As New York City and the Congress look at the competitiveness of US financial services and regulatory “reform” (see earlier posting), I hope they include all voices — including the customers of those services. One of the major customers is the investor community. And the investor community is not so gung-ho to “reform” the system, especially when it comes to Sarbanes-Oxley, as Business Week reports in Not Everyone Hates SarbOx:
Not so fast, says a growing chorus of investors. Lost amid all the boos over SarbOx, they say, are some major benefits. The biggest: SarbOx and related reforms have produced much more reliable corporate financial statements, which investors rely on when deciding whether to buy or sell shares. For them, SarbOx has been a godsend.
What’s more, says Duncan W. Richardson, chief equity investment officer at Eaton Vance (EV ) Management and overseer of $80 billion in stockholdings, even the act’s much disparaged requirements for testing internal financial controls could drive gains in corporate productivity and profits. Says Donald J. Peters, a portfolio manager at T. Rowe Price Group (TROW ): “The accounting reforms have been a win.”
Earnings will be on investors’ minds over the next several weeks as most corporations announce yearend results. The numbers will include results tallied under generally accepted accounting principles and, thanks to a Securities & Exchange Commission regulation adopted during the reform years, they’ll also come with reconciliations to any nonstandard or “pro forma” numbers that companies use to try to spin their results. The reconciliations, says Peters, are “extraordinarily” helpful. “It is [now] much easier for me to have a view of the true economics” of a company, he says.
Beefed-up disclosure requirements have also meant that companies now deliver numbers with fewer adjustments for unusual charges and write-offs, which in the past have been used to make earnings look better. Thomson Financial’s (TOC ) Earnings Purity Index, which tracks earnings adjusted for such write-offs, shows improvements in each of the past four years. And now earnings reports reflect expenses for incentive stock options, information investors like that wasn’t available before the big accounting scandals.
Just as important, executives appear to have a firmer grasp of costs when they talk about operating margins, according to Richardson of Eaton Vance. He credits the improvement to the infamous Section 404 of SarbOx, which requires documented testing of internal controls. “Even not-so-good management teams have good controls now, and that leads to an ability to cut costs,” he says.
One of the strengths of the US capital markets is the people from all over the world are still willing to sent their money here. They generally trust the system. Weakening that trust is not a way to strengthen the system.
Likewise, as I have stated earlier, it is not clear that regulatory tightening is the sole or major cause of the problem. As the Wall Street Journal reports – In Call to Deregulate Business, a Global Twist – WSJ.com, the standard answer so far has been blame the regulations:
Yet this position, which has gone largely unchallenged, downplays a different explanation for why U.S. exchanges are under pressure — the changing nature of global finance. Stock markets around the world have become better and deeper, encouraging companies to seek IPOs in their home market. Trading across borders has become simpler, cutting the prestige and usefulness of a big-country listing everywhere. And private-equity buyouts are a global phenomenon, not a uniquely American one.
Meanwhile, other countries are stiffening their own rules, bringing them closer to the U.S. model.
. . .
There’s little doubt U.S. exchanges are facing increasing competition. They’re losing out to overseas exchanges for initial public offerings. Many overseas companies are deciding they don’t need an American listing. And in the U.S. itself, many companies have decided they’re better off private.
Taken alone, the cost of regulation can’t explain what’s happening to U.S. financial markets, and paring regulations might not alter the outcome, except to give a helping hand to Wall Street.
Jenny Anderson, the New York Times “Insider” columnist, notes About Those Fears of Wall Street’s Decline … :
Some of these claims make sense. Others do not. For starters, there is a fixation on data showing that initial public offerings are gravitating to London and China. This data seemed problematic: smaller companies are listing in London because there is a market there that boasts of having virtually no regulation, a benchmark the United States should not lower itself to meet.
And larger companies, especially Russian and Chinese ones, are increasingly staying home or going to London to raise capital, which can be attributed to factors like London’s being in a better time zone.
More important, the main reason companies are listing in their home markets is that globalization is not a lofty theory but has truly produced more competitive global markets. That means more companies will choose not to trek halfway around the world to raise money — especially when fees in London are half that of the United States.
By the way, Brad Selzer inadvertently underscores the changing situation of the US financial services sector when he states (in RGE – Yet more evidence that emerging markets cannot create the financial assets their citizens want to hold …):
Indeed one of the big (underreported) stories of the past few years is how savers in emerging markets are increasingly willing to hold their savings in the local banking system in local currencies despite low nominal interest rates (China) or low nominal and negative real interest rates (Russia). It has been better to get low returns in the local bank than to hold (depreciating) dollars.
Foreign investors — private investors that is — have also been quite keen to put funds into emerging market financial assets.
That is the basic problem I have with all theories that attribute the uphill flow of capital to financial underdevelopment. Right now, emerging markets don’t seem to be having any trouble generating financial assets that their citizens want to hold, or that foreign investors find attractive.
If foreigners are don’t need/want to buy what we have to sell, the financial markets are going to lose vis-a-via other markets. That is the essence of competitiveness.
The question of improving US competitiveness in financial services is an important — and ongoing — question. One of my earliest research projects was an Office of Technology Assessment study in the 1980’s on International Competition in Services – which included banking and financial services (although I didn’t work on that part of the study). That report found a combination of regulation, technology and the maturation of foreign markets to be the major drivers behind slipping US competitiveness in financial services. And the policy options included increased international regulatory cooperation.
The OTA study provided a broad look at the issue. We need to continue to take a broad look as we approach the issue. Otherwise, we will have piecemeal changes that may simply make the problem worse.