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HAVE CAPITAL, WILL
TRAVEL:
The Future of the U.S. in a
Mad Money World
Giant international investment funds. Rival stock exchanges. The U.S. is facing a rapidly changing global capital market. What will it take for America to remain the world’s premier financial destination?
By Jeff
Hellman
Giant international investment In a story that could be comical save the circumstances, Red Herring reported that during the battle with Hezbollah in the summer of 2006, Israeli entrepreneurs-turned-soldiers were transacting deals from inside tanks and bomb shelters. Amid an exploding global capital market, perhaps nothing is surprising; money is in motion everywhere, with few corners untouched by international investment fever.
Even a short list paints a big picture. The rupee is spiced up; China’s economy is ablaze; Russia has a nominal GDP of $1.2 trillion. The World Bank reports that a record $325 billion in foreign direct investment (FDI)—roughly one-quarter of the global FDI total—flowed into developing countries last year, driven by a relentless M&A market that as of this September, has already blazed a 9,178-deal, $1.36 trillion trail across Europe alone. Brazilian stocks are soaring, New Zealand VCs are prowling, and euros are flowing into places like Serbia and Estonia.
Hungry for more? The all-world deal du jour is the titanic fight between Barclays and the Royal Bank of Scotland for Dutch bank ABN Amro, priced at nearly $100 billion and involving a mix of European, U.S. and Asian suitors. Headier still is the estimated $2.5 trillion primed for worldwide deployment from the state-backed “sovereign wealth funds” of China and other countries.
Manna, manna everywhere—but how much will fall on the
United States? The U.S. is still the world’s preeminent financial center, but its leadership in outward and inward investment is slipping. Representing more than 12 percent of the total U.S. capital
stock, FDI is vital to the U.S. economy, helping domestic companies penetrate markets abroad and boosting American wages, tax revenues and productivity. But perception abroad of a difficult and even unwelcoming U.S. investment climate has foreign firms
thinking twice about crossing the U.S. financial
border.
Complicating matters further is the current crisis
of confidence in the markets, sprung this summer by
defaulting sub-prime mortgages. Even with U.S.
stocks reacting favorably to the Fed’s September
19th lowering of the lending rate, the first in four
years, anxiety abounds. Following the media
day-to-day can be nerve-wracking. September 12:
“Home loan demand is up as rates tumble.” One week
later: “The residential real estate downturn could
spiral into ‘the most severe since the Great
Depression.’”
Regulators, bankers and politicians are worried.
“The dollar is down, public offerings are going
abroad, and for now, there remains significant
pressure to privatize, which is altering foreign
attitude to investment and capital raising here,”
says Timothy Pfister, a corporate partner in Patton
Boggs’ New York office. The SEC is promoting reforms
designed to restore foreign confidence. But the
effort to win back hearts while fraud-proofing
America’s financial industry will not be easy. In a
time of shifting global wealth and growing liquidity
abroad, the dominance of U.S. capitalism may be
waning—and fixing the problem requires walking a
delicate line between protecting the money and
protecting the nation.
“The U.S. was the primary force for pushing policies
that set globalization in motion,” says Patton
Boggs’ Jay Gladis, also a New York corporate
partner. “Now, it must find great nimbleness and
ingenuity to stay ahead.”
THE AMERICAN ADVANTAGE?
As an investment center, the U.S. is hard to beat.
Few countries can match the sophistication, size and
liquidity of the U.S. capital markets; the
marketplace offers unparalleled depth and diversity;
the political and financial environments are
relatively stable; and the legal infrastructure is
attractively even-headed and egalitarian.
“From a risk perspective,” says Gladis, “the U.S. is
still the safest bet.” New York in particular is
especially attractive abroad “because of its
dedicated financial and legal culture,” notes
Pfister.
“Agreements struck here are the real deal—parties
can expect performance while counting on all
available legal recourse.”
Nonetheless, even as global FDI rose 34 percent from
2005 to 2006, the U.S. is losing ground. While last
year’s $177 billion inflow (out of $1.2 trillion
global FDI) was good enough to reclaim the world’s
top spot from 2005 winner the United Kingdom, the
U.S. is well off the peak of $321 billion in 2000.
What happened? Some investors may have been put off
by the U.S. government’s thwarting of Dubai Ports
World’s proposed takeover of P&O last year and China
National Offshore Oil Corporation’s run at Unocal in
2005—transactions that would have transferred
control of U.S. shipping and energy assets into
foreign hands. Most observers say, though, that the
biggest deterrent is the over-regulated,
over-litigious U.S. public market.
“Before the Internet bubble burst,” says Patton
Boggs’ Michael Smith, another New York corporate
partner, “foreign start-ups often skipped their own
exchanges and headed straight for NASDAQ. But then
came the scandal-driven re-emphasis on anti-fraud
measures, which significantly increased the cost of
raising capital in the U.S. and scared IPOs and
foreign investors abroad.”
How scared were those investors? In 2001, the U.S.
hosted 57 percent of IPOs valued over $1 billion,
compared to Europe’s 33 percent and Asia’s 10
percent. Last year, the picture flipped, as the U.S.
scraped in 16 percent versus Europe’s 63 percent and
Asia’s 22 percent.
Foreign money and hot offerings that once flowed
through U.S. public exchanges are ducking public
disclosure and scrutiny here by going abroad, or
going private. U.S. Treasury Secretary Henry
Paulson, New York City Mayor Michael Bloomberg and
New York Senator Chuck Schumer are among influential
voices concerned about the weakening competitive
positions of New York and the U.S. A McKinsey & Co.
report commissioned by Bloomberg and Schumer states
that, “The world’s corporations no longer turn
primarily to stock exchanges in the United States,
such as the NYSE or NASDAQ, to raise capital
internationally.” McKinsey warns, “Within 10 years
... we will no longer be the financial capital of
the world.” America’s open-floor, opendoor landscape
seems to be losing favor: Foreign and private
exchanges as well as dark pools, algorithmic trading
and other clandestine techniques are diverting
further liquidity away from U.S. public markets. But
weeding out what McKinsey calls the U.S. regulatory
framework’s “thicket of rules” may not be enough to
improve the investment pasture. Already losing
ground to Europe and Asia in the capital markets,
the U.S. must contend with changing foreign
investment strategies and the dramatic surge of
wealth abroad.
THE DECLINE OF OLD-FASHIONED BANKING
“The incentive to invest in America has shifted from
the public markets to the private, or alternative
asset, industry,” notes Pfister. “Runaway spending
and offshore borrowing have left the U.S. with the
world’s largest account deficit, making it the
world’s leading debtor nation. Relatively weak
against the euro, the sterling, even the Canadian
dollar, dollar-denominated assets are essentially on
sale. The
incentive for offshore players to come here is
therefore a monetary one, to take advantage of
currency conversion and to leverage their
competitive edge on valuations.” With the continuing
trend away from listing publicly in the U.S., driven
by the Sarbanes-Oxley corporate reform act of 2002
(SOX), Pfister sees the foreign modus operandi
changing.
“The total asset value in private equity is truly
astonishing,” he says, “but of course, those dollars
have to be put into play. The traditional private
equity play has been to acquire and burnish assets
before divesting them to a strategic buyer. With the
public markets drying up, though, private equity
investors are making more pure financial plays,
frequently trading assets among themselves.”
Following this trend, foreign investors coming to
the U.S. are not seeking traditional public exits,
which Pfister describes as “a startling new
development.”
Gladis sees private equity and other increasingly
arcane funding instruments pushing banks to the
sidelines and taking democracy out of the U.S.
capital markets. Echoing his concern is England’s
Chancellor of the Exchequer, Alistair Darling.
Commenting on the risk associated with today’s
“fantastic ways of making money,” Darling was quoted
as saying that “going back to old-fashioned banking
may not be a bad thing.”
The backlash against SOX is having a splintering
effect as well, spurring some domestic financial
players to create private exchanges. Dubbed “A Child
of Regulatory Decay” by financial blogger Roger
Ehrenberg, Goldman Sachs’ “GS Tradable Unregistered
Equity OTC Market” is open only to sophisticated
investors—and largely free from the regulatory
requirements of traditional share offerings. Rivals
include NASDAQ’s PORTAL system and closed exchanges
at investment banks such as Citigroup, and Lehman
Brothers.
Another seismic shift is the sheer volume of
available free capital concentrated in the booming
Asian markets and energy and natural resource
centers such as the Middle East and Russia. Pfister
sees energy in particular as the epicenter of the
global capital shift. “Energy inextricably binds us
together,” he says. “Some have it but we all need
it, and from oil and gas extraction to alternative
fuel development, global energy interdependence runs
right alongside the transactional and financial
markets. Carbon credit trading, derivatives trading,
project finance—you name it, energy-themed
transactions run the gamut. Take Canada, for
instance, sitting on enormous reserves of
hydrocarbon- yielding tar sands, which hold the
promise of huge revenue streams. But unbinding and
distributing that fuel, in turn, takes huge amounts
of energy and capital. Energy is more fundamental
than money and as complex as your imagination will
allow.”
SOVEREIGN FUNDS: CAPITAL ON THE LOOSE
Energy revenues create big profits and big capital
reserves. So does rapid economic growth, such as
China’s remarkable 11.5 percent expansion and $112
billion trade surplus this year. Deep in liquidity,
China, along with a roster of mainly Asian and
Middle Eastern countries (plus Australia, Norway and
the U.S.), is buying foreign assets through
state-backed investment pools known as sovereign
wealth funds. “China,” notes Gladis, “used to park
its surplus funds in U.S. Treasury bonds, until they
realized they were missing the boat on more
profitable ventures. Along with their sovereign fund
counterparts, they are recycling their high profit
margins into long-term, strategic investments,
including buyouts.”
The Washington Post writes that these funds
“dwarf almost anything in the private sector,” with
annual growth large enough to “buy up every one of
the $461 billion worth of bonds issued last year by
the governments of Europe and the United States—and
still have $720 billion left over.” Their strategic
moves are momentous, too—government-backed lenders
in China and Singapore contributed around $18.5
billion to help Barclays in that bid for ABN Amro.
While presently as secretive as the private equity
realm, these government funds—Norway’s is considered
the most transparent—are seen as generally
beneficial to the world’s financial markets. The
possibility exists, however, that these giant pools
of capital, with increasing influence over major
dealmaking, may choose to bypass the dollar and the
U.S.
The SEC now realizes that swift action is needed to
counter the swirl of skepticism about investing in
the U.S. “Foreign investors still have an enormous
thirst for U.S. capital,” says Smith, “and the SEC,
mindful of investors’ problems in accessing the U.S.
capital markets, has recently introduced reforms to
make their life easier.”
In 2006, Rule 144A private placements—influential in
the heightened trend of private-to-private
sales—raised $162 billion in the U.S., compared to
$154 billion raised publicly. “Rule 144A allows the
resale of restricted securities among qualified
institutional buyers, often without reconciliation
of an issuer’s financial statements to U.S. GAAP,”
says Smith. “The SEC has proposed easing the resale
restriction by shortening the statutory hold period
from one year to six months, along with other
amendments.” Other reforms ease registration
restrictions for smaller companies, expand the
definition of accredited investor, and liberalize
certain rules covering financial reporting,
accounting and delisting. “The SEC’s intent,” says
Smith, “is to send a welcome message to foreign
investors.”
PROTECTION, OR PROTECTIONISM?
As new doors open, however, homeland security issues
are threatening to close them again. For more than
three decades, the Committee on Foreign Investment
in the United States (CFIUS)—the multi-agency
federal panel responsible for evaluating potential
foreign acquisitions of U.S. assets—generally
operated under the radar, quietly reviewing deals in
the telecom, defense and other industries. Then came
the failed Dubai Ports World and CNOOC deals, which
exposed CFIUS to the harsh glare of Congressional
lawmakers irate from being excluded from the review
process.
“The storm certainly caught people off-guard,” says
Norma Krayem, a senior policy advisor in Patton
Boggs’ Washington, D.C., office, “but it was not
surprising in a time when the concept of national
security in a post 9-11 world was dramatically
changing.” After quashing the deals, the Senate
proposed a heavyweight bill tightening CFIUS review
and emphasizing the protection of “critical
infrastructure” in the U.S., including airlines,
energy and ports of entry. The business community,
fearing the bill’s deterrent effect, protested
loudly enough to persuade Congress to draft less
restrictive legislation. Among a host of provisions,
the bill requires Treasury Department approval of
CFIUS-reviewed transactions, Presidential approval
of cases deemed to concern national security and
notification of Congress of all proceedings.
Krayem sees the revised bill, signed by President
Bush this July, as a way to ensure increased
transparency. “The U.S. isn’t saying it does not
welcome foreign direct investment; rather, it is
inviting foreign firms to transact business here
according to a set of rules and understandings that
make sense in a world that has been redefined by
terrorism.” Presumably, foreign firms will view the
new bill and the SEC’s reforms in the same light,
appreciating that the U.S. is inclined not toward
protectionism but protection—of its investors,
issuers, capital and national interests. Krayem is
optimistic. “Finding the right balance will take
time,” she says, “but it is something everyone will
work hard to achieve.” CT
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HOMELAND SECURITY
NEW RULES FOR INVESTORS
The
controversies over the Dubai Ports World
and CNOOC deals showed that when it
comes to foreign investment in the
post-9/11 world, some economic sectors
are more sensitive than others. The
White House made this clear in its
National Strategy for the Physical
Protection of Critical Infrastructure
and Key Assets, which identified
“critical sectors”: Agriculture and
Food, Water, Public Health, Emergency
Services, Defense Industrial Base,
Telecommunications, Energy,
Transportation, Banking and Finance,
Chemical Industry and HazMat, Postal and
Shipping.
The Committee on Foreign Investment in
the United States, the federal panel
that evaluates potential foreign
acquisitions of U.S. assets, has until
April 2008 to define which industries
will comprise “critical infrastructure.”
Since DHS is responsible for protection
of critical infrastructure, it is safe
to rely on this list until that guidance
is issued, says Patton Boggs’ Norma
Krayem. Foreign investment in these
areas is not unwelcome, but foreign
investors will need to be aware that
they may face an additional layer of
review.
The National Strategy also
defined the concept of “homeland
security.” Unlike national
security—historically the sole
responsibility of the federal
government—homeland security is “a
shared responsibility
that cannot be accomplished by the
federal government alone.” The
Department of Homeland Security requires
the cooperation of the private sector as
well as other levels of government,
explains Krayem.
Whether owned by foreigners or domestic
investors, a company in one of these
sectors is “uniquely positioned to
provide information about the
infrastructure it owns and operates,”
the National Strategy
says. As such, it is expected to be
vigilant and proactive in making efforts
to minimize vulnerability to terrorist
attack.
The overall message is clear: Whether
it’s your homeland or not, you’ll be
expected to make homeland security a
high priority if you invest in these
sectors. —J.H.
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A MORE
FLEXIBLE SEC
Responsible for
protecting U.S. issuers, investors and
capital, the SEC is the world’s toughest
securities regulator. When protections
become deterrents, though, the
safeguards have to change. As SEC
Chairman Christopher Cox said recently,
“we have climbed down from our
regulator’s ivory tower and planted our
feet firmly on the ground.” Fraudsters
should still beware, but foreign
companies wanting to make an honest buck
in the U.S. should take note of some
recent reforms:
Accounting Rules:
The SEC is close
to eliminating the burdensome and
expensive mandate for foreign companies
to reconcile their financials with U.S.
GAAP standards. The change would allow
public companies to choose between GAAP
and International Financial Reporting
Standards (IFRS), used by over 100
countries, including the EU. The
measure, currently in the public comment
period, would apply to 2008 annual
reports.
Financial Reporting:
This May, the SEC
adopted new interpretative guidance on
internal controls. Intended to make SOX
404 compliance more cost-effective, the
new rules recognize that companies have
varying risk and fraud assessment
requirements. Managers are now permitted
to exercise “reasonable” judgment in
tailoring controls commensurate with
their company size and complexity. The
change is aligned with a more flexible
new auditing standard from the Public
Company Accounting Oversight Board.
Delisting:
The SEC is also making it easier for
foreign companies to delist from U.S.
exchanges and deregister with the SEC.
While the predecessor rule may have
scared foreign investors away, the SEC
believes that the new regulation will
serve to reinforce America’s message of
openness. To qualify, companies’ U.S.
trading must be less than 5 percent of
their worldwide volume, while meeting
other reporting and listing
requirements. —J.H.
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