and limit potential spillover effects before they occur, and to take into account the global nature of the capital markets as we consider domestic rulemakings.