09.19.2017

Capital Formation in the Spotlight

This article first appeared in the magazine of the STA’s 84th Annual Market Structure Conference, which was held Sep. 13-15 in Washington, D.C.

On January 6, 2017 Financial Services Committee Chairman Jeb Hensarling announced the selection of Congressman Bill Huizenga to Chair the Financial Services Capital Markets, Securities and Investment Subcommittee for the 115th Congress. Representative Bill Huizenga, a Republican from Michigan’s 2nd congressional district is serving in his fourth-term and replaces former Congressman Scott Garrett who lost his re-election bid in November 2016. In his new role, Rep. Huizenga will, among other things lead the subcommittee’s efforts regarding all aspects of the Securities and Exchange Commission’s (SEC) operations, activities, and initiatives to ensure that it fulfills its congressional mandate to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. Since assuming his position, Rep Huizenga has played a contributing role in advancing several committee bills including the Financial Choice Act which includes reforms to certain parts of Dodd-Frank and seeks to ease regulatory costs on small businesses. After passing through the House Financial Services Committee, the 600-page legislation passed a full House vote 233-186 on June 8, 2017.

“Senate Banking Committee Chairman Mike Crapo and Ranking Member Sherrod Brown earlier this year requested proposals that might help foster economic growth,” says Joel Oswald of the Washington DC law and lobbying firm, Williams & Jensen. “Chairman Crapo has expressed his desire to move bipartisan legislation that would improve the regulatory framework.”

Rep. Huizenga has also held a series of hearings on topics relating to his committee, including one on June 27th which examined the state of U.S. equity markets and featured a wide range of industry professionals like exchange leaders, Tom Farley, President & CEO, NYSE and CBOE’s new President, Chris Concannon and Matt Lyons, Capital Group. A common strand through the Financial Choice Act and the June 27th hearing is capital formation and how it may be better facilitated through changes in regulation and/or market structure. Capital formation and job growth are very much a priority for the new Administration as witnessed by the selection of the Presidential Cabinet and the nomination of Jay Clayton to be the SEC’s new Chairman.

To most in the industry, capital formation through incentivizing companies to go public needs to be seriously looked at and soon.

“Since the 2007 financial crisis brokers dealers and banks of all sizes have undergone a tremendous amount of de-leveraging. This resulted in capital, normally available for liquidity in initial and secondary markets, being removed from the markets. ” Says Jim Toes, President & CEO of the Security Traders Association, “In looking at what can be described as a prolonged period of low GDP, our economy needs an effort of equal scale to bring real economic growth back to our nation. Our markets need to ramp up their capital formation role.”

Toes goes on to highlight that there were indications that our markets were under-performing in their capital formation function before the 2007 financial crisis, suggesting that reviews and potential revisions of regulation need to look further back. In an letter dated May, 2003 to then SEC Commissioner William Donaldson, STA expressed concern on the secondary trading of less active securities due to a loss of liquidity providers:

“The raising of equity capital by corporations is the cornerstone of our economy. However, given the recent regulatory events surrounding research and investment banking and market structure changes affecting trading, the raising of capital has become exceeding more difficult. That, in turn, is impacting the U.S. economy and its ability to create jobs.

“Action must be taken soon to remedy what could soon be a capital formation crisis.”

Industry professionals believe that the declining number of IPOs is not attributed to any single regulatory or competitive event, nor is it isolated to one segment of market structure. Capital formation is a multifaceted process that in order for financial markets to perform it, efficiencies in regulation and competition need to exist among and within all the participants involved: issuers, broker dealers, investment banks, exchanges and investors. When it comes to the role of the SEC, there has been debate as to whether their involvement has been too little or in some areas, too much.

“Rather than mandate market behavior, grant exchanges trading monopolies or micromanage capital formation, we believe markets are at their best when regulations remove barriers, lower costs and create opportunities for fair and transparent choices between different business models so innovation can flourish.” Says Cromwell Coulson, CEO of OTC Markets.

There are several efforts at the exchange level which seek innovative ways to incentivize companies to go public. Earlier this year Nasdaq published their “Revitalizing the Capital Markets” report which they believe will be a blueprint for creating “a vibrant ecosystem” that delivers enhanced capital formation opportunities and in March NYSE asked the SEC to alter its listing standards to allow for direct listings. This request is commonly referred to as the “Spotify rule”. If approved and successful, direct listings could be an alternative for those companies who are currently choosing to remain private for reasons associated with compliance and underwriting costs. Most recently it was IEX that took a major step forward in becoming a listing exchange when the SEC approved its openings and closing auction processes.

“The attractiveness and integrity of our public markets is critical to the health of the U.S. economy. Exchanges play an important role in reducing companies’ pain points in going and staying public. As a new listing exchange, we are focused on reducing unnecessary complexity and excessive costs for companies.” Says, Sara Furber, Head of Listings for IEX.

While there is broad consensus that capital formation needs to be improved, designing legislation which strikes the proper balance of regulation, competition and investor protection will be a challenge. How much of that solution falls to Rep Huizenga is to be determined, but his actions thus far show a willingness to engage those participants instrumental to any success.

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