Howard Davies In Davos: Balls must save us from US regulatory creep
It has been easy to make money in the markets of the last couple of years. Liquidity is easy, rates are low, almost all asset classes have risen
Saturday 27 January 2007
Mayor Bloomberg of New York, though 4,000 miles from Davos, set the cat among the snow eagles this week. On Monday he released a report from McKinsey which drew some stark conclusions about American capital markets.
They are losing market share relentlessly against London. The volume of international bonds denominated in euros is now greater than the dollar quantum, new share issues have become as rare as trans fats in Manhattan and there is no cavalry in sight. The ghosts of Sarbanes and Oxley, now both retired from Congress, stalk Wall Street. If not for them, Lloyd Blankfein would have trousered even more than $52m (actually that last point was omitted from the record).
Wherever two or three masters of the universe have gathered, the New York-London debate has dominated conversation.
You would have to be impossibly hard-hearted not to gain some innocent amusement from this American breast-beating. But how true is it? And if there is a grain of truth, what will the US do - gracefully accept decline and buy up more property in South Ken, or find a way of clawing back? One piece of good news for London is that the US regulators say it just isn't happening. As long as they take that line, there is unlikely to be an effective response. They found an unlikely ally in the Boston Consulting Group, perhaps conditioned to try to junk any conclusions from their great rivals McKinsey. Hans-Paul Burkner, their German CEO, said it was quite normal that New York was losing share as globalisation means that the relative size of emerging markets is growing. Either he is classifying London as an emerging market, or he is, shall we say, a touch deficient in the logic department.
Almost everyone else, including Bloomberg and, indeed, even Eliot Spitzer, thinks that Sox went too far and that a price is now being paid. US capital markets are uncompetitive and business is shifting across the Atlantic. Can anything be done? Tom Russo of Lehman Bros risks losing his table at the Four Seasons for telling the press that the trend "probably cannot be reversed". Others, led by the persuasive John Thain of the NYSE - who was an early Cassandra, warning of trouble ahead a couple of years ago - have tried to turn McKinsey's doom-mongering to advantage. Maybe the rough edges of the legislation can be smoothed, maybe the costly Section 404 can be simplified, maybe the SEC can help, maybe the Treasury can promote simplification? The NASD and NYSE have indeed merged their regulatory arms, though in itself that does little to rationalise an over-complex regime.
But what if these efforts fail, and nothing can be done? Barney Frank is here from the House of Representatives to warn that rolling back the frontiers will not be easy politics, especially as new scandals keep emerging from the corporate woodwork - options backdating being just the latest. Although Hank Paulson has commissioned his own report from a group of academics, which produced conclusions similar to McKinsey's, the Treasury's powers in this area are limited: they depend on Congressional initiative to deliver new legislation, and Congress has many other things on its mind. The President is also unlikely to devote any of his fast-diminishing political capital to this problem.
It took an acute banker from the Gulf to point out that there are, in principle, two ways of dealing with a competitive disadvantage: you can try to remove it or, if that is not possible, you can level the playing field by exporting it to everyone else. The Americans, as we know, are famously generous people, and they are even prepared to export their regulations, free of charge, to the rest of the world. Part of Sarbanes Oxley has already been exported. The new US audit regulator, the Public Companies Audit Oversight Board, is required to inspect the overseas arms of any audit firm with US clients who may have an overseas subsidiary. So why not seek to oblige new issues in London to meet the other bits, especially if Nasdaq gets its hands on the (other) LSE? We have the so-called Balls clause to protect us, and Gordon Brown patrolled the conference corridors, ready to explain that the London markets, like the NHS, are safe in his hands. In this territory he has a good story to tell. Let us hope the clause proves watertight.
But the London-New York story is not the only hare running. Those pesky hedge funds are causing trouble as usual, or at least many suspect they might, given half a chance. And as for the private equity crowd, well! Soon they'll have bought up corporate Europe and spat it out, earning themselves 80 per cent in the process. Surely something must be done to protect the poor downtrodden managers, not to mention the stock exchanges themselves? It is remarkably difficult to have a sensible discussion on hedge fund and private equity regulation. Are they locusts, as Franz Muntefering would have it, or the capital market equivalent of Medecins sans Frontieres, smoothing out market distortions and curing sick companies wherever in the world they find them? At Davos, the locust tendency is, not surprisingly, in a minority, but there is no shortage of CEOs looking anxiously over their shoulders, and trying to construct a public policy case for reining them in.
Even Michael Spencer of Icap, not a natural regulator shall we say, mused on the difficulty of dealing with shareholders with horizons measured in hours, not years. Both types of funds have, in effect, put the capital markets on hyperdrive.
Corporate managers with underperforming assets under their control, or living with bloated costs, are identified far more quickly than before, perhaps before they know they have a problem. This undoubtedly generates high anxiety in boardrooms, and the ranks of those who say loudly over the gluwein that they have done with the public markets are undoubtedly growing fast.
Where will it all end? Are the current mergers a kind of gotterdammerung of the exchanges? Has the NYSE rung its famous bell for the last time?
Probably not, was the verdict. The private equity funds need an exit, and an IPO is often, though not always, a plausible option. Hedge funds themselves are looking at listings, whether of the whole, or a component fund. So exchanges will survive, though perhaps in a different shape. But the appetite for private equity exits is not clear. The average multiple on deals has risen quite sharply in the last couple of years, as even the funds admit (from six to eight times Ebitda on average over just two years). They will need all their ingenuity to restructure and sell at the kind of return they have become used to.
It has been easy to make money in the markets of the last couple of years.
Liquidity is easy, rates are low, almost all asset classes have risen. Even if the economy remains benign, the consensus view is that it will be a little tougher from now on. It's time to go home, before someone tells me that when the going gets tough, the tough get... There's only so much capital market testosterone a man can take at a sitting.
Sir Howard Davies is the Director of the London School of Economics
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