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Deep dish

23 February 2016 By Rob Cox

The Chicago Stock Exchange is so obscure that Google doesn’t even know who’s behind it. Plug the question into the search engine, and up pops the logo of National Hockey League champions the Chicago Blackhawks. For the avoidance of doubt, the Stanley Cup winners do not own the city’s stock market.

A group of Chinese investors would like to, however, and a gaggle of Republican congressmen are up in arms about the prospect. They are badly missing the point. An acquisition of the minuscule Midwestern bourse would give its new Chinese owners an important lesson on the importance of robust disclosure, smart regulation and the merits of free capital markets. That’s a good thing.

In the first instance, it’s easy to forget that Chicago even had a stock exchange to call its own. While the city is a global leader in the options, futures and commodities trading businesses, the Chicago Stock Exchange, or CHX, is a minnow, accounting on most days for less than 1 percent of all equity trading volumes in the United States.

In fact, the exchange founded in 1882 is probably better known as an artifact. Its original trading floor and entrance are literally preserved in the Art Institute of Chicago as a museum piece.

That isn’t stopping 46 congressmen, all but one of them Republicans, from getting exercised about its loss of independence to similarly obscure Chinese entities. Last week they sent a letter to the Committee on Foreign Investment in the United States, itself a murky arm of the Treasury Department, urging it to consider blocking the deal over national security implications.

The letter argues that Chongqing Casin Enterprise Group, which is leading the consortium buying the bourse’s parent, CHX Holdings, “shares many of the traditional opaque qualities of a Chinese company.” Moreover, the elected U.S. representatives asserted, some of Chongqing Casin’s financial assets were originally owned by the Chinese government, suggesting some measure of ongoing state involvement or even control.

“The fact is that having a foothold in the market itself provides some measure of leverage and an ability to manipulate,” Robert Pittenger, the North Carolina congressman who is leading the charge for a CFIUS probe into the deal, put it more bluntly in an interview. “We have seen historically (China’s) role in manipulating currencies and markets, so this demonstrates a valid concern.”

It’s certainly worrying to John Kerin, a 27-year veteran of the exchange who is now its chief executive and the architect of the deal. As he explains it, CHX – which over the years merged with exchanges in St. Louis, Cleveland, Minneapolis and New Orleans and demutualized to seat-holders in 2005 – needs financial support to establish a listings business. That will create more jobs in Chicago and foster greater capital formation for U.S. companies.

“We need additional capital to support staff and a buildout to create a third-tier JOBS Act listings program,” Kerin said during a Tuesday phone call. The investors “like our plan and it is consistent with their strategy, and they are willing not just to acquire the exchange but inject the capital to grow.”

As for control, Kerin says one of the investors in the Chinese group does count a state entity as a shareholder, which may result in a 3 percent indirect interest in the Chicago exchange’s parent. As he points out, however, under Securities and Exchange Commission rules, no single investor can own more than 40 percent of the exchange’s holding company.

Not only that, the SEC requires the exchange itself to have its own board of directors, half of them comprised of independent directors who are neither affiliated with the owners nor actively working in the industry. Their role is to protect the interests of the public, says Kerin.

And there is more protection than that. “The SEC mandates that all sorts of information be made available all the way up to the beneficial owner,” Kerin said. “They can’t hide behind corporations, and if they do not cooperate then trustees take over the company. That gives them an incentive to be more transparent.”

The ultimate goal for the new Chinese owners is to bring the Chicago exchange’s know-how and technology to Chongqing to create a stock market for companies and investors in southwestern China. Spending a few years owning an insignificant one in the United States and subjecting themselves to the regulatory rigors of the SEC and other watchdogs will teach them a few things.

They will probably learn that transparency can lead to more efficient price discovery and higher valuations for assets, and that trying to manage the market, as Chinese authorities failed to do over the past year, doesn’t work. They also may come to understand that burning investors with dodgy companies and poor disclosure is a bad idea. All in all, it feels like a pretty good way to export free-market capitalism.


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