FEI’s Global Financial Reporting Convergence Conference

 

NYSE Regulation Overview
Almost four years ago, I accepted an offer to serve as Chief Regulatory Officer for the New York Stock Exchange.  The creation of this position was part of sweeping corporate governance reforms that were launched after the independence of regulation at the NYSE had been questioned.

 

As part of those new reforms, the NYSE created a structure in which members of its Board of Directors were independent of the interests of the NYSE member organizations that they regulate.  A Regulatory Oversight Committee of the Board was established to assure the independence of regulatory decision-making and establish a governance structure in which the Chief Regulatory Officer reported not to the NYSE’s Chief Executive Officer, but directly to the Regulatory Oversight Committee of the Board of Directors.

 

While this structure worked extremely well, new developments required even further structural changes.  In April 2006, the New York Stock Exchange demutualized.  It merged with Archipelago, the Chicago-based operator of the all-electronic stock and derivatives market ArcaEx, forming the new public company, the NYSE Group, Inc.  As a public company with a fundamental responsibility to maximize shareholder value, the NYSE Group increased the organizational separation that had been created between the market and regulation segments, now also providing full legal separation.

NYSE Regulation became a separate Not-for-Profit Corporation, wholly owned by the NYSE Group, but with its own independent Board of Directors.  This new structure strengthened the regulatory independence at the NYSE.

 

Continuing to evolve, on April 4, 2007, NYSE Euronext became the parent company of NYSE Group and Euronext and each of their respective subsidiaries upon consummation of their business combination.  NYSE Euronext operates the world’s largest and most liquid exchange group, bringing together six cash equities exchanges in five countries and six derivatives exchanges, is a world leader for listings, trading in cash equities, equity and interest rate derivatives, bonds and the distribution of market data. 

 

Today, NYSE Euronext has a market capitalization of approximately $21 billion.  The aggregate worldwide market capitalization of all listed companies totals approximately $29 trillion.  One-third of the world’s cash trading takes place on these exchanges.  In addition to the businesses in the U.S. and in Europe, the NYSE has a strategic alliance with the Tokyo Stock Exchange, as well as a five per cent interest in the National Stock Exchange of India. 

 

In the continuing effort to maximize the efficiency of member-firm regulation in the United States, we recently consolidated NYSE Regulation’s member-firm oversight function with that of the NASD.  The new consolidated SRO, named FINRA, Financial Industry Regulatory Authority, will operate from Washington, DC, New York and district offices throughout the U.S.  Approximately 470 of the NYSE Regulation staff that served in our Member Firm Regulation, Arbitration, Risk Assessment and related Enforcement units have joined the new organization.  I will serve as the Non-Executive Chairman of FINRA’s Board for a three-year transition period, while Mary Shapiro will continue in her role as Chief Executive Officer.  I will also continue as Chief Executive of NYSE Regulation.

 

Going forward, NYSE Regulation will focus on areas in which its unique market experience is critical to effective regulatory oversight.  Specifically, we will continue to be responsible for conducting market surveillance and related disciplinary actions for both NYSE and NYSE Arca, as well as ensuring that companies listed on the NYSE and NYSE Arca meet their financial and corporate governance listing standards.  NYSE Regulation remains dedicated to strengthening market integrity and investor protection.  It will continue to play a vital role both in overseeing the trading on the NYSE markets and in NYSE-listed securities and in assuring the regulatory integrity of our listing process.  These activities do not present the issue of regulatory duplication that we confronted in the oversight of the financial operations and sales practices of the “upstairs” members – the activities that are now overseen by FINRA.  Additionally, the activities we retain are the ones that are best performed by NYSE Regulation, so that regulatory systems and processes can be developed and improved in real time and in close coordination with changes in the trading systems or listing requirements.  Our ability to effectively regulate these important activities is significantly enhanced by continuing to operate within the independent, yet connected, entity that is NYSE Regulation.
 
International Overview
The title of today’s conference, Global Financial Reporting Convergence, is especially timely, given the unparalleled changes that not only NYSE Euronext but virtually all exchanges in the U.S. and globally are undergoing.  While NYSE has been a leader in cross-border consolidation of market operators, we and Euronext are not the only ones that have been involved in this activity.  The Swedish OM Group was an early consolidator, as well as a technology provider to markets throughout the world.  Now, of course, it appears OM will be acquired by Nasdaq, with the help of Dubai, which itself will take a strategic position in Nasdaq while also taking Nasdaq’s 30% of London.  Just to make things more interesting, the Quatar Investment Authority has also bought up about 20% of the LSE.  And while London has been most famous in recent years for resisting take-overs, it has recently announced it will merge with Borsa Italiana.  The German Deutsche Borse has contracted to acquire the electronic options exchange in New York, the ISE.  And that’s just on the securities side.  In financial futures we have also had this year the announced combination of the CBOT and CME.  These transactions reflect the ongoing competition among exchanges to build scale and speed, generate increased liquidity, attract more investors, better serve issuers and diversify risk.  To paraphrase Jerry Lee Lewis, there’s a “whole lotta combinin’ goin’ on”. 

 

I believe that the U.S. regulatory system has consistently demonstrated its ability to adjust and become more flexible as financial markets have grown and become more complex.  Increasingly investors seek to diversity their portfolios, tap into the growth in non-U.S. markets and hedge risk.  We need to be able to offer the ability and opportunity to trade products across time zones and asset classes on a global scale.  Attracting non-U.S. listings is important to the continued leadership of the U.S. capital markets.  While the NYSE has long been the global leader in attracting international listings, our share of non-domestic IPOs is declining.  The NYSE and Nasdaq together listed 57% of the global IPO proceeds for companies that listed outside their home market in 1999, but that share declined to 18% in 2006.  Overall, the U.S. exchanges’ share of the global market cap of listed companies has shrunk from 46% in 1999 to 39% in 2006.

 

Local markets outside the U.S. have improved as a result of stronger corporate governance and regulatory standards as well as investments in technology.  Increasingly, many companies are choosing to raise capital globally, while only listing on their home country exchange.  It used to be that if a company wanted to raise $1 billion, it only had little choice but to access the U.S. markets.  Now there are many markets that can facilitate such an offering.  In 2006, three of the top 20 global IPOs from India and China listed solely on their domestic market while raising over $1 billion each.  This would not have been possible five years ago.

 

Non-U.S. companies can also access institutional capital in the U.S. through private offerings under SEC Rule 144A, without the need to register in the U.S.  As long as the securities are listed in a sophisticated market, such as London, Euronext or Tokyo, our institutional investors are quite willing to trade there, meaning that the issuer has less to list in the U.S. 

 

The number of Rule 144A private placements grew from 130 in 2004 to 204 in 2006.  Even more telling, the amount of capital raised by foreign issuers with a 144A component grew from $57 billion in 2004 to over $137 billion in 2006.  By comparison, NYSE Euronext (NYSE and Arca markets only) and Nasdaq raised $58 billion last year.  This phenomenon raises cause for concern, as it potentially undermines the transparency needs that are the hallmark of our markets, and it limits access by public investors to these investment opportunities.  A careful and considerate regulatory response is warranted.  

 

Today, the debate often encountered is whether or not a regulatory system impacts the competitiveness of the United States in the global capital market place.  Many reports have been published on this issue.  It is argued that the U.S. is losing to London its position as the financial capital of the world.  Although most of these reports acknowledge that factors ranging from the enormous growth of the world economy, geography, time zones and increasingly open capital markets explain many of the reasons why the U.S. is in a more competitive position with foreign financial markets, their concerns regarding the impact of excessive private litigation and prescriptive regulation in the U.S. deserve careful attention. 

 

In the matter of litigation, the U.S. is losing listings because of the persistent concerns surrounding the U.S. trial bar and the litigious environment in the U.S.  We need to recognize that the United States today has the reputation, both at home and globally, as an increasingly difficult place to do business.  The possibility of being sued for huge sums, while also bearing high costs of legal defense has brought many companies to a moment of reckoning that mitigates against registering their securities in the United States.  The total value of settlements in securities litigation class action lawsuits has continued to increase from $150 million in 1997 to $9.6 billion in 2005.  Given the risks and threats to their bottom line, regrettably, foreign companies are simply concluding that it’s not worth it to come to our market.  This is especially true since they have acceptable alternatives in their home markets on other sophisticated financial centers such as London.

 

Regulatory Developments
Today’s FEI Conference focuses on a certain element of the international regulatory debate – accounting standards and accounting standard setters.  In fact, the subtitle of today’s conference - “What IFRS means to the GAAP filer” - focuses on one of the most significant developments in financial reporting over the last dozen years.
 
We are watching carefully and analyzing the recent regulatory developments, both at the SEC, as it pertains to IFRS, and at PCAOB, as it pertains to Auditing Standard No. 5, internal controls.  Under the leadership of SEC Chairman Chris Cox and PCAOB Chairman Mark Olson, both the SEC and PCAOB have taken a forward-looking and global view of capital markets.  As a result, we have seen the beginnings of a dialogue between U.S. and European regulators that has already gone much further than one would have thought possible as few as ten years ago.

 

The SEC has made a series of bold moves on this front including its draft for public comment of the proposed standard allowing foreign registrants to utilize IFRS without the reconciliation to U.S. GAAP, and the publication for public comment of its concept release allowing U.S. companies to utilize IFRS, and its project on Mutual Recognition on the Basis of Substituted Compliance. 
 
Mutual Recognition
The concept of Mutual Recognition allows the SEC to recognize a non-U.S. regulator as comparable to the U.S. regulatory scheme and would, among other things, allow foreign exchanges to make their screens – and thus their markets and the securities traded on their markets – available in the U.S. to U.S. investors, without requiring the exchanges or the securities traded there to be registered with the SEC.  Similarly, the SEC has indicated its intent to consider more flexible requirements for foreign broker-dealers accessing U.S. investors.  Investors from recognized countries would also be offered reciprocal access to U.S. exchanges and their listed securities.  This would permit more efficient trading by substantially easing the complexity of cross border trading, resulting in expanded availability of capital and increased opportunities for market participants on a global scale.

 

Clearly, the recent events and current developments in the credit markets underscore the global nature of the world’s markets.  The impact not only on U.S. investors, but also on international investors certainly re-emphasizes the impact of cross-border finance and cross-border regulation.  An impairment in a U.S. loan portfolio may in fact impact European investors.  Today’s current events with Northern Rock in the U.K. would be a good example of this.

 

We firmly believe that pursuing Mutual Recognition is the most effective next step to foster global markets and to most expeditiously increase opportunities for investors while continuing to provide necessary and adequate investor protection.  The SEC would seem to believe that there is an approximate 12-month window of opportunity to obtain Mutual Recognition, and it is expecting to publish a concept paper on this issue by the end of this year.  I had the privilege of participating in the SEC’s roundtable meeting to address this topic in June 2007.

 

To satisfy the SEC’s mission of investor protection and fostering capital formation, any exemptions from registration would depend on whether the foreign exchange and the foreign broker-dealer are subject to comprehensive regulation in their home market.  To make this determination, the SEC likely would engage in detailed conversations with all applicable regulators in the foreign jurisdiction to explore the specific regulatory regime.  This review would need to assess whether the local regulatory system adequately addresses aspects currently part of the U.S. regulatory scheme including general investor protection principles, such as prohibitions against fraud and manipulation, the vigor of the inspections and enforcement regime, and the effectiveness of the clearance and settlement system.

One would envision a process that is collaborative and flexible in which the SEC could engage in an assessment of the foreign regulatory regime well in advance of exemptions being sought by interested broker-dealers or exchanges.

 

Other limits also are likely to be considered.  For example, trading could be limited – at least initially – to foreign securities, so as to address concerns about the impact of this approach on U.S. market activity.  Similarly, exemptions could initially be limited to trading with market professionals and certain large sophisticated investors.  These parties would be expected to more fully appreciate the risks of trading directly with foreign markets and intermediaries.

 

To continue exclusively along a “national treatment” model is to continue to deny global and cross-border investment opportunities that are in ever-greater demand.  To allow unfettered global cross-border access to investors is to give too short shrift to investor protection concerns.  Mutual Recognition, if it is extended to a wide-range of qualified nations, will allow the development of global investment opportunities and promote increased global competition (including within the crucial areas of clearing and settlement), while at the same time permitting the SEC and other regulators to make judgments about the overall comparability of regulatory structures to protect investors and markets.
 
NYSE Euronext has recently submitted a letter praising the Commission’s initiative and recognizing its awareness and sensitivity to the issue that exclusively negotiating with only one other country at a time could trigger distortion in the markets.  Granting of Mutual Recognition for similar regulatory regimes should be done broadly enough to avoid providing an improper competitive advantage to one or a small number of markets.

 

International Financial Reporting Standards (IFRS)
The recent SEC progress on IFRS is a significant financial reporting event and properly needs to be framed with the broader based Mutual Recognition review underway.

 

The SEC first addressed differences in non-U.S. financial reporting in 1967.  While reconciliation was not formally required, the rules noted that the financial statements needed to be in a form as if the registration statement were filed on Form 10.  In 1979, the SEC further added significant amendments to non-U.S. issuers’ disclosures to provide more meaningful information for investors.  Then, in 1982, the SEC formally adopted the existing reconciliation requirement.

 

Beginning in September 2002, the FASB and the IASB formally began striving to achieve short-term convergence between their accounting standards.  These efforts became known as the “Norwalk Agreement.”  The goal was to make their existing financial reporting standards fully compatible “as soon as possible.” 

 

That same year, the European Parliament and the Council of the European Union determined that all European listed companies would have to prepare their financial statements using IFRS in 2005. The use of IFRS is increasingly widespread throughout global business.  Almost 100 countries now require or allow IFRS, and many countries are replacing local and national standards with IFRS.

 

It is with this momentum that the SEC then published its “Roadmap” for IFRS in April 2005.  The SEC first adopted an accommodation to allow first-time IFRS adopters to file their SEC document with only two years of financial statements rather than three.  Additionally, recognizing the significant efforts made to transition to IFRS, the SEC also extended compliance dates for management’s report on internal control over financial reporting.  The roadmap most significantly commits the SEC to eliminate the U.S. GAAP reconciliation, which would result in companies reporting either in U.S. GAAP or the English language version of IFRS as published by the IASB.  It is everyone’s belief that global accounting standards would improve investor confidence in the capital markets, provided that the standards are of a high quality, comprehensive and rigorously applied.

 

The FASB and IASB have made significant progress to-date in harmonizing U.S. GAAP with international accounting standards.  In 2006 they published their joint Memorandum of Understanding indicting that a common set of high quality global standards remains the long-term strategic priority of both FASB and IASB.  While the SEC, FASB and IASB have established a goal to eliminate the reconciliation requirements for financial statements of non-U.S. issuers by 2009, there still is no firm target date for the true convergence of U.S. and international accounting standards.  While the European Union has made progress by requiring IFRS for its listed companies, there still remains various country-by-country and EU interpretations regarding what IFRS is or should be.  The European Association of Listed Companies released its response this past Monday, requesting that the current IFRS approach in which the European Commission accepts IFRS modifications be allowed to continue.  The SEC’s proposed standard requiring IASB-sponsored IFRS is very important, as it will centralize the accounting standard and standards setters and hopefully avoid the growth of various versions of IFRS.
 
Accounting standards are, of course, complex and continue to be updated and modified.  Many feel that full convergence between U.S. GAAP and IFRS may not occur.  Recognizing this possibility, the SEC is still, to its credit, moving ahead, noting that it does not expect total convergence to be necessary for the elimination of the U.S. GAAP reconciliation.  A robust process for convergence and a consistent and fruitful application of IFRS, with the IASB as the IFRS standard setter, are the keys to continued forward movement.  Progress, education (both professional and academic) and dialogue are considered the yardsticks with which to measure this effort.  If there is a robust and active process in place, then the differences will be minimized over time.

 

NYSE-Listed Companies 

We continue to hear from our listed companies on the adoption and utilization of IFRS.  The NYSE recently held a round-table of listed company CFOs and Audit Committee chairpersons with representatives from the SEC and PCAOB.  While the primary focus of this round-table was Section 404, the international issues of IFRS, on-going convergence and harmonization efforts were all covered.  Our listed companies stressed that, while a world-class global  standard was desirable, the process to achieve it needs to be thoughtful and prudent. The SEC also received feedback from many interested parties (investors, analysts, companies and auditors) at its March 2007 open meeting.  This feedback indicated that the US GAAP reconciliation is, among other things, costly, not timely, complicated, not utilized nor questioned.  While the majority of the comment letters received to-date by the SEC on its proposed IFRS Standard supports that same view, others believe that reconciliation should continue since material differences in the two systems still exist and   that there should first be in place consistent auditing and enforcement mechanisms prior to acceptance.  All of these concerns need to be carefully evaluated and considered.
 
A decade ago, the NYSE had 150 companies listed from outside the U.S.  Today, the NYSE has 426 companies from 45 countries that report over $10.6 trillion of market value.  Everything we see points to the increasing globalization of business.  Every day the NYSE trades some $8 billion of non-us stocks.  Non-U.S. volume is almost double the year before.  Clearly, investor demand for non-U.S. securities is very strong.  U.S. investors now hold about 20% of their portfolios in non-U.S. stocks.  That represents almost $3 trillion in assets.
 
While it is interesting to note that the recent SEC changes to de-registration have caused an initial number of European companies to delist and begin the process of deregistration, we still expect their financial reporting to remain strong.  These companies already report in IFRS.  Their current plans, while prospectively eliminating the U.S. GAAP component of their financial reporting, will not cause them to become any less appealing to U.S. investors, both at the retail and institutional level.

What we all hope for is one world-class accounting standard that can be prepared by management, properly audited by the independent public accountants and understood by investors.   In other words, any global accounting standard needs to be world-class, transparent and understandable.

Instrumental in achieving that goal is the need to ensure that isolated examples of differences between GAAP and IFRS don’t drive or delay the progress.

 

With that goal in mind, from my seat in the periphery, responsible for Listing Compliance and Market Regulation of the NYSE Group, but by no means an expert in accounting and auditing standards, what seem to be the right questions to answer in order for the SEC to reach a final decision in this area are the following:

 

Q: Do the IFRS standards provide acceptable levels of transparency and allow effective comparisons of similar companies?

 

Q: Does the IASB have this goal as its fundamental mission?

 

Q: Is the process sufficiently protected from parochial political interests to ensure principled decisions?

 

Q: Is the IASB capable of responding to new marketplace developments and adjusting its standards to reflect lessons learned?

 

Q: Will IFRS accounting standards be improved by active U.S. participation in the process?    And finally,

 

Q: Will investors and issuers benefit overall from an inclusive process that provides more uniform and comparable standards?

 

From where I stand, the answer to these questions is a resounding “YES”.  But I am not the expert.  What does seem to be clear is that, in the borrowed colloquialism of my British friends, it is “time to get on with it”, and I heartily congratulate the SEC on its determination to do just that.
 
 
Conclusion
In closing, I would like to thank FEI for the opportunity to address all of you this morning at this important conference.  We all look forward to the sessions scheduled for today.  The speakers and panelists are all leaders and experts in their respective fields.  While the speed of global transformation is remarkable, I believe that in the coming years we have the opportunity to continue to improve our regulatory system.  While the challenges that all of us face have never been greater, I believe that working together we can achieve change that supports the continued flourishing of the global capital markets while retaining a bedrock commitment to effective investor protection.  Thank you and enjoy the conference.  I am happy to take a few questions if we have time.