Brian Gaynor: An open letter to Lianne Dalziel

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Hon Lianne Dalziel,
Minister of Commerce,
Wellington.

Dear Ms Dalziel,

I am writing to you to express my dismay and disappointment over the establishment of the Capital Market Development Taskforce, particularly its composition.

The announcement of the taskforce demonstrates a disturbing lack of decisive leadership by you and your Government, particularly as the main problem affecting our capital markets has been evident for more than two decades.

This week's announcement shows once again that politicians and public servants in Wellington have little idea how capital markets work.

This means that we will have another long wait - the taskforce isn't due to report until September next year - before any meaningful policies are introduced to restore confidence in our capital markets.

Unfortunately, given the composition of the taskforce, it would not be surprising if it came up with the wrong solutions.

Successful markets depend on having a large number of sellers and buyers who have total confidence in the integrity and reliability of the process.

For example, Goodman Fielder supplies bread to Foodtown and consumers buy this bread in large quantities because they are confident the product is consistent with the images depicted on the packaging and in advertising.

Capital markets are no different. The sellers are the companies that offer shares, debentures or other fixed interest securities and the purchasers are the individuals and institutions that buy these securities.

Vibrant capital markets depend on a high level of integrity and investor confidence.

Investor confidence was extremely high in the 1980s when individuals dived into the sharemarket and bought large quantities of shares in a plethora of high-flying companies including Chase, Equiticorp, Judge Corp, Robt Jones Investments, etc.

Unfortunately, after the October 1987 crash we discovered that most of these companies had little substance. It was as if these investors had bought a loaf of bread but when they got home they discovered the loaf was hollow; there was nothing inside the crust.

Investor confidence took a dramatic drop after the 1987 crash with no new listings in 1988, a substantial fall in market trading volume and only $87 million raised through share placements and rights issues. The then Justice Minister Geoffrey Palmer recognised that the decline in investor confidence had to be arrested and established the Ministerial Committee of Inquiry into the Sharemarket in October 1988.

The committee reported back in March 1989 but none of its recommendations, or the recommendations from other reports at the time, were implemented.

The reason for this was the dominance of "Treasury dries" and the Business Roundtable. They argued that regulation, which protected investors or the buy side of the capital markets equation, created an unnecessary cost on businesses and individual investors were little more than free-loaders.

The free-loaders concept, which was consistently promoted by dries at conferences and seminars, was based on the elitist view that a small group of business people created most of the value in New Zealand, while individual investors rode on their coat-tails and did relatively little.

Accordingly there was no justification for introducing rules and regulations to protect these free- loaders, particularly as it would impose extra costs on listed companies. The dries won the argument, virtually nothing was done to protect individual investors and their confidence in capital markets has never been restored.

As a result most New Zealanders have turned their backs on New Zealand's capital markets and have overinvested in bricks and mortar.

The total value of the country's residential housing stock has surged from $81 billion to $614 billion since the end of 1986, whereas the total value of all domestic companies listed on the NZX has risen from $42 billion to just $62 billion over the same period. The NZX, our main capital market, has dropped way behind Australia both in absolute terms and relative to domestic housing (see table).

The 1990s was a depressing period for investor confidence for a number of reasons, including:

* The Takeovers Code, which was designed to protect individual investors during a bid, was rejected by the National Government following strong lobbying by two Cabinet dries, Ruth Richardson and Bill Birch.

* The NZX showed virtually no interest in restoring investor confidence while under the stewardship of chief executive Bill Foster, another dry.

* The Securities Commission, which is supposed to "strengthen investor confidence", was hopelessly underfunded.

* Most of the brokers servicing small investors were absorbed into large, overseas-owned organisations because their customer base had been eroded. The majority of these multi-national brokers are not interested in small investors.

* The funds management industry stopped in its tracks as investors abandoned financial assets in favour of residential property.

* There were a large number of disgraceful market developments including partial, overseas-sourced, bids for Brierley Investments, Carter Holt Harvey and Lion Nathan, where directors often jumped the queue while giving minority shareholders no opportunity to participate.

* A small number of people made huge profits from the privatisation of Government assets while small investors suffered large losses.

Minister, it is true that your Government introduced the Takeovers Code in 2001 but, under your watch as Minister of Commerce, we have probably seen the biggest debacle of all. That is the collapse of more than 20 finance companies and the potential loss of more than $2 billion by mainly elderly investors.

These investors have been driven into the finance company sector in an attempt to achieve higher returns because they have no confidence in the sharemarket. In addition, there are few brokers left who are interested in helping individuals with relatively small amounts of investable funds.

Ironically the finance company sector is unregulated because of the influence of the dries in the 1990s.

They fought such a successful battle, albeit disastrous for the economy, that large parts of the finance and investment sector have remained unregulated and inhabited by sharks.

Most ordinary investors in New Zealand have little confidence in our capital markets because they have been misled, pillaged and raped since the mid-1980s. They have also received almost no regulatory protection, with the Securities Commission being notably quiet during the finance company debacle.

These investors represent the buy side of capital markets and our capital markets are crippled because they have no confidence in the integrity of the market.

Minister, why did you need to set up a 14-month taskforce when it is clear that urgent initiatives are needed to restore confidence in our financial and investment sectors? Why have you stacked the taskforce with dries and representatives of the sell side of the market and appointed no genuine representative from the investor or buy side?

Why has the chairman of the Business Roundtable been appointed but not Bruce Sheppard of the Shareholders' Association?

Why is the chief executive of the broker who brought Feltex to the market been appointed when Neil Craig of ABN-Amro Craigs, who has done so much to promote New Zealand, is missing? Why haven't Simon Botherway or Lloyd Morrison been appointed to give some balance?

A National government might be expected to stack a taskforce with sell side representatives but a Labour government would normally have more sympathy for small investors and appoint a reasonable number of representatives from the buy side to a capital market taskforce.

Unfortunately, minister, that is why your timid response to the capital markets and finance company sector problems is difficult to understand from either a political or business point of view.

Yours etc,
Brian Gaynor.

Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management.

- NZ Herald

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