: Breaking Down the Barriers Separating Supply and Demand by James L. Cochrane; James E. Shapiro; Jean E. Tobin　NYSE Working Paper #95-04　　 Abstract 　The internationalization of U.S. capital markets has accelerateddramatically during this decade, and there is no reason to xpect thisprocess to stop anytime soon. Two powerful forces drive this trend. 　First, in nearly every country in the world, equity is replacingalternative ways of raising capital. This shift to equity financing isgenerating fundamental and only partially understood dramatic shifts inboth the worlds capital markets and phenomena beyond them, including howand for whom companies are run. Traditionally, firms have raised capitalthrough debt, through bank financing, from governments, from retainedearnings or by selling equity to investors. Roberta S. Karmel, Living WithU.S. Regulations: Complying with the Rules and Avoiding Litigation, FordhamInternational Law Journal, Volume 17, 1994, pp. S154-S155. 　One pair of facts illustrates the worldwide surge in the use of equity: Thetotal capitalization of the worlds publicly traded equity was $10 trillionat year-end 1990; today, its about $18 trillion. 　Economic and political forces pushing the privatization of state-ownedfirms have been an important factor underpinning the equity boom. From 1991to 1994, about $200 billion worth of state-owned assets were sold to theprivate sector. According to London-based Privatisation International,another $65 billion will be sold by the worlds governments in the nextone-and-a-half years. As long as equity markets remain buoyant, this seemsa reasonable, perhaps conservative forecast. 　The second force behind the internationalization trend is a massive shiftin the holdings of U.S. investors into foreign equity. Of the total worldcapitalization of $18 trillion, U.S. investors hold around $7 trillion.Within the next few years, they are expected to double the foreigncomponent of their equity portfolios from 5 to around 10. While this maynot sound dramatic, a shift of five percentage points in an aggregate $7trillion portfolio translates into $350 billion moving into foreign equitymarkets. 　Overall percentages mask even more aggressive diversification among U.S.institutional investors. Many U.S. institutional investors have set targetsof 20-25 　for the foreign portion of their equity portfolios; a number ofthe more aggressive or sophisticated institutions have already achievedthese levels. Major corporate pension funds, on average, have alreadyinvested around 12 percent of their equity portfolios in foreignstocks.Profile Survey, The Committee on Investment of Employee Benefit Assets, Washington, D.C., 1994. 　Public sector pension funds, too, are removing many of the restrictionsthat have to date limited their participation in this trend. Risks and highcosts still limit the fulfillment of these mandates, but there is littledoubt where major U.S. institutions are headed. 　The U.S. securities markets stand to benefit enormously from these twotrends. U.S. intermediaries act as the primary conduit between the growingU.S. investor demand for foreign equity and the growing supply of equityissued worldwide. U.S. investors already hold the largest single nationalportfolio of foreign stocks. Perhaps even more important, from the point ofview of U.S. market participants, the evolution of the worlds securitiesmarkets appears to be taking a distinctly American path -- towards greatertransparency, increasing reliance on equity financing mechanisms and,concomitantly, changing relationships between shareholders and management.See, for example, Reto Francioni, The German Equities M arket, in Robert A.Schwartz, ed.: Global Equity Markets: Technological, Competitive, andRegulatory Challenges. Burr Ridge, Ill.: Irwin, 1995. 　U.S. capital markets have a unique opportunity as a result of thesedevelopments. For example, the NYSE has begun to accelerate itstransformation into a truly global exchange. It currently trades 252non-U.S. companies from 40 different countries. But these companiesrepresent only a small portion of the 2,300 overseas companies that meetthe Exchanges quantitative requirements for listing. If the NYSE were tosuccessfully attract just the largest third of the qualified internationalcompanies, the current NYSE market capitalization of around $5.6 trillionwould double. 　Unfortunately, the NYSE and U.S. public equity markets in general arehampered in their attempts to develop as global markets because of the U.S.regulatory requirement that non-U.S. companies reconcile their home countryfinancial accounting documents to U.S. Generally Accepted AccountingPrinciples (GAAP). Many companies, even those which are household nameswith a global shareowner base, are reluctant to do so. As a result, foreignissuers and U.S. investors are usually forced to find each other overseas,or in less regulated, non-public markets in the United States. This harmsU.S. investors in two ways. It drives them into markets with less investorprotection. And it raises costs for those choosing to investinternationally. 　Current regulatory policy is unnecessarily driving business overseas at acritical time when the worlds major financial capitals are all striving toestablish -- or maintain -- themselves as international financial centers.Now is the time for U.S. policymakers to act. Five years from now -- in anenvironment of lower telecommunications costs and higher levels ofinternational activity -- actions taken to maintain the pre-eminence ofU.S. capital markets will be much less effective. By then, the costadvantages that U.S. markets now enjoy will be substantially smaller. MostU.S. institutions will have learned to trade abroad more easily, and willhave established custodial and brokerage relationships abroad. 　The ability of the United States to drive financial activity offshore withregulations is substantial, as experience with the U.S. interestequalization tax, enacted in 1964, has shown. By imposing that tax, U.S.policy created the overseas Eurodollar markets. Even after the policychanged, the business remained overseas. This risk to drive financialactivity offshore is true today more than ever.