Investor Choice in Global Securities Markets

Our recent paper, which forms part of the first phase of the New Special Study of the Securities Markets Project, explores how globalization has affected the operation of securities markets and the challenges this poses for their regulation.

Securities markets have experienced unprecedented levels of cross-border activity over the past 30 years. Three secular trends have contributed to this phenomenon of ‘globalization’. First, liberalization: the removal of national foreign exchange controls and barriers to trade and investment. Second, the growth of collective investment, encouraged by favorable tax treatment of retirement saving. This has fostered a shift away from retail, and toward institutional, participation in securities markets. Professional asset managers have the skills and the scale to invest beyond national borders. They are also in a better position to access less liquid asset classes, such as non-publicly traded securities. The third trend has been ’technologization’: advances in information and communications technology have enabled the digitization of business processes, increased connectivity to seamlessly link market participants regardless of location, and the automation of processes and services. This has facilitated new order-driven markets and precipitated a gradual decline in the role of exchanges as pools of liquidity.

Together, these factors have broken the link between listing on a particular exchange and having access to the capital base originating in the country where that exchange is located. At the same time, they have increased the attractiveness of using alternative (private) forums for capital-raising. We suggest that a framework to understand international competition and coordination issues in securities law can usefully be introduced by the slogan of ‘investor choice’. Thanks to the removal of barriers to free movement of capital, the intermediation of professional managers who have the skills and the scale to invest internationally, and the digital interconnection of markets across the globe, investors can reach all markets and issuers, regardless of where the issuers raise capital and have their securities traded, or which securities laws apply on the issuers’ side.

We then discuss the regulatory dynamics of international securities transactions, by considering unilateral rules governing market access and bilateral and multilateral regulatory coordination. Formerly, the well-understood dilemma in international capital-raising was that regulatory competition might pressure states to compromise domestic investor protection goals. To avoid this, international coordination was used to encourage states to align their regulatory requirements and cooperate in enforcement. Initiatives for regulatory coordination were spearheaded at the global level by the US SEC (through international institutions such as IOSCO) and, on a regional level, by the EU.

However, the trends toward institutionalization and technologization have changed this picture. If domestic retail investors’ funds are channeled into investment funds, international issues need no longer affect the position of these investors. Cross-border investment and capital-raising can become a dynamic between issuers and sophisticated investors—primarily the collective investment funds themselves. Sophisticated investors do not need extensive protection, and so the former trade-off with regulatory competition is lessened. Funds are consequently channeled instead through private or ‘wholesale’ markets, relying on exemptions from ordinary securities laws for transactions with sophisticated investors. Growing global competition for listing and liquidity services is paradoxically paired with a waning significance, in policy terms, of regulatory competition. As a result, regulatory coordination seems likely to engender less enthusiasm in the future.

In Part II of the paper, we consider international aspects of the substantive regulation on the three topics covered by the other papers forming part of the New Special Study (Primary markets; Secondary markets and trading venues; and Intermediaries) as well as supervision and enforcement.

For primary markets, we first consider inbound market access rules – that is, domestic rules governing how foreign issuers may raise capital from local investors. After establishing these ‘rules of the game’ and potential frictions with cross-border capital raising, we present new hand-collected data on how the number of SEC-registered foreign issuers has decreased over time and discuss the state of the international market for IPOs, including case studies of the UK’s Alternative Investment Market (AIM) and US private placements, the London Stock Exchange’s experiments with different listing segments catering to foreign firms of differing quality, and Asian primary markets.

For secondary markets, we provide an overview of the trading venue options available in the US and in Europe, explore three areas where EU regulation differs significantly from the US (dark pools, the new concentration rule for EU broker-dealers, and high frequency trading) and reflect upon how these differences may impact international markets.

This segues into a discussion of global regulatory issues in relation to intermediaries. Here we focus on a comparative overview of the US and EU regulation of cross-border investment services relating to equity markets, the US regulation of foreign broker-dealers, the implications of Brexit, and EU-style fiduciary duties for broker-dealers. A key policy question is whether and to what extent restrictions on the freedom of institutional investors to execute their trades wherever it is suitable to them and through their preferred broker-dealer wherever it is based and regulated are justified.

In the final substantive section of our paper, we offer a brief review of the literature on securities enforcement and the impact of Morrison v. NAB.

We conclude with a discussion of implications and an agenda for future research.

John Armour is the Hogan Lovells Professor of Law and Finance at the University of Oxford and an ECGI Research Fellow .

Luca Enriques is the Allen & Overy Professor of Corporate Law at the University of Oxford and an ECGI Research Fellow.

Martin Bengtzen is an LSE Fellow in Law at the London School of Economics.