There is clearly a need to differentiate between stock exchanges that are geared to domestic company listings and those that focus on what is often described as a “technical listing” exchange.
By technical listing, we mean listings on exchanges in international financial centers that are primarily set up for the purpose of regulatory requirements or tax efficiency in order to gain third-party scrutiny for the distribution of certain more complex products, legitimately plan for tax efficiency and ultimately provide offshore domiciled securities a stronger route to market.
The traditional purpose of a stock exchange is to raise capital for the domestic business sector, however there exists a number of stock exchanges that are primarily used to provide a listing facility suited to rather complex professional products such as hedge funds and debt securities. As financial products become more sophisticated, regulated and under scrutiny by more authorities, there may be less of a role for these smaller exchanges since:
- There is no real liquidity for funds on offshore exchanges,
- The cost of regulatory burden onshore is ever increasing, and
- Fund managers may take a view that even a marginal cost levied on the fund adds no value.
While small exchanges must provide legitimate control and oversight, they are susceptible to criticism when something goes wrong. The recent case in the Channel Islands (the Arch Cru investment funds case) illustrates this point.
The CF Arch Cru Investment and Diversified funds were two U.K. open-ended investment companies authorized and regulated by the FSA. These funds invested in a series of Guernsey-domiciled investments listed on the Channel Islands Stock Exchange (CISX), and were run by an investment manager, Arch Financial Products LLP. They were sold to retail investors as low risk when they should have been marketed as high risk.
With this particular case, CISX admitted that they were “seriously at fault” in relation to these events. At the time, CISX had to suspend future listings and subsequently settled with the regulator. CISX was wound up in December 2012 and replaced by the Channel Islands Securities Exchange (CISE). The case raised many questions from investors and large competent authorities regarding the listing process and adequacy of supervision.
The result was some loss of confidence from investors in smaller offshore exchange models. The question is how can offshore exchange models overcome international challenge and will they survive?
New European Union regulations are causing a shift in the funds industry. A primary driver for fund promoters who are considering re-domiciling funds is investor preference for regulated onshore jurisdictions, the desire for tax certainty and the need to ensure that funds are structured and located such that they can maximize the opportunities to attract new investors.
Call for greater transparency
Since the financial crisis, investors and regulators are demanding more transparency from smaller exchanges. Legislation such as AIFMD, FATCA and Dodd-Frank have all changed the regulatory landscape for offshore exchanges.
This pressure has led to offshore centers implementing measures to improve transparency and the exchange of information so that they can be favorably compared to onshore centers.
Offshore exchanges in jurisdictions such as Guernsey (with its new exchange) and the Cayman Islands have accepted that they need to be part of a transparent worldwide financial system.
Recently the Barbados Stock Exchange signed the FATCA agreement with the United States to join the likes of CISE, who signed the FATCA agreement in 2013. We have also seen the Cayman Islands Stock Exchange (CSX) sign a FATCA-style tax information exchange agreement with the U.K.
By ensuring that there is greater transparency within these exchanges, it also provides the investors and regulators greater confidence in their suitability. For example, the HMRC has a list of stock exchanges that it considers ‘recognized stock exchanges,’ providing legal tax structures.
This list includes, amongst others, the CSX and CISE. Likewise, the Bermuda Stock Exchange (BSX) was granted Designated Exchange status by the Department of Finance in Ottawa under the Income Tax Act, thus providing certain tax benefits to Bermudan subsidiaries of Canadian corporations.
The EU Statutory Audit Directive also affects exchanges in that exchanges may be forced to make clear whether its listings should be considered to be public interest entities and thus fall within the scope of an auditor oversight authority.
Joint ventures and consolidation
Recently there have been a number of joint ventures between more established onshore exchanges and smaller offshore exchanges. An example of an exchange consolidating its services has been the CSX. CSX migrated its electronic securities trading to Deutsche Boerse’s Xetra trading system. CSX are not alone in doing this and other offshore stock exchanges, such as the Malta Stock Exchange (MSE), are also using the Xetra trading system.
Collaboration like this gives these exchanges access to a high-performance trading infrastructure which facilitates the highest possible market transparency. Moreover, they will also benefit from all future improvements to the system and associated services.
Gibraltar is in the process of opening its first stock exchange, which will be known as the GSX. The GSX will list collective investment schemes known as open-ended funds, after receiving approval from its financial regulator. The full opening, when open-ended funds will be able to list on the exchange, will take place in the first quarter of 2015.
The exchange will give funds greater exposure to investors in the European Union, while the listing process will require the funds to become more transparent, benefitting investors wishing to take advantage of Gibraltar’s strengths.
It will be interesting to observe the present and future role of smaller exchanges such as the GSX in the global market and, in particular, the evolution of technical listings particularly in Europe. Time will tell but the road to profitability for small exchanges is long and the route to entry is full of international regulatory scrutiny and associated cost.
While it is not perceived to be an offshore exchange but in fact a well established, smaller onshore exchange, the Irish Stock Exchange (ISE) has recently launched a web-based information repository for listed funds called the ISE Fund Hub. This new portal displays information such as fund net asset values, key fund documents and an individual profile area for each manager as well as extensive performance based analytics.
The ISE Fund Hub is clearly a favorable initiative that should please both the investor community and the regulators as access to information on funds increases transparency, much like that required for traditionally listed companies. In a world where we are seeing greater demand for accessibility to information, this initiative is extremely positive for the ISE and its users.
The innovative approach by the ISE cements a view that there is a role for exchanges that list and oversee more complex products. In a world of increased scrutiny by third parties, an argument for the survival and indeed positive future of the smaller exchanges is precisely that.
Directors and investors alike must welcome well-run offshore listing authorities and their continuing obligations as it gives another layer of regulation and oversight to structures that may be incorporated in less regulated jurisdictions. Onshore politicians should also welcome this.
The question remains as to why these structures do not list on the larger exchanges. It is cheaper and also very quick to list offshore as these exchanges do not have the layers of regulation imposed upon them that the larger onshore exchanges and listing authorities have to battle with. This, as always, comes at a price, in terms of the reputational risk.
That said, well-run and well-governed offshore exchanges will likely survive this tsunami of global scrutiny and regulation and find their foothold in the market. They just need to be open minded to connections, innovation and even more global regulatory scrutiny.