SECURITIES INDUSTRY ASSOCIATION ANNUAL MEETING
"The Role of US and European Capital Markets in Global Consolidation"
Don Cruickshank
Chairman, London Stock Exchange
Friday 9 November 2001
Good morning ladies and gentlemen.
It is a great pleasure for me to attend this conference and to be invited to address you.
In my speech, I'd like to touch on three areas.
First, to outline the key features of the UK securities markets – both the regulatory system and the markets of the London Stock Exchange.
Then to look at greater integration between the US and European markets on the basis of the highest standards of regulation.
Finally, to take some of the issues facing the US securities markets and talk about the extent to which they are reflected in Europe.
September 11
Before any of that, a word on the events of September 11 from a European perspective.
We want to pay our respects to our friends and colleagues in the US financial community who lost their lives. We feel their loss deeply.
We also want to pay tribute to those in leadership positions – such as Chairman Pitt, Dick Grasso, Wick Simmons – who did a superb job, even from our distant vantage point, of organising a return to business as usual.
The European markets remained open during September 11 and the days that followed. We felt that was right for all sorts of reasons, not least the ability of US investors, if need be, to invest through an alternative business centre – the European capital market. That was a tangible demonstration of the evolving global market and particularly poignant for us in London given the strength of our ties with New York.
The UK Securities Market
Let me talk now about the UK's place in the global market.
The City of London has for centuries been one of the world's most open and international financial centres.
- There are now more institutional funds under management in London than in any other city – over €2.8 trillion or the equivalent of the entire German Gross Domestic Product.
- And the London Stock Exchange is the global capital market of choice for over 500 international listed companies from over 60 countries, more than any other stock exchange.
We believe that a primary factor in attracting international investors to London - particularly the major US institutions - has been the development of a high quality and internationally respected system of regulation. That has been of critical importance particularly during a time of turbulence in markets.
UK Financial Regulation
And yet, during the last four years, we have been through a period of substantial reform and modernisation of our system of regulation.
The introduction of the UK Financial Services and Markets Act - just like your own Gramm-Leach-Bliley Act - has introduced a more flexible and modern approach. We share with you the view that legislation based on sound principles interpreted by independent professional regulators who are in touch with the markets is much preferable to detailed, ex-ante rules that can quickly become unnecessary, outdated and restrictive.
It may be helpful if I briefly describe our new system of regulation.
We now have a single regulatory body – the Financial Services Authority or FSA – which is responsible for integrated regulation of the financial sector. It is responsible for banking, insurance, listing of companies, securities, derivatives and commodities.
And I think it is interesting that a number of member states of the European Union are now looking to follow this model.
The FSA is one of the broadest based financial regulators in the world. We hope it proves to be as close to the market as the SEC has been during its long and distinguished history.
As far as securities markets go, the new system will build on an already successful model. London is already the European leader in such areas as market transparency, disclosure of corporate governance and dissemination of company information.
Institutional investors – the judges that really matter – view UK companies as being far more transparent than their European counterparts. On corporate governance standards, we score far higher than, say, Germany or France, and we are up there with the US.
London Stock Exchange
As for the London Stock Exchange itself, it is a public listed company and, properly, has no public policy regulatory role.
We are solely responsible for the admission to trading – what you call listing - of UK and international companies, and the supervision of secondary market trading activity. High standards of supervision and effective collaboration with the regulator and prosecuting authorities are the key to our reputation and, hence, commercial success.
There are significant differences between our own market structure and that of both NYSE and NASDAQ.
Our trading platform supports a wide range of order types, market models and reference data including SETS, our electronic order book, and a market maker system similar to that on NASDAQ. Over 99% of trading in UK equities is transacted through our markets.
Average spreads on our electronic order book are under 30 basis points.
Order book share - by value traded – is today 63%, the balance made up by internalised trades.
The rest of the market is supported by our quote-driven system and there is an alternative quote and order hybrid market for smaller companies.
A very successful development in recent years has been to create techMARK, Europe's leading market for innovative technology companies. techMARK is a market within the main market with nearly 250 constituent companies – companies with NASDAQ-type attributes – and tailored rules overseeing admission to trading. Last week, within the techMARK umbrella, we launched techMARK mediscience, the world's first market for healthcare companies.
Our alternative market – AIM - is our global market for smaller companies. Its entry rules have been designed to reflect the unique requirements of such companies. No trading record is required. There is no requirement for a particular percentage of shares to be in public hands. There is a less stringent regulatory regime, allowing businesses to learn to experience life as a public company without the full cost of compliance of the UK Listing – in US parlance registration - rules.
What about our US business?
Nearly 70 US companies with a combined market cap of over €2 billion have listed on London's main market. Trading in US equities represents 10% of all trading transacted in our international market and it's growing.
We offer trading in all of the world's major currencies. In fact, the euro is the most traded currency on our market - approximately 40% by value. That's more than sterling which has dropped to 30% of the total.
So, similarities in culture and standards, differences in market structures.
The US and Europe: Increasing Mutual Access
However, from a European perspective, the US capital market is still the deepest and most effective market in the world. But there is no reason why that depth and effectiveness cannot be reflected in Europe.
The next era can be an age of truly global access and competition. An international era, if you like, when SIA members and US exchanges take increasing advantage of global opportunity and when the European market is given the opportunity to engage more fully in the US market.
The interest is certainly there.
Nearly half of all US investors have some exposure in non-US companies. US holdings of overseas securities have increased eight-fold in the last decade. Flows in the other direction, holdings by foreign investors in US stocks and bonds are now four times the 1990 level.
So reciprocal access is not a one sided issue. The emerging European capital market can be big enough and liquid enough to compare with the US.
For example, at the end of 1999, the European Union had a total population of 374 million and a gross domestic product worth €9.5 trillion, not far off the US number. EU stock market capitalisation totalled 109% of GDP, less than the US 180%, but growing fast as the issuance of equities and bonds has overtaken traditional bank lending as the principal source of corporate finance in Europe.
Now, as the leading European equity market, the London Stock Exchange would like to explore whether US investors would value the choice of directly investing their funds on its markets. 'Directly' is the key word here.
But at the present time, it's just not possible. Rules have not yet been developed which would allow an overseas exchange to register with the SEC on the basis of mutual recognition and operate in the US market. Meanwhile, NASDAQ, the Chicago Board of Trade, the New York Mercantile Exchange and the Chicago Mercantile Exchange are recognised exchanges in the UK, principally on the basis of their registration in the US.
We believe that the UK system of regulation is of the highest standard and perhaps most akin to the SEC model anywhere outside of North America. If that's the case, then the most effective, lowest cost and expeditious approach would be for the SEC to recognise the UK Financial Services Authority's regulation of both the London Stock Exchange and UK listed companies as being of equivalent standard.
There are other routes and there are seeming obstacles like accounting standards – although approximately half of all FTSE 100 companies in the UK are registered in the US and must therefore prepare US GAAP accounts, and for a variety of reasons many others reconcile to US GAAP.
But the question is: do SIA members and their customers lose out from the lack of direct access to markets in the UK and Europe? Well, we don't know. It could well provide lower-cost trading in overseas securities and increased opportunities for US broker dealers.
However, you will notice that I've put all of this in tentative terms: "could be this, could be that".
I do so because the big issue here is what linkages between time zones do investors, companies and intermediaries actually want? If we opened for another few hours to allow trading in a limited number of stocks with potentially limited liquidity, would that be a service that investors would want, far less be economic to run?
Perhaps information flow and liquidity are so crucial to confident and informed trading in equities and derivatives of equities, that elimination of time zone creates high risk and more costly trading. That would be in no one's interest.
But perhaps not. My point is that is a debate worth having and it would be sensible to explore such developments practically, not theoretically.
Key Issues Facing the US, UK and European Markets
I'd like to turn now to two issues which are facing the securities markets and which SIA members have done much to progress this side of the Atlantic.
Section 31 Fees / Stamp duty
I'll start with one where I am sure to win your sympathies: the repeal of securities transaction taxes.
When I met Marc Lackritz in Washington earlier this year, one of the issues we talked about was our experiences on this front. He told me about the progress SIA members had made in creating a consensus across the political spectrum to reduce Section 31 user fees at the same time as ensuring that the SEC was properly funded.
I know that the SIA supports passage of the House's Investor and Capital Markets Fee Relief Act to avoid a time-consuming conference with the Senate's Competitive Market Supervision Act.
The issue has not been settled yet but the consensus for action across both parties is obviously there.
I wish the same could be said of our own situation in the UK.
First of all, our securities transaction tax is called stamp duty. As you may recall, a tax with the same name and same principle led to the Boston Tea Party and began the process of losing us one important market in the eighteenth century. It may well have the same impact if left to fester in the next few years!
The tax is levied by the UK Treasury at 0.5% - yes 0.5% - on purchases in the shares of UK companies, a rate unchanged since 1986. That's 150 times higher than your own Section 31 fees.
The major obstacle remains not as you would expect the competitiveness of the UK equity market – the only country in the G-7 with such a high rate. It's how the Government can afford to let go of the high annual revenues that it brings in – €7.5 billion at the last count but pro rata to the US economy, think $50 billion!
We've made strenuous efforts to elicit a commitment to abolition from the UK Government on the grounds that it would
- boost investment by UK companies by around €5 billion a year; and
- generate significant compensating revenues from income and corporation taxes.
And we've made some progress. Now it's just wait and see. The UK Government's interim Budget statement takes place shortly and I'm pleased that we have received such strong support from the SIA.
T+1 / European Clearing and Settlement
Let me turn to clearing and settlement, an issue that I have taken a particular interest in since I became Chairman last year.
While I would argue that our trading systems are equally competitive, the United States is without doubt far ahead of Europe in the area of clearing and settlement. In fact, the cost for every post-trade user transaction is, on average, around 7 times higher in Europe.
There are two huge barriers to achieving reform.
First, the current structure of European clearing and settlement is so fragmented as to make any vision of a truly European capital market hopeless if the situation persists. To link all the exchanges and Central Securities Depositaries in Europe would require over 600 separate bilateral connections.
Second, there is little incentive for CSD providers to act because more often than not they are owned or part-owned by stock exchanges and provide a valuable source of revenue. Echoes of the 70s in the US before the SEC acted to create what is now the DTCC.
At the London Stock Exchange, we don't own a clearing and settlement business. Our interests in this particular case are therefore primarily aligned with companies, investors and broker dealers. It is important to make that clear distinction.
This aligned ownership of exchange and CSD – what I would call the vertical silo - is an unstable structure that cannot possibly be relied upon to deliver an efficient market structure in Europe.
Indeed, intervention is required to ensure that exchanges cannot distort competition in exchange services by leveraging their ownership of, or other close relationship to, clearing and settlement systems.
You had this debate in 1975 when the SEC came down in favour of a well governed utility, now the DTCC. We've calculated that a single pan-European clearing and settlement system, operating at a similar efficiency to that of the DTCC, could have produced savings of around €1.6 billion in 2000, or 89% of the European clearing and settlement systems' current revenues.
I'm pleased that the G-30 and the European Securities Forum support our initiatives in this area. The Competition directorate of the European Commission – the equivalent of your Department of Justice - is also investigating anti-competitive behaviour.
In the round, I see significant changes for the better in the next few years. It would certainly reduce enormously the cost to US firms of setting up a truly pan-European business.
Conclusion
So to end.
I've hopefully given you a clearer understanding of the make up of the London market; of our aspiration for greater ties with the US market; and of two key competitive issues facing the European market.
I'd like to close my remarks with a call for your support.
There is a philosophical debate taking place today about the future development of the European securities market.
In many ways, it is between what may crudely be termed US and UK standards of regulation – including high transparency and disclosure – and a more restricted corporatist outlook that exists in other European countries.
The European Commission and the Lamfalussy Committee - which looked at the future of European regulation - have recognised that a 'Fortress Europe' approach is misplaced, that we need consistent and internationally respected standards of regulation to continue to attract international – for which read US - institutional investment.
Yesterday, in fact, to demonstrate my point, the whole consolidation process looks to have been set back by the opposition of a single political grouping in the European Parliament. I note that the group in question chose to meet behind closed doors to reach its decision. No commitment to transparency there.
Many SIA members have an important stake in seeing that the debate is resolved to the satisfaction of the US / UK approach, particularly within the clearing and settlement area. I believe that those of you who have a stake – or may look to have a future stake – in the European market should keep abreast of this debate and, where necessary, make your views known and heard.
I would be interested to hear your views myself on the issues I've touched on. I'd welcome your comments, in particular, on whether direct access to markets such as the London Stock Exchange would be an attractive option for your businesses and customers.
Once again, thank you for inviting me to speak at your conference.
