Visualizing History
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Governmental Regulation of Common Carriers by Railroad (1916)
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The spirit of honesty haunts a corporate boardroom.
Today we are going to discuss a topic that sends shivers down the spines of compliance offers and general counsel everywhere: government regulation. This is a particularly topical subject given all the recent headlines around the world concerning anti-trust, industry crackdowns (China), securities regulation and cryptocurrencies. To make sure we are all up to speed let’s do a quick recap of each:
China’s Business Crackdown
As the Wall Street Journal described it:
“In recent months, China has blown up what would have been the world’s largest initial public offering, launched probes into some of its biggest technology companies, and wiped out more than $1 trillion in market value while investors scramble for cover. There are many signs it isn’t over yet.
Investors, analysts and company executives believe the government is just getting started in its push to realign the relationship between private business and the state, with a goal of ensuring companies do more to serve the Communist Party’s economic, social and national-security concerns.
Since November, Chinese regulators have taken more than 50 actual or reported actions spanning antitrust, finance, data security and social equality… more than one move a week.”
The chart below demonstrates the toll that these heightened regulations have taken on China’s stock market index:
More on that later.
SEC Takes on Crypto
It seemed inevitable, but it would appear that the SEC is finally getting serious about regulating cryptocurrencies.
“The Securities and Exchange Commission will regulate cryptocurrency markets to the maximum extent possible using its existing authority, Chairman Gary Gensler said Tuesday, while also calling on Congress to grant the agency more scope and resources to oversee the sector. Calling the asset class rife with ‘fraud, scams and abuse,’ Mr. Gensler signaled the SEC is likely to become more active in policing crypto trading and lending platforms, as well as so-called stablecoins.
‘We just don’t have enough investor protection in crypto. Frankly, at this time, it’s more like the Wild West,’ Mr. Gensler said in prepared remarks to the Aspen Security Forum. ‘We have taken and will continue to take our authorities as far as they go’…
‘If this innovation has any chance of surviving into the, you know, late 2020s and 2030s, it can’t stay astride of the public policy,’ said Mr. Gensler.”
Emphasizing Anti-Trust
While there have been less specific actions on this front in the United States, last month President Biden announced an executive order “to promote the interests of American workers, businesses, and consumers.” CNBC reported:
“Through its tech-related actions, Biden’s order aims to make the case that the biggest companies in the sector are wielding their power to box out smaller competitors and exploit consumers’ personal information.
The order calls for regulators to enact a slew of reforms, including increasing their scrutiny of tech mergers and putting more focus on maneuvers such as “killer acquisitions,” in which firms acquire smaller brands to take them out of the market.”
Time will tell what this prioritization of anti-trust policy at home will mean for markets and competition, but it cannot be questioned that the current administration is electing for a more “hands on” approach to anti-trust / regulation. Some of the links in today’s post will look at a previous period in American history where the government transitioned from a similarly hands off administration to one that was fiercely anti-trust.
Now, let’s dive in!
China and the World Financial Markets 1870-1930: Modern Lessons From Historical Globalization
Why This is Relevant:
The onslaught of regulatory actions in China has served investors with a stark reminder of just how brutal regulatory risk can be for one’s portfolio. What is particularly interesting, however, is how similar this all is to events in Chinese markets a century ago. In one of Bloomberg’s recent articles on China’s crackdown, they wrote:
“While Xi’s comments went largely unnoticed by global investors at the time, the crackdown on tutoring companies that followed has become the starkest illustration yet of the Chinese president’s commitment to a sweeping new vision for the world’s second-largest economy — one where the interests of investors take a distant third place to ensuring social stability and national security.“
It is the last line that is so important: “the interests of investors take a distant third place to ensuring social stability and national security.” This sentiment will sound familiar to those that know about China’s pushback on foreign investment and outside capital in the early 20th century. Essentially, in the late 19th century / early 20th century foreign investors were pouring huge sums of capital into China as the country was one of the hottest emerging markets in that era. For decades, China welcomed this investment and used the capital to finance its military, fund infrastructure projects and more. Since foreign investors were placing their capital in an emerging market that was inherently riskier than other countries, they put certain “investor protections” in place to safeguard their capital to the extent that it was possible. Eventually, these investor protections proved to be the controversy that sparked a backlash against foreign capital and outside influence in China.
“What makes the external financing of China particularly interesting in this era is the role it played in colonial designs on Chinese sovereignty and the dangers of disequilibrium in the development of financial markets. Foreign investment over roughly eight decades financed remarkable growth in the Chinese economy, however the very protections that induced investors to commit capital to a risky, emerging market also nearly tore the nation apart.
From the foreign perspective, investor protections seemed reasonable – the Chinese government bonds floated by leading investment banks in Europe were backed by revenues collected and overseen by European nationals. Likewise, Chinese railroad bonds were secured with mortgages on the property and revenues of the railway lines, and, while nominally owned by China, they were operated by foreign representatives of the firms that built them. From the Chinese perspective, however, these terms were viewed as an affront to Chinese sovereignty and an impediment to a domestic corporate sector. As a consequence, the terms of Chinese external loans led directly to a backlash against foreign ownership of Chinese capital and foreign encroachment on Chinese sovereignty.”
While the specifics are different, the underlying theme of Chinese leaders taking actions that relegate investors’ interests below those of the state and nation is very similar.
Summary:
“China began to borrow in the world capital markets in the late 19th century, issuing bonds to pay for defense as well as for large-scale economic development. Particularly interesting is the role that the clash between domestic and international investors played in China’s 1911 revolution. The protection of external investor rights was perceived at the time as an infringement on Chinese sovereignty.
In this paper we interpret the conflict over foreign investor rights in terms of a disequilibrium in the development of financial markets. Europe’s high level of investor diversification put her investors at a relative advantage in bidding for development projects in China, while European investor expectations about protection from expropriation and default, lowered Chinese cost of capital, but also led to erosion of national sovereignty and a dramatic, grassroots political backlash. Despite fundamental differences between China today and China 100 years ago it is still important to consider the dangers of an imbalance between domestic and international investor markets, and the mismatch between domestic and foreign expectations about investor protection.
The lessons of the last century suggest that China today should consider opening Chinese investor access to foreign capital markets in order to equilibrate the level of diversification between foreign and domestic investors. In addition, protection of domestic corporate investor rights is at least as important as protecting foreign investor rights.
Visualizing History:
Notable Quote:
In light of the SEC Chairman’s comments on increasing regulatory scrutiny on the crypto space in order to protect investors, it is worth revisiting what markets were like before the Securities Act. In particular, what did things we take for granted today such as prospectuses look like pre-securities act? If you’ve ever wondered about this, I have the article for you. It truly was a different world. Of the more than two dozen prospectuses of major companies that this author surveyed, only one contained any language pertaining to “risk factors”. The largely unregulated environment that this author describes is very reminiscent of the one that exists today within crypto markets.
Notable Quote:
“absent from most pre-Act prospectuses were risk factors. Of the twenty-five prospectuses that I reviewed, there was a discussion of risk in only one. That one exception was Coca-Cola, which candidly revealed that there were questions about its ability to enforce its trademark (see below).”
Coca Cola’s Risk Factor Disclosure in 1919 Prospectus
We are in the midst of a transition between two Presidential administrations holding very opposing views on anti-trust and regulatory action. How have markets reacted to such stark contrasts on anti-trust policy before? This paper analyzes the market reaction to President McKinley’s assassination and the prospect of a Teddy Roosevelt administration through the lens of anti-trust policies. While McKinley had been extremely laissez faire in regards to anti-trust actions, Teddy Roosevelt was a notorious trust buster that took the opposite approach.
This table shows the market’s reaction to anti-trust related events in this era:
Visualizing History:
Startups being launched in 1720 in the wake of South Sea Company bubble:
Source: Dr. Andrew Odlyzko, An Undertaking of Great Advantage, But Nobody to Know What It Is
Notable Quote:
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