Brunswick Review The Resilience Issue

The Cost of Transparency

Regulators have to walk a delicate line to keep markets fair—but also affordable, says Brunswick’s Rob Webb.

The publicly quoted “joint stock” company, in its current form, has been a feature of the open markets of the West for well over a hundred years. It allows individual investors, pension funds and “activists” to share in the profitability, or otherwise, of quoted commercial concerns; they can come and go at will, according to their assessment of the future prospects of the company. They can set a price for its shares that becomes transparent and available to all, Dark Pools notwithstanding.

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Modern technology, and the anxiety of today’s regulators in the public sector, however, are changing the nature of the relationship between these investors, the owners of the company, and its management and staff. They rarely meet. Their interests may not be aligned. The “investor” may be short in the stock—thus hoping its share price will go down (and sometimes tempted to lure the facts and rumors toward the short position) and even when “long,” investors may be holding the stock only for a few micro seconds until their algorithm requires them to discard it; the long holder may even be a reluctant holder—it may have to hold shares in companies in a particular FTSE or other index because its own rules make that a requirement. The need of one investor may be for short-term cash or, for the individuals, for the hope of bonus glory for a clever investment at year end; the need of the company may be for long-term money—“for the loser now will be later to win, for the times they are a changin’” as Bob Dylan puts it. What looks right to the micro-second day trader may not look right to the pension fund whose liabilities will crystallize in 40 years’ time.

Coupled with this disparity of interest is the desire of politicians to make sure members of the public do not lose money; whenever there is a fire in the backyard, they wish to legislate for all potential fires in all backyards “just in case” a unique or unusual event could happen again, and the blame for it laid at their door. Prevention is an easy tool. But wealth creation, on which we all depend, is more difficult.

If the regulatory boundaries on public companies become even more costly, and if the hunger of detached and remote algorithmic investors becomes even less relevant to the performance or purpose of the company, then open markets will shrink to the benefit of private markets: sovereign wealth funds, family offices, privately owned companies and a myriad of vehicles that can be invested privately—for the long term, for the benefit of the company and, not being owned by the public, free of the regulatory and political howling of the public markets that softens the risk appetite of those who are routinely subjected to it. Thus, it will be that the public will lose some of its access to successful commercial ventures, and price transparency will be reduced.

In a prosperous society, all these models should be able to co-exist profitably, but it is vital that public markets should be able to hold their own; visible price setting and transparency of shareholdings help to create a chance for the public and their pensions to share in the profitability of a venture. These are highly desirable features of an open society, and of a free market open to all. Let us hope they do not become less relevant as the years pass.

Regulatory arbitrage can make the difference between profit and loss. Investor involvement, and comprehension, can make the difference between success and failure. If the cost of trading openly exceeds the cost of trading privately, even by a small amount, over a long period, the public will be deprived of its access to capital. While wealth inequality remains a hot political tropic, regulators need to make sure that markets remain fair, for sure, but also that the costs of their regulation do not make them unaffordable.

Rob Webb QC is a Senior Advisor based in Brunswick’s London office.

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