Opinion: Stock exchange merger debate conceals weightier issues
Combining the ASX and NZSE aren't the panacea for the local market's poor performance, Arcus Investment's Simon Botherway says.
Sunday, February 4th 2001, 10:15PM
The proposed merger (read takeover) between the stock exchanges of Australia and New Zealand has prompted much debate from a broad range of interested parties including politicians, brokers, companies and individuals.
Argument both for and against the merger proposal has at times been passionate and has polarised the broking community. Individuals have even expressed simultaneous contrary opinions, for example senior company executives torn between what they consider to be the best outcome for their companies and their private views as to what they consider best for New Zealand. Some sectors of the 'No merger' camp even claim that the merger is a threat to the economic sovereignty of New Zealand.
In essence, proponents of the merger claim New Zealand companies have a higher cost of capital than their international counterparts and this negatively impacts their stock prices, impairs their capacity to raise equity capital and severely hampers their ability to carry out mergers and acquisitions.
In addition, the New Zealand market is considered to be too small and illiquid to attract international capital flows. A merger of the stock exchanges would purportedly expose New Zealand companies to the much larger pool of investable capital in Australia at a lower effective cost of capital.
Prior to taking a view either way it is appropriate to examine the factors which have contributed to the failure of the New Zealand stock market to attract a broad investor base (either domestically or internationally) or create the wealth that the US, and to a lesser extent Australian, markets have done for investors in those countries.
We believe the merger proposal is symptomatic of a number of factors (discussed below) unique to the New Zealand market which, if properly addressed, would put the stock market on the sort of footing that would result in the development of a vibrant investable market that creates value for all stakeholders. We conclude that all this could be achieved without a merger.
The major factors contributing to the relative failure of the New Zealand stock market are as follows:
1. Substantial shortcomings in the structure, regulation and surveillance of capital markets in New Zealand which have negatively impacted investor confidence;
2. Poor performance by New Zealand company management and directors;
3. Investor indifference;
4. Failure of successive Governments to establish a compulsory retirement savings regime.
1. Shortcomings in the regulatory and surveillance regime
New Zealand could be considered the "wild west" of global capital markets. Unlike Australia, the US and the UK, New Zealand currently has no takeover code to prevent discrimination against smaller investors in stock transactions involving large portions of a company's stock. For example, under the regimes of the foreign countries mentioned, Kirin's purchase of 45% of Lion Nathan would have triggered a requirement to make a pro-rata offer to all shareholders.
In the event, many shareholders were disadvantaged whereas some shareholders including directors and senior management participated fully in the offer.
International investors often avoid New Zealand due to the lack of legislation protecting minority shareholders. A takeover code will become law in New Zealand on 30 June 2001 and this will have the effect of substantially reassuring investors that they are not in the underclass in terms of corporate citizenry.
The Securities Commission is under-funded and under-resourced. Trading activity which, in many international jurisdictions, would likely be considered 'insider trading' has for many years gone unpunished in New Zealand.
The perception that directors and company managers have a substantial information advantage which affords them the luxury of regularly taking advantage of less informed investors is detrimental to the establishment of a widespread investment culture. Insider trading laws require an extensive overhaul and the Securities Commission powers of investigation should be substantially broadened.
We welcome the current legislative review of insider trading laws. Insiders' capacity to trade in a company's stock should be restricted to periods when the market is as fully informed as possible of the company's performance and insider transactions should be continuously disclosed.
In general we believe the model adopted in the US and enforced largely by the Securities and Exchange Commission (SEC) must be considered the most effective globally due to the success of the US capital markets and the high level of stock ownership by the public at large.
The following extract is from a SEC paper authored by Newkirk and Robinson of the SEC's Division of Enforcement and presented in September 1998:
More Americans are investing in the stock market than ever before and Americans now have almost twice as much money invested in the stock market as in commercial banks. We believe this reflects Americans' trust and confidence in the American stock markets and that trust stems from a belief that our government relentlessly pursues its mandate to maintain the fairness and integrity of the stock markets.
SEC chairman Levitt observed as follows:
"An essential part of our regulation of the securities market is the vigorous enforcement of our laws against insider trading, an enforcement program that "resonate[s] especially profoundly" among American investors. The enforcement program includes both civil and criminal prosecution of insider trading cases. In the fiscal year ended September 30, 1997, the Commission brought 57 insider trading cases".
An additional compelling reason for modelling the New Zealand laws and regulations on the US legislation is the growing dominance by the many and large US funds management and investment institutions of the global pool of investable capital.
The "hurdle" rates of return on investment required by these institutions vary from country to country. The higher the perceived risk, the higher the risk premium required. In order to attract foreign investment to New Zealand a regime as similar as possible to that of the US is therefore desirable.
2. Poor Performance by company management and directors
Corporate New Zealand has, in aggregate, performed dismally over the past decade. New Zealand companies have been slow to adjust to the rapidly changing business environment of the information age. There has been an almost naïve approach to investing internationally with many high profile disasters.
Staggeringly the directors and managers (both current and former) of many such companies are still lauded as icons of the business community. A fresh approach is required.
We would welcome an influx of new talent into the currently severely limited pool of professional directors in New Zealand, many of whom warm multiple board seats but perform no useful function other than to ensure the boxes are ticked and director's fees periodically hiked!
3. Investor indifference
It is often claimed that New Zealand is a land of contrast. No more vividly is this portrayed than in the attitude of New Zealanders to their sportsmen compared to the attitude towards those stewarding the companies into which they have invested their hard-earned savings. The vilification that was so liberally heaped on John Hart following the demise of the All Black campaign in the 1999 World Cup should have had perennially under performing company directors shaking in their boots at annual meeting time.
Yet how many directors have failed to be re-elected? When was the last time a board was rolled by a group of shareholders?
Individual shareholders cannot be blamed. Despite directing the odd spirited question at annual meetings, individuals by and large do not have the analytical resource or skills to address the critical issues on the basis of comprehensive company knowledge. It is the media, brokers and institutional investors who must take responsibility for this. The media appear reluctant to criticise (with a few notable exceptions), brokers in many cases are in positions of conflict and would not risk jeopardising a corporate relationship for the sake of telling it like it is and institutional shareholders have largely been sleepy and complacent.
4. Failure of successive governments to establish a compulsory retirement savings regime
Unfortunately New Zealand has, to date, failed to adequately address the issue of unfunded pension liabilities as the baby-boomers age and swell the number of retirees. Unlike Australia there is, as yet, no compulsory retirement savings regime. The effect of the Australian regime has been to swell the pool of investable capital, stimulating the creation of new companies and probably even industries. It is this source of capital that is so attractive to many New Zealand companies.
As never before the current Government has the opportunity to shape the medium-term future of the New Zealand capital markets.
The national savings pool will no doubt have an allocation to New Zealand equity investments. We believe the Government can ensure a vibrant domestic capital market by carefully choosing the index (indices) against which the performance of the selected fund managers is to be measured.
Resolution of the problematic "triangulation" of tax credits for trans-Tasman companies will also likely result in greater investor interest from Australia and may also make a New Zealand listing a more compelling proposition for Australian companies.
In any event an Australian domicile and listing has not proved to be the tonic that some companies had expected. Lion Nathan and Nufarm (formerly Fernz) are examples of companies that don't appear to have materially benefited from their relocations. Baycorp on the other hand has not relocated yet has a multitude of Australian fund managers on its register and enjoys a premium market rating comparable to Australian companies, CSL and Computershare. There simply is no substitute for a strong business franchise coupled with excellent management.
We contend that the merger debate is essentially putting the horse before the cart. Many of the problems facing New Zealand companies and the New Zealand stock exchange could be rectified by sensible regulation and the introduction of a compulsory savings regime.
Indifferent management and investor complacency are more difficult issues to address but we believe that, in time, more of a US-type active approach to companies from investors is inevitable as funds drift from underperforming fund managers to those better performing managers requiring a realistic return on investment.
Simon Botherway is head of equities at Arcus Investment Management
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