Can the U.S. Remain An International Financial Center?
For as long as most of us can remember, the U.S. capital markets have been the envy of the world, promoting the free movement of capital and propelling innovation and growth within a framework of stability and the rule of law. But can the U.S. remain an international financial center? To be blunt, the answer is no-at least, not without major reforms. This may surprise many who are comfortable thinking of the U.S. capital markets as the envy of the world. But increasingly, our foreign counterparts view us not with envy, but as a cautionary tale.
Concerns regarding the competitiveness of our capital markets predate the financial crisis; indeed, the crisis-which affected the U.S. and E.U. capital markets far more than those in other parts of the world-both exacerbated the problem and diverted attention from it. In the mid 2000s, one group after another, including a bipartisan commission at the U.S. Chamber of Commerce, Bloomberg-Schumer, and the Committee on Capital Markets Regulation-led by one of the co authors-issued reports expressing deep concern over the declining international competitiveness of the U.S. securities markets.
The arrival of the financial crisis, however, pushed the question of U.S. capital market competitiveness aside. The Dodd-Frank Act was a massive response to the crisis mainly focused on the banking system, but it also contained some new regulations, like the Volcker Rule, that diminish the ability of our major financial institutions to participate in the markets, thus negatively impacting their liquidity. In addition, Congress mandated new ideologically-motivated rulemakings, such as the not-so-crisis-related conflict mineral disclosure requirements, that create added burdens on public companies.
The results, as illustrated by two reports out this month, are sobering. Our historical competitor London has apparently once again eclipsed New York as the top global financial center, despite having abandoned its traditional "lite" touch regulation. But even more worrisome, the U.S. must now compete with major markets such as Hong Kong, Singapore, and Shanghai, the first two of which yet again are beating the U.S. in terms of "financial market development," according to the World Economic Forum's newest Global Competitiveness Report. In addition, there are new emerging international financial centers (IFCs) designed to promote their countries' financial sector and the development of their capital markets through regulatory regimes designed to entice issuers and investors from more developed markets. Singapore has become a thriving financial center in just over four decades; it is now home to over 700 financial institutions, maintains liquid capital markets, and specializes in asset management. And the Dubai IFC, which recently celebrated its 10th anniversary, has a distinct legal system and is home to over 1,100 active registered companies. We should welcome this competition, but we must meet it head-on, through introspection and innovation, lest we continue to see our position slip. Unfortunately, this has not been occurring: the Committee on Capital Markets Regulation has found that the U.S. share of equity raised globally has declined from 50% in 2012 to 31.5% in 2014.
So what should be done? By focusing on smart, tailored regulations we can do much to improve our standing without diminishing protections. The Securities and Exchange Commission (SEC)-where one of the co-authors currently serves as a Commissioner-should focus on eliminating the red tape that prevents small businesses from accessing our capital markets to grow and create jobs; it should implement the JOBS Act enthusiastically, not begrudgingly. The SEC should also continue to improve its cost-benefit analysis to account not only for the direct and indirect impacts of the rule being analyzed, but also the burdens of the overall regulatory framework imposed on market participants, and whether those rules impede capital formation. For example, one of the worst consequences of Sarbanes-Oxley Section 404 was that it deterred small companies from going public and resulted in fewer incentives for venture capitalists to support the formation of small companies, which remain the engine of our economic growth.
We need a renewed focus on eliminating duplicative or counterproductive regulation. Due in large part to the burden of implementing Dodd-Frank Act rulemaking mandates, the SEC has failed to comply in any meaningful sense with President Obama's 2011 Executive Order requiring independent agencies to undertake a retrospective analysis of their rules. Consequently, many SEC requirements remain outdated and not fit for current purposes.
Finally, we should improve competitiveness through securities class action reform. Issuers that brave our burdensome regulatory regime are frequently "rewarded" with securities class action litigation. The negative impact of these lawsuits cannot be underestimated as companies increasingly must allocate resources and money to defend against often-frivolous allegations-or avoid our public capital markets entirely. These actions result in trivial recoveries for shareholders and fail to deter corporate wrongdoers. One solution would be to allow shareholders to substitute non-class arbitration for securities litigation.
The U.S. can and should be the global capital markets leader, but that status should not be taken for granted. On our current path, we risk losing our competitive edge.
In the words of the 2006 Committee on Capital Markets Regulation report, "What is needed is the proper balance among mechanisms that protect investors-regulatory laws and rules, the activities of the courts and regulators, shareholder voting rights-and the cost, burden, and intrusion that these mechanisms inevitably impose on firms and individuals that participate in the capital markets."
Nearly a decade later, that prescription is still the right medicine.
