On March 4, the US Securities and Exchange Commission (SEC) took a small step toward increasing New York’s global financial position by decreasing burdens on foreign companies listing in US financial markets. The new rule, aimed at reviving New York’s competitive position in relation to London and emerging global financial centres, eliminates a requirement that foreign companies file financial statements according to US Generally Accepted Accounting Principles (GAAP) if they have already filed according to International Financial Reporting Standards. While seemingly technical, reporting requirements such as these make operating in the United States significantly more expensive for foreign firms and often spur companies to list in London, where regulations are more lax.
For a decade, the two cities have had different competitive advantages in attracting firms; London currently has an advantage based on reduced regulatory compliance costs while New York has the edge regarding cost of capital. Listing in New York can be painful, but New York has a far lower cost of capital, meaning firms find it easier to raise money because the thorough regulatory environment in the United States increases a firm’s credit rating and, in investors’ eyes, the likelihood that a firm has its finances in order. London has been able to compete with New York because it reduced the difference in cost of capital while widening the difference in regulatory distraction.
With the SEC’s March 4 decision, the battle between London and New York has reached an inflection point. Regulations of New York’s financial dealings are coming to a halt, and any changes to the system will likely only include reductions or streamlining of existing rules.
Meanwhile, following the 2007 Northern Rock banking crisis in the United Kingdom, London is in the process of re-evaluating and tinkering with its existing regulatory framework, bringing uncertainty and likely stricter regulations for London-listed companies. If this trend continues, London is likely to lose its mantle as the city of choice for new listings. In the long run, however, both financial capitals will have to look beyond competition with each other and watch out for the growing influence of emerging market financial centres.
New York was the premier exchange for decades, but more recently competition for new listings has become fierce. During the 1990s, listing in New York indicated that a company had arrived on the international stage. Firms from Europe, Japan and developing countries would tolerate complex US regulatory compliances in order to raise capital and their prestige. Around the turn of the century, several factors cut into New York’s allure. First, the myriad of financial scandals, from Enron to WorldCom, led to even more stringent US regulations, culminating in the passage of the Sarbanes-Oxley Act of 2002, which created new management and accounting requirements for all public companies listed in the United States. Second, London made a concerted effort in the late 1990s to increase its attractiveness as an international financial centre by streamlining and relaxing requirements for firms operating in its financial markets. Third, and more recently, the rise of emerging market financial centres such as Shanghai and Hong Kong gave companies in developing markets other avenues for raising capital.
The US regulatory framework compels firms to account for every possible litigation issue that might arise due to regulatory non-compliance and requires financial regulators to abide strictly by the law, rather than focus on the ends specific regulations are intended to achieve. Much of this is a reflection of the highly litigious nature of the US economy relative to the United Kingdom and other nations; the risk of legal action is high and companies must pour considerable resources into ensuring they are obeying the law.
Extensive laws take time to implement and clarify in court. This reduces US financial markets’ real-time ability to adjust to global trends and business demands compared to London and other less-regulated financial markets. The existence of multiple state regulations, along with different national agencies with overlapping responsibilities over the financial market, further complicates business activity and delays US regulatory reaction to the rest of the world.
Beyond Sarbanes-Oxley and the American litigious milieu, more temporal trends – such as increased restrictions on foreign entry into the United States following the September 11, 2001, attacks and the growth of Russian, Middle Eastern and Asian funds that have chosen to do business in London because of its geographic proximity – have contributed to London’s edge over New York in recent years.
Value versus compliance costs
The first goal of many financial institutions and Wall Street is to turn back some of the burdens inherent in Sarbanes-Oxley – such as redundant auditing – largely blamed, but not wholly responsible, for London’s ascendancy over New York. A Financial Executives International survey claims that on average, a survey of 200 companies (most with market values exceeding $75 million) allocated $2.92 million in 2006 for Sarbanes-Oxley compliance costs. While this figure is quite high, the survey did find that it was significantly less than the average $4.51 million in compliance costs that similar companies doled out in 2004.
The much-talked-about Bloomberg-Schumer report in 2007 warned that without changes to these and other long-standing US financial norms, New York would become only a regional market for financial capital, not a world leader. The new reporting rules the SEC implemented allowing foreign companies to list without complying with GAAP satisfies a portion of the recommendations Bloomberg-Schumer laid out as ways of rectifying threats to New York’s financial industry. However, these are not likely to be the last changes; an alteration in New York’s financial culture is afoot.
Proponents of a move toward a UK-style system, described as "principles-based,” argue that instituting a set of common goals and principles that guide all national and state regulators and allow firm managers and regulators greater ability to interpret rules will correct many of these downsides to the US financial market. The financial industry in the United States largely agrees with this argument and views London’s ascendancy as a global financial centre as proof that principle-based rules are efficient and competitive. The US financial industry has recently launched a campaign to lobby Congress on many of these points.
However, New York’s stricter standards also have advantages that could once more make it the world’s hottest financial centre – if it can balance its existing advantages with attempts to simplify and streamline its financial operations.
Trading costs in New York are lower than in London, and everywhere else, because these transactions are considered more transparent and safer. When a company lists in more regulated markets, particularly in the United States, its cost of capital usually decreases and the value of its stock goes up. The numerous precautions in place in the United States reassure investors and increase assurances that a listed company is on sound footing. This gives each company listing in the United States a premium. A recent study from Ohio State University and University of Toronto compares cross-listings on the New York and London stock exchanges from 1990 to 2005 and indicates that foreign companies that list on a US exchange are valued higher than their domestic counterparts that do not cross-list. There was no such premium for foreign companies that listed in London, however.
The Northern Rock fiasco in England in the fall of 2007 has decreased confidence in London’s market and led to calls for increased regulation. More relaxed regulatory oversight can lead to fears of insider trading and false reporting, which in turn lead to reduced confidence in a firm’s performance under such a regime. London is not only suffering a lack of confidence in its ability to regulate after Northern Rock, it has also lost some faith in measures designed to correct this perception; a recent survey among financial professionals indicates that the United Kingdom’s regulatory system is increasingly confusing and unpredictable.
London currently attracts hot money, but in times of economic uncertainty, which the world’s investors acutely feel, the security of New York will be increasingly attractive. And the tide may be turning in New York’s favour as it pushes through (though slowly) clearer rules and less burdensome reporting requirements while maintaining its status as the most secure financial market in the world. After years of Sarbanes-Oxley, the value companies place on the depth of US capital markets is holding New York steady as it begins to rebound. From January to October 2006, at least $40 billion worth of initial public offerings (IPOs) were placed on London exchanges, while $30 billion in IPOs were sold in New York during the same time. In November 2007 the New York Stock Exchange and Nasdaq had raised $51 billion for the year, and London had raised $47 billion.
The emerging threat
Beyond the trans-Atlantic stock market, all the established exchanges (e.g. London, New York, Frankfurt) have been feeling increasing heat from their much younger but more agile Asian competitors. This is partly because of a dynamic similar to that between London and New York; emerging markets have fewer stringent regulations and lower transaction and paperwork costs. But another key reason is the fact that new Chinese and Asian company listings are driving new revenue streams for stock exchanges across the world (Western company markets are more or less saturated), and most exchanges see companies from developing countries (that have yet to list) as the future for big bucks.
Chinese and other Asian companies tend to prefer listing closer to home, not only because of lower costs and legal requirements, but also because of the closer cultural business matches (look at the number of Chinese companies that make Hong Kong their first stop in any international listing plan). This makes business easier for these companies. The Chinese government is starting to encourage its companies to list outside of Hong Kong in the region (e.g. Singapore), as the Hong Kong market is getting saturated with mainland companies as well. What this means for US, UK and European exchanges is that geography and culture are making them less competitive than their Asian counterparts in courting future Asian clients. The New York Stock Exchange and London Stock Exchange know this and have started trying to respond; they both recently opened representative offices in China, but these offices will not fundamentally change their weak positions (alliances might work better). While New York and London need to focus on each other as competition, but in the longer term the real threat lies elsewhere.
Still, there are competitive advantages New York and London can maintain as long as these two massive markets are so intently focused on providing regulatory clarity, protection for investors, reduced costs of compliance and reduced costs of capital. Furthermore, both are turning to their host governments to act as agents on their behalf, and the governments are going along with it. If this continues for a few more years, it will be difficult for any emerging financial centre to catch up with both of these for years to come. Additionally, Asian centres will definitely grow quickly due to domestic business, but their long-term ability to become truly global centres of commerce is not certain. For example, Tokyo has failed to become a truly global centre, though it is very large, because of its insular culture and inward-looking financial sector that has relied on the strength of Japan’s economy to fuel its stock market.
Only if emerging Asian financial markets and corporate structures fundamentally change can they compete for global business. One major reason Chinese firms, for instance, list in China is that the fundamentals of many Chinese firms are inherently flawed (often by design) and could not list in New York if they wanted to. State control – or partial or complete state ownership – of many Asian corporate entities is still persistent. A foreign company listing in China will not gain a value premium any time soon.
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US regulatory change promises to give New York a new edge over London as the financial market of choice, though both must fend off competition from emerging markets.