The FSA should let investors make their own mistakes
13 February 2012
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Government and Institutions
The IEA’s 2010 monograph Does Britain Need a Financial Regulator? argued, amongst other things, that the Financial Services Authority (FSA) has been guilty of overreach and empire building. Recent events suggest little has changed in that regard.
The FSA has published a consultation paper on prospective companies seeking to list on the London Stock Exchange. It is partly in response to alarm bells over ‘exotic’ or foreign listings, where investors are being seen to be caught out by deficiencies in corporate governance standards. The most recent example of this has occurred on the Toronto exchange. The Chinese lumber company Sino-Forest, once worth $5bn, had its shares suspended as a result of doubts about the existence of some of its assets. This incident is now being used as a test case for greater protection for investors through tougher rules for main market flotations.
The FSA has suggested that companies should, before having their shares go public, go through stricter eligibility tests to prove they have the required maturity to be publicly listed. This represents problems on several levels:
It is the last point that is the most worrying. In Paul Murphy’s FT column he correctly recognised that an old adage has been forgotten my many investors. If someone is deciding to buy shares in a company: ‘The further away the assets, the higher the premium’. He then concludes that because the adage has been forgotten, the investors need greater protection by the FSA through tougher listing requirements, stating that when the Sino Forest incident is replicated in London ‘the damage will be reputational and it will apply across the board’.
Views such as these demonstrate a fundamental misunderstanding of the proper role of a financial regulator. If an equity fund invests in overseas companies, it should undertake research and factor the following into its valuations: distance, management history, political risk and cultural differences. It is inevitable that poor decisions will be made from time to time and shareholders will suffer losses. But this does not mean that there should be greater regulation. Overseas companies have provided UK investors with sizeable returns in the recent past, and these companies have been able to take advantage of London’s highly liquid markets to fund their development. This beneficial relationship should not be undermined by heavy-handed controls.
The FSA has published a consultation paper on prospective companies seeking to list on the London Stock Exchange. It is partly in response to alarm bells over ‘exotic’ or foreign listings, where investors are being seen to be caught out by deficiencies in corporate governance standards. The most recent example of this has occurred on the Toronto exchange. The Chinese lumber company Sino-Forest, once worth $5bn, had its shares suspended as a result of doubts about the existence of some of its assets. This incident is now being used as a test case for greater protection for investors through tougher rules for main market flotations.
The FSA has suggested that companies should, before having their shares go public, go through stricter eligibility tests to prove they have the required maturity to be publicly listed. This represents problems on several levels:
- It will add extra hurdles to an already heavily regulated area of the financial sector;
- It presupposes that the FSA has within its capacity the ability to ‘test’ which private companies are suitable to go public and which are not;
- It could result in London having to turn away good overseas companies, which would then apply to other bourses, thereby further damaging the UK’s competitiveness as a financial centre;
- Calls are already being heard for the proposed test to be applied to the junior ‘AIM’ market, where the majority of overseas listings take place. This could deny smaller companies the necessary capital to compete and grow;
- A standardised test would detract from potential investors’ ability to innovate how they would decide whether or not to buy shares in an ‘exotic’ company.
It is the last point that is the most worrying. In Paul Murphy’s FT column he correctly recognised that an old adage has been forgotten my many investors. If someone is deciding to buy shares in a company: ‘The further away the assets, the higher the premium’. He then concludes that because the adage has been forgotten, the investors need greater protection by the FSA through tougher listing requirements, stating that when the Sino Forest incident is replicated in London ‘the damage will be reputational and it will apply across the board’.
Views such as these demonstrate a fundamental misunderstanding of the proper role of a financial regulator. If an equity fund invests in overseas companies, it should undertake research and factor the following into its valuations: distance, management history, political risk and cultural differences. It is inevitable that poor decisions will be made from time to time and shareholders will suffer losses. But this does not mean that there should be greater regulation. Overseas companies have provided UK investors with sizeable returns in the recent past, and these companies have been able to take advantage of London’s highly liquid markets to fund their development. This beneficial relationship should not be undermined by heavy-handed controls.
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Good post and an issue worth raising. Maybe I could point out that “Does Britain Need a Financial Regulator?” did not just suggest that the FSA had over-reached but that we did not need a state regulator – exchanges are perfectly capable of determining this sort of thing for themselves. They always did and they still can (if only the state regulator would let them).
Absolutely Philip, balancing corporate governance compliance for investor confidence, and the ability of management to operate with necessary freedom would be far better achieved by self-regulating exchanges. What the FSA seems to be doing is trying to protect equity investors from making bad investments, which oversteps the remit of a regulator.