As financial markets evolve, exchanges forced to adapt

March 1, 2007
There is a lot of discussion and concern that Sarbanes-Oxley compliance is driving many issuers abroad to other markets (mainly AIM or Frankfort) and that the US financial markets are losing their position as the world’s leader.

There is a lot of discussion and concern that Sarbanes-Oxley compliance is driving many issuers abroad to other markets (mainly AIM or Frankfort) and that the US financial markets are losing their position as the world’s leader. Couple this with the rash of mergers, alliances, and most importantly, technology advances, world markets are becoming very competitive. A recent report out of New York City by McKinsey & Co. (Sustaining New York’s and the US’ global financial services leadership) indicates that over-regulation may continue to erode the US markets.

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McKinsey & Co. worked with the New York Economic Development Corp. to develop a survey that focused on US competitiveness in the securities and investment banking sectors, where competition among global financial centers is most intense.

Study findings

The report shows the US is losing ground to London in the financial services industry and increasingly competing with cities like Dubai, Hong Kong, and Tokyo.

According to McKinsey & Co. statistics, with nearly $51 trillion as of 2005, US financial stock - including equities, bonds, loans, and deposits - is more than twice that of Japan, the next largest country, which has just short of $20 trillion in financial stock. Combining the 12 Eurozone countries with the UK gives Europe $38 trillion financial stock, but that is still only about three-quarters the size of US financial stock.

The US markets are also the most sophisticated: equity and private debt are the largest components of financial stock (approximately 34% and 35%, respectively), while in many less developed markets, bank deposits still account for a large portion. Although growing at a slower pace than other regions, the US, because of its significantly larger financial stock base, will remain the world’s largest repository of financial assets for years to come.

Nevertheless, it should be pointed out that, at constant exchange rates, the Eurozone, UK, and non-Japan have all enjoyed faster financial stock growth rates in recent years than the US. While financial stock grew at 6.5% annually between 2001 and 2005 in the US, the Eurozone grew 6.8% annually over the same period, the UK 8.4%, and non-Japan 15.5%. (See Figure 1.)

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Industry views

When asked if they saw the US losing its ground as the “financial capital of the world,” officials had various opinions.

John McGonegal, senior vice president of American Stock Exchange (AMEX) equities is concerned. He spoke of an article he read in the NY Times about 4 companies from Massachusetts that listed on the London AIM market and bypassed the US entirely. “We can’t allow that to continue and still expect to lay claim as the capital of the financial world,” he said.

Sarbanes-Oxley is one reason US companies are looking elsewhere. Class action lawsuits are another. That type of litigation is rare in other parts of the world. Add in relatively high banking fees stateside and you have a recipe for other markets to prosper.

Bill O’Brien, senior vice president of new listings in the corporate client group at NASDAQ saw it differently. “In terms of US markets soliciting international companies to list, I think it’s a little overstated at times.” He said that NASDAQ has had a lot of success; 23 non-US companies did their IPOs on NASDAQ in 2006, which is higher than 2005. This included the first Russian company to list on NASDAQ in 3 years, the first Latin American privatization listing, and a billion dollar company listing out of the UK.

He says a lot has changed over the last 5-10 years that has increased the competition for listing across the world and that “there is no assumption about where the ‘right’ place to list is anymore.” To him, this new environment is beneficial because “regardless of where they’re domiciled or what type of company, executives are looking at their choices very objectively,” and “companies are listing that wouldn’t have considered NASDAQ even 5 years ago.”

Kevan Cowan, senior vice president of business development at the Toronto Stock Exchange (TSX), says that Canada is, indeed, “more aggressively pursuing international listings.” He says there are over 200 companies outside Canada trading over the exchanges’ two listings (the venture market and the TSX stock exchange), over half (110) are from the US.

He says he hears a lot from small- and micro-cap companies. The overwhelming opinion is that the public markets are not very accommodating related to the size of US capital markets (massive and focused on larger companies). The Toronto Stock Exchange doesn’t have as many multibillion dollar companies as the US markets. Cowan feels this allows the TSX to focus on small to medium enterprises.

He says there is a public market funding gap “which is why many are looking north of the border.” Canada, like the US, is a massive public equity culture. While not as big as the US, almost one out of every two Canadians invests in public equity.

This gap has also been beneficial to London’s Alternative Investment Market (AIM) where you see very small-cap companies in the US increasingly favoring the AIM over US markets. The London Stock Exchange’s AIM gives companies from all countries and sectors access to the market at an earlier stage of their development by combining the benefits of a public quotation with a more flexible regulatory approach.

Greg Wojciechowski, president and CEO of the Bermuda Stock Exchange (BSX) sees it from a similar perspective. “Places like Bermuda and the BSX will continue to carve out niche opportunities to bring new products and services to its market and clients, which may not necessarily be the focus of other exchanges.”

Perhaps New York isn’t losing ground as much as other jurisdictions are maturing and beginning to compete head on,” he says. As recently as 20 years ago, the world’s financial hubs were very clearly regional with large exchanges dominating the landscape.


On a related note, there is another factor that may be playing into the decision by smaller companies to list on international markets. A June 2006 study by Oxford-based Oxera reveals that underwriting fees for non-domestic listings were 5.6% and 7.0% on the NYSE and NASDAQ respectively, compared with just 3.5% on London’s main market. While the underwriting fees aren’t enough to drive international issuers away from US equity markets by themselves, the markets are becoming increasingly competitive and all variables must be reviewed to protect one’s competitive advantage.

Wojciechowski notes, “Thus, the cost to go public, the cost to list, the cost to comply, the cost to report, the cost for advice and ancillary services, dealing and operational costs...these all come into play.”

McGonegal agrees and states, “The smaller company is very sensitive to these types of fees and it is hurting efforts. No question about it.”

As far as the choice of venue for IPOs, the world no longer turns primarily to stock exchanges in the US to raise capital internationally. According to the McKinsey & Co. report, “Over the first 10 months in 2006, US exchanges attracted barely one-third of the share of IPOs measured by market value that they captured in 2001, while European exchanges increased market share by 30% and Asian exchanges doubled their share.”

Some international markets, including those in Europe and Asia, are now deep enough to meet large companies’ capital needs locally.

O’Brien sees this as reflective of the competition and says that having liquidity isn’t enough. “The market can absorb that kind of liquidity anywhere in the world right now,” he explains. Institutional investors have the ability to trade anywhere in the world at this point.

McGonegal sees the same trend. “The markets will continue to become more global. Markets that were once considered ‘emerging’ now have very good liquidity. Liquidity begets liquidity. It’s a vicious cycle and these markets are experiencing it right now. It is a concern, but I am confident it will be addressed. At the end of the day, the US is still the deepest and most transparent capital pool in the world.”

According to Wojciechowski, as is the case with Bermuda, other financial centers are taking advantage of their ability to support capital raising and after market trading. He says, “Companies looking to go public do take into account the cost to do so and the cost to maintain the company’s listing for public trading, there is no doubt that increasing regulatory pressures, which add to the costs of taking a company public, is putting pressure on using the services of the traditional IPO venues.”

This is true even from a trading perspective with the emergence of electronic trading. It started with the NASDAQ and is spreading to every market as the technology becomes more and more accessible.

In the stock exchange realm, technology has also created the ability for exchanges to work together and therefore create economies of scale which ultimately should drive down some of the costs associated with clearing and settlement.


Many agree the biggest factor may well be the much publicized and oftentimes criticized Sarbanes-Oxley Act, particularly the implementation of Section 404, which produced far heavier costs than expected. This affects not only US companies, but foreign companies that are required to conform to US accounting standards.

O’Brien says the objectives of Sarbanes-Oxley are “noble,” but the issues lie with the execution. He, along with many others, have been lobbying for reform among the policy makers, spending many hours communicating the need for rationalization of the regulation.

There is currently a set of reforms being contemplated by the Securities and Exchange Commission (SEC) and Public Companies Accounting Oversight Board (PCAOB) that would address many of the “unnecessary and onerous aspects of 404,” the internal controls portion of regulation that most people take issue with. He says “It’s set to put responsibility where it should be...relying more on management and less on perpetual oversight of accounting firms to set how to judge risks and create controls around them.”

John McGonegal, AMEX
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McGonegal agrees. “We have heard loud and clear from our listed companies, which tend to be small- and mid-cap in size, that SOX costs are really hurting them.” The cost is much harder proportionally on the smaller firm. The added cost to comply may be a rounding error on the balance sheet of a 200 billion dollar company, but it is onerous for a $200 million company.

AMEX has also been working “aggressively, yet constructively” with the government “to make sure the voices of our companies are heard.” He says that the act, in theory, is useful and well purposed, “but it has made our competitive edge become less so.”

This may, in fact, be an advantage for exchanges outside the US. Wojciechowski says, “It is quite common for the market to seek an alternative if it perceives that a similar product is available that offers a compelling commercial reason to do so and which doesn’t seriously impact value.”

Greg Wojciechowski, BSX
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“From the BSX perspective, we watch these developments with great interest...changes that occur in the markets close in proximity and philosophy to ours and which prompt users to analyze alternatives create a huge opportunity for us,” he continues.

Kevan Cowan, TSX
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The markets in Canada and Bermuda may also be benefiting from this phenomenon. Cowan notes that Canada and the US get to the “same place” in terms of quality, but that there are some differences in terms of financial reporting. He describes the approach in Canada as “more rules than standards.” “Canada has an extremely strong standard of corporate governance, but the rules are not as prescriptive as Sarbanes-Oxley.”

He describes their financial reporting as more of a “disclosure-based approach” where they “don’t go as far as dictating what will be done.” Companies have to discuss governance in terms of those standards. He sees it as a “different situation than external auditors with high fees having to get involved in internal controls certification and verification.”

Securities litigation

Another factor to consider is that of increased securities litigation. 2005 set a new high for the number of securities class-action settlements in the US, and for the overall value of these settlements. While many suits addressed legitimate claims by investors and consumers of corporate wrongdoing, the perception may still be an issue.

“I think the perception of possible litigation drives away business as opposed to the actual process of it happening,” McGonegal says. He has heard this first hand from people in Europe and the UK. He says it is more a concern for the large companies, that this type of litigation is not as common in the small-cap area in his experience. He says the notion of class-action suits by shareholders is completely foreign to those companies. “It just does not happen in their countries with any degree of regularity or size,” he continued.

O’Brien agrees. “Our society is a little more litigious than others in the world.” He also agrees that many of the suits address valid investor concern, and believes that as the legal infrastructures across the world improve as they have over the past generation that the “advantage” becomes neutral, and what we’re left with is a “greater amount of global competition.”

Arguments can be made for listing on both domestic and international markets. Perhaps this is why many companies are choosing to list across borders. Christiaan Brackman, NYSE, sees the value in non-US companies listing in the US (in this case the NYSE) as well as overseas. He says, “Foreign companies are continuing to list in the US because of the valuation premium that comes with being cross-listed, and for strategic reasons. They are looking to broaden their investor base, to have an acquisition currency.”

His opinion is that cross-listing in the US:

  • Offers listed companies superior access to the world’s largest pool of capital;
  • Provides a company unsurpassed visibility benefits (research analysts/branding);
  • Gives a company unprecedented access to retail investors;
  • Maximizes a company’s valuation (peer group benchmarking);
  • Creates a US-dollar acquisition currency;
  • Enables a company to offer US employee compensation plans;
  • Offers tax benefits to a company’s US investors;
  • Reduced stock volatility can help a company achieve a lower cost of capital;
  • Enhances a company’s credibility and reputation;
  • Reflects a company’s unqualified commitment to good corporate governance.

Talk of cross-border acquisitions is becoming more common. One such deal was recently lost by NASDAQ. The company was, until recently, involved in a hostile bid for the London Stock Exchange PLC for $5.3 billion.

NASDAQ only acquired 0.41% of the British exchange in this transaction. It will be added to the 28.75% of shares it already holds from purchases in recent months. NASDAQ needed 50% to begin a company takeover.

One such transaction that was successful is that between the AMEX and the Tokyo Stock Exchange (TSE). The two established a strategic alliance for the cross-listing and trading of US and Japanese Exchange Traded Funds (ETFs). Ultimately the exchanges hope to achieve seamless cross-listing and cross access of each other’s products.

Salvatore F. Sodano, AMEX chairman and CEO stated, “As the globalization of financial markets continues, there is no question in my mind that innovative, progressive products - like ETFs - will continue to grow in both significance and popularity.”

What needs to be done

This type of collaboration is a step in the right direction for the US in terms of keeping up with the globalization of the markets and holding a top position. In addition, companies need to continue their work with the governing boards to provide clearer guidance for implementing the Sarbanes-Oxley Act. SEC and the PCAOB need to follow through on their proposed revisions to the guidelines controlling the implementation of Section 404.

Another step is to implement securities litigation reform. For example, the SEC could invoke Section 36 of the Securities Exchange Act of 1934, which effectively allows it to exempt companies from certain onerous regulations where it deems such exemptions to be in the public interest. Give smaller companies (which usually lack the executive “horsepower” to efficiently and effectively comply with the rules, the ability to “opt out” of some portions of SOX, provided other investor safeguards are retained.

In the meantime, companies need to continue to innovate and differentiate themselves in the global exchange landscape. Many of the exchanges are doing just that.

At NASDAQ, “We’re doing innovative things,” O’Brien states. For example, NASDAQ owns an insurance agency and an investor relations firm to further assist its clients.

The firm also adds value from a visibility perspective. O’Brien believes there are brand building opportunities that you may not get overseas. For example, the 7-story NASDAQ video tower in Times Square which is seen by about a million and a half people each day from around the world.

For the Toronto Stock Exchange, the difference is a public market stock exchange system with factors that differ from the US and the UK. The focus is on small to medium enterprise and younger, more junior companies. Secondly, TSX has put both exchanges (the venture market and the TSX stock exchange) under one roof to “provide a seamless system of companies coming into public market and graduating to our more senior market,” says Cowen.

“To distinguish ourselves from AIM we provide aftermarket support,” he continues. After the listing occurs, most of the trading is back in Canada. The market supports companies in aftermarket in a very different way.

The Bermuda Stock Exchange is offering up something different as well. The exchange offers a ‘Mezzanine Market,’ a unique pre-IPO market listing for start-up, high growth potential companies, that, unlike AIM or the European Neur Market, offers development stage companies the opportunity to list on a recognized international stock exchange without having to commit to a full IPO.

The New York Stock Exchange has also recently implemented a listings platform to differentiate itself. NYSE Arca is designed to attract new listings (25 in 2006 since its launch for emerging issuers) for companies which do not (yet) meet the NYSE’s higher listing standards. Companies listing on NYSE Arca still require SEC registration, SOX compliance, and US GAAP.


While the decline in large, global IPOs ignites concerns about New York and other US markets’ strength and future as global competitors, it is still too narrow a view to gauge in absolutes. That being said, the trends should not be taken lightly. Competition is healthy, but the US wants to remain on top; after all, a strong financial services sector is critical to the health of the overall economy.