Do you think regulators should harmonise listing rules in order to enhance cross-border listing?

• Sale of shares to private equity funds

This is normally used by limited partnerships of international and wealthy individual investors that raise their capital in the most liquid capital market.

• Sale of shares to a foreign firm as part of a strategic alliance.
• American Depository Receipt (ADR).

It is a negotiable certificate denominated in US Dollar that represents the                     ownership of shares in a non-US company.

Although there are several benefits for firms to cross list their securities, companies resorting to this scheme can face a number of problems. The main barrier to cross listing may be the requirement of full disclosure.  Other drawbacks associated to this policy are high transaction costs, the risk of a foreign takeover and problems associated with differences in disclosure requirements between the home stock market and the foreign ones, registration costs with regulatory authorities and listing fees (Karolyi, 1998).

1.3 The role of Regulators

The main role of regulators is to make the best use of information and resources available to better deal with uncertainty and help to have a proper functioning of their financial system. Their key objective is to assist investors in their investment decision-making by providing them with all the available information necessary to choose the best decision.

In order to reduce problems due to disparities in disclosure requirements between local and foreign markets and to help these regulators to perform their job in a proper way that will satisfy the needs of each and every investor and company that wish to be listed on a particular stock exchange, the International Organisation of Securities Commissions (IOSCO) have put forward a core set of disclosure requirements (International Disclosure of Standards) which must be contained in the documents presented by companies offering their securities to the public.

1.4 The International Organisation of Securities Commissions (IOSCO)

IOSCO is a worldwide forum for securities regulators that promotes co-operation and high standards of regulation so as to uphold fair, efficient, and sound markets. It is the worldwide association of national securities regulatory commissions, such as the Securities and Exchange Commission in the United States, the Financial Services Authority in the United Kingdom, and about 100 other similar bodies. The Financial Services Commission, which is the regulating body for the stock market of Mauritius, is also a member of that international organisation.

In fact, the main functions of the IOSCO in assisting its members are:

1. To promote high and efficient standards of regulation to maintain a stable world financial environment.
2. To provide a forum for its members to share and discuss about their experiences so as to enhance the performance of their domestic markets.
3. To gather ideas to establish new standards for the proper functioning of international securities transactions.
4. To provide mutual assistance to encourage adherence to the standards and to enforce the laws against any offences.

The main aim of the International Disclosure of Standards is to facilitate cross border listings by specifying clearly the minimum amount of information that companies, issuing securities abroad, need to disclose. Thus, costs involved in analysing listing rules of foreign markets are reduced. Furthermore, these standards provide a framework for Stock Exchanges worldwide from which they can enhance their listing rules. Another advantage resulting from these standards is that since these standards will act as a benchmark from which harmonisation of listing rules will occur and this will prevent regulators from lowering the severity of the rules of their markets.

PART 2: COMPETITION OR HARMONISATION?

2.1 The Importance of the Regulatory Approach towards Disclosure Rules

 Regulatory approach towards disclosure rules can be very beneficial to issuers, investor and regulators.

2.1.1 Issuers’ Perspectives

• Issuers benefit from many facilities while offering securities globally that they cannot enjoy in their home-country such as:
• additional capital supplied by foreign investors
• increase in share value
• reduction in capital due to decreased exposure to domestic markets risk
• additional liquidity to issuers’ securities, hence increase in trading volume
• increased publicity and media exposure boost issuers’ name recognition in foreign markets and promote business developments
• issuers can enjoy the benefits of being traded on a prestigious foreign exchange

However, these benefits are not the sole motives for issuers to offer securities globally. The domestic markets may be too small or unsophisticated to meet the demand for capital. Therefore the issuers often have to offer their shares globally in order to raise large amount of capital necessary for their operation.

The benefits of multinational offerings and the magnitude of disclosure costs make it essential for issuers that a cost-benefit analysis of competition against harmonization be conducted in order to determine the most-efficient approach for regulating the global market. 

2.1.2 Investors’ Perspective

• International diversification- allows investors to reduce the systematic risks due to low correlation between returns on foreign and domestic securities.
• Opportunities for increased risk-adjusted returns by providing investors with opportunities to outperform domestic markets.  For example, from 1992 to 1994, the returns on a price index of 215 ADRs from 26 countries outperformed S&P 500 by 25%.
• Cross listing of stocks reduces market risks and cost of capital, both for cross listed stocks as well as for purely domestic stocks.

In order to exploit the above benefits, investors need an efficient disclosure system which can supply them, at the best cost with all information needed for the accurate pricing of foreign stocks.  The disclosure system can as well serve as an efficient means to encourage managers to manage better and to reduce the risks of fraud and manipulation.  Hence, these factors can make investors interested in the regulatory approach that will eventually govern securities disclosure in the international market. 

2.1.3 The Limitations of Alternatives to Exchange Listing

Since there are no real alternative to listing and trading on a public exchange, the importance of the regulatory approach towards disclosure rules is increasing. 

Non-public offering and non-exchange trading cannot serve as an alternative for multinational public offerings and exchange listings.  To avoid the cost of multiple disclosure requirements, current practice in multinational offerings only in the issuer’s home country and one additional market together with non-public offerings in other markets.  On the other hand, non-public offerings do not give the same benefits to issuers and investors that public-offerings do such as:

• Shares are sold at a discounted price in a non-public offering, to compensate investors for the limited liquidity and transferability.

• Amount of capital that can be raised in non-public offering of equity is limited since small investors cannot usually participate in such offerings.

As a result, the supply of capital in non-public offerings is limited relative to public offerings, which is open to institutional as well as retail investors.  Hence, despite the lower disclosure costs, the cost of equity in non-public offerings is higher than in public offerings.  Moreover, issuers involved in non-public offerings do not enjoy the publicity and prestige connected with public offerings. 

Another drawback is that securities which are offered in a non-public offering cannot usually be used for employee compensation plans.  Many foreign issuers prefer to avoid the costs involved with registration under the exchange Act by using pink sheets market.  However there are many disadvantages for using pink sheets for example,

• Pink sheets market is  significantly less transparent than the regulated exchanges,
• Liquidity is very poor
• Bid-Ask spreads can be 8 to 10 times higher than those on the exchanges.
• Quality of information available about issuers is very poor. 
• Pink sheets market is less exposed to media coverage than regulated exchanges

Hence considering the above disadvantages, the issuers can expect the price of the securities in the pink market sheets to be discounted by investors. 

2.2 Regulatory Alternatives

Under regulatory competition, domestic regulators operate independently when circulating disclosure rules for their markets. Competition for foreign listing is done by offering disclosure rules that are more attractive to market participants.  The main alternative to regulatory competition is the harmonization of disclosure rules which was implemented in the European Union Harmonization plan and the MJDS between the US and Canada. 

2.2.1 Regulatory Competition Theory

This is a competition to attract market participants by offering them the most efficient regulatory environment in which to operate, with competitive discipline and seeking the least costly means of production.  This theory originated with Adam Smith’s theory of the “invisible hand of the market.”   Concerning securities disclosure rules, regulatory competition is supposed to lead to competitive equilibrium. In markets where the regulation is stricter, the issuer can expect higher prices on his securities as the investors in those markets are less exposed to risks of fraud and manipulation and hence they benefit from comprehensive disclosure system supplying them all relevant information in order to make sound investment decisions.  If there are no regulatory system of trading in other markets, investors will not invest in those unless the price discounts compensate them for the additional risks and information costs involved.  Similarly, issuers will not offer securities in markets with weak or no regulatory framework due to high risks and costs engaged.   

2.2.2 Harmonization Theory

Harmonization of securities disclosure rules consists of two legal orders:

• Reciprocity- based on deference to the standards of another jurisdiction.  If the jurisdiction of two or more countries have the same regulatory regimes, one can accept compliance with the rules of the other country as compliance with its own law.  However, reciprocity is limited to situations in which there is strong economic connection among all the countries involved and all hold similar minimum positions.

• Commonality- based on the production of a substantially uniform standard to govern securities issues in different jurisdiction.  Commonality modifies or replaces the domestic rules of one country to fit another.  Therefore it can be said that commonality approach can be used to harmonize the rules of jurisdictions that did not initially share the same rules.

PART 3: THE LIMITS ON REGULATORY COMPETITION ON THE GLOBAL MARKET

There are many shortfalls in regulatory competition and its inability to provide the most efficient regulatory solution to global listing rules. The need for a ‘global coordinator’ with the ability to coordinate and monitor the operation of domestic regulators of domestic regulators and market participants is primordial. Among the various shortfalls are included:

3.1 Cost of Information

Informational efficiency is very important for a market to be efficient. This is posited by the Efficient Market Hypothesis. However, the cost of information has a huge impact on the market participants, who have asymmetrical access to information compared to others. With cross-border listing, informational efficiency becomes more important as investors would not like to put their money in a foreign company, on which they have little information.  Information cost thus significantly limits the operation of regulatory competition. Therefore the intervention of a ‘global coordinator’ with a view to harmonize listing rules is required to improve market operations:

1. Cost associated with identifying Efficient Jurisdictions

In order for regulatory competition to work, market participants need to be able to evaluate the regulatory burden and the advantages of disclosure rules in all competing markets, that also, at a minimum cost.

However, market participants bear significant costs in the process of gathering and evaluating information on foreign markets.  To identify the most efficient jurisdiction, market participants need to obtain information on many markets around the world (written in different languages and different formats), analyze it, assess the efficiency of pricing under the various regulatory regimes and, finally, compare all the information.   This process is not a one-time event; market participants must continually assess all regulatory changes in all potential markets.  Even assuming that all the necessary information exists, the process of gathering and analyzing it is very costly and this adds to the cost of capital and prevents market participants to conduct an accurate cost benefit analysis of disclosure rules.

2. Incomplete Information

When market participants do not have accurate information about the quality of securities, the market system does not operate efficiently. Due to high costs of information, investors are unable to obtain and utilise all relevant information for the efficient pricing of foreign securities. Without uniform listing rules, it might result in a ‘market for lemons’ in jurisdictions in less stringent disclosure rules. Akerlof (1970) states that, a ‘market for lemons’ develops when information about the quality of securities is either unavailable or very costly. As investors cannot distinguish between profitable and unprofitable securities, they will discount the price for all securities. As a result, profitable securities will be driven out of the market, leaving only the unprofitable ones (that is, the ‘lemons’).

3.2 Lack of Mobility  

The main problem with regulatory competition is that it assumes perfect mobility of participants. However, in reality, it is barely the case. Lack of mobility is inhibited by:

1. Compliance with more than one regulatory regime

The existence of overlaps among jurisdictions prevents market participants from choosing their preferred regulatory regime and subjects them to additional costs of compliance with multiple regulatory requirements. Market participants often find themselves subject to multiple jurisdictions. Investors usually try to diversify their investments over different markets, to reduce systematic risk in their portfolio –especially in the case of multinationals.  To do this, they must use disclosure documents from different markets, the form and content of which are determined by distinct regulators. This is more complex more the issuer as complying with one rule in a market may mean violating a rule in a market in which it operates and is subject to sanctions.

2. Regulatory Barriers

Usually firms will operate in a foreign market only if the costs of accessing that market are lower than the returns on the market. But with regulatory barriers, such gains are reduced. Such barriers include regulatory friction from foreign exchange controls, differential taxation rules and restrictions on foreign ownership of capital. In addition, regulations provide that foreign companies should bear higher costs of compliance as they need to publish more additional information than domestic companies and may put them at a competitive disadvantage as such.  

3.3 Market Power

Competitive Regulation might put firms in a monopolistic situation, where there are high costs of entry to the market. This reduces efficiency and harmonisation can help in bringing competition for the benefit of market participants and consumers also. If we take the international financial market, the USA can be considered as a monopoly, whereby it attracts more foreign firms than on any other market to be listed. As such it has market power and can raise the costs of compliance. But this also means the concentration of capital on a single market. With the Credit Crunch, and the number of foreign firms operating in this market, we are already seeing the international impact this has had on the global economy as a whole. But if listing rules were harmonised, firms would be attracted to diversify in other markets also – reducing the risk of having such financial crises – as the compliance rules would be same.

3.4 Management opportunism

Internationalisation of firms is also affected by the agency theory – whereby managers might favour rules which enhance their own wealth rather than that of shareholders. Thus, when making multinational offering decisions, managers might not select the most efficient regulatory regime from the shareholders’ perspective.

Disclosure is a very effective tool for monitoring managers’ performance.  The need to disclose all material information induces managers to manage better. Disclosure might also prevent managers from taking actions that have window-dresses their performance, such as insider trading and self dealing. As a result, managers may prefer to offer securities in a market with a less rigid disclosure system, which enables them to act opportunistically. The risk of managerial opportunism exists mainly in offerings by companies that are not subject to rigid disclosure systems in their home countries (such as the offerings by companies from emerging markets, the EU and Japan in the U.S.).

There are many examples of disclosure rules, including those of major capital suppliers such as Japan, Germany and the U.K., which enable managers to take significantly self-profitable actions.  Self dealing is a very strong form of managerial opportunism. For instance, in Japan there is no such comprehensive disclosure system and corporate insiders are required to disclose only their trading in the company’s securities.

Another example is “income smoothing.” Managers have incentives to “smooth” reported income and avoid the reporting of negative changes.  U.S. disclosure standards require managers to report enough information to enable investors to determine real income.  In contrast, Japanese accounting practices enables managers to “smooth” income by the use of hidden reserves on the balance sheet, a liberal translation of foreign currency and the ability to characterize certain transactions as extraordinary.    

3.5 The ‘race to the bottom’ effect

All states compete for multinationals to invest in their country. This brings significant FDI to their country, improving the GDP per capita, and increasing employment.

All states together might find it beneficial to offer rules that improve the aggregate welfare of society. In the absence of cooperation, each state is better off providing a system of corporate disclosure rules that attracts multinationals. But usually multinational would prefer to have less disclosure requirements especially so as not to inhibit their competitive position on the market. Hence, states might be forced to offer disclosure rules that are below the level of stringency which they think is desirable.  The result could be a race to the bottom.  

An example of a race to the bottom which developed as a result of the competition to attract issuers is the dispute among the NYSE, NASDAQ and AMEX concerning the issue of dual class common stock.   For many years, the NYSE did not permit the listing of common shares of a company that had super voting shares, while NASDAQ and AMEX allowed such listings. The common explanation of this policy was that companies which complied with the higher corporate governance standards of the NYSE could enjoy a lower cost of capital.  During the 1980s, when managers were feeling great pressure because of the threat of hostile takeovers, many managers favored their own job security over shareholders’ interests, so they moved to NASDAQ and AMEX, which allowed issuers to use super voting rights to avoid takeover threats.        Only in 1994, after a long battle, did the exchanges and the SEC compromise on a standard which allows the listing of dual class common stock, but prevents the disenfranchisement of the existing shareholders.    

Thus, all these shortcomings call for the harmonisation of listing rules rather than competitive regulation on the global market.

PART 4: WHY GO FOR HARMONISATION?

4.1 Harmonising listing rules

Harmonisation of listing rules refers to unified listing regulations that will facilitate cross border listings in particular regions. To foster cross border trading, there needs to be progress towards simultaneous disclosure of company/ price sensitive information on all markets and harmonisation of settlement and trading arrangements. Normally harmonisation of listing rules is a very complex issue since it considers the macro economic situation of a country, its currency, the state of its stock exchange, whether there will be violation of investors rights, the implementation implications of proposed principles, the challenges in adopting them given the diversity of nature of exchanges as well as consultation with member exchanges are required and new listing regulations have to be discussed among the regulators so as to reach a consensus.

4.2 Benefits of Harmonising listing rules

 Harmonisation leads to creation of a set of international disclosure standards for cross border and initial listing of debt securities by foreign issues. The main benefit of adopting such disclosure standards by jurisdiction would be to facilitate cross border offerings because a foreign issuer can use one disclosure document that would be accepted in multiple jurisdictions. At the same time, adequate investor protection would be ascertained through the use of high quality disclosure standards.

• Reduces Cost of Capital

Normally both issuers and investors bear significant transaction cost when participating in international activities.  The use of one standard would eliminate the need to comply with multiple disclosure standards and would reduce the cost of issuing and trading in securities.

• Favourable effect on share prices

Since no new free issue of shares is made by the company wishing to cross list its securities, foreigners will have to buy existing shares. As such, the increase in demand for that company’s stocks will increase its price since its supply will be limited. This will result in capital gains for the existing shareholders.

• Increased Shareholder Base and reduction of risk of individual shareholder

Since the securities of the company will be listed in more than one country, the number of shareholders will increase and will range over all the countries where the shares are listed. As such, the shareholder base will increase. This will lead to a diversification of equity funding risk. In fact, with more shareholders, the risk of the company will be distributed over a larger number of people. As such, individual shareholder risk will be reduced. 

• Relative mis-pricing

Firms may decide to list abroad to take advantage of a temporarily high price for their shares abroad relative to their home market, due either to an overvaluation in the foreign market or to an undervaluation in the domestic market.

• Visibility

Cross-listing enables to increase visibility on the international stage. In addition to greater demand for its stock, listing abroad provides a firm with greater access to foreign money markets and makes it easier to sell debt there. A firm becomes more convincing by providing information to the local capital market, and, in turn, this continuous flow of information allows the capital market to make faster, more accurate decisions.  Hence it leads to more transparency in financial reporting requirements as well as enhances the comparability and credibility of reported information.

• Other Advantages

Cross-listings can also be made for marketing reasons. According to this reasoning, foreign listing can boost corporate marketing efforts by broadening product identification among investors and consumers in the host country. The listing, it is claimed, creates greater market demand for the firm’s products as well as its securities

In addition, cross-listing can be an advertisement for the firm's products and thereby increase its foreign sales, by raising consumer demand and improving relationships with suppliers and employees.

Harmonisation eases the way of preparing financial and non-financial statements with the elimination of multiple jurisdictions thus resulting in a common accounting system for adjusting, reconciling and explaining different bases applied in different countries.

Harmonisation lowers investment risk because it reduces an element of risk associated with understanding foreign financial reporting for investors and lenders.

Although there are several benefits for firms to cross list their securities, companies resorting to this scheme can face a number of problems. The main drawbacks associated to this policy are high transaction costs, the risk of a foreign takeover and problems associated with differences in disclosure requirements between the home stock market and the foreign ones.

4.3 Is Harmonisation a perfect solution?

With harmonization of listing rules, common standards need to be developed with the existing market structure and not as part of the creation of a single securities market regulated by a “Global Regulator.”  The creation of a “Global Regulator” would be likely to raise strong political resistance from domestic governments fearing loss of their sovereign powers.  Thus it is found that the process of harmonization will require compromises among various domestic regulators that hold different views about disclosure standards.  Political opposition by various interest groups may hinder, if not stop, the process of harmonization.  

Moreover, when standards are “formally” harmonized, their enforcement and interpretation might differ among nations.  An inefficient harmonized standard would be worse than an equally inefficient domestic market, since it would govern the activities of many more market participants than any single domestic standard.  Finally, even if harmonization is proved to be an efficient solution, the transition costs involved in implementing such a radical change might outweigh its benefits.

Conclusion

While financial markets worldwide have become more integrated, geography still matters in finance .After a profound understanding of what cross-border listing is all about and the role of regulators in monitoring such financial transaction, it can be said that their work of facilitating the smooth flow of security listings involved much risk and is quite a difficult task as more than one country’s listing rules are involved. Stock exchanges are trying to circumvent barriers to international capital flows by creating strategic alliances that reach across borders.

Firms are also constantly striving to overcome market segmentation by adopting financial policies such as cross listing. Cross listing allows firms to reduce the cost of their equity capital by reducing the systematic risk of their shares for investors, by increasing the liquidity of their shares, and by improving the information environment. Global competition for order flow among stock exchanges and the resulting enhancement in market quality not only improve the financial conditions of firms, but are also beneficial for investors.  Presently many regulators are working on the harmonization of their listing rules in order to enhance cross-border listing as this transaction is becoming more and more popular especially with globalization and the technological progress.

However, this will be a long term process as there need to have a proper consensus among the regulators involved as well as a number of issues will have to be resolved in order to stabilize the world financial system whereby a more elaborate and detailed reviewed of securities laws and regulations of each country is required.

Moreover, given the innovating nature of today’s financial market and their rapid integration, securing the financial stability is a continuous task where we need to find the proper balance in answering the question: “How much freedom is possible, how much regulation is necessary?”

Indeed, harmonization of listing rules by regulators becomes a vital component as this will be one of the major contributions to the creation of the “Level playing field” that enables cross-border linkages to develop quickly.

This however remains the major challenge…

REFERENCES:

• Chouinard, E. and D’Souza, C. 2003/2004, “The rationale for cross-border listings”, Accessed on 14 October 2008. Available from: .

• “International Organisation of Securities Commissions”, Accessed on 14 October 2008. Available from:

• Merchant Taylor’s Hall, “The global equity market – An enforcement perspective”, Accessed on 14 October 2008. Available from: .

• Geiger Uri (1998), “The case for the harmonisation of securities disclosure rules in the global market”, Available at SSRN

• http://www.financialtimes.com