The ability of the US financial sector to compete in an ever more global industry has become a hot topic of late (see my earlier posting). At noon today, Treasury Secretary Paulson gave what was billed as a major speech on the Competitiveness of U.S. Capital Markets. In it he asked the key question: “Does the decline in initial public offerings in U.S. capital markets signal potentially broader challenges to our competitiveness?”
His answer was a conditional yes:
Some observers cite the decline of foreign IPOs in the U.S. market as an indicator of the competitiveness of our capital markets. We should go beyond the numbers and examine some of the possible reasons for this decline. Several factors contribute to the recent trends, including public policies in other countries. But several other contributing factors offer a framework to assess our own capital markets. These include:
* The development of markets outside the U.S., particularly in London and Hong Kong – and the ability of U.S. investors to participate in these offerings;
* A legal system in the U.S. that exposes market participants to significant litigation risk;
* A complex and confusing regulatory structure and enforcement environment;
* And new accounting and governance rules which, while necessary, are being implemented in a way that may be creating unnecessary costs and introducing new risks to our economy.
Concerning the rise of markets outside the US, he was positive:
A number of foreign exchanges have also aggressively embraced technology and developed innovative business models that increase efficiencies and reduce costs to investors in their markets. These competitive forces have spurred responses in our country. In the most recent example, the Chicago Mercantile Exchange and Chicago Board of Trade announced plans to merge and offer investors a broader range of exchange-traded derivatives, with the goal of creating efficiencies in technology and operations.
On the legal system, he was less positive. He first mentioned the strength of the US:
A sophisticated legal structure – with property rights, contract law, mechanisms to resolve disputes, and a system for compensating injured parties – is necessary to protect investors, businesses, and consumers.
However, he ended with repeating an age old refrain:
Simply put, the broken tort system is an Achilles heel for our economy. This is not a political issue, it is a competitiveness issue and it must be addressed in a bipartisan fashion.
But it was the regulatory and accounting systems which were his focus, including Sarbanes-Oxley. Unlike some, he did not put all the blame on Sarbanes-Oxley, but looked at the balance needed to operate the entire system.
Most importantly, he did not advocate any specific short term fix. Instead, he laid out broad principles and announced a Conference on Capital Markets and Economic Competitiveness to be held next year. Those principles include:
First, it is necessary to take a global view. We don’t operate in isolation, so it is very important to consider how changes we make affect the ability of our companies to compete globally and how these changes affect our interaction with markets and regulators around the world.
Second, our regulatory structure should be more agile and responsive to changes in today’s marketplace.
Third, to stand the test of time, rules should be embedded in sound principles.
Fourth, regulators should take a risk-based approach to regulation, weighing the cost to shareholders against the benefits.
Fifth, our enforcement regime should punish and deter wrongdoing and encourage good behavior without hindering responsible risk-taking and innovation.
And, lastly, the best way our business leaders can protect the integrity and competitiveness of our markets is to exert moral leadership, where the threshold question is, “Is this right?” not “Do the rules allow us to do this?”
I am especially heartened to hear of the conference. There are a number of issues which the financial markets need to confront that have not been on the so-called “reform” (i.e. the anti-regulation) agenda. These include the short-term nature of the markets in the face of the need for long-term, patient capital and the rise of intangibles as a new asset class.
As we move deeper into the I-Cubed Economy, intangible assets will become more and more important in the financial markets (which is the subject of an ongoing Athena Alliance research project). The conference will need to confront this new reality if it is to be anything more than a look back at the past.
The Secretary has laid out a path. It is up to the rest of the financial community to follow.