The Australian Stock Exchange (ASX) has amended its foreign-exempt rules to attract
larger offshore listings as part of a growth scenario that could threaten market liquidity in New Zealand.
Introduced by the ASX in 1989, the foreign-exempt listing category was aimed at giving Australian investors access to a wider range of global securities. Effective July 1, 2002, listing thresholds have been increased to either net-tangible assets of $1.06 billion or annual profits of at least $100.06 million for three years.
Fifteen of New Zealand's (NZ) largest companies, including NZ Telecom and packaging conglomerate Carter-Holt-Harvey (51-percent owned by the U.S.' International Paper), have recently converted their existing ASX "foreign exempt" status to fully list on both exchanges in a move that Mark Weldon, CEO at the New Zealand Stock Exchange, believes will further fragment liquidity.
NZSE is capitalized at about one-tenth the size of the ASX but, according to Weldon, the markets are similar in that liquidity is pooled in a small number of large-cap stocks. "Eighty to 90 percent of liquidity is tied up in about 2 percent to 3 percent of the stocks," he said. "In Australia, that equates to 80 percent in around 20 stocks, but in New Zealand just 15 stocks account for 90 percent of liquidity. Clearly, those stocks and investors in those stocks co-listed on the ASX would be very much advantaged by having them trade on one exchange."
Some NZ broker-dealers are not convinced of the benefits of foreign listing either. Neil Paviour-Smith, managing director of leading retail broker-dealer Forsyth-Barr, said prices fell when NZ companies listed in Australia. And despite the assertion from an ASX spokesperson that prices will recover as NZ companies relinquish their "foreign-exempt status" and provide full disclosure compliant with ASX rules, Paviour-Smith is not convinced.
"These companies are not on [Australian] investor radar screens," he said. "They are not known in Australia and do not have the research, analysis, coverage or following. It's a reality check."
Outflow of retail cross-border investment is also increasing, according to Paviour-Smith. This is significant since, unlike Australia, where about 40 percent of market capitalization comes from domestic institutions, most NZ fund managers allocate their portfolios with very high offshore weightings. "The Australian market is a growing part of the Kiwi portfolio," Paviour-Smith said.
Investors have easy access to either market through online or full-service broker-dealers. But any talk of a possible merger between the two exchanges was abandoned in 2001. According to Weldon, the critical issue of the proposed merger for the NZSE was the ongoing health of NZ's capital markets, which has a relatively low level of capitalization as a proportion of gross domestic product. "The NZ economy faces a very strong growth imperative over the next five years," he said. "The exchange has a very significant role to play in creating easy access to public capital markets at the lowest possible cost, so people can lower their cost of capital, finance their extensions and grow their businesses. It's absolutely critical that this is looked after and it's nonnegotiable."
Weldon believes that market participation by innovative, fast-growing mid-sized enterprises is the key to expansion. "I think it would be fair to say that in the way the merger was proposed, the health of the lower end of the NZ stock market was not pre-eminent in considerations," he said.
The ASX in recent years has broadened its participation in the investment value chain, extending activities beyond execution, settlement and clearing into offshore market linkages with Nasdaq and the Singapore Exchange, pursuing initiatives targeting the buy side, and acquiring technology. But according to Weldon, the factors driving business and capital markets are quite different and should be kept distinct.
For example, Weldon dismisses the possibility of a flight of capital from NZ, because he believes markets simply do not work that way. "Liquidity is a natural monopoly," he said. "You don't see many examples of Italian handbag manufacturers being successful on the Frankfurt market. There is a natural investor pool."
According to Weldon, in the case of the Daimler-Chrysler, merger analysts expected deep pools of liquidity for the merged stock in both Frankfurt and New York. "It didn't happen. All the liquidity went to Frankfurt," he said. "The deeper the pool of liquidity, the smaller the impact on price. So in terms of an investor in Australia or America, there is no benefit at all from NZ Telecom being traded in New Zealand and Australia. They would prefer to see most stocks being traded in one place, where the liquidity pool is not fragmented. There may be business reasons for some companies co-listing, but they are different from capital market issues."
Weldon also believes co-listing is an expensive source of capital, given that investors can access any market in a stock more cheaply through their broker-dealers. "If you look at the cost of capital, the basic theory of companies is that they should not do something that costs them more money to do that investors can do more cheaply," he said. "And it's a lot cheaper for an individual investor to invest in one place and just trade through a dealer, who are in every location anyway, than it is for a company to comply with the different regulatory regimes of different markets."
Unlike the ASX-which facilitates offshore trades for Australian investors on behalf of their stockbrokers, through the ASX World Link service-Weldon believes exchanges have to define their roles and delineate activities from broker-dealers and other participants. "I could set up the NZSE to buy and sell Intel, but what's the point? Broker-dealers are the ones best set up to do that," he said. "I think exchanges are over-reaching and potentially providing a disservice to investors by fragmenting liquidity."
Paviour-Smith also said mergers and/or linkages between exchanges are part of an inefficient model. "The idea that exchanges should link up and provide 24-hour, seamless trading is, in my view, something that the global institutions and investment banks already provide, with high levels of execution and research anywhere in the world, but through your local office," he said.
Weldon believes technology is also a barrier to exchange linkages. "I am more pessimistic about the value of alliances or mergers between stock exchanges," he said. "I don't believe technology is significantly in place for a low-cost way that includes clearing and settlement to get worked out in everyone's interest. It may be more important to certain aspects of the European community, but it's not the prime place of investment for any of the world's global exchanges in the next two to three years. It's an element that the media loves to talk about, but its not impacting on the daily life of investors."
Weldon said clearing and settlement is one area markets should deregulate, but like the telecommunications industry, infrastructure remains an issue. "Clearing and settlement is the ultimate commodity," he said. "Anyone who trades has to clear, but it's a commodity with high barriers to entry and that's the sign of a good market that ought to be deregulated."
Scale remains an issue for the Kiwi market, but like the ASX, the NZSE punches well above its weight. Weldon claims that over the last 10 years, the NZSE significantly outperformed Nasdaq and the Dow Jones, with dividends growing at an all-in, annualized rate of 11.2 percent. "This is the same as the top seven industrialized stock exchanges," he said. "The companies on the exchange have performed well in the short and long term and are positioned well now on a relative basis to the U.S. and northern hemisphere countries. NZ has the fifth-highest dividend rate globally. They are very strong cash flow companies."
Unlike Australia's high savings rates and levels of share ownership driven by a compulsory pension scheme-which also fuels institutional investment in equities-New Zealand has yet to introduce a compulsory savings scheme. Total funds under management in Australia is expected to peak at about $740 billion by 2010 and drive supply. But this is double jeopardy for the NZSE, as its rates of private investor participation are very low. Meanwhile, the ASX will continue to seek product to soak up what ASX Managing Director Richard Humphry calls "a wall of money" by courting large-market-cap, high-yield companies listed in NZ and other offshore markets to list on the ASX.
Topping Weldon's list of priorities for the NZSE are demutualization; a more diversified market structure, with listings by smaller, aggressive-growth firms; extending the range of instruments supported, including forwards, to facilitate robust and flexible hedging strategies; and investor education, to shift the Kiwi portfolio from its traditional appetite for property and cash, into equities.
Weldon is confident about the NZSE's role in a globalized market and contends that the exchange can attract flows from global portfolio managers. "NZ has to be intelligent about the way it participates in capital markets," he said. "The way capital markets work is fundamentally different to the way trade flows move around. NZ is low-cost, extremely efficient and is reasonably well placed to capture various parts of the value chain. We're not going to be one of the largest markets in the world, but the [demutualized exchange] that actually runs the market can grow it.
"If we do a good job," he added, "Australian investors attracted by NZ companies should invest in those companies on the NZ exchange."
