Before the Great East Japan Earthquake struck on 11 March, the following remarks had been prepared for delivery at the Asian and Oceanian Stock Exchange Federation (AOSEF) General Assembly, which was to be hosted by the Osaka Stock Exchange on 30 March 2011.
The text is respectfully submitted to Focus in memory of the victims of this catastrophe, and to salute the survivors and Japanese and international aid workers whose efforts have been remarkable.
• AOSEF Chairman and Osaka Securities Exchange President & Chief Executive Officer, Mr. Michio Yoneda
• AOSEF members and distinguished guests, ladies and gentleman
One year ago, AOSEF generously invited me to speak at its general assembly in Bali. It would seem that there may still be some appetite for more news from WFE, so on behalf of that Federation I am delighted to return to Osaka to be with you again. For WFE’s work, your allowing me to listen in on your conversations is truly beneficial. I hope that in the course of this presentation, you will come to see just how influential this region’s exchanges are in the work WFE does.
It will not be lost on any of you that there are business issues which unite all regulated exchanges across the world, but at the same time others that are particular to certain jurisdictions and regions that have come to the foreground in the last few years. Some of these are of global significance, which is why I address them here. I will return to the themes that unite us, and some of the others that are causing some fragmentation within our industry, a reflection of what is happening on the marketplaces where many exchanges now operate.
One year ago in Bali, I shared thoughts on exchange industry strategy prepared by the Johannesburg Securities Exchange for the concluding chapter of WFE’s 50th anniversary jubilee book, “Regulated Exchanges,” published in October 2010 by Oxford University Press. Without developing those arguments again, it is notable to see how profound those issues are. I refer to them briefly here as a baseline for thinking about business development:
• gone from club to company
• made acquisitions as a strategic tool
• transformed technology
• seen “emerging” markets move to the center, and
• observed the return of risk, together with the public’s declining belief in market self-discipline
For exchange businesses, the JSE authors noted three statements on value:
• Trading services are being devalued.
• Risk management services are being re-valued.
• Regulatory services are being un-valued.
When looking up from our daily business concerns, we note the overlapping paradoxical contexts in which exchanges will have to respond to these value statements:
The regulatory paradox: despite the post-crisis emphasis on enhanced regulatory supervision, the drive for increased competition in unequal forms has allowed for execution venues subject to different and lower regulatory standards to compete with regulated exchanges. This poses a severe long-term threat to capital markets, if one believes that exchanges are uniquely well positioned to perform critical market quality functions. I underscore this point here in Osaka, because the Asia - Pacific markets have yet to be hit in the same way and extent by this contradiction compared with those in the US and European Union, and somewhat also Canada and Australia. In this important sense, when WFE responds to public market policy points, the division of membership into “fragmented” and “non-fragmented” environments serves to show the world that trading is happening in different ways on any one day, one clearly and the other far less so.
The liquidity paradox: while deep and liquid markets are valued as a good, the existence of multiple execution venues for the same instruments, serving the same customer base, is having the effect of fragmenting liquidity.
The transparency paradox: it is ironic that in this post-acute crisis environment where transparency is so highly valued – by regulators and clients – dark order execution venues continue to be allowed to proliferate.
The paradox of national interests in a world of global capital: while this financial crisis has seen some focus on global regulation, national leaders naturally remain focused on what is necessary for the recovery and protection of their economies.
The near-term future of exchanges depends on their ability to navigate large shifts in the value of exchange services. To survive and prosper, exchanges will have to be better than their competitors in managing the long-run devaluation of trading services and the re-valuation of risk management services – and also in turning to account the business and social value generated by their regulatory functions, particularly listings. In the longer run, exchanges must position themselves by creating new and lasting value for customers and society.
In closing this introduction, I wish to share my own repeated surprise and disillusion on the matter of fragmentation, without doubt the most worrisome question before our industry. When speaking to some officials in private, they can see the contradictions in policy objectives and effects, and so the failures ahead. Some will admit that current structures allow risk of malfeasance, too much that is private or dark or less regulated. Too often the easy reflexive response is “competition will work,” or “the competition genie is out of the bottle, so it’s too late to go back.” I find that shocking. If there is something wrong in the public space, our officials are supposed to identify the problem and correct it. And being based in Europe, I believe that big problems can be solved by political leadership – I refer here to the resolution of one of the great problems of our era, the end of confrontation of armies with nuclear weapons after a multi-decade-long stand-off in the heart of the continent. Is correcting capital markets structure problems really harder than East-West disarmament in the heart of Europe was?
And I find encouragement in some capital markets authorities outside the North Atlantic world which explicitly reject competition as a false or at best very incomplete answer to efficiency of infrastructure. After all, what is the goal – competition for its own sake, or lower cost of the capital markets function to society?
One year after AOSEF met in Bali, I wish to share with you some of the WFE’s responses to the authorities on behalf of exchanges.
As many of us see matters, there is a growing imbalance in the commercial relationships among the various actors who make up the marketplace, investors, issuers, and intermediaries – with exchanges somewhere separate and neutral in this picture. To rebuild confidence, one has to restore some of the balance.
For the issuers, WFE has continued its involvement in the area of responsible investment. We have had presentations to the Working Committee from institutional investors on their preferences, the Federation joined the International Corporate Governance Network and is assisting in building its annual meeting program in Paris next September, and Peter Clifford represented the industry at a United Nations Principles of Responsible Investment Forum last September in Xiamen.
Financial reporting evolves. WFE remains involved in advisory work for the International Audit and Assurances Standards Board; in fact, the chairmanship of that advisory group has passed to our colleague from the JSE in South Africa. Certainly, expectations about how an enterprise describes itself to investors and the professional public are changing.
In December 2009, led by the Global Reporting Initiative and The Prince’s Accounting for Sustainability Project, a global group of individuals and institutions came together to form the International Integrated Reporting Committee (IIRC). WFE director Atsushi Saito of the Tokyo Stock Exchange is one of those overseers; and Doug Webb, chief financial officer of the London Stock Exchange, represents British business on that body. Other exchanges have become involved in improvising the first implementation of integrated financial statements in their countries. Peter Clifford and Thomas Krantz have been involved in some of the working party efforts to get IIRC up, on the radar screen of G20, and into implementation phases.
With the encouragement of Saito-san, the Secretariat has joined forces with IIRC as a way to get closer to issuers. This is not about more rules for compliance; it is about presenting issuers with a useful management tool for their enterprises, one that describes their work well for them, identifies sources of efficiencies, and explains corporate prospects comprehensively to persons who follow those companies.
The Federation’s work since Bali has considered numerous discrete market policy points, too.
Group editing of WFE policy statements is hard with many voices joining in, but we do find that there are points to be made that matter to all members. As the regulatory bases of our industry have changed in many jurisdictions, it is important that this Federation find its public voice and get the exchange message out.
The starting point is that the regulated exchange / clearing house business model worked well throughout the financial crisis post 2007. Few financial services companies can make the same claim. Exchanges understand why that is, but apparently other actors and many officials do not seem to appreciate in sufficient detail what it takes to operate a regulated marketplace.
Building on that, Chairman William Brodsky wrote to IOSCO to highlight the multifaceted, very complex problems resulting from fragmentation of the price discover processes. Exchanges no longer have a complete view of trading in many jurisdictions for surveillance purposes, undermining a fundamental element of investor protection. Neither do the non-exchange platforms, or for that matter the market supervisors, either. Corporate treasurers have far less information on prices, and just as damaging in terms of information loss, the way prices get formed in the course of a trading session.
WFE has written to the Commodities Futures and Trading Commission (CFTC) in Washington on the question of swap data recordkeeping and reporting requirements. This concerns the OTC derivatives problem, and the goal of G20 governments to have more of this business conducted in the exchange or clearinghouse space. In principle, this sounds attractive, but there are questions of adaptability to a different environment – our environment – and considerations of position risk management.
The European Commission has issued a Green Paper on audit policy, in the wake of the financial crisis. In its response, the Federation wished to be sure that auditors remain answerable to their clients, the listed companies being audited, rather than to government officials overseeing the accounting profession.
The European Commission called for public comments on the main Directive governing the 27 countries’ financial marketplaces, MiFID. Perhaps the main comment I wish to make in the AOSEF meeting context is that the review questions were longer than anticipated, cover more areas, and were concentrated almost entirely on intermediaries’ issues. There were only a few questions on how investors are getting along in this new environment. Thanks in good part to the Asia - Pacific marketplaces, WFE was able to refute the contention made by the EU Commission that explicit trading costs were lower because of MiFID – they were lower across the world, with or without MiFID, as exchanges adjusted their prices to take advantage of new technologies, and with the goal of increasing volumes passed through their platforms.
Many exchanges in Asia - Pacific now report their own accounts under IFRS. WFE wrote to the IASB in response to its exposure draft on revenue from contracts with customers. What this new principle would do if adopted would hit revenue recognition from new listings by forcing exchanges to amortize them over an unknowable life as a public company. In the context of our industry, this rule would simply not make economic sense.
The European Commission had a public inquiry on short-selling. The Federation’s letter highlighted the points that if the EU is afraid of high volatility, bans on shorts will not make a difference; they could even exacerbate the problem by reducing liquidity. If the EU is concerned about settlement problems, there simply have been no serious problems experienced by member exchanges post-2007. The EU has effectively chosen to ignore the Principles IOSCO developed with good global consensus in 2009, leading to the possibility of regulatory arbitrage across jurisdictions. Perhaps even more problematic is the point that exchanges must always remain neutral as to the direction of the market – we are getting cases of regulators essentially pushing the market upwards only, which truly is curious.
Most recently, IOSCO held a public consultation on dark liquidity. The consensus written position submitted by WFE is that dark orders can be necessary for block trading, and when they are sent through the exchange environment they remain subject to surveillance and position monitoring. This does not hold for other platforms offering dark execution services. Also, as matters stand in the US, where dark orders have grown considerably, there is no justifiable economic reason – in the eyes of this Federation – for small retail orders to be passed away from the central limit order book.
By way of conclusion, in Asia - Pacific and elsewhere in the world, the member exchanges of WFE are invited to raise issues and to stand ready to help the Secretariat with editing our common positions and also in delivering messages to securities commissions, parliamentary committees, central banks, and other trade associations. We are defending and building an important social good – regulated exchanges – whose prices are central to market economies and the societies they support.