Mr. Chairman, Members of the Committee, I am Allen D. Wheat, CEO and Chairman of the Executive Board of Credit Suisse First Boston. I appreciate the opportunity to offer our view of the future of the U.S. securities markets and the U.S. regulatory environment.
In summary, Credit Suisse First Boston believes that the U.S. markets are at a critical point in their evolution. Technology is driving change throughout the world's equity markets. If the U.S. is to retain its role as the preeminent world equities market, then it will need to embrace and master the new trading technology. Our competitors in other parts of the world are currently ahead of the U.S. in using technology to provide greater efficiency, liquidity and transparency to their markets. Unless the U.S. markets react to this competition, capital will inevitably flow to more efficient systems outside the U.S. Credit Suisse First Boston would urge Members of the Committee, government regulators, the SROs, the exchanges and market participants to work cooperatively to meet this challenge.
With this challenge in mind, Credit Suisse First Boston believes that U.S. policymakers should set a goal to establish a global, 24-hour, seven days a week electronic marketplace utilizing U.S. technology. Such a market should be established with an emphasis on liquidity, transparency and best execution. While hundreds of details will need to be sorted out along the path to this goal, Credit Suisse First Boston strongly believes that by establishing a fixed goal for the U.S. markets, U.S. policymakers can act as a catalyst to the process that will transform the U.S. marketplace as well as preserve its dominance in world capital markets.
Credit Suisse First Boston
Credit Suisse First Boston ("CSFB") is one of the leading global investment banking firms, providing a comprehensive range of financial advisory, capital raising, sales and trading, and other financial products for wholesale users and suppliers of capital around the world. CSFB operates in over 60 offices across more than 30 countries and six continents and employs more than 15,000 staff -- approximately 6,000 in the U. S.
CSFB is an integral part of the Credit Suisse Group, one of the ten largest financial services companies in the world. Acting through a decentralized management structure of five business units -- of which CSFB is one -- Credit Suisse Group is active on every continent and in all major financial centers. Credit Suisse Group's businesses include not only investment banking, but also international private banking, global asset management and insurance. For the year ended December 31, 1998, Credit Suisse Group had revenues of $15.2 billion, shareholders' equity of $20.4 billion and total assets of $473 billion. Its 63,000 employees serve the financial needs of almost 15 million clients worldwide. CSFB is itself one of the largest securities firms in the world in terms of financial resources. The Firm produced approximately $10 billion in revenues in 1999 and had $7.7 billion in equity and $274 billion in assets at year-end 1999.
CSFB's business model is based on a commitment to serve the needs of our clients -- governments, corporations and investors -- through a combination of global reach and local expertise. CSFB is alone among investment banks in operating from not one, but three home markets: the U.S., the United Kingdom and Switzerland. In fact, Euromoney magazine recognized our unique global structure and abilities in calling us "the world's first truly global investment bank."
CSFB brings this global expertise fully to bear in its approach to the equity markets. First, CSFB is a leader in each of its home markets: in Switzerland, CSFB has long been the dominant equity underwriting house and market-maker; in the U.K., we are among the leading managers of equity offerings and one of the top ranked equity market makers; and in the U.S., CSFB is currently enjoying great momentum, almost doubling our market share of equity and equity-linked new issues in 1999 over 1998. That momentum is also evident in Europe where we increased our equity market share by 120% in 1999, with a rise of over 150% on a global basis. Elsewhere, CSFB is the No. 1 equity underwriter in Brazil and one of the premier equity houses in the Asia/Pacific region.
Second, CSFB has specific industry and sector expertise that crosses national and regional lines. Most prominent is CSFB's global dominance in high-growth technology. In this area, CSFB was the No. 1 equity underwriter in 1999, measured by the largest number of lead managed IPOs -- most of them for internet businesses. CSFB is also the leading equity underwriter in the media/broadcasting and business services sectors and among the top three in the financial services, power and energy and consumer sectors. CSFB does not make this expertise exclusively available to its institutional clients -- through distribution alliances with others we have arranged to provide retail customers access to CSFB-underwritten IPOs and secondary equity offerings.
Third, along with CSFB's global presence, of course, also comes the responsibility to be a primary participant in the regulatory dialogue in the markets where the firm does business. CSFB is involved actively with nearly 60 major state and federal agencies, SROs, exchanges and governmental authorities throughout the world -- twenty of them in the U.S.
In short, I believe that due to CSFB's financial strength, global perspective and equity expertise, we are well positioned to comment and provide our views on the important U.S. equity market structure and regulatory issues being considered by the Committee today.
Global Capital Marketplace
The world's trading markets are being changed radically by the twin forces of technology and globalization. The trading world we see today is vastly different from the world only a few years ago and the pace of change is accelerating. Technology has allowed systems to be created at bewildering speeds. Millions of on-line accounts have changed the nature of trading in our markets. Pure electronic auction markets are no longer a myth, instead, millions of Americans make on-line bids for items through eBay every day. Globalization has caused corporations, individuals and markets to transcend national boundaries. Our customers today demand global sector trading. U.S. investors already have the ability to obtain real-time information about trading in foreign markets from multiple sources and to use automated order routing systems to execute their orders electronically. Corporate issuers today routinely look beyond the borders of the U.S. to raise capital at the lowest possible cost. U.S. issuers accounted for 22% of all international issues in 1998, with a value of $170 billion.
If there is one thought that I could leave with you today, it would be this: IT IS INEVITABLE THAT WE WILL HAVE A GLOBAL, 24-HOUR ELECTRONIC EXECUTION EQUITY MARKET. The issues we debate today will determine whether the U.S. will continue to be the preeminent market in such a world and whether the U.S. will set the standard for a global system. This global platform will operate with an open architecture, i.e., unrestricted access, to allow maximum participation from both retail and institutional investors, and with total transparency of all orders in each stock. CSFB believes such a global system will not only trade cash products such as equity securities and fixed-income bonds, but may also encompass the derivative markets including futures and options. Technology and globalization demand that this marketplace be created. It will be desirable for issuers as well as investors, and it is practical with the advent of the new technologies available today. In 1999, foreign purchases and sales of U.S. securities climbed to $15 trillion; at the same time, U.S. purchases and sales of foreign securities grew to $4.6 trillion. These global investors want to trade across markets in their daytime hours, a need that can only be served by a global platform. NASDAQ is already leading this trend and the NYSE continues to increase foreign listings. CSFB believes that as competing electronic trading systems emerge around the world, it will be the most technologically advanced platform which will draw the most liquidity, leaving others behind.
The U.S. is the center of the technological revolution that is a driving force behind many of these market changes. Therefore, the U.S. has an advantage, if we put that technology to work. The U.S. has a further advantage in that, unlike foreign currency markets which are centered in London, and the derivatives markets which have in some ways migrated overseas, the vast majority of equity market trading still takes place in the U.S. Prior to 1987, the U.S. markets accounted for over 50% of equity trading globally. In 1989, the U.S. share was only 27% of the equity value traded. However, by 1995, the U.S. share of global equity trading once again reached 50% and in 1998 stood at 57.5%. The U.S. also has the advantage that the U.S. equity markets are respected the world over. Both the NYSE and the NASDAQ are brand names that every global investor knows well. The U.S. equity markets have an international reputation that we cannot afford to lose: that of fair, safe, and efficient markets.
CSFB is confident that if all market participants approach the coming changes with an unbiased view and seek solutions that allow technology to serve the needs of all investors, the world's preeminent equity markets will remain in the U.S. Our challenge is to embrace this goal of a 24-hour global system, agree on the principles that should govern our markets, and take the necessary steps to put those principles to work. CSFB believes there is every reason to expect that if we keep firmly focused on creating the world's premier global trading platform, the U.S. can and should lead this revolution.
European Equity Markets
We in the U.S. can and should learn from our global competitors. In many ways the European markets are ahead of those in the U.S. in terms of technological innovation. Trading on major European exchanges is now done electronically within centralized limit order books and several major European exchanges have demutualized. Europe, however, has different obstacles to overcome in order to be the home to a global electronic platform. Europe's markets are fragmented along national lines with nationally based exchanges, trading, and clearing. For example, in order to trade the 50 most liquid stocks in Europe, a dealer must belong to 8 exchanges and maintain staff to deal with multiple regulatory and clearance and settlement systems. Strong local interests support this nationally based infrastructure and have repeatedly thwarted efforts to develop a pan-European exchange.
The problem presented by independent national markets in Europe creates the clear need for a pan-European electronic exchange. While the European exchanges have reduced execution costs through electronic trading and central limit order books, the process of clearance and settlement remains costly. An effort to create an Exchange Alliance seems to be disintegrating, even though a new centralized model would have significant cost advantages over the existing national systems. New focused competitors, some led by U.S. market participants, including Tradepoint and NASDAQ, are targeting this opportunity. CSFB believes, however, that, sooner or later, the pan-European exchange or trading system will become a reality. If it appears before the U.S. fractionalized system is integrated, it would potentially become the structure for a global system.
Unlike Europe, U.S. policymakers have developed a centralized clearing and settlement system. Potentially, in the near future, exchange-listed and NASDAQ stocks will trade on common platforms. Therefore, CSFB believes that the U.S. is on the threshold of change which will allow it to build a global trading platform. The markets in the U.S. have been artificially constrained and are more easily bridged by technology, provided regulatory barriers to competition are removed.
Equity Market Structure
CSFB believes that the most capital and liquidity will be attracted to markets based on fundamental fairness, integrity, and quality, provided they are also the most technologically advanced and are permitted to evolve through fair and open competition. Accordingly, we must actively foster and develop market structures that capture the savings that technology can offer, promote clarity and transparency and serve the needs of both retail and institutional investors. The trading markets in the U.S. are in a fundamental transition to a new, more efficient marketplace. This is true not only of equities but also of fixed-income products, futures, and options. Four elements are playing a key role in this transition:
Financial markets participants are investing, in one form or another, in electronic trading. Investment banks have built electronic trading systems for their customers and invested in ECNs. CSFB, for example, has been at the forefront of this development in the fixed income area since 1993, and we currently offer electronic trading products to our institutional clients for U.S. Treasury securities, commercial paper, agency discount notes, certificates of deposit and futures. Moreover, CSFB will soon be offering on-line secondary trading for corporate debt through our PrimeTrade system, which now allows trading of FX globally and direct access, where permitted, to the world's exchanges in all time zones for derivatives. These same forces have caused a sea-change in equity trading in the U.S., from dealer-centric markets to more transparent, lower cost, more efficient, electronic markets. This must be viewed by both investors and issuers as a vastly improved marketplace. [See attachment 1] This transition has been in process since the 1970's, with the rate of change currently accelerating. We have seen this transition spurred on by the forces outlined above to the point where the market is besieged by new entrants, new methodologies and new ideas. This transition at times may seem chaotic as well as uncomfortable to traditionalists. Competitors appear out of nowhere, new ways of doing business challenge the established order, and everyone is required to justify their place in a new world.
In evaluating the current market situation, CSFB believes the new electronic marketplace will most likely evolve into one of three models:
One of these models may simply be a transitional form on the way to another. The simple fact is that liquidity will seek to form a centralized pool unless blocked by artificial barriers. [see attachments 2-4]. We need to examine each of these models to determine the best means to accomplish the ultimate goal of an expanded and more efficient U.S.-based global trading platform.
Limited Participation Networks-
In this model, liquidity will aggregate only through linkage of multiple limited participation electronic trading systems. Market participants benefit from some greater transparency and a lower cost base because of the aggregation. Exchanges and ECNs will survive in altered roles. The greatest benefit is derived by the most liquid stocks. CSFB views this model as likely in the near term assuming repeal of Rule 390 and open access for ECNs to ITS and the consolidated quote system. The major drawback to this first model is that it continues the present day differential treatment of retail and institutional investors, and of investors and market intermediaries. In preserving separate liquidity pools and the roles of various market intermediaries it retains much of the inefficiency in today's markets. Therefore, it is a modest improvement over today's marketplace, but not a model likely to become the global marketplace.
Centralized Exchange-like Markets-
In this model, electronic markets become centralized execution facilities. Centralized execution facilities would be a single electronic book where dealers and investors interact electronically in a hybrid market structure serving different customer and order types (e.g., order crosses, quote driven, and continuous auction trading) with full market liquidity. Futures and option products could easily be added into the same execution facility. CSFB sees this model as one which will provide full transparency of the entire order book to all market participants on a real-time basis.
Market participants benefit from a centralized integrated liquidity pool, open connectivity to the central market allowing equal access for retail and institutional investors as well as dealers, and lower cost execution. In order to be the survivors, existing exchanges would be forced to change models and invest significantly in technology to facilitate better execution than available currently even through ECNs. This model assumes repeal of Rule 390, open access to ITS and other linkages, exchange status for ECNs and removal of other barriers. If the central market develops from exchanges, the role of ECNs changes radically; if it develops from the ECNs, the exchanges are at least partially disintermediated. Existing roles of specialists and market makers would be redefined as a greater number of market participants would be able to take on a liquidity providing function. Market practices which advantage such intermediaries would be replaced with practices favoring the investor.
Decentralized Electronic Webs-
This model assumes an open-portal internet-based network with electronic bulletin boards, allowing direct access for both investors and dealers. It would require a new web of electronic networks, common protocols, and new tools which would enable the model to work for illiquid stocks or in times of volatility. This model causes fundamental disintermediation of existing exchanges, ECNs, and broker/dealers. New models may emerge for market makers in illiquid stocks, trade advisors, and integrators of market information. However, this model requires advanced technology not yet readily available and raises regulatory issues. In CSFB's view the most critical reason this decentralized market is unlikely because it only works well for the most liquid stocks.
CSFB's view is that the most likely endgame is the second model, centralized exchange-like markets. CSFB's view is based on the lack of tolerance by the markets for fragmentation of liquidity and the need for central price discovery. CSFB believes this model also presents the best balance for the needs of all customers. When regulatory impediments such as Rule 390 and barriers to ITS access are removed, CSFB believes that the market will naturally move in this direction. Further, the centralized exchange-like market is the most optimal for both issuers and investors and for the most stocks, including illiquid ones. It is also the model best suited to deal with volatile markets by increasing the likelihood that there will continue to be liquidity in times of market stress.
CSFB believes this most likely scenario can be created by either existing exchange markets or by new entrants. The NYSE and NASDAQ have the best opportunity to accomplish this result. Their established liquidity pools and nationally and internationally established brand names give them an enormous advantage. However, they must move quickly to provide what investors want -- faster execution, lower cost and anonymity.
Both the NYSE and NASDAQ do recognize change is necessary for survival. CSFB believes demutualization may be a necessary part of this change. Trader-owned markets face the potential for conflicts between the long-run interest of the market and the short-term interests of its members. Further, demutualization can provide the capital necessary for substantial technology investments. The NYSE must continue to invest in improved electronic systems. NASDAQ is actively engaged in reinventing an existing system which is functioning with trading volumes it was not originally designed to handle.
CSFB further believes this centralized exchange-like electronic model has the best chance to be the basis of a global capital market. It would function in a similar manner to Europe's electronic central limit order books but on a much larger, more commanding scale. Further, it is a superior model for all investors, with maximum liquidity, open access, and full transparency.
Elements for Success
CSFB believes the elements for a successful equity marketplace which can meet the goal of being a global execution platform are still related to the original goals set forth in 1975 by the Congress for the National Market System: transparency, liquidity and fairness. CSFB believes the greatest amount of market share or liquidity will be captured by the facility which best serves the needs of both retail and institutional customers. These two types of customers have different, but related, needs. Retail customers want the fastest execution and the lowest execution costs. Institutional customers want low market impact costs -- i.e., minimizing the impact on market price when trading particularly large blocks of stocks -- anonymous trading, innovative trading alternatives, as well as fast execution. As a policy matter, meeting the needs of both kinds of investors in one market is desirable. The U.S. has always favored one integrated market rather than segregated institutional and retail markets -- a situation which almost always disadvantages the retail investor.
CSFB believes the future market place must incorporate the following elements to be successful:
CSFB believes that the U.S. does have the opportunity to lead the revolution in global trading, but the evolution of our own marketplace is a condition precedent to that potential. Keeping that goal firmly in mind, we must not allow such a slow evolution that our markets are leapfrogged by our competitors, including a potential pan-European exchange.
Implications for Regulation
CSFB's view of the U.S. regulatory system is based on two premises: first, the goal of creating a marketplace which sets the standard for and is the preeminent global trading market; and, second, the belief that both competition and pragmatic regulation must be balanced to achieve that goal.
We believe that competition is a necessary agent of change. A monopoly by any definition, whether natural or created by regulation, is unlikely to embrace change in the face of vested interests. If existing institutions -- exchanges, ECNs, or broker/dealers -- fail to embrace change they simply will cease to exist. CSFB thinks of this competitive spur to innovation as an integral part of the creativity and entrepreneurship that is the hallmark of the U.S. capital markets. This is one of the reasons, in our view, that the U.S. has the best chance to continue to be the center of the global capital markets.
We view regulation as a counterbalance necessary to tame the potential excesses of competitive markets. Pragmatic regulation acts much like a referee who ensures that the basic goals of transparency and fairness are met and that the investor is protected. Our regulatory system, however, reflects historical realities, many of which have already changed and must change further. CSFB believes the SEC has an important role to play in removing barriers to competition. CSFB believes regulatory change is necessary and desirable and we welcome the leadership of Chairman Levitt in this most important task. CSFB welcomes the Commission's February 23rd Release which asks for comment on some of the most important issues relating to the market structure debate.
Twenty-five years ago we could not foresee the world of today. It is the National Market system which since 1975 has brought us the successful markets in which we participate today. Nor should we believe that our vision is any clearer today than it was twenty-five years ago. We need a regulatory system which allows competitive forces to effect everyone in the marketplace so no one has a protected niche, whether exchange, ECN, or broker/dealer.
CSFB believes that we should look at regulatory issues facing us with a new focus. We suggest that the SEC and this Committee employ the following analysis:
If the answer to any of these questions is "no", the burden should be much heavier on those who would impose or retain such rules.
If you apply this analysis to reform of the ITS system and other linkages, where change can increase competition, increase transparency, and benefit investors, the need for reform should be obvious. However, the exchanges have argued that ECNs do not have the same burden of regulatory responsibilities as exchanges and therefore should not be given access to ITS. As a policy matter, CSFB does not believe that electronic trading systems require the same type of regulation as physical trading systems, and agrees with the SEC's actions, in adopting Rule ATS, in imposing a lighter form of regulation. Moreover, CSFB does not believe that the ECNs should be denied access to linkages. This creates an undue barrier to entry and it hurts competition. The burden should be quite heavy to justify further regulatory requirements as necessary and to show they will not act as barriers to entry. The time has come to open access to linkages and to begin to effect a cure for our fractionalized markets.
Using this analysis in regard to another critical issue, internalization, CSFB questions whether internalization benefits the investor. Internalization is the practice whereby a dealer does not show an order to the market at large, but fills the order internally from its own order flow. This practice has a negative effect on transparency, and does not, in our view, promote competition. Indeed, this practice may leave an investor's limit order in the public market unfilled while trades are made at the same price internally. We must structure a marketplace that promotes externalizing orders for all investors, retail and institutional. The market and all investors benefit from transparency and having the greatest number of orders in the public marketplace. Within that comprehensive order flow, we believe in price priority -- that is, the best bid or offer should move to the front of the line, and within a series of identical best bids or offers, we believe in time priority -- that is, first come, first executed.
CSFB believes a properly functioning market with open access, transparency, and liquidity would substantially reduce any need or desirability for most internalization.
CSFB does not mean to suggest that our regulatory scheme is broken. Indeed, we would argue that the ability and willingness of the Commission to be flexible and allow the regulatory scheme to change and take into account market developments is the only reason that our markets have been able to change and grow successfully.
The Future of Self-Regulation
The tradition of self-regulation paid for and conducted by market participants and overseen by an independent regulator is deeply ingrained in our system. It has served the markets well. There has always been an element of conflict of interest inherent in the concept of self-regulation. It is also true that these conflicts are exacerbated by demutualization of the exchanges. Clearly self-regulation is not a panacea, but it seems preferable to multiple regulators disconnected from the marketplace.
However, the marketplace can only afford so many regulators. If you assume that ECNs will become exchanges, the idea of two or eight additional regulators becomes the stuff of nightmares. CSFB believes the concept of a hybrid regulatory system bears serious investigation. Market surveillance and the related responsibilities of policing adherence to trading rules should be the province of the marketplace itself, whether it is physical or electronic. However, examination of market participants, sales practices and other functions should be consolidated into a single entity. Streamlined functional regulation which reduces duplication is a necessity in a new global environment.
CSFB firmly believes that in the very near future execution in the new electronic marketplace will be virtually cost free in order to be competitive. We must realign fees and revenues in a way to insure both continued competition and strong regulatory presence. CSFB understands that other fees and revenues -- from ECN fees to market data revenues -- are under review at the SEC. CSFB welcomes that review.
The critical issue from our vantagepoint at CSFB is that we approach the new trading world together with a common purpose. Market participants, regulators and the Congressional overseers working together toward the common goal that the U.S. capital markets set the standards for, and be preeminent in, the global capital market. If we keep that goal in mind, and focus on competition and the elimination of barriers to innovation; if we demand markets which have the clarity and depth fostered by transparency; if we insist on the highest standards of integrity; we will allow the participants in the U.S. capital markets to put the twin engines of competition and technology to work to create the most liquid, most valuable capital markets the world has ever known. This will insure that the U.S. is preeminent in the creation of the global, electronic capital market to come. In short Mr. Chairman, "if we build it they will come." But we must move quickly -- time is short and the competition will be fierce. But CSFB believes firmly that the U.S. capital markets are equal to the task. CSFB welcomes your leadership and that of Chairman Levitt and CSFB will be pleased to join in the effort in any way it can. Thank you for the opportunity to share the views of Credit Suisse First Boston on these issues of national and international importance and I will be pleased to answer questions or provide further information to the Committee.
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