Overview
European and American equity markets present an interesting duality: while it is true that the market cap of the US equity market overcomes the European one, the former amounting to $38tn and the latter to $17tn, it is also true that the structure of the European equity market is far more complex and diverse compared to the US one. To get an idea of these differences it is appropriate to have a look at some figures that capture in a nutshell the different magnitudes, in terms of complexity, of these markets.
Before doing that, it is necessary to keep in mind that while the United States represents one single country (even if formed by different federal States), the EU is a more heterogeneous reality since it accounts for several different countries.
Coming back to the figures, the US equity market is organized into 7 exchange groups, 3 listings exchanges, 16 trading exchanges, 1 CCP and 1 CSD. For what concerns Europe (accounting also for non-EU countries) those numbers change a lot, we have 22 exchange groups, 35 listings exchanges, 41 trading exchanges, 18 CCPs and 22 CSDs.
While this difference may be justified by the fact that, as said before, Europe accounts for countries with different legislation, language and cultural matrices; it is fundamental to address this complexity with a more pragmatic approach. Empirical evidence suggests that this complexity in the European equity market structure and regulation may be a factor that contributes to the slowdown of the market itself.
Those differences are the mirror of the two areas we are focused on. In fact, in terms of regulation, Europe is more rigid in pretty much every aspect of the management of Equity markets, there are more stringent rules for companies that wish to be listed on the exchanges and, even considering the latest consolidation at the group level into bigger exchange blocks, such as Euronext, the common praxis for companies is still that of getting listed on the exchange of the country in which they operate. In other words, competition among exchange groups is too tight from the operational regime adopted in the US where, for example, Nasdaq and NYSE compete fiercely to get as many IPOs as possible.
When it comes to stock markets, empirics have shown that size does matter. In fact there is a correlation between size, depth and level of IPO activity. One reason why the number of listed companies in Eu markets has fallen by 17% is that the smaller exchanges lead to a smaller level of IPOs and less liquidity.
Bigger stock markets with a high market value generate an enormous level of IPOs activity and have significantly higher trading volumes. On the other hand, a lower level of trading volumes leads to higher market costs that are disadvantageous for the investors, thus, a consequent higher cost of capital for listed companies, which makes listing less attractive.
Which policies should be adopted in order to give a boost to the European stock Market?
Opinions strongly diverge on those matters. On one side a less rigid regulative approach would give new life to the market by pushing more companies towards the listings proceeding, and this would help many new companies to raise funds from markets instead of counting just on the banking sector. On the other hand, an exaggerated easing of the regulation may lead to greater instability with the possible downside effects of a too financialized economy.
The right solution should be a break in between, which is something that European policymakers are trying to solve, even considering the strong political divergence that exists among European countries. Despite all of Europe's efforts, to date, the attraction of the NASDAQ remains very strong, and this is due to both reputational reasons and market composition. Below we will analyze the composition of the market and the reasons that drive European companies to list outside their national and continental borders.
Why NASDAQ?
The NASDAQ is the American market for technology stocks; it is characterized by the presence of traders who are required to continuously provide a bid-ask quote for the stocks for which they are market makers.
Markets of this type are called 'quote-driven' where operations are guaranteed by the presence of market makers. This structure means that this market has a high degree of liquidity; in fact, the settlement of concluded orders occurs after about one to two days. Let us now analyze what are the reasons why European companies want to list abroad (NASDAQ):
1. Market size and depth: growing companies. especially technology companies have a very high cash consumption and a continuous need for capital to finance future projects. The perfect place to meet this need is the United States; the NASDAQ, in fact, is one of the largest sources of capital in the world with a capitalisation of around $9700 billion.
2. Confidence and type of investor: institutional investors in the US are less reluctant when it comes to investing in businesses with high growth potential and innovative designs, the US investor has an unprecedented interest in high-risk companies developing drugs and working in highly specialized biotechnology fields. In addition to supporting technological development, American investors put up higher sums of money than their European competitors. With all these risks, however, American investors can rely on the efficient functioning of the NASDAQ. Shares listed on the NASDAQ tend to be more liquid than those traded on most European markets: this allows for price corrections at any time, which in turn has a positive effect on post-IPO investor confidence, and allows anchor or initial shareholders to cash in some of their shares without causing large fluctuations in the share price
3. Reputation counts: ever since its inception in 1971, the NASDAQ has opted for a fully electronic trading platform; this sophisticated image immediately attracted the attention of the largest technology companies in silicon valley and in their wake, pharmaceutical and media companies followed. Moreover, since many of these companies pay dividends, it is no longer just a growth market. but a mature market that also shows 'growth in returns'. According to some issuers, the reputational advantage of this market is sufficient to justify a NASDAQ listing. In some cases, listing provides significant advantages such as a better credit rating and access to US commercial paper.
4. ADS: An American depositary share ADST is a share in a non-US company that is held in a US depositary bank and is available for purchase by US investors. This allows companies to opt for a dual listing, where the company's shares are listed in Europe, while the ADS are listed on NASDAQ. Foreign companies that choose to otter shares on US exchanges gain the advantage of a larger investor base, which can also reduce future capital costs. For US investors, ADS offers the opportunity to invest in foreign companies without dealing with currency conversions. It is also possible to use these tools as a means of payment in acquisitions of other companies in the US, replacing cash, and in the stock option programmes of US managers.
But what are the possible solutions that could increase the interest of investors in the EU markets? We have said that the main issue is that the EU market is much more complex and fragmented than the US market, so a first solution could be making more exchanges that are part of an Umbrella group that operates more than one stock market, this will make possible a better performance in terms of IPO activity than standard exchanges. Small exchanges that are part of a larger group generate three times the value of IPOs relative to GDP as small independent exchanges and generally, they are more liquid.
Another solution could be improving and simplifying the prospectus and listing regime, reviewing the impact of MiFID II and applying a more suitable regime for smaller markets. The obstacles not only originated from institutions but also come from national barriers that increase the difficulty for investors to access in particular exchanges, so the removal of those hidden national barriers for investors and intermediaries could improve the transactions. This fragmentation leads to the problem of discontinuity of legislation among different EU countries. So, having a unique market supervisor among the exchanges can contribute to making homogeneous and standardized operations of the agents of the markets, this can simplify the capital gain tax: withholding taxes would incentivise more long-term and more cross-border investment.
On the other hand, having fragmented and complex exchange structures was a sort of protection against other issues that are part of the US markets, like the exposition of shareholder capitalism. In fact, EU markets seem to appear more conservatively financed. In Europe, fairness and reasonableness are still guiding much of economic life: proportionality, social responsibility and sustainability, taking the interest of future generations into account.
European companies should be better positioned to take advantage of the business opportunities and it will be possible if EU policymakers remove existing obstacles to the full realization of EU potential. And continue on the road to a more balanced corporate finance landscape with adequate attention to sustainability, resilience and agility.
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