International markets for securities have grown tremendously in recent years. The world's securities markets have become increasingly automated and linked with each other. The market break last October dramatically demonstrated the degree of this linkage. Never before have events in one market so dramatically affected other world markets.
The growth of foreign markets has presented U.S. securities markets with new competitive challenges, as investors worldwide begin to enjoy an increased ability to seek the best investment opportunities. Competition for investment in equities will surely increase during the next few years, with continued growth of foreign markets, such as those in Japan and Great Britain, and with the projected arrival in 1992 of a unified capital market in the European Community.The U.S. capital markets continue to be the best in the world, but they must be evaluated in a changing environment, both in the United States and worldwide. Four developments in particular must be evaluated as they contribute to changes in our equity markets.
First, our capital markets are increasingly dominated by institutions. Today, institutions own about 45 percent of the corporations actively traded in our markets, and institutional trading accounts for more than 70 percent of the market volume. In many cases, institutional portfolios are so large that investment decisions are based upon perceived developments in the economy as a whole rather than upon decisions regarding the value of individual companies.
Second, this institutional market has facilitated growth of trading in representative market portfolios. The most active portfolio trading in the futures market is in the Standard & Poor's 500 Index; and, in the options market, it is the Standards & Poor's 100 Index.
On the New York Stock Exchange, portfolio trading is accomplished by using that exchange's automated trading system, called DOT. The development of portfolio trading has resulted in greater volatility and in greater compression of market movements. A market accustomed to relatively slow changes in total valuation, based upon trading in individual stocks, risks being shocked by sudden and volatile market movements such as occured in October 1987.
Third, our markets have witnessed, and are witnessing, an explosion in automation. At present, we have excellent automated facilities for reporting of stock price quotations and last sale transaction, for transaction execution and for clearance, settlement and payments.
These automated facilities permit excellent information transmission and fast execution capability. The ability of these systems to withstand stress was severely tested in October 1987, and substantial system improvements have been put in place since that time.
Fourth, we continue to witness dishonest activity in our markets by market professionals and others.
These developments in the U.S. markets demand constant regulatory attention. We must continue to promote fairness and honesty, to guard against unusual market developments that strain our automated systems and to better understand the effects of institutional trading and derivative instrument trading on our markets.
A related development is that our brokerage and banking communities are both becoming active participants in overseas markets, particularly in Japan and Great Britain. At the same time, the presence of foreigners, particularly the Japanese, continues to increase in our securities industry.
Of course, other markets are developing rapidly, and deserve our close attention.
This internationalization of markets presents the world's securities regulators with numerous challenges, and I believe the Securities and Exchange
Commission must play a leadership role. Foreign regulators seeking to establish viable markets should be encouraged to consider the following regulatory principles:
* Sound standards for disclosure, including mutually agreeable auditing and accounting standards.
* Promotion of market fairness, including prohibitions against insider trading, market manipulation and misrepresentations to the marketplace.
* The widespread availability of quotation and price information.
* Efficient and compatible national and international clearance systems.
* Broker-dealer registration qualifications and conduct requirements designed to promote integrity and honesty in the profession.
* Improvement of capital adequacy standards to provide greater stability and liquidity for national and international markets.
* Establishment of international surveillance and enforcement agreements.
Some commentators in the past have expressed fears that increased competition among world securities markets would result in a deregulatory race to the bottom between regulators of those markets. The theory behind this fear is that less regulation in a given country's markets will invite increased capital flows into those markets.
In contrast, I believe that investors will seek out markets that they perceive as fair and honest. Regulation must be adequate to give investors the confidence to invest in the markets involved.
Accordingly, I believe that enlightened regulation, balancing the goal of investor protection with the need to be responsive to the realities of the marketplace, is the formula for success. If we adhere to these principles and continue to urge their adoption by others, I am confident markets will fare well in the face of global competition.