Saturday, February 10, 2007

The Weak Case for Regulatory Reform Gets Even Weaker

At the heart of recent calls for regulatory reform in the Interim Report of the Committee on Capital Markets Regulation and in the Bloomberg/Schumer Report is the assertion that the U.S. securities markets are losing global IPO marketshare because of supposed regulatory overkill and the litigious environment in the U.S. Accompanying this assertion is the concern that foreign securities markets (particularly in London) are supposedly attracting IPO activity by their comparatively light regulatory touch. Reform of the U.S regulatory approach and litigation system is needed, these Reports assert, so that the U.S. can recapture a larger share of the global IPO activity.

The D & O Diary has previously presented (most recently here) its belief that the reformers' case for regulatory reform is “weak.” More recently, events both overseas and in the U.S. further belie both ends of the reformer’s premise – that is, these recent events suggest that companies (even foreign companies) may yet seek to list on U.S. exchanges, in preference to other exchanges, even without regulatory reform; and that companies might not be able to count on a lighter regulatory touch on competing exchanges.

1. London’s Attraction To (or Appetite For) Russian and Chinese Companies May be Waning:

Photobucket - Video and Image Hosting A very large part of the London markets’ success in growing their share of the global IPO market in recent years has been based on their success in attracting listings from Russia (and other former Soviet republics) and from China. Indeed, in 2006 alone, 12 offerings by companies from Russia or other former Soviet republics raised proceeds of nearly 6.6 billion pounds. But now in early 2007, the bloom very much seems to have gone off the rose for Russian offerings in London. As reported in a February 8, 2007 Financial Times article (here), the listing of the shares last week of two Russian companies (Polymetal and Sitronics) came in at the low end of the offering range and in response a third company, GV Gold, withdrew its offering amidst “lackluster demand.” According to the Financial Times article, these developments “underline the increasingly tough environment companies from Russia and other former Soviet states are likely to face this year as investors become increasingly selective.”

At the same time the pipeline of Russian companies to London has started to slow, two Chinese companies, 3SBio and JA Solar Holdings, completed successful offerings on NASDAQ.

Without the flood of Russian listings, and with Chinese companies successfully listing in the U.S., the apparent market share advantage enjoyed by the London exchanges could be diminishing

2. The Successful Fortress Investment Group IPO Will Attract Additional Hedge Fund and Private Equity Fund Listings on U.S. Exchanges

Photobucket - Video and Image Hosting Fortress Investment Group’s successful February 9, 2007 IPO was not the first public offering by a private equity fund or hedge fund, nor was it the largest. But it was the first public hedge fund offering on a U.S securities exchange, and it was the most successful. According to the February 10, 2007 Wall Street Journal (here, subscription required) 19 private equity and hedge fund firms sold shares in 2006 on foreign markets, raising $12.4 billion. U.S. groups have been among the firms to list their shares in these offering. KKR, for example, sold shares in a private equity fund on the Euronext Amsterdam exchange. But the KKR fund shares trade in a narrow range close to their offering price.

Fortress chose to list its shares on the NYSE, notwithstanding those supposedly prohibitive regulatory constraints that are driving companies away from the U.S. securities markets. Its reward was that its offering priced at the top end of the range and its shares jumped 68% in the first day of trading. Commentators can argue all they want about whether regulatory burdens are deterring companies from listing on U.S. exchanges, but high valuations and a successful debut like Fortress Investment Group’s will unquestionably attract companies to list on U.S. exchanges.

The title of the Wall Street Journal's February 10, 2006 article about the offering, "Hedge Fund Crowd Sees More Green As Fortress Hits Jackpot with IPO" (here, subscription required) says it all. Along those lines, a February 9, 2007 Business Week article (here) reporting on the Fortress Investment Group IPO contained a prediction that more than 30 hedge funds and private equity funds could seek to list their shares on U.S. exchanges by the end of 2008.

It should also be noted that the Fortress group was one of 17 offerings this week on U.S. securities exchanges, raising over $3.4 billion, the most active week in terms of deal value in over three years. It certainly seems like the market for IPOs on the U.S. exchanges is healthy -- perhaps healthy enough to question whether the reformers' dire warnings about the competitiveness of the U.S. markets are seriously overblown.

3. London’s Regulators, Perhaps Spurred by Criticism, Have Begun to Show Some Teeth

Photobucket - Video and Image Hosting It probably has nothing to do with the remarks (here) of John Thain, the head of the NYSE, at the recent World Economic Forum in Davos, Switzerland, that the London markets need to “tighten up” to avoid “damage” to “their reputation.” But within days of these remarks, the U.K.’s Serious Fraud Office launched an investigation (here) into Torex Retail, following the London Stock Exchange’s suspension of trading of Torex Retail’s shares on the Alternative Investment Market (AIM).

The Torex Retail matter may involve only one company, but it does serve as a reminder that markets will strive to maintain their integrity in order to preserve investor confidence. There are no advantages for being perceived as having won the race to the bottom. Companies attracted to the London markets out of a perception of a lighter regulatory touch will find that they still face regulatory scrutiny. It will not take too many cases like Torex Retail before the London regulators will have shown their vigilence is not less than regualtors elsewhere.

UPDATE: On February 12, 2007, another AIM listed company, Adamind LTD, disclosed (here) that the Financial Services Authority had initated an investigation regarding the company. The Adamind investigation is noteworthy because it involves one of those companies -- Adamind is a U.S.-based company with R & D facilities -- that chose to list in London and about which the would-be reformers have been fretting so much. Special thanks to alert reader Uri Ronnen of the AccountingClues blog for the link to the Adamind disclosure.

Each of these developments serve as a warning against seizing upon possibly temporary or transient phenomena as pretexts for reducing regulatory rigor in the U.S. In the global economy, transactions will go where they can realize their greatest financial advantage. The factors that in the recent past led to a greater number of listings in London may have had little to do with the regulatory regime in the U.S. The changing IPO market place so far in 2007 suggests that the competitive landscape among the various securities markets is already evolving, and will continue to evolve – and that that is happening without the adoption of any of the various proposed regulatory reforms. We should be very wary of compromising this country’s regulatory rigor based on transient shifts in the global financial marketplace that have no relation to the level of regulation in this country.

Now This: When we heard about the untimely death of Anna Nicole Smith, we found that we could not think of her marriage to J. Howard Marshall without associating this scene from the film, Best in Show:

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