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Speech by SEC Commissioner:
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| The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of Ms. Unger and do not necessarily reflect the views of the Commission, the Commissioners, or other members of the Commission's staff. |
Thank you for the kind introduction. I'm very pleased to be invited back for a second straight year to speak while you eat your dessert and drink your second cup of coffee. I actually look back fondly on last year's speech. It was the first speech I gave that focused solely on on-line brokerage issues. The speech helped me to formulate the agenda for the on-line brokerage roundtables I held last spring, which led to my report that the Commission released last November.
I spent a lot of time thinking about a possible topic for today's remarks. First, I thought I could talk yet again about the report, but whoever wanted to read it probably has already. Then, I thought I could talk about how I intend to follow up on the recommendations, but that's not enough for an entire speech (although I am willing to take questions on that at the end). I could try to find still another angle to take on on-line brokerage, but nothing seemed to stand out that was worthy of an entire speech.
Finally, I thought, we have spent endless amounts of time talking about Regulation ATS. Why not take some time to talk about an issue raised in the concept release but dropped in the actual rulemaking – foreign market access. It's a very difficult issue that has come up in the question-and-answer session of almost every speech I've given over the last year – and one that I admittedly haven't been able to address very well. Before I begin, let me say that the remarks I'm about to give are mine and mine alone, and do not represent the views of the Commission, the other Commissioners, or the staff.
The technological underpinnings of a global securities market already are in place. Telecommunications networks have extinguished any truly discernible differences between sending an order from New York to Chicago, London, or Tokyo. Investors can link to a foreign market by 'passing through' a member of that market – typically the investor's broker-dealer – using either a proprietary system or the Internet. Just type in the URLs of U.S. on-line brokers operating abroad. Many offer their foreign customers ready access to trading in U.S. securities. The only real impediments to a global market are regulatory, not technological. Specifically, what is lacking is an appropriate regulatory framework for that market to operate in.
The obstacles to be overcome in developing a global regulatory framework for securities trading don't involve any lack of jurisdiction on the Commission's part. Quite the contrary. The Exchange Act gives the Commission ample authority over the activities of foreign markets and broker-dealers in the United States. What really is at issue is to what extent the Commission should exercise that authority.
Over the years, the Commission and its staff have grappled long and hard with this issue. In 1989, the Commission adopted Rule 15a-6 to exempt from registration foreign broker-dealers engaged in certain activities involving U.S. institutional investors. Since that time, the staff has worked closely with the industry through interpretive and no-action letters to make this somewhat labyrinthine rule more workable for international business. These efforts also were successful in moving a more comprehensive resolution of the foreign market access issue to the back burner for several years.
However, technology has continued its progress in the time since Rule 15a-6 was adopted. During the 1990s, almost all the major foreign markets closed their physical trading floors and adopted screen-based trading. Another element bringing the issue of foreign market access back to the forefront is the Internet and its empowerment of the individual investor. The Internet potentially puts access to foreign markets a URL and a couple of mouse clicks away from any investor with a PC and an on-line brokerage account – and that population of investors grows daily.
Recognizing this, the Commission's 1997 concept release on exchange regulation solicited comment on the issue of foreign markets' activities in the U.S. The concept release set out three non-exclusive approaches the Commission could take.
The first is a mutual recognition approach. The Commission could rely on a foreign market's primary regulatory authority if we determined that the foreign authority provided 'comparable' regulation to U.S. exchange regulation.
The second is an exchange regulation approach. The Commission could require foreign markets that provide direct access to U.S. investors to register as U.S. exchanges or use our authority under Section 36 of the Exchange Act to provide them with an exemption from exchange registration.
The third is an access regulation approach. Instead of regulating the foreign market itself, the Commission could regulate the entities that actually provide U.S. investors with access to trade on the foreign exchange.
Each approach had its supporters among the commenters on the concept release and each raises unique issues. For example:
Naturally, foreign exchanges, regulators, and firms generally favored the mutual recognition approach. But what exactly is regulation 'comparable' to U.S. exchange regulation? Few countries have the rigorous regulatory oversight we do. Almost certainly, accepting 'comparable' regulation would mean that the Commission would have to compromise on our approach to regulating U.S. markets. This would require the Commission to determine what regulations we would be willing to sacrifice in the name of comity, such as transparency, trade reporting, and antifraud protections. To say the least, that would be a difficult task.
Of course, jettisoning regulation for the sake of comity would create another problem. Foreign markets would be able to operate in the U.S. with fewer regulatory burdens than U.S. markets. U.S. markets justifiably would cry foul and ask the Commission to cut back on regulation. We have witnessed this recently when the U.S. futures exchanges reacted to the CFTC's willingness to allow foreign market terminals in the U.S. The CFTC responded by moving to reduce the regulatory burdens of U.S. futures exchanges – many would say not a bad result.
U.S. exchanges could use technology to game the system by moving offshore to a country with 'comparable' regulation. In the old days, we could largely discount that possibility as an idle threat, given that markets required a physical trading floor. Not so today. Almost with a mere flick of a switch, a floorless electronic market could move overseas, have the same access to U.S. investors, and face less regulation.
Naturally, the mutual recognition approach would not be without international politics. The Commission might come under a great deal of pressure to accept as 'comparable' the regulatory schemes applicable to markets of important U.S. trading partners – even though they may have significant failings.
Finally, foreign regulators would have to do more than just adopt comparable regulation. To be truly effective, the mutual recognition approach would require vigorous enforcement. The Commission could not make this assessment only once but would have to expend resources to monitor it on an ongoing basis.
Next, I'll turn to the exchange registration approach. The primary benefit of this approach is that it eliminates the problem of regulatory arbitrage. All markets operating in the U.S. would be subject to the same regulatory regime. Not surprisingly, foreign regulators didn't respond favorably to this approach. Foreign markets could become subject to inconsistent U.S. and home country regulation. Moreover, I would assume that foreign regulators' likely response would be to impose their full panoply of regulations to U.S. markets seeking to access their own markets. The nascent global market would quickly suffocate in red tape.
Another drawback of this approach is that it would require the Commission to take on a significant regulatory burden. As with any other national securities exchange, the Commission would be responsible for oversight of all of the foreign market's activities. Even if we had access to unlimited resources, which we obviously do not, a U.S. regulator would be hard-pressed to accomplish that task. In addition, foreign regulators might not take the most enlightened view of the situation, and consider our benign oversight efforts as somewhat of a jurisdictional overreach.
Finally, the Commission could regulate the entities that provide U.S. investors with access to foreign markets. Access providers would include foreign markets, a broker-dealer, or any other service provider. The Regulation ATS release contemplated that access providers could be required to comply with limited recordkeeping, reporting, and disclosure requirements, as well as the antifraud provisions of the federal securities laws.
Many commentators on the release subsequently pointed out that this approach seemed to be the one being given the most serious consideration. By regulating only the U.S. activities of the foreign market or third party entities, it might reduce some of the conflicts between U.S. and home country regulations. It might also alleviate concerns that the Commission would overstep its statutory authority by regulating foreign market activity in the home country. Moreover, by creating a regulatory regime specifically tailored to foreign markets, it could ensure appropriate protections for U.S. investors while clarifying the status and uniform regulation of all access providers.
Whatever the purported drawbacks and benefits, the Commission has not moved to adopt any of the three approaches. Instead, the Commission deferred action on the issue of foreign market access for another day. There are several reasons why. First, the concept release led directly to Regulation ATS. As you can appreciate, developing a regulatory framework to accommodate alternative trading systems into the national market system was no small undertaking.
Second, foreign markets trade unregistered securities. As you know, this raises significant issues under the Securities Act, which were not ready for resolution. I'll talk more about this in a few minutes.
Finally, the Regulation ATS Adopting Release made it clear that U.S. exchanges could adopt for-profit structures. This spurred many existing markets to announce that they were considering going for-profit and maybe even public, and two ECNs to file applications for registration as for-profit exchanges. These developments raise all sorts of questions as to the sufficiency of the self-regulatory model in the U.S. Obviously, getting our own regulatory house in order takes precedence over adopting a regulatory approach for foreign market access to the U.S.
The Commission hasn't completely closed its eyes to foreign market access since the concept release. In a 1998 interpretive release, we let foreign brokers and markets know how they could use the Internet and avoid triggering U.S. broker-dealer and exchange registration obligations. Specifically, we stated that a foreign broker or exchange could avoid U.S. registration obligations by posting a prominent disclaimer and refusing to transact business with investors it had reason to believe were U.S. persons. Moreover, we stated that a foreign market would have to refrain from providing U.S. persons with access indirectly through its members.
In March 1999, the Commission issued our second statutory exemption from exchange registration in 62 years, this time to the London-based Tradepoint Stock Exchange. The exemptive order allows Tradepoint to provide U.S. persons with access to ordinary share trading in securities listed on the London Stock Exchange. However, while U.S. qualified institutional buyers have access to all such securities through Tradepoint, other U.S. persons only have access to trading in securities that are registered in the U.S under the Exchange Act.
The statutory exemption from exchange registration is available only to exchanges that execute a limited volume of transactions. In the case of Tradepoint, its daily volume of trades involving a U.S. member cannot exceed $40 million. Moreover, Tradepoint must remain a limited volume exchange in the U.K. The upshot of this is that the limited volume exemption is not a solution for the issue of foreign market access. As we've interpreted it, the exemption is not available to a foreign country's primary market, and the volume restriction would hamper the growth of a foreign market's business in the U.S.
As I alluded to earlier, even if we were able to resolve the question of how we should regulate foreign market access to the U.S., that wouldn't do much good if all the foreign markets were able to offer individual investors was access to ordinary share trading in securities registered in the U.S.
Therefore, the Commission needs to address the question whether U.S. investors should have access to trading in securities not registered in the U.S. or whether we should hold the line until agreement is reached on international accounting standards. Over the years, the International Accounting Standards Committee, regulators, and practitioners from around the world have put an enormous amount of effort into developing workable international accounting standards.
There has been a renewed focus on the issue as of late. Last November, the IASC adopted a restructuring plan, and is moving forward on appointing high-quality trustees and board members. In addition, the Commission will soon consider a release soliciting commenters' views on issues related to international accounting standards.
International accounting standards would provide a wealth of benefits to every participant in a global securities market. But access to the world is already available through our PCS. Technology has become the great leveler between individual and institutional investors. Direct access to foreign markets and trading in foreign securities are some of the last distinctions that exist between individual and institutional investors. I fully expect these distinctions to fall as well. The only question is how soon.
The alternative is to seal our borders and create a regulatory 'Electronic Curtain' around U.S. investors and markets. Remember, though, even an Oz could only hide behind the curtain for so long. In other contexts, history clearly has shown that such an approach won't work, and that U.S. investors and markets will suffer. If foreign markets can offer U.S. investors more cheap and efficient trading venues without sacrificing critical investor protections, the Commission has little choice but to let them compete with U.S. markets. Competition has benefitted our marketplace. Most recently, competition from ATSs has prompted the traditional markets to respond. The competitive challenge posed by foreign markets would likely provide similar benefits.
Concurrently, the Commission must work to move U.S. market structure forward to enhance our markets' competitiveness in the emerging global marketplace. Progress is being made on many fronts, with plans in the works for markets to adopt proprietary models, the NYSE's proposal to eliminate Rule 390, and the recent expansion of the ITS/CAES linkage to name a few. It's a cold, cruel world out there, and U.S. markets have to be ready to meet the competitive challenge at home and abroad.
Thanks for your attention. I'll be happy to take a couple of questions.
http://www.sec.gov/news/speech/spch344.htm
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