March 1, 2016 | By Phil Levy

The Next FDI Firestorm

Traders in Chicago, Illinois. REUTERS/John Gress

In the midst of a heated presidential campaign, in which Donald Trump accuses China of “killing” America, the Chicago Stock Exchange decided the time was right to sell itself to a Chinese consortium. The reaction was predictable; dozens of congressmen have demanded an investigation into the deal on national security grounds. It leads one to wonder – what were they thinking?

Since the Chicago Stock Exchange is right down the street, I figured I’d ask.

I spoke with CEO and President John Kerin a while ago, just before he headed to Washington to defend the deal. First, a little background. There are a dozen stock exchanges in the United States, but they are not all created equal. Chicago’s market, in Kerin’s words, is a “boutique” exchange, handling less than one percent of all equity trades in the country. The exchange is privately held, with common shares in the hands of those who owned seats on the exchange and additional preferred shares with banks who invested. The firms that list on it have their primary listing elsewhere (e.g. in New York).

Kerin, who took the job in April 2014, is hoping to change that. There are at least two innovations in the works. For those who worried that speedy computer connections were dominating stock trading, a là Michael Lewis’ Flash Boys, the Chicago Stock Exchange has developed a new auction technology (SNAP) intended to emphasize the quality of a bid – best price rather than sizzling internet links. Kerin also wants to follow up on one of the promises of the 2012 JOBS Act, which aimed to provide smaller businesses with easier access to funds through public equity markets. Kerin wants small growing firms to be able to list through the Chicago Stock Exchange.

To do this, the exchange needed additional capital. It went looking for investors and connected, late last year, with the Chongqing Casin Enterprise Group (CCEG). The two sides reached a stock purchase agreement in January, under which CCEG will acquire all outstanding shares.

So what’s in it for the Chinese? Kerin identified two potential benefits: CCEG would ultimately like to allow Chinese companies to list through the Chicago Stock Exchange; and further down the road they would like to use their acquired expertise to start an exchange in Southwest China. He did not mention a third potential motivation – at a time when the Chinese economy is faltering, the US economy is growing, and the RMB may well depreciate, overseas investments have a particular appeal.

Kerin was not surprised that Chinese investment in the US financial sector would draw public suspicion. He acknowledges that the Chinese government is involved – as a minority investor in one of the minority members of the CCEG consortium. But he considers the concerns unfounded. He notes that exchanges are tightly regulated by the Securities and Exchange Commission. Even if CCEG is allowed to purchase the holding group that controls the Chicago exchange, Kerin says they would not be allowed majority control of the exchange’s board. Any push to change the management of the exchange would require SEC approval.

What of the concern that China could gain access to sensitive information? Kerin has two responses. First, there are firewalls that prevent even board members from having access to the workings of the exchange. Second, Kerin says there really isn’t that much sensitive information. In general, details about listed firms and about trades on the Chicago Stock Exchange are made public. Everyone has access to the information now.

Nonetheless, Kerin plans voluntarily to seek a national security review by CFIUS (the Committee on Foreign Investment in the United States). These reviews are classified, preventing any public accumulation of case law defining the limits on foreign purchases in the United States. This case will raise some deeper questions ­– are we suspicious of all Chinese investment? Only investments with potential government involvement?  Only investments with clearly identifiable security risks? Subsequent to the above discussion with Kerin, a separate Chinese plan to invest $3.8 billion in data storage firm Western Digital fell apart over national security questions.

Beyond these specific questions about investment policy, there is the timeless issue of reciprocity. Should the United States allow Chinese firms a level of access to the US market that China denies to US firms? This is the generic question of whether to drop a bad policy if a trade partner won’t match the move. Critics usually contend that a unilateral move gives away a valuable bargaining chip. Proponents argue that, just because another country does something stupid, it doesn’t mean we need to match them. As Joan Robinson, the eminent economist once put it, just because another country throws rocks in their harbor, it doesn’t mean we need to throw rocks in ours.

Kerin hopes the entire transaction concludes by the 3rd or 4th quarter this year. In theory, the U.S system of vetting foreign investments is supposed to be transparent, objective, and insulated against politics. An election-year Chinese purchase of the Chicago Stock Exchange should provide an interesting test.
  

About

Phil Levy is senior fellow on the global economy at The Chicago Council on Global Affairs. Previously he was associate professor of business administration at the University of Virginia’s Darden School of Business. He was formerly a resident scholar at the American Enterprise Institute and taught at Columbia University’s School of International and Public Affairs. From 2003 to 2006, he served first as senior economist for trade for President Bush’s Council of Economic Advisers and then as a member of Secretary of State Rice’s Policy Planning Staff, covering international economic matters. Before working in government, he was a faculty member of Yale University’s Department of Economics for nine years and spent one of those as academic director of Yale’s Center for the Study of Globalization.

His academic writings have appeared in such outlets as The American Economic ReviewEconomic Journal, and theJournal of International Economics. He is a regular contributor to Foreign Policy magazine’s online Shadow Government section and writes on topics including trade policy, economic relations with China, and the European economic crisis. Dr. Levy has testified before the House Committee on Foreign Affairs, the Joint Economic Committee, the House Committee on Ways and Mean, and the US-China Economic and Security Review Commission. He received his PhD in Economics from Stanford University in 1994 and his AB in Economics from the University of Michigan in Ann Arbor in 1988.

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