There have been concerns voiced about the U.S. capital markets losing market share. Earlier this year, the market capitalization of European equity markets surpassed those of the United States for the first time, prompting many to speculate that New York has lost its dominance as the financial capital of the world.
The argument is that our regulation is viewed as too costly, too time-consuming, and a deterrent for non-U.S. companies to list their IPOs or to place their established stocks on U.S. exchanges. There are secondary advantages for overseas exchanges. For instance, in terms of geography, the London Stock Exchange (LSE) is open when the U.S. markets are not, thus providing an advantage to the LSE and large exchanges that operate in other time zones, such as Tokyo, Hong Kong, and Dubai. Foreign markets have emulated those in the United States and some are now growing at a faster rate, which has led many companies to list in their local markets. Finally, competition has intensified among U.S. and foreign exchanges.
These and other factors are creating waves in the exchange seas that, for boards, could impact where IPO-minded companies and larger companies looking to tap into foreign capital consider listing their shares. Changes in trading regulations are also making it harder to follow trading patterns in stocks, which could make it more difficult for boards to spot potential activist investors.
Toward the end of the first quarter, Europe’s market capital grew to $15.72 trillion, exceeding the $15.7 trillion value of the U.S. markets. (Europe is comprised of 24 equity markets including Russia and Turkey.)
A number of factors combined to push Europe into the pole position: the declining value of the dollar, the strength of the euro (which has risen against the dollar in the last four years), acquisitions by European companies, the growth of Eastern European markets, and the increased profitability of European companies vs. U.S. counterparts.
In addition, regulation has in fact driven companies away. In recognition of this fact, the SEC enacted new rules in June that facilitate the delisting process for foreign companies. If a company’s shares in the United States trade less than 5 percent of the trading volume for all of its shares globally, then a company can deregister. British Airways, Danone, Telekom Austria, and Vernalis have all announced plans to delist their shares from the Big Board. BA’s CFO said it “no longer makes sense from a cost and administrative perspective” to have to adhere to U.S. accounting standards; delisting will save the company £10 million a year. Danone also cited low volume and U.S. accounting standards as reasons for its delisting. Both Telekom Austria and Vernalis cited the increased regulatory burden due to Sarbanes-Oxley (SOX) as reasons for no longer listing in the United States.
Emerging equities markets in Europe have grown dramatically and established markets such as Germany and France have been able to grow at faster rates than the United States. For example, equity markets in both Germany and France have gained from 130 to 150 percent since 2003, compared to 80 percent here in America. Emerging equity markets such as Russia and Turkey have faired even better, gaining 320 and 350 percent, respectively.
Essentially, the U.S. model has been replicated around the world quite successfully but perhaps at the expense of the U.S. markets. Furthermore, the increased equity market cap also reflects the underlying improvement in the fundamentals of European companies relative to those here. Overall, this growth has resulted in increased IPOs in local markets. It’s estimated that 90 percent of companies around the world choose to list in their primary market.
London Calling
Is London becoming the new financial capital of the world? In 2006, the number of new IPOs that went public on London exchanges exceeded the number of new issues on both the NYSE and the Nasdaq combined. In 2006, 250 companies bowed in London vs. 205 in New York. Furthermore, the total market value of London IPOs ($51.2 billion) exceeded those in New York ($46.8 billion). As of mid-July this year, London had the upper hand again. Some 137 companies chose the London exchanges for their debut vs. 111 for both the NYSE and Nasdaq. Both market share and the value of new deals in London exceeded those in New York.
London’s Alternative Investment Market (AIM) market has been attracting more new issues than the LSE or the New York-based exchanges. The main advantages of the AIM market are less stringent regulation and listing requirements than other exchanges. Lower listing fees and speed to market are also advantages. Typically, it takes an average of four months to get a company listed on AIM, much faster than other exchanges, which can range from six months to a year. Also, companies that choose to list on AIM only need to report earnings every six months vs. every quarter in the United States.
Is London becoming the new financial capital of the world? The number of new IPOs on London Exchanges exceeded the number of new issues on both the NYSE and the Nasdaq combined.
Furthermore, revenue contributions from international operations for many U.S. companies are growing rapidly and in some cases, are stronger than U.S. growth. For example, Goldman Sachs reported that for the first time since its inception 138 years ago, its revenue from international operations was equal to the revenue generated from its U.S. operations; as of the second quarter, international revenues had exceeded revenues generated from the United States. London also benefits from less-stringent regulation of the markets (no SOX compliance issues and no SEC) and fewer litigation concerns (no class-action lawsuits). Meanwhile, of the lawsuits filed around the world, it’s estimated that 94 percent are filed in U.S. courts.
The news isn’t all bad, however. Although the number of foreign IPOs has slowed a bit in the United States, the total number of IPOs on U.S. exchanges hit a seven-year high. During the first quarter of 2007, there were 64 IPOs that listed in the United States, valued at nearly $12 billion and led by financial services firms. The Nasdaq raised $6 billion from 39 deals, while the NYSE raised $4.7 billion from 11 deals. Meanwhile, in Europe, IPOs raised $13.3 billion in the first quarter, down slightly from the previous year.
NYSE vs. Nasdaq
Exchanges generate revenues through trading commissions but most revenues are derived from IPO listings and annual listing fees, which can range anywhere from thousands to a quarter of a million dollars, depending on the size of the company (calculations typically are based on shares outstanding and on single or dual listings).
Many companies seek to list on an exchange for different reasons. The Nasdaq has long been known for its dominance as the exchange for technology stocks, although many technology stocks list elsewhere. Nasdaq is also known for its own technology, having pioneered electronic trading, and for the liquidity and speed of execution it provides. Typically, companies that choose to list on the NYSE will cite prestige and visibility (co-branding opportunities, ringing the bell on CNBC, etc.) and the involvement of a specialist to help provide clarity on trades. Price is not often a consideration, although there are major differences between the exchanges for companies of different sizes.
For example, if a micro-cap company (market cap under $500 million) decided to go public on the Nasdaq, the initial listing fee would be $100,000, vs. $150,000 on the NYSE. There isn’t much of a difference in IPO fees for a mid-cap or large-cap company, but for a small start-up company generating little or no revenues, a difference of $50,000 to $70,000 could be something the CFO would notice.
If we examine the annual listing fees for both exchanges, however, there can be more notable differences for the very smallest companies. For a micro-cap company with a market valuation of $100 million, the annual listing fee for the Nasdaq is $30,000, vs. $38,000 for the NYSE. Over the course of five years, a company would save $40,000 by listing on the Nasdaq. For a company categorized as a small market cap ($500 million to $2 billion), the cost difference between the two exchanges is less important. The savings would only amount to $500 in one year and only $2,500 over five years. For mid caps and large caps, the difference is a little more pronounced, but unlikely to amount to a serious consideration for companies this size. More importantly to international listings, both the NYSE and Nasdaq are expensive in comparison to exchanges in Europe, especially in London. But there are other factors besides cost in selecting an exchange, although more than half of the companies we surveyed in the United States and Europe and 82 percent of those surveyed in Asia, believe that it’s worth a premium to list on the NYSE.
Penny for Your Trades
The exchanges have been challenged to keep up with intensified competition, advances in technology, regulatory changes, and increased demand for anytime-trading. Advances in technology, especially electronic communications networks (ECNs), have changed the way exchanges operate and the price of trades. Electronic trading, coupled with the SEC’s so-called Regulation NMS, enables trades of any stock on any exchange regardless of where the company is listed. Thus, where a company lists becomes less important as does the need for dual listings. Most of the trading that is done by exchanges is now electronic or automated. This fact has been a key to Nasdaq’s success in the United States, and it is the driving factor in the electronic exchanges’ European expansion.
The ability to trade instantly and anonymously has influenced the pricing structure and, in some instances, relegated the role of the specialist to “middle man.” This has caused pricing to become very intense, with some exchanges offering penny trades on certain products. While ECNs have increased market volumes, trades are increasingly becoming a commodity-like product similar to long-distance pricing.
Historically, the NYSE has been an auction-based exchange with specialists on a trading floor. Since trading of cross-listings has begun (whereby any exchange may trade any stock regardless of the listing), the NYSE has had to adapt.
Electronic trading and speed are vital to traders and for exchanges who charge a small fee for every trade. Thus, the NYSE has created a hybrid-trading market whereby most of its trades are handled electronically while the remainder are done through a specialist. Some companies still like the client focus involved with their shares. In fact, in a survey that Thomson Financial conducted of investor relations officers (IROs) of NYSE-listed firms, 30 percent cited client focus as a reason for selecting the exchange. Despite advances in technology, companies still value having a specialist to talk to if they have questions about the trading levels of their stock.
Regulation NMS was established by the SEC to provide better price visibility for equity trades. Under Regulation NMS, brokers must execute trades with the market offering the best price for investors. Implementation began in March and will be completed in stages by September. Regulation NMS intensifies competition among exchanges competing for trades. And for companies that list on the NYSE, Regulation NMS (coupled with electronic trading) can lead to a decrease in visibility into which investors are trading their stocks.
For example, on June 6, shares of Macy’s, listed on the NYSE, traded more than 5.7 million shares, of which only about 3.1 million shares, or slightly more than half, were accounted for by the NYSE.
Thus, there’s less visibility in knowing which investors are trading NYSE stocks in third-markets such as the Nasdaq. But for IROs, knowing which shareholders are trading in and out of their stocks is essential, especially given the increased influence of activist shareholders.
The changes in technology and regulation have led to increased competition and lower prices, which explains why there seems to be a race to buy available exchanges (including foreign ones) and other profitable businesses such as options and derivatives.
The NYSE and Nasdaq have been aggressively pursuing global opportunities in an effort to diversify revenue streams and to capture a larger piece of the worldwide pie.
The NYSE expanded its reach into Europe this year with its acquisition of Euronext, a pan-European stock and derivatives exchange, thereby creating the world’s largest cash-equities exchange. It’s estimated that the market capitalization of the NYSE is valued at $28.5 billion, exceeding that of the next four largest exchanges combined. The NYSE also purchased a 5 percent stake in India’s National Stock Exchange and formed a strategic alliance with the Tokyo Stock Exchange. The NYSE’s shopping spree hasn’t ended, with expectations that it will expand its derivatives business in the United States. After Nasdaq ended its bid for control of LSE, it turned to Stockholm-based OMX, which it agreed to buy for $4.9 billion.
The Outlook
The commoditization of trading fees has led to a spate of acquisitions in this space. The exchanges are seeking other revenue sources besides trading and listing fees. Thus, additional M&A in the exchange space will likely occur with exchanges (and investment banks in Europe) fighting to capture global market share. The landscape may comprise large oligopolies providing a multitude of services on one platform, much like the telecommunications services industry. Geography will be less important, while cost, execution, and speed will be most important.
Is London the real threat to U.S. markets or will it be an emerging market such as Shanghai, Dubai, or another competitor such as Project Turquoise? In regard to IPOs, it’s debatable as to whether or not SOX has scared away investors. While the United States is capturing less of the global IPO market, it remains strong in the listing of U.S. companies and many non-U.S. companies who seek the NYSE for liquidity and prestige. But many companies have chosen to forgo the IPO process in favor of private placements, which afford companies access to capital without the costly fees and regulatory hurdles of going public. In fact, last year more companies raised capital through the private-placement market than through IPOs.
While it seems that some investors are willing to pay a premium for companies that choose to list on the NYSE vs. listing in London, the burden of SOX regulation is onerous for many, especially small companies. The general consensus among corporations is that easing SOX regulation will help make U. S. markets more competitive and level the playing field. The SEC has taken notice and is implementing steps to ease internal auditing guidelines mandated by SOX regulation for small companies and is weighing the adoption of more uniform accounting practices.
In November, John Thain, CEO of the NYSE, accepted the CEO job at Merrill Lynch. New leadership could bring a new direction for the Big Board. In the same month, Nasdaq continued its buying spree with the acquisition of the Philadelphia Stock Exchange, which gives it a foothold in options trading. Certainly, there are more moves to come, only highlighting the state of flux for nearly all exchanges.
Arzu Cevik is director of strategic research at Thomson Financial.
Sidebar: To IPO or Not to IPO
For all the strength of U.S. IPOs, the private-placement market has been even stronger. Last year, for the first time, more money was raised via private placements than through IPOs in the United States.
Many companies are seeking alternatives to the somewhat costly and regulation-heavy public markets. Private placements are becoming popular among companies seeking to raise capital without having the hassle of going through the IPO process or raising debt through the public markets. Private placements (which became more attractive because of SEC Rule 144A), allow companies to sell unregistered shares of their company to qualified institutional buyers (QIBs) —defined as individuals or institutions with at least $100 million in assets. QIBs are restricted to 500 for U.S.-based firms and only 300 for foreign-based firms, but QIBs are allowed to trade with each other. By utilizing the private market, companies do not have to comply with SOX or with public accounting rules. More than 1,000 companies have utilized the private-placement market including Archer Daniels, Adidas (Germany), and the Bank of China.
Nasdaq has launched its own “portal” for private placements and it’s anticipated that other exchanges will launch their own versions. Investment banks including Goldman Sachs, Citigroup, Merrill Lynch, and Morgan Stanley also plan to create their own electronic trading platforms, allowing institutional investors to trade in unregistered securities in the private- placement market.