Is the SEC Heading Down the Correct Path?
The U.S. has the deepest, most liquid capital markets in the world. Those markets have $45 trillion in equity and $50 trillion in the fixed income and Treasury, corporate bonds and muni markets. The question many have been asking since Gary Gensler took over as SEC Chair is what is the agency going to do not just to preserve these markets but to continue their improvement. Last week, while speaking at London City Week on June 23, 2021, Mr. Gensler outline at least part of his program (here).
Three areas are key, according to the new Chair: 1) Public company disclosure; 2) market structure; and 3) transparency. First, in the area of company disclosure, Chair Gensler cited two key issues he has directed the staff to study. One is climate change and the other people. On the former, Mr. Gensler has directed the staff to develop recommendations around “governance, strategy, and risk management related to climate risk. In addition, staff is looking into a range of specific metrics, such as greenhouse gas emission, to determine which are most relevant to investors in our markets,” he stated.
Mr. Gensler also asked the staff to assess requirements for companies that have made forward looking climate commitments or companies that have operations in other jurisdictions that have targets. These requests follow the receipt of 400 comment letters addressing these question that were received by Commissioner Allison Herren Lee.
Another area is people. Investors want to better understand this key asset of every company. Accordingly, the staff is assessing the question of disclosure around people. This might include a number of metrics such as those involving workforce turnover, training, and diversity. This type of disclosure can aid investors in putting their capital to work in areas that fit their needs and interests.
A second area of focus is market structure. Key in this area, according to Chair Gensler, is efficiency and competition. While just over half of investments go to equity markets like Nasdaq, just under 50% of investor capital goes to alternative trading markets. The significant interest in these alternative venues is not reflected in the National Best Bid and Offer quote. Accordingly, the Chair has asked the staff to consider if this model best promotes efficiency and competition.
Another question centers on payment for order flow. That practice is banned in a number of jurisdictions which include the U.K., Canada and Australia. The EU has raised concerns regarding the practice. This practice will apparently be considered in conjunction with the staff’s overall evaluation of market structure.
The Chair also asked the staff to evaluate the transparency and resiliency of the manner in which Treasury securities are purchased and sold. This evaluation will be undertaken in conjunction with Treasury, the Federal Reserve and the CFTC.
The final point focuses on transparency. Here Mr. Gensler identified four areas where the rules need to be updated. Those are: Beneficial ownership which has not been updated since 1968; security-based swaps which involves issues such as the collapse of family office Archegos Capital Management; short selling; and company buy-backs of their securities. New rule writing in each of these areas, as well as those discussed above, have the promise of significantly impacting all market participants.
Chair Gensler has outlined an impressive number of research projects that will keep the staff and agency busy for far more than the immediate future. Analyzing issues as diverse as climate change, corporate work staff composition, the efficiency of the markets, short selling, payment for order flow and company stock buy-backs is sure to strike a cord with every group of market participants as well as those on Capitol Hill.
Many of the issues identified are likely to be very controversial and even political. Environmental disclosure metrics, for example, are likely to attract the interest of a number of powerful interests ranging from environment organizations, investors who favor certain metrics and political interest who will argue that the Commission should stick to financial and corporate governance questions and not medal in these areas.
Others, such as corporate work force composition and diversity, are likely to draw interest from other diverse market participants. Many may argue that work place standards have nothing to do with the federal securities laws; others may contend that investors are very interested in the composition of the work force at a firm in which they have capital invested because this metric can make all the difference in issuer performance over time. Indeed, virtually every issue identified by Chair Gensler has this potential.
Mr. Gensler should be congratulated for taking on these difficult issues – many in his position might put on the blinders and keep to the straight and narrow of accounting standards and similar matters. At the same time, it is critical that Mr. Gensler steer the agency on the correct path, mandating disclosure and not picking winners and looser among different metrics. The new Chair has made a great start; the proof is in the long-term performance – as always.