27 November 2006

November 2006

Graham Bishop’s Personal Overview

Stock exchange consolidation has changed gear – with possible combinations dropped, but hostile intentions coming to the fore elsewhere. The lengthening shadow of MiFID has also prompted a spate of developments, whilst the insurance and payments industries have both seen significant developments. But the eventual strategic implications that may flow from the winds of change across the Atlantic may turn out to be the most powerful.

US Treasury Secretary Paulson delivered a landmark speech in New York - the heart of US financial markets – and discoursed on a number of topics that go straight to that heart. Some of it was triggered by the simple recognition that the London Stock Exchange – a European exchange – has comprehensively overtaken US markets as the preferred place for raising new global capital. The diagnosis is very flattering for the EU’s approach to regulation – base it on principles as these can be timeless, rather than on “ticking today’s box” which can be (and was) as they can be (and were) manipulated by wrong-doers.

The potential implications of this speech could be profound for the balance of global financial power because the first step to solving a problem is to recognise its very existence. But Secretary Paulson has a huge mountain to climb in his remaining two years in office. The current regulatory culture is deeply embedded in US society.

He called for ”tort reform” and pointed out that liability costs now amount to a remarkable 2.2% of US GDP annually but, astonishingly, only 42% of the penalties find their way to the plaintiffs. Will the US legal system willingly give up this scale of rewards, especially now with Democrat Party control of Congress? As another example, he called for a more agile regulatory system. But on the ground, the SEC seems to be coming out exactly as expected (and feared) in its assessment of the use of IFRS accounting standards for foreign companies. The torrent of questions to companies seems not to be about principles, but about the ticks in specific boxes.

A competition in legal systems may be getting underway that can only highlight the advantages of the EU system in the short run. But there should not be complacency about the ability of the US to respond vigorously and competitively – if its society becomes convinced there is a real problem to be fixed.

Stock exchange consolidation has dominated financial headlines as Deutsche Borse backed away from possible combinations with Borsa Italiana and then Euronext. On the one hand, it had become apparent that the EU would respond to complaints by customers about the potential monopolistic situation in derivatives trading and settlement (see the Graham Bishop.com paper) with a full enquiry that would take time, and could have led to a review of the vertical silo business model of Deutsche Borse. However, the formal reason cited for suspending the proposals was that a hostile bid would be unlikely to work in this industry. That risk did not seem to disturb NASDAQ which made a “final” bid for the LSE – in the teeth of management opposition.

Surprisingly, the specific trigger for this bid was the drop in the price of LSE shares after the announcement by seven investment banks that provide more than 50% of the trading volume in the EU of a platform to compete with the exchanges generally. But that capped a string of announcements that reflect the growing shadow of MiFID across the EU capital markets. Equiduct and Chi-X have both stepped forward to offer competition, and Deutsche Borse and Euronext have also indicated that they will offer their trading platforms to banks for their own trading. A key element that differentiates these competitive offerings from earlier failures may be the success of the European Commission in getting the clearing and settlement industry to sign up for its market-opening Code of Conduct so that settlement should not be an obstacle to competing trading venues.

The insurance industry is also moving closer to its rendezvous with the impact of Solvency II. As always, supervision is a major element and the concept of a lead regulator is now firmly embedded into the thinking. But that requires all the regulators to have sufficient powers to be able to enforce the agreed standards. The CEIOPS members meeting at the end of October agreed a raft of papers for consultation and they have short deadlines for responses (January 12th) as the July publication date for the draft Directive gets closer.

The payments industry was expecting an early agreement on the payments services directive but Council and Parliament have deadlocked on the length of time for a payment to be settled. As the first stage of the new system is due in 2008, time is now perilously short, given the lead times of such a massive project.

Footnote: GrahamBishop.com welcomes the appointment of Jorgen Holmquist as Director-General of DG Markt, thus taking charge of the financial services portfolio. As DG Fish, he is highly regarded by his peers and it is inevitable that the principle of rotation will move people into areas where they have no previous direct experience. We wish him well in speedily gaining a deep understanding of financial services.

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Graham Bishop

© Graham Bishop