Strong medicine to fix capital markets

Photo / Kenny Rodger

Next week, the Capital Market Development Taskforce's report will be released, recommending a course of steroids to turn our 98 pound weakling of a sharemarket and its weedy siblings into far more muscular entities.

While markets including the NZSX have strongly bounced back from the global financial crisis, that shouldn't disguise the fact that chairman Rob Cameron and his team's mission is an urgent one.

The crisis saw the proportion of the wider economy that intersects with the NZSX main market fall to what must be its lowest level in several decades.

The crisis also tipped the finance company sector into a worse mess than it had arguably brought on itself and, as previous bouts of economic mayhem have done, threw regulatory shortcomings into sharp relief.

But in enabling our leading companies to raise cash directly from investors when our foreign-owned banks decide to limit their exposure to this country, the crisis may also have demonstrated how important it is that we preserve and nurture local capital markets to ensure we retain a modicum of economic self-determinism.

Standing back for a moment, it's hard to say how far the difficulties facing our capital markets are preventing them from performing their role in supporting economic growth and health, or how far they are simply symptomatic of wider economic issues.

Shamubeel Eaqub, chief economist at the New Zealand Institute for Economic Research, points out the issues being dealt with by the taskforce and a number of other working groups, including that dealing with tax, "are all very inter-linked and very similar".

"New Zealand suffers from too little capital relative to our population and our labour market and we seem to work very hard but not get very rich. Part of the issue is that the cost of credit and cost of capital is pretty high. That stems from one: our incomes are pretty low, and two: we don't have a deep capital market that assesses risk appropriately."

It's at this point Eaqub makes the inevitable comparison with Australia, whose capital markets are burgeoning and may eventually overwhelm our own completely, a prospect the taskforce must surely be mindful of. He believes the taskforce must recommend we attempt to emulate our big brother in at least one aspect.

"The introduction of Australia's compulsory superannuation scheme, while it hasn't done a huge amount to change national savings behaviour, has made a huge impact on the capital market, on the depth of their financial market and the quality and breadth of industries there.

"Generally speaking businesses in Australia are able to access capital for a range of purposes, from angel investing right through to just a standard bond issue. All of these things are relatively easy because the pool of funds is quite large."

While compulsory superannuation may not be a silver bullet in terms of treating what ails our capital markets, it is widely seen in some circles as a crucial step.

"All roads lead to Rome," says Selwyn Pellett, who heads the Productivity Council which has been lobbying for major changes to a number of economic settings including tax and monetary policy.

"The only thing that's going to fix the capital markets is compulsory superannuation. Every issue that's thrown up is almost instantly solved by compulsory super.

"That applies in the general economy but particularly applies to our ability to fund our own growth and build deep and meaningful capital markets."

Among the wider benefits, not least of all the alleviation of looming superannuation related fiscal stress, Eaqub also points out Australians' financial literacy has improved dramatically in recent years, something few would deny is badly needed in this country.

"As people have seen their superannuation savings grow they have become more financially literate and they have started to invest their own money as well."

Boosting financial literacy would likely go a long way towards increasing public confidence in the capital markets, which was a particular focus of the taskforce's interim report this year.

In a piece published in the Business Herald some weeks ago, Cameron said the taskforce "aims to make it easier and safer for people to invest knowledgeably in our capital markets and to broaden the choices available to them, so they can enrich themselves and their families".

On that basis, it seems likely that regulatory issues will figure prominently in its final report.

Pellett would like to see a nuanced approach to capital market regulation with a more rigorous approach for "serious" investment and less for smaller amounts.

"For example I'd love to see a situation where, with almost zero regulation, investors could put a maximum of $1000 into a start-up company and it's 'buyer beware'.

"Then you could get capital flowing at that worst stage, the seed start-up type area, whereas at the other end where people are investing $300,000 you need tons of regulation."

But apart from regulatory reforms and compulsory super, the other frequently occurring item on the wish list for recommendations from the taskforce is something that could deliver a relatively quick hit but is fraught with political and, some would argue, considerable economic risk - privatisation.

Frank Aldridge, of retail broking and investment banking firm Craig and Co, says his firm wants to see recommendations around raising the profile of equity markets "and more particularly how to foster and encourage the investment by private individuals".

"In our view that starts with getting larger companies listed on the NZX and that comes down to the Government ownership debate.

"I think we should stop being quite so sensitive on that and look at pragmatic ways to encourage some of those large SOEs to be listed in some shape or form even if it is only smaller amounts and encourage public ownership. That could extend into co-ops as well."

Given Cameron's previous work on SOE privatisations and his comments even since the taskforce was established, recommendations that big government-owned businesses be at least partially privatised and floated appear to be inevitable.

It is, as the present Government which has ruled out asset sales in its first term is obviously well aware, a divisive issue and potentially very costly from a political point of view.

On that topic, Council of Trade Unions policy director and economist Bill Rosenberg holds what he acknowledges are probably very unfashionable views in the business community.

He fears that should SOEs be listed, "they will go the way of all those other large and very attractive firms, they would become overseas owned and very possibly withdrawn from the sharemarket".

Rosenberg believes SOEs have "non-commercial objectives that are very important to retain".

"Even partial listing forces a focus on profit that may be OK for a private firm, but for an enterprise that's there for public reasons it's not the best single objective."

It's safe to assume Rosenberg's views are anathema to the Business Roundtable's Roger Kerr. But then again Kerr is sceptical that the taskforce will recommend medicine sufficiently strong enough for his liking.

Instead he points to the Don Brash-led 2025 Taskforce's report.

"All the things there they were talking about, like getting the government spending share of the economy down, getting stronger regulatory disciplines, getting central and local government to exit from businessses and so forth, I think those are the big picture kind of issues. In the process you would get much more scope for getting a less distorting tax structure, lower personal and income tax rate and those things would give a bigger boost to the capital market than what we're into with Rob Cameron's report."

Rosenberg and the CTU are, like Kerr, concerned about distortions arising from the present tax structure.

"We'd certainly welcome encouragement of investment in productive areas rather than property and I think that's one of the areas they're looking at in terms of taxation or deductions that would do that."

Meanwhile, Rosenburg says the CTU would like to see focus on encouraging investment of more KiwSaver and NZ Superannuation funds locally.

He would also like to see moves towards bonds issued to domestic investors to raise funds for infrastructure projects and the like.

Rosenberg also sees a greater role for government investment and support for firms in the initial stages of growth that have international potential either through exports or through competition with imports.