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Page last updated
February 15, 2003



IEuropean equities:
Regulation, education and innovation


I would like to begin by commenting on that expression - "the global securities market". It's one of those odd phrases that - although it has been around for a number of years - trips off the tongue like it's some kind of new phenomenon that people love to impress friends with by discussing at a dinner party. Of course, you can hardly blame people for thinking that way - given what they read in the papers. The financial press; and increasingly the mainstream press - got itself highly exercised over the wranglings between London and Frankfurt over the late iX proposal this was a mass debate that journalists clearly enjoyed !

If you look behind the headlines of the past two years or so, and give it some more serious thought, there is nothing new about the global securities market at all. In fact, cross-border trading of international debt securities goes back to the early 1960s, when skirts were shorter and hair was longer (not to be confused with England footballer David Beckham).As many readers will know, the driving factor behind the growth and development of the international debt markets was the tax regime introduced by the American government back in 1963, aimed at discouraging foreign issuers from borrowing from US investors. Whereas the vast majority of international borrowing had been channelled through New York, borrowers wishing to raise US dollars came to Europe, where a growing pool of investors was ready to provide those funds without the burden of expensive taxes.

So, the Eurobond market was born - but it came not without its hiccups. Trading was pretty much a no-brainer: pick up the phone; find the best price; do the deal; go to lunch! ... However - and remember this was in the days before the concept of de-materialised securities had even been thought up - the physical movement of securities from one corner of the world to another was by no means as effortless as it is today. Primitive communications systems, coupled with a shortage of experienced back office staff, left the market unable to cope with the increasing volume of primary issuance and secondary market activity. A backlog of failed or late deliveries of securities, exacerbated by the lack of standard settlement procedures, threatened to bring the international securities market to a standstill.

That's where ISMA came in - although in those days we were known as the Association of International Bond Dealers. An organisation that now has more than 600 members from almost 50 countries was started in a function room in a London hotel, by a small group of senior bond dealers representing banks and securities houses from the market's principal financial centres. Unshackled by the politics, xenophobia and national pride that characterizes and, indeed, hinders so much of today's decision making processes, these guys needed a business solution and knew how to go about it - they certainly weren't going to wait for Edward Heath to come along! ... The founding members of the AIBD set up a committee and cracked on with forming of a series of rules and recommendations governing trading, settlement and good market practice for the international debt markets. And, whilst product innovation and geographical diversity have since led the way for a change of name from AIBD to ISMA, the basis of the international self-regulatory framework created during the early days of the organisation continues to remain in place today.

Unsurprisingly, almost forty years down the line, the market has experienced immense growth. Hundreds of dealers and brokers world wide now trade issues denominated in a host of currencies, structured in a number of innovative ways, and issued to investors all over the world. Reflecting the market's ability to innovate, the range of instruments traded has also grown, and now includes warrants, global depository receipts and international floating rate notes. The value of outstanding issues is, most estimates suggest, in excess of 3,000 billion US dollars.

The reason I am stating this is to help explain what I consider a fundamental problem underlining much of the contemporary debate about the direction in which Europe's equities markets are heading. My concern relates to the manner in which that debate is being influenced and, indeed, sidetracked by issues that; in the cross-border debt markets; have managed never to impede the business or undermine the way in which ISMA, as an international self-regulatory organisation, provides a framework within which its member firms operate.

The beleaguered deliberations over the future of the London Stock Exchange and Deutsche Börse underline what I mean. The turbulent events of the past few months render it patently obvious that Europe's national bourses face an urgent choice: shape-up or ship-out (no, I'm not lisping!...) Now, whether that means joining forces with others (as in the case of Euronext) or going it alone as the LSE indicated it would do when iX fell apart, depends on how each exchange perceives its fundamental purpose in life. Historically regarded as national institutions; like airlines; every government wants an exchange regardless of whether they really have an economic justification for one. The trouble with the London and Frankfurt bourses is that they carry more political baggage than Air Force One and have frequently exhibited the failings associated with virtually all monopolies: monolithic and bureaucratic, and staffed by people hell-bent on pursuing their own agendas rather than meeting members' and, more recently, shareholders' requirements.

In jostling for position and pursuing the objective of consolidation, both London and Frankfurt proved themselves unable to snap out of a mentality that remains based fundamentally upon competition rather than co-operation all of which goes back to a basic crisis of national identity. When the iX plan was first announced, the financial markets were presented with a grand vision of the way forward for Europe's traditional bourses. Yes, there were a number of issues to sort out but, at the end of the day, the merger was supposed to be in the interests of the business and everybody would just have to get along with one another; live with their differences in the short term and iron them out later in the day. But, as any seasoned cynic (like yours truly) would have predicted, that's not how things panned out. I recall, for example, how - not long after the merger discussions got underway; huge volumes of ink and paper in the financial press were devoted to people arguing the toss over whether all stocks should be listed and traded in euros. Come on! in business terms, this is almost a non-issue! A single platform does not need to confine itself to a single currency to be feasible and successful. If ISMA members can trade international bonds denominated in more than thirty currencies under the same self-regulatory framework, I can only surmise that all the fuss over the euro is about politics rather than practicalities.

What really concerns me is that it does not stop there. The near-asphyxiating pressure that built up during these painfully protracted talks rendered it patently clear that the wider debate over the future of exchanges and the myriad of other breeds of trading platforms runs far deeper than market demand for lower trading costs and deeper pools of liquidity. The euro is just one example of the issues that got caught up in the power struggle between London and Frankfurt. However, the concerns over the iX proposal - which worked in combination to deflate much of the enthusiasm for the deal - manifested themselves in a number of ways.

A strong contender among the issues raised as the debate unfolded was regulation. The proposed split of the markets into five separate life forms - with the key focus on high-tech in Frankfurt, blue chip in London; caused confusion and controversy over listings and, more crucially, raised immense concerns over the standards of regulation that would be adopted with Germany clearly on the defensive in that context. Howard Davies will probably not thank me for reminding you of this, but with the Financial Times screaming in one headline that staff at the UK's financial regulator had branded the iX plan "a nightmare", you can easily see why support for the plans waned so rapidly. In that sense, the grouping of the French, Dutch and Belgian exchanges was always on the front foot vis-à-vis iX. The Euronext model of one rule book, one trading system and one clearing and settlement system has proved far simpler for markets to get to grips with and, politically, easier to digest - to the extent that its acceptance by the three constituent exchanges was almost a non-event.

Whilst I accept that reassurances were made for the long term future of iX - particularly in the regulatory context; I firmly believe that underpinning the discussions surrounding the proposal appeared to be agenda based on emphasising, rather than removing, differences. The result is that I find myself questioning what effect this will have on the parallel, highly constructive deliberations over the future of securities regulation in Europe that were taken a major step forward by the publication of Baron Lamfalussy's report a couple of months back. If member states really want to see progress in bringing together the EU's patchwork regulatory framework, it has to be clear to all involved in the process that the business interests of those who participate in Europe's financial markets must be paramount. Lamfalussy's report envisages an ambitious timetable: to get its recommended approach up and running by the end of 2001. If this is to be realised, there will be no place for the type of politicisation of the debate that we have seen in the context of the exchanges. I earnestly hope that I am being over-sensitive, but I do confess to having some doubts as to whether politicians will be able to keep national interests sufficiently distant from the process.

On the whole, I am confident that the interim conclusions of the somewhat Biblically-styled group of 'Wise Men' are healthy. Anybody who has heard my views on European integration will not be surprised to hear that I wholeheartedly, and with a huge sense of relief, agree with its rejection of a single EU regulatory agency - and I am not just saying that because I live and work in Switzerland! I only wish the same logic had applied when it came to the single currency Mind you, I am not planning to get complacent on the subject - the group's conclusion applies, and I quote, "at this stage of the development of the EU's securities markets." This carefully couched language - that so epitomises bureau-speak - patently leaves the door wide open for future debate in this area.

As regards the key proposal that has emerged from the Lamfalussy committee's report, it is clear that any development that can speed up the process of drawing together the various laws and standards that apply across the content has a lot going for it. If the proposed 4-level procedure can genuinely offer the chance of cutting the time needed to introduce new financial market rules by the 50% that was claimed in a recent Financial Times article, then I believe that the mighty organs of the European superstate (and its constituent governments) have a strong chance of shifting the framework closer to the needs of Europe's financial markets or at least getting nearer to doing so than they have managed up until now. As the report itself sets out, the current system is too slow; too rigid; too ambiguous and inconsistent; and depends far too much on primary legislation for determining detailed rules. This clearly has to change if the differences between the rules and laws that apply to issuance, accounting, insolvency, taxation etc. are to be reduced. At the end of the day, of course, whether words become deeds depends on whether all the individual member states have the political will to make it work. If it fails, it certainly won't be due to any failing on the part of the financial markets: it was market practitioners themselves who had the foresight and ambition to establish ISMA's regulatory framework. If they had waited for national regulators to help them overcome the differences between one market and another, their business would have curled-up and died.

Something else that will be needed to make it work will be a continuing dialogue with the financial services industry. This must take place right across the spectrum - from those firms operating in the wholesale markets to those serving a retail client base. In their report, the 'Wise Men' make clear that the private sector has a role to play in reducing inefficiencies in European financial markets - and they identify the costs of clearing and settlement as one of the key areas that needs to be addressed. However, this must be a two-way street: the Commission must, if this idea comes to fruition, maintain a strong and consistent dialogue with firms and industry bodies like ISMA in the process of establishing the broad principles of securities legislation that would need to be enacted. Lamfalussy is quoted as saying that "financial markets are changing week by week, and European regulation is simply not up to speed." In my view, it will never get out of first gear unless the innovations in financial instruments, trading systems, investment strategies and the like are fully understood by Commissioners and their baggage-carrying officials. Reassuringly, the report stresses that the Commission would need to consult widely in drawing up the principles necessary to deal with each issue. Certainly, it would have to make a more thorough attempt at obtaining market opinion than it did before publishing its withholding tax Directive back in 1998. Anyway, we shall have to wait and see how things in this area develop; ISMA, for one, will be monitoring this issue very closely.

I would like to make a few short observations on a topic that will be of increasing importance to Europe's competitive capital markets going forward. As someone who has been in the bond markets for some thirty years, I have seen how we have changed from being a fringe business to a major industry. The opportunities for corporate bond issuance have provided for huge expansion of some industries; takeovers and mergers have started to revolutionise industry competitiveness; and, of course, traditional bank finance has been increasingly replaced by securitisation. Amongst our own membership, the trend for merger-mania is leading to more and more rapid consolidation of banks within Europe and the emergence of mind-blowingly large financial groups, certainly compared against what I grew up with in my early career.

The impact of the international debt markets on the European and, indeed, global economies and their visibility to governments throughout the world has important consequences in that the activities of ISMA members and others are under constant external scrutiny. Big companies and groups (not just banks) are much more vulnerable to government interest and, where necessary, action - as Microsoft found out to its cost. In this regard, the need for our workforce to have more technical education is becoming progressively more significant. As the firms in the financial services industry grow larger and more complex, there will be an increasing need for those who have been working in one small part of the industry - international bonds, for example - to acquire the general management training that is a sine qua non of senior management in other types of business. Another important area is ethics. It has to be said that; as our industry continues to mature - it will be all the more essential that ethics becomes part of the training and development of people working in the financial services industry, if only to demonstrate to the powers that regulate us that we are managing our own businesses in an acceptable way. I would add that the International Organisation for Securities Commissions (IOSCO) in 1999 formally enshrined the concept of self-regulation into its thirty principles of securities regulation. High standards of professional education will help to keep it that way.

ISMA itself has been active in this context since the 1970s and was a pioneer in the field of technical education. Over six thousand people have gone through our professional education programmes. Equally, we have supported academic education through our funding of the ISMA Centre at the UK's University of Reading; from which some 200 students from around 55 different countries graduate each year. They obtain a very specialised education in securities and investment, where not only do they learn the academic theory, but they put it into practice. That innovation - which we initiated seven years ago - was, I believe, a great step forward and one that is only now being copied by other universities.

John L Langton
Chief Executive and Secretary General
International Securities Market Association


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