Friday, December 08, 2006

It's time for 'better regulation'

In recent months there appears to have been somewhat of a backlash against over-regulation. The US is indulging in some long overdue navel gazing with US Treasury Secretary Henry Paulson weighing in on the debate by saying that the US capital markets "face significant challenges" and that Sarbanes-Oxley may have gone too far.

The Committee on Capital Markets Regulation further inflamed the debate with its publication of 32 recommendations for making US capital markets more internationally competitive. It also published some startling figures which suggested that over a period of five years, the value of global initial public offerings raised in the US had declined from 50% in 2000, to 5% in 2005.

Of course, the US is only probably just waking up to the fact that they are no longer the epicentre of capital raising for companies and that listing on an exchange is not quite the badge of honour it used to be for companies particularly in those markets where compliance is onerous.

I think it may be a slight overreaction given that US investment firms like Goldman Sachs, JPMorgan et al still underwrite a number of the deals that take place, but the competition as to where to list may be hotting up again and the US may not necessarily be able to have it all their own way.

The Committee on Capital Markets Regulation may have some problems getting its recommendations drafted into law, as there is only two years of the Bush administration left to serve and me thinks Bush junior may have his hands full 'cherry picking' from another set of recommendations on how to get the US out of Iraq without any more egg on their face.

At least the SEC has correctly gauged the general mood and is expected to announce on 13 December revisions to the onerous Section 404 of the Sarbanes-Oxley Act (SOX), which requires companies to audit the effectiveness of their financial control procedures. Also it is expected to announce that it will make it easier for foreign companies with more than 300 shareholders that are US residents, to withdraw from US regulatory oversight if they wish to do so.

Interestingly, before SOX came into effect, the SEC was by law required to conduct a cost/benefit analysis of the regulation's impact. But it appears no analysis anticipated the spiralling costs associated with Section 404 compliance.

Could all of this hold some interesting lessons for the UK and European markets where regulations such as MiFID, which comes into effect next November, could cause the same backlash as SOX has in the US?

Like the SEC, the FSA is also required to conduct a cost/benefit analysis of regulations. It has done that for MiFID estimating that there will be a "one-off" cost of between £870 million and £1 billion with ongoing costs of around an extra £100 million a year, although this is likely to vary from firm to firm. Click here for more info on the FSA's analysis of MiFID.

According to the FSA, some of the largest MiFID-related compliance costs are one-off costs arising from the introduction of changes to client categorisation and best execution requirements. However, the benefits in all these cases are difficult to quantify as the rationale behind implementing regulations such as SOX and MiFID is to protect the investor not to make life easier for the companies that service these investors.

While no one will argue that greater transparency is needed around the costs of trade execution, will MiFID like SOX go too far and force companies to spend more time on compliance than actually running their business? Furthermore, whilst the UK and the US conduct cost/benefit analyses before regulation is implemented, other European regulators are not required to do so. Surely that has to change.

The International Securities Market Association appears to be on the right track with its 10 "Principles for better regulation," which has been endorsed by the International Capital Market Association. The principles are based on the belief that in the case of a market failure, regulators should determine whether current regulations or market forces will sort the problem out before putting pen to paper on a new set of regulations. The question now is, will the International Organisation of Securities Commissions (IOSCO) support these principles?

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