Foreigners Demanding a Say in US Market Regulation

Some reformers have argued that we are at the end of a regulatory paradigm and need to consider fundamental change in securities laws. A major obstacle, given that capital markets are now global, is the need for greater international cooperation and possibly even a new international body.

It turns out some foreign regulators are already making that case. As the New York Times tells us:

Politicians, regulators and financial specialists outside the United States are seeking a role in the oversight of American markets, banks and rating agencies after recent problems related to subprime mortgages.

Their argument is simple: The United States is exporting financial products, but losses to investors in other countries suggest that American regulators are not properly monitoring the products or alerting investors to the risks.

American regulators would have dismissed this view as lunatic fringe as recently as a month ago. After all, America’s financial markets set the standard for the world and if anything, what was needed was less, not more, regulation.

For example, the recent handwringing over the US’s loss of market share to London led to a couple of studies, one informally called the Paulson report, the other the Bloomberg/Schumer report, after their respective sponsors (see here for a very good write-up plus links). The subtext of each set of recommendations was that the US needed to become an even friendlier place for foreign issuers.

Although there were some differences (the Bloomberg/Schumer report called for lowering visa restrictions to make it easier to attract top talent), the two reports were broadly in concert, for example calling for some changes in Sarbanes-Oxley, limiting the liability of foreign issuers, capping auditors’ damages, limiting punitive damages, (Note that these reports argue for some pet corporate causes, namely, chipping away at Sarbox and restricting punitive damages. At least as big an issue for foreign companies is the confusion and uncertainty of being subject to both Federal and state law, but that admittedly unsolvable problem appears not to have been acknowledged).

The events of the last month have illustrated, vividly, how failings in our regulation can wreak havoc overseas. Recall that the European money markets seized up before ours did due to subprime fallout, first with German bank IKB, then with three Paribas funds that froze redemptions.

Given that the US is a chronic capital importer, foreigners may have more leverage than it might appear (although far and away the biggest source of overseas funds is central bank purchases of Treasuries, and it’s highly unlikely any of our creditors will use that bludgeon). And the demands are coming from many quarters. The Germans want rating agencies to be nationalized, complex debt to have much better disclosure, and large loans to be registered. The Chinese want standardized disclosure for asset backed securities. Even conservative French President Nicolas Sarkozy wants tougher rules:

President Nicolas Sarkozy of France, who has vowed to “moralize financial capitalism,” has asked his finance minister, Christine Lagarde, to prepare a proposal for stricter disclosure rules on market participants before an October meeting of finance ministers from the Group of 7. On Monday, in a foreign policy speech, Mr. Sarkozy called again for stronger global regulations to avoid financial crises.

Clearly, being right wing in France isn’t the same as being right wing here.

These calls for at least more international harmonization of rules, and perhaps even international oversight, should be welcomed in the US but instead are being rebuffed out of a misguided sense of exceptionalism and national pride.

We should take a lesson from the Japan. Its leaders are masters of invoking gaiatsu, or foreign pressure, when they want to force unruly domestic constituencies into line. Perhaps a little foreign arm twisting is precisely what we need to help overcome the obstacles to politically charged securities law reform.