Cultural club

Globalization is pushing markets and stock exchanges to consolidate, and the broadening scope of collaboration indicates a convergence of regulations may also be near. Speculation abounds that stock market mergers will involve more than just technological collaboration, and all eyes are on the NYSE-Euronext link-up. As early as 2004 Alan Beller, then Division of Corporation Finance director at the SEC, called for a global approach to market regulation. The movement appears to be underway, with UK-style shareholder responsiveness influencing US companies and US regulations like Sarbanes-Oxley pushing regulatory reforms globally.

Unsurprisingly, strict US regulations are the most common point setting off debate. One moment Sox is blamed for huge increases in costs leading to the loss of international listings on the NYSE and other US exchanges, the next it’s named a beacon for investors concerned about the more loosely regulated markets like the London Stock Exchange’s Alternative Investment Market. The pendulum swings daily between arguments to strengthen or slacken regulations internationally.

New alliances

Larry Tabb, CEO of Tabb Group, points out that because companies are already struggling to implement US Regulation National Market Systems (NMS) and Europe’s Markets in Financial Instruments Directive (MiFID), no one wants to talk much about global regulatory convergence just now.

Yet the NYSE is forging ahead with consolidation, signing a memorandum of understanding (MOU) late January with Euronext regarding recognition of some listing regulations for companies on the Mumbai, India-based National Stock Exchange, of which NYSE owns a 20 percent stake. The Tokyo Stock Exchange is also making headway signing MOUs with Euronext and the NYSE and forming alliances with South Korean and Chinese exchanges.

The NYSE has said it will confer with Euronext on issues in the realm of technology and investor protection. NYSE spokesman Scott Peterson says flux in the US regulatory environment won’t affect Euronext, but not everyone is convinced.

Several significant structural changes affecting the way NYSE regulates its listed companies are pending: In the second quarter 2007, the National Association of Securities Dealers (NASD) and NYSE will become one self-regulatory group, temporarily named NUCO. ‘Trade on the US exchange will be regulated by NUCO … trading that happens on the NYSE will be surveyed by market surveillance, and they’ll stay with the NYSE,’ says Peterson, adding that the College of Euronext Regulators will separately regulate NYSE Euronext trading that occurs in Europe.

Initially, business lobbying group Paris Europlace was wary that US-style regulation would still creep into the European marketplace. So it conducted a study, which ended up dispelling fears that US regulations would infringe EU structures. So even the querulous are gaining enthusiasm about the merger, which will allow US companies to list their shares in Europe and European investors to more easily purchase US stocks.

Inevitably tensions will arise when amalgamating two systems. Elsewhere some countries are pushing through conflict by intensifying commitments to regulatory progress. Japan is ‘in the process of moving from unwritten statements and specific guidance from ministries to a much more here is the law approach,’ says Grant Kirkpatrick, a senior economist at the Organization for Economic Cooperation and Development (OECD). He adds that though the road to more formal rules has been difficult, legislation is gaining clarity. For example, Yoshiaki Murakami’s closely watched 2006 arrest for insider trading in Nippon Broadcasting System shares solidified Japan’s conviction for progress in this area.

Institutional Shareholder Services (ISS) executive vice president and special counsel Patrick McGurn says there is tremendous variation in critical market issues ‘like transparency, accuracy of the financial statements, shareholder voting rights [and] baseline corporate governance’ across countries. Foreign investors respect local regimes and even borrow from them, he says, noting that Europe has already modeled some of its reforms on those exercised in the US.

Assurances from exchanges, particularly those in the UK and the rest of Europe, do not always appease companies. The simple fact remains that the US is the largest single capital market in the world and as investors become accustomed to greater transparency and empowerment that now exists in the US they will demand the same from overseas companies and markets. In the race to attract capital market inflow regulators may be faced with little to no choice but to heed these demands.

It’s a cultural thing

While there is doubtless significant financial pressure for greater regulatory cooperation regulations are much more than ascetic rules borne out of economic regimes; they reflect culture. And disparity between cultures makes simultaneously abiding multi-jurisdictional regulations trying. Sometimes concepts embraced in one place don’t translate elsewhere.

Take the case of France which had a hard time letting go of its anti-whistleblower practices, a holdover from World War Two when they were in place to protect French patriots. There was a standstill when the government tried to keep US-based companies from installing whistleblower hotlines even when Sox compelled them. Eventually in 2005 the Commission Nationale de L’Informatique et des Libértes (CNIL) began to allow hotlines but the rules regarding their application remain different from what is required in the US.

Still, recent studies laid bare the potential cultural dissonance on the subject. ‘When we had a first version of the principles … we used the term whistleblower and the French translation came in as denonciateur,’ says Kirkpatrick, adding, ‘in Japanese the word’s even worse.’

The difficulty arises when national regulators insist on applying their own rules. When a number of US companies implemented whistleblower systems in all jurisdictions in which they operate, some were fined by regulators in other markets. The companies cried foul because had they not taken this course of action they would have been fined by the SEC. This is an archetypal example of the rock and a hard place scenario. There are only three solutions to this problem. Either one country agrees to waive its requirements, both countries implement the same rules – also unlikely, or the two bodies get together to agree a compromise.

At a recent Society of Corporate Compliance and Ethics workshop, Adam Turteltaub, corporate relations executive for LRN, mentioned ‘bribery used to be tax deductible in Germany’ as another example of divergence.

Yet as investing across foreign borders becomes easier and perhaps more necessary, investors may start to push for a common regulatory environment and pressure for specific reforms. Majority voting in director elections is a prime example of an idea that will cross borders. Tabb thinks in the long-run it’s the corporations that will benefit most because ‘as exchanges consolidate … they’ll be able to raise capital from a wider number of marketplaces much more easily.’

The right environment

Investors’ ability to shape regulation will differ by nation. McGurn cites concentration as a key market differential. ‘You could fit the majority of UK holders into a phone booth,’ he says. ‘But when you come to the US it becomes a rose bowl.’ Its ‘breadth and its depth,’ which McGurn considers its greatest benefit, also limits ‘coordinated shareholder action.’ Where there is a greater degree of concentration, shareholders are more likely to be able to directly influence corporate management. Kirkpatrick takes Sweden as an example where ‘the major shareholders basically appoint the board,’ and can get rid of directors easily. There may be less need for strict regulation in such markets because shareholders already have a significant level of influence, he says.

While a lot of focus is put on US-style rules being adopted in international markets, some facets of the European regimes are finding their way back to the US. It is arguable how effective such systems will be in the US, but the UK’s ‘comply or explain’ model is gaining some support. Coordinating a principals-based with a rules-based approach could pose hurdles. Whether majority voting and ‘say on pay’ will have the same impact in the US as in the UK is also debatable since the relationship between companies and shareholders in the US tends to be more adversarial than collegial.

The underlying relationship between investors and corporate management may make the adoption of a principles-based approach in the US difficult. The system, as it exists in the UK, relies on the existence of effective lines of communication between the companies, shareholders, exchanges and regulators. If a company is unable or unwilling to comply to a particular regulation it must explain the business reason for doing so. If all stakeholders accept the explanation then the issue is resolved. The relationship between the various stakeholders in the US is far more strained. Strict regulation like Sox is often seen as necessary to achieve a minimum standard of compliance. Proponents of the UK system highlight that it is more about complying to the spirit of the rules and that it is, even in the US, possible to comply to the letter of the law but still not be in great compliance.

Despite the underlying differences some level of coordination is already underway. Shortly after Arthur Levitt called for a ‘comprehensive proxy access plan’ at the ISS Pre-Season Briefing, SEC chairman Christopher Cox announced that he would make a statement on proxy access in time for the 2008 annual meetings. Maybe the SEC will follow Levitt’s other recommendations too: ‘promote majority voting as a best practice’ and embrace the ‘UKs non-binding shareholder votes on executive compensation.’ Rich Ferlauto, director of pension and benefit policy at the American Federation of State, County and Municipal Employees and chief proponent of say on pay and proxy access thinks ‘commonwealth countries and the Scandinavian countries’ will influence the reforms in the US and will also put an emphasis on ‘increasing shareholder rights … as an important part of US competitiveness.’

Impact of globalization

Darla Stuckey, corporate secretary for American Express, says that governance styles prominent in the UK have already influenced her company: ‘We certainly see shareholder proposals for votes on the compensation committee report … so there certainly is a push by certain shareholder activist groups to pick things that they like that are done in other countries’ markets.’ But this isn’t a side effect of the NYSE buying Euronext, she says, ‘it has to do with the fact that we’re now more of a global economy.’

Exchange and government regulation is only one part of the picture, however. One of the biggest challenges multi-national companies and cross-border investors face is dealing with varying auditing and accounting regimes. In response some nations are already moving closer together on the accounting front in adopting international financial reporting standards (IFRS). The US, somewhat behind in this effort, has committed to IFRS-Gaap convergence as both the Public Company Accounting Oversight Board (PCAOB) and Financial Accounting Standards Board (FASB) are agreeing to advance convergence efforts. A number of in-person meetings have been held between FASB and European counterparts. And the EU molded some of its auditing requirements to the US’ via the Financial Services Action Plan and the 8th Company Law Directive.

Under pressure

As with the accounting standards, there may be a middle ground reached on shareholder rights as well. A recent report from the Committee on Capital Markets Regulation led by Glenn Hubbard suggests securities litigation in the US is too easy. And as US lawmakers consider restricting the ability of shareholders to sue companies, countries like Australia, Germany and the UK are increasing shareholder and consumer rights in these areas.

Although achieving common ground has significant benefits for shareholders and companies, stock exchanges themselves may lose some of their comparative advantage since they have been using their differing regulatory regimes to compete for listings. The creation and success of London’s AIM, which has a much less restrictive set of compliance and disclosure requirements, is a prime example.

The exchanges may not necessarily be coming together out of a natural inclination to converge in an era of globalization, McGurn says, but could be ‘more of a response to the market forces faced by those markets as businesses themselves.’

He thinks that the NYSE union with Euronext and also Nasdaq’s bid for the LSE are really attempts of the exchanges to ‘diversify their market offerings.’

In any case, the business argument for greater access to overseas capital markets is undeniable in this global age. The problem is that many shareholders fear that, as companies list in foreign jurisdictions, the temptation will be to relax transparency and disclosure standards. In other words, a race to the lowest common denominator. Others are concerned that enshrining these protections in a rigid legal framework will greatly increase costs and damage short and long-term corporate revenue – and thus erode shareholder value.

There may always be tension between the extremes of relaxed and strict regulation. It is likely, however, that the best outcome will be a combination of the two prevalent systems – the rules-driven model of the US and the ‘comply or explain’ approach of the UK. Ferlauto hopes that mix will advance a global ‘balance between regulation and shareholder empowerment.’