So maybe you didn’t lose a night’s sleep when the TMX group, the owner of the Toronto Stock Exchange, announced plans to merge with the London Stock Exchange Group. But the ownership of Canada’s biggest stock exchange might be a wake-up call.
The stock market is sort of like the air traffic control centre of finance. How a stock market works will influence how money gets moved around the economy. And while all that money is moving around, some gruesome mid-air collisions may happen if the air traffic controllers aren’t on top of their game. A stock exchange merger across national boundaries will undermine the ability of the exchanges’ regulator supervisors to prevent financial smash-ups.
Let’s start with the basics: what is a stock exchange, anyway? A stock exchange used to be a physical space where people bought and sold shares in corporations. Stock markets historically have played a vital economic role by enabling corporations to sell shares in order to raise funds to invest. Because the allocation of capital to investment is necessary to support economic growth, stock markets historically have been considered vital to national interest.
Stock exchanges have become much more complex virtual entities in recent years. But the basic idea is that they bring together those individuals and institutions (brokerage firms, pension funds etc.) who wish to buy and those who wish to sell a variety of financial securities. Sometimes all these transactions serve a useful social and economic purpose (like promoting investment in something that is economically productive), and sometimes they generate the destabilizing speculative bubbles that fuel financial crises.
When buckets of money are changing hands every minute, lots of things might go wrong. Thanks to a long history of hair-raising stock market intrigue, not to mention periodic stock market crashes, governments have assumed the responsibility of regulating stock markets, and financial markets in general. Regulators need to keep a watchful eye for all of those nefarious schemers who just can’t resist the temptation of all of that money flying around. And in addition to preventing outright fraud and other skullduggery, it’s in the public interest to make sure that stock markets do more of the economically useful roles (like encouraging productive investment) and less of the destabilizing activities (like fueling speculative bubbles).
The regulators of financial markets face a relentless task. They must perpetually monitor financial activities to discover the endless new ploys of clever operators who attempt to subvert the rules. They are constantly bombarded with demands to change seemingly innocent regulatory details, and it is notoriously difficult to figure our which of these regulatory fiddles are harmless and which will open the door to the next speculative mania that comprises systemic financial stability.
Take the Enron Loophole. In the 1990s Enron lobbied American legislators to exempt certain derivatives contracts for commodities from the regulatory oversight that would apply if these financial instruments are traded on an exchange. This lobbying paid off in 2000, when new legislation created the Enron Loophole, enabling energy contracts to trade outside of the usual regulatory scrutiny of the Commodity Futures Trading Commission. In particular, the 75 year old limits that impeded speculators from trading in energy commodities were circumvented. After the spike in energy prices in California in 2001, suspicion grew that this loophole had enabled Enron to use its electronic energy trading platform to manipulate energy prices.
The Enron loophole is just one example of the kinds of trouble that can happen if regulators are compelled to water down regulations. But because there is no effective international regulation of stock markets, it becomes much more difficult for regulators to be proactive and tough when the entities that need regulating cross national boundaries
If a stock exchange is partly owned and operated in Canada, and partly owned and operated in the UK, two (or more, given the many provinces involved) jurisdictions have authority to regulate. When there are multiple regulators, the tendency is for the most lenient regulations to prevail.
If tough rules existed in Canada alone, a stock exchange with operations in Canada and the UK would just move any affected activities to the UK. So if one regulator succumbs to lobbying to dismiss an inconvenient regulation, the other regulators know that their jurisdiction will lose business if they don’t buckle too. So the more lax regulations anywhere in the jurisdiction become the regulations everywhere in the jurisdiction.
This same principal applies to the attempt to get any new regulation passed. All regulatory authorities in each relevant jurisdiction must cooperate to pass new rules, otherwise the stock exchange will just evade new rules by shifting their operations to the most regulation-friendly setting. This should cause progressives to pause: in the wake of the financial crisis, demands have increased for securities transactions taxes (sometimes called Tobin taxes) that both deter speculation and raise money that could be put to good use. As hard as it is to push these taxes on speculation now, it would be much more difficult to try to get them instituted in two different countries simultaneously.
In the absence of an international watchdog with teeth, we have to make sure that national and provincial regulators have every opportunity to stand up to the relentless lobbying of financial services industry to bend rules in ways that may have negative consequences. And since these consequences are difficult to foresee, regulators must err on the side of caution. With a flurry of mergers among stock exchanges, a lot of pressure will be put on regulators to make sure rules are friendly to the success of these new stock market entities.
The world is still hobbled by the continuing ramifications of the financial crisis, and we are a long way from learning the lessons of that nightmare. The last thing we want to do is to encourage a situation in financial markets that compromises the abilities of regulators to get tough and allows further financial deregulation to flies under the radar. Don’t sleep through this one.
Ellen Russell is a Research Associate with the CCPA. This piece was originally published on rabble.ca.