Monday, 20 November 2006

The pitfalls of market regulation

Here's some interesting news this morning from London. The NASDAQ has made a proposal to buy the London Stock Exchange. The LSE has rejected the first offer, but analysts are saying they expect this deal to eventually go through.

This is interesting for a variety of reasons. This will now mean that two of the major stock exchanges in Europe will be owned by American exchanges. The New York Stock Exchange has just about completed its acquisition of the Euronext, a Paris-based Europe-wide exchange.

So at first glance this would look like bad news for Europe and good news for the US right? In fact, it’s the opposite. It’s important to point out that the reason these acquisitions are happening is not because the US is riding in on a white horse to prop up the European exchanges and help them grow. They’re grabbing them because the European exchanges have been so wildly successful in the past few years, outperforming their American counterparts.


A new regulatory oversight was placed on public US companies in the form of the Sarbanes-Oxley corporate governance law in 2002. It was enacted in response to the headline corporate scandals at that time, most notably the collapse of Enron. The law requires publicly-traded companies to hire an independent auditor to verify how well their procedures for publishing accurate financial statements work. But small businesses have complained that the cost for these extra requirements are so prohibitive that it prevents them from going public. The result has been that more businesses are offering themselves to private equity firms for buy-outs rather than go for an IPO. But American businesses have also been increasingly listed on foreign exchanges, especially the Alternative Investment Market (AIM), which is part of the London Stock Exchange. In my reporting on technology and life science start-ups the AIM is constantly coming up, as it has had a great degree of success with IPOs while the US IPO market has remained stagnant.

Another interesting thing about these stock exchange acquisitions is that because of US protectionism, the opposite could never occur. The London Stock Exchange could never acquire the NASDAQ because US law is so unfriendly to foreign acquisition for things like stock markets and public works. On the contrary, Europe is very open to these foreign acquisitions.

The challenge in today’s global economy is that when you increase regulation domestically, businesses can just move to a different area that isn’t regulated. We’re seeing it happen over and over again. The largest EU nations have strict labor laws, so many companies are moving their facilities and plants east. The US is tightening business oversight for public companies, so companies list on foreign exchanges. Every action seems to have an equal reaction, which is making countries hesitant about regulation, even in Europe. I worry that this could eventually cause a free-market tidal wave where no country is willing to regulate because they fear losing business to foreign competitors, a sort of keeping-up-with-the-Jones’ global scenario. But if governments lose their ability to regulate economic activity we could be looking at a world completely controlled by business interests, which are inherently not looking out for the best interests of the citizenry.

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